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Investing in a stagnant world

23 September 2014  |  News

What to doIt is called late stage capitalism. In many consumer product areas, there is chronic over supply. Populations are ageing, which means demand weakens in many industry sectors. And there is a big shift to making money from managing money (finance), instead of making money from making things or providing services. In Australia, the biggest industry sector is finance. Similar trends are being seen in the US.

Because of the shift towards finance, there is a tendency to create asset bubbles, one way that money is made out of money. And even when those bubbles are unwound, in this era of late stage capitalism, it is hard to find enough jobs. A widening gap between the haves and the have nots inevitably results, as economist Larry Summers speculates:


"We saw, even before the crisis in the US, that the creation of a huge housing bubble had not been enough to lift the economy back to full employment. This condition of chronic demand deficiency has been exacerbated by the global financial crisis. Despite five years of recovery, the US economy has continued to operate well below potential.

Says Summers: “The new secular stagnation hypothesis suggests that macro-economic policy as currently structured and operated, may have difficulty maintaining a posture of full employment and production at potential, and that if these goals are attained there is likely to be a price paid in terms of financial stability.”

Low interest rates and low inflation are at the core of the problem. Official or nominal interest rates are at record lows but they can only fall to the zero-bound, which means they cannot fall below zero. Real rates can go below zero. Consider an official nominal rate of 2 per cent with inflation running at 3 per cent. The nominal rate is in positive territory even though the real rate is below zero.

Theoretically at least, there is a level at which the animal spirits of entrepreneurs will be aroused and they will borrow at the ultra-low negative real rates and begin investing and hiring. But, as Summers points out above, this figure could well be incompatible with financial stability.

While the numbers involved in the illustration are not actual examples, they are close to real life.

The following are actual recorded data:

US annual economic growth over the past decade – a period that encompasses boom, recession and recovery – has averaged just 1.55 per cent, inflation in the US over the past decade has averaged just 1.74 per cent, and the US official short-term bank rate averaged 1.75 per cent over the same period.

Such low rates combined with billions upon billions of dollars that have been deployed to kick-start the economy, testifies to a deep malaise in the US economy."


That malaise to which Summers refers is late stage capitalism. A system that is becoming exhausted. It is being seen across the developed world. Australia has been a partial exception because of our resources, but the trends are still evident. Deutsche Bank is talking about a "secular stagnation world”.

It poses a great challenge for investors, including SMSF investors. Where do you find good returns, especially if interest rates stay near zero? Summers again:


“We may well need, in the years ahead, to think how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activity, holding our economies back below their potential,” he said.

The tone of that observation suggested that the secular stagnation thesis was a scholarly contribution to public debate that would be road tested “in the years ahead”.

Summers’ colleague Paul Krugman was an early convert in terms of the theory’s potential, writing: “The idea that the liquidity trap is temporary has shaped the analysis of both monetary and fiscal policy.

“The real possibility that we’ve entered an era of secular stagnation requires a major rethinking of macroeconomic policy.”


What it suggests from an investment point of view is that many of the obvious investment plays are being taken away. Also, many of the conventional ways of analysing investments are being compromised by extremely low interest rates (such as the usual way of comparing stocks and bonds, which becomes meaingless when interest rates are close to zero).

In the end, financial systems only reflect the economy. When that economy becomes extremely mature, the financial systems will struggle to adapt.


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