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James Athey's view on: French election - no need for panic, but caution warranted

In his latest update, Marlborough Global Bond Co-Manager James Athey shares his thoughts on the market implications of elections around the world.


I was recently sent a quote often attributed to Alexander Fraser Tytler, an 18th/19th Century Lord (Lord Woodhouselee) and judge (although the first part is sometimes attributed to 19th Century French political philosopher Alexis de Tocqueville):

"A democracy is always temporary in nature; it simply cannot exist as a permanent form of government. A democracy will continue to exist up until the time that voters discover that they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy, ensuing, always to be followed by a dictatorship, then a monarchy. Nations always progress through the following sequence: From bondage to spiritual faith; From spiritual faith to great courage; From courage to liberty; From liberty to abundance; From abundance to selfishness; From selfishness to complacency; From complacency to apathy; From apathy to dependence; From dependence back into bondage."

The second half of this quote has come to be known as the Tytler Cycle or Fatal Sequence.

In his writings, Tytler was often critical of democracies, in particular representative democracies, such as we have across the developed world today, on the basis that they are a chimera which produces a mirage of freedom and sovereign power among citizens. His conclusion was to favour monarchies – he described all government as essentially of the nature of a monarchy.

In the modern world it would be hard to find too many citizens, and even fewer political scientists or historians, who would agree with those conclusions, even if many would acknowledge some of the criticisms of the functioning of the democratic system.

As Winston Churchill famously said: “Many forms of Government have been tried, and will be tried, in this world of sin and woe. No one pretends that democracy is perfect or all-wise. Indeed, it has been said that democracy is the worst form of government… except for all those other forms that have been tried from time to time.”

Reading these quotes, one cannot fail to see the pertinence with respect to the present-day political discourse.

Over the next six months there will be general elections in the UK, France and US, following on the heels of elections in major democracies of the developing world, in India and Mexico. In the space of a single calendar year over half of the world’s democratic population will have had the chance to vent their frustration, or champion their causes, at the ballot box.

Quite obviously, given the significant differences between these economies and the specific challenges they face, the issues which are top-of-mind for these various electorates are not identical. However, one strand of discourse which has played, and will continue to play, a major part in the election results themselves but also the perceived success or failure of the manifestos of those parties which emerge victorious, is fiscal policy. What role should it play, and to what extent should voters be concerned about the potential negative effects of one approach versus the alternatives.

This is where the quote from Lord Woodhouselee at the beginning of piece becomes so relevant. The days of economic policies of left and right being starkly divided by the battle between state ownership and activist public spending versus free markets and fiscal conservatism seem dead. In many cases parties from the extreme right of the political spectrum propose policies which are further left with respect to government deficits than those being espoused by traditionally left-leaning or even socialist parties. Nationalism and identity politics coupled with the perceived lack of differentiation among centrist parties of right and left has created a fracture in the political spectrum which has allowed strong leaders, demagogues and populists to soar in popularity.

Both the long shadow of the Global Financial Crisis and the bi-partisan support for fiscal incontinence have created a potentially explosive environment of unhappiness, unease and unrest across great swathes of the global democratic population. The former through the apparent distribution effects of monetary policy, as a response to the economic challenge. The latter leading to a generational inflationary shock and the inevitable decimation of real incomes. In point of fact similar dynamics may be occurring in the worlds’ biggest autocracies but of course data to support such an assertion is far less easy to come by.

Investors often dismiss the significance of political events for market performance over a reasonable investment horizon. It is more often than not the case that events occur and volatility is elevated, but with the passage of time we move on, make peace with the ‘new norm’ and the behaviour of markets reverts to the status quo ante. If one were to play the historical odds then one would thus ‘look-through’ these events and not allow the noise to distract you from the fundamental signal – economies tend to grow through time, well-run businesses in growing industries tend to outperform badly run companies in obsolete or dying industries and so on.  Every now and then however political decisions are taken which can have a more lasting effect on the performance of particular markets. When President Richard Nixon announced the end of the Bretton Woods system in 1971 by ‘temporarily’ suspending the US dollar’s link to gold, it had a lasting effect which may persist to this day.  The question in front of us is thus – are this year’s elections to be considered in the camp of the former or the latter?

Our bias is to say that in the US and UK we are probably not at a point where the year’s electoral choices are going to usher forth a meaningful shock to the pricing or functioning of financial markets. The choices in front of electorates are familiar, and while the rhetoric is at times naïve, misleading, bellicose or outright unfathomable, the reality is that we still operate in stable democracies with credible institutions and credible constitutional checks and balances. We should be concerned about the long-term trajectory of fiscal policy but to be honest we should already have been somewhat concerned. There are secular challenges that we, as populations, have been reluctant to admit to, let alone face up to, and there will come a time where more painful choices will need to be made. The sustainability of pension systems, healthcare systems and social care systems remain thorny issues, with open and honest dialogue and debate largely absent. The impact of ageing populations on labour forces, savings rates and economic growth likewise. I suspect the coming elections however will be won and lost on less structural and more emotional issues. That is not to downplay the importance for many people, rather to surmise that the investible economic impacts of our immediate choices will be unlikely to rock the boat too much in the next parliamentary term.

I feel less confident making quite such a firm prediction in the case of France. There is, of course, a very reasonable chance that when all is said and done the choices of the French electorate in late June and early July have a similarly manageable and fleeting effect on market pricing. The polls do currently suggest a worryingly extreme and unstable government may be the likely outcome, but we know from recent experience that polls can both shift dramatically and be outright misleading. What magnifies our concern just that little bit more is the inherent instability and fragility of the common currency area. Release valves which are available to UK and US policy makers, through independent monetary policy and freely floating currencies, do not exist in France. The potential for contagion and feedback loops within and without the Eurozone markets is real and not to be dismissed lightly. The movement of prices in just the few days since the surprise snap election was announced are already indicative of frayed nerves among the investor community and it seems likely that markets will remain on tenterhooks for the coming weeks as polling data takes centre stage as the election approaches. In the end that must be considered a good thing. One of the roles of financial markets, and the process of efficiently pricing risks, is that they act as one of the checks and balances within a free-market democracy and thus in doing so serve to limit or moderate the undesirable behaviour of governments. Of course, as an investor that can be scant comfort in the immediate present if you find yourself on the wrong side of an aggressive and adverse price move. There is currently no justifiable cause for panic, but we very much recommend some caution may be warranted.

This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.