The Great Recession tested all conventional wisdom in monetary policy in a crisis. That wisdom stated that central bankers should restrict the flow of money when economies are growing too quickly and expand the money flow when growth slows to artificially prop up the economy. What, then, when that money flow is never enough? The last decade served as that test case, as the U.S. (the Fed), the European Central Bank (ECB), the Bank of England (BOE), the World Bank, and several other nation states (e.g. Japan, China, Italy, etc) have pulled these individual monetary levers to attempt to keep their economies afloat. We’ll talk about what has been done and what it means.
THE SOLUTION TO THE RECESSION
The prevailing theme surrounding the post-recession monetary policy around the world is “economic stimulus.” Quantitative easing. Bond purchasing. Printing money. All of these names equate to central banks pumping money into their respective economies by the trillions by buying bonds and manipulating interest rates. This contrasts with the Great Depression, where the U.S. invested in infrastructure projects to employed people and improve the country’s…infrastructure. Today by solely resorting to buying bonds and holding interest rates near zero (or negative in Japan and some other countries) as recent administrations have, there is no tangible benefit to the money being spent by the government. Roads are still crumbling. Bridges are still falling. Corporations are making record profits but wages are still stagnant. The jury is still out on the effectiveness of quantitative easing, as this is the first test case with such a large sampling of diverse economies. This is also the first major recession in a globalized world. Economists struggle to explain the slow rebound of the global economy and pundits struggle to explain the populist anger that has emerged in the U.S., UK, France, Netherlands, and Germany. Not only did Obama and Trump having to deal with this from Ben Bernanke and Janet Yellen, but in the coming years Mario Draghi (ECB), the Bank of England, and the rest of the state central bankers will enact similar fallout from rate increases. Is globalism dead? Capitalism? Socialism? Time will tell.
THE DEBT BOMB IS COMING
It is important to understand as a baseline fact that central banks are not typical branches of government, despite them being federal appointees. Central banks truly are banks that loan money to governments (and banks) at adjustable rates. This is the Federal Funds Rate in the U.S. As such, when the central banks announce interest rate hikes, this means that the associated government must pay out more in interest payments on its debt. Since the two most recent U.S. rate hikes, payment outlays have increased some $30B for the government on its debt. Right now this is a drop in the bucket for the world’s largest economy, the public debt continues to increase. These interest payments fall solely on the shoulders of the American taxpayer, and this debt expansion is a large part of Barack Obama’s legacy. There are healthy arguments on both sides of the debate over prudence of this prolonged easing. While the economy has been “saved,” by virtually every measurable out there, has it set us up for an even greater demise? I wrote previously about the boon the upcoming rate hikes will be for U.S. banks, but this reality is also potentially perilous for the U.S. government.
President Donald Trump follows in a long line of Republican politicians that espouse tax cuts for the rich and for businesses. I am not here to debate the merits of policy, but it makes any hope of beginning to pay down the national debt extremely bleak. Reducing the tax revenue through cuts and deductions means the government has less to operate on, while health-related entitlements continue to rise with the aging of baby boomers. Government may shrink incrementally under the Trump administration, but not enough that it will balance the budget anytime soon. This debt issue therefore becomes Trump’s problem to solve, or not. Interest rates will continue to rise, debt will not fall (but increase if his infrastructure and tax bills pass), so money will continue to fly out the door. Innovative governing is required to get out of this quagmire going forward.
The U.S. situation seems precarious but take heart in knowing that all of the developed nations are facing the same issue. The world will solve the issue together. Slow recovery over the past decade makes it seem as if we never left the Great Recession, but the reality is we have witnessed one of the longest growth periods in history; we are overdue from another major contraction or recession. Typical growth periods last just shy of six years, the U.S. is approaching the end of its eighth year on the upside of this business cycle. The question is, as investors, are we prepared to weather another decline? If you cannot answer that question, do your studies. If you know that are not, take a serious look at your portfolio and reallocate as necessary.