It is hardly a calm before the storm since pretty much all that could trigger a “crisis” is already in situ and happening. But it feels that way.
5 years in from the start of the current crisis and the US Federal Reserve still has to support asset prices because the economy and markets are apparently too frail to survive without it. This is pretty much the same everywhere you look: China, Japan, Europe; there is a massive and historically absurd, economic, market and financial system support operation still in place.
In truth the world’s central banks have been fighting a one way battle with the increasing excesses of financial and economic imbalance since 1997, when the Asian crisis hit, and quite possibly since the first false alarm, the bond market collapse of 1993/1994. Interest rates have moved lower and lower to the point they can no longer get off the ground. This is absurd!
If superior historical world economic growth has moved us to this frail point in time, then where is the weak growth of the present taking us? The starting points are so much less favourable and the potential so much reduced.
Economies used to move in cycles because demand at certain points used to exceed supply’s short term ability to meet it, and central banks had to put a short term cap on it. The cycle existed because of irresistible fundamental dynamics that drove growth forward, yet these fundamental dynamics are no longer forcing anything of substance forward and have to be artificially induced.
The truth is that growth, without debt financed expansion, in many economies had already started to slow down in the last two decades, and became in some areas essentially dependent on debt during the early 2000s. But from 2008 onwards the growth machine ground to a halt, paralysed by excess debt that risked coming through the financial system.
The natural balance and interplay between the different components of the business cycle has for a long time been missing from the growth equation. We have activity and we have investment and we have consumption and production but not enough to push growth to a rate which brings the value of our assets and our liabilities into line with future output growth. This continues to place pressure on the financial system and it therefore remains exposed to reruns of the 2008/2009 crisis.
We also have significant lingering structural imbalances: consumers in key economies remain over leveraged, especially with respect to income growth; many economies still consume too much (US) and produce/invest/save too little, or consume too little and produce/save/invest too much; wealth and income distribution favours the accumulation of returns and income at one end and weak consumption, debt and too little saving at the other.
Far from a new normal of high debt and low growth, we appear to be stuck in an ever decreasing circle where the excesses of the past become overly focussed on an ever smaller present. High unemployment and weak income and capital distribution is a very strong impediment to growth and it is also a grave risk to price of assets of all kinds.
If the Fed and other central banks still have to support markets it means that risk is indeed higher than current prices suggest. Since 1997, each subsequent economic and market high has become less sustainable and less vigorous and much less able to deal with rising interest rates. The world is now being forced to invest in assets at prices that are unrealistic for the scenario we live in, though not unrealistic, necessarily, for the past.
And, so the Fed stood back from tapering last week, for a while, possibly worried about weakening employment data in the latest report, possibly worried about rising bond yields, and possibly concerned about the overall strength of the global recovery. We need to remind ourselves that this is absurd and it is not normal. Or, of course, you can take the positive spin?
One unfortunate truth remains, and it is echoed in many of the references I note below. Our capitalist society has in many respects no other choice but to remain broadly invested (as noted in my Capitalism in Crisis 3 report, a dash for cash will kill us all), but it needs to have its eyes wide open with respect to the risks and the costs of the current financial experiment. I would rather have low growth, low asset prices and higher yields than low growth, high asset prices and lower yields since it is so much more in keeping with the imbalances we face.
Some reading on the relevant issues
Occupy QE (Project Syndicate) by Stephen Roach
“The problem continues to be the crisis-battered American consumer. In the 22 quarters since early 2008, real personal-consumption expenditure, which accounts for about 70% of US GDP, has grown at an average annual rate of just 1.1%, easily the weakest period of consumer demand in the post-World War II era. That is the main reason why the post-2008 recovery in GDP and employment has been the most anemic on record.
CommentsView/Create comment on this paragraphTrapped in the aftermath of a wrenching balance-sheet recession, US families remain fixated on deleveraging – paying down debt and rebuilding their income-based saving balances. Progress has been slow and limited on both counts”
GMO Quarterly Newsletter Q2 2013
“And this gives today’s markets a vulnerability that has not existed through most of history. Today’s valuations only make sense in light of low expected cash rates. Remove that expectation, and pretty much every asset across the board is vulnerable to a fall in price, as the rising real discount rate plays no favorites….But most of the reason we have been complaining about this issue as loudly and continuously as we have is that there is no good way out.”
Seventh Inning Stretch – Bill Gross of PIMCO
“So what to do here, folks? For those of you who are still fans of the old American pastime – in this case capitalism and the making of money as opposed to baseball – how do you play on this rather unstable field of our own making? Which pitch do you swing at?”
Five Years on from Lehman: The More Things Change, the More They Stay the Same (Institute For New Economic Thinking)
IMBALANCES AND GROWTH IMF September 2020
Psychological Ether (John Hussman’s Weekly commentary)
“In my view, the problem with quantitative easing is that its entire effect relies on provoking risk-taking by those who would otherwise choose not to do so; that the FOMC has extended and amplified financial market distortions without regard to the rich valuations and dismal prospective returns that financial assets are most likely priced to achieve; and that this distortion of financial asset prices has precious little to do with the presumptive goal of Fed policy, which is greater job creation and economic activity.
Unfortunately, even though the equity market has been rising on what we view as nothing but noxious psychological ether, the FOMC has – perhaps unintentionally – released another tank of the stuff. Quantitative easing only “works” however, to the extent that investors have no immediate desire to hold short-term, risk-free assets. In any environment where investors become eager to hold currency and other low-risk, default-free assets despite their low yield, I expect that both investors and the Fed will discover that quantitative easing is wholly ineffective in supporting the prices of risky assets. This is an experiment that has not yet run its course, and we have no intention of being the guinea pigs in that study. “