The problem with that idea is that it presupposes a natural upward trajectory of global economic growth – and even were you to stipulate that the way forward is also upward, questions remain. At what pace can the world continue to grow? What happens if we overestimate its potential for growth and recovery? What are the stumbling blocks in our path?
Everyone is familiar with the causes of the 2008 financial meltdown. Excessive lending along with extreme risk taking resulted in what has been dubbed the “Great Recession”. To combat this central banks worldwide employed monetary policy in an unprecedented way to an unparalleled degree. That was the medicine – what we forget is that medicine tends to have side effects and while you may survive a crash, you rarely walk away without injury.
To a large extent the world is currently coasting along on what some have termed a sugar high. Given the extreme nature of intervention one might venture that it is a high of a more dangerous sort. It is important to remember that while the world is seemingly in recovery, many issues remain.
The first is the massive amount of deleveraging that still needs to happen. Both business as well as the consumer became overleveraged before the crisis and recently governments joined the fray by trying to keep the global economy afloat. In 10 mature economies internationally, domestic private and public sector debt rose from 200% of GDP in 1995 to over 300% by 2008. The UK and Japan are both over 400%, with the UK topping the list at 469%.1
Following such extreme credit expansion, deleveraging has to occur. The problem is that traditionally these episodes are characterised by low GDP growth. Some may posit that the extreme nature of the countercyclical measures will indemnify the economy from following the traditional path – an argument that was effectively rebutted by Reinhart and Rogoff in “This time is different: Eight centuries of financial folly”.
Or as Mark Twain quipped, “History does not repeat itself, but it does rhyme.”
Whether you focus on an analysis of history by Reinhart or Rogoff, on Minsky and the “Reverse Minsky Journey” or if you are of the Austrian school and have a belief in creative destruction, the conclusion remains the same. We are not out of the woods yet.
A second problem is the one surrounding property and mortgages in general. It has become accepted dogma that the housing market in the US is through the worst. It took unprecedented actions and billions of dollars, but it’s been done – yet there are still problems. A large number of US homes still have negative equity – ie the outstanding loan is higher than the value of the house. While this is a niggling problem, it can quickly become a catastrophe should interest rates rise and owners have to reset at higher interest rates.
Add to this is the fact that the commercial property market has a similar problem. Between 2010 and 2014 US$1.3 trillion worth of commercial real estate loans become due. If the securitisations market is still anaemic, the economy struggling or interest rates too high, refinancing could be very challenging.
Inefficiencies is another thorn in the side. From Brown to Obama, increased regulation and government involvement seems inevitable. While the recent Great Recession has certainly demonstrated that unfettered capitalism is a utopian ideal, many forget that the other half of the problem was incorrect/inefficient government regulation and too much influence by corporations in forming policy. Woody Brock commented on the investment side:
“Many of today’s policy proposals start from the view that “greed” and “incompetence” and “poor risk assessment” are the ultimate source of what went wrong. In fact, they were not the true cause at all. Moreover, even if they had been, it is fatuous to think that we will now create a post-crash generation of bankers and traders who are not greedy, much less a new generation of quants who will be able to assess and manage risks much better than “the idiots” who have brought us to the current abyss. Greed cannot be exorcised. Nor can the inherent inability of any quants to determine the “true” probability distributions of all-important events whose true probabilities of occurrence can never be assessed in the first place.”
In the same vein, the drive for increased regulation and the belief that it will solve all issues, suffer from similar problems. It is naive to assume that increased regulation and more regulators will solve all the problems imposed by the credit crises. It is irresponsible to alienate the persons in the industry and use them as scapegoats when they were only part of the problem. To jump from one philosophy of regulation completely to the other is not the solution.
Further, with recent developments from the US Supreme Court softening the limits on corporate lobby spend one should expect a distinct lack of political will to make serious inroads to restrict corporate power.
Lastly I wish we had not wasted this recession. Recessions are like brushfires, they clear the weeds, making the economy sounder. It points out faults in regulation and causes poor companies to fail. With the immense interventions enacted by global governments, this creative destruction was limited. Is there a doubt in anyone’s mind that the world is producing too many cars? Is there any doubt that the Americans should not be making cars? To quote Paul McCulley, though he was certainly not referring to the American car industry, “If you are a poor company, it is your duty to fail” – the fact that relatively few did is to the detriment of long term growth.
Reviewing this it looks severely bearish. That is not my intent. It is however my job as an investment professional to identify as many possible risks and opportunities in the global environment. All these represent opportunities counterbalanced by risks – navigating through them is our daily occupation.
1) Debt and deleveraging: The global credit bubble and its economic consequences 2010. McKinsey & Company
