Western governments’ penchant for spending more than their revenues is being indulged by their central bankers, who persist with accommodative monetary policies and repressing interest rates.
They turn a blind eye to the long-term fallout of their policies. For example, low interest rates produce a misallocation of capital: one in 10 British businesses is only being kept alive by low rates.
Repressed interest rates also cause pension liabilities to balloon. In the UK, they are estimated to have risen by an astonishing 40%-50% since 2009 by Hymans Robertson.
Thus, the politicisation of the major central banks continues, step by step.
Ben Bernanke at the US Federal Reserve now promises to continue quantitative easing until the unemployment rate falls to 6.5%. Those who worry about the inflationary fallout from all this printing of money should reflect on the chairman’s in-built stabiliser: as soon as growth starts heating up (measured by the fall in unemployment to 6.5%), the punch bowl will be eased off the table.
Indeed, it is interesting to note in the minutes of the December 2012 Federal Open Market Committee meeting that some members mooted slowing or even stopping bond purchases by the end of 2013.
This would clearly be prudent, given the huge inventory of bonds now on the Fed’s balance sheet – but might it also reflect a quiet confidence in the US recovery?
The seeming inability of Congress to tackle the deficit in any meaningful way, forcing the Fed’s hand, casts a spotlight on the Achilles’ heel of democracy.
As Gillian Tett observed in the Financial Times: ‘Modern American political rhetoric is peculiarly addicted to the presumption of permanent growth.’ She quotes Peter Thiel, founder of the company PayPal: ‘Democracy works where voters think that things are getting better.’ It presumes that the economic pie can be made to expand.
In Japan, a country that has effectively been ex-growth for over two decades, they have just elected their seventh prime minister in six years. The economy is moribund, with total debt at 235% of GDP.
This in strong contrast to China, where the problem of overheating was successfully tackled head on by the politburo of nine people, and they are now in a position to again loosen the reins.
Faced with a choice of investing in a company with a board of more than 500 directors or a board of nine directors, which would you choose?
And the expansion of the Western world’s economic pie will not revert to the growth rates seen in the 1980s and 1990s any time soon as deleveraging takes its course and as the Baby Boomers retire. This does not augur well for political leadership in the major democracies.
Rising tide 2020
Is the best behind us? Where is growth going to come from?
The past 250 years saw three great waves of innovation based on first, the invention of the steam engine; second, electricity; and third, computers. The past 25 years have been buoyed by the successful integration of the world’s most populous country, China, into the global economy.
We see two major positives for the world as we look past its current troubles to 2020 and beyond.
First, technological innovation is still revolutionising many industries. The internet is extending education to the developing world. Driverless cars (pioneered by Google, in which we are invested) have the potential to turn car journeys into productive time.
Three-dimensional printing is set to transform areas of manufacturing. Hydraulic fracturing has sent gas prices tumbling in the US. The decoding of the human genome is opening areas of research for a pharmaceutical industry that was struggling to find new products.
The second major positive is that, despite an ageing population in the West and in China, the working age population in the rest of the world is expected to continue growing.
Following on from the Brics (Brazil, Russia, India and China) are the Mints (Mexico, Indonesia, Nigeria and Turkey), aided by the spread of education over the internet. Integration may not be as effective as China but it will be huge.
The expansion of the global middle class means emerging market consumption could make up an astonishing two thirds of the world’s total by 2050, according to Karen Ward and Frederic Neumann at HSBC.
Furthermore, the savings surpluses of the emerging world that have financed the current account and budget deficits of the West look set to continue.
Barclays 2012 Equity Gilt Study estimates that in 2002 the gap between international foreign exchange reserves and ‘safe haven’ bond issuance was a chunky 35% of global GDP, the gap being funded by the private sector. The gap has now fallen to only 12%, and is projected to remain broadly at that level through to 2021, even allowing for sizeable Western government issuance.
A gap of this order should be readily funded by the private sector. Those looking for an early return of interest rates to normality may be disappointed.
At Veritas, this approach of looking through the current malaise to what the world will look like in 2020 and beyond is the fabric of our current investment strategy. ‘Rising tide, 2020 winners’ is our core conviction theme at present.
We are constructive that the eurozone, the US and China will, step by step, work their way through their issues, but we are not going to speculate on timing nor on the inevitable attendant volatility in markets.
Rather, our strategy is to ferret out those sound businesses with a competitive edge and global perspective that we believe will become winners by 2020, and in which we can invest on a sensible valuation. Despite the challenging backdrop, there are opportunities.