Is Per­fid­i­ous Al­bion un­der­min­ing ‘Shang­hai Agree­ment’?

Financial Mirror (Cyprus) - - FRONT PAGE - By Louis Gave

Back in the early 1980s, for­eign ex­change volatil­ity wreaked havoc on business spend­ing plans and coun­tries’ abil­ity to re­pay for­eign cur­rency debt. To rem­edy this sit­u­a­tion, the world’s key fi­nan­cial pol­i­cy­mak­ers got to­gether, first at the Plaza Ho­tel, New York in late 1985 and then in early 1987, in Paris to agree on a plan for co­or­di­nat­ing mone­tary poli­cies; the idea was to re­duce cur­rency volatil­ity and so limit the scope for fi­nan­cial shocks. Un­sur­pris­ingly, global in­vestors loved the idea that they would no longer get sucker-punched by large cur­rency swings and as a re­sult all risk as­sets ripped higher.

Gold and sil­ver min­ers were es­pe­cially big win­ners as sil­ver prices more than dou­bled be­tween the sum­mers of 1986 and 1987. Deep cycli­cals ral­lied hard, as did emerg­ing mar­kets (Hong Kong eq­ui­ties more than dou­bled in the pe­riod, while Tai­wan (where 10% of adults were day-trad­ing) started to re­de­fine what a fi­nan­cial bub­ble looked like. These go-go years came to an abrupt halt af­ter a rise in bond yields through the sum­mer of 1987. In re­sponse, the Bun­des­bank (which back then was a gen­uine in­fla­tion hawk) pan­icked and in Oc­to­ber 1987 raised short rates. US Trea­sury Sec­re­tary James Baker re­sponded an­grily: “We will not sit back in this coun­try and watch sur­plus coun­tries jack up their in­ter­est rates and squeeze growth world­wide on the ex­pec­ta­tion that the United States some­how will fol­low by rais­ing its in­ter­est rates”. Hence, it was clear to all con­cerned that the Lou­vre Ac­cord was dead and buried. The next day, the Dow Jones In­dus­tri­als opened down -27%.

So, why re-hash an­cient his­tory? Be­cause care­ful read­ers will have no­ticed that in re­cent months I have es­poused the idea that, af­ter a big rise in for­eign ex­change un­cer­tainty— linked to fears of fur­ther yen, euro or ren­minbi de­val­u­a­tion— the big fi­nan­cial pow­ers acted to calm mar­kets fol­low­ing their Fe­bru­ary meet­ing in Shang­hai by spread­ing the ru­mour that hence­forth cen­tral banks would co­or­di­nate mone­tary poli­cies and avoid im­pos­ing “shock and awe” on frag­ile fi­nan­cial mar­kets. And sure enough, since then, al­most ev­ery press con­fer­ence fol­low­ing a cen­tral bank meet­ing has de­liv­ered yawn-fests of plat­i­tudes. In short, we have in re­cent months, been liv­ing un­der the calm­ing in­flu­ence of a “Shang­hai Agree­ment” (such an agree­ment may or may not ex­ist, but the fact that market par­tic­i­pants be­lieve it does has per­haps min­imised the ac­tual in­ter­ven­tion re­quired!). And, as in the post-Lou­vre Ac­cord quar­ters, since Fe­bru­ary’s G20 meet­ing in Shang­hai, emerg­ing mar­kets have started to out­per­form, as have deep cycli­cals, gold and sil­ver min­ers. It’s all felt won­der­ful, if not quite as care-free as the mid1980s.

As an emerg­ing-market bull, I don’t want to look a gifthorse in the mouth. If a “deal” was done to en­sure lim­ited cur­rency volatil­ity, then the re­ally big risk to emerg­ing mar­kets (namely, a US dol­lar spike) has been re­moved. If cor­rect, this al­lows in­vestors to fo­cus on the su­pe­rior growth pro­file of emerg­ing mar­kets, at­trac­tive val­u­a­tions and fall­ing real in­ter­est rates. But of course, this does not re­move the nag­ging worry of “what if the Shang­hai agree­ment comes to a bru­tal end as in 1987?” (back in 1987, the Hong Kong stock ex­change closed for a week as it could not han­dle a tsunami of sell or­ders). And how could such an end come to pass at a time when no cen­tral bank is ever go­ing to be as hawk­ish as the mid-1980s’ Buba?

Un­til his re­cent self-immolation, the most ob­vi­ous threat to the Shang­hai Agree­ment seemed to be a Don­ald Trump pres­i­dency. Af­ter all, here was a US pres­i­den­tial can­di­date who threat­ened, with his open pro­tec­tion­ism and iso­la­tion­ism, the very equi­lib­rium on which the post World War II eco­nomic or­der had been built. So with the odds of a Trump win melt­ing faster than morals at a bach­e­lor party, should we as­sume that the Shang­hai Agree­ment lives on un­threat­ened, and pile on the risk? Per­haps not so fast, for in re­cent days, it “feels” as if for­eign ex­change volatil­ity, af­ter months in a coma, is com­ing back to life. And it may turn out that it is not Don­ald Trump who put the boot in to the lovely com­pro­mise reached in Fe­bru­ary, but in­stead Per­fid­i­ous Al­bion. Let me ex­plain:

When Bri­tain voted for Brexit on June 23, ster­ling log­i­cally fell to one stan­dard de­vi­a­tion un­der­val­ued against both the US dol­lar and the euro. Amaz­ingly enough, the broader ram­i­fi­ca­tions of this sud­den shift were ig­nored by in­vestors and, soon enough, global mar­kets were ral­ly­ing hard. But then, at the Tory Party con­fer­ence two weeks back, Theresa May dou­bled down by promis­ing to ac­ti­vate Ar­ti­cle 50 by next March, and with it an ir­rev­o­ca­ble exit for the UK from the Euro­pean Union.

Now, this March date was surely not a co­in­ci­dence: by ac­ti­vat­ing Brexit just be­fore the French and Ger­man elec­tions, Prime Min­is­ter May made sure that Brexit would be­come a big part of the cam­paigns un­fold­ing in the eu­ro­zone’s two key economies, and more im­por­tantly, Bri­tain’s two largest trad­ing part­ners. In short, by choos­ing this date, Theresa May has en­rolled the lob­by­ing depart­ment of ev­ery ma­jor French and Ger­man au­tomaker, ma­chine-tool man­u­fac­turer, and even farmer, to the cause of ne­go­ti­at­ing a grace­ful exit for Bri­tain. And, in case these var­i­ous eco­nomic ac­tors did not get the mes­sage, the sec­ond mas­sive leg down in the pound in re­cent weeks should fo­cus minds on Bri­tain’s needs. To cut a long story short, with a euro at a gen­er­a­tional low of 0.9 to the pound, will it be long be­fore French farm­ers start to bar­ri­cade the ports of Calais and Boulogne, and un­load truck­loads of ma­nure in cen­tral Paris while com­plain­ing about un­der­priced Bri­tish milk, beef, and sheep in­testines (or what­ever foul things peo­ple eat in north­ern parts of the UK)?

With the GBP col­laps­ing, Euro­pean pol­icy-mak­ers now be ea­ger to do one of two things, namely:


1) Quickly sur­ren­der to Bri­tain’s Brexit de­mands, in a bid to push the pound higher and avoid a world of trade pain.

Af­ter all, con­sider the lob­by­ing power of dif­fer­ent in­dus­tries around the world. In the US, the strong­est lobby, big­ger even than the Na­tional Ri­fle As­so­ci­a­tion, is that of the lawyers’ which en­sure there can never be mean­ing­ful land tort re­form. In Ger­many, the auto lobby dom­i­nates, which is why ev­ery­one can drive like a bat out of a hell on Ger­man high­ways. Mean­while, in France, the most pow­er­ful lobby, by far, re­mains that of the farm­ers—farm­ers who, along with the Ger­man au­tomak­ers, will not look kindly on the cur­rent ex­change rate of the euro to the pound.

2) De­value the euro, in a bid to cush­ion the ef­fect of the pound’s col­lapse.

But if such a pol­icy does now get em­braced, the ac­tion surely spells the end of the Shang­hai Agree­ment?

In re­cent days, it “feels” as if the mar­kets sense this lat­ter threat. Not only does the euro seem to be break­ing down, but other coun­tries’ cur­ren­cies are also start­ing to feel wob­bly. The ren­minbi is back to test­ing its lower lim­its. The Swedish krona has lately been weaker on no news at all. De­spite higher oil prices, the loonie is back at CAD1.33 to the dol­lar. The Mex­i­can peso has not cel­e­brated, as one might have ex­pected, the demise of the Trump cam­paign. Per­haps all of this will amount to noth­ing. But in the face of the re­cent pick-up in for­eign ex­change volatil­ity, I would re­it­er­ate the point made a few weeks ago. A pick-up in forex volatil­ity from here would very much be a “risk-off” de­vel­op­ment.

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