It is not often that one can go back and prove that one’s predictions have come true. In the aftermath of the 2008 crisis when governments and central banks let loose a monster in the form of fiscal and monetary stimulus, i wrote a few articles in DNA Money on the potential repercussions of this stimulus. A couple of articles were not directly in my name as I was then associated with a mutual fund and the tone of the articles was strong. The links to the articles are given below.
The past is coming to haunt the markets, and the question is will the future turn out as bad as the markets predict? The answer is no, as all stakeholders of the economy, when on a back foot, start doing things right. I am now very much positive on the economy, though you will require patience for the economy to start turning around.
What about ghosts of the future?
The current market volatility is a reflection of what happened in the past, what is happening now and what might happen in the future. The future course of the market will depend on the current response to future events, and if like the Charles Dickens character Ebenezer Scrooge in “A Christmas Carol” economies can change their ways to the good, the future is will be brighter than what markets are projecting it to be right now.
The ghost of the future does not paint a good picture, very similar to that of the ghost in the Dickens book. Economic growth is slowing, with downward revisions in growth in countries across the globe. Morgan Stanley research cut global GDP forecast by 30bps for 2011 and by 70bps for 2012. The fact that policy response to a downward trajectory in economic growth is extremely muted increases the potential for further reduction in growth estimates. The policy response is muted because governments across the world do not have fiscal ammunition while central banks have limited policy options. The sovereign debt issues facing countries from US to Japan is leading to governments focusing on cutting down on fiscal deficits to bring about a balance in government finances. Central banks including US Federal Reserve (Fed), Bank of Japan and European Central Bank (ECB) are all running extremely loose policies where policy rates are at all time lows or close to all time lows and further easing is not possible from these low policy rates.
Emerging market countries are facing inflationary pressure forcing central banks to tighten policy to bring down inflation expectations. Inflation from China to India is trending at multi year highs and centrals banks in these countries have raised policy rates to counteract inflationary pressures. Governments in these countries too are facing their own problems. China is facing property bubbles, local government debt and social unrest on the back of inflation running at higher levels. India is facing corruption scams and public unrest on corruption and inflation. India is also facing issues on poor government finances as the government is struggling to keep down its overall borrowing for calendar 2011-12 on the back of a rising subsidy bill.
The ghost of the future is telling us that weak economic growth coupled with lack of policy tools to stem the downward growth tide will lead economies into deeper trouble. The markets are factoring that prediction. Equity indices across the globe are down over 14% over the last four month, while commodities are down over 10% in the same period. Gold and bonds seen as safe have assets have performed with gold returning over 25% while the US ten year treasury returning absolute returns of 8% over the last four months.
Wait, it need not be as bad as projected by the ghost of the future. There are many positives in the scenario projected above. The first positive is that debt levels of governments are likely to come down strengthening government finances. The second positive is inflation will come off on the back of weak demand leading to lower borrowing costs globally. The third positive is with inflation coming off, central banks in emerging markets can lower policy rates and become more accommodative to increase demand, which is latent. The fourth positive is the corporate sector will have become leaner and meaner and with lower cost of borrowing will start leveraging for future growth. The fifth positive is many governments will be forced into reforms, which will come into play down the line.
Scrooge changed his ways for the good, there is no reason why governments, central banks and corporates cannot do the same.