Recent political events across much of the developed world have signalled an end to the policy consensus that has existed for most of the last 30 years. The free-market liberalism which took hold in the US and UK in the early 1980s, and subsequently across much of the developed and emerging world, heralded a period of economic stability and globalisation, which has been characterised by the free movement of capital, labour and trade.

Globalisation has, in aggregate, led to economic gains, and has created many winners. A wide range of developing economies have benefitted from increased trade, with countries such as China exporting cheaper goods to the West, resulting in millions being lifted out of poverty and the emergence of a growing middle class. Consumers in developed markets have also gained from cheaper, imported products and from increased choice and competition.

However, there have been losers too. Most notably, many jobs in developed economies have been lost and transferred to lower-cost countries. In other cases, middle-class workers have seen their pay stagnate for years, often with the perceived threat of jobs being exported to the developing world. Workers have also faced the challenge of technological disruption, with many traditional jobs at risk in sectors such as retail as businesses move online. Such an environment has led to wage deflation: taking the UK as an example, the chart below highlights that while the country’s GDP has risen over the last 20 years, wages have fallen in real terms, with average wages lower than they were 20 years ago.

UK wages as percentage of GDP vs nominal GDP

Source: Bloomberg, Office of National Statistics, Newton, February 2019

In the US, while unemployment may be at its lowest rate for 50 years, the low-paid nature of numerous positions means that many individuals are struggling to make ends meet. According to the US Census Bureau, over 50% of under-18s live in a household receiving welfare payments.1 This is reflected by data which shows that the US corporate sector’s contribution to the country’s economy (measured by after-tax profits) has risen to record highs over the last 20 years, while employee compensation’s share has significantly declined.2

The crisis effect

The aftermath of the 2008 global financial crisis has reinforced the trends which had already been developing over the previous two decades. Extraordinarily loose monetary policy such as quantitative easing has driven asset prices higher. However, this price inflation has been concentrated in financial assets, and so those people with assets have seen their wealth inflated, while those without such assets have seen them become often unaffordable. With the great bulk of financial assets owned by the few (a study suggests that 84% of US stock-market wealth is owned by 10% of the population3), the result has been an increase in inequality.

Total return performance in local currency since January 2009

For illustrative purposes only. Source: Bloomberg, March 2019.

In addition, while profits have soared once again, wages have stayed low and public services have been cut, while governments have made little headway in tackling the effects of longer-term structural challenges facing their economies, such as the debt mountain, ageing demographics, and technological disruption. With austerity a near-permanent feature in recent years for many countries, it is perhaps unsurprising that more extreme politics have begun to attract growing support.

The inexorable rise in populism

A series of events over the last five years have defined the continuing surge in populist movements. One of these was the election of Donald Trump as US president, and his administration’s subsequent protectionist policies which have included the trade dispute with China. However, the majority of these developments have taken place in Europe, where the overall populist vote share has risen from 7% in 1998 to over 25% in 2018.4 Significant events in Europe have included the UK’s 2016 vote to leave the European Union, the formation of a populist government in Italy following an indecisive election result in March 2018, and, most recently, the ‘gilets jaunes’ protests on the streets of France.

Such developments indicate to us that we may be entering a new ‘post-globalisation’ era, which is likely to look very from different from the previous 30 years. In particular, history suggests that populist policies result in fiscal expansion, as governments are forced to consider radical new means of empowering their citizens. This can lead to inflationary pressures, higher debt (leading to higher bond yields) and, ultimately, an economic slowdown, as occurred in the UK in the 1970s. There is also a growing wave of support for what is being described as ‘modern monetary theory’ (MMT) or ‘helicopter money’. This centres on a belief that, as a government owns its currency, it can essentially run an infinite deficit to fund whatever it desires, because a public-sector deficit has always resulted in a private-sector surplus. However, such a policy could only work if central banks maintained interest rates at a very low level without sparking inflation.

From an investment perspective, this new era is likely to be very different from the previous 30 years. The global economic uncertainty index indicates that such uncertainty is now higher than at the height of the global financial crisis,5 and, with the potential for further populist developments, it is likely that volatility will remain elevated. Furthermore, correlations between equities and bonds may continue to break down. Historically, this relationship has tended to see bonds perform better when equity markets have taken a dive and vice versa, acting as an important diversifier for multi-asset portfolios. However, in a more inflationary environment, there is potential for both asset classes to be weaker: inflation will naturally eat into fixed-income returns, but rising yields can also make the stocks of those companies with higher debt look less attractive compared with ‘safer’ securities. In such an environment, ‘growth’ stocks, which have driven much of the stock-market gains over recent years, may be less favoured, with ‘value’ equities making a comeback.

While the stimulus of recent years may have helped a rising tide to raise all boats, we believe we may now be entering a financial regime that is very different from the world we have become used to. In seeking to navigate this uncertain environment, we believe the importance of an active, flexible portfolio, with an eye to capital preservation, is likely to come to the fore.

1 Source: US Census Bureau, 2017
2 Source: Bloomberg, CPA London, March 2019
3 Household wealth trends in the United States, 1962 to 2016: Has middle class wealth recovered?, Edward N Wolff, National Bureau of Economic Research working paper 24085, November 2017
5 Source:, August 2019

We have long held the view that, in terms of economic and monetary policy, the global direction of travel is broadly towards greater levels of state intervention. In recent times, Modern Monetary Theory (MMT), a fringe school within academic economic circles, has become the latest potential example of how this might play out.

MMT has recently arrived on the main stage via politics in the United States, courtesy of Democratic Party politicians such as Alexandra Ocasio-Cortez and Bernie Sanders’ 2020 presidential campaign manager Stephanie Kelton, but what exactly is it?

Before addressing this, it is worth reviewing why an unorthodox economic policy is gaining serious airtime within the public discourse in both the US and Europe, and why we have to regard it as a realistic future policy platform.

The new masters of the universe?

Before the global financial crisis, central banks barely registered on the radar of the general public, reflecting the ‘laissez-faire/light touch’ approach most took towards economic management. Ten years of monetary policy experimentation, however, has ensured politicians and the general public are well aware of the existence and actions of monetary policymakers.

While it is fair to say that the general public does not fully grasp the full and often arcane remit of central banking, a decade of money printing and unprecedented asset-purchasing programmes has not gone unnoticed. Today the public’s perception of the central bank is that of an institution tasked with managing the economy. Central banks, however, are not beyond reproach. There is a growing recognition from both politicians and electorates that through asset purchases, they are likely to have played a key role in returning the world to levels of wealth inequality not seen since the 1920s.

And that is not the only charge levelled at central banks; the performance of the majority of major economies in the aftermath of the financial crisis is deemed by many to have been below par. With the orthodoxy of ‘austerity economics’ largely still intact, governments focused on reducing fiscal deficits, and so the task of returning economies to full health fell to the central banks. Leaving aside the question of whether this was the correct policy decision, rate cuts and money printing/quantitative easing (QE) have failed to return economic growth rates to pre-crisis ‘norms’.

Given this failure, it is perhaps surprising that central banks are being looked to at all as a potential solution to apparent current problems. Rather than question whether monetary easing is the correct medicine (or indeed whether the problem has been correctly identified), central banks are likely to be asked to do more, and this is where the ‘Monetary’ in Modern Monetary Theory comes in.

Will next time be different?

When the next downturn does come, central bankers are once again likely to stand ready to stimulate economies, but the only problem is that they are nearly out of ‘ammunition’. With interest rates close to zero across most of the developed world, the scope for rates cuts of a magnitude similar to those in previous rate-cutting cycles is simply not there, while the buying of financial assets is increasingly becoming politically unacceptable. Taken in combination, these factors mean that greater coordination between monetary and fiscal policy – the essence of MMT – is the likely response to growing demands from dissatisfied electorates for governments to do more.

The rise and rise of the state

At its core, MMT is the recognition that government spending is not constrained by how much the government can tax or borrow (at least not if the government has independent control of its own money-printing press and no obligation to maintain a fixed exchange rate), whether against gold or another fiat currency. In these terms, therefore, the US federal government is not constrained, but the governments of Italy, say, or Hong Kong, are, so it is important to recognise that not all countries meet the conditions necessary to implement the policy prescriptions of MMT.

Print and spend…

Where governments do qualify, proponents of MMT argue policymakers can (and should) print and spend as much money as necessary to ensure all resources are fully exploited. Anything less than the full use of resources – in particular labour – is considered to be a failure of policy. The government can print the money necessary to pay public employees as much as it wants, with no nominal limit. As such, the MMT argument goes that governments should exercise this power to ensure all workers have paid employment – often referred to as a ‘job guarantee’ programme. Failure to use fully the resources available means economic output (and thus collective welfare/prosperity), is not at full potential.

When this is the case, MMT proponents argue that the government should increase deficit spending, and this is where the central bank comes in. The MMT view is that the increase in deficit spending should be financed through central-bank money printing, either via crediting the government’s account at the central bank directly (effectively permanently extending a limitless line of credit to the government), or by buying the debt instruments issued by the government with newly created money, otherwise known as debt monetisation.

Both methods of financing government spending would boost nominal demand. Fiscal policy would be the main tool used to manage the economy, with monetary policy playing a supporting role by fixing interest rates at or close to zero. It is important to recognise that, should these policies be put into action, it would mark a radical departure from the status quo of the last few decades, during which interest rates have been the main tool for managing economies.

…But not too much

While many MMT advocates see no constraints on government spending in nominal terms, they do recognise that there may be constraints in terms of the availability of real resources, in particular labour supply. They advocate using inflation targeting to calibrate fiscal policy. If a given amount of money printing and deficit spending results in the desired amount of inflation, policy is regarded as correctly calibrated. However, if inflation is seen as below target, they would argue for the government to print and spend even more money.

If inflation were to overshoot the target, the government can take some of the money back out of circulation, either by increasing taxation relative to government spending, or by issuing government debt.

More money, fewer problems?

What governments will use their respective printing presses to finance in the future, should policymaking evolve along the lines advocated by MMT exponents, cannot be known. We have no clarity on what policy goals future leaders, democratically elected or otherwise, will pursue, but we can say that MMT has gained the greatest traction with people that occupy what is traditionally defined as the left side of the political spectrum.

As such, many of those calling for the implementation of MMT want increased spending on items such as public health care, education, universal basic income and a ‘Green New Deal’, as promoted by Democratic Congresswoman Alexandria Ocasio-Cortez. In this respect, the current crop of high-profile MMT advocates subscribe to the socialist economist Abba Lerner’s assertion – put forward in the 1940s under the banner ‘functional finance’ – that the government should use all its tools, and use them as much as necessary, to achieve its goals. The uncomfortable truth from history is that, once the printing press is used to finance government deficit spending, financial and economic instability has often followed.


To this end, MMT is not without its critics, and a full discussion is beyond the scope of this piece; rather, the purpose is to outline how policy is likely to evolve. It should be noted that we have intentionally focused on the mechanics through which monetary financing of fiscal deficits can be achieved and how this differs from the current status quo. It is also by no means exhaustive – even among proponents of MMT, there is considerable disagreement about the detail of how it should be implemented. This obviously makes opining on how greater coordination between monetary and fiscal policy will affect economies and financial markets in the future difficult, which is compounded by the lack of visibility as to the projects increased government spending would prioritise. What we can say is that it would constitute a structural break from the policies of the last few decades.

While we cannot be certain how monetary and economic policy will evolve, it is likely that it will move further from the free-market liberalism consensus that predominated before the global financial crisis. As investors, it is imperative to monitor how economic and monetary policy evolves. For whatever its perceived successes or failures, the era of free-market liberalism has delivered remarkable returns to investors.

Valuing gold from an investment perspective can be tricky as there is no obvious yield. It may sound counter-intuitive, but we believe that it is necessary to think about money creation to understand why gold might be useful to investors.

What’s the point?

For most professional investors, the shiny metal is a relic of the past that serves little useful purpose in today’s complex and sophisticated investment landscape. We believe that part of the problem of how gold is perceived lies in too much emphasis being placed on what gold is (a metal with no apparent intrinsic value), and too little discussion about what almost all other financial assets are (paper promises to pay). What is interesting is that, for most of human history, precious metals were a superior form of ‘money’ to IOUs; today, it is the reverse. We would argue that much of that change in perception is the result of stability and ‘progress’ in an economic and societal sense, but (and it is a big but) finance is not science, and, however sophisticated we may think we have become, we tend to make the same mistakes (generally involving money debasement and leverage) over and over again.

The stark truth is that most money is credit and is created by commercial banks. Unsurprisingly, banks create the kind of money that suits them at any particular time. This is why they need to be regulated and why, if policy is not well thought out, much of our credit growth can consist of claims on non-productive assets that do not support future GDP. As our ‘financialisation’ theme identifies, the recent history of persistent loose monetary policy has created strong incentives in the financial system to emphasise financialisation overtaking risks to finance the real economy. As Bernstein puts it, “the growth in claims on the future productive capacity has grown faster than the productive capacity itself”, which means that we are piling more and more liabilities on a slowly growing productive base.1

It is in this context, of one person’s asset being another’s liability, that the monetary authorities’ view that inflating asset prices (via quantitative easing, for example) also inflates ‘wealth’ can be seen as somewhat fallacious. In aggregate, it does not – indeed, like all inflations, it is better described as a wealth transfer. Moreover, asset-price inflation has significant costs (such as inequality and financial distortion), some of which are already apparent in the fractious nature of politics in much of the Western world. The costs in terms of misallocation of capital are likely to emerge when the asset-price tide goes out.

We have consistently argued that policymakers have risked stoking the third major bubble in the last two decades, and it appears to us that the US Federal Reserve’s ‘pivot’ to a more dovish stance in response to the market’s winter swoon all but confirms it. The scale of the financialisation of the US economy is breathtaking. Bank of America Merrill Lynch reports that the value of private financial assets is approaching six times GDP, whereas a range of 2.5-3.5 times was normal for the 50 years before 2000.2 The financial-market tail now really does wag the real-economy dog. If the market goes down, so does the economy.

Why hold gold?

With this in mind, the key factor for gold is that it is not anyone’s liability; it is not a promise to pay, and is thus not part of the credit system. This makes it a good insurance policy in times of credit stress, and thus a good diversifier in a portfolio context. In addition, gold cannot be printed at will (it is increasingly difficult and costly to extract), the supply of gold is fairly flat, and the stock/flow dynamics are quite different from industrial commodities in that annual production is tiny in comparison to the amount of gold in circulation. Moreover, gold has physical monetary attributes (principally lack of degradation) which have been proven over thousands of years. Some may think that that is irrelevant in today’s digital world, but with cyber-security breaches presenting more and more issues, we do not think physical assets are a feature of the past just yet.

As an investment, the ‘barbarous relic’ has tended to keep its value in real terms over the (very) long term. However, we need to be careful with returns statistics over extremely long time periods. What are important are time periods that represent sensible investment horizons, and there is no doubt that gold has had multi-decade periods where its price performance has been poor. We are therefore not suggesting that gold is an asset for all seasons unless one plans to live forever!

When would you want to hold gold?

Traditionally, there are a number of reasons you may wish to hold gold. For example, if there was a reasonable risk of monetary inflation or debasement, or if the credit system looked shaky, or if the prevailing monetary system was under strain, or even if the faith in central banks to levitate asset prices was to be found wanting.

The following are just some (of the less extreme) scenarios that we believe are reasonably plausible in the months and years ahead:

  • In the recent past, we have had lots of monetary inflation (central banks have printed something like $12 trillion since the global financial crisis) and asset inflation, but hardly any consumer-price inflation. The next cycle, or the down leg of this one, is likely to see efforts to create inflation redoubled. Using monetary finance to reflate real economies rather than reward asset owners is already being talked about (‘modern monetary theory’ and the like).
  • The current credit cycle is a monster with all the usual characteristics, such as excessive leverage, lax investor protection (covenants falling away) and dubious accounting. China is currently setting a world record for corporate leverage.
  • The Trump administration’s keenness to eliminate bilateral trade deficits seems to be at odds with the current monetary system (a de-facto US-dollar standard) which relies on the US doing just that in order to provide the world with a supply of dollars.
  • Central banks are short on traditional ammunition to counter the next crisis.

Subtle changes in the world order, away from multilateralism to more polarisation, may also be spurring central banks (such as in China and Russia) to increase their reserve holdings of gold.

As a final thought, it’s worth considering how investment has changed over the last few decades. The ‘great levitation’ in asset prices has combined with modern financial theory and computing power to create a system where the end saver or investor is likely to invest in a ‘structure’ linked to an index which is someway removed from the underlying assets. In this world, ‘price’ is the key determinant of worth, and historic price volatility is the primary measure of risk.

The problem for gold in the institutional portfolio context, and why it is perhaps more suited to the individual investor, is that price is not always relevant; investors who want a generalised ‘insurance policy’, or central banks that want to diversify away from fiat currencies, also see value in other attributes that are independent of price. This concept is more likely to be understood by investors in the developing world rather than those of us in the West who have experienced the most stable period in human history.

That is not to say that institutional investors should not consider a holding in gold. However, we believe they should not expect it to perform in a conventional manner, and should perhaps think of it more as a ‘currency’ that they are choosing to denominate a portion of their assets in, and which should retain its acceptability, liquidity and value in times of stress.

1 Bernstein: Global Quantitative Strategy: A strong case for holding gold
2 Bank of America Merrill Lynch

Environmental, social and governance (ESG) risks are of increasing importance to investors. ESG analysis has its roots in sustainable and ethical investing, and there are no universally accepted definitions of these risks. However, given that these factors affect a government’s ability and willingness to pay its debt obligations, ESG factors have always been part of our sovereign credit research here at Newton.

Indeed, our sovereign investment process has always begun with an expectation that issuers retain a realistic appreciation of their fiscal/economic, social and political reality. From an emerging-market perspective in particular, this requires an acceptance of past failings and policy constraints under which governments will (we hope) aim to navigate a path of reform towards improved prosperity and greater creditworthiness.

Not all ESG risks are the same

ESG risks are commonly referred to as a single category of risks, but, although often related, they are in fact distinct. Environmental factors reflect the physical conditions under which a government operates, both now and in the future. The examples of those governments significantly exposed to environmental risks are plentiful. For smaller Caribbean island states, characterised by low incomes and volatile economic growth, the International Monetary Fund (IMF) calculates the cost of annual hurricane damage to be as much as 2.4% of GDP, while low-rated countries such as Cambodia, Kenya and Rwanda are acutely exposed to climate change via agriculture’s 30%+ contribution to GDP. Among the GCC (Gulf Cooperation Countries), the vast financial assets of some smaller issuers (such as Kuwait and Abu Dhabi) should make it easier for them to adapt to reduced demand for fossil-fuel exports, while their more populous or indebted neighbours (like Saudi Arabia or Bahrain respectively) may feel these risks more acutely. The World Economic Forum’s Environmental Protection Index and Notre Dame University’s Global Adaptation Index represent widely used rankings of countries’ vulnerability to climatic disruption and capacity to adapt to these challenges.

Social considerations encapsulate those factors derived from a society’s characteristics and structure, and include issues such as demographics, education levels, the social safety net, and income levels. These factors are significant from a sustainable/ethical investment standpoint, but also have implications for sovereign creditworthiness. Higher education standards tend to be associated with high productivity levels (see the contrast in long-term economic performance of Northeast Asian economies with their Latin American peers), while low-income countries are typically associated with a narrow tax base and a limited ability to carry debt. Furthermore, high income inequality erodes the social contract between a government and its citizens, and, when combined with a large underemployed young population, can often lead to violent protest and demands for social change (the Arab Spring of 2010 is a prime example), raising investor uncertainty and therefore borrowing costs. The United Nations Human Development Index captures many of these factors, with Norway currently ranked the highest and Niger the lowest.1

Governance analysis captures the effectiveness, quality, predictability and transparency of a government’s institutions, both political and social, in the sense of policy implementation, and its broader integrity with respect to corruption, power transition, and the rule of law. Governance is the ESG risk factor most closely correlated (over -0.5) with borrowing cost premiums, and is the primary input to the sovereign ratings methodology of one of the major credit-rating agencies. Respect for the rule of law is a key indicator of willingness to pay, and a weak legal framework typically results in lower investment and economic growth. President Macri’s 2015 election victory in Argentina, and the institutional reforms and curing of default that followed, triggered a sharp decline in Argentina’s borrowing costs. In Turkey, meanwhile, the erosion of electoral transparency and judicial and media independence, and the concentration of policymaking under President Erdogan, has coincided with a sharp rise in the country’s borrowing costs in recent years. The World Bank’s Governance Indicators and Transparency International’s Corruption Perceptions Index are valuable and widely used measures of governance-related sovereign risks.

Building an ESG sovereign index

Combining these environmental, social and governance inputs allows us to build an ESG sovereign index with which we can evaluate countries’ existing ESG risks, as well as the direction of travel and sustainability over time. Mapping our ESG country scores against five-year sovereign credit default swap (CDS) spreads – a consistent measure of credit risk – illustrates the degree of negative correlation between ESG rankings and sovereign credit risk. The strength of the negative correlation is not as high as that between GDP per capita or credit ratings and sovereign spreads. This reflects the importance of GDP-per-capita growth to the ability and willingness to pay, as well as highlighting the status of income levels and economic strength as primary inputs to the sovereign rating methodology of two of the world’s major rating agencies. That said, ESG factors do help to capture the residual component of CDS spreads not explained by sovereign credit ratings.

Source: Data from Newton, Bloomberg, UN, WB, World Economic Forum, University of Notre Dame and Transparency International, June 2019.

The emerging angle

ESG risks can be particularly important to consider in the emerging world. For, while the privilege of reserve currency status, high income levels and established institutions provide a considerable buffer to developed markets, for emerging markets there is a greater degree of negative correlation between changes in ESG scores and sovereign credit spreads, as improved institutional and governance settings help to support economic growth, capital flows and the balance-of-payments backdrop. Ecuador and Mongolia are two examples where positive electoral changes and significant ESG improvements in recent years have allowed spread tightening amid improved policymaking and ultimately IMF support.

Source: Data from Newton, Bloomberg, UN, WB, World Economic Forum, University of Notre Dame and Transparency International, June 2019.

Combining data from the previous two charts helps to illustrate whether current levels of spread compensate investors for the trend in emerging-market sovereign ESG scores. This analysis could potentially highlight some attractive investment and alpha opportunities (via high carry and significant capital appreciation) in countries where credit spreads have yet to narrow in accordance with significant progress on environmental, social, and (particularly) governance risk factors. Argentina is a notable example in this regard. Conversely, this approach also helps to ensure countries with optically ‘cheap’ spreads can be contextualised in the reality of sharply deteriorating ESG measures (e.g. Turkey).

Source: Data from Newton, Bloomberg, UN, WB, World Economic Forum, University of Notre Dame and Transparency International, June 2019.