Is Goldilocks back?
06 May 2019
In the classic fairy-tale the baby bear’s porridge was described as not too hot and not too cold. In financial markets, the economy is “not too hot” because of the absence of inflation, and “not too cold” given reasonable economic growth, strong employment and profit growth.
Inflation remains below target despite strong employment both in Australia and the US.
The recovery in the US since the GFC is often described as the most unloved bull run in history. There has been a general lack of confidence for the last 10 years - fears that interest rates will have to rise, debt problems, crazy politics, inflation must rise, quantitative easing will cause big problems in reverse, Europe will collapse, Brexit, China will get into trouble, the market has not had a big fall for many years, etc..
Yet here we are. Employment is strong, China seems to be able to inject policy stimulus when required and inflation is falling. Earnings growth has been good in the US, but it is a bit tougher to find in Australia, outside of the mining sector.
The ongoing pessimism has seen a long run of people exiting US share Mutual Funds month after month. This has kept things from getting too hot because if people remain sceptical, markets will not become overpriced. Whilst we can never know when, if everyone in the market agrees with your positive assessment of the economy or a particular company, it is probably the top of the market as there is no one left to buy. It can be exciting when people are jumping on, but it tends to end in tears.
While Australia still seems concerned about our National Debt, in the US the numbers are off the chart and nowadays, no one seems to care. It is much easier when you are the global superpower and the world’s dominant currency.
There is even a new economic theory linked to the Economic Adviser of the left leaning Democratic hopeful Bernie Sanders. It is known as Modern Monetary Theory and relies on the fact that governments can print as much money as they want (more electronic nowadays). So unlike a household, a government that holds debt in their own currency cannot default. It is not a matter of government expenditure vs taxes, as you can have much more debt - just create more IOUs in the money that you can make. Milton Friedman would be turning in his grave. They do add one proviso, that you still need to be careful inflation does not get out of hand.
Theoretically the argument is rational and the GFC experience supports it more than general economic theories on inflation and monetary policy. It sounds great, however in complex issues such as the economy, things can turn out very different to how you expect. Economic history is riddled with stories about being careful what you wish for. If governments did not have investment markets to ensure that they are responsible, we suggest that politicians may make some very poor decisions as they focus on short term benefits at the cost of medium to longer term problems.
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