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GUEST ARTICLE: Cheer Up - There Are More Reasons For Optimism Than Supposed - SocGen

John Birdwood

Societe Generale Private Banking

21 October 2016

The author of this article is John Birdwood, group head of discretionary portfolio management at the private bank of . The views expressed here are those of the author and not necessarily shared by the editors of this news service but we are delighted to add these insights to debate and invite readers to respond. They can email tom.burroughes@wealthbriefing.com.

“And he gave it for his opinion, that whoever could make two ears of corn, or two blades of grass to grow upon a spot of ground where only one grew before, would deserve better of mankind, and do more essential service to his country, than the whole race of politicians put together.” - Jonathan Swift, Gulliver’s Travels.

In the years since the financial crisis broke upon us in 2007, we have seen an extraordinary series of new developments in monetary policy. As we get further into negative rates, the pace of change appears to be accelerating. Recently, the bank of Japan thought aloud about the effect of negative rates and appears to have concluded that they do more good than harm. 

In the US, John Williams of the Federal Reserve Bank of San Francisco, has floated the idea of a 4 per cent inflation target. Over the last four years, interest rates of close to zero have not been able to push the American rate of inflation above 2 per cent. Therefore, it remains to be seen what level of negative rates would be required to push inflation up to 4 per cent. Meanwhile, Kenneth Rogoff, who was the chief economist at the International Monetary Fund, has published The Curse of Cash, in which he notes that the principal hindrance to the operation of negative interest rates is the presence of bank notes.

Remove large denomination bills and the public will no longer be able to avoid negative rates by holding cash.

The enthusiasm for these ideas in a number of central banks and academic circles does not seem to have rubbed off on the general public. Also, the impact on pension funds, insurance companies and banks is rather troubling and appears to have been overlooked. So too has the impact on investor behaviour been overlooked, where the search for yield continues to entice investors to put money into riskier and less liquid assets.

Increased infrastructure spending as a means of giving the economy a fiscal boost is being seriously contemplated in a number of countries. However, all too often the projects chosen have very poor or negative pay-offs, such as Hinkley Point (the building of a nuclear power station) or HS2 (new high speed rail link) in the UK. Equally, genuine shortages in capacity have not been addressed for various reasons, in areas such as housing, London airports and commuter rail networks. By most reckoning Japan has introduced 26 stimulus packages since 1992.

Subsequently, the economy has, according to the World Bank, experienced an average growth rate of 0.8 per cent per annum and an inflation rate of 0.1 per cent. The inflation rate is only this high because the consumption tax rate has been increased twice. The price of this stimulus is that government debt now stands at 227 per cent of the size of the economy.

The third aspect of government policy is tax and regulation. In the US, estimates from George Washington University show that 441 economically significant regulations will have been issued in President Barack Obama’s term of office, which compares with 361 under Bill Clinton and 358 under George W Bush. It is a far cry from the third fall in the number of pages in the Federal Register in Ronald Reagan’s term of office. The weaknesses of both presidential candidates this year are well known, but at least on the issue of regulations, Donald Trump appears to have an understanding that too much regulation is impeding the growth of the economy. In the UK, according to the Daily Telegraph, we have the longest tax code in the world. We do not know what proposals the government will make in the Brexit negotiations, but it is reasonable to suppose that future British success will rely, in part, on simplifying the tax and regulation regime in order to make Britain a more competitive place in which to do business.

Some people might conclude that there is little reason for optimism. However, let us not overlook the fact that the world’s most important natural resource - human ingenuity - is flourishing.

In many fields outside economics there is a remarkable combination of new technologies in areas such as materials (graphene), production (3D printing and automation), energy production (fracking and rapid advances in the cost efficiency of renewable sources), data availability to enable the sharing economy (Airbnb, Uber) and the management of distribution (Amazon), and financial technology in, for example, lending and payments. It might well be that these trends have decades to run as they create new businesses to reduce the inefficiencies in the economy.

Also, there are rapid advances in medicine in areas such as Alzheimer’s disease and cancer. Hopefully these developments will not only increase lifespan, but could also allow many people to enjoy a better, more productive old age.

None of this means that it will suddenly become easy to make money at a time when there are very few cheap assets and the political and economic choices are hard. However, it does suggest that our ability to adapt and innovate will form a very important part of the bridge to the future, driving economic growth and helping to support returns for investors.