Global economic overview
I’ve literally just got back from a week of conferences in the United States. One was a global economic summit (SIC 2015) involving advisers from the Federal Reserve, leading hedge fund managers, and world-renowned economic advisers. They were discussing the state of the global economy, and the prognosis was a little better than expected. That said, there were still enough risks and caveats to keep the "black hats" happy. Remarkably the world economy has come out of the GFC intact, at least so far. But the side effect of so much quantitative easing has been rocketing asset prices and so far, next to no wage inflation.
In effect, central banks have created more wealth inequality than existed prior to the GFC. They know it too, and refreshingly, I get the strong sense that the “inner Keynesian” in them doesn’t like it. Central banks desperately want to see some wage inflation to help balance the ledger. (Wage inflation would mean labour finally getting an increased share of wealth.) It would allow central banks to increase interest rates and we'd likely have an orderly exit from our post GFC world. In a NZ context we can see the impact of loose monetary policy in the Auckland housing market. We have rocketing property prices at a time when the rest of country could do with a rate cut. Savers (and retirees) are paying for this with extremely low investment yields. Low interest rates are a major threat to pension funds that need yield to cover future commitments. Put $1m in the bank these days and you earn $32,000 per year net.
One of the causes of growing inequality has been no fiscal response from government. Politicians have left central banks holding the baby so too speak. It has been left to monetary policy because it’s easy, the cost is less visible, and it's not democratic. Of course making the rich richer was always going to work! The consensus at the conference was that we would have a long expansion with low growth. In fact the current expansionary period since 2008 is already one of the longest in history, but at the same time it is also one of the slowest. So low growth is a "best-case scenario." Others believe we are not far off another market correction. There was plenty of debate about what could end up being the catalyst and it fell back on shares or bonds. Poor corporate earnings and economies continuing to revise down their growth forecasts, could trigger a share market correction. Lower future growth will mean that current valuations are too high. It will also mean that quantitative easing hasn't really worked or has lost effectiveness.
Most economists are waiting for inflation. If we ever see inflation it will hit bond prices. Higher inflation, means higher interest rates and higher interest rates means lower bond prices. US Treasury yields have been generally tracking downward for 30 years from around 10% to 2.50% now. Most financial market traders have never seen meaningful inflation, and for them bonds have been the investment of a lifetime. At its peak PIMCO, the world’s largest bond trader, had NZD$390 billion in funds under management. (To put that in perspective the NZ Super Fund has NZD$29 billion under management.) These are very large numbers betting on interest rates and inflation, and for 30 years everyone’s been playing the same hand. Those believing the deflation story think Treasury's still have room to fall further. Everyone agreed that bonds are overpriced. But what if inflation is dead?
Consumers are ladled with debt, we have weak commodity and oil prices adding to deflation, and we are faced into exponential technology innovation that is putting deflationary pressure on wages and the service industry - like banks, airlines, hotels, and taxis. And we have decreasing workforce participation. Herein lies a theme of low growth and possible deflation. Maybe "printing money" goes from a traditional inflationary view to a deflationary view when, we have so much debt (at extraordinarily low interest rates) that no matter how much more we take on, it can't lift consumption and in fact reduces it. Maybe debt has got to a level that it is now debasing growth, and what we are really seeing is the gradual demise of our "fiat money" based financial system. I'm thinking Mr. Creosote in Monty Python’s The Meaning of Life. The waiter tries to convince a monstrously obese man to eat one more wafer thin piece of chocolate. He responds “F##K off I’m full” but is finally convinced by the waiter to have one more thin wafer, only to explode all over the restaurant. Low cost debt is the food, but ultimately it’s deflationary forces that will erode corporate earnings and confidence and bring about an economic stagnation. We can keep printing money, but increasing private debt after a credit crisis will not solve this. The middle-class is full and at some point it needs to purge. What I think you can expect to see:
- China will continue to revise down its growth forecasts
- Weak commodity prices
- Ongoing weak consumer spending
- No wage growth
- Weak corporate earnings
I think the real threat is deflation and low earnings. That would result in interest rates staying low for a long time. I also think we are hugely under-estimating the displacement of labour and capital that will occur as a result of exponential technology innovation. As you read or watch the news over the coming months, listen out for the themes bullet pointed above, watch the market reaction, and you'll start to see the pattern. It's there and its happening. Central banks can keep the party going on cheap money for a while yet. Contra to my view there were some very bright minds at the conference who see this expansionary period of low growth going for some time yet. Closer to home, if you look at the Auckland property market, although prices are high, sales volumes have only recently increased above cyclical averages. All things being equal that might suggest that this property bull market could have at least two or three years to go. I thought our property market was peaking 18 months ago and got that wrong. Who knows! BUT everyone agrees that whenever the next market correction happens (and corrections are an inevitable part of life), it will be a humdinger.