An Economic Conundrum
Monetary policies out on a limb, new growth strategies and overdone trade agreements
By Jean-Luc Burlone, M.Sc. Ecn., FCSI (1996)
Central banks have used their last tools to prop up our economies. Economic growth sustained by demand remains elusive in spite of their efforts. Most developed economies have low rates: Britain and the US offer a 0.5% bank rate while Japan and Europe have dented the negative zone.
After years of reducing rates, supplying helicopter money and practicing quantitative easing, central banks have fuelled the supply side of the equation rather than the demand one as intended. A stunning result since inflation was always considered a direct consequence of monetary policy; a low interest rate stimulates the economy by increasing investments and demand, while a high interest rate cools down the economy by restraining investment and demand. One consequence of this inverted result is the down pressure on prices which entertains the dreaded deflationary scenario.
Most of the free money did not create wealth over the economy through investment because low rates rendered banks reluctant to finance new investments.
Most of the free money did not create wealth over the economy through investment because low rates rendered banks reluctant to finance new investments. Available funds went through financial networks to established corporations that reduced or refinanced their debts, bought back shares, financed mergers and acquisitions (the number of listed companies in the US has decreased from 6,457 in 2008 to 5,283 in 2015), built up their inventories or filled their war chest.
Among the latter, it is noteworthy that leading global corporations now sit on a pile of cash equivalent to 10% of GDP in the US and 47% in Japan. Such savings are in stark contrast to the IMF Fiscal Monitor calculations that estimates current total world private sector debt at $100 trillion, 66% of the world total debt or 134% of world GNP. These figures are the highest percentage point ever reached. They underline the financial power cash-loaded leading firms own and the contrasting situation between them and other economic agents.
The economy sails unfamiliar seas when corporations start to sell bonds baring a negative yield. Why would buyers agree to receive less than they paid for corporate bond issued in Euros by corporations such as Sanofi (France), Henkel (Germany), BP (Britain) or Nestlé (Swiss)? There are several possible answers: They expect the Euro to increase in value, they wish to secure some of their capital, they fear deflation, they expect more negative rates or they may be required to buy high rated bonds to comply with their statute as insurance companies and pension funds must do. In addition, a study by the Bank of International Settlements found that negative rates beget the same; German insurers, for example, added another €20 billion to the €60 billion of negative yield bonds they originally owned.
These leading corporations shape today’s economy in a context where the winner takes all. They are becoming gatekeepers of their secured and impressive market.
Another unfamiliar reality currently impacts the economy. Leading companies issued from information technology and the digital revolution became household names in two or so decades. The likes of Apple, Alphabet, Amazon or Facebook dominate the present economy as US Steel, Standard Oil, General Electric or Ford did in the 20th century. With a major difference though; their strength is neither based on assets nor on production strategies such as economies of scale but on strengthening the opposite side of the equation i.e. the size and relevance of their demand. They build entry barriers for new incumbents: Using their impressive cash reserve they increase their market by acquiring fledging corporations and promising start-ups – that now compete not to grow in size but to be bought by one of those giants.
These leading corporations shape today’s economy in a context where the winner takes all. They are becoming gatekeepers of their secured and impressive market. They develop networks that enable participants to trade goods and services while supplying them with more reliable information on their values, taste, behaviour, shopping habits, political views and voting tendency. Facebook for one, is the prime social network with which one has to be connected socially because everyone else is on it. Taking advantage of its imposing clout, the company has launched Market Place: where friends and neighbours buy, sell and recommend. The service is free since its first objective is to amass more information on participants.
Another major difference between the old and new corporate leaders is highlighted by the following numbers: In the 1990, three top carmakers in Detroit had combined revenues of $250 billion, a capitalisation of $36 billion and 1,2 million employees. In 2014, three top technology companies had revenues of $247 billion, a market capitalisation over $1 trillion and only 137,000 employees. With a similar revenue, their market capitalisation and number of employees differ strikingly. It highlights how efficiently technology pervades our economies and influences financial markets.
There is no untapped market left but the poor of the world and free trade agreements favouring foreign investments are effective in fostering a middle class in developing countries.
Like a good argument pushed too far, globalisation is loosing its steam. One fuelling element of growth in the past decades was the entry of new markets into the global economy: The reconstruction of Europe, the inclusion of Eastern Europe and then of China. That is all over now. There is no untapped market left but the poor of the world and free trade agreements favouring foreign investments are effective in fostering a middle class in developing countries. China, where trade fosters over 300 million middle class people, is the most obvious example. Trade agreements have clearly increased the GDP of open economies and they still do but to a lesser degree. A recent study by the International Trade Centre estimate that the TPP will increase the United States GDP by a mere 0,15%!
On the other hand, opponents to the agreement vehemently protest the Investor-State Dispute Settlement (ISDS) clause that allows multinationals to sue a government when it enacts public laws that may hinder the profitability of the investing company. The ISDS implicitly surrounds the power of a government to service its population. (NAFTA, CETA and bilateral investment treaties have a ISDS clause but current negotiations aim at amending it.) Trade agreements should be used as an important tool to promote the middle class in the developing world, but its rules should be rewritten to avoid slanting the economy in favour of investing companies with little concern for the well being of the people.
Globalisation must take into account the wellbeing of people as an objective different in nature and scope from the financial success of multinationals.
Clearly the present is quite different from the past. The world is changing faster than our ability to adapt. Institutions are loosing some efficiency, numerous people feel left behind and solutions to complex problems are expressed in 140 characters. Looking toward the future, we see structural reforms to improve the mobility of the labour market, investments in infrastructure to facilitate trade, and programs to support the unemployed, as seriously considered. Already, solutions or elements of solutions are emerging from the disaffection of people in diverse countries: Sweden, Norway, India, for instance, are experiencing very different economic approaches to support their labour force.
Globalisation must take into account the wellbeing of people as an objective different in nature and scope from the financial success of multinationals. While leading companies accumulate power, cash and information to consolidate their respective market, they are simultaneously distributing power as never before to individuals by linking them through networks. From the Arab Spring to Brexit, power to the people changes the world, maybe for the better, maybe not.
Jean-Luc Burlone, M.Sc. Ecn., FCSI (1996)
Economist – Financier
The text above is my personal view on the current financial context, based on reports and data from the financial press. It should not be viewed as either promoting an investment or an action of any sort.
October 19, 2016 – JLB