Playing With Fire – Animal Spirits Ensconce Progress and Trepidation In Economies

The global economic environment is traversing new frontiers. Textbooks, historical data and policy frameworks of the past are blunt in the face of diverse trade war, global monetary policy divergence to convergence, emerging market inflation polarisation, downgraded global growth, splits in Monetary union (UK/Brexit) and emancipation like protests in powerful markets like Hong Kong. The resulting impact will not only be to integrated supply chains (not the least in high tech products), but a disruption of all industries that embody supply chain management. In the UK, Brexit itself may sway and be chaotic. In the middle east and Asia, geopolitical risk pervades sentiment. Barack Obama was right when he proclaimed “don’t do stupid shit” as its becoming clear most of the worlds problems stem from doing stupid stuff! We have all capitulated to the animal spirits that supported our evolution for thousands of years! Trump, Draghi, Morrison and the new MD of the World Bank? Yes, perhaps businessman in White House is good, but this bilateral balancing is defying the trading mechanics that transformed through the ages to become focal points of neutral trade talks to drive growth. Monetary policy is a blunt instrument and people are petrified of government borrowing even though lenders are prepared to pay for the privilege. Now look at interest rates, Olivier Blanchard (senior fellow at the Peterson Institute for international Economies has noted that “…it is usual for safe interest rates to be below growth rates. Today seems to just be an extreme version of this reality” Even Peter Costello, whom I regard as one of Australia’s best treasurers criticised the Reserve Bank’s monetary policy for giving rise to both private and public interests. Controlling the foreign exchange rate is outside of the RBA charter and we all know that the interest rate differential inspire carry trade which leads to currency appreciation or depreciation. He told a conference that Monetary Policy has “run its race” and any further cuts were unlikely to have the desired stimulatory effect. Inflation targets are being undershot (the band is to maintain inflation at 2-3 percent over the business cycle) but its currently at 1.6%. Costello asserts that the RBA was was motivated by competition as the central banks in the US, Europe and Japan cut their cash rates. “I think what is driving this as much as anything else is the international position [of US and European central banks cutting interest rates] rather than domestic conditions. “Now a central bank will never talk about exchange rates and it’s not supposed to think about exchange rates. Exchange rates are supposed to be free-floating market instruments, so a central banker could never say ‘I’m looking at exchange rates or I’m influenced by the exchange rate.’ “They’ll always put it in another way,” he said.

“Even in the US, it was impossible for the Fed to raise the short-term rate above 2.5 per cent in this cycle, before cutting it. In other big high-income economies, the room for a conventional policy response to a slowdown is still more limited. Importantly, this tells us that structurally deficient aggregate demand, on which some of us have been writing since before the 2007-08 financial crisis, remains pervasive. This forces us to recognize not just the “nationalist-populist-protectionist” stupid stuff noted above but, as lethal, the “austerity-as-secular-religion” stupid stuff.” …. It is elementary economics that prices matter. The astonishing fact is that the six largest high-income economies, including now even Italy, can borrow for 30 years at a fixed nominal rate of close to 2 per cent, or less, and so at zero-to-negative real rates, provided central banks deliver on their inflation targets. One has to be desperately pessimistic about growth prospects to believe it is impossible to manage substantial borrowings, on such terms. This is especially true if borrowing was used to produce high-quality human, intangible and physical assets.

Monetary Policy Has Run Its Race, Says Costello – Elouise Fowler : Wed 16 Oct 2019 AFR

“We are collectively playing with fire. Worse, we are doing so while living in a flammable building. As Lawrence Summers tells us, the danger is not so much a global economic slowdown, as the difficulty of doing much in response. In this context, the recent shift in Federal Reserve policy, towards lower rates, and the associated decline in interest rate expectations, are particularly telling.”

Global economic policymakers are playing with fire – Martin Wolf: Wed 16 Oct 2019 AFR

Now dont get me wrong, I am actually all for lower interest rates – it brings the benchmark rate down and gives us greater credit leverage with tier one banks, which allows our investment entity to go full steam ahead and inject capital and investment back into the economy. Commercial Real Estate to Venture Capital – the world is our oyster here! However, what I am concerned about is the animal like spirits that are inhibiting progress of innovation in government policy to drive inter-sectoral reform, boost productivity and nurture innovation. Australia’s affinity as an iron ore and coal exporter cannot be perpetually entertained. According to an article in today’s Australian Financial Review entitled “Australia’s most complex exports are not counted by Harvard boffins”; its said that the services economy must be acknowledged as they account for 70% of the measure within international trade. These exports dont go through customs offices and hence are not uniformly reported to the United Nationals.

Our collective animal instincts and evolution has lead to an emergence of economic systems and people capabilities. All of us are no longer living in the definition of the ‘open economy’ but more so in a knowledge, integrated and digital economy. Twitter sentiment impacts investor behavior like herds of sheep and flocks of birds and the price of cryptocurrency has strong correlation to other securities. Algorithmic traders find arbitrage opportunities in milliseconds and market maker firms trade their own capital and inject enormous liquidity into the stock markets. Finding value and gaining from equities has taken a twist in the context of a global synchronised stagnation. Private sector bonds issues by innovative companies and private equity funds that create breakthrough value to the businesses it acquires and incubates will flourish. Entrepreneurial activities in the value chain will always be an enabling force, so instead of playing with fire, control it – play it cool and appreciate the emergence of the human capital into any innovation process. At the end of the day, economic systems vary and they are not homogeneous. Quantitative Easing impacts Asia and the USA differently to Australia.

References
Monetary Policy Has Run Its Race, Says Costello – Elouise Fowler : Wed 16 Oct 2019 AFR
Global economic policymakers are playing with fire – Martin Wolf: Wed 16 Oct 2019 AFR