Understanding the GFC
Transcript of Understanding the GFC
Understanding the GFC
Navigating deflation and inflation
Hamilton Wealth Management
Melbourne, May 2016
Dr Sam Wylie
Principal Fellow, Melbourne Business School
Director, Windlestone Education
[email protected] 0428 103 859
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Introduction
Outline of talk
The global economic outlook: Bulls versus Bears
Evidence of global deflation
The fight against deflation
Why anti-deflation measures might overshoot into inflation
What should investors do?
Main points
Global deflation is the elephant in the room for investors
Defeating global deflation may take ‘extreme’ action by central
banks that is likely to overshoot into substantial inflation
Investors need to prepare for a slowing global economy, a
possible deflationary shock and extreme action that will follow it
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Evidence of global deflation: Actual inflation3
Bulls: Global economy heading back to normal
Bulls
US economy is picking up steam
-- Everything that was broken by the GFC is mended: Unemployment is
below 5%; the budget deficit has returned to normal, the banking
system is healthy; monetary policy is returning to normal,
-- Falling employment is finally causing wage growth (2.6% annual)
-- US growth will build global confidence
Global GDP growth is still ok
-- Global growth has been consistently above 3%
-- Green shoots of growth in Europe, especially Germany
-- Chinese and Indian Governments are determined to maintain growth
-- Inflationary expectations have not collapsed (no self-fulfilling
deflationary mind set)
Falling energy prices
-- Halving of the oil price is like a $1.7 trillion tax cut for global economy
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Bears: Deflation is a grave and growing threat
Bears
Quantitative easing
-- Additional QE and negative interest rates will be needed to preventconsumer price deflation
-- Extra QE will inflate asset price bubbles (stocks, property, bonds). Negative interest rates will damage the banking system
-- Bursting of bubbles has been the problem (Japanese stock and property
bubbles, US dot-com bubble, Global property bubbles)
Where is the ammunition to fight another crisis?
-- Government spending ?? (fiscal policy)
-- Cutting interest rates ?? (monetary policy)
-- Exchange rates ?? A zero sum game
-- Structural reform ?? Not easy
The low demand in the global economy may be permanent
-- Secular stagnation
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Is inflation the only way out of the GFC?
Explanations of slow growth
Secular stagnation Larry Summers, et al
-- Global demand has been falling relative to supply for decades, but was hidden before the GFC by growth in credit (which then caused the GFC)
-- The deficit is caused:
Demand side: demographic factors / globalization / concentration of wealth
Supply side: technological change / larger global work force
-- Real interest rates can’t get negative enough to stimulate investment
Debt overhang Carmen Reinhart and Ken Rogoff
-- Financial crises in which a massive credit growth leads to bad debts that lead a failed banking system are followed by 10-20 years of slow growth
-- Deleveraging by governments, corporates and households takes time
-- Growth is restored once debt runs down enough
We don’t know which explanation is correct
-- But . . . In both scenarios higher inflation will help a lot
-- High inflation means higher real interest rates (secular stagnation) and inflating away of debt (debt overhang)
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Evidence of global deflation: Expected inflation10
Australian wage growth11
Expected inflation: Commodity prices12
Expected inflation: Long term bond yields13
Expected inflation: Australian survey evidence16
The fight against deflation
What is being done to fight deflation
Quantitative easing
-- QE in the US, Japan, Eurozone and UK will soon amount to the
creation of $12 trillion of new money
-- QE is intended to increase consumer product prices, but actually has
increased financial asset prices (stock, bond and real estate prices)
Negative interest rates
-- Negative rates on the deposits of commercial banks in central banks
-- European Central Bank (-30 bps) and central banks of Switzerland (-
30bps), Sweden (-50 bps) and Japan (-10 bps) all charge commercial
banks for depositing funds in the central bank
-- This policy is intended to force commercial banks to turn the money
that is currently hoarded in the central bank into loans
‘Helicopter money’
-- Printing money and distributing it to households is really just another
form of Quantitative Easing
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QE and helicopter money18
Currency
Reserves
Other
LiabilitiesAssets
Central bank
Other
Treasury
bonds
Agency
bonds
Bonds &
Bills
Deposits
Equity
LiabilitiesAssets
Commercial
banks
Other
Loans
Currency
Reserves
Debt
Equity
LiabilitiesAssets
Households &
firms
Other
Currency
Deposits
Sector balance sheets
Treasury
bonds
Navigating deflation and inflation
Measures to defeat deflation will likely cause high
inflation in the long term
Deflation fighting measures are blunt instruments
Inflationary expectations must be shifted upwards, and there is
no fine-tuning of that shift
Central banks actually want significant inflation because it may
be the only way out of the GFC
-- High inflation will reduce the real amount of debt that is ‘over-hanging’
the world economy
-- High inflation permits negative real interest rates which are needed to
stimulate demand
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What should investors do?
Navigating the threat of deflation in the short-medium
term
Reduce net debt (debt – cash)
-- Deflation is the enemy of debtholders because the principal of the debt
increases in real terms
-- Higher cash holding will facilitate taking investment opportunities
Reduce overall investment risk by one or more notches
-- More defensive (less aggressive) asset allocation
-- Reduce leverage (as stated above)
Navigating the transition to inflation in the longer term
Asset classes that will deliver real returns in a deflationary
environment and an inflationary environment
Infrastructure investment
Variable rate notes and bonds
Bank hybrid notes
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Growth of debt
Source: AFR 6 May 2016
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