AI beats humans in an increasing number of games because it is able to make guesses about a much higher number of scenarios and because it is not subject to emotions. Humans, on the other hand, have various manufacturing flaws that lead them to be linear and extrapolative in their way of reasoning and to foresee a limited number of scenarios. Faced with Brexit, a shock, the European stock exchanges reacted by losing up to 12 percent because they stopped to see the event without looking at the context (the global economy which continues to grow) and without giving weight due to the next move (the expansionary reaction of central banks and governments).
The emotion then led to thinking in a linear and extrapolative way that Brexit would produce a domino effect, increasing Eurosceptic sentiment in all European countries and everywhere promoting referendums for leaving the Union destined to be won by nationalist forces without fail. In this context, the Italian banking crisis would quickly become European and global. Someone (Soros) has evoked gloomy scenarios and assumed a global crisis worse than that of 2008 as imminent.
And here we are, two weeks after Brexit, with the New York Stock Exchange at all-time highs and with that of London up 7 per cent on the beginning of the year. Why? Let's start from the epicenter of the earthquake, the United Kingdom, which has already demonstrated, with the drastic devaluation of the pound, with a Bank of England with an excellent capacity to control the situation and with the rapid formation of a new cohesive and strong government , to have the main quality needed to absorb shocks, flexibility. The European history of recent years is a clamorous confirmation of the fact that the flexible win and the rigid lose.
Ireland has suffered in the crisis like Italy, but has drastically cut public spending, allowed the highest percentage of residents in all of Europe to emigrate without feeling sorry for themselves and kept taxes low. The result is that Irish GDP grew by 26 per cent in 2015 (with all the ifs and buts of the case, pace Krugman, it is still an impressive figure) and will grow a lot again this year thanks to the exiles from the City of London. France, by contrast, has maintained high taxes and rigidity and thus finds itself with zero growth and strong social discontent. The United Kingdom will certainly follow the path of Ireland rather than that of France. He will suffer for a couple of years and then recover.
European public opinion has also reacted positively to Brexit. Spain voted for stability and in Germany the desire to keep close to the European Union is back strong, Cdu and Spd have returned to growth in the polls (while AfD is in free fall) and Merkel is once again firmly at the helm. The French Gaullists are taking away Le Pen's space with sensible proposals for the democratization of the Union. Mind you, Europe remains the most fragile area of the developed world, but it is not descending into chaos. Thanks to Brexit, European fiscal policies are further softening. Spain and Portugal, which have sensationally gone over the deficit, have had their ears symbolically pulled, but nothing more. The same will happen to Italy and France. Merkel ignores it and lets the Commission do it. A stronger Merkel will also have more room to allow Italy to tackle its banking crisis with fewer social costs.
Brexit prompted the Fed to de facto postpone a possible rate hike to December. The fear that Brexit could take American forms with Trump as president induces the central bank to push the accelerator as hard as possible and not to disturb the share price rise. Earnings are lower than a year ago and the stock index is higher, but nobody is talking about a bubble anymore. Brexit was then joined by Abe's strong electoral victory in Japan. Abenomics may have disappointed, but voters intelligently understood that without Abenomics it would have been worse. Strengthened by this consensus, Abe will relaunch that mix of monetary and fiscal policies for which the only thing still to be decided is whether it should be called helicopter money or not (a marketing choice, not a policy one).
As Blanchard noted, There's a bit of false advertising going around on helicopter money by those who extol its miraculous virtues. In fact there is a lot of confusion and it is worth clarifying. Between the early Qe and the helicopter money there is a continuum with various gradations of color. The first Qe was the temporary purchase of bonds by the central bank with the commitment to sell them as soon as possible. Over the years, the temporary purchase became medium-term and then long-term. Expiring bonds are being replaced with longer and longer bonds (the Fed is doing it too). For now we stop at 30 years, but there is already talk of 50 or 100. Bernanke is suggesting to Abe that he issue zero-interest perpetual bonds to be bought by the Bank of Japan instead of the current JGBs.
Perpetuals are the modest form to express the concept of definitive cancellation of the debt. The next step is the official cancellation of debt held by the central bank. So far, attention, we are on the monetary. The fiscal begins when the government, which has seen its debt stock gracefully lowered, decides, by spending, to bring it back to the previous level. Then, as we said, there are the marketing aspects, which could however have an economic impact. In accounting terms, in fact, the difference between infinite debt extension and cancellation is formal, but economically it becomes substantial if taxpayers, freed from the prospect of future taxes that one day will have to repay the debt, relax and start spending more. The shift towards full-blown helicopter money will take place gradually and with experimentation that we will soon see in Japan and perhaps, later, in the United Kingdom. In America, on the other hand, after the elections, we will see a tout court increase in public deficit spending, but without monetization.
In Europe things will be slower and more difficult, but between the greater tolerance of budget overruns and the possible introduction of a mutualised unemployment benefit something will be seen. In the medium term, recourse to increasingly aggressive monetary and fiscal policies will increase inflation expectations and will not be good for bonds. In the short term, however, the European and Japanese Qe, by crushing government yields below zero, will continue to push many investors to seek refuge in Treasuries and will therefore keep the American curve compressed. With the curve increasingly flat, it will gradually make less sense to stay on long maturities. For stock markets, the prospect of even more expansionary policies is obviously positive until these policies translate into higher rates. And until the US elections in November, rates are unlikely to rise.
Last point. Why did the markets show impatience with China, geopolitics and oil in January, while today they cash in Brexit and the renminbi at lows with a smile? The difference is not in the monetary responses (which also occurred in February and March) but in theUS economy, then weak but now in good health. Let's keep this in mind for the future and for the upcoming autumn and spring referendum and electoral deadlines.
