Today I do not look at specific investment issues. Rather I explore the positive backdrop which might unfold in the coming years, and considerably boost both economic and investment potential. But it needs new thinking. The pandemic and the Tory leadership contest have together revealed the weakness of the thinking which dominates today, and, much more importantly, shone a light on that huge untapped potential if that thinking changes.
The Conservative Party leadership debate has brought to the fore the impression of austere conventional economists in the Treasury who have overwhelmed government decision making for many years past. In contrast, “Lizenomics” hints at a more imaginative path, albeit lacking in detail, with much higher government spending to encourage growth.
In the post-pandemic world, with raging inflation and stagnant economies, the time for this debate has come. Some of us have been wittering on about these alternatives for years, but now it is mainstream. This debate, with greater calls for an unconventional push for growth, will directly impact your investing opportunities in the years ahead.
The Pandemic Reveal
Before the pandemic, most Western economies, including the UK, had been living beyond their means for many years. To pay for this over-spending, a mountain of government debt kept growing, a bit like households having to go further into debt each month just to meet their most basic day to day expenses – food, heating, petrol.
That would, of course, be unsustainable for any of us. But governments have been able to do this because, effectively, they have the ability to print money to pay the bills! As long as central banks kept interest rates at zero or thereabouts, as they had since the emergency of 2008/9, it meant there was limited cost to the government by taking on more debt, as the interest paid on the government debt (bonds or gilts) was negligible.
Governments ducked when they should have been leading a charge forward.
Then along came the pandemic and proved them wrong.
Governments had little choice but to pump vast sums into the economy to prevent a financial disaster when countries went into lockdown.
Let’s have a look at the leading cast in this unfolding drama.
“Whenever money becomes very cheap, experience teaches us to expect that it will be misspent”
This was said in 1856 by Walter Bagehot, editor of The Economist. Such insights abound over time, both before and after 1856, but with particular vehemence in the last decade.
Why were the lessons of history, and increasingly vocal opponents of zero rates, ignored by central banks?
The central bankers thought that they knew better, starting with Alan Greenspan from 1987.
I wanted to know what makes these individuals tick, particularly at the US Federal Reserve. Then along came a revealing analysis by Ben Hunt (Epsilon Theory). Ben does not pull his punches.
To paraphrase Ben on the Fed, how can more than four hundred PhD economists, with a budget of hundreds of millions of dollars, massive computer power, and billions of data points, be so completely and utterly wrong?
It is well understood that the emergency action by central banks in 2008/9 (zero interest rates and quantitative easing) were kept in place long after the fire went out. This encouraged directors to line their pockets financial engineering, widened the wealth gap, and pushed the US stock market and global bonds to levels which are extremely dangerous, not just for investors, but for the stability of economies in general.
Rising inflation now provides them with the cover to do what they should have done 10 years ago – raise interest rates.
They can blame rising inflation for the coming debt-fueled collapse of many businesses; and rising inflation can be blamed on COVID and Putin. Neat.
Those of you who have kept up with this story in recent years, know that the central banks have been a big part of the problem, not part of the solution.
Central banks are populated by macro economists. They also dominate the HM Treasury, are littered around the banks and a wide range of influential consultancies, and regularly pop up in the media.
The late Benoit Mandelbrot compared economists to real scientists:
“Biologists know that studying disease helps to understand the healthy body.
Physicists collide high energy particles to understand ordinary matter.
Meteorologists study hurricanes to forecast local weather.
And economists? They are a curiously incurious lot…
Financial economics, as a discipline, is where chemistry was in the 16th century; a messy compendium of proven know-how, misty folk wisdom, unexamined assumptions and grandiose speculation.”
A significant part of the lack of confidence in macro economists is derived from their insisting on making forecasts, and invariably being wrong. In 2001 an IMF economist published a survey of the accuracy of recession forecasts by economists throughout the 1990s. He found that their record of failure was not far off 100%.
In 2020 an updated survey was undertaken, over a longer period taking into account the 2008/9 period. As one commentator put it: “The record of failure remains impressive”.
Forecasting is a mug’s game, whether as an investor or economist, yet macro economists try to do this all of the time.
Trust is at the heart of the capitalist system. If you can’t trust the actions and forecasts of central bankers, what about politicians?
In terms of what was possible by governments, the genie was let out of the bottle in 2020. The government was able to direct money right at the heart of the economy – there was none of the hocus pocus which followed the collapse of Lehman Brothers in 2008, and which over the next decade blew a massive bubble in financial markets with no benefit to the mainstream economy.
As the economy grows, as it did after the War, the volume of that government debt goes down proportionately, though the ability of the financial system to sustain large levels of debt depends on a vibrant and growing economy. By the 1950s and 1960s the levels of government debt became more sustainable, enabled by the post-War economic growth encouraged by political leadership in economic matters.
Let’s see more government guarantees backing bank loans for key businesses and projects (albeit with more robust checks than occurred with the Covid bank loans). There is a banking network in the UK which connects government policy directly to the sharp end of the economy. The government can compel banks to lend, with some level of government guarantee, and dictate the size, interest rate, term, and the purpose.
Inflation – Problem Or Opportunity?
It must be acknowledged that inflation is a big problem for many households. It means struggling to buy sufficient food for your family, or not being able to buy enough petrol to drive to work. That this should be so in a modern Britain is appalling – there are now 1,172 independent food banks in the UK. It is similar elsewhere, and it preceded interventions by COVID and the war in Ukraine. For example, in 2019 there were 38 million Americans receiving food stamps, about 12% of the population.
This is the free world folks.
All of this occurred while central bankers supported financial markets with billions of pounds and dollars, politicians sat on their hands, and the rich got richer.
There is a very angry debate taking place, with insults being slung around as those wanting greater government spending are attacked by the mind guards of conventional economics.
The stalwarts of the status quo will proclaim that more spending will trigger hyperinflation – they will conjure up images of the Weimar Republic, and people taking barrow-loads of bank notes to buy a loaf of bread.
All very polarised, capturing the mood of our time very effectively, but not otherwise enlightening.
Whatever system evolves, it will still require both flexibility and discipline, not always easy bedfellows. But a robust architecture can certainly be put together to facilitate this change in direction, achieve greater spending directed at the real economy, and give it credibility.
With more imaginative political leadership, and less obstructive central banks and economists, considerable economic and investment potential can be unlocked, in the UK and beyond.
It would be nice if that happened sooner rather than later, but don’t hold your breath just yet.