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Will central banks be called to the rescue again in 2019?
Didier Saint Georges, managing director, member of the Investment Committee at Carmignac, has noted the following:
About 10 years ago, a majority of western governments shouldered the debt load of their domestic banks in a bid to save them from the dire consequences of the Great Recession. Thus overburdened, those governments left it to their central banks to try to put the economy back on its feet.
The latter did what they knew best how to do, which is to inject liquidity into the financial system to prevent it at least from seizing up completely and sending the economy into free-fall. But the central bankers also hoped for more - that the fresh liquidity flooding markets would drive up prices for financial assets ranging from government paper to equities, and from corporate bonds to real estate, so as to create a "wealth effect". Well-known to economists, the wealth effect involves the appreciation of individuals' assets which boost consumers' confidence and their propensity to spend, thereby rekindling demand across the economy.
However, the outcome these past several years has been a mixed bag. In Europe, the wealth effect proved negligible, due to widespread underemployment and the low share of European savings invested in equities. In the United States, where people invest much more heavily in financial assets, rising stock prices significantly helped fuel a consumer spending revival.
But in both cases, the wealth effect created a divide - which soon widened into a yawning chasm - between the lucky holders of financial assets and wage-earners with no such holdings who saw their incomes stagnate as a result of anaemic economic growth and hawkish fiscal policies.
Such divergent fortunes sparked mounting discontent in the social strata hit hardest by the monetary policy response to the Great Recession. At the same time, they discredited successive governments, which proved incapable of providing fiscal solutions to the problems at hand for lack of sufficient elbow room to implement their policies.
Today, 10 years down the road, the major political fallout from that dissonance is plain to see. Across the largest western democracies, alternative radically populist platforms have been put forward that have paid off in the voting booth, depending on how much economic frustration the lower-income segments of the population have experienced. Though that trend can be attributed primarily to specific sociological, and even narrowly political factors, it's hard to get rid of the feeling that the election of Donald Trump, the pro-Brexit referendum vote and Matteo Salvini's coming to power in Italy are all to a large extent side-effects of the choice to respond to the Great Recession with a combination of financial asset-price inflation and fiscal austerity. It is also worth recalling that even Emmanuel Macron got elected in France by promising a break (however reform-minded) with "economic policy as usual".
As 2018 draws to a close, investors therefore have ample grounds for anxiety, given that the monetary policies that worked so well for them are being dialled back to normal everywhere. To make matters worse, economic growth still appears shaky and the economic policy agenda uncertain. Looking at the big picture, we can say we're in the midst of a three-way collision between monetary, macroeconomic and political cycles. Mr Trump's lavish spending programme may have fostered the illusion that fiscal policy can solve our problems. Moreover, though debt-financed (the Federal deficit is on track to reach a full 6% of GDP this year), his fiscal policy has so far managed only to a limited extent to produce its own antidote - ie, higher interest rates. But even with the uniquely privileged status enjoyed by the United States in financial markets, it is only a matter of time before the same side-effects kick in there as well. The global debt overhang condemns us to maintain perpetual growth - an unattainable goal - because it will intensify economic slowdowns and threatens to turn any recession into a devastating slump. As it happens, the US economy is beginning to decelerate. It's also hard to imagine how Italy and France could escape their debt shackles. So in 2019, the first risk facing investors is that financial asset prices may continue to deflate. But that deflation could also have disturbing repercussions on the real economy by reversing the wealth effect: lower asset prices would further undermine consumer confidence just when policymakers won't have the leeway needed to implement adequate stimulus programmes. Will central banks be called to the rescue once again?