Comment

The increasing polarisation of American politics and recent Supreme Court decisions suggest the onset of a new age of conservatism, and Europeans should be worried as the centre fast erodes. Judy Dempsey explains why  First came the US Supreme Court decision to overturn Roe v Wade, the ruling that declared abortion a constitutional right in 1973. Then came its decision to limit the authority of the Environmental Protection Agency to set standards on climate-changing greenhouse gas emissions for existing power plants—it is up to Congress to set the norms, the Supreme Court concluded.  Both of these decisions—evidence of the increasing polarisation of American politics—will feed into the agendas of politicians standing in the mid-term elections in November.  Pro-life supporters will be encouraged by the statements of Supreme Court judges who mentioned banning contraception. Climate change opponents will push the ‘denial button’, despite the evidence to the contrary.  And the polarisation of American politics is only set to deepen as the centre fast erodes.  President Joe Biden, saddled with rising inflation, the war in Ukraine, and working out how best to deal with Russia and China, does not have the executive powers to overturn these Supreme Court rulings.  So, what does this all mean for Europe, America’s main ally? Europeans seem perplexed and inured to what is happening in the United States, a country that played such a pivotal role in getting Europe back on its feet after the Second World War ended in 1945. Washington actively supported the creation of today’s European Union and, for over seven decades, the US has provided a security umbrella to Europe. The era of shared values and commitment to democracy and security is waning, however. The trends emerging in the United State—polarisation, isolationism, and an increasingly dysfunctional political system—should worry Europeans. For one thing, the conservative swing in the US could encourage the mobilisation of populists and their leaders in Europe, who believe the European Union is becoming too liberal and too obsessed with imposing its values on citizens.  One example is the Polish government, which has made systematic moves to control the appointment of judges as well as banning abortion. A right-wing win in 2022 could embolden Warsaw to take further steps to curb women’s rights or put a chokehold on judicial powers.  In Hungary, Prime Minister Viktor Orban has clamped down on the courts, the media and non-governmental organisations. Orban is hoping for the return of a Republican administration in the US in 2024, urging them to take the same steps against the media as he has. In France, Marine Le Pen’s National Rally now dominates the far right in the French National Assembly.  Then there is the state of democracy across Europe. According to the Economist Intelligence Unit, Europe (alongside North America) is host to the worst-performing democracies since 2006. These trends are bad news for pro-democracy activists in authoritarian countries. They look to the United States and Europe as models of tolerance, integration, prosperity, and hope.  In a nutshell—though not as drastic as what is happening in the United States— the centre and culture of consensus in Europe is weakening.  Without a centre that fosters listening, tolerance, dialogue, and leadership, from top to bottom and vice versa, democratic structures will become degraded.  China and Russia could only capitalise on a decline that would weaken the influence of the West.  The question is: are European leaders heeding the warnings? Judy Dempsey is a Non-Resident Senior Fellow at Carnegie Europe and Editor-in-Chief of Strategic Europe

The glorious era of falling inflation has come to an end as we enter a concerning new cycle of spiralling prices, so what now for the global economy? Cormac Lucey looks ahead to the potential implications of tightening monetary policy and second-round psychology Recent spikes in inflation were initially described as “transient,” and attributed generally to one-off supply chain problems. The comforting implication was that high inflation readings would swiftly retreat once supply arrangements returned to normal.  This has not come to pass, however, and successive central bank forecasts predicting inflation would soon retreat have  failed to materialise. Instead, price hikes have accelerated.  The most recent inflation readings are 8.6 percent in the euro area, 9.1 percent in Ireland and 12.7 percent in the UK. These inflation rates compare to central bank base rates of a mere 1.25 percent for Sterling and 0.5 percent for the euro.  In fact, real base rates of interest have never been this low — so, have central bankers fallen behind the curve? Whether we wish to accept it or not, the reality is that we are currently experiencing inflation regime change. Zoltan Pozsar has observed: “It’s blatantly clear that this is not an average business cycle. This is not an average inflation backdrop. And this is not an average hiking cycle.” The post-1980s era of steadily falling inflation rates has ended. From a financial perspective, it was a glorious era as ever-falling inflation rates permitted ever-falling interest rates that spawned ever-rising asset prices.  Following an unprecedentedly large economic stimulus to combat the pandemic-induced economic slowdown, that era culminated in record stock, property, and bond prices. With the return of inflation, all of this is at risk.  The danger is that inflation expectations rise and second-round effects kick in as companies, unions and workers seek to raise their prices, not just to recoup past cost increases, but also in anticipation of future increases.  As the Bank of International Settlements noted in its recent annual report: “Ultimately, the most reliable warning indicator is signs of second-round effects, with wages responding to price pressures, and vice versa. These can be especially worrying if they go hand in hand with incipient changes in inflation psychology.”  The report also points out that “the degree to which the general price level becomes relevant for individual decisions increases with the level of inflation. When inflation rises, price changes become more similar.”  With inflation at nearly 10 percent, this danger is now very real. What can the authorities do to squeeze the inflation genie back into its bottle?  In a nutshell, central banks need to tighten monetary policy to slow down the economy. If inflation is a form of economic cancer, monetary tightening represents economic chemotherapy.  While its aim may be to treat only those parts of the economy that are diseased, however, monetary tightening risks unleashing unpleasant side effects, including recession.  The economic downturns in the US over the past 50 years were  preceded by tightening monetary policy. It was the ECB’s steady raising of interest rates after July 2005, however, that finally pricked Ireland’s property and banking bubble.  As Pozsar notes: “We have never achieved a soft landing, so let’s not pretend that the fastest pace of [interest rate] hikes in a generation, and an unprecedented shrinkage of the [central bank] balance sheet, will yield one.” In my opinion, the monetary conditions for recession are now present. Even before central bank interest rate hikes really get going, the growth of real money has turned negative in both the US and the eurozone.  And, as was stated in the March 2019 issue of the ECB Economic Bulletin, “The leading and pro-cyclical properties of real M1 with respect to real GDP in the euro area remain a robust stylised fact.”  Previous chairs of the Federal Reserve, Alan Greenspan and Ben Bernanke, drove asset prices up. Jerome Powell is driving them down, and he could keep pushing against stock price rallies until he succeeds. Cormac Lucey is an economic commentator and lecturer at Chartered Accountants Ireland

At a time of rising conservatism and regressive thinking, the EU’s progressive approach to ESG reporting is raising the bar on climate change action and it will have an impact far beyond the boardroom, writes Dr Brian Keegan  Bad law, like the British legislation overturning the Northern Ireland Protocol, and bad judgments, like the US dismissal of Roe v Wade, don’t just change the rules. They disrupt attitudes within a society. A disruptive change in attitude can be more damaging than any one piece of repressive law or legal interpretation. Some people speculate that we are seeing a return to the protectionist thinking of the 1980s, given the resumption of the Cold War and soaring inflation. The evidence suggests that the reset is more dramatic than that, however.  Disregard for the rule of law in international treaties and women’s welfare points, not to a 1980s outlook, but to a medieval way of thinking about the world. Against this backdrop of toxic conservatism and protectionism leading to international conflict and rising inflation, the management of climate change is slipping down the list of international priorities.  Shepherded through the EU institutions last month by Mairead McGuinness, Ireland’s EU Commissioner, the new Corporate Sustainability Reporting Directive is looking to address this slippage.  Reporting standards traditionally address shareholder concerns and what is material to them. Now the EU has taken this idea a step further by insisting on what it is calling “double materiality” — reporting not just on what is directly material to shareholders, but also on what is material to the wider community and society.  Double materiality is a concept that remains highly subjective, and expert groups within the Institute are working through how it can best be interpreted.  Critical also for this profession is the recognition within the directive of the role of auditing firms in assuring both the “traditional” financial report and the environmental, social and governance aspects.  Chartered Accountants Ireland lobbied hard to ensure that this recognition was included in the text of the directive, because it was by no means guaranteed at the outset. International accounting standards currently under development by the International Sustainability Standards Board (with the blessing of the G7) are committed to the notion of single materiality, albeit recognising that it is usually in the interests of shareholders that the environment be preserved too. About 50,000 larger companies within EU member countries will be directly caught by the new directive. They will have no choice but to adopt these new reporting requirements as the directive will have the force of national law.  The profession will, therefore, have to adopt additional standards for reporting and assurance, and draft standards are already in the public domain. This adoption will come at a cost, for the companies themselves and the firms that audit them. Are these costs worthwhile? I hope so. The Corporate Sustainability Reporting Directive will have a greater practical impact on climate change than any number of impassioned Thunburg-esque speeches from quangos, or government white papers as high on aspiration as they are thin on funding.  Voluntary codes and practices won’t deliver climate change management, but a legal requirement on corporates to declare progress or failure can. However, the real benefit of the Corporate Sustainability Reporting Directive is the way it will change attitudes on sustainability and the public attitude towards the accountancy profession as assurers of sustainable change over time.  A new legal framework doesn’t merely reflect existing attitudes in society – it changes future attitudes. This directive is a piece of modern thinking at a time when thinking has been turning distinctly medieval. Dr Brian Keegan is Director of Advocacy and Voice at Chartered Accountants Ireland

Russia’s War in Ukraine changed many assumptions held by European governments, but Judy Dempsey asks is Europe prepared to embrace significant strategic issues that will change the status quo? Russia’s full-scale invasion of Ukraine in February could radically re-shape the European Union.  And it’s about time.  For too long, the EU and most member states were content in the comfort zone that did not have to deal with issues that would fundamentally change their way of doing things. These included energy, security, the future of enlargement and Russia. Until Russia’s second invasion of Ukraine, there was a tactic consensus that Europe could continue along the path of perceiving Eastern Europe through the prism of Russia and depending on Russian energy. The EU accepted the independence of Ukraine, Moldova and Georgia, not to mention Belarus. However, among many big member states, their sovereignty and independence were ambiguous.  While it was never publicly stated, this part of Europe, whose history and culture are unknown to many EU member states, was considered in Russia’s sphere of influence. In several ways, Russia’s all-out attack on Ukraine has changed that perception. First is the energy issue. It is only a matter of time before Europe will wean itself off Russian gas and oil. This dependence had given President Vladimir Putin immense leverage and blackmail over several EU countries, particularly Germany.  The EU, and German Chancellor Scholz’s Green coalition partners, say they now want to become independent from Russian energy as soon as possible. Despite the considerable pressure from German industry and its business lobbies tied to Russia, who wish to retain the status quo with Moscow, don’t underestimate this goal.  The reality is that Russia’s war in Ukraine has become the catalyst for speeding up Europe’s transition to renewable energy and alternative sources of supplies. As dependence on Russian gas decreases, so will the Kremlin’s geopolitical influence. Another impact of Russia’s aggression is security. Neutral Finland and Sweden are poised to join NATO. These two countries that have long cherished their neutrality now recognise that their security needs to be boosted. Joining NATO would fill a big security vacuum in Northern Europe, where Denmark and Norway are members of the US-led military alliance. The Baltic (NATO member) States will be more than reassured with Finland and Sweden on board. In short, Putin’s aggression in Ukraine has given NATO and the transatlantic alliance a new lease of life. It is changing the geo-security architecture of Europe. It will be interesting to see how Ireland deals with its long-standing neutrality stance.  Another big issue is enlargement that is tied to the future direction of Europe. President Emmanuel Macron’s speech at the conclusion of the Future of Europe conference set out how to make the EU more efficient by having a qualified majority voting system for certain policy issues and having a much closer, structural relationship with Eastern Europe.  But what about making the EU more politically integrated? This would require a treaty change that several member states oppose. However, this is where the war in Ukraine comes into play. European governments cannot retain the status quo when its own security and that of its eastern neighbours are at stake.  For a union with ambitions to be a global player, muddling through is no longer an option. It’s going to require a major shift in the mindset of EU countries to end Europe’s comfort zone that, until now, didn’t take its – nor Eastern Europe’s – security vulnerability seriously.  If it doesn’t make that shift, Europe will fail to use the war in Ukraine to develop a strong, integrated and secure Europe – with Eastern Europe as part of that house.  Judy Dempsey is a Non-Resident Senior Fellow at Carnegie Europe and Editor-in-Chief of Strategic Europe.

Economic conditions might seems prime for investment, but with a recession on the horizon, Cormac Lucey recommends looking at the global economic outlook before you make any decisions. Capital allocation is a senior management team’s most fundamental responsibility, according to Michael J. Mauboussin and Dan Callahan in their essay “Capital Allocation: Evidence, Analytical Methods, and Assessment Guidance”.  Capital allocation is always important but is imperative today as the return on invested capital is high, growth is modest and corporate balance sheets have plenty of cash.  Unfortunately, there is one key risk on the horizon today that may upend many investment decisions: the prospect of a global economic downturn.  Recessions are one of the most significant risks that confront senior managers. They weaken financial performance and cause company values and share prices to drop. Suppose those drops are accentuated by expensive investments or acquisitions made on the eve of a recession. In that case, they can unleash a search for managerial scapegoats that lead to executives departing their positions “to pursue other interests”.  However, whether one looks at the USA, China or the eurozone, the immediate economic outlook is gloomy. GDP growth has gone negative in America, which recorded an annualised -1.4 percent rate in the first quarter, and that’s before the Federal Reserve’s interest rate tightening campaign began to bite.  April’s US consumer price index surprised on the upside, with the core measure rising 0.6 percent month-on-month, or 6.2 percent year-on-year. With monthly price rises at this level, it will be difficult for elevated base effects from last year to decrease the annual inflation rate. That high inflation data came shortly after labour market reports showed a 20-year record for the ratio of job vacancies to numbers unemployed.  This recent data is only likely to harden the Fed in its resolve to choke inflation out of the US economy. Bill Dudley, a former President of the Federal Reserve Bank of New York, recently warned investors to pay closer attention to the words of Jerome Powell, Chair of the Federal Reserve (Fed).  “Financial conditions need to tighten. If this does not happen on its own (which seems unlikely), the Fed will have to shock markets to achieve the desired response. This would mean hiking the federal funds rate higher than currently anticipated. One way or another, to get inflation under control, the Fed will need to push bond yields higher and stock prices lower,” Dudley stated. The situation in China provides little comfort. Whereas its economy often provides a counterweight to US influences (growing fast when the US is growing slowly and vice versa), the Chinese authorities’ zero-COVID-19 policy is choking economic activity. China could already be in a recession.  Shanghai’s port activity is falling faster than in early 2020, when the COVID-19 outbreak caused the entire global economy to shut down. Chinese purchasing manager index measures have already fallen well below 50, signalling a contraction in activity levels.  In Europe, inflation has also become too uncomfortable for the European Central Bank. President Lagarde has said that quantitative easing will end in Q3, and interest rate hikes will likely commence at the ECB’s 21 July policy meeting.  However, this year, the eurozone first-quarter growth was a measly 0.2 percent over the previous quarter. The war in Ukraine has directly affected energy supplies to EU economies, forcing many to seek alternative, and costlier, sources. With recession looming, be careful not to make significant investment decisions you might later regret. Cormac Lucey is an economic commentator and lecturer at Chartered Accountants Ireland.

Where can small businesses find the advice they need to keep growing? Trusted advisers, says Emma Jones.  My company solves problems for small businesses based on data sets and evidence that guides businesses from different localities and sectors to support that is proven to work for their peers. We shortcut a founder’s route to success through pointing them to the right intervention for their business, at the right time, boosting productivity by saving valuable hours searching for relevant advice.    One factor that has aided the move towards standardised and personalised advice is the number of businesses now operating on common platforms.  Take the e-commerce sector as an example: most online sellers use the same ‘stack’ of technologies, whether that is Big Commerce for sales, Facebook to drive advertising, or Google Analytics to measure results.  This means smart data companies can show a founder if they are selling more or less – or paying more or less for those sales – than competitors.  With insight in hand, a founder then wants advice on how to improve and get into the top tier of performers. Business owners want to simply be told ‘how’ and ‘where’ to spend their time and money. They are willing to share data on key company metrics in return for advice on how they can perform better.  This is where the role of trusted advisers comes in.  With a foundation of data, advisers can guide a business owner through a personalised support journey, with in-built accountability as the adviser takes on the role of a coach in setting out milestones for the business to deliver.  There is a key role for accountants in this as managing or raising money is integral to business progression. While we want to connect small business owners with the right support, we also want to connect them to the trusted experts who can help them to do the jobs that need to be done to spur growth.  Guiding business owners to make the right moves, based on data and insight, and connecting them to the right advisers can help to boost their efficiency, potentially delivering a similar benefit to the wider economy.  Emma Jones is Founder of Enterprise Nation.