While quantitative easing and fiscal stimulus have supported markets and economies in recent years, are they accumulating longer-term problems?
The decline of communism was heralded by the West many years ago, for many reasons. One of the main reasons was that the “invisible hand” of the market was a much better way to allocate capital than the centrally planned approach favored by communist economies.
However, these same Western economies and their asset markets are increasingly centralized. It’s been a slow but relentless journey, which began in the 1980s, when central banks became less concerned with inflation and more concerned with growth and, therefore, market levels. The logic being that higher markets have generated wealth and increased consumer confidence.
The expression “Greenspan put” was coined; a concept that refers to the US Federal Reserve (Fed) then chairman Alan Greenspan and the belief that the Fed could and would guarantee asset markets. This deviation from the mission has been largely undisputed by subsequent Fed chairmen and has been embraced by central banks in other countries, to a greater or lesser degree. Since then, crises have followed one another and everyone has seen the concept increasingly adopted, with official interest rates lowered and turned negative in some countries.
The 2007/08 global financial crisis (CFM) then saw a revolutionary shift in monetary policy, with the dawn of quantitative easing: a focus on the quantity of money rather than the price of money. It was a philosophically important time, a time when central banks took a new step in influencing the free market.
It is now widely accepted that the experimental post-GFC monetary policy has been much less effective in stimulating real economic growth than initially hoped by central banks. Instead, the policy had much of its impact on financial markets, with the impact on the real economy creating ‘unintended consequences’, such as supporting zombie companies that would previously have gone bankrupt and whose the assets were recycled by the market in more productive areas. .
The recent about-face in fiscal policy, from austerity to massive stimulus, is a natural progression of this policy. The crisis this time is Covid, and the associated lockdowns, but it was also triggered due to the reduced impact of monetary policy, which meant that massive fiscal policy was always going to be necessary to support the economy in a new major crisis.
As a result, we face a situation where increasing shares of asset markets and economies are centrally controlled, rather than left to market forces. It might have been the right thing to do in the face of Covid, but it appears to be causing inefficiencies in the allocation of capital in the economy, which in turn appears to reduce productivity as business investment is also reduced. In addition, the accumulation of debt means that increasing amounts of economic output will be spent on debt servicing, especially when interest rates rise. Inflation is therefore starting to weigh on investors’ thinking, as interest rate hikes are usually the main tool to curb inflation.
Some have commented that the traditional business cycle is dead as economic activity is increasingly manipulated. While he may not be dead, he is driven much less by market forces and increasingly by centralized politics. For stocks, this means that factors specific to stocks seem less important as the sector or theme becomes more and more important. This has favored index funds as macro factors have more impact and markets are supported while the difference between the best and the worst companies has less impact. It can also lead to misallocation of capital, with liquidity being directed to large companies rather than growing small businesses where it could be of most use.
David Thomson is Director of Investments at VWM Wealth