The following speech was delivered at the Federal Reserve Bank of New York's 40th Annual Central Banking Seminar on Wednesday, October 5, 2016.
It is both an honor and a very special opportunity for me to be able to address such a large and esteemed group of central bankers at such an interesting time for central bankers. I especially want to thank President Dudley and Vice President Schetzel for inviting me to forthrightly share my perspective as an investor and my unconventional template that I believe sheds some light on the very unconventional circumstances that we face.
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It is no longer controversial to say that:
- …this isn’t a normal business cycle and we are likely in an environment of abnormally slow growth
- …the current tools of monetary policy will be a lot less effective going forward
- …the risks are asymmetric to the downside
- …investment returns will be very low going forward, and
- …the impatience with economic stagnation, especially among middle and lower income earners, is leading to dangerous populism and nationalism.
While these things are now widely agreed, there still isn’t agreement on why these things are true or what to do about them. While there are many factors at play, I believe that the most important ones are covered by a simple template that I use to guide my global macro investing.
Where does that leave us now?
By and large:
- Productivity growth is slow, though properly accounting for it has never been more difficult
- The short-term debt/business cycles as measured by GDP gaps are closer to their mid-points than to their extremes, and
- The long-term debt cycles are approaching their very late-stages as debts can’t be raised much and central banks are approaching “pushing on a string” limitations to their effectiveness.
The biggest issue is that there is only so much one can squeeze out of a debt cycle and most countries are approaching those limits. In other words, they are simultaneously approaching both their debt limits and central banks’ “pushing on a string” limits. Central banks are approaching their “pushing on a string” limits both because interest rates are approaching their maximum lows, and because the effectiveness of QE is approaching its limits as the risk premiums and spreads are compressing. Also, the wealth gap and numerous other factors make lending to spenders more challenging. This is a global problem. Japan is closest to its limits, Europe is a step behind it, the US is a step or two behind Europe, and China is a few steps behind the United States.
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Concerning what policies will likely be required of central bankers given the reduced effectiveness of interest rate cuts and quantitative easing, and assuming that political limitations on fiscal policies and structural reforms remain stringent, it appears to me that there will have to be greater purchases of riskier assets and more direct placements of purchasing power in the hands of spenders, especially as the previously described squeeze intensifies.
While no period is entirely analogous, the most recent similar period for the world economy as a whole was 1935-45. After the debt-financed bubble of the late 1920s (which was analogous to the debt financed bubbles of the 2005-07 period), and after the 1929-32 stock market and economic dives (like those in 2008), and following the great quantitative easings that caused stock prices and economic activity to rebound (like those we saw since 2008), came “pushing on a string” in 1935, for analogous reasons – i.e. interest rates and risk premiums approached 0%.
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Similarly, the last 20 years in Japan are analogous in that there has been a similar combination of high levels of indebtedness, interest rates hitting 0%, risk premiums and asset returns shrinking, growth and inflation being low, and “pushing on a string” being a problem.
By VW Staff
