Goldilocks and the bearish blogger
The world’s financial markets appear to continue to believe in the continuation of the so-called Goldilocks economy – one that is neither too hot nor too cold, sustaining solid economic growth and low inflation allowing for market friendly low interest rates. The name comes from the children’s story The Three Bears, where the trickiness of managing to heat porridge to the right temperature is tested to its limit. It’s tricky to get right as my wife and I know when trying to figure out the length of time to heat our baby’s chicken and sweetcorn mush in the microwave. It’s even trickier for economic policy makers to get the timing right too.
It’s been argued by many who believe in cost push inflation that deflation (when the porridge is “too cold”) remains the main concern as we have sustained higher unemployment and underutilized productive capacity, gradually or potentially rapidly pushing down the equilibrium level of prices of assets throughout the economy (wages included for any British Airways cabin crew reading this).
On the flip side is the case for stagflation (porridge “too hot”) and potentially in the worst cases something akin to Zimbabwean hyperinflation. The scale of the increase in global money supply, through quantitive easing programs and extended budget deficits are the badges of this argument.
At the moment, however, the world’s financial markets seem to be taking the view that the powers that be can manouevre successfully between these two courses. That means keeping the fiscal and monetary stimuli in place in order to create aggregate demand and the growth and employment that go with it.
I am generally one for betting on human incompetence in dealing with complex tasks, and for the talented economic policy-makers of the world maintaining the the Goldilocks outlook is becoming increasingly difficult.
While the bullish of the world will point towards the recent past and say that governments have managed this balancing act well, my sense is that the sustainability of this course is going to become more and more tricky.
As a recent example; last week’s jobless claims for the UK were represented as signs of “green shoots” by the bullish: the monthly jobless claimants figure saw the fastest fall since 1997. Sounds good eh?
Economists had expected the dole queues to lengthen – instead they shrunk by 32,300. Statistically excellent, but not the full picture. The reality is somewhat different when you consider that the UK employment rate (the percentage of the workforce that’s actually working) is now at it’s lowest rate since 1996.
The number of Brits who are either without a job, or who’ve given up looking for one, has soared to 28% of the UK workforce. That’s a striking 10.6m people. The total of those who are classified as “economically inactive” has now hit a record high of 8.2m. And with jobs hard to find, many more have gone into full-time education. There are now 2.3m students in the country, the highest level since records began in 1993. And the really scary bit: The last three months of 2009 saw the public sector take on 7,000 workers, while the private sector continued to lose staff. The data on closer inspection would suggest that the UK is moving further away from its peak production capacity and consequently from a higher economic growth path.
Against this backdrop there is likely to be a reluctance to look to tighten monetary policy through increased interest rates, nor to remove the financial Red Bull that quantitative easing represents. In an environment that is seeing greater and greater under-employment, where foreclosures and underwater mortgages continue to mount it’s really staggering that investors are willing to pay such high multiples for the companies they are investing in. The potential for many years of sub par earnings is high. In the US the S&P 500 recently attained new highs in the forward price/ earnings trading multiples.
The market rally that has been unfolding since March 2009 continues to be based on too much money in the system, rather than underlying strong company fundamentals. Similar to many other periods of financial leverage, easy credit and excess, I for one am not a believer in the Goldilocks economy. The losses from excess leverage and easy credit, toxic securities, derivatives and potential sovereign defaults will continue to be placed onto government balance sheets and funded through printed money. There doesn’t seem to be any real evidence that this will change soon. This is essentially an attempt to cheapen these obligations by pushing them onto the backs of future generations of taxpayers, so that the ongoing debt super cycle can continue.
I genuinely hope that the policy-makers can effectively manage their way and stay within the Goldilocks economic scenario, but it’s going to getting harder and harder. It may take some time, but I’m betting that we’ll end up over cooking the porridge.