One of the consistent ideas that emerge from credible Marxists critics of the capitalist system – I’m thinking people such as Chris Dillow and Paul Mason – is that the modern global economy is suffering from a worrying slow down in productivity growth and an even more worrying increase in indebtedness. In essence, their argument is that we’re taking on ever more debt to produce ever more meager amounts of GDP growth.
You don’t have to be a Marxist to be worried by this argument. Respected liberal and mainstream economists have mounted both the low rate of innovation growth (William Nordhaus) argument and the secular stagnation argument (Larry Summers), though rarely both together unlike the Marxists who will grasp at any argument that predicts capitalist cataclysm.
Followers of economist Hyman Minsky – Marxist or otherwise – also then add a further twist. These twin processes tend to result in bubbles in asset price valuations as investors chase the few hotspots of growth where innovation is producing abnormal earnings growth.
Perhaps the most comprehensive articulation of this latter, Minsky moment thinking can be found in a recent paper called Bubble or Nothing. The always excellent Peter Coy of Bloomberg Businessweek tipped readers off about this powerful special report by David Levy, chairman of the Jerome Levy Forecasting Center, published September last year.
You can download the full report here –
The background of this paper is what investment commentator Richard Duncan has called creditism. Richard’s argument is that for much of the last few decades we’ve been engaged in a deadly pursuit of ever more debt which has, in turn, helped fuel asset price bubbles. This addiction to debt – ably demonstrated by reports from the likes of McKinseys, available HERE https://www.mckinsey.com/featured-insights/employment-and-growth/debt-and-deleveraging-the-global-credit-bubble-update – shows no signs of abating and is being encouraged by central banking monetary policy.
As soon as investors start worrying about the costs of debt – increasing interest rates – central bankers panic, loosen their balance sheets and encourage ever more debt.
We are in essence trapped in a doom loop and according to Duncan the only way out of it is to go for one last final debt binge and get governments to invest in a vast new Green New Deal which will kickstart growth and increase productivity.
I have my doubts about some elements of this argument but in aggregate this makes sense to me, in a worrying way. I also think this line of thinking has no obvious investment implications except that investors need to be damned careful about preserving capital. If the crisis predicted by creditism does materialize, the policy consequences and choices are varied and legion. A socialist government could nationalise to survive. A radical Trumpite government might try helicopter money. A hard-right government might try a combination of helicopter money ANDS massive tax cuts. Social democrats might go for a Green New Deal. Take your pick but all have varying asset allocation implications.
You can catch a sense of the creditism argument from Richard Duncan here – https://richardduncaneconomics.com/credit-growth/
Bubble or Nothing by David Levy presents an investment perspective on these trends. The core argument presented by Levy is that as debts mount, investors relax their risk rules and engage in ever more leverage which in turn pushes asset prices higher. Risk-taking is encouraged and strict covenants ignored, with predictable consequences.
Again, the doom loop. How this ends no-one knows!
I thoroughly recommend Bubble or Nothing but if you can’t read it in full, here’s the summary of the doom loop argument, kicking off with a nice chart immediately below which reminds us that leverage levels are rising as we speak.
“From the mid-1980s on—the era of the Big Balance Sheet Economy—financial decision makers have had to choose between progressively lower returns and higher risk.
- Too much private-sector debt relative to income has adverse consequences, of course, but so does an excessive total value of private sector assets relative to income. An extreme value of aggregate assets relative to income means meager yields and operating returns on assets, distorted financial decisions, and an economy vulnerable to asset price deflation.
- Each successive business cycle in the Big Balance Sheet Economy era has started with proportionately larger balance sheets and has involved more reckless balance sheet expansion leading to even bigger balance sheets and a worse financial crisis.
- Each successive crisis, with more bloated balance sheets to stabilize, was more difficult to resolve and therefore required the government to engineer dramatic new lows in interest rates, heavy fiscal stimulus, and other measures to stabilize economic conditions. The measures eventually overcame recession and chronic weakness, but in doing so they necessarily caused further expansion of balance sheets relative to income.
- During the 2000s, either the housing bubble or some other set of highly speculative, excessively risky, and destabilizing activities was virtually inevitable.
- Increasingly unsound risk taking has been occurring again in the 2010s.
- The present cycle is almost certain to end badly. Although there are signs that balance sheet ratios are undergoing an extended, secular topping process, they remain extreme and will produce serious financial instability during the next recession.
- There is no nice, neat solution to the Big Balance Sheet Economy dilemma, no blueprint for a politically acceptable resolution. The task of preserving prosperity while shrinking assets-to-income and debt-to-income ratios is, if not outright paradoxical, at least plagued by conflicting forces.
- Government policy cannot prevent serious consequences when the Big Balance Sheet Economy corrects, but it can moderate them and help households, businesses, and the financial system cope with them. However, these tasks would be difficult, politically tricky, and prone to cause some backtracking on balance sheet correction even if policymakers fully understood the economic problem.
- Although the outlook is fraught with uncertainties, individuals and organizations can benefit by taking steps to prepare for, endure, and in some cases capitalize on some of the developments ahead. The U.S. economy continues to face a bubble-or-nothing outlook. Participants in the economy and markets will keep increasing their financial risk until the expansion breaks down, and the bigger the balance sheets are relative to income, the more severe the breakdown is likely to be.”
I think it’s fair to say that these arguments have some purchase in the wider investment strategy community. Analysts at French bank SocGen seem especially tuned in. They’ve recently pulled together a compendium of all the charts that make clear their major concerns for 2020. It’s a long old document but I thought I would pull out the two charts below which seem to be very relevant to the earlier discussion.
The first shows that even during an era of near-zero interest rates, interest expenses have been growing rapidly. The second chart shows that interest cover amongst smaller caps is “terrible for this point in the cycle”.
If central banks and policymakers do respond to these trends discussed above by increasing interest rates sharply, god alone knows what carnage those increased leverage costs could wreak on cashflows and thus share prices.
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