Financial markets are enduring one of their periodic “growth scares”, albeit not yet as severe as that of early January.
Investors and commentators are still struggling to come to terms with much lower levels of trend growth, and a global economy that is neither materially expanding, nor yet recessionary.
Let me take you through just three of the concerns du jour, if not “unexplained phenomena”: productivity, end demand, and business investment.
Many economists would like to see end demand stimulated, and are disappointed by the lack of capital expenditure from corporates. In terms of productivity, the weak data is either taken as evidence that “something needs to be done”, or that it is too difficult to accurately assess this metric in a digital world (this is probably at least partially true).
The reality is that all three of these problems are connected. I’d argue that the world is not so much suffering from a lack of demand, as it is swamped by an oversupply.
The aftermath of the Great Financial Crisis did not involve the “creative destruction” that accompanies recessionary periods, at least not to a commensurate level, and which is a prerequisite for an effective rebound in the global economy.
When the chickens do come home to roost, as they will, creative destruction will be that much more virulent than had it been embraced at the timeOn the contrary, exceptionally loose monetary policy has kept zombie companies afloat, allowed a maintenance and indeed growth of excess capacity – the very opposite of the supposed cleaning effect of a recession – and consequently a massive misallocation of capital, on an unparalleled scale.
I’m not about to argue that creative destruction is in anyway enjoyable at the time, but I will say that it cannot and should not be wished away. The end result of delaying dealing with this issue, and in fact stoking the original problem, is that when the chickens do come home to roost, as they will, it will be that much more virulent than had it been embraced at the time.
This global over-capacity, and yes, China is naturally a large part of this, is also a reason why corporates are unwilling to invest into further expansion. They would not be fulfilling a need, and the return on capital is liable to be lousy.
To me, this is surely building up problems for the future, but it is hardly the fault of corporates, which are arguably acting entirely rationally.
The highly indebted world weighs heavily on all these three issues of demand, investment and productivity, while the benefits of globalisation have stacked up in a lop-sided manner on the consumer side of the ledger (e.g. Skype someone on the other side of the world, for free), as opposed to appearing in statistics for traditional productivity.
Without knowing future fiscal and monetary policies, investors such as myself have to instead handicap two possible outcomes.
One being an extended era of anaemic (at best) growth and stalled living standards, as excesses are steadily worked through the system, via more top down control and interventionist central banks. The other, and the perhaps more likely outcome in my view, is a sharp reckoning, involving true price discovery of financial assets, accompanied by a severe recession, although extremely difficult to time.
As I see it, this painful experience would only be marginally ameliorated by the rebalancing of economies, and an improved future for return on invested capital.
Andrew Wilson is head of investment at Towry
