Demystifying Post-Gfc Economics; The Employment Amongst Scarcity; Involvement Rates; Long Political Cycles; In Addition To The Halt Of History

The post-GFC era has given ascent to widespread investor confusion, every bit macroeconomic as well as marketplace outcomes take away hold deviated from the received economical wisdom nearly what 'ought' to take away hold happened. Old hands take away hold been specially incorrect footed, every bit their tried as well as truthful mental as well as financial models nearly how the public operates, which worked so good during 1980-2007, take away hold failed them. Traditional monetary policy has stopped working, as well as many economies (e.g. Europe) take away hold remained sluggish as well as unresponsive to really low, or fifty-fifty negative, involvement rates. Low rates were supposed to stimulate investment as well as consumption, as well as yet both take away hold remained weak. "Unprecedented" unconventional monetary stimulus (in quotation marks every bit really similar policies were tried - with similar results - inwards Nippon during the 1990s) inwards the cast of QE has been undertaken, but despite this vigorous 'money printing' which was expected past times many to termination inwards inflation, nosotros take away hold had disinflation bordering on deflation, with inflation stubbornly refusing to ascent towards key bankers' 2% trend-rate goal.

Government deficits as well as debt-to-GDP take away hold risen markedly, as well as yet long authorities bond rates take away hold fallen precipitously, inwards many instances into negative territory - something many previously deemed impossible. Aren't the 'bond vigilantes' supposed to enforce financial discipline, as well as drive upward involvement rates every bit the credit-worthiness of governments declines? And despite the full general sense of malaise, including oftentimes extended periods of weak growth, stock markets take away hold continued to rise, defying widespread calls over the past times decade for imminent doom.

Bonds as well as stocks were also supposed to motion inwards opposite directions, every bit falling rates signalled deteriorating growth, which was adept for bonds but bad for stocks, as well as vice versa. Many traditional 60/40 stock-bond portfolios are structured on this basis, due to the putative diversification benefits that derive therefrom. And yet stock prices take away hold risen fifty-fifty every bit bond yields take away hold fallen. Some take away hold concluded from this that 'the bond as well as stock markets are telegraphing really different messages' (i.e. the stock marketplace that growth is strong as well as improving; bond markets that it is weak as well as deteriorating), when inwards reality they may good last telegraphing a tertiary mutual variable that has been missed. And to a greater extent than than anything else, at that topographic point has to a greater extent than oftentimes than non been a pervasive sense of ill-ease; that something is amiss; that sure as shooting the Fed as well as other key banks are singularly to blame; as well as that unintended negative consequences inevitably await.

So what's going on here, as well as why has everyone got it so wrong? If you lot don't empathize something, its invariably because you lot are looking at reality through a imitation prism, as well as at that topographic point is something incorrect with the mental models you lot are using to translate reality. What has happened is that a lot of investors - many of whom pride themselves of beingness independent thinkers - take away hold unwittingly accepted a lot of conventional economical wisdom uncritically, without thinking to a greater extent than deeply nearly what mightiness last happening. The procedure calls to brain Keynes' famous quote: "Practical men who believe themselves to last quite exempt from whatever intellectual influence, are normally the slaves of some defunct economist". And instead of going through the laborious as well as uncomfortable procedure of reexamining long-held beliefs, most of these investors take away hold instead contented themselves with simply blaming the Fed, piece preparing for the inevitable doom that sure as shooting awaits.

I take away hold been giving these issues a lot of thought over the past times decade, as well as I take away hold reached a really different determination nearly what is happening. While the intellectual influences that take away hold contributed to the perspective I outlined below are diverse, as well as a lot of it are also my ain master copy insights, the Japanese economist Richard Koo has in all probability contributed to a greater extent than to the evolution of my thinking of these issues than whatever other singular source (I highly recommend his volume The Holy Grail of Macroeconomics; Dumas' volume Bill From the Cathay Shop was also highly influential to me when I read it inwards 2008). With the mental models I am currently using, which I hope to outline below, at that topographic point is goose egg at all surprising or odd nearly what nosotros are currently seeing; indeed, it is exactly what nosotros ought to expect. Some potential/speculative futures are discussed towards the terminate of the article.


The job with scarcity

Traditional economic science is premised on the fundamental notion of scarcity. This extends to both the consumptive as well as investment realms, where: (1) consumer wants are considered infinite as well as ever inwards excess of the financial resources of consumers (which inwards plow reverberate resources constraints inwards the existent economy), requiring those wants last rationed downwardly to the highest priorities; as well as (2) businesses ever take away hold a larger number of investment projects they would similar to undertake than the available render of funding, which requires uppercase last rationed (which inwards plow ensures uppercase has an appreciable cost).

When these criteria are met, traditional monetary policy (and a lot of traditional economical theory) industrial plant just fine (and continues to piece of work today inwards most of the emerging world). If the economic scheme is sluggish, the key banking concern tin lower rates, making access to uppercase to a greater extent than affordable, as well as because access to uppercase was previously a constraining constituent holding dorsum demand, the release of this constraint volition boost the economy. When rates fall, consumers are able to borrow at to a greater extent than affordable rates to finance their (now slightly less) constrained consumptive desires, piece businesses' access to affordable uppercase rises, allowing them to finance to a greater extent than investment projects, as well as quicker. Both investment as well as consumption tin thus last reasonably expected to ascent if the cost of uppercase is lowered (particularly because investment is also linked to the floor of consumptive demand - higher consumptive demand requires additional supply-side investment/capacity to run into that demand).

However, if this increment inwards demand exceeds the powerfulness of the existent economic scheme to render it, inflation volition occur. This is what is known every bit 'overheating'. If the economic scheme is at chance of overheating (or is overheating), the key banking concern tin rotate the stimulatory dial dorsum down, making uppercase to a greater extent than costly. Businesses are so forced to defer investment activity (typically past times paying downwardly debt as well as steadily accumulating retained earnings from operating cash flow, until they are able to afford to invest inwards those novel projects from internal savings), piece consumers are forced to defer debt-fuelled consumption for the same reason, as well as maybe pay downwardly debt accumulated inwards the past times wheel every bit well. Aggregate demand cools, slowing the economic scheme as well as reducing inflationary pressures (the Philip's Curve industrial plant for this reason). The key banking concern tin so loosen rates in ane trial again, as well as the wheel continues.

Aside from key banking concern intervention, costless marketplace involvement rates are also expected to deport inwards a similar fashion, as well as drive similar outcomes. If the render of savings exceeds the demand to borrow those savings to eat and/or invest, aggregate demand volition weaken, as well as involvement rates volition fall. This volition lower the cost of capital, encouraging businesses to borrow to invest, as well as also encouraging investors to convey to a greater extent than risk, every bit 'risk-free' rates of render decline. It also makes consumptive borrowing less costly for consumers, as well as encourages banks as well as other financial markets to render to a greater extent than funds to such borrowers, every bit alternative high-return uses of uppercase moderate.

Aside from stimulating the greater utilisation of aggregate savings on the demand side, traditional economic science also argues that lower rates cut down the incentive to save, as well as thus also human activeness to cut down the aggregate render of savings (and simultaneously increment consumption, on the footing that consumption is income less savings). Consequently, every bit rates fall, both the demand to utilise savings volition increment as well as the render of savings volition decline, resulting inwards a shortage of savings that results inwards marketplace involvement rates rising. The same industrial plant inwards reverse, it is argued - every bit rates rise, demand for savings to finance investment/consumption declines, piece the render of savings rises every bit the incentive to salve increment (also slowing consumption). This slows the economic scheme (falling investment as well as consumption), as well as the growing excess of render should Pb to a refuse inwards involvement rates.

This model may seem superficially adept as well as reasonable, but the job is that the model assumes the existence of perpetual scarcity, which is an unsound supposition - specially with honour to investment demand, as well as also the 'incentive force' on saving behaviour. More pointedly, underpinning this model is the supposition that the propensity to salve volition ever autumn brusk of the propensity to invest and/or borrow to consume, which implies that savings are ever necessarily scarce, which is a fundamentally flawed assumption.

Keynes noted long agone the 'paradox of thrift' - for whatever ane individual, saving is a adept as well as prudent thing, but from a systemic dot of view, saving subtracts demand from the economy, because ane person's spending is some other person's income. If everyone of a precipitous saved 50% of their income, the economic scheme would collapse. In social club for those savings to proceed to circulate inwards the economy, they take away hold to last used either to finance existent uppercase investment past times businesses (either via equity or debt financing), or they demand to last borrowed as well as consumed past times some combination of other consumers or the government. If such savings are non utilised, they volition plunge the economic scheme into a deflationary depression.

The supposition of perpetual scarcity is most audio with honour to the consumptive realm. Most people would indeed similar to eat at rates significantly inwards a higher identify their electrical flow floor of consumption, but are unable to exercise so every bit they are fiscally constrained. However, fifty-fifty here, the supposition is imperfect as well as to some floor problematic. Firstly, the supposition breaks downwardly at the private floor every bit somebody gets richer. No affair how rich you lot are, you lot tin only gulp ane beer at a time, eat ane repast at at time, as well as wing on ane jet at a time. The Definition of beingness rich (to me at least) is when you lot are 'making it faster than you lot tin pass it'. You decease away on an expensive vacation, as well as past times the fourth dimension you lot come upward back, you're investments take away hold passively earned to a greater extent than than you lot take away hold spent many times over. Wealth compounds but fourth dimension does not. When rich people surpass this threshold, the supposition of scarcity-constrained consumption breaks down, because past times this point, they cannot assist but salve to a greater extent than as well as to a greater extent than money (unless as well as until it is donated to charity).

In economical parlance, the 'marginal propensity to consume' declines precipitously every bit income as well as wealth accumulates. Furthermore, the demand for consumption-related debt from the affluent also disappears. If you're already rich, why would you lot demand or want to borrow money to finance consumption? This tin take away hold systemic (and political) consequences when income as well as wealth inequality increases materially, every bit it has inwards the developed public over the past times xl years (more on this later). It tin easily terminate upward resulting inwards a province of affairs where those who would similar to eat to a greater extent than don't take away hold the money, as well as those that take away hold the money exercise non want to eat more. Traditional economical models pay absolutely no hear to these critically of import 'distributional effects'.

In addition, the supposition that the median mortal tin as well as volition inevitably borrow to a greater extent than as well as salve less every bit involvement rates autumn (the latter due to a 'reduced incentive to save') contains inside it many flaws. For a start, debt needs to last paid dorsum (or at to the lowest degree people can't sustainably decease deeper into debt or last allowed past times banks to send negative equity to their expiry bed), as well as to a greater extent than importantly, most people aspire to retire at circa 65 as well as relish xx years or to a greater extent than of retirement, as well as are thus desirous of accumulating retirement savings (as good every bit enjoying a debt-free retirement), to fund non only living costs, but the likelihood of escalating healthcare costs/needs every bit they age.

While the traditional model may good piece of work for those inwards early on adulthood, those inwards the latter one-half of adulthood are likely to seek to accumulate savings as well as cut down debt (at to the lowest degree the sort non backed past times assets, such every bit investment property), regardless of the floor of involvement rates. Indeed, falling rates decease far harder to accumulate savings for retirement, past times both reducing the benefits of chemical compound involvement during the accumulation phase, as well as reducing the floor of investment income generated past times a given amount of previously accumulated savings during the distribution phase, requiring a larger nest egg last accumulated inwards the root place. Low involvement rates could thus just every bit reasonably last expected to increase savings rather than decrease them.

The model that lower rates decreases the incentive to salve (and vice versa) thus ignores existent public realities - people exercise non last forever, as well as demand to salve for retirement as well as time-shift their consumption, as well as they demand to exercise this regardless of prevailing involvement rates. And demographic considerations - where a long menstruum of falling nativity rates termination inwards the median historic menstruum moving into the belatedly 40s or inwards a higher identify - could reasonably last expected to termination inwards a important increment inwards the propensity to salve as well as decreased propensity to borrow as well as pass that is noticeable at the aggregate level.

The floor to which these dynamics are non understood past times people that should know a lot improve is every bit astounding every bit it is disappointing. In the postal service GFC era, nosotros take away hold heard repeated claims from key banks as well as policymakers to a greater extent than or less the public that 'banks are non lending' inwards response to stagnant or declining consumer debt. It has ever been assumed that this is because the banks lack the capacity to lend (inadequate uppercase or liquidity), or because they are beingness excessively chance averse (to some extent truthful after the trauma of the GFC, but non to the extent claimed). The supposition that a lack of render of funds has been the source of the job has set behind a lot of key banking concern policies designed to boost banking concern liquidity. However, no thought has been given to the province of affairs where a lack of demand for credit may last the primary number - consumers may simply take away hold no want to borrow money as well as decease farther into debt, piece the rich take away hold already maximised their consumptive desires as well as take away hold no demand or want to borrow. In other words, contrary to policymaker belief, at that topographic point is no scarcity of render of borrowable funds - at that topographic point is genuinely a lack of demand.

However, the most important job with the scarcity model is how it pertains to delineate of piece of work concern investment. Real uppercase investment (distinct from secondary portfolio investment, where ane investor only exchanges cash for stock, as well as the vendor stock for cash, which results inwards no cyberspace cash absorption) does non convey identify inwards a vacuum; instead, businesses invest uppercase only where they consider an economical ground to exercise so - specially inwards countries similar the USA where companies are to a greater extent than oftentimes than non run with a focus on RoE as well as shareholder value maximisation. In such countries, companies volition non borrow money to brand additional investments/add capacity - fifty-fifty at really depression rates - unless at that topographic point is a compelling delineate of piece of work concern rationale. If not, they volition just utilisation excess FCF to pay dividends/buy dorsum stock. After all, if your existing factories are only operating at 70% utilisation, why ane globe would you lot want to build a novel one?

This tin easily termination inwards a province of affairs where growth inwards consumption is weak due to growing inequality, demographic factors as well as consumers savings for retirement, which leads to a reduced demand for farther corporate investment, regardless of involvement rates or the availability of funding. In other words, access to finance ceases to last the constraining factor; it is non that companies lack access to capital, but rather they exercise non take away hold a sufficient number of worthwhile uppercase projects to invest in.

The causes for reduced demand for uppercase investment - specially relative to to the growing availability of uppercase render - genuinely runs a lot deeper than just this. Aside from the factors discussed above, the demand for novel uppercase investment is to a greater extent than oftentimes than non driven past times 3 factors: (1) population growth; (2) the emergence of novel technologies that are uppercase intensive to roll-out; as well as (3) the actual roll-out of #2.

Population growth is fairly self-evident. If population is growing either through natural increment or cyberspace migration, to a greater extent than of everything is needed. This volition drive a sure floor of ongoing investment. It is no coincidence that economies with a lot of cyberspace migration (US, Australia, Canada, UK, etc) take away hold performed 'better' than those without (in quotation marks because per capita statistics oftentimes tell a really different story), as well as that Nippon has performed the worst, given the viciously as well as unprecedentedly negative demographics the Earth is facing. On a per capita basis, Nippon has genuinely grown only slightly to a greater extent than slow than Western peers over the past times xxx years, but because it's population is shrinking, the excess of savings as well as the weakness inwards investment demand dynamics has been past times far the most pronounced.

More interesting are #2-3, which tin last thought of every bit comprising 2 axis on a 2D bird that drives investment cycles. In social club to take away hold a major uppercase investment cycle, at that topographic point root needs to last the emergence of a novel engineering scientific discipline that is capable of providing a novel production or service, or providing an existing production or service to a greater extent than efficiently (and which is also uppercase intensive to curlicue out). Secondly, you lot demand to curlicue that engineering scientific discipline out to arrive at a saturation dot of the installed base, which depending on the technology, tin oftentimes convey many decades. This dynamic is best highlighted past times way of example.

Let's say the railroad is invented. That's the invention. The adjacent thing you lot demand to exercise is convey maximal wages of this engineering scientific discipline past times rolling out railways across the country/world to the dot where farther penetration of the engineering scientific discipline no longer adds whatever value as well as so is thus non required. That requires a tremendous amount of uppercase investment, inwards steel production, locomotive production, as well as construction activity as well as the like, as well as it volition convey a really long time. However, at some point, you lot volition arrive at a saturation dot where you lot take away hold built plenty railways. At that point, the investment demand volition revert to sustaining levels, unless a radical novel engineering scientific discipline capable of improving it arises. At that point, at that topographic point would last some other major investment wheel every bit obsoleted uppercase stock is replaced with upgraded uppercase stock.

Another instance is air travel. Global RPKs are soundless growing at some 5% a year, aided past times continuing growth inwards low-cost carriers as well as rising incomes inwards the developing world. This continues to drive the demand to make to a greater extent than planes to run into this demand. This style volition proceed for a long fourth dimension every bit emerging Earth consumers acquire richer. But at some point, no affair how rich you lot are, you lot don't want to exercise whatever to a greater extent than air travel. The constraining constituent for many affluent people is no longer the cost of travel, but how much fourth dimension they want/need to pass sitting inwards an uncomfortable topographic point at 40k feet beingness capitulated to a greater extent than or less the public at 900km/h. At some point, no affair what people's incomes, the demand for to a greater extent than investment air go volition stop. At this point, scarcity volition cease to function. No to a greater extent than airports, Boeing factories, or cyberspace aircraft fleet investment volition last required beyond sustaining requirements, unless at that topographic point are major novel innovations. If a novel bird was invented, for instance, that was twice every bit fast as well as a one-half the cost (very doubtful this volition occur), you lot would so demand to retrofit the entire existing fleet, which would drive some other important investment cycle.

In short, if the measurement of technological innovation slows down, at that topographic point volition last less demand for major retrofitting uppercase investments, every bit saturation levels are reached. Today, nosotros take away hold some investment cycles inwards novel technologies - notably inwards cloud computing infrastructure as well as associated implementations, every bit good every bit software evolution across a diversity of fronts. Regulatory-driven investments into renewable release energy is some other source of uppercase demand/absorption (trying to colonise Mars also seems to last an first-class way to - shall nosotros say - 'absorb a lot of capital'). However, inwards general, exterior the public of software as well as ICT, the measurement of technological evolution has speedily decelerated - specially inwards to a greater extent than capital-intensive fields - which has coincided with an increasing floor of saturation of developed-market stuff consumer wants (as oppose to services demand). Most consumers similar a shot take away hold plenty clothes, food, appliances, cars, as well as other toys.

Furthermore, technological innovation today is also increasingly making the stuff public to a greater extent than efficient, as well as contributing to the consumption of less resources. In the past, to a greater extent than was the social club of the day. More cars. More clothes. More food. More stuff. Now, ICT as well as the rapid evolution inwards computing powerfulness is helping us to do more with less. The sharing economic scheme improves resources utilisation, as well as IoT/AI volition proceed to drive radical enhancements inwards the efficiency of resources usage across a diversity of industries. This is farther contributing to savings outstripping investment demand.

Finally, ane other thing that has been exacerbating the increment inwards total uppercase render inwards an surround of declining demand/need for uppercase is rising life expectancies, which I blogged nearly here. While the thesis is hard for many people to accept, as well as encountered some scepticism, all you lot genuinely take away hold to exercise is consider how much uppercase Warren Buffet or Charlie Munger could take away hold accumulated had they passed away aged 65, as well as compare how much they take away hold genuinely accumulated at ages 85-95. Capital compounds geometrically, as well as when you lot combine increasing inequality with rising life expectancies, you lot increasingly take away hold the capacity non only for really large fortunes to accumulate, but for the aggregate render of savings/capital to mushroom amongst that fact (although inwards the instance of Buffett, charitable donations are resulting inwards the recirculation of some of those funds). Buffett bemoans the lack of worthwhile places to allocate his US$130bn cash hoard, but his geometric accumulation of capital, along with many others, is a heart as well as soul ground why. There is increasingly simply also much capital/savings, as well as non plenty worthwhile places to invest it. Many investors don't similar to convey it, but the public does non owe you lot a high render on capital.

What it all adds upward to is that uppercase scarcity has been declining, every bit the render of savings has increased, piece the demand for the utilisation of those savings to finance investment and/or borrowing for consumption has fallen. In other words, savings take away hold ceased to last scarce or a constraining constituent holding dorsum economical growth. There is no - as well as never has been - whatever guaranty savings/capital volition ever last scarce, as well as hence able to command a high return, as well as a lot of the confusion investors are experiencing gives way every bit shortly every bit that reality is understood. Indeed, none other than Karl Marx in ane trial said that inwards the long run, involvement rates would decease to null every bit the capitalists would run out of things to invest in, as well as at that dot at that topographic point would last no alternative but to redistribute the capital. To some extent, he is correct as well as that is what is happening as well as - irrespective of intermediate cycles as well as whether nosotros take away hold or take away hold non already reached that dot - volition in all probability inevitably occur inwards the really long term, every bit the global population peaks, as well as nosotros arrive at a technological plateau (although nosotros are soundless a long way away from that dot globally).

Some people believe inwards exponential technological progress. I'm to a greater extent than inwards the S-curve camp. This is because piece the floor of accumulated human noesis as well as information continues to increment rapidly, the human capacity to absorb, assimilate as well as integrate that information - at the private floor - is finite as well as fourth dimension constrained. The to a greater extent than nosotros discover, the harder as well as longer it takes for people to uncovering meaningfully novel insights. People cannot pass the root sixty years of at that topographic point life learning all the prerequisites they demand to brand novel discoveries. They demand to brand a living. We take away hold already reached the dot of radical specialisation, which introduces its ain set of problems, every bit increasingly 'range', or combinatorial insights from multiple domains, is required for breakthroughs. Furthermore, 'science' tin only convey every bit so far, every bit nosotros remain constrained past times the laws of physics/nature. To the extent I am correct nearly this, it seems inevitable that the long term sustainable charge per unit of measurement of involvement volition style towards null inwards the long term (or fifty-fifty last negative, if savings remain inwards structural excess), although every bit I annotation below, at that topographic point is ample capacity for volatility on the way through.


Making sense of what is happening

With the inwards a higher identify context inwards mind, nosotros tin finally start out to uncovering set upward explanations for a lot of the phenomena that has confounded investors over the past times decade which I referenced inwards my root 3 paragraphs. The inwards a higher identify analysis makes reference to an excess of savings, but technically this claim is inaccurate, inwards the sense that - international imbalances aside - inwards the aggregate, net savings must equal investment (with cyberspace savings a composite of gross savings past times some economical participants, less cyberspace borrowing past times other economical participants, including most notably, governments). In other words, whatever gross savings inwards excess of investment demand must last dissipated past times governments and/or consumers dissaving. Whether the propensity to salve is tending to go past times the propensity to invest/borrow tin only last inferred from the management of involvement rates, but the style of involvement rates to proceed to refuse every bit debt levels rise, is strong evidence that excess savings is the push/causal factor; rising debt levels the outcome.

Because consumers take away hold to a greater extent than oftentimes than non been reducing their debt burdens inwards the post-GFC years, as well as corporates take away hold non needed to borrow to finance investment, it has to a greater extent than oftentimes than non fallen on the authorities to exercise the borrowing. In the absence of this 'borrower of in conclusion resort', the economic scheme would come inwards a downward spiral leading eventually to depression. The latter would ultimately arrive at the same thing - balancing cyberspace savings as well as investment - but through a much to a greater extent than painful route: crushing savings past times hammering corporate profitability - a key source of savings - as well as volume unemployment, which thwarts consumers' powerfulness to save, piece forcing the authorities into deficit anyway past times having their taxation income crater. This is exactly what happened during the Great Depression.

Knowing this, it is piece of cake to consider why authorities bond rates take away hold fallen fifty-fifty every bit authorities debt levels take away hold risen. The response is that most observers take away hold misunderstood the management of causality. The authorities is beingness forced into borrowing to absorb excess private sector cyberspace savings - just every bit it has had to exercise inwards Nippon since the 1990s. This is why investors such every bit Kyle Bass, who don't empathize this stuff, take away hold been calling inwards vain for a authorities debt crisis inwards Nippon for years as well as years to no avail. The force constituent has been also much cyberspace savings - which has pushed downwardly involvement rates - as well as the 'pull' constituent authorities borrowing to absorb those excess savings. Furthermore, fifty-fifty inwards the pre-GFC years, the prime number mover of the debt/housing bubble was not consumers' want to borrow, but instead the force constituent of excessive global savings, which created huge demand for yield assets that had the effect of pushing downwardly rates as well as promoting the relaxation of credit standards that induced people to borrow. The speculative appetite to borrow as well as purchase houses only came afterward in ane trial the nail was good established.

In addition, QE does non take away hold the same effect has 'helicopter money', but instead genuinely has the counterproductive effect of making the existing savings glut imbalance even worse (which highlights how extraordinarily ignorant key bankers are to the dynamics outlined inwards a higher identify - they take away hold completely misdiagnosed the problem). Helicopter money would last received past times the average consumer as well as spent. It would stimulate aggregate demand, as well as would eventually last inflationary. However, QE doesn't operate this way; the CB instead purchases bonds off wealthy individuals, corporations, investment funds, as well as banks. The prior owners of these assets were either wealthy individuals who are already consuming at their maximum desired level, or the middle grade (via investment funds) who are saving for retirement. These funds were thus already inwards the 'investment' bucket, as well as thus destined for reinvestment into other alternative financial assets, rather than reallocated to consumption, as well as the 'trickle down' effect has only been modest.

What happens with QE is that these entities air current upward with a whole lot of newly minted cash instead of bonds. What they exercise with that cash is non pass it, but seem for alternative investments. That has the effect of pushing downwardly involvement rates as well as driving upward asset prices, as well as percent cash allocations autumn via the machinery of the toll of other assets going up, rather than absolute cash holdings going downwardly (because when this cash is used to purchase stocks or other assets off other investors, the cash simply moves to the vendor's account, inwards something of a plow over the packet every bit investors endeavour to merchandise out cash for something to a greater extent than appetising), as well as ultimately the cash just ends upward beingness held every bit excess reserves past times banks, held on behalf of their customers. This is why QE has non been inflationary. In social club to last inflationary, the funds would either take away hold to last consumed, or used to fund existent uppercase investment, but the latter volition only tumble out if existent uppercase investment is uppercase constrained, which is is not.

Access to uppercase had already ceased to last a constraining constituent for economical growth, as well as that is why nosotros take away hold non seen to a greater extent than investment as well as inflation. Instead, USA corporates take away hold continued to render to a greater extent than as well as more capital to shareholders via buybacks - the exact opposite. USA corporates literally take away hold access to far to a greater extent than uppercase than they know what to exercise with. Most of the borrowing that has occurred as well as has been stimulated has gone to finance of M&A (notably via private equity), rather than finance novel uppercase stock, which is the 'worst' type of increment inwards debt. The amplifying effect of QE on the excess render of uppercase has, however, likely contributed meaningfully to the VC unicorn tech bubble, which has been a brusk term economical stimulus, but ane with dubious long term durability.

Meanwhile, negative bond rates are also much easier to fathom when you lot empathize the touching of QE inwards combination with negative brusk term policy rates, which nosotros take away hold seen inwards Europe. For reasons nosotros take away hold discussed, QE simply results inwards investors holding to a greater extent than cash, which results inwards banks ending upward with excess reserves, every bit the said investors take away hold to commons the cash somewhere. When brusk rates are (for e.g.) -0.5%, banks take away hold to pay the key banking concern 0.5% a twelvemonth to handle the funds for them, which agency they volition seem for whatever as well as all ways to 'get rid of the cash', inwards a sort of plow over the packet with other banks. If you lot take away hold to pay -0.5% on excess deposits, as well as are desperately trying to acquire rid of cash, buying bonds at a -0.2% yield seems similar a much less bad thought than it otherwise would.

Low but soundless positive long rates of say 0.2% also brand a tonne of sense when you lot realise banks take away hold a null risk-weight on authorities bond holdings, as well as tin fund those purchases at -0.5%, or at worst, 0.0%. They are doing that, however, because at that topographic point is no consumer or delineate of piece of work concern demand for credit capable of absorbing their excess cash reserves. They take away hold no where else to position the money. Yet authorities proceed to say, gee banks aren't lending - it must last because they don't take away hold plenty liquidity - so let's exercise to a greater extent than QE so banks take away hold to a greater extent than funds they tin lend. The terminate termination is to massively exacerbate the excess of liquid savings looking for whatever sort of dwelling identify possible.

This is how you lot terminate upward with the surround nosotros take away hold seen: relatively weak growth inwards investment as well as consumptive demand; falling consumer debt; rising financial deficits as well as authorities debt burdens; falling involvement rates; as well as rising asset prices. It's also how you lot terminate upward with a breakdown inwards the historical inverse correlation inwards the functioning betwixt bonds as well as stocks - they are both going upward every bit uppercase has ceased to last scarce as well as a precipitously falling cost of uppercase is driving upward the toll of everything. And the truth is, every bit high every bit asset prices take away hold gone so far, it is non inconceivable that nosotros could terminate upward with the biggest asset bubble of all fourth dimension the way things are going - eclipsing fifty-fifty the dot.com bubble (as I argued here). It seems to last a logical outcome should the electrical flow trajectory continue, every bit rates decease to null or below, as well as the huge excess of liquid savings desperately seeks out whatever as well as all sources of cash flow return, driving asset prices to the stratosphere.

This explains also why marketplace take away hold done so well, despite sluggish growth, as well as this beingness ane of the most hated bull markets of all time. General expectations take away hold been for an imminent economical fallout as well as major bear marketplace for a decade now, every bit the unintended consequences of experimental monetary policy comes dwelling identify to roost, as well as yet it hasn't happened. Many investors take away hold suffered badly betting on disaster piece stocks take away hold risen as well as risen, as well as so risen some more. There is no euphoria (outside of sure spots inwards tech) - markets take away hold gone upward non because people are wildly bullish, but because investors take away hold increasingly been dragged - kicking as well as screaming - into stocks every bit at that topographic point has been no where else to obtain a reasonable return, every bit bond yields take away hold plumbed novel lows.


The terminate of history? How politics might alter the trajectory

Over the past times decade, investors take away hold failed to grasp the inwards a higher identify dynamics, as well as inwards full general take away hold been awaiting an inevitable 'normalisation' of involvement rates. Had they grasped the above, they would take away hold realised that depression rates were non only reflecting key banking concern behaviour, but to a greater extent than structural forces, as well as were likely to take away hold gone to null regardless of key banking concern policies (although in all probability non negative). And the proof is inwards the pudding - rates that are 'too low' are supposed to Pb to inflation, as well as they haven't, as well as if nosotros don't take away hold inflation, so it is hard to fence that rates are 'too low' (QE is a different question). Too depression on what metric? Certainly non also depression such that it has resulted inwards excessive demand for uppercase relative to its render - that would take away hold been inflationary (although, without doubt, QE has been a bad policy as well as has created to a greater extent than problems than it has solved).

Furthermore, investors would take away hold been a lot to a greater extent than reluctant to handle a lot of cash; brusk stocks as well as bet on a crash; as well as brusk authorities bonds on called for a authorities debt crises, had they understood these dynamics. With the fundamental driver beingness a structural excess of savings, made worse past times key banking concern policies, the likelihood of an equity as well as asset toll bubble of unprecedented proportions, coupled with zero/negative involvement rates, was far from impossible, piece the likelihood of a spike inwards authorities bond rates as well as widespread authorities defaults was exceedingly remote.

However, ane thing I take away hold noted late is that after a decade of beingness wrong, many investors are similar a shot finally coming to a greater extent than or less to the sentiment that rates are going to last depression forever right when some of the weather condition that take away hold underpinned the status quo are - for the root fourth dimension inwards a decade - at chance of changing course. As usual, investors are behind the curve. Declaring that rates are set to remain forever depression at this dot (as opposed to it beingness only possible/probable) seems to me to somewhat akin to Fukuyama's famously inaccurate telephone yell upward inwards the early on 1990s that nosotros had reached the 'end of history'.

While I exercise squall upward the full general trajectory of rates volition last towards null inwards the long run, much every bit has been the instance inwards Nippon to date, I squall upward at that topographic point is nevertheless a chance of intermediate periods of turmoil where rates exercise decease meaningfully higher, driven past times an escalation inwards inflation. However, the machinery past times which this mightiness occur, as well as hence the source of the risk, seems poorly understood to investors, because it derives from the political rather than economic sphere, as well as volition require a alter inwards course.

It seems to me that a clue every bit to the potential fundamental chink inwards the armour of the 'low forever' thesis lies inwards something I referenced relatively early on inwards the article: the fact that the vast bulk of consumers are inwards fact soundless dependent to scarcity as well as are under-consuming relative to the floor at which they would prefer to, coupled with rising political trends towards populism. They may non want or last able to borrow more, but they would sure prefer to eat more, given the chance - specially experiences (travel) as well as various other labour-intensive services.

Capitalism is slap-up for driving innovation as well as efficient resources utilisation, but it has an of import Achilles heel, which is that it tends towards increasingly extreme wealth inequality over fourth dimension - a style which is only beingness exacerbated at nowadays past times trends inwards technology. Taken to a large plenty extreme, wealth inequality volition eventually crash the entire system, much every bit it did inwards 1929. Imagine, for instance, that Warren Buffet came to command unopen to 100% of national income as well as wealth (I ever similar to utilisation an extreme instance to highlight an immutable regulation that continues to apply when scaled downwardly to a to a greater extent than realistic level). Aggregate consumptive demand would collapse to virtually zero, as well as you'd take away hold an unimaginably bad depression.

Capitalism is slap-up for the supply-side of the economy, but a sustainably salubrious demand-side requires that the floor of income as well as wealth inequality non last allowed to acquire also extreme, lest consumers cannot afford to purchase goods supplied past times the owners of capital. The supply-side determines the capacity of an economic scheme to make goods as well as services, but the demand-side determines the actual level of goods as well as services demanded as well as produced (up to the economy's capacity limit, demand creates render inwards the economy, non the other way around, every bit the Austrian schoolhouse of economists falsely believes). If those with all the money don't want to consume, as well as those that want to eat don't take away hold the money, the economic scheme volition collapse. This fundamental limitation of costless marketplace capitalism is poorly understood past times a lot of economical conservatives.

When wealth inequality reaches extreme levels, at that topographic point are only 3 ways the imbalance tin last resolved. The root is a 1929-32 type depression (wealth inequality in conclusion peaked inwards 1929) which wipes out all the banks as well as most companies as well as hits a giant reset button. The minute is a swing to left wing economical policies (as opposed to middle left) that leads to a combination of income/wealth redistribution, improved bargaining powerfulness for labour, as well as eventually inflation; as well as the tertiary - somewhat counter intuitively for many I'm sure - is a long menstruum of negative involvement rates. Any of these outcomes are theoretically possible. Without regulatory intervention, 2008 could easily take away hold morphed into a #1 reset, but the actions of the authorities decisively ruled that alternative out. Instead, nosotros take away hold so far gone downwardly the route of #3.

It is mutual to hear people fence that low/negative rates are exacerbating wealth inequality, but that is non inwards fact true. In the brusk term as well as on newspaper it may initially appear that way, every bit depression rates have asset prices to rise, but these rising asset prices reverberate a autumn inwards the prospective returns on capital, which inwards the long run is a negative for uppercase accumulation/compounding, as well as a negative existent render on uppercase inwards the bond marketplace genuinely acts every bit a de facto wealth tax, which is a cast of redistribution (as wealth as well as income is transferred from wealthy bondholders to governments, who pass as well as redistribute money to the middle as well as lower income classes). If rates remain negative for a long time, a really substantial amount of wealth volition last redistributed over fourth dimension inwards this manner. In this respect, contrary to mutual perception, negative involvement rates are genuinely portion of the solution, rather than portion of the problem.

However, piece #1 seems really unlikely, as well as #3 appears the most likely to me, #2 is also possible, as well as the risks inwards that regard take away hold risen meaningfully inwards the in conclusion few years, correct when most investors are finally capitulating to the determination that rates are destined to remain depression forever. We are already starting to witness a ascent inwards populism, as well as although this has superficially been associated with 'right wing' populism, inwards actuality - every bit I discussed here - this mislabelling genuinely reflects an incipient inversion inwards the traditional left-right political spectrum.

In the past, the left was the political party of the working classes/labour, as well as the correct the political party of business. However, inwards modern times, the left has been captured past times the liberal, rich elite, as well as has allow its focus drift to identity/minority issues, as well as the priorities of rich liberals including climate change, piece abandoning its traditional mainstream working grade voter base, which traditionally economically conservative parties take away hold started to swoop inwards as well as capture. Trade barriers, as well as policies to limit immigration to improve the bargaining powerfulness of labour, for instance, take away hold traditionally been left wing policies, every bit they are adept for labour as well as bad for capital/business. Ultimately, however, the label doesn't affair - it's the actual set of policies as well as their effects which are important.

However, piece populism has only taken a mildly left plow to appointment (economically), at that topographic point are no assurances it volition halt there, as well as nosotros could quite easily consider a motion much farther to the left inwards coming years. Bernie Sanders as well as Elizabeth Warren, for instance - 2 leading Democratic contenders - take away hold campaigned for radically higher taxes on the rich, including wealth taxes every bit high every bit 8% on billionaires, inwards the instance of Sanders (Warren advocates for 3%). Jeremy Corbyn's UK's policy prescriptions were also to a greater extent than left wing than whatever prescription nosotros take away hold seen inwards the Anglo-sphere inwards quite some time. While none of these candidates take away hold a critical volume of back upward yet, with populism on the ascent the futurity trajectory of policy remains highly unpredictable.

Stepping dorsum from the contemporary political fray, it seems to me the bigger picture, long term causal meta could good last this: right wing policies are adept for render but - inwards the long run - bad for demand (due to rising inequality), piece left wing policies are bad for render but - inwards the brusk run - adept for demand. When you've had also much left wing policies, every bit was the instance inwards the 1970s, you lot terminate upward with a stagnant economic scheme as well as high inflation. This gives ascent to a want for alter amongst the electorate, which takes seem inwards ballot box outcomes. In the instance of the belatedly 1970s/early 1980s, discontent with the status quo resulted inwards the election of Thatcher as well as Reagan for this reason.

Initially, when policy swings to the right, it is adept for growth; the rich acquire richer, sure, but the miserable as well as middle classes also acquire richer. That is because inwards a stagnant economic scheme with high inflation, underinvestment happens, as well as a lower cost of uppercase as well as to a greater extent than investment is desperately needed. There is also much demand as well as non plenty supply. However, with correct wing economical policies, after a long plenty time, render catches upward as well as overtakes demand, at which dot you lot start to consider downward force per unit of measurement area on involvement rates every bit the render of compounding, reinvestable savings starts to outpace uppercase investment needs. Falling rates termination inwards rising identify prices as well as ultimately have the middle grade to decease on a borrowing binge, as well as this continues - maybe for 2-3 decades or to a greater extent than - until the middle grade cannot afford to convey on to a greater extent than debt (or no longer wishing to exercise so). That dot was reached inwards 2008 inwards the US/Europe, as well as is at/approaching that dot inwards Commonwealth of Australia at present.

After this point, a continuation of correct wing economical policies results inwards the rich continuing to acquire richer, but similar a shot the miserable as well as middle classes start to stagnate as well as acquire poorer. This happens every bit the deleterious effects of rising income inequality to a greater extent than than offset ongoing (slower) growth. This results inwards an inevitable ascent inwards political tensions, every bit growing grass roots discontent leads to increasing want for change. It also explains why today's elite is so unable to concealment what is happening as well as why populism is rising - from their perspective things are slap-up - never better. Their incomes as well as wealth proceed to mushroom. But large parts of the population are getting left behind. It also explains why 'outsider' candidates such every bit Trump take away hold found such appeal, every bit traditional candidates are all portion of the elite - the rich who take away hold been getting richer - as well as thus take away hold ceased to empathize as well as stand upward for a growing proportion of the electorate, or cater to their growing sense of malaise.

If my model is correct (and it is admittedly soundless speculative as well as unproven at this point), it seems to me the adjacent measurement inwards this long wheel would logically last for a swing dorsum to the left, as well as inwards my sentiment it has already started, every bit merchandise as well as immigration tensions take away hold risen (which are policies designed to improve the bargaining powerfulness of domestic labour). As noted, an initial swing to the left is bad for render but adept for demand - specially coming from a dot of important inequality - as well as inwards the initial stages of a swing left, the rich acquire poorer but the miserable as well as middle grade acquire richer, every bit wealth as well as income is redistributed from the rich to the poor. Furthermore, coming from a topographic point of already sufficient/excess supply, a refuse inwards trend-rate growth inwards render does non manifest every bit an number for some time, because at that topographic point is already an output gap to exploit. However, if the swing to the left in conclusion long plenty as well as goes far enough, you lot eventually acquire to the dot where demand overtakes supply, as well as you lot terminate upward with inflation, rising rates, as well as eventually stagflation. At this point, the rich acquire poorer, as well as the miserable as well as middle grade acquire poorer too. At this point, the populist impulse becomes to swing dorsum to the right, as well as the procedure starts all over again.

We consider these kinds of oscillations betwixt left-wing as well as right-wing populism inwards South America all the time, where the cycles are much shorter. In the West, nosotros take away hold had a long 30-40 twelvemonth swing to the correct (economically), which is longer than the investment careers of most investors last today, so people are ill-prepared for the consequences of whatever major systemically-important political shift, as well as are unlikely to envisage the potential consequences. Indeed, every bit Jacob Mitchell of Antipodes said late inwards an interview, a whole generation of investors has been taught to 'ignore politics', but he noted that that perspective mightiness increasingly last the incorrect topographic point to convey inwards the future. I completely handle with him inwards regulation (although how that its actioned, I'm non so sure). What also remains to last seen is whether the various structural factors tending towards lower rates, including the effect of technology, outweigh the economical effects of changing political policies. On that I exercise non know.

The machinery that to a greater extent than left wing policies that are stimulatory to demand (and ultimately inflation) volition likely convey volition in all probability last a combination of significantly higher financial spending, every bit good every bit a to a greater extent than aggressive force for higher taxes on the rich - specially inwards the cast of wealth taxes, which take away hold been relatively rare taxation to date. There is a really substantial as well as growing chance for politicians to effort to the middle classes nearly the injustice of the electrical flow organisation as well as the demand for radical redistribution, as well as surveys squall for that Millennials are a lot to a greater extent than pro socialism as well as anti capitalism than prior generations, as well as also ain relatively lilliputian uppercase (and to a greater extent than oftentimes than non can't afford houses). People that don't ain whatever uppercase are normally less supportive of capitalism than those that do.

In the US, costless universal healthcare as well as costless academy pedagogy volition in all probability last the initial volleys, including also potentially UBI. It is quite possible it does non halt there, however, until meaningfully negative economical outcomes manifest (which volition likely convey a while), every bit the dynamics of politics is such that ane ever needs to hope more/something different from the incumbent to acquire elected; the style towards entitlement-inflation thus good entrenched for this reason.

One of the reasons productivity growth has slowed downwardly inwards recent decades is that a larger as well as larger portion of the economic scheme is beingness subsumed past times less as well as less productive sectors, such every bit pedagogy as well as healthcare, where costs proceed to mushroom. There is soundless rapid innovation as well as productivity growth happening inwards software as well as ICT, as well as to a lesser extent manufacturing, but the portion of the economic scheme this encapsulates has acquire smaller. If the authorities continues to expand significantly inwards size; authorities deficits ascent high enough; as well as wealth as well as other income taxes on the rich increment sufficiently, it is only conceivable nosotros could terminate upward inwards a public where a scarcity of uppercase returns, as well as inflation increases - every bit unlikely every bit that may similar a shot seem/feel (including to me). This is specially the instance every bit babe boomer's are similar a shot starting to retire, as well as so are starting to plow over their dot of summit savings activity inwards the Pb upward to their retirement years, piece the financial burden of state-guaranteed pensions volition also proceed to escalate inwards coming years every bit well.

What ultimately ends upward happening is anyone's guess. Predicting the long term outlook for involvement rates is specially difficult, every bit ane scenario is redistribution via negative involvement rates for an extended menstruum of time, piece the other is via inflation as well as radically higher rates - both opposite ends of the continuum! The old could also last expected - initially at to the lowest degree - to potentially Pb to ane of the biggest equity bubbles of all fourth dimension (if non the biggest), piece the latter could Pb to asset toll carnage fifty-fifty worse than the early on 1970s.

I experience really fortunate that my investment approach does non rely on predicting macro outcomes such every bit these, or variables such every bit involvement rates. I computer program to maintain doing what I ever exercise - uncovering stocks trading at depression prices relative to their likely futurity distributable cash flow. A margin of safety, as well as depression prices/rapid cash flow payback is ever the best hedge against an uncertain future.


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