Governments and central banks have had to resort to intervention on a massive scale – there will be a price to pay for the distortion caused.
Consequences. It’s always about the consequences. It’s a pleasure to write something for the Property Chronicle because I can think about the long term, rather than just the short-term daily market shifts I write about each day in my Morning Porridge commentary. At the moment I’m trying to understand the likely economic effects, and particularly the consequences of government and central banking responses to the coronavirus. It’s been the biggest shock ever to the global economy – and I’m not sure whether to blame the virus or the response to it.
Credit where credit is due: governments have done particularly well in providing swift and generally unlimited economic backstop support to ailing business sectors impacted by lockdowns, and for providing cash to enable workers to be furloughed. Even the EU was able to agree on a €750bn virus recovery package. These measures can’t be permanent but are designed to see economies through a period of intense and unprecedented economic disruption. Even if that disruption was the result of government policy.
Central banks have done their part. QE Infinity initiatives have enabled larger corporates to borrow the cash to see them through lockdown and have kept interest rates artificially low. But zero interest rates are generating massive consequences – which are likely to rebound upon the economy as a whole.
The result of government and central bank action has been some surprisingly strong economic numbers, suggesting the global economy is showing more strength than we expected. But for every economic release that seems to suggest underlying global economic resilience, it feels like there will be an equal and opposite force in the form of renewed social distancing, travel restrictions or even lockdowns as second waves or hot spots threaten. Renewed restrictions feel likely to strangle any real recovery.
Some sectors of the economy – aerospace, hospitality, tourism and sports – have suffered more than others. This has multiplier effects. Tourism is 10% of global GDP and is bound to nudge growth lower. Boeing accounts for nearly 1% of US GDP and it’s producing a fraction of its usual output, which in turns impacts on avionics and engine-makers such as Rolls-Royce and GE.
Replacing the invisible hand of markets
with the dead hand of state control is one
route to disaster. But there are plenty
of other ways to damage business
An issue we are struggling to understand in recovery is human behaviour. The virus’s effect on the economy is a macro event – but it comprises the sum of every single human’s behaviour. How individuals respond is critical. Scare them enough and they stay scared. By keeping the economy and particularly the schools open, the Swedes maintained normality. Although their economy will take a hit in line with the globe, individual behaviour will not have been permanently damaged by the virus. Here in the UK, nearly 60% of workers think it’s unsafe to go back to work – so they won’t!
In the face of such a bleak outlook, it is staggering how detached markets – at record highs in stocks and record low yields in bonds – have become. Investment analyst headlines warn that “markets can’t deny economic gravity indefinitely”. Actually… yes, they can. The reality of the last several months, since March, is that you can’t fight global central banks. QE Infinity is distorting markets even more dramatically than the original QE. When it all inevitably goes wrong, then QE X-Power will see markets bailed out again and again.
The problem is that there are consequences from distorting behaviour and markets. Massive consequences are coming. Financial asset stagflation means that savers, and particularly pension savers, are in serious trouble as returns have essentially flatlined. To reiterate a point I’ve made many times: ten years ago a £1m pension fund would buy you a very comfortable retirement income. Today it won’t even buy an OAP train season ticket to keep working in London. That’s a serious issue in terms of disincentives to save, but it’s also a rising social issue likely to trigger dissent and unrest as unions and workers demand retirement benefits. It raises the fundamental issue: why bother working if you can never retire?
We’ve just paid £2trn to bail out the economy from covid, but how much will the unfunded pensions crisis cost the economy? What other spending will covid spending also crowd out? If we are using the nation’s resources to fund retirement, then how much is not being spent on desperately required reform of the NHS or education, and how much is not being allocated to required infrastructure projects?
And then there is the damage to the market economy. Dynamic capitalism works – but only where it is free to do so. Where evolutionary capitalism doesn’t work, and new bright young entrepreneurial companies don’t replace tired old dinosaurs, the result is inevitable stagnation. If it’s not happening, it will be due to distortions – which can cover a host of competitive issues.
We all know that replacing the invisible hand of markets with the dead hand of state control is one route to disaster. But there are plenty of other ways to damage business. All distortions lead to inefficiencies, such as through the rise of the bureaucratic mindset and ‘satisficing’ strategies where companies are free to milk revenues with little regard to cost or customer choice.
Today QE Infinity is allowing zombie companies to stay afloat and boosting the price of sub-investment-grade junk debt. As the global economy continues to reel from covid’s septic shocks, I suspect it’s only a matter of time before we see QE 3.1 ‘Max Power’ propel markets even higher when global central banks cut the bluff and just start buying company equity directly. And that will make the distortion consequences even larger.
Who knows where it will all eventually lead… but if you are trying to understand where today’s markets are headed, then understand the reality: it’s going to remain about desperate distortion as central banks keep playing whatever cards are left to stay in the game. To win they have to stop an economic slowdown, and to do that they need to avoid a catastrophic market crash triggering recession.
One indication of where confidence is headed is gold. It has few uses, and you can’t eat it. It’s at record levels. What does that tell us about expectations, fear and the dismal rate of return on financial assets? While this crisis lasts, playing markets is all about playing the distortion and consequences it creates.
Listen politely to what analysts and City writers are saying about over-bought markets and financial resets… and follow what the central banks actually do. A crisis is coming – but it might not be the one everyone expects.
