"There are decades where nothing happens; and there are weeks where decades happen."

So said Vladimir Ilyich Lenin. I guess he wasn’t wrong about everything.

The last month has most definitely felt like one in which decades are occurring. Many assumptions about the way in which the world works are being tested, if not simply torn up.

Finding column inches decrying the words and deeds of the US president is no more difficult than locating articles from those same news outlets cheering and praising the words and aspirations coming out of continental Europe. I have no intention of embroiling myself in a political debate about the risks or virtues of the courses of action being taken. As an investor first and foremost, suffice it to say that the significance of these potential policy shifts cannot be overstated.

Markets have been in shock over the last month. Bond yields, currencies and equity markets are spinning and reeling – buffeted from all sides by starkly contrasting rhetoric and sentiment from either side of the pond. Jean Monnet always said that Europe would be forged in crisis, and the prospect of NATO without the US is most assuredly being viewed through the crisis lens by European leaders. This is particularly true of those with underfunded militaries or who are geographically proximate to the villain du jour in Moscow. The response, in words if not yet deeds, has been resolute. It may well be a pretext, but that’s pretty irrelevant for now. Germany is wading waist deep into the fiscal Rubicon with the stated intention of making it to the other side. More fiscal policy, more defence, more cohesion, more growth and certainly more Bund supply make for a cyclical rotation. Sell bonds and buy European equities and the single currency. The starting point was a secular underweighting of the euro and European equities, with an entrenched long in euro duration as the bond investors’ equivalent. These strategic positions are being washed away in tidal bore of upratings.

Commensurately, investors, economists, commentators and Redditters are falling over themselves to downgrade the US outlook as policy-by-Truth Social reaches fever pitch with tariffs coming and going faster than I lose faith in my beloved Tottenham Hotspur (for those that don’t follow soccerball – that means very fast indeed).

This MAGA→ MEGA trend has been significantly enabled by rhetoric from the White House. On several occasions, when offered the chance to soften policy, soften words or reverse course on the basis that he may cause a recession, Donald Trump has not only refused to do so, but has actually acknowledged that such an outcome is both possible and, in his opinion, a potentially necessary evil in order to put the economy back on the right track. Again – in his opinion.

As stated at the outset – I do not wish to get into an argument about the specific desirability or wisdom of the policy prescription that President Trump has written. But I do wish to use this very real and very live example to make a much more general point about recessions.

In the last week I have seen and read countless articles essentially making the same point – if President Trump causes a recession, then his actions must be wrong. This isn’t surprising at all. This completely tallies with the received wisdom from most corners of academia and by extension the major seats of power the world over. Recessions are bad and thus actions which cause them are bad and of course actions which seek to prevent them are good.

The appeal of this rather simplistic and heuristic approach to economic management is obvious. Of course people losing their jobs is bad. Surely anyone who thinks otherwise is a heartless psychopath?

Unfortunately, capitalism just doesn’t work that way. Capitalism without default is like Catholicism with no hell. Both work because there are appropriate incentives. As Charlie Munger used to say – show me the incentives and I’ll show you the outcomes. In the case of capitalism if economic actors don’t fear the negative consequences of their decisions then ultimately they will take too much risk and, to put it kindly, there will be a significant misallocation of resources (to put it more prosaically – bad actors will do stupid things and that will cause serious economic/financial problems…the GFC contains myriad examples of this…but that would be an entire paper in itself).

The problems with this heart of gold approach to policy making don’t end there. It is not just the case that perversion of incentives will conjure the very outcomes that the policy-driven perversions were intended to prevent. It is actually the case that recessions are a necessary part of the economic cycle. This concept of “creative destruction” has been around for centuries and is most often associated with Austrian economist Joseph Schumpeter (though it was not of his creation). Even before we account for perverse incentives it is inevitable, because of economic dynamism and human psychological fallibility, that resource misallocation and economic imbalance will build up over time. These economic efficiencies work to clog the economic machinery moving the economy further away from an efficient equilibrium and ultimately impeding growth. Creative destruction serves to unclog and clear away this economic deadwood and take capital from where it is being poorly or inefficiently used and move it to where it will have maximum benefit at both a micro and macro level.  

The analogy I always use to illustrate this concept concerns forestry management in the United States. From its creation in 1905, up until the middle of the 20^th century, the US Forest Service had a policy of rapid and unequivocal fire suppression. By 1945, when suppression was materially more successful than it had been due to advent of vehicles, roads and more effective firefighting equipment, fires were to be supressed by 10am the day after they were first identified. All well and good, you might think – particularly given the devastating fires we have seen so frequently on the news in the last few years. Fire is bad – therefore stopping it must be good.

What happened, however, was that the forest began to die. By the 1960s it was realised that no new Sequoia had grown in the forests of California for some considerable period of time. For, it is the case that fire is an entirely natural and essential part of the forest’s life cycle. In forests as in economies – if the deadwood is not cleared away then there is no room for healthy green shoots to emerge.

Nasim Taleb coined the phrase naïve intervention to describe this sort of approach. Blinded by a desire to do good it is often the case that a poorly understood intervention can have significant unwanted consequences – often the very thing the initial intervention is designed to prevent or ameliorate. It seems incredibly apt in these contexts. Left unchallenged these interventions can become constant. Each intervention requires a secondary intervention to offset the unwanted consequences of the first. Extrapolate over decades and you probably end up with a situation that looks quite similar to today’s.

When I look at the US economy today, I do not see the beacon of health and dynamism that is often described by commentators and researchers seemingly blinded by aggregate statistics like GDP and the previously inexorable rise of the S&P 500 and Nasdaq Composite. To describe as strong or healthy an economy growing at roughly its trend rate, having seen record inward migration, or that is at full employment but with a budget deficit amounting to 7% of GDP, with a debt stock that’s over 100% of GDP and an interest bill that’s starting to make the defence budget blush really does strike me as misleading at best and downright ignorant at worst. If the economy is so strong and vibrant then why does it require so much government support? (I haven’t even touched on the $7 trillion worth of US Treasuries and mortgage-backed securities still sat on the Federal Reserve balance sheet, nor the similarly sized piles of assets strewn across the balance sheets of the world’s other major central banks). Furthermore if 50% of consumers within that economy are living pay cheque to pay cheque (that’s a rough number based on analysis of IRS data and surveys conducted by the Federal reserve in recent years), while all of the benefits of the growth that does exist continue to accrue predominantly to the very upper echelons of society, then really how healthy and sustainable is that growth?

I promised I would not wade into political debate, and I don’t intend to. The policies being espoused by the president are seen as shocking to most, dangerous to many and unpredictable to all. Of that there can be no doubt. But I repudiate the notion that the value or virtue of any policy action can be reduced to a binary assessment of whether the short-term effects on GDP are negative. Furthermore, I cannot accept that the status quo ante should be considered unequivocally preferable via a naïve assessment of its health and sustainability. Policies designed to affect the structure of the economy (as opposed to merely influencing its cyclical path) are notoriously hard to implement for this very fact – they de facto make things worse in the short term in order to fix deep seated problems. In that respect they are equivalent to and commensurate with recessions. At times both are necessary, and to vacuously judge either to be unacceptable, purely on the basis of their short-term negative effects, is ill-informed and irresponsible.

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