article courtesy of: Martin Barnes
In the distant time before COVID, I gave talks to VRMNC members about the economic and financial outlook. Given the clear evidence that I was totally unable to predict the future and even had trouble explaining the past, it is a mystery why I was asked to do this each year. But I am not complaining as I have made a living over the past 48 years from peoples’ insatiable need for guidance about an essentially unknowable future.
Obviously, I was unable to give a talk last year, and cannot do so later this year because my wife and I have made the difficult decision to leave Victoria. Our children and grandchildren are thousands of miles away from this little corner of paradise and we have decided it is time to move closer to our family. So, we have sold our house in Cordova Bay and will leave Victoria at the end of July. After a detour via Toronto and Florida we ultimately will end up settling in Edinburgh to be with our daughter and her family.
As a parting ‘gift’ to VRMNC, I provide my thoughts on four common questions that get asked about the outlook. Of course, I will be long gone from here before you discover whether I was right or wrong. Here goes…
Question 1. Will the longer-run economic outlook be affected by the pandemic?
Long-term growth is driven by two forces: the growth in the labor force (i.e. demographics) and the growth in productivity. Demographic trends are baked in the cake because the people that matter for economic growth (those who will be of working age in the coming two decades) are already here and we can count them. We know that the growth in the working-age population will continue to slow in the years ahead because of the past decline in the birth rate. The pandemic does not really affect any of this unless you want to assume that new variants will spread and wipe out larger numbers of people. That is too pessimistic, even for me.
The productivity question is more interesting. There is a case that the pandemic has forced companies to become more efficient and to invest in labor-saving technologies. And the rise in working from home has freed many workers from an unproductive commute. On the other hand, there may be a negative impact of home working if younger people lose the mentoring and learning that occurs in an office environment. In any event, I am skeptical that the office is “dead” and expect a return to old working ways, assuming the pandemic fades into history.
The pre-pandemic outlook for long-run growth was never great because of poor demographics and disappointing productivity. The former has not changed and there is a question mark about the latter. Meanwhile, growth will also have to contend with the consequences of recent extreme policy actions on the outlook for inflation and government debt. Bottom line: the long-run growth outlook has deteriorated modestly.
Question 2. What is the outlook for inflation?
Most of us are old enough to remember the high inflation of the 1970s and we are not going to return to those days. However, there are good reasons to expect inflation to be higher over the next decade. During the past 20 years, annual inflation in the major economies has averaged less than the 2% that most central banks wanted.
Globalization, technology, and periodic negative shocks to growth all helped to keep inflation in check. But globalization is in retreat, there is pressure to increase wages and hyper-stimulative monetary and fiscal policies pose risks for inflation. On the monetary front, central banks have made it clear that they will keep interest rates at very low levels for as long as necessary to boost inflation. On the fiscal front, rising government deficits and debt will make higher inflation an attractive way to reduce the real burden of debt.
Inflation recently has spiked higher but that should be temporary, and it will retreat as economic conditions and supply chains return to normal. However, inflation could well rise back to the 4% to 5% level later in the decade. It should not rise much above that because inevitable economic downturns will be deflationary, and technology should continue to be a disinflationary force.
Question 3. Government debt has surged – how will we ever pay it back?
Government debt is rarely paid back as this only happens when there is a budget surplus. And this is not going to happen for the foreseeable future given the trend in public spending. Government finances are a kind of Ponzi scheme where future taxpayers bear the burden of supporting the previous beneficiaries of government profligacy.
Politicians have little incentive to restore fiscal discipline because it’s much more rewarding for them to spend than to impose austerity. And do not expect voters to care because they are the beneficiaries of the spending. The only discipline on public finances comes from the financial markets. Unfortunately, they do not care as they are enjoying the asset inflation associated with easy monetary policies. In effect, the financial policemen are having coffee in the donut shop.
At some point, the policemen will emerge and start creating a fuss. Politicians will then be forced to act. Taxes will rise and some spending will be cut. But that may not be enough. There also will be a loose attitude toward inflation as that will help reduce the real burden of debt. And central banks will have an incentive to keep interest rates down to make debt easier to finance. The world will not end but dealing with the debt will be a negative for growth.
Question 4. Where is the stock market headed?
It has gone up a lot in the past year and it looks expensive compared to company profits – a common measure of valuation. But it is not expensive compared to the returns you get from cash or bonds. Low interest rates have been the key driver of equity prices and the market is unlikely to enter a major decline until rates head higher. That may not happen for another year. Nevertheless, while further gains cannot be ruled out, this is not a bad time to take some money off the table. Behavioral finance studies show that the pain of losing $100 far exceeds the joy of making $100. To put it another way: you don’t go broke by taking profits.
I could prattle on with other stuff but this already is too long. To close, it has been fun being part of the VRMNC and I wish you all the best.
Ciao
Martin Barnes