By Mark Brett
Global bonds have been on a tear. So far, 2016 has seen some of the highest returns of the post-post-crisis period — the mixed environment for bonds since the US Federal Reserve concluded its bond-buying activity in late 2014.
Anticipation that interest rates will need to remain lower for longer has helped fuel a 10% gain this year in the Barclays Global Aggregate Index. Unfortunately, there’s a problem with central banks taking rates ever lower in a bid to turbo-charge growth: it’s not working.
Cue the recent calls by some market pundits for governments to try helicopter money: large-scale cash payments to individuals, financed via additional money supply from a central bank.
However, I believe the helicopters will remain grounded for now. That said, smaller targeted payments to individuals — drone money, if you will — could be used more widely. It seems increasingly likely that developed-market governments will conclude that they have to spend more to grow more. How did it come to this?
Post-crisis growth: not enough to ease debt burdens
I recently watched The Big Short. The final act of this 2016 Oscar-contender reminded me of a simple fact: nearly a decade has passed since the financial crisis erupted, but the global economy is still dealing with the problem of too much debt.
The turmoil occurred because of a significant build-up of debt in the US housing sector (the film’s focus), as well as among European governments, corporations and households. And since 2007, credit booms in China and the emerging markets corporate sector have added to the mountain of debt.
Central banks have thrown everything at the problem of excessive debt and its bedfellow, sluggish growth. They’ve unleashed quantitative easing programmes that pumped hundreds of billions of dollars, euros, yen and pounds into the financial system. They’ve also tried near-zero and negative interest rates. In response, bond yields (which move inversely to prices) have plummeted. Still, growth rates in many countries have not climbed enough to significantly reduce private-sector debt burdens.
Furthermore, extreme monetary policy may also be harmful. During a research trip to Japan in May, I heard how negative rates were pressuring bank profits and doing little to spark credit growth. It’s been a similar story in the Eurozone.
Even in the US, where years of easy money have supported modest growth and the Fed has begun to raise interest rates, the economy isn’t firing on all cylinders. Capital expenditure remains stubbornly low as corporations have used cheap financing for M&A and financial engineering instead.
Some economists also believe that central banks have inadvertently widened the gap between rich and poor. Prices of financial assets and housing have been pushed up by QE, the argument goes, without commensurate gains in capex, job creation and wages. This may explain the rise of populist politicians and the resulting pressure on governments to counter income inequality by opening the coffers.
As one of the leads in The Big Short put it, the economic repercussions of the crisis were always likely to be severe and lead to scapegoating.
Post-post-crisis: fiscal stimulus takes centre stage?
The trajectories of government finances are already shifting. Japan has grabbed the headlines lately because of plans to spend big on infrastructure and construction. In China, a new round of public infrastructure spending is underway. Changes in the Eurozone and US have been subtle, with budget deficits drifting higher. I expect post- Brexit deficit drift in the UK, too.
Tax cuts, rebates and modest spending increases will likely become more prevalent across the globe. Helicopter money seems too controversial to attempt at present — unless global growth takes a major hit. In the Eurozone, Germany favours fiscal discipline and reform. In the UK, sweeping experimental policies are unlikely as the new government works through exiting the European Union.
On the other hand, we may see governments follow the trail Japan blazed with drone money. There, as part of a wider programme of government spending, the government is giving cash to low-income households (arguably, the payments are indirectly financed through central bank easing).
Mark A. Brett is a fixed income portfolio manager at Capital Group
