Inside investment: Gluttony made indigestible
The global savings glut will continue to buoy markets, for now. But all sins come at a price.
As the occasional writer of a restaurant column, and an even more occasional visitor to mother church, one does, only very occasionally, think about the cardinal sin of gluttony.
A pleasant fate does not await those of a Billy Bunter-ish bent. If Dante Alighieri is an accurate guide to the other side, the third circle of the Inferno condemns its gluttonous denizens to an eternal marinade of fulminating filth. It is a fate worth avoiding.
If there is ever a time to reflect on too much indulgence, it is after the excesses of Christmas, at the beginning of a new year. In finance, 2016 may also be the year in which gluttony rises to the top of the agenda. This is not a new problem. In 2005, Ben Bernanke, then a humble Federal Reserve governor, made a speech to the Virginia Association of Economists on the consequences of the “global savings glut”. To paraphrase, he argued that the US was able to run large current account deficits due to surpluses elsewhere and an “increase in desired global saving”.
Bernanke was right to point to this as the explanation for Alan Greenspan’s low bond-yield conundrum – the yield on the benchmark 10-year Treasury was falling even as the Fed raised rates. Sadly, he did not foresee that the result of that glut would be an investment binge, fuelled by leverage and financial innovation, nor did he use policy in an attempt to deflate the gargantuan bubble it created.
The fundamental catalysts for this savings glut have not changed, though some of the elements have. The biggest driver is demographics. The world is aging. This is not just a developed-market phenomenon, though the oldest populations in the world are in Japan and Europe. Between 1996 and 2000 the global working-age population was growing at 7.2%. The current figure is 2%. Saving for retirement requires investing in growth assets. Post-retirement, investors require income. There is a lot of money chasing investment opportunity. It has created the mother of all gluts.
The result of too much gluttony can be seen in microcosm in China. Between 1978 and 2014, the Chinese economy doubled in size every eight years. It accumulated $4 trillion of foreign exchange reserves and turned 260 million agrarian labourers into urbanites. In just three years China used more concrete than the US in the entire 20th century and it remains the destination for 40% of the world’s steel production. These are awe-inspiring achievements. But they have not come without costs.
Resources have been misallocated in ways that are hard to comprehend: there are ghost cities, state-of-the-art airports in destinations no one wants to reach and roads to nowhere. By some estimates there are 50 million unoccupied homes across China. That is almost half the number of occupied homes in the US. Swathes of empty properties and talk of a housing bubble seems incongruous. In fact they are two sides of the same coin.
Construction supports overcapacity in many industries, encourages excess money supply and debt, which has doubled since the financial crisis, and helps keep growth rates high. Only the elites can squirrel cash away overseas (and that is a dangerous game). Domestic capital markets are immature and owning property comes with kudos. Money needs to find a home, though in China it is often an empty nest.
The Chinese investment glut fed others. It has led to the indigestion seen across commodity markets in 2015. Like stock market cheerleaders that extrapolate current trends into the distant future, miners saw the Chinese investment binge as a never-ending story, rather than as a transitional process of economic development. They too over-invested and created a supply glut. Copper, aluminium and iron ore are now all at post-financial crisis lows.
The west too has experienced property bubbles and resource misallocation. But the only money-hoover big enough to suck in the global savings glut is capital markets. Bernanke’s savings glut has been super-sized as a result of unprecedented reserve accumulation (China, alone has added $3 trillion in the last decade), expanding corporate cash piles (the surplus savings of Japanese companies is the equivalent of 8% of GDP) and the transition of Europe from current account balance to net creditor.
These cyclical forces ebb and flow. Chinese reserve accumulation has gone sharply into reverse and the fall in the oil price means there are fewer petrodollars finding their way into financial assets. But these flows pale beside the secular force of demography. For a modern version of the Greenspan conundrum, witness the paltry effect of ending QE-Infinity in the US on yields. A central bank splurging $80 billion a month on bonds does not sound like a marginal buyer. But when the bond purchases stopped, yields responded with an insouciant shrug.
The end result of too much money chasing too few assets will be fast-breeding bubbles and recurrent financial crises. Macro-prudential regulation might ameliorate some of the excesses seen in 2007, but policymakers are fighting an ineluctable force.
The day of reckoning may not come in 2016. The chances are that a little less fiscal austerity in Europe, almost imperceptible US tightening and a relatively benign economic outlook could result in a choppy but ultimately positive year for financial assets. With that backdrop, contrarian plays in emerging markets may be the best bet for outperformance.