There’s no chance of a return to anything remotely resembling conventional capitalism and free private markets with the public sector now firmly in the driver’s seat following the Global Financial Crisis (GFC) and the Covid-19 pandemic, Macquarie Capital argues.
Macquarie Capital analysts Viktor Shvets and Terrence Leung make this argument in a report named Rights, Wrongs & Returns 2022 – Between COVID, Hubris and Nemesis. They argue the combination of the GFC between 2008 and 2010 and now Covid are turbocharging developments that were already underway. They are dislocation events accelerating change.
This makes states and public sectors the most important and dominant players in modulating economies and capital markets.
“It is accelerating atrophy of private sector and free market signals while making it next to impossible to unwind the process of financialization and an ever-deeper dependence on debt and asset prices,” Shvets and Leung say.
“The Information Age and financialization are also aggravating social tensions, including inequalities within and between nations, with Covid accentuating these developments even further. This brand-new world that is tentatively emerging favours size, localization, wealth, and liquidity and generally disadvantages anything that is small, generically globalized, illiquid, and poor. It brings to the end the decades of a global convergence, which never truly worked but was at the core of political and economic consensus.”
Shvets and Leung say they don’t subscribe to the view that the state is the obstacle standing in the way of private sector vibrancy. Rather, they see the private sector as artificially propped up by the public sector through a range of monetary and fiscal support, with any resetting of the economy being neither politically, economically nor socially acceptable.
“In other words, because of profound technological, economic, and financial changes, we maintain the private sector will never be able to run again under its own steam and societies will insist on ever-greater public sector dominance, which would gradually spread from just trying to restart economies and reduce asset volatilities to effectively running ever-larger parts of economies,” say Shvets and Leung.
‘Burning rubber to rejoin highway traffic is not the same thing as overheating the engine’
They point out that the US, UK, Eurozone, and Japanese central banks will finish 2021 with combined assets of about US$27 trillion. But they do not see the current inflation spike as signifying a new era of high inflation like the 1970s.
Shvets and Leung endorse comments on inflation by Brad DeLong, professor of economics at Berkley. DeLong said; “Burning rubber to rejoin highway traffic is not the same thing as overheating the engine.”
This, they say, suggests what the US economy is experiencing is broadly equivalent to a driver suddenly accelerating the car, leaving ‘inflationary’ skid marks on the asphalt, which is not the same as overheating the engine. While DeLong was discussing the US, they argue his comment also runs true for most other economies including the Eurozone, Japan, and China.
“Essentially what he tried to do is to differentiate between the impact of rapid acceleration against the backdrop of significant supply disruptions and a far more insidious case of long-term overheating, when pricing power consistently shifts towards providers of labour and certain resources. As we have frequently discussed, there is no doubt that over the last 18 months, demand and supply curves were not able to move in tandem.”
“The state-sponsored support for income resulted in much swifter and more powerful recovery, with most economies regaining their pre-Covid GDP levels by mid-to-late 2021. However, persistent disruptions and choke points, as well as lack of investment and occasional hoarding, have all contributed to an exceptionally complex environment,” say Shvets and Leung.
“Essentially, while demand had recovered, supply has thus far not been able to catch up, mostly in the goods area. At the same time, there were other uncertainties facing supply, from port closures to geopolitics, especially in energy, that aggravated supply bottlenecks and resulted in even higher than otherwise prices.”
This, however, is different from arguing the world faces a persistently high inflationary climate, or that this would lead to an un-anchoring of inflationary expectations, like in the late 1960s and 1970s. Shvets and Leung see significant and profound differences between today’s environment and the 1970s.
“We are significantly more leveraged and financialized. Whereas in the 1960s-70s, debt to GDP globally was not much more than 1x-1.5x, today the global debt burden exceeds 4x. Indeed, even these massive numbers understate the real degree of financialization, which on our estimates could be between 5x-10x the global economy, with financial assets alone approaching US$500 trillion, and that is after counting derivative transactions on a net rather than gross basis. Financialization and leveraging are inherently disinflationary, and although inflation is one of the solutions to an excessive debt burden, it is almost impossible to ignite unless one is prepared to destroy the economy à la Zimbabwe. Instead, one gets a steadily eroding velocity of money, and hence, declining marginal utility of both monetary and fiscal policies.”
‘It is hard to maintain inflation if both corporates and labour are losing pricing power’
They also argue we live in an age of innovation with much more limited inventiveness, whereas the 1950s to 1970s was an age of inventiveness and much more constrained innovation.
“As a result, technology is now rapidly replacing products, undermining the value of brands while disintermediating corporates from their products and distribution systems. In the 1960s and 70s, corporates enjoyed a strong pricing power. Today, corporates are losing pricing power, and while there are sectors that seem to regain it, this is only a temporary phenomenon,” Shvets and Leung say.
“Similarly, while in the 1960s labour had strong pricing power, buttressed by high levels of unionization, in the US, unions commanded around one-third of the labour force, and in many other countries, such as the UK, Sweden or Australia, this ratio was as high as 60% to 80%, today unionization is low, in most countries closer to 10% to 15%, and labour is no longer the key productivity driver and has been losing marginal pricing power for two decades.”
“While it is true that Covid-19 has returned some power back to labour, we view this as more of a temporary event rather than a reversal of a negative long-term trend. It is hard to maintain inflation if both corporates and labour are losing pricing power.”
Young people ‘must be encouraged to continue borrowing and consuming at an ever-faster pace’
The Macquarie Capital analysts also argue that we are now living in a world of radically different demographics and wealth inequalities. And a legacy of the Information Age and deep financialisation is that wealth inequality is well imbedded.
“Not only are most more developed economies, including some emerging markets like China, Korea, Taiwan, Thailand etc ageing rapidly, but in addition, what normally would have been a post retirement inflationary drawdown of savings is now offset by older cohorts accumulating assets at a faster pace than they can consume and what is realistically needed for their retirement.”
“At the other extreme, younger cohorts and the bottom 50% to 60% of wealth pyramid have almost no assets. The top 1% to 10% own pretty much all assets, and the bottom of the pyramid as well as younger cohorts effectively represent the liability side of the balance sheet and must be encouraged to continue borrowing and consuming at an ever-faster pace,” Shvets and Leung say.
“At the same time, the ‘middle’ – between the top 10% and bottom…