Rothschild busts macroeconomic myths

Popular mis-characterisations of debt, deflation and QE result in a distorted picture of macroeconomic investment risks, said Kevin Gardiner, global investment strategist at Rothschild Wealth Management.

Rothschild busts macroeconomic myths


Gardiner, who previously held senior positions at Barclay’s Wealth Managment and HSBC Investment Bank, began as an economist at the Bank of England.
He exposed some oft-repeated investment concerns that do not hold up under scrutiny.

Myth 1: Global net debt is worrisome

There is $200trn of global indebtedness, but that’s gross liabilities. The average person owes $25,000-$30,000, but you should ask, `To whom do they owe it?’ At the global level, every borrower is matched by a lender. Every liability is matched by someone else’s asset, and global net debt is precisely zero. 
We also get the impression that the US consumer is massively indebted. That’s not the case. We focus only on liabilities and forget that there are assets on the other side of the balance sheet. The US consumer balance sheet is not fragile, it’s strong. If you add together tangible assets plus financial assets and subtract liabilities, the result is net worth. The US consumer’s new worth is still 4-5x US GDP. 
So US consumers are not in debt, they are massively wealthy. This is for the average consumer. You can debate about distribution, but in aggregate the balance sheet is pretty strong.
People think we’re seeing something called the `great deleveraging’. Of course, were not. There won’t be a great deleveraging, ever, and the next financial crisis will be accompanied by even higher levels of gross liabilities than the last one. 
It’s not the gross exposure that drives things economically. 
Not that debt doesn’t matter. But you have to view it in some sort of wider perspective and then you get a different picture of US consumer solvency than if you only focus on liabilities.

Myth 2: Deflation freezes spending

Question statements about deflation fears. The worry about deflation is that if prices fall, the consumer stops spending because he will wait and buy something when it gets cheaper. 
Oil prices have fallen, but consumers haven’t waited for the price to go lower. If you don’t buy petrol, you can’t drive the car. 
Technology prices have always been falling. But when did you hold back buying the latest gadget because you thought it would be cheaper in a year’s time? 
Everything depends on context. 
Spain, for example, has seen deflation. But as consumer prices started to fall, Spanish consumer spending accelerated.
Meaningful deflation for me would be if the CPI in aggregate would fall 5-7% annum and that repeated several years in a row. We’ve only seen that once in living memory and that was during the depression of the 1930s. Absent economic depression, we haven’t seen deflation associated with very bad news on the growth front.

Myth 3: Central banks are printing money, which spells doom

Money supplies have not grown quickly as a result of quantitative easing. Although we say QE is `printing money’, it isn’t really. What central banks do is buy bonds with reserves they create themselves. The immediate liquidity, which they create themselves with sleight-of-hand using electronic key entries, is used to purchase bonds, usually from the banking system. 
That means bank liquidity certainly improves and bond prices are higher than they otherwise would’ve been. 
What doesn’t happen is that liquidity doesn’t go into the larger economy. It doesn’t go to consumer spending because the central banks are not printing money. 
Liquidity in the banking system only becomes money creation if people want to borrow that liquidity from the banks. If bank lending is subdued, the QE doesn’t get into the wider economy and does not have the impact people think it does. 
People say all this money printing means a risk of a scenario unfolding like the 1920s Weimar Republic in Germany. That’s unlikely to happen. Back then, the central banks did print a lot of bank notes to pay people and people took their pay home in wheelbarrows. That’s not what’s happening this time around. In a modern economy, you can’t just print banknotes and use that to finance government deficits like in the 1920s.

Myth 4: Falling oil prices are bad for growth

Lower oil prices are definitely a good thing and I’m surprised people are questioning it from the point of view of growth. In the short term, markets react. The profitability of the energy sector accounts for one-tenth of the US market and that profit has been revised down. 
But further down the road, if prices stay roughly where they are, 2% of the world economy will be transferred from producers to consumers. 

Advice to clients

Gardiner believes the global economy will “muddle through” at a modest growth rate. The firm is advising clients to invest in corporate securities instead of government instruments, emphasising ownership. “We prefer owning rather than lending to businesses.”
In a balanced portfolio, developed market, growth-related equity is preferable to safe haven assets, he said. 
“The muddle-through scenario favours stocks over fixed income and developed market stocks are not yet particularly expensive, even though the S&P has trebled.
“The outlook for investing in the global economy is still pretty positive. We’re aware of risks, but the glass is still pretty much half full.”


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