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Who murdered Monsieur Free Market?

(FT Alphaville has published an edited 1000 word version of this post. This is an unedited 2000 word version, with a video explaining the economic and market concepts raised in the article - RC)

Who murdered Monsieur Free Market?

“Look around, mon amis, for one of you is the murderer.” Hercule Poirot looked at the motley crew of his fellow passengers. He had been summoned back to London on an urgent case and his friend, Bouc, was able to secure him a first-class berth on the Orient Express. It was however his misfortune to share his carriage with various characters all returning from a lavish shindig in Davos. To add misery to his misfortune, and avalanche had derailed the train, causing him to have to spend far more time than he wished in the company of fellow travellers.

Hercule resigned himself to a few days of reading in the mountains and drinking fine wine while the tracks were repaired, when misfortune struck again. One of the Davos set, Monsieur Free Market, was murdered in his sleep. The attack was frenzied, with multiple knife wounds, from many angles, and in such a way to make it impossible to determine if the attacker was left-handed or right-handed. Hercule Poirot, did not care much for Monsieur Free Markets, but his friend Bouc insisted he needed to solve the case for his own employment prospects, which given his various proclivities did not need further sullying with an unsolved murder.

“Bon, toute ensemble? Let us begin.” Hercule looked at the gathered passengers. “When a murder occurs, we must first find motive, must we not? And all of you have claimed to have no problem with Monsieur Free Market, but this is not true, is it?”

Madame ECB stood up “Look here Poirot, Mademoiselle Fedreserve has already told you that old man Demographics was on the train, pushing deflation everywhere, and that he is responsible for low bond yields. He obviously killed Monsieur Free Market, and then fled the train. Surely, you should be spending your time looking for him!”

“Ah yes”, replied Poirot, “ this is a popular bogie man for you, is it not? And yet it seems to effect different countries differently nest pa? Singapore and Korea have low birth rates, and low yields, but soaring property markets? Very unlike Japan, the spiritual home of this ‘Mr Demographics is the murderer’ theory. I fear he has become a popular scapegoat, a red herring if you will. I think we will progress far more if we begin with motives. Shall we start with you Madame ECB? Monsieur Free Market had threatened to destroy your beloved Euro project did he not? He had looked past your claims that bonds from Italy were as good as bonds from Germany had he not? He threatened to destroy a life time of work? Surely a strong motive for murder, non?”

Madame ECB looked coolly at Hercule. “It is true that Mr Free Market had moved from an ally to a hinderance, I cannot deny this. But we merely acted to keep bond spreads within tolerable levels. But surely I cannot be a suspect. As Captain BOJ and I were having drinks in the dining car when the murder happened.”

“Ah oui. First, we shall deal with motive Madame, alibis come later. But Captain BOJ, you too had your problems with Monsieur Free Market have you not? For years you have sought to keep your exchange rate weak, but at the first sign of trouble Monsieur Free Market would buy it aggressively, no? Causing deflation to return, and ruining your plans and reputation” Captain BOJ looked at Hercule and replied, “Oh no, you are quite wrong. We at the BOJ strongly believe in rules, and fairness. We are only adopting policies that other central banks use. If Madame ECB is forcing bond yields lower but that causes the Euro to be weaker than it should, then what can we do but respond.” Hercule pondered this reply. “But Captain, are you now not a close ally of the Government, have you not made it your mission to generate 2% inflation no matter what? Is it not true that you not only buy bonds, but equities too? And you care not what price you pay? Ahh - no need to answer Captain - you can save your excuses for later. And no doubt, you will also say that it could not have been you, as you were drinking with Madame ECB. Let us examine more motives, shall we?”

Hercule turned to Major Corporate. A most distasteful fellow, where profits mattered more than anything else, and which the share price was the sole criteria upon with success could be judged. Major Corporate eyes widened in surprise. “I am Monsieur Free Markets oldest and greatest friend! We have been together since the 1980s, we grew up together, I would never lay a finger on my friend! You are crazy to think I have motive” Hercule studied Major Corporate. “Tell me Major, did not Monsieur Free Market believe in the idea that freely determined market prices was the most efficient possible system? And is it not true that the biggest buyer of your shares are corporates who issues the shares in the first place? Perhaps the complete opposite of a disinterested arm's length buyer? And often these purchases are funded by bond issuances at yields below inflation, which are supported by Madame ECB and Captain BOJ? And is it not true that with this support, corporate valuations have reached all time highs? And you tell me all this, and you say you a Monsieur Free Markets best friend? Oh, I think not, if his ideas were to gain currency again, surely you would suffer a severe fall in your share price? Oh no, Major Corporate. I think you believe in capitalism, and the maximisation of capital, and for a while free markets and capitalism were the same thing. But now capitalism and free markets are very different indeed. Perhaps of all the suspects, you have the most to lose….” Major Corporate stared at Poirot, agog. “But but but, you can suspect me… I was in bed with Mademoiselle Fedresrerve when he was shot….”

Mademoiselle Fedreserve piped up, “It’s true.. we have been in love for years and Major Corporate and I were together when the murder happened…” Hercule turned to face Mademoiselle Fedreserve. She quickly averted her eyes to the floor. Hercule pursed his lips. “Ah Mademoiselle, I suspect you are the most tragic of the characters here ” Hercule said in a soft tone, and a gently as possible. “Were you not one of Monsieur Free Markets best friends? And if I remember correctly, did you not publish research suggesting that long period of low interest rates caused malinvestment and bigger problems later on?” Mademoiselle Fedreserve nodded her head slowly, almost mournfully. “Tell me, what happened” Mademoiselle Fedreserve looked up, tears welling in her eyes. “Well, it started as an experiment, a temporary experiment, but then the Japanese and the Europeans went crazy, I mean negative interest rates, and buying corporate bonds? It's crazy, but then the corporates realised what it meant for them, and then the governments as well, and when we tried to get back to where we were before, it was too late, there was too much money involved for us to go back…. but, but… I didn’t kill him… it was Old Man Demographics I tell you! Demographics created deflation, and there is nothing we can do to avoid it… I told you I saw him running away from the scene of the crime, you must believe me. He must of jumped of the train somewhere, I swear….” Mademoiselle Fedreserve broke down in tears…

Other than the quiet weeping from Mademoiselle Fedreserve, the room was still and silent. Poirot looked at Madame ECB, Captain BOJ, Major Corporates all in turn, until his eyes locked with the final suspect in the room. Chairman PBOC stared coldly back. “It is no secret that I was the least fond of Monsieur Free Market, but as we say, I don’t care if the cat is black or white, as long as it catches mice, and Monsieur Free Market caught us many mice”. Hercule looked at the Chairman, “And when you introduced capital controls, did that catch you any mice?” “No, but it kept the mice we had from leaving” Poirot took a long breathe, “So Chairman, you had motive, and no one here has an alibi for you, so you are our prime suspect I believe”

Chairman PBOC lent back in his chair and let out a huge bellowing laugh! “Oh Poirot, why I don’t just have one alibi, I have two! I was with the Madame ECB and Captain BOJ. Why we are as close as they come!!”. Madame ECB and Captain BOJ both looked sheepish, but neither denied the Chairman’s claim.

“Mon Dieu, I am a fool! It is so clear to me now!” exclaimed Hercule. Hercule turned to Bouc, “Remind me, when did China face capital outflow? Was it 2015?” Bouc thought for a moment and then replied in the affirmative. “And remind me again, when did Captain BOJ and Madame ECB begin using negative interest rates? 2016?” Again, Bouc replied in the affirmative. “Now I believe we get to the heart of things.” said Poirot.

“Madame ECB, what would have happened if Chinese capital outflows had led the Chinese to devalue back in 2016?” asked Poirot. “Well… “ said Madame ECB, “the experience of the Asian Financial Crisis and the Eurocrisis would suggest a severe collapse in Chinese demand, and ultimately a large devaluation of the Chinese Yuan”

“But what would it have meant for Europe?” queried Poirot to which Madame ECB answered “More deflation, more unemployment, slower growth obviously” Hercule looked at Captain BOJ, “What would have been true of Europe, would have been doubly true for Japan. And as Mademoiselle Fedreserve has explained, when the Japanese and Europeans acted to keep Chinese capital flows from causing China from devaluing, it has the powerful effect on corporate valuations, and Major Corporates have coaxed the Mademoiselle Fedreserve to cooperate. But of course! No single one of you could have murdered Monsieur Free Market. If required, all of you to play your part. Chairman PBOC wished to control the currency but to keep it strong, while Madame ECB and Captain BOJ wished to keep their currencies weak. Major Corporates were happy to borrow cheap, and browbeat Mademoiselle Fedreserve to cooperate. You all had motive, and you cooperated to create alibis, and the preposterous demographics arguments to hide your actions.”

Madame ECB looked at Poirot, “What would you have us do? Invite another depression? Have another lost decade? You speak of justice, but surely there is more justice in peace and growth than unemployment and breadlines!”

“Madame, your arguments are good and sound, and I have much sympathy. But I am not a man who enjoys hypocrisy. I have no proof, that you murdered Monsieur Free Markets, but we all know that you did. If you can find solace in your conscience, then let it be. For now, my work is done, and I shall rest”

Poirot retired to his room, just as the now repaired train began moving again. He understood their motives, but by tilting the scales so far to capital and corporates and away from labour, he was sure that his passengers had unleashed political forces well beyond their control. His beloved world of free markets and globalisation was dying. What would this new world look like he wondered? His thoughts drifted to populists, dictators and war. The sun slowly set below the alps.

Capital Flows and Asset Markets
Russell Clark