Brief thoughts on the asset-based global recovery

The global economic recovery continues as all of the most important economies in the world are on track for growth. Europe is the laggard and the tepid recovery there could still stall out. Below are some brief ideas on where this is headed and why.

I am going to try to make this as brief as possible, but here are a few ideas. Let me frame the ideas with an interesting piece I read at the BBC on the views of Joseph Stiglitz on the reasons this recovery has been so difficult. Here’s the characterization of what Stiglitz said that resonated with me.

Stiglitz maintains that those sorts of inequality figures are the main impediments to economic growth. The rich pay less tax, so higher inequality depresses tax receipts. Also, most importantly, the poor consume more of their income than the rich.

This lower “marginal propensity to consume” of the rich was originally pointed out by John Maynard Keynes.

Rich v poor?

In other words, poorer people have less disposable income, and spend more of it on necessities such as food.

Richer people tend to spend proportionately less of their income since they have more money to spend.

It implies that raising incomes for the poor would generate proportionately more consumption.

While it may be contentious whether the rich consume less than the poor, what is clear is that rising wealth and income gaps have been closed via debt accumulation. And this is true nearly everywhere in Europe and North America. Stiglitz is looking at the issue through a prism of wealth gaps and inequality and I am looking at the issue through my prism of private debt as an economic destabilizer. But both of these thought processes arrive at the conclusion that strategies focused on more private debt accumulation rather than private income accumulation are destined to fail in a world of zero rates.

The goal of policy makers today is to boost growth by keeping rates as low as possible and keeping monetary policy as easy as possible in the hopes that this will increase private credit and spur growth. The goal then is toward further private debt accumulation, something that will impede longer-term economic growth.

That is the framing here.

These policies are working. Just look at some of the links from today.

For example, Hugh Hendry, a noted bear, has said that he can no longer stick to his fundamentals-based investing approach. The psychology of the market is at odss with this. So he has thrown in the towel and gone bullish. In Australia, despite worries from commentators like Steve Keen, house prices have gone from strength to strength. And this has pushed prices well out of reach for many first-time buyers. The result is households have taken on more debt to fulfill their home-owning dreams. In Germany, the savings rate is at a 12-year low as low rates and low unemployment have buoyed the economy (link in German). The Wall Street Journal gave us a look as well at how German savers must adapt to the low-rate environment. Their analysis helps explain how reaching for yield may be  a large part of why savings rates are sinking.

Everywhere you look, nominal interest rates are low. And it is working. As the links posts have documented in the past few weeks, we can see these signs. It is getting people to reach for yield and to reach for risk. It is getting lenders to extend loans with relaxed covenant terms. Low nominal rates are helping get investors to look into real estate investment trusts and master limited partnership types of vehicles to increase returns. Low nominal rates are also driving the huge rise in high yield and convertible debt issuance.

So we should expect some incremental credit growth. The US and the UK are leading the charge via a reflated housing market. But these same factors should increasingly affect Europe as well, if it can reach economic lift off without another crisis.

The Fed has already become concerned about this. It is clear that the Fed wants to separate asset purchases and forward guidance as policy vehicles. And it is also clear that the Fed wants to rely more on forward guidance than asset purchases in part because of a fear of asset bubbles. So the Fed is trying to maintain accommodation without fuelling bubbles. I say, “Good Luck”. The goal of these policies is increased private debt accumulation, something that is very much geared toward rising asset prices and bubbles. So I expect bubbles, even if they are not here yet.

The question remains then as to how this ends and what are the consequences for the economy and the financial system. I tend to believe this ends badly, in credit writedowns, deleveraging, bankrupticies, and the attendant civil unrest. How long off are we from this period? It is hard to say. We will need to see the bubble phase develop and then see the unwind process begin. Right now, we are still in the upswing. And there are no signs on the horizon that this asset-based recovery is about to end.