Introduction to January 2016 Economic Commentary

May I start by wishing all of our clients, contacts and other readers of our economic commentary well over the festive season and a prosperous 2016

At this time of the year we review the year that has just gone and we share our thoughts for 2016 and beyond.

Earlier this year I was drawn to a paper published by McKinsey Global Institute – a worldwide business and economic think tank. The headline starts

‘Seven years after the bursting of the global credit bubble resulted in the worst financial crisis since the Great Depression, debt continues to grow. In fact rather than reducing indebtedness, or deleveraging, all major economies today have higher levels of borrowing relative to GDP than they did in 2007. Global debt in these years has grown by $57 trillion, raising the ratio of debt to GDP by 17 percentage points. That poses new risks to financial stability and may undermine global economic growth’

The paper goes on to show that government debt is up 75% and this is not surprising given the reaction of central banks and governments world-wide looking to avoid a slump. It also demonstrated that corporate debt is up 47%; again, this is a direct consequence of cheap interest rates and low-cost borrowing. More worrying, I think, is that household debt and bank debt are both up 21%.

This is worrying on three counts;

– Debt has to be serviced, interest has to be paid on debt and money spent servicing debt is money not available to drive economic growth or the delivery of public services.
– Debt has to be repaid, and in due course our children and grandchildren are going to have to do without.
– The population of the developed world is aging. The proportion of ‘producers and savers’ is declining whilst the proportion of the retired and net spenders is increasing.

Some countries are in a worse mess than others. Hardly surprising is that Japan, Ireland, Greece, Spain and Portugal are amongst the countries in the biggest pickle. Total debt in these countries is equivalent to their total production for the next four years. China has spent so much on infrastructure that the debt to GDP ratio has quadrupled since 2007 and now stands alongside the US and the UK in terms of debt being equivalent to two years production.

Our politicians world-wide are playing a massive game of ‘Economic Jenga’ building towers of debt on an unsustainable base.

It is true that the world will learn to live with the new levels of debt and it may well get worse before it gets better – but we also have to expect that economic growth will suffer as a direct consequence of the cost of servicing the debts and the aging population base. Many commentators are now thinking that in this new world economic growth may well be reduced by as much as 2% per annum. Now 2% to the emerging economies just means a slow-down – a 2% reduction in the UK means that we will be fortunate to enjoy any economic growth at all.

The Governor of the Bank of England has stated that whilst he would like to see interest rates rise, he is virtually powerless. An increase in interest rates will further stifle economic growth and cause the government to have to tax more – or cut more services – to get the books to balance.

The only positive news is that the continued low price of oil is shifting wealth and growth from the oil-producing countries to the oil-consuming countries.

So for 2016 and beyond, our Investment Committee at Gould Financial Planning are managing expectations downwards and reducing our long term investment performances.

10 year averages 1970-80 to 2004-14 real returns above inflation [rpi] Future growth assumptions for the next 20 years real returns above inflation [rpi]
Cash 2% 1%
Long Term Lending to governments 4% 2%
Property 5% 4%
Equities – Developed World 7% 6%

Mckinsey concludes thus;

But government debt has now reached high levels in a range of countries and is projected to continue to grow. Given current primary fiscal balances, interest rates, inflation, and consensus real GDP growth projections, we find that government debt-to-GDP ratios will continue to rise over the next five years in Japan (where government debt is already 234 percent of GDP), the United States, and most European countries, with the exceptions of Germany, Ireland, and Greece.

It is unclear how the most highly indebted of these advanced economies can reduce government debt. We calculate that the fiscal adjustment (or improvement in government budget balances) required to start government deleveraging is close to 2 percent of GDP or more in six countries: Spain, Japan, Portugal, France, Italy, and the United Kingdom Attaining and then sustaining such dramatic changes in fiscal balances would be challenging. Furthermore, efforts to reduce fiscal deficits could be self-defeating— inhibiting the growth that is needed to reduce leverage.

Welcome to the new world order …….