UK fiscal update: Counting the Brexit costs

Just four months after the Chancellor presented an autumn budget, and with no new fiscal measures scheduled today, it was rather puzzling why the OBR bothered to churn out the standard 243 page Economic and Fiscal Outlook following today’s Spring Statement. It was, as usual, a thorough and considered analysis of the current situation in the UK and contained an updated forecast, but it all seemed a bit superfluous. So what did we learn?

First, that the OBR’s medium-term forecast remains broadly unchanged compared to November, and second, that the fiscal outlook has improved a bit, with a cumulated reduction in borrowing of around £20bn over the forecast period. In other words, nothing to write home about. With regard to the growth outlook, recall that the OBR cut its medium-term projections in November by reducing the outlook for productivity growth. I did note at the time that this might have been a little premature, primarily because a tightening labour market might be expected to boost capital investment which in turn would lead to a faster pickup in spending relative to labour input. As the OBR acknowledged, “the biggest surprise in the economic data released since November is that productivity growth – measured as output per hour – has been much stronger than expected.” But since this reflected an unanticipated decline in hours worked in H2 2017, which the OBR expects will be reversed, the fiscal watchdog sees no reason to change its view regarding its medium-term productivity assumption. The jury is still very much out.

With regard to fiscal projections, however, it is evident that the UK has now managed to bring current income and outlays back into line. Having reduced the current deficit from 6.5% of GDP in 2009-10 to zero, you might think that now is a good time to pause and rethink the austerity strategy. The bulk of the reduction has fallen on public spending, whose share in GDP has fallen by a whopping 6.3 percentage points over the last eight years whilst the revenue share is only up by 1.4 points. To the extent that the current balance effectively measures the day-to-day cost of running the public sector, it is now clear that services have been reduced to levels which can be covered by tax revenues. In any case, it is possible to stabilise – and even reduce the debt-to-GDP ratio – so long as the primary balance is broadly zero and the rate of nominal GDP growth is higher than the interest rate on government debt. Seeking overall balance on total borrowing, which implies that today’s taxpayers are paying for investment that will be enjoyed by future generations, makes little sense.

I have pointed out many times previously (here, for example) that there is only so much austerity that can be put in place without cutting front line public services beyond the point of no return, and with the strain on health and welfare services unlikely to improve there is a case for raising expenditure in both areas in the near future. Incidentally, I was struck by the French government’s recent suggestion to scrap all jail sentences of less than one month on the grounds that they are both costly and counterproductive. With the UK prison service struggling under the burden of cost cuts, it seems to me that part of the austerity drive in future will not be how to do more with less, but simply how to do less.

One of the key areas of interest in the OBR’s publication was its attempt to quantify the cost of the Brexit divorce bill, which it puts at £37.1bn – 75% of which will be incurred by 2022. Whilst this is at the lower end of the estimates which have been bandied around over the past year, largely because the UK will continue paying into the budget until end-2020, by my reckoning this is about £10bn more than the UK would have otherwise paid to stay in the EU over 2021-22. Moreover, the UK will continue paying off its liabilities until 2064 (chart). The OBR also pointed out that the UK will continue to pay into various EU funds in order to retain access to specific schemes – although the government was unable to suggest how much this will ultimately cost because it has not yet decided in which schemes it wishes to participate.

It is clear, however, that there will be ongoing EU liabilities above and beyond the divorce bill, which will put further pressure on the budget, and highlights that a “clean Brexit” is virtually impossible. Although the OBR was too polite to say so, the notion that the UK will make savings from no longer having to contribute to the EU budget, which can be used for other purposes such as the NHS, is a complete and utter fiction. Here’s looking at you Boris!

Making sense of social trends

Populism has been at the top of the political agenda for much of the last two years. It is manifest in the Brexit vote; the election of Donald Trump; the rise of the AfD in Germany and last weekend’s election in Italy, which saw the Five Star Movement and Lega Nord perform particularly well gaining almost 50% of the votes. To many people, this backlash against the status quo came out of the blue. In reality, it has been brewing for quite some time.

The economist Simon Wren-Lewis recently wrote in a blogpost that “those who think the UK descended into political madness with Brexit are wrong: the madness started with austerity in 2010.” I would argue that the roots extend even further back, and have long believed that Tony Blair’s decision to participate in the invasion of Iraq in 2003 marked a fundamental erosion of trust in government in the UK. Around the same time, in 2004, the journalist David Goodhart wrote an influential essay in Prospect Magazine, entitled “Too diverse?” in which he argued that tolerant western societies face a “progressive dilemma” as the greater diversity of lifestyles and beliefs make it more difficult to find common issues around which society can coalesce.

Goodhart is no tub-thumping populist – indeed he is very much part of the “liberal elite.” Thus, his argument that “large-scale immigration …  is not just about economics; it is about those less tangible things to do with identity and mutual obligation … It can also create real – as opposed to just imagined – conflicts of interest” saw him vilified in sections of polite society. But as the journalist Jonathan Freedland remarked last year in a review of Goodhart’s latest book “you don’t have to like any part of that argument to recognise that it was prescient.”

Fast forward to the present and the recent book by political theorist Yascha Mounk The People vs. Democracy argues that the glue that has held together the liberal democratic model of the post-war era is becoming unstuck. I suspect that the conclusion is a bit overdone but he does accurately nail some of the governance problems faced by western societies. In his view, “elites are taking hold of the political system and making it increasingly unresponsive: the powerful are less and less willing to cede to the views of the people.” In a highly readable review of this book in The American Interest, Shadi Hamid, a senior fellow at the Brookings Institution, argues that this is primarily the result of a change in the nature of government which has become more technocratic and thus has less room to listen to the people.

In Hamid’s view, “technological progress, scientific advancement, and the necessity of ambitious welfare states to maintain social order” has necessitated this more technocratic approach. The electorate has outsourced issues such as taxation, healthcare and a whole manner of regulatory issues to government – they simply do not have the expertise to deal with them nor the time to become fully informed. Hamid points out that governments made a mistake in treating immigration as just another technocratic problem that could easily be dealt with, but “voters didn’t see it that way and repeatedly tried to get politicians to listen.” Worse still, “governing elites wished to make sensitive conversations … off-limits for polite democratic deliberation. To make matters worse, it was done in a condescending way, with enlightened moral appeals … juxtaposed to the untutored bigotry of the masses.”

This was a particular problem in Europe where the rise of AfD; the Italian election result and the Brexit vote are all related in some degree or another to domestic concerns about immigration which governments were unwilling to confront. It may not be a problem that liberals such as myself are willing to acknowledge, but as a partial explanation of why the populist backlash of recent years has taken place it does fit the facts. This does not make the vast majority of the European population racist or xenophobic. But it does echo Goodhart’s warning that recent changes in western societies could “erode feelings of mutual obligation, reducing willingness to pay tax and even encouraging a retreat from the public domain. In the decades ahead European politics itself may start to shift on this axis, with left and right being eclipsed by value-based culture wars and movements for and against diversity.”

It also suggests that governments across the continent have taken their eye off the ball when it comes to addressing the concerns of their electorates. Obviously, these concerns have been magnified by the aftershocks from the global financial crisis of 2008-09, and perhaps governments were so preoccupied with trying to generate a recovery that they were distracted. But as I pointed out in early 2015, it is “evident that the world is not going to return to a pre-2007 “normality”... and policy makers need to start having honest discussions with their electorates about these issues.” In recognition of the fact that the French electorate has concerns, the government last month put forward a plan to tighten immigration controls. Had Angela Merkel known in February 2016 what she knows now about German voters’ concerns, perhaps the EU would have offered the UK more concessions ahead of the Brexit vote.

But pulling up the drawbridge is not the answer. The idea that limiting immigration makes life better for European voters is based on the notion that there is a fixed amount of work, and reducing immigration reduces the competition for that work. This is clearly wrong, but whatever the economics profession might say, a large body of the electorate does not want to hear that message and in order to get re-elected governments have to take a line which may not be in their best economic interests. I am sure that the prevailing opposition to immigration will eventually change, but perhaps not quite for some time, and governments may not be quite so willing to open their borders for an even longer period for fear of the political backlash this generates. I hope I am wrong when I say we may well look back at the last 20 years as the golden age of the liberal economy.

Steeled for trouble

The announcement last week by Donald Trump that he intends to levy tariffs on US imports of steel and aluminium, of 25% and 10% respectively, was the first indication that the President intends to follow up on his campaign promises. The announcement came a matter of hours after I sat in a client meeting and said something to the effect that Trump had so far not implemented the worst of his campaign promises, thereby demonstrating my great prescience.

It came at a bad time for markets, which were beginning to recover from the wobble at the start of February and the S&P500 is currently around 5.7% below the high achieved in late January. What particularly spooked markets was Trump’s claim that “trade wars are good, and easy to win.” Nothing could be further from the truth, as the experience of the 1930s demonstrated. They are nasty and do not result in any winners – everyone loses. Obviously, the steel tariffs will matter because the US is the world’s largest steel importer (26.9 million tonnes in the first nine months of 2017). But who will pay the price? Initially, it will be US industry which uses the steel as an input but ultimately it will be consumers – primarily in the US but also those elsewhere which buy US products using imported steel as an input.

The initial kneejerk reaction was that this was a way of hitting back at China, which has been the focus of the President’s displeasure for some time. Admittedly, China was accused by the EU of dumping steel on the world market at artificially low prices. Only last April the EU introduced levies ranging from 18.1% to 35.9% on certain types of Chinese rolled-flat steel products for a five year period. But China is not even in the top 10 sources of US steel imports. Canada, Brazil, South Korea, Mexico and Russia (in order of importance) account for 57% of the total – and the irony is that two of these countries are NAFTA partners (see chart). With regard to aluminium imports, Canada alone accounts for 56% of the US total, followed by Russia (8%) and the UAE (7%), with China lagging behind in fourth with a mere 6% share.

Trump also turned his focus on the EU at a press conference yesterday, saying “The European Union has been particularly tough on the United States … They make it almost impossible for the United States to do business with them. And yet they send their cars and everything else …” Spot the EU exporter in the list! In fact, Germany is the only EU country which manages to get on the steel importers list, coming in ninth, accounting for 3% of the US total.

We are still waiting to hear which countries will be affected by the tariffs and it really does look like the President has lashed out without regard for the consequences of his actions (why should we be surprised?). There has been speculation in the media that Trump’s actions were nothing more than an angry reaction following the resignation of communications director Hope Hicks, and a series of other incidents.  If true, it certainly raises a concern about the state of mind of the man with his hand on the nuclear button.

The damage from the trade action is likely to be twofold. On the one hand, there will be some limited form of retaliation from US trade partners, and even though an all-out trade war is unlikely, it is still a very bad sign. Second, it may raise questions about the quality of people prepared to serve in the President’s Administration. Gary Cohn, Trump’s highly rated chief economic adviser, has already resigned in opposition to the plan and a number of other cabinet members are believed to be opposed, including Treasury Secretary Mnuchin and Secretary of State Tillerson.

Perhaps more importantly, it calls into question the rules-based system that underpins the global economic order which has served the western world so well for 70 years. If the US, which has acted as guarantor for so long, no longer appears inclined to play by the rules, why should the likes of China or India, which are set to become major economic powers in the course of the 21st century? It will certainly give China greater moral authority to write a set of trade rules to suit itself. And on this side of the Atlantic, at a time when the UK has decided that it no longer wants to be part of the EU, the customs union or single market, it should give those pushing for trade deals with the rest of the world pause for thought about who our friends are and where our interests lie.

I'll tell you what I want (what I really, really want)

Theresa May’s “big speech” on Friday where she outlined her five point plan for what she wants from Brexit, was supposed to be her Spice Girls moment - telling us what she really, really wants. It would bring the Conservative party together, pacify governments elsewhere in the EU27 and apply some balm to the festering domestic wound caused by the vote to leave the EU. To read various domestic media outlets, you could be forgiven for thinking that it had hit many of its targets. According to the FT "Theresa May warns Eurosceptics to 'face facts'". The Telegraph called it “her most pragmatic Brexit speech to date” and noted “if only [she] had given this speech 13 months ago at Lancaster House.”

Instead, I heard a speech that was long on words but short on content. Guy Verhofstadt got it broadly right in his Twitter feed when he noted that “PM May needed to move beyond vague aspirations. While I welcome the call for a deep & special partnership, this cannot be achieved by putting a few extra cherries on the Brexit cake.” In some ways, the Telegraph was right about one thing – it would have made a far better starting point than her car crash Lancaster House speech in January 2017. But it was not a speech which gives anyone any confidence that at this stage of the Brexit negotiations, the UK government is on track for a Brexit that works for anyone – politically or economically.

The five “tests” were themselves an exercise in irony: (i) “the agreement we reach with the EU must respect the referendum”; (ii) “the new agreement we reach with the EU must endure”; (iii) “it must protect people’s jobs and security"; (iv) “it must be consistent with the kind of country we want to be … a modern, open, outward-looking, tolerant, European democracy”; (v) “it must strengthen our union of nations and our union of people.” In terms of (i), the only thing the electorate voted for in 2016 was to leave the EU – not the customs union nor single market. With regard to (iii), most economists struggle to see how we will be better off and on (iv) I have remarked previously about how the world sees the UK as becoming more, not less insular. But (v) really was a corker: Two areas of the union voted to remain and they are being dragged out of the EU because of the choices of voters elsewhere. Brexit poses the biggest danger to the union in modern times.

May’s statement that “we must bring our country back together” produced this rejoinder from Jolyon Maugham QC, the prominent Remain campaigner: “When your Brexit doesn't deny our children the privileges we enjoyed, we'll listen. When you apologise for calling us "citizens of nowhere", we'll listen. When your policies respect the dignity of our friends, colleagues and partners, we'll listen.”

As I parsed the speech, it was difficult to discern anything new. It was similar in tone to that in Florence last September (albeit way better than the efforts of 2016 and early-2017) though it better reflected the reality that the UK is not going to leave the EU on its own terms. There was nothing of any substance about how to resolve the Irish border problem, although the phrase “we want as frictionless a border as possible” was directly used four times and another twice in a slightly different guise. Nor was any justification provided for the decision to leave the customs union. Another thing that struck me was the mention of introducing processes to differentiate between small and large businesses in Northern Ireland to reduce the administrative burden on smaller companies. So we introduce more admin to reduce the administrative burden? It would be laughable were it not so serious, and none of this would be necessary at all if the UK simply remained in the customs union.

To compound the litany of dreadful decisions, May reiterated that the UK would leave the Digital Single Market – the EU's strategy to make it easier for digital businesses to work across borders and which guaranteed things like no roaming charges. And “on financial services, the Chancellor will be setting out next week how financial services can and should be part of a deep and comprehensive partnership.” Only six months too late as banks begin to implement processes to allow them to cope with the business disruption caused by an end to passporting – a process which, once it starts, will not be reversed. With regard to services more generally, “we want to limit the number of barriers that could prevent UK firms from setting up in the EU and vice versa, and agree an appropriate labour mobility  framework.” So there is at least a recognition that non-tariff barriers are a major hindrance for the services sector, so that’s a start, but we have been saying this all along. But scrapping the existing movement of free labour in order to introduce a new set of plans? It all defies logic. As I pointed out in 2015, swapping one set of rules for another means “much of what is currently legislated by the EU would have to be done domestically in the event of Brexit.”

As an economist, I found the speech content-free. But increasingly, it seems to me, the problem is Theresa May herself. As the blogger David Allen Green has pointed out, the PM and her colleagues make speeches whereas the EU issues detailed legal documents. Worse still, May is neither a strong leader nor a good communicator. She can't lead because she is a prisoner of the two factions of her party who want either a hard Brexit or the softest possible and can please neither side as she walks the Brexit tightrope, giving the impression of a leader who is in office but not in power. The PM seems not to understand how to communicate with other EU leaders – her speeches are bland and lack any of the specific detail which her soon-to-be-erstwhile EU partners want to hear. I’m afraid to say that whilst her predecessor David Cameron will go down in history as one of the worst prime ministers in recent history, Theresa May is currently running him close.

Major issues

I don’t want to keep banging on about Brexit but as the Article 50 period approaches the halfway mark, the pitch of the debate is intensifying as Remainers line up to point out the flaws in the Leavers arguments, who in turn respond by accusing Remainers of being unpatriotic. Former prime minister John Major waded into the debate yesterday by pointing out all the flaws in the Brexit argument and criticising the government for boxing itself into a corner by refusing to countenance any deviation from a policy which is likely to prove extremely costly.

It was punchy stuff but then Major has never shied away from a fight, and we should not be fooled by his calm demeanour. When it was suggested by the likes of Iain Duncan-Smith that he should hold his counsel in order to avoid undermining his successor, Major responded that he has rarely spoken out on the EU issue, unlike his own predecessor Margaret Thatcher, who in his recollection spoke out “weekly”. Indeed, Major has more cause than most to be irritated by the actions of a vocal minority of backbench MPs who spent the years 1992-97 undermining the efforts of his government.

At the time, Major was not regarded as a particularly impressive prime minister but he increasingly looks like a political giant as we deal with the pygmies attempting to implement policy today. Indeed, in June 1995 he memorably faced down his detractors by resigning as leader of the Conservative Party whilst serving as prime minister and challenged anyone to take him on. In the end, he comfortably beat off the challenge of the Eurosceptic John Redwood (who still haunts the backbenches of Westminster today). It was a very courageous move and one which Theresa May would do well to emulate, though she appears to lack the political courage (and probably the support of her party’s MPs). And lest it be forgotten, it was Major’s government that secured opt-outs from the Maastricht Treaty which kept the UK out of the European single currency. The legacy that he bequeathed to successive UK governments was thus a considerable one which his party now appears intent on squandering.

The years of Major’s premiership were not happy ones, dogged as they were by a party that was split on the issue of the EU, and as prime minister Major often seemed to be a prisoner of events. But his was a remarkable triumph over adversity, coming from a poor household and without the benefit of a university education. If anyone should be able to understand how Brexit will impact on the poorer members of society, surely it is him. And as has been pointed out many times, it is ironic that the leading lights of Brexit are well-educated, well-heeled members of the establishment such as Boris Johnson and Jacob Rees-Mogg. But as well-educated as these honourable gentlemen may be (and I use the term advisedly), they are clearly none-too-bright.

The attached pic shows a tweet from Rees-Mogg which highlights an article from The Sun newspaper outlining how much consumers would save if the UK were to leave the customs union. For example, the article notes that a pair of Nike Air Trainers, which currently cost £120, would be reduced to £99.60 if the 17% tariff on imports of such items was eliminated. Unfortunately, that is arithmetically incorrect. A £120 pair of trainers would actually cost £102.56 if the 17% tariff is abolished because the authors have wrongly calculated the new price as 120*(1-0.17) instead of the correct method of 120/1.17 – and have done so for every single item on the list. Jacob Rees-Mogg, educated at Eton College and Oxford University and who runs his own fund management firm, failed to spot the error and indeed compounded it by retweeting the original. He also accused Jeremy Corbyn of voting against the implementation of the Good Friday agreement in Northern Ireland when in fact he did no such thing.

So the next time Rees-Mogg makes claims in favour of Brexit, remember he is the guy who does not do the checking of basic details. John Major’s speech laid out the Brexit facts – and for too many Leavers the facts are an inconvenient detail which undermines their case. But they must be held to account on the facts because the Brexit vote was determined in their absence – and look where that got us.

Borderline insanity

As we reach the end of another month in which the UK government has failed to make any real Brexit progress, the European Commission has taken the initiative by producing a 119 page draft document detailing the legal text that will form the basis of the UK’s departure from the EU. One of the key protocols indicated that in the absence of any other solution, the EU will establish a common regulatory area in which “the territory of Northern Ireland, excluding the territorial waters of the United Kingdom (the "territory of Northern Ireland"), shall be considered to be part of the customs territory of the Union.”

This puts the UK government in an awkward position. Last summer it produced a Position Paper in which it committed to (i) upholding the Good Friday Agreement; (ii) maintaining the Common Travel Area and (iii) avoiding a hard border for the movement of goods. It did not give any detail on how these objectives could be achieved but instead talked vaguely of “technical solutions” without outlining what they are nor how they would work. Following the December agreement between the UK and EU, the two sides essentially kicked the can down the road, agreeing that progress had been made on the Irish border question without having done anything of the sort (as I noted at the time).

The extent to which influential Leave supporters really do not understand what is at stake was highlighted by Boris Johnson’s  crass remark earlier this week that the Irish border was no more of a problem than boundaries between different boroughs of London. Apart, that is, from the fact that we are talking about a border between two sovereign states with different legal systems – so pretty much identical, then (and this man is the Foreign Secretary for pity’s sake).

Obviously, the EC’s action met with a hostile reaction from both Prime Minister May and Unionist politicians in Northern Ireland who see this as an attempt to drive a wedge between the UK and the province. May told the House of Commons that “No UK prime minister could ever agree to it and I will be making that absolutely clear.” At that point – and you know what is coming next – the EU’s chief negotiator Michel Barnier will politely ask what is the UK’s alternative plan. Unless the UK can magically find a way to introduce the technology to maintain an open border, it seems to me that the only alternatives are either to reject the EU proposal, raising the likelihood of a hard Brexit, or rethink the plan to leave the customs union which would eliminate the Irish problem but annoy those pushing for a hard Brexit.

Jeremy Corbyn has already committed the Labour Party to supporting EU customs union membership following his speech on Monday. And there are plenty of Conservative MPs who support this position, which gives rise to the possibility that a cross-party grouping could yet force the prime minister to abandon her ruinously idiotic policy of leaving the customs union. From an economic perspective, departure makes no sense. Leavers will, of course, claim that it will give the UK the freedom to sign up to trade deals with rapidly growing countries outside the EU. But as I – and many others – have repeatedly pointed out, the gains from such deals are unlikely to make up for losses incurred by leaving the single market and customs union.

However, the Leavers have now convinced themselves that in June 2016 voters opted for leaving the customs union, even though that was never once discussed (let alone appear on the ballot paper). As a result we have head bangers such as Liam Fox claiming that backtracking on this commitment would be a “betrayal” of voters’ wishes in 2016. But it is clear that opposition to this damaging form of Brexit is mounting. Martin Donnelly, a former senior civil servant who served under Fox, recently described current government policy as like “swapping a three-course meal for a packet of crisps.” If leaving the EU represents the crisps diet, then maintaining customs union membership might be seen as swapping our banquet for a miserable course of cheese and biscuits – still sub-optimal but better than the processed potato-based option.

The EC knows, of course, that what it has proposed regarding the Northern Irish customs union is unacceptable to the British government. But at the very least, this intervention might force the UK to commit to what it wants from Brexit rather than simply talking in vague generalities. It could even persuade Theresa May to stand up to the ultras in her party who have commandeered Brexit to further their own ideological ends, rather than looking after the interests of the UK as they were elected to do. That may be a forlorn hope but with time running short and the prime minister increasingly reminiscent of Captain Queeg of The Caine Mutiny fame, someone has to take control. And if the EU forces the UK to take action to end the vacillation, so much the better. After all, despite their tribulations, Greek voters appear to prefer remaining in the EU than hand the keys over to domestic politicians. I increasingly know how they feel.

Asynchronicity

Comments by new Fed chair Jay Powell in Congressional testimony, suggesting that US interest rates might rise more rapidly than the markets currently anticipate, did nothing to assuage a jittery market which has been on edge since the beginning of the month. Powell indicated that his “personal outlook for the economy has strengthened since December” which has been interpreted as an indication that the Fed may be inclined to raise rates four times this year rather than the three that markets are currently expecting.

Such a pace of tightening would then put the upper limit of the Fed funds rate target corridor at 2.5% by year-end compared with just 0.5% in November 2016. That is not quite as aggressive as 2004-05 when the funds rate rose by 200 bps in the space of just 12 months, and a further 225 bps between May 2005 and June 2006, but having got used to a prolonged period of central bank inactivity over the past decade, that would represent a big move by the standards of recent years.

In addition, the Fed has already clearly set out a path for running down its balance sheet. Last June, it announced that it would reduce its holdings of Treasury securities at a rate of $6bn per month, rising by $6bn each quarter until it reaches a maximum drawdown of $30bn per month. Mortgage-backed securities are expected to decline by $4bn per month initially, with the drawdown rate being increased by $4bn per quarter up to a maximum of $20bn per month. By the end of this year, we can thus expect the balance sheet to decline at a pace of $50bn per month (ceteris paribus) which implies a $600bn reduction per year. If we assume that the minimum size of the balance sheet required to meet the cash needs of the US economy in future is around $2.5 trillion (it is currently at $4.4 trillion), the planned rate of reduction would enable this level to be reached by the middle of 2021 (see chart). This is at the lower end of the time period given by Powell in today’s testimony, when he said that a “normal” level will be reached in “three, four, five years.”

To the extent that the US economy looks to be back on its feet, posting solid growth and levels of unemployment consistent with full employment, monetary normalisation is clearly desirable. But with the duration of the US economic cycle already highly extended in the context of previous upswings, the fairly rapid degree of policy normalisation could be one of the factors which trips up either the economy or markets over the next one to two years. As the economist Rudi Dornbusch once remarked, “None of the post-war expansions died of old age. They were all murdered by the Fed.”

This also raises a question of how other central banks could or should respond. The ECB is well behind the Fed in the monetary tightening stakes, and is indeed still expanding its balance sheet even as the Fed is reducing its own. If the ECB starts to raise rates in 2019, it will be almost four years behind the US. The Bank of England may be less than happy about having to aggressively tighten if the UK economy suffers from any Brexit-induced weakness whilst the BoJ continues its extensive monetary easing. Such an asynchronous global monetary cycle might be expected to put upward pressure on the dollar. This is all very reminiscent of the situation in the late-1970s/early-1980s when Paul Volcker’s efforts to squeeze inflation out of the US economy necessitated a tight monetary stance which forced the greenback higher. This ultimately led to the Plaza and Louvre Accords of 1985 and 1987 which respectively attempted to weaken, and then stabilise the dollar.

Even today, old-timers in the FX market hark back to these agreements as an example of how to coordinate global monetary policy. We were reminded again in 2008-09 of the value of a co-ordinated policy stance. Today, we are nowhere near this position, and we can hardly blame the Fed for other central banks’ tardy efforts to remove the policies put in place in 2009 to combat conditions which are far different from those prevailing today. Whilst everything today appears to be going swimmingly, particularly in the euro zone, there will come a point where central banks elsewhere will have to start the process of taking away the punchbowl. Man cannot live by bread alone, but nor can he continue to rely on ultra-cheap credit.