BY GUY CARSON – INVESTMENT SPECIALIST
Something quite remarkable has happened this year. The world has entered a sharp recession but thanks to Government policy, household income in totality has actually increased. Central banks have cut interest rates back to zero and asset prices have held up or risen. This is not your normal recession.
On a holistic view, it appears the response has been well co-ordinated and effective. However, behind the scenes a wide range of unsolved issues remain. COVID-19 has increased inequality among individuals but also businesses. Online monopolies which have grown for years unchecked have further consolidated their power. To top it all off the global economy is also now reliant not only on zero interest rates but significant levels of fiscal stimulus.
Whilst share markets hit record highs the future remains very uncertain. It is worth examining this uncertainty in order to understand investment markets and for us it highlights the need to think differently in this environment.
1. UNREGULATED MONOPOLIES & THEIR IMPACT ON INEQUALITY
Back in May we wrote “The Rise of Monopolies”. In this article we examined how the share market was becoming increasingly driven by large IT companies that had effectively become unregulated monopolies. The chart below shows the rise of the largest five.
The drive to online consumption driven by lockdowns has clearly been a big part of the rise. The other component has been the response of Central banks. Part of this response has seen the Federal Reserve expand its bond buying program from Government bonds to Corporate bonds. It first started buying via Exchange Traded Funds (ETF) and then later via small amounts in specific issues. The idea behind buying these bonds is to drive corporate borrowing costs down which in turn reduces bankruptcy risk and should help companies invest and grow. Of course, this ignores the potential moral hazard that arises when companies can take risk and not suffer the consequences.
The above sounds broadly positive but some side effects of the project appear quite ludicrous. Monetary policy is a blunt tool, it treats all things as equal. Bond buying programs are dependent on available securities. In the case of Apple, the Fed has started buying their bonds and driving down their borrowing costs. This is despite the company holding a net cash balance of $192 billion. Apple has no funding issues; it has more cash than it will ever need and yet the Fed is assisting it with lower borrowing costs. The result is a benefit to both bond holders and equity holders of Apple stock but has no economic benefit and will not lead to further investment by the company. Meanwhile small businesses struggle and don’t receive the Fed’s support.
The concentration in power to a small number of monopolistic / oligopolistic companies flows through to the rise of inequality. Since the 1970s corporations have got more powerful and labour has suffered. Corporate profits have risen at the expense of labour.
The issue of online monopolistic businesses is not new but the pandemic combined with monetary policy as well as a complete disregard of the issue by governments has exacerbated the problem.
2. ADDICTED TO STIMULUS
Back in July, we wrote an article “What is Universal Basic Income.” In this article we noted a strange phenomenon. This phenomenon (which is also mentioned above) was the fact that personal income has actually risen in the midst of a recession. We can see this spike in the chart below.
This spike was driven by government stimulus either via pay-outs or increased unemployment benefits. Governments needed to act as businesses shut down. In addition, they had to act in the place of monetary policy. The increase in fiscal spending is really a continuation of almost forty years of monetary easing.
Interest rates have declined since the early 1980s. For the last 12 years we have lived in a “ZIRP” (Zero Interest Rate Policy) world. For a majority of this time people have wondered when will interest rates rise, when will we get back to “normal”? The answer is clearly not any time soon (if ever). The Fed started to rise rates back in 2015 and didn’t get very far before they had to backtrack.
Now with rates at zero and in the midst of recession it is the turn of Fiscal Policy to stimulate the economy. Governments have been forced to act. The only issue is that similar to Monetary Policy, governments will find it difficult to wind back policy. Maybe we have to accept that government spending will remain elevated for some time in yet another “New Normal”. This means government deficits will rise from current levels.
Of course, the fiscal conservatives amongst us will be very concerned over this development. How can we afford bigger deficits? According to the Congressional Budget Office the US deficit is set to reach $3.3 trillion in the year to September 30 and the federal debt is set to reach a record 107% of GDP by 2023.
So, with these numbers how can the government afford to spend more? This is where the latest economic theory comes in, Modern Monetary Theory (MMT). MMT works on the premise that a country that issues its own currency can’t run out of money so there is no limit to what they can spend. This is the “new normal” that we have to get used to. Governments effectively will print and spend. They will try at times to reduce the deficit via taxes. MMT views increased taxes not as a way to fund spending but as a way to control inflation. A government that spends excessively will cause inflation; printing money is not a free lunch. Taxes will effectively replace interest rates as the way to control inflation.
The economic world looks very different today than it did a year ago. Similar to the 2008 crisis, new ideas will drive the coming decade. Investors will have to adapt to this world and look at the risks and opportunities. We look to work with advisors who are prepared to think differently and adapt to the environment we are in.
Please contact us if you like to know more about these advisors and the products we use to protect your financial future and legacy.