By John Richardson
IT IS only a question of when rather than if there will be a further unwinding in all the global economic, social and political unbalances resulting from the end of the Economic Supercycle.
Sure, we might get away with it for another six months, maybe 12 months – even 18 months, perhaps. Or everything could go wrong within the next few weeks. And when it does go wrong, any chemicals company that hasn’t prepared for a new global economic crisis will be in a lot of trouble.
The data is the thing, and the data tell us that after 672 interest rate cuts and counting by the world’s top 50 central banks since the Global Financial Crisis, monetary policy isn’t working.
One result of this is ever-greater desperation by insurance companies and pension funds as they hunt for acceptable returns. They are being pushed into ever-riskier investment decisions because the long-standing, old and safe option of investing in developed-world government bonds no longer works. The reason for this is that monetary policy has pushed yields on these bonds to all-time record lows.
As insurance companies and pension funds take ever-greater risks, there is a danger they will get it wrong and there will be another sudden rush to safety across all financial and commodity markets. This will expose unpayable levels of debt left over from central bank policies – hence, tomorrow’s global economic crisis.
Adding to this risk is the behaviour of hedge funds and other financial speculators. Because the cost of borrowing money remains so cheap, they have found it very easy to take big risks across many different asset classes.
In this Upside Down World, It Is Differentials That Matter
A good example of the constant search for better-yielding investments is this year’s shift back into emerging-market debt. As Morgan Stanley’s Ruchir Sharma tells the FT this has very little to do with a recovery in growth prospects in the emerging markets:
He says investors in emerging markets are less concerned about whether these economies are growing more quickly than those in the developed world. Rather what excites them is whether the differential between GDP growth in the two is actually increasing.
And the FT continues:
In 2007 — the peak of the boom for emerging markets — there were 60 economies in the world that were growing annually at a pace of more than 7%t, Mr Sharma notes. “Today, that number is down to eight or nine countries,” he says. “The baseline for success is changing everywhere.”
Crucially, also, opportunities to invest in emerging sovereign bond markets total $800bn. This compares with a lost opportunity of $12 trillion – the amount of developed-market government debt that now carries negative yields.
And all of us should of course know that emerging markets ex-China have yet to find a viable new economic growth model to replace the one that used to hinge on China’s seemingly limitless demand for commodity imports.
Identifying the Trigger Factors
The renewed flow of debt into emerging markets might well further inflate real estate and other bubbles. But what happens if the Fed raises interest rates again this September? Will recent history repeat itself as money flows in the opposite direction, back to the developed world and the US dollar? This is one of the potential triggers for the second phase of the Great Unwinding.
Here are four more candidates:
- The renewed fall in oil prices. If sustained, this will expose the some $2 trillion of debt, most of which won’t get paid back, in the global energy sector.
- The acceleration of economic reforms in China following Xi Jinping’s consolidation of political power. Investors might finally realise how much further economic growth will have to fall before it can improve. And they may also realise that there are no cast-iron guarantees that reforms will be successful.
- The outcome of presidential elections in the US this year and in France next year. If populist politicians win one more of these polls, then investors could take fright on concerns over a retreat in global free trade and an increase in geopolitical stability.
- In perhaps a last throw of the dice, Western central bankers might opt for helicopter money. Helicopter money can take various forms, including literally crediting a few thousand dollars in each citizen’s bank account in the hope that this money will be spent. But what if this results in a collapse of currencies, putting at risk the some 25% of developed-world bonds owned by overseas investors?
One more of these triggers may occur at the same time. Or quite obviously, there might be other triggers that I haven’t considered.
But, as I said, the only doubt is when rather than if. Do you have a plan in place?