The constant imperative to support indebted markets hasn’t allowed capacity to be removed; nor has it reduced debt, although it has made debt more sustainable (as interest rates have been reduced). Politicians and their central bankers are unable to break this cycle. Defaulting on debt or causing mass unemployment is not a vote winner, and the rise of populism makes it increasingly unlikely that the authorities will change direction in the near term.
So when does this cycle to ever-lower yields end? If loosening monetary policy is the only tool being used, then it could come to an end when the policy becomes counterproductive. The move to negative rates, and the crowding out of investors from the bond markets, suggests we may be reaching that point. Given the inherent self-survival characteristics of politicians, it looks like they want to try a different tack – fiscal stimulus.
Tax cuts and the loosening of the relentless increase in regulations could reignite some of the ‘animal spirits’ that have been lacking since the financial crisis. Economic growth could be supported and investment reignited with government investment in infrastructure. As a result, government debt would increase, but this would be funded by the central banks, who print money to pay for the debt.
There are a number of issues with this type of approach. First of all, are governments good at leading investment trends? The current idea may be to invest in existing transport infrastructure (owing to its poor maintenance) when, actually, building electric charging stations and improving grids and electricity production may be better as we shift towards electric cars.
Another issue could be that not all populations will respond to an increase in government spending positively. In Japan, for instance, there have been 42 fiscal programmes since the economic peak in 1989, but each time there has been a temporary pickup in activity before the consumer has decided to increase savings and the economy has fallen back.
Finally, if many governments try this at the same time, it will cause a global increase in capacity and inflation won’t necessarily rise.
To learn more about the challenges facing investors, and whether fiscal stimulus could really be the answer to a tepid returns environment download the full whitepaper
Paul Brain – Newton, a BNY Mellon company