Toppling Scales of Balance
by Guy Haselmann, Director, Capital Markets Strategy, Scotiabank GBM
· Everything happening today is in some ways interconnected: popularity of ‘non-establishment’ political candidates; ineffectiveness of central bank policy in lifting inflation; economic pessimism; weak capital spending (from handcuffed capitalism); and angst due to perceptions of inequality. Let me explain.
· Business investment and capitalism are being held back by a lack of visibility on what a future return might generate from an investment in a capital project. Not only are future economic forecasts cloudy and highly-uncertain, but the rules governing business engagement are changing too frequently. Capitalism and entrepreneurship are simply being hand-cuffed by unclear and overly-burdensome regulation. Small businesses in particular do not have the economies of scale necessary to keep up under these conditions.
· Domestic and global uncertainties always exist, but most would agree that they are unusually elevated. The strange and unpredictable political environment - and uncertainties over who will be the next President and what his/her policies will be – further restrains capital investment. Understandably, determining the present value of a future cash flow is impossible when the tax code and health care costs are in flux.
· Stimulative monetary policies cannot offset these powerful forces. In the past, I have referred to this dynamic as “Great Aunt Addy Policy” in honor of my aunt who drove with one foot on the accelerator and a heavy foot on the brake. Restrictive regulatory and fiscal policies are one reason why massive amounts of global central bank stimuli have underwhelmed. In addition, artificially low official interest rates distort financial asset valuations, which further harm the ability to properly assess the value of a future stream of cash flows.
· Fed officials often cite Japan’s economic malaise as the basis for their own concerns and the basis for providing and maintaining highly accommodative policy. In my opinion, Japan’s quagmire should absolutely not be used as the prototype for Fed policy justifications. The reasons are beyond the scope of this note. However, Japan has had sustained 0% rates since 1999 (and conducted various QE programs). Yet, it has had more success over that period raising debt than lifting inflation. Why then do other central banks follow their lead?
· If there is a lesson from Japan, it is that low inflation is a function of high rates of savings, caused by low interest rates, rising VAT taxes, harmful economic and regulatory policies, poor demographics, and a falling population. Comparisons to Japan and associated deflationary fears are unfitting. By mis-diagnosing the reasons for subpar nominal GDP, and by taking the lead to offset its weakness, central banks have veered too far from their true capabilities without proper regard for the long run consequences and risks to financial stability.
· Profitability has become ever more challenged in a ‘new normal’ world of slow growth and tepid pricing power. In such an environment, worker anger cultivates as a ‘labor vs capital’ battle ignites. Worker resentment and blame targets both employers and government officials.