Macro Wounds: Surviving the Mirage of Growth
The time period between 1870 and 1970 was special. Much of the developed world enjoyed the most significant economic progress in history. In the United States, GDP multiplied nearly 31 times during this era, to about $3 trillion in 1990 International Geary-Khamis dollars, according to the late British economic historian Angus Maddison.
Economic growth before and after this “century of greatest change,” however, has paled in comparison to the unprecedented expansion of those 100 years. Given that this period also witnessed many great scientific innovations, is it possible such rapid growth might never be achieved again? Or can the internet and smartphones — among the most successful modern innovations — be as disruptive and beneficial to growth as electricity and antibiotics? It may be too early to conclude whether such periods of growth, driven by inventions and real economic activity, are a thing of the past. But the question is worth investigating given the sustained emphasis placed on growth by the world’s leading finance ministers and central bankers.
Savings Surplus, Deficient Demand
Bank of England governor Mike Carney demonstrated how secular and cyclical forces have depressed “equilibrium” interest rates globally in a speech at the G-20 summit in Shanghai. Carney’s presentation suggests that an excess of savings and dwindling investment opportunities are among the difficult structural constraints that central bankers may be facing. Income inequality (both domestic and international) and demographic transitioning have increased savings relative to available investment opportunities. It is interesting to note that the five central banks with negative policy rates — Danmarks Nationalbank (DN), the European Central Bank (ECB), Sveriges Riksbank, the Swiss National Bank (SNB), and the Bank of Japan (BoJ) — are among the top income-per-capita countries that also have aging demographic profiles.
Steroids and the Perils of Too Much Quantitative Easing (QE)
The 2008 credit crisis highlighted and worsened the effects of such inherent macroeconomic gaps and the longer term forces of demographic change and productivity growth. QE did provide an important respite, giving economic agents time to nurse themselves back to better health. But can easing alone correct a demand deficit that shows no signs of improving? Will the easing actions result in undesirable side effects since QE only has a short-term impact on propping up asset prices?
Negative interest rates, on the other hand, which insulate the retail/domestic market but are allowed to operate through wholesale channels, weaken exchange rates and can result in weakness in transferring demand.
The post-QE asset price reversion in Carney’s presentation is intuitive: As expected, asset prices revert to their intrinsic levels. After all, the cash-flow-generation capacity of an asset is the most important contributor to its intrinsic value. Regarding post-crisis easing, Raghuram Rajan, the Reserve Bank of India’s governor, too, has cautioned against the dangerous bubbles that stimulus policies can create. Recently, he called for a discussion among the world’s monetary policymakers about crafting an effective and coordinated international response. Rajan has demonstrated his prescience before. In 2005, he noted a build-up of risks in the US economy, but his warnings were dismissed or ignored.
Weak Global Trade
The Financial Times shows how the fall in the flow of goods and services may signal an important structural shift in the fundamentals driving globalization. The weak performance in global trade over the past five years could continue unless there is a strong turnaround trigger. Increased automation and new manufacturing technologies could worsen the fall from the 53% peak share that global goods and services accounted for in global GDP. Shortened global supply chains — a consequence of rapid automation — are perhaps an example of creative destruction, but they are adversely affecting global trade in the short term. The fall in real goods and services contrasts with a cross-border information exchange that has more than doubled over the last couple of years, to an estimated 290 terabytes — about half the size of the US Library of Congress — per second.
A knowledge-intensive, internet-powered world may be the path to significant scientific innovation. The supply-chain example, however, highlights the upheavals that innovation can trigger.
Investing Rules Will See Minimal Change
Growth, it is has been argued, “is a behavioural response to needs that become new demands.” Practitioners would need to update their frameworks to changing realities. Warren Buffett isn’t concerned about US economic growth, and he considers a 2% GDP growth forecast for the US economy to be not bad at all. Thomas Piketty, too, has demonstrated the significant impact that a 2% annualized growth rate can have on both lifestyles and economic prosperity in Capital in the Twenty-First Century.
In any case, uncertainty may actually present opportunities for those who realize that the established guideposts for investing would hardly change. Whether we ever see a return to the sort of growth that occurred between 1870 and 1970, then as now, relentless focus on comprehensive research, a healthy dose of skepticism, and mastery of the art of letting paint dry will continue to help minimize mistakes and maximize returns.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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