5 min read

A crisis foretold

The UK bond market crisis was predicted years ago; is Credit Suisse the weakest link; the Bank of England was asleep at the wheel; and China's goal of Common Prosperity has led to Common Poverty.
Image showing Charles examining a tiny pound.
The British pound has taken a beating in recent weeks. Source.

1—A crisis foretold

What should one make of the turmoil in UK bond markets last week, an event so severe that it forced the Bank of England into purchasing £65billion in Government debt "to prevent first the pension system and then the entire British economy from suddenly unravelling"? Writing in the Daily Mail, Guy Adams traced the cause back to before the pandemic:

"One day in May 2019, a Dutch financier named Hans Van Zwol hit 'send' on a document outlining what he suggested was a 'terrible' threat to the global economy.

It was several months before Covid would up-end money markets – and the Ukraine war, which would later turbo-charge our cost of living crisis, was but a figment of Vladimir Putin's imagination.

Van Zwol was, therefore, sounding the alarm about something entirely different. Namely, the bespectacled fund manager had become concerned about a range of complex products known in the trade as 'Leveraged Liability-Driven Investments' or LDIs.

In the UK, where they had barely existed 15 years earlier, LDIs were then representing around £1trillion in assets held by ordinary people's pension funds. Today that figure has risen to a massive £1.5trillion, which equates to two-thirds of our country's entire gross domestic product."

Essentially pension funds were chasing 'risk-free' yields and were using leverage to do it. It was a model that worked only so long as interest rates kept falling – so well over a decade:

"For years, the system worked relatively well. Indeed, in the ten years to January, while stocks recovered from the financial crisis, the proportion of pension schemes which were under-funded fell from 80 per cent to around 20 per cent.
The genius of these products was that, despite performing solidly, they looked extremely conservative – at least on paper. Government bonds are among the most reliable investments. The world of pensions is designed to be dull. While the sheer volume of gilts being packaged into these products was unprecedented, regulators and the vast majority of observers saw nothing in the way of red flags.

Yet, as ever in the world of investing, greater rewards tend to carry greater risk. And with pension funds becoming more and more comfortable using LDIs to dramatically 'leverage' their holdings – at times using them to purchase £3 of gilts for every £1 they actually invested – they would inevitably become sensitive to changes in market conditions."

Who's to blame for the massive build-up in risk and financial vulnerability? "Smooth financiers", politicians and regulators. But the former "for years profited from these exotic deals" – good luck pinning this on them – while the latter will "deflect and... seek others to blame".

The only certainty is that taxpayers will foot the bill for what "was well and truly a crisis foretold". You can read Adams' full coverage here (~7 minute read).

"Every bear market produces national and corporate victims who get skewered. In the 1997-98 rout Thailand's economy imploded, as did LTCM, a hedge fund. Iceland and Lehman Brothers were victims in the 2008-09 slump."

So writes The Economist, which selected Britain as the country that "has already been picked-off". But there's also a company at great risk, Credit Suisse:

"Its shares have fallen by 55% this year and its credit-default swaps, which measure default risk, have risen. These two red lights will be familiar to anyone who witnessed Wall Street firms struggling in 2008-09, as will the statements by Credit Suisse's managers that the bank has a strong liquidity and capital position. This year's version of a confidence scare at a bank comes with a new twist, too: a swirl of malicious, mad and made-up rumours on Twitter and elsewhere. Welcome to the too-big-to-fail problem in the social-media age."

But Credit Suisse is unlikely to bring down the global economy. It's small – the 54th biggest listed financial firm in the world by assets – and its problems are more due to poor management over many years than a sudden shock. In other words, it was always going to come under pressure "as financial conditions tighten and the economy flags".

Credit Suisse is more zombie than Lehmann; a lacklustre firm propped up by ultra-low interest rates for far longer than it should have been, struggling under the weight of tighter trading conditions.

You can read the full breakdown by The Economist here (~3 minute read).

3—'No one could have seen it coming'

Tweet about financial stability and regulators being asleep.
If only regulators were warned, say with a letter in 2019. Oh wait, they were.

4—Common poverty

China's upcoming party congress (16 Oct), an event at which Xi Jinping will go against modern tradition and seek a third term in power, looks set to bring the idea of "common prosperity" back to the forefront, according to "a senior party ideologist".

For those who need a refresher, common prosperity was a term used by Xi Jinping in 2021 to describe a "socialist push [that] was meant to broaden China's middle class, extending it to include those without university degrees, small-business owners, migrant workers and farmers". But it hasn't gone so well:

"By 2020, China's widening wealth gap had become alarming. Its richest, such as Alibaba Group Holding Ltd.'s Jack Ma and Tencent Holdings Ltd.'s Ma Huateng, were worth well over $50 billion, in a country where the disposable income per capita was just 47,412 yuan ($6,681). Meanwhile, a key measure of income inequality ticked up again after falling from a peak in 2008, making socialist China even less equal than the US.

As such, the yearlong big tech and real estate crackdowns, which wiped out trillions of dollars of wealth, probably did narrow the Gini coefficient, a measure of inequality. However, these policy measures did not meet Xi's end goal of broadening China's middle class. Instead, over the last year, everyone got poorer. So far there's been silence from Beijing on this unintended impact."

The crackdown on the likes of relatively wealthy tech professionals in Shenzhen was supposed to help "the 170 million migrant workers that Xi wanted to bring into the middle class", one quarter of which worked in "the services sector, such as retail, transportation and catering". But unintended consequences are a b***h:

"Beijing's big tech crackdown upended that steady income stream. The yearlong ban of ride-hailing giant Didi Global Inc. from app stores inserted a lot of uncertainty, while delivery workers risked being stranded for days as a result of local governments' tough Covid-zero controls. Many threw in the towel and went back to their home villages."

You can read the full article by Shuli Ren here (~3 minute read), which also reports that the property crackdown disproportionately caused home prices in smaller cities – where migrant workers buy apartments as a means of saving for retirement – "to tumble".

5—Further reading...

♟️ A 72-page Chess.com report concluded that Hans Niemann "likely received illegal assistance in more than 100 online games, as recently as 2020". It also flagged "irregularities" through his rise in in-person chess, noting "many remarkable signals and unusual patterns in Hans' path as a player".

👎 "NFT Trading Volumes Collapse 97% From January Peak."

👩‍⚕️ "Republicans are abandoning their long crusade to repeal the Affordable Care Act, making the 2022 election the first in more than a decade that won't be fought over whether to protect or undo President Barack Obama's signature achievement."

🤔 "Iran's supreme leader Ayatollah Ali Khamenei has accused the US and Israel of masterminding anti-regime protests prompted by the death in police custody of a young woman arrested for allegedly violating the Islamic dress code."

🐵 The Nobel Prize in Physiology/Medicine went to Sweden's Svante Paabo who sequenced the DNA from Neanderthals, showing that they "were distinct from both modern day humans and chimpanzees".

❌ UK Prime Minister Liz Truss scrapped plans to cut the country's top 45% income tax bracket just days after announcing it.