The irony of timing will not be lost on the author of the article ‘Politics remains rooted at the top of the economic agenda’ (in Finance Director, 18 April), which opened with ‘Foreign Exchange markets often reflect political fears, so the fact that none of the major currencies has moved dramatically this year is testament to the lack of big surprises.’ The article, by the Head of investment strategy at Investec Wealth & Investment, appeared on the day UK Prime Minister Theresa May called a snap general election on 8 June.
Since then, markets have been giving their own verdict on the decision. The UK pound surged to its highest level in nearly six months, while UK blue-chip shares suffered their biggest one-day fall since Britain voted to leave the EU.
The pound, reversing the sharp downturn it took ahead of Mrs May’s announcement, climbed 2.7 per cent to a five-month high of $1.2905, on expectations that she would win a much-increased Parliamentary majority in June. The suggestion being that investors and economists across Europe anticipated the benefits of a softer Brexit with a UK-EU free-trade deal. The pound strengthened 1 per cent against the euro, its highest level since late February. The FTSE 100 dipped 2.2 per cent, amid fears that a stronger currency undermines the foreign-based revenues of multinational companies.
It is just under a year after Britain voted to leave the EU and the new strength of the pound unnerved UK stock markets, which had been energised by sterling’s slide since the vote. As voting started the pound stood at £1=US$1.48 and £1=€1.31. By the time the results were declared this had fallen to £1=US$1.34 and £1=€1.22.
In the words of Deutsche Bank’s George Saravelos, the prime minister’s move was ‘a game-changer for both the UK’s Brexit negotiations and sterling’.
But does politics inevitably trump other economic drivers?
For purists, economics analyses the economic consequences of human actions. It considers any goals that have been chosen, and looks for the most direct and cost-effective means to achieve those goals. It is ‘value-free’ and neither justifies nor condemns the motives of any economic action.
In contrast, politics is partisan and employs tactics that prioritise factional goals – values, preference and judgement are key – and economic policy becomes a battleground. As the economist and political philosopher Thomas Sowell has it ‘The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics’.
‘Political economy’ originated in moral philosophy and emerged in the eighteenth century as the study of the economies of states ¬– how production and trade relate to customs, government and law. It was in the late nineteenth century, when the term ‘economics’ largely replaced ‘political economy’, that its relationship with politics was perhaps confirmed if not clarified.
Some criticise economics for prioritising economic growth and financial welfare, arguing that governments should focus not simply on financial indicators like investment and productivity but on more human, qualitative measures like satisfaction, wellbeing and the environment. For political scientist and commentator Michael Perenti ‘large governments evolve through history in order to protect large accumulations of property and wealth’ and ‘the close relationship between politics and economics is neither neutral nor coincidental.’
Economics can be considered in isolation from politics and history, but for many, as Marxists have always maintained, the economic can only be understood through the lens of politics. ‘Politics … can make anything happen’ suggested Financial Times Columnist Martin Sandbu this week. Although all too often the ’thing’ that ‘happens’ is not what was intended.
Amidst all the commentary, there can be few stronger voices on the importance attached to policy’s impact on the economy than those of businesses – French business leaders have broken their normal silence ahead of Sunday’s French presidential election to urge the country not to vote for some of the candidates.
Two hundred businesses have used Le Monde to urge voters not to support candidates with extreme manifestos, contrasting sharply with the situation a few weeks ago when corporate leaders were quietly confident that a pro-business candidate would win.
Pierre Gattaz, the president of the employers’ federation Medef said voting for extreme candidates would ‘put our companies at great risk, from the small to the large’.
Bernard Spitz, head of the French Federation of Insurance Companies, issued equally stark warnings: ‘We have to do everything we can to open people’s eyes to the risk of a final between the two extreme candidates. If that were to happen the game is over. It would be a tragedy for the French economy and a licence to kill Europe.’
Financial markets have been pricing in the risk of a second round with Ms Le Pen and Mr Mélenchon – the premium France pays over Germany to borrow for 10 years has jumped to 70 basis points, from less than 60bp in late March.
It’s not just macroeconomics at national level that can be impacted. In the UK, US and Europe, fiscal policy has been relatively tight, given the state of the economy. It has therefore been central banks that have pursued expansionary monetary policy, to offset any deficiencies – if politicians pursue tight fiscal policy, central bankers have had to adapt monetary policy. But any sudden shift in monetary policies from major advanced economies increases the risk of volatility in global liquidity and systemic instability, and this can have a significant impact on the stability of emerging economies.
Policy, politics, or politicians?
It’s not only party politics that can have economic consequences, but also the behaviours and language of politicians.
Since his inauguration at the start of the year, US President Donald Trump had been vocal about his intent to introduce pro-growth policies. Along with plans for an executive order to make buying US-based products more favourable, this risked a global liquidity crunch and a reversal of capital flow.
But it was his complaint in April that the US dollar had risen too high that triggered an immediate, significant economic response – a slide in the currency. Although he had previously expressed concern about the level of the dollar as he discussed tackling the US trade deficit and bolstering manufacturing, it was this explicit statement that contrasted so profoundly with America’s traditional ‘strong dollar’ policy, and triggered concerns of a more aggressive approach to foreign exchange diplomacy. Although stabilising overnight, the dollar index long remained at levels lower than before Mr Trump’s comments.
Eswar Prasad, a senior fellow at the Brookings Institution, considered it ‘rather extraordinary for an American president to explicitly link the value of the dollar to his administration’s policies and to indicate what direction he’d like the dollar to move in’.
Charles Edison, businessman, inventor, behaviourist and New Jersey Governor in the 1940s, was clear: ‘Economics, politics, and personalities are often inseparable.’
Is anything certain?
Perhaps the only thing everyone’s certain about – business, politicians and commentators – is that it’s uncertainty in politics that most influences economics.
For Spitz in France ‘both candidates would mean substantial uncertainty and it’s the uncertainty that stops business investment in its tracks’.
The Financial Times highlights how investors have long regarded the prospect of an early UK election as unsettling, with the prospect of uncertainty in the run-up to the poll and beyond leaving ‘some analysts feeling unnerved’. However, it also suggested ‘investors tend to equate snap elections with uncertainty … yet those investors with political antennas knew that far greater uncertainty lay down the road without one.’
Richard Hunter, head of research at stockbroker Wilson King, considers the UK’s June election as ‘a fresh addition to the risk calendar’. David Docherty, UK equities fund manager at Schroders, feels the UK vote introduces ‘new uncertainties for investors’ and a global market strategist from JPMorgan suggests the ‘huge uncertainty facing the UK is unlikely to disappear soon, even if the near-term risks do end up reducing after the election. With all the political uncertainty ahead, fund managers who focus on stock selection over size and sector preferences are less likely to get caught out by surprise political announcements. The path for sterling, gilts, credit, UK equities, the relative performance of different sectors, and of large companies relative to smaller companies is still far harder to predict than usual’.
For Stephen Gallo, European head of forex strategy at Bank of Montreal, a political outcome can appear to be worth economic risk, ‘a snap UK general election is positive for the pound. Yes, the election adds a layer of uncertainty, but from what I can see the Conservative party stands to pick up a decent amount of seats’.
Politics appeals to motives and intentions, and is guided by preferences. Many of these are moral choices made by individuals in their relationship with others. It’s these persistent tensions that mean politics are destined to stay at the top of the economic agenda.
At least for some, the only recommendation is to keep them separate. Laith Khalaf, senior analyst at Hargreaves Lansdown, feels investors would be best served to ‘keep politics out of their portfolios … Investors will be once bitten twice shy when it comes to positioning their investments based on what happens at the ballot box, following the Brexit vote last year. Not only was the result a surprise, so were the effects on financial markets’.