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Article / 16 March 2016 at 16:13 GMT

Steen's Chronicle: The social contract is broken

Chief Economist & CIO / Saxo Bank
  • Political and economic landscapes in upheaval
  • Voters demanding anything but the status quo
  • 'Emergency' measures have led to stagnation
  • Wall Street needs to shrink, Main Street to grow
  • Infrastructure, capex investments key

Donald Trump on the campaign trail
At this point, it's not enough to point out how strange this all is. 
For those who are willing to look, the reasons are quite clear. Photo: iStock

By Steen Jakobsen

How do we explain Donald Trump’s rise, the risk of a Brexit, the fact that Marie Le Pen stands a good chance of becoming France's next president, and the general situation of a political world in which all incumbents appear ready to be knocked off their stools?

Simple, Dr. Watson! It is the social contract, which is not only being broken but is also being tossed out! Meanwhile, the political elites are losing their hair trying to analyse why someone like Trump, a four-times bankrupt, immoral, profane, self-promoter of a candidate can win the GOP election.

The point is that this has nothing to do with Trump’s policies (or lack thereof) but has everything to do with the fact that he is anti-establishment. We need not fear that the US is turning towards Trump's policies, but the political elite needs to recognise that voters are turning away from the “social contract” and its elitist political judgments.

The social contract is the political theory behind all of today’s societies, an actual or hypothetical compact or agreement between the ruled and their rulers defining the rights and duties of each. This idea goes all the way back to the Greek Sophists, but social contract theories had their greatest currency in the 17th and 18th centuries with such names as Jean-Jacques Rousseau, Thomas Hobbes, John Locke and, in modern times, John Rawls.

The point is the state of the social contract itself – society as we know it is done with being orderly and accepting the never-ending “emergency status”. One can only deal with so many emergencies in one’s lifetime!

Now the world's voters want anything but the traditional establishment. This is why Hillary Clinton cannot win the US election – she is the epitome of the establishment class, of the elitist order. Trump, on the other hand, is so far away from being a politician that he represents chaos in a world of order, and this is what US voters want.

Economically, this makes perfect sense and has been a long time coming. The employee compensation to GDP ratio in the US is the lowest ever in history... the lowest ever!

Wages to GDP
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Meanwhile, corporate profits are their highest-ever point in history.

Corporate profits
No wonder the “employees” and the middle class want change. But this change is also inevitable for other reasons...

Corporate profits are contingent on the “employees” of the world having enough earnings left after taxes to buy the goods of the “profit makers”. In other words, we have underpaid the middle class and Main Street throughout this cycle while over-supporting the banking and profit-generation classes.

The European Central Bank action seen last week was yet another failed attempt to “help” – it was nothing but another handout to the banks and will do little to stimulate end demand from consumers and businesses.

It seems as though the ECB and policymakers fail to understand simple economics: inflation comes from velocity of money and the velocity of money is in its most simple form driven by loan demand – not loan supply!

Incentivise investors and consumers to spend or invest, and loan demand goes up. Supporting banks will do nothing to inflation or growth, but will make the social contract even more likely to break. 

It does not work and it’s presently counterproductive for both banks and the goal of normalisation.

Finally, I am glad to have this moment and space to re-introduce my "Bermuda Triangle of Economics" theory – which has still failed to earn me a Nobel prize, by the way!

At present, monetary policy action is designed to cater to, or help, the 20% of the economy that already has access to credit: banks and market-listed companies. This comes at the expense of the 80% – the small- and medium-sized companies that get less than 5% of the credit and 0% of the political capital.

Meanwhile, the 20% – Wall Street – gets 95% of the credit and 100% of the political capital.

So what's the problem? The 20% that gets 95% and 100% of these benefits creates less than 10% of all new jobs and productivity. The 80%, however, which gets 5% and 0%, creates 90% of all new jobs and 100% of all new productivity.

No wonder we live in an economic model with no social movement, one in which the profit expansion of companies is generated not by productivity but by buyback programs and a lack of capex investment (withholding capex ironically “improves the bottom line” of companies in the first three to five years) .

Both the social contract (read: Main Street), and the business model are broken, and at the same time as well. My theory – and let me remind you that I am a libertarian economist – is as follows:

2016 is all about rebalancing the economy away from Wall Street and towards Main Street. For economic growth and productivity to increase, we need to see Wall Street underperform and Main Street to improve while being paid more.

Furthermore, companies urgently need to start investing in productivity and capital goods, something they have largely ignored for almost a decade now.

This is why the social contract is broken and why it will will continue to penalise the political elite, who largely remain certain that “logic prevails” in the end. Yes, logic prevails... but not in the way pollsters, spin-doctors and others think. Instead, it prevails from the bottom up.

Governments that can borrow at 0% need to project infrastructure investments on a large scale – how can infrastructure ever be negative over time?

San Francisco's Golden Gate Bridge
San Francisco's Golden Gate Bridge was constructed in the aftermath 
of a crisis, after all, and few seem to regret it. Photo: iStock 

Companies need to stop maximising cash flow and maximise profit over time, not merely quarter-by-quarter but through investment in people: re-education, better products, faster internet, and more big data.

The breakdown of the social contract was and is predictable from a historical perspective. The good news is that the end of pretend-and-extend is not going to be a new war, but instead a much-needed paradigm shift away from a social contract based on fear and emergency measures.

No one can be survive being afraid 24/7, and as the social contract ends, a new and more focused agenda will come through. It will be noisy and the political spectrum will get “worse” before it improves, but it’s a sorely needed expansion of the spectrum away from an “everyone in the middle” political landscape in which being a safe pair of hands is more important than ambition, high aspirations and dreams.

I have seen dramatic changes in almost every country I have visited over the past six months and let me report this:

Main Street is improving, and it wants and need goals that are more ambitious. The microstructure of any economy is working hard and will work harder. What we need is the end of central bankers acting as “rock stars” and of politicians selling “emergency measures”.

The world is just fine – it needs a little help from infrastructure and capex investments, but in overall terms the world is more balanced and more ready for change than ever before in this crisis. 

We may have reached the nadir in terms of political ambitions, investments, capex, employment, inflation, and growth, but it is up and up from here.

Change is good and a new social contract should be seen for what it is: the end of the planned economics that we have (ironically) adopted ever since the Berlin Wall came down. But what does it mean for markets and politics? 

A Brexit is more likely to happen than not. The average UK voter is not going to vote based on facts but on his ability to lift a middle finger (or in the case of the UK, two fingers) to the elite.

In the US, it is not about Trump but about how no one wants the established political elite – the present movement is "anything but the elitists". I doubt Clinton has any chance of winning the White House, as she is so “old world” vis-à-vis the social contract.

Across all countries, the far left and far right will do better – not because of their programmes, but because they are far away from the middle. A broad, full political spectrum is, by the way, an improvement: maybe we can finally try to differentiate by subject matter rather than mere positioning!

The market will not like this and, as stated, the price for this transition is that Wall Street will need to do worse, partly because of a transfer of income to Main Street and partly due to the need for an increase in capex, but this is a good thing. 

The alternative is more of the same emergency nonsense we have lived with over the last eight years.

The king is dead, long live the king.

The head that wears the crown
Heavy is the head that wears the crown. Photo: iStock

— Edited by Michael McKenna

Steen Jakobsen is chief economist and CIO at Saxo Bank

Albee Albee
Only when you removed those shaded pink glasses, do you see the real color of the economy.
Marcus Antonius Marcus Antonius
It's good you took the freedom to publish this interesting piece, Steen.

Simple answers to complex problems are discredited as populist these days. I wouldn't second such a judgement regarding your article, but I'd say some aspects need to be considered carefully.

The US is pretty different from Europe.

Europe has a demographic problem. Corporations try to compensate for that by exporting.But the value of careful engineering is fading, and in the western part, the younger generation is frustrated or part of the LIME attitude, not used to working hard and not seeing much sense in achieving something. In the eastern part, people are still eager. Europe's "circle of debt" (two thirds being circular) is no good news since it can easily collapse in the face of demographics. Refugees could lead to a new industrial boom but not many companies are actually prepared for such a move. Despite LIME, people are relatively well educated and have a wider viewing angle than in the US.

Marcus Antonius Marcus Antonius

The US, however, has a clear immigration strategy and no demographic problem.

It is the strongest developed economy and financial market in the world.

It has the power to destroy Europe's industries (GE - Alstom) for its own advantage.

While in Europe some innovation can be spotted, the US can bring home production capacities to sell pricey bullshit (patented lip balm being only one example) to anyone in the world, including the LIME generation in Europe which live off their parent's wealth.

Education in the US is very different from that in Europe and many people aren't aware of the most basic facts regarding the globe, while their self esteem is pumped up.

I think the conclusion is that in Europe, some people older than the LIMEs are just fed up being fooled victims of the "everybody's profiting" claims.

In the US, I guess people see how weak Obama actually was. From Guantanamo to global instability: Attributed to him.

BTW, "Idiocracy" is one of my favourite movies.
TheWillinator TheWillinator
Great analysis... fits story of recent Irish Election. Economy growing at 8% GDP but government lost election because effects are not been felt on 'Main Street'.

Political elites must understand that logic "prevails from the bottom up!" So true!
bparkes19 bparkes19
The last time the social contract was broken was the early 1930s. Has anyone looked at inflation charts around that time? The contract breaks down at the end of deflationary periods. UK inflation spikes 1934 into 1942 and they were the reserve currency so parable to the US today. US inflation (today China) bottoms 1932 and spikes into 1950. This is why you see all commodities -lumber to iron ore to coffee rallying since December. I'm always early but stocks and commodities are all going much higher based on the historic comparisons
BobbieMac BobbieMac
Clinton will win, especially if Trump is the opponent. The real issue will be in the congressional races. If the Republicans maintain control it will be gridlock as usual. If Democrats gain there is a chance for some improvement.


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