Era of ‘expand and pretend’ can’t last forever

By

31/10/2017

If Satyajit Das had a magic wand, he’d take the world back to 2008, get central bankers and policymakers to admit the economic model that delivered the global financial crisis was deeply flawed, and proceed to shift slowly to a new economic framework.

But with the problem having grown even bigger over the last 10 years, the former banker and corporate treasurer says, the global economy – plagued by excessive debt, financial imbalances and an enormous expansion of entitlement systems – has far less room to manoeuvre.

“With financial risk-taking (share buybacks, dividends, and mergers and acquisitions) now greater than economic risk-taking (investing in research and development, capital expenditures and buying other business), we’re not actually creating new industries,” Das said, during his keynote address at the 2017 Investment Magazine Fixed Income, Cash and Currency Forum, held in Healesville, Victoria on July 25-26. “We’re just playing an elaborate game of financial masturbation.”

Instead of moving away from debt and speculation, back to a ‘real economy’, which would have wound living standards back by 30 per cent, Das said, policymakers opted for a quick fix.

“The world never really deleveraged after the GFC, and what we saw was the massive transfer of debt from the private to the public sector, and then we leveraged some more,” he said.

Waiting for inflation

With technological change failing to drive growth, and quantitative easing encouraging massive over-spending, while also discouraging greater productivity and innovation, Das said, the emphasis, by default, goes back onto generating inflation.

“It’s worrying that what creates inflation is excess demand over supply, and we don’t have the demand in the economy and output gaps are still persistent,” the former banker and corporate treasurer, turned author and columnist, said. “In many areas, technology is eroding pricing power, so it’s hard to see where inflation is going to come from.”

In the absence of inflation, Das suspects stagnation, including managed depression, low growth and rising debt, to continue, along with a continued reliance on central bank policy and financial repression to manage it.

“Continuing to ‘expand and pretend’ seems like a good game, since most people can suspend high levels of frugality for long periods of time, and we just get more used to high levels of debt and continued debt monetisation.”

He expects the debate around ‘helicopter money’ to finally resurface, eventually. However, instead of being a one-off money drop, Das expects an ongoing deluge.

He reminds investors that some central banks are still operating regimes of negative interest rates, and suspects secular lows in the bond cycle are yet to be seen.

Given that International Monetary Fund (IMF) estimates suggest rising interest rates would make interest rate coverage deteriorate by 25 per cent and the number of companies at risk of default increase from 12 per cent to 20 percent, Das doubts it’s likely to happen.

“We’re trapped in a weak economy, and while QE does perk up the economy, it has toxic side effects,” Das said. We’re in a ‘QE-forever’ world, which leads to a much less stable recovery.”

He suspects we’re close to the panic phase, with further deterioration of middle-class personal wealth likely to be reflected in a rising anti-establishment vote.

Next time there’s a financial crisis, Das warned, the magnitude of problems will be larger, with less government policy room to move. Unlike the last crisis, he says, emerging markets won’t be there to bail us out, and the geo-political risks will be considerably higher.

“Last time, we believed policymakers, next time will be different; remember, air bags are single-use and we’ve already used ours.”

 

UPCOMING EVENTS: The theme of the next Investment Magazine Fiduciary Investors Symposium, to be held in Healesville Victoria, November 13-15, 2017, is Radical Uncertainty and its Unknown Consequences. For more information, please visit the event website, or contact Emma Brodie via [email protected] or +61 2 9227 5708.