What future uncertainties remain?
March 2009
In the final piece of our series on
managing your assets in the current economic climate, we consider
how uncertain the future may still be. Whilst the combination of
very low interest rates, huge increases in public expenditure,
enormous fiscal incentives, sharply reducing inflationary forces
and, in Britain’s case, a weaker pound, all serve to create a very
powerful cocktail which will ultimately stimulate economic
recovery, a new question ultimately has to emerge. What will be the
consequences of applying both monetary and fiscal stimuli and how
will the resultant outcome be controlled and managed? We believe
there is a real risk with such an aggressive strategy that an even
more damaging outcome could materialise.
Firstly, after the inevitable period of
deflation, the scale of surplus liquidity risks the introduction of
hyperinflation and thereafter sharply rising interest rates. Such
an outcome would create more loan defaults and corporate collapses
together with higher taxes to repay the ballooning national debts,
choking still further consumer demand.
Secondly, by applying such aggressive
interest rate cuts, the ability of banks to repair their already
battered balance sheets in order to free up lending capacity
becomes seriously impaired. Given that the banks fulfil a critical
role, acting as the principal conduit in stimulating economic
growth through their lending policy, the main route to recovery
risks remaining firmly blocked. On the one hand, governments
criticise the banking sector’s reluctance to lend, and on the other
are busily removing their ability to do so.
The reality may see neither borrowers nor
savers benefiting. If you are a borrower, corporates included, you
are unlikely to see the benefits of rate cuts much below 3% in the
current climate and compared with the number of savers, you sit
very much in the minority. If you fear for your job, whether
interest rates are 3% or 1% becomes irrelevant, as neither rate is
likely to make you feel like spending. If you are a saver, it
matters a lot and the lower the rates, the poorer you feel (not
conducive to spending), and if you are a crippled bank, your
revenues fall along with the interest rates and serve to destroy
still further your already damaged balance sheet. The conventional
strategy of ever-lower interest rates can’t work if banks can’t
afford to lend and with no winners around the table, it’s hard to
imagine why this particular game should be played at all.
None of us, however, have a crystal ball
where we can accurately see the future. No one can accurately
predict what the right course of action will prove to be. There is
no precedent, we are in unchartered waters, and there is bound to
be an element of the unknown before the final outcome materialises.
What we are saying, however, is there are still considerable
uncertainties and questions that need answering before we can
confidently move forward with strong purpose. Mistakes were made in
the last Great Depression by inaction and the US and UK
governments, in particular, are bent on ensuring these are not
repeated. That doesn’t, however, stop them from making altogether
new ones, and their twin monetary and fiscal policy strategy may
well prove to work, but it is not without significant potential
risks as outlined above. All political leaders need to urgently
address how they propose to clear the enormous budget deficits they
are now busily creating.
The opinions in this article are those held
by the authors at the time of publication.