Talib Sheikh and Mark Richards preview 2021, as a new era begins that still has echoes of the old. As we reach the limits of what central banks can do to foster growth, the baton passes to governments.
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We are living through an earthquake for the global economy and the ground is still shaking under our feet.
It’s hard to say where everything will settle. Covid-19 vaccines may signal the end of the health crisis, but the damage wrought by the pandemic is still working its way through the global economy.
The policy response to the crisis from central banks and governments around the world has been enormous. There will be no simple reset back to pre-crisis days: the fiscal and monetary landscape has changed.
Economic history is punctuated by generational inflection points, and these developments could prove every bit as profound as coming off the gold standard in 1971, or Paul Volcker taking over the US Federal Reserve at the end of the 1970s and hiking interest rates to 20% (source: Blomberg).
Profound changes have already taken place
There have been two profound changes already. The first is that most developed market central banks have changed how they implement policy, essentially accepting that they have a less robust model for how inflation is generated.
Historically interest rates were set according to where central bankers thought inflation would be in future, but the link between growth, employment and inflation has weakened. There is such doubt about how to forecast inflation that central banks are going to be more reactive rather than pre-emptive in setting interest rates and are likely to use ever more innovative tools to meet inflation targets.
The second change is in the scale of government intervention, with the state stepping in to effectively guarantee the bulk of bank lending since the start of the pandemic, while effectively nationalising the wages for large parts of the workforce through job retention schemes.
As we reach the limit of what central banks can do with monetary policy, the baton is being handed to governments to foster the growth that will be vital for economies to recover from the pandemic. Expect aggressive fiscal and monetary policy to work together for years to come.
Structural shifts in the global economy
Low taxation, deregulation and deindustrialisation have seen economic growth benefit the owners of capital over the providers of labour for decades: corporate profitability has gone up, while wages have stagnated. After this crisis we expect governments worldwide to focus on “fixing the system”. The most visible signs of this, alongside persistent deficit spending, will be higher taxes and the threat of regulation, particularly on tech oligopolies. This is likely to somewhat reduce corporate profitability.
Lastly, following a period of trade war and deglobalisation, we think a Biden administration would seek to improve global cooperation and that will be positive for the global economy. Yet we must remember that there is a fragmentation already underway across regional lines, with the Americas, Europe and Asia forming three trading blocs. The pace of deglobalisation will slow, but is unlikely to reverse.
A new era, with echoes of the old
The pandemic will probably disappear in 2021, but it will leave a different world behind it. Many of the issues that have plagued the global economy over the last ten years, especially excessive amounts of debt, have been exacerbated by the crisis. In response, central banks and governments have committed to ever more innovative efforts to get inflation and growth back into the system.
We are in a new world where no-one can quite be sure how these changes will play out. That’s why we believe a flexible investment approach is the best way to provide an income or total return from among a wide array of asset classes in global markets. While we do think the world will be a brighter place to live in 2021, nobody should be thinking about a return to the world we saw before the pandemic.
Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.