The Return of Political Economy

Same crisis, three years older, just more political The 2008/09 financial crisis unleashed three fundamental shocks that still reverberate, and are likely to continue to do so for a while. First, it wrecked the financial stability and order that had previously prevailed, leaving us with a mountain of private and public debt to be reduced and restructured, aka the Great De-leveraging. Second, it blew up the economic model based on housing, credit expansion and financial services, not least depriving our governments of substantial tax revenues, and leaving us looking for new output and employment growth drivers.

These financial and economic shocks have produced widespread insecurity, and revealed critical weaknesses in our capacity to re-create sustainable growth. It looked a bit simpler in late 2009 and 2010, when the full range of stimulus measures and QE were in full flight, but as these have been withdrawn or terminated, the language of 'recovery, mid cycle, and double dip' seems rather inappropriate and misleading. The levels of economic and employment activity look worryingly depressed, and remind us that the Great De-leveraging is something totally different from anything we have
experienced in the West in the last 60 years from an analytical and a policy standpoint. We demand answers and solutions from politicians, who either
haven’t grasped the implications of the change in the economic environment, or are wrestling with appropriate responses.

The interaction between political and economic decision-making would come to play
an increasingly significant role in the determination of economic, and market outcomes. Looking at the time at the complicated legacy of de-leveraging
in developed markets, the embryo of the sovereign debt crisis, especially in Europe, and growing social and economic contradictions in China, it was possible to imagine, if not predict precisely, pretty much what we see playing out today.

Input: Convulsions of the Political Economy In his latest piece “Convulsions of the Political Economy” (Economic Insights, 16 August 2011), Senior Economic Advisor George Magnus re-visits the “Political Economy” theme and considers the existential crisis in the Eurozone, ‘deficit attention disorder’ in the US and other advanced economies, and China’s current political economy, for which the recent high-speed rail accident serves as an interesting metaphor.

Output: Implications for Asset Markets As we have highlighted over the past year, most prominently in our “Outlook 2011” work (29 November 2010), the timing of such shocks is difficult to predict, but the implications lead to episodic volatility and occasional market setbacks. From an asset allocation perspective, political risk is very hard to price across capital markets accurately, but at the very least we believe should be reflected in higher risk-premiums and lower risk-asset valuations.