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When successful investors warn of a global market crash, we should all be nervous

Profits are so thin that the slightest pothole could cause a crash.

This year’s January sales seem to have extended to the world’s stock markets. A week in to 2016, you could buy the FTSE for 6 per cent less than on New Year’s Eve. It is the worst start to the year in at least two decades.

What is behind these New Year blues? As ever, when it comes to the markets, there is an embarrassment of plausible culprits and a cacophony of self-styled experts willing to tell you what they are. This time, however, you can also turn to someone whose hard-earned credibility is not in doubt.

Martin Taylor is probably the best-known investor you have never heard of. A legend among the trading cognoscenti, he has returned over 20 per cent a year to his investors for more than two decades. On 4 January, he announced that he was closing his Nevsky Fund, arguing that we are heading for a combination of catastrophes that even the most skilful investor will be unable to avoid. His assessment makes fascinating reading. The root of the challenge that Taylor sees facing the world economy is simple. In December 2015, the US Federal Reserve raised its policy rate from near zero for the first time since December 2008. It is likely to be the start of a cycle. The direct effect is that the cost of borrowing dollars is rising. The indirect effect is that the dollar is strengthening on the foreign exchanges. After seven years in the bargain basement, the greenback is becoming expensive again.

Interest-rate hikes are always a shock to the system but they have happened numerous times before over the past few decades: so why should they be such a problem now? The answer is that, this time, the situation is different in three crucial respects. First, interest rates have been stuck at unusually low levels for an unusually long period of time. (In Britain, the Bank of England’s rate has been 0.5 per cent since 2009.) Borrowers throughout the economy have got used to easy money; a generation of homeowners and investors has never seen anything else. After more than seven years of cheap debt, the shock of the old will be all the worse.

Second, a terrible irony is at work in the corporate sector. Companies have responded to the lacklustre recovery from the global financial crisis with Protestant virtue, cutting costs and sweating assets, to make do now in the hope of better times ahead. Yet the perverse result is that even those companies that have not gorged themselves on free money are ill-prepared for the end of the cheap dollar era. Profit margins are so thin and balance sheets so stretched that the slightest pothole may cause a crash.

If we are lucky, that possibility will not materialise. Taylor’s third fear already has. In today’s financially globalised world, the US dollar is the currency not just of America but of half the countries on the map. Borrowing in US dollars by companies in emerging markets stood at a staggering $4trn as of June 2015. Rising US interest rates will put the squeeze on them, too.

By far the most important participant in this global dollar economy is China. Its companies have borrowed over $1trn. Now, just when the Chinese economy is slowing, its debts are becoming more onerous as the dollar becomes more expensive.

If that all adds up to a dismal outlook for the world economy, Taylor’s verdict on the state of the financial markets is perhaps even more worrying. Whereas many of us find William Goldman’s verdict on the movie business – “Nobody knows anything” – remarkably apt when it comes to economic predictions, few would bet against an assessment of the financial markets from a man with Taylor’s experience.

The successful co-ordination of modern capitalist economies rests on three critical supports. The first is reliable data – about company performance and macroeconomic activity – on which people can base their decisions. The second is the transparency and logical coherence of the frameworks used by powerful non-market actors: central bankers, politicians and regulators. The third is well-functioning stock, bond and currency markets, which generate prices that provide true signals to investors, businesses and governments.

Today, Taylor argues, all three supports seem ramshackle. China is the world’s second-largest economy and the decisive market for most emerging economies, yet its own leaders deride its macroeconomic statistics as unreliable. The old theories of monetary policy were discredited by the crash and nothing has yet replaced them, and so no one fully understands what central bankers are doing. The financial markets, meanwhile, are dominated by computer-driven trading. They have become a postmodern parody of themselves, in which prices are determined not by economic fundamentals but by the behaviour of other prices.

With an economic and financial-market outlook such as this, the New Year hangover for stocks hardly comes as a surprise. Yet there is a germ of optimism amid this well-founded gloom. In Taylor’s analysis, there is barely a mention of any of the structural economic challenges that have been exercising policymakers recently: the secular stagnation, the slowdown in productivity, the threat of technological unemployment, and so on. The problems that he foresees are, almost without exception, financial.

If this diagnosis is correct (and, in large part, I think it is), it is a reason for hope. We are not condemned to crisis or stagnation by epochal forces outside our control. It is the financial system – rules and institutions of our making – that has gone awry. The hardware of the global economy is in reasonable shape. It is only the software that has become corrupt. As such, it can be debugged. The alternative is a crash.

Macroeconomist, bond trader and author of Money

This article first appeared in the 14 January 2016 issue of the New Statesman, David Bowie

How Jim Murphy's mistake cost Labour - and helped make Ruth Davidson

Scottish Labour's former leader's great mistake was to run away from Labour's Scottish referendum, not on it.

The strange revival of Conservative Scotland? Another poll from north of the border, this time from the Times and YouGov, shows the Tories experiencing a revival in Scotland, up to 28 per cent of the vote, enough to net seven extra seats from the SNP.

Adding to the Nationalists’ misery, according to the same poll, they would lose East Dunbartonshire to the Liberal Democrats, reducing their strength in the Commons to a still-formidable 47 seats.

It could be worse than the polls suggest, however. In the elections to the Scottish Parliament last year, parties which backed a No vote in the referendum did better in the first-past-the-post seats than the polls would have suggested – thanks to tactical voting by No voters, who backed whichever party had the best chance of beating the SNP.

The strategic insight of Ruth Davidson, the Conservative leader in Scotland, was to to recast her party as the loudest defender of the Union between Scotland and the rest of the United Kingdom. She has absorbed large chunks of that vote from the Liberal Democrats and Labour, but, paradoxically, at the Holyrood elections at least, the “Unionist coalition” she assembled helped those parties even though it cost the vote share.

The big thing to watch is not just where the parties of the Union make gains, but where they successfully form strong second-places against whoever the strongest pro-Union party is.

Davidson’s popularity and eye for a good photo opportunity – which came first is an interesting question – mean that the natural benefactor in most places will likely be the Tories.

But it could have been very different. The first politician to hit successfully upon the “last defender of the Union” routine was Ian Murray, the last Labour MP in Scotland, who squeezed both the  Liberal Democrat and Conservative vote in his seat of Edinburgh South.

His then-leader in Scotland, Jim Murphy, had a different idea. He fought the election in 2015 to the SNP’s left, with the slogan of “Whether you’re Yes, or No, the Tories have got to go”.  There were a couple of problems with that approach, as one  former staffer put it: “Firstly, the SNP weren’t going to put the Tories in, and everyone knew it. Secondly, no-one but us wanted to move on [from the referendum]”.

Then again under different leadership, this time under Kezia Dugdale, Scottish Labour once again fought a campaign explicitly to the left of the SNP, promising to increase taxation to blunt cuts devolved from Westminster, and an agnostic position on the referendum. Dugdale said she’d be open to voting to leave the United Kingdom if Britain left the European Union. Senior Scottish Labour figures flirted with the idea that the party might be neutral in a forthcoming election. Once again, the party tried to move on – but no-one else wanted to move on.

How different things might be if instead of running away from their referendum campaign, Jim Murphy had run towards it in 2015. 

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to British politics.

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