In a recent op-ed, IMF chief economist Gita Gopinath noted that: “For the first time, in 60% of the global economy – including 97% of advanced economies – central banks have pushed policy interest rates below 1%.” As we emerge from yet another once-in-a-hundred-years crisis, what are investors to make of the unprecedented economic predicament in which we find ourselves?
"Debt is arguably one of mankind’s greatest inventions"
At the centre of the debate is the sharp rise in public debt levels across the world in recent years and months, whether in response to the 2009 global recession or covid-19. I confess that I find it hard to decide whether I agree with economists who say there is nothing to worry about or with those who argue we are getting dangerously close to a tipping point. Economics tends to get portrayed more as a formal or natural science like maths or physics than as a social or behavioural science.
While mathematical formulae can tell you precisely how a planet will orbit around the sun, economics provides no such certainty.
Following the 2009 crisis, fiscal policy across the developed world was pro-austerity. Although public debt levels necessarily rose in 2009 to combat the economic crisis, further stimulus that would have required public debt to continue to increase in relation to GDP was widely resisted. In support of their position, governments frequently cited a paper by two Harvard academics that argued that once public debt to GDP reached a certain level, economic growth fell sharply.
The paper has since been discredited, a further stain on the profession. It has also become clear that neither the rise in public debt nor the massive money printing by central banks led to rampant inflation as many had feared. As a result, governments now seem more willing to come to the rescue. Indeed, they may be starting to understand that monetary policy has reached its limit, and that fiscal policy must step up to the plate.
Although debt is often associated with words such as crisis, bondage, and burden, it is arguably one of mankind’s greatest inventions. Debt allowed a deed that has been done to be repaid later, which vastly increased the efficiency of economic activity. In fact, if one considers debt in its purest form – reciprocation – then credit must go to our cousins, the chimpanzees. Studies have shown that chimps have a good understanding of reciprocation and the need to repay a debt – back scratching, for instance, literally and metaphorically.
True, excessive debt every now and again gets countries, companies and individuals into difficultly, but the costs of this to societies broadly are generally far outweighed by the benefits that debt provides.
In support of further borrowing, some economists and commentators are citing the fact that interest on public debt as a percentage of government revenues has been falling steadily in recent decades. This is true, but it ignores the fact that if debt is rising sharply as it is, repayment of principle in relation to GDP will also rise. It should not be assumed that refinancing will remain as easy as it has been in recent years.
Although, if pushed, I side with the optimists who declare there is still lots of scope to increase public debt, I am saddened by how little the role of taxation – the alternative to debt as a financing option – gets mentioned. Public debt is regressive in that the liability effectively gets spread equally across a population.
Furthermore, the asset, a government bond, together with interest, ends up in the hands of the wealthier. Even the most regressive of taxes, VAT, is more progressive than debt in that a larger share of it gets paid by those who have a higher propensity to spend. Perhaps, in the end, the real benefit of the increasing acceptance of higher public debt will be improved equality.
But I digress. As far as the investment outlook is concerned, covid-19 may well have precipitated the end of one economic cycle and thus the start of a new one. Yield curves – long term interest rates minus short-term interest rates – are positive again across much of the world. Against such a backdrop, equities in general should remain well supported.
Until the next crisis that is.
Published in What Investment
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
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