Like the Enigmatic Title Role in the Play Waiting for Godot, a Resolution Regarding Global Monetary Policies Remains Elusive. But Perhaps We’re Waiting in the Wrong Place.
I last used Waiting for Godot as an analogy in my “Message to Shareholders” dated January 4, 2013. Waiting for Godot, which premiered in 1953, is a play by Samuel Beckett who wrote about characters caught in hopeless situations. Beckett’s brand of existentialist fiction was often referred to as the “Theatre of the Absurd.”
My message in 2013 said, “Godot, in the form of resolution [referring to whether our economy was going to expand further or tip over into recession], will not arrive for a long time, if ever.” Here we are almost four years later, and Godot still hasn’t arrived.
Back in 2013 when I wrote about Godot, the U.S. Federal Reserve (Fed) had already instituted zero interest rates and had already tried three rounds of massive bond purchases known as “quantitative easing”—QE1, QE2 and QE3—all in futile attempts to spur rapid economic growth. But gross domestic product (GDP) growth has actually declined in the face of these and other monetary experiments.
As if zero interest rates in the U.S. weren’t crazy enough, the Bank of Japan and the European Central Bank have instituted negative interest rates. So hiding cash under the mattress would produce better returns. And as I pointed out last quarter, some homeowners in Denmark are actually being paid money back on their mortgages via negative interest rates. Talk about a real-life Theatre of the Absurd!
In theory, low and negative central-bank rates are intended to encourage economic growth by making business and personal loans cheaper—as loan rates take their cue from central banks. But in reality, the economic consequences have been very different.
Many lenders aren’t particularly excited about providing credit because their projected returns are modest due to the interest-rate environment. In addition, prospective borrowers are tentative because of the lackluster economy—and that’s if they can even qualify for a loan.
There’s also another trend going on. With interest rates so low, individuals approaching retirement realize that the returns on their savings will be minimal or nonexistent. As a result, the members of our aging population—who might otherwise have some wealth to spend—have a tendency to save even more. This tendency creates a vicious cycle in which reduced spending leads to even less growth in the economy.
So from the perspective of soon-to-be retirees, we can certainly criticize the actions of central banks around the world, as I have done from time to time. And, broadly speaking, I think central banks have pushed accommodative monetary policies way too far—which has done more to drive up asset prices (e.g., stocks, bonds and real estate) than to promote economic growth.
While others might disagree with my criticisms of the Fed and its global cohorts, and might argue that central banks were simply filling a void left by gridlocked politicians, there’s a more profound question that goes beyond the discussion of monetary policies: Are we waiting for Godot in the wrong place? By “in the wrong place,” I mean in the U.S. and other developed countries.
If Godot is some sort of economic resolution (expansion or recession) resulting from our monetary policies, perhaps that resolution will never come because developed countries are facing larger issues that cannot be addressed by monetary policies. These larger issues have to do with demographics and productivity trends, which have transformed our previously cyclical economy into a much more static economy. Let me explain.
In recent years, the average age of the population in developed countries has gotten older and productivity growth (the rate of change in output per person) has declined. Yet our way of thinking about growth remains stuck in the context of the growth stemming from the phenomenal innovations during the previous century.
In his book The Rise and Fall of American Growth, Robert J. Gordon discusses the massive improvements in our economy and standard of living since the Civil War. Gordon argues that productivity and hence prosperity accelerated due to an unprecedented age of innovation that is “unlikely to be repeated.” While this last part of his thesis remains controversial—especially in the age of mobile apps and technology unicorns—our recent slow-growth economic conditions are playing out according to his prognosis.
The next time you feel impressed by the new capabilities of your latest smartphone, just consider how insignificant those new capabilities are compared to the changes in the last century brought by the following: indoor plumbing, electric lighting, telephones, air travel, phonographs, television, air conditioning, central heating, antibiotics, automobiles and better working conditions. Moreover, these tectonic shifts in technology and living standards went way beyond what was reflected in “real GDP” and “real wages.”
Like air travel and automobiles, electric lighting was extremely rare beyond urban areas 100 years ago. So the last century was characterized by the spread of these modern necessities around the world.
Furthermore, the workforce expanded dramatically during the century. Women increasingly entered the job market as a result of both labor-saving appliances and the necessities of war.
More recently, the same productivity improvements that benefited the U.S. took hold in country after country. As a result, billions of new consumers—and producers—participated in the global economy.
As these productivity improvements spread, wealth in developed countries grew. And as wealth grew, there was a surprising side effect: Birth rates eventually fell. While the reasons for the eventual link between growing wealth and declining population trends have been debated, this link has held true in almost every nation around the world.
Falling birth rates lead to aging populations. In some countries like Japan and Russia, population growth has been sufficiently slow that their populations are not only aging, but are actually getting smaller. Even the population of China is projected to decrease within the next 20 years.
Aging populations create economic effects that account for some of the issues facing the world. Most notable is that aging populations tend to save more and spend less. John Maynard Keynes’s basic contribution to economic thought was his purported solution to the problem of excessive savings and inadequate demand. His solution was to supplement private spending with government spending.
While the policies advocated by Keynes have proven effective when an economy is experiencing a spending shortfall due to a recession, they have not proven effective when an economy is experiencing a spending shortfall due to an aging population—a situation currently seen in Japan, for example. In fact, Japan may be the poster child for the limits of Keynesian deficit spending.
The problems of an aging—and potentially a decreasing—population are not limited to Japan, Russia and China, but are spreading around the world into Eastern Europe including Ukraine, Belarus, Moldova, Estonia, Latvia, Lithuania, Bulgaria, Georgia and Armenia, and into Central and Western Europe including Albania, Bosnia, Croatia, Serbia, Slovenia, Germany and Hungary, and now into Greece, Italy and Portugal, along with Puerto Rico in the Caribbean.
The resulting widespread demand shortfalls and savings surpluses may have become permanent features of our economic landscape. Demand shortfalls translate into slowing economic growth rates.
As described above, developed countries have been trying to deal with these slowing growth rates through stimulative—arguably overstimulative—monetary policies ever since the global financial crisis ended in 2009. The failure of these policies to achieve anything but the most limited success underscores the intractability of the slow-growth problem.
In developed countries, therefore, maybe it’s time for the monetary authorities—and the rest of us, for that matter—to stop waiting for Godot. Instead, perhaps we should be celebrating the more or less full employment that at least the U.S. economy has managed to achieve. Then, our politicians and the broader government could turn their attention to improving the skills of those who truly lack adequate jobs.
While the slow-growth economy may have created an environment of less-excessive behavior on the part of businesses and of increased saving by a portion of the population that’s approaching retirement, I continue to be nervous about some of the speculative forces in the stock and bond markets.
To review 2016 so far, the year began with widespread declines in stock prices. While many analysts attributed those declines to prospective interest-rate increases by the Fed and to fears of China’s slowing economic growth, I believe the main cause was deteriorating creditworthiness among energy companies.
When oil prices later rebounded from their lows, investors became less concerned about the plight of energy companies being shared by other companies, and stock prices began to rise in February. Since then, we’ve had periodic scares in the markets—notably surrounding the Brexit vote—but stock and bond prices have generally been strong.
For the third quarter of 2016, the large-cap S&P 500® Index gained 3.85% and the Russell 2000® Index of small caps rose a very robust 9.05%. International stocks were also up nicely, as indicated by the 6.29% increase in the MSCI World Ex-U.S.A. Index.
After solid gains during the previous quarter, high-quality bonds were relatively flat for the third quarter. The intermediate-term Barclays Capital U.S. Aggregate Bond Index returned 0.46%. Meanwhile, the long-term Barclays U.S. 20+ Year Treasury Bond Index declined by a marginal -0.30%.
So what makes me nervous? First, stock and bond valuations are high relative to historical levels. Second, sales and earnings growth may be harder to achieve in the tepid economic environment I expect to see. Third, relative to earlier periods, equity holders in public markets may be compensated differently because many of today’s businesses are less capital-intensive and companies are finding it easier to raise money through private sources—which is evident by declining levels of initial public offerings. Fourth, market volatility in recent months has been comparatively low, which indicates that investors may be too complacent.
Based on these main factors, which haven’t changed much in the last few years, I continue to expect lower returns than many investors are counting on. I also expect to see periodic “air pockets” in prices—like we saw during January.
As a result, investors may want to keep some cash on hand in order to take advantage of lower prices after the air pockets occur. But we should also be prepared for the possibility that markets may not rebound as quickly or as strongly as they did earlier this year.
With sincere thanks for your continued investment and for your trust,
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Brexit is an abbreviation for “British exit,” which refers to the June 23, 2016 referendum whereby British citizens voted to exit the European Union. The referendum roiled global markets, including currencies, causing the British pound to fall to its lowest level in decades.
Earnings growth is a measure of growth in a company’s net income over a specific period, often one year.
The financial crisis of 2007-09, also known as the global financial crisis (GFC) and 2008 financial crisis, is considered by many economists to have been the worst financial crisis since the Great Depression of the 1930s.
An initial public offering (IPO) is a company’s first sale of stock to the public.
Quantitative easing is a government monetary policy used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. QE1, QE2 and QE3 are the nicknames for the first, second and third rounds of quantitative easing announced by U.S. Federal Reserve (Fed) chairman Ben Bernanke in an effort to jump start the sluggish economy following the financial crisis of 2007-09.
Gross domestic product (GDP) is a basic measure of a country’s economic performance, and is the market value of all final goods and services made within the borders of a country in a year. Real GDP is a macroeconomic measure of the value of economic output adjusted for price changes (i.e., inflation or deflation). This adjustment transforms the money-value measure, nominal GDP, into an index for quantity of total output.
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