“Trying to understand what the global economy has in store is something that can be very difficult for all of us. The global economy has always been a very complex animal, and although there’s a lot of research and a lot of data available today, I’m not sure that most people understand it any better now than they did hundreds of years ago. There was a piece of research we came across recently that showed of 36,000 registered economists in the world, only twenty of those people actually managed to predict the biggest single global economic event of our lifetimes, which was the financial crisis of 2008. All the others simply didn’t see it coming.”
At MBMG we have been doing some research as to why only 20 people managed to predict this, whereas 36,000 simply did not see it coming at all, and one factor that has emerged is that the people who seem to have the best understanding are the ones who are able to look at a very big-picture take on the economy and actually try and understand exactly where the economy is in context.
As long term readers of this column know, MBMG has long believed that the economy is cyclical and that there are four main aspects or seasons, as we call them, to that cyclicality. We see it almost as a western type year with Spring and Summer followed by Autumn and Winter. If you look at the current cycle, we think that the last Spring cycle started in 1949 when the Great Depression ended, and at that point the Dow Jones Industrial index was at about 181 points. We started to see growth; we started to see job creation; we started to see trade, and that ran for a period of probably about 17 years up until around 1966. That is when Spring ended and Summer started, and the difference between them was that economic Summer is a period when we get much more leverage, much more borrowing and people are feeling good because there is so much trade, and that brings a lot of growth and also debt into the economy. The debt fuels the growth but it also fuels inflation, and so that tends to be a period that is good for commodities and real estate, but it causes head winds and problems for bond markets and equity markets because interest rates generally tend to get raised.
We think that phase lasted until the end of the Seventies, and the Dow Jones, which had risen from 181 to 968 points in the Spring cycle pretty well went nowhere and actually fell back to about 838 by 1980. The price of gold, which in the Spring cycle had not really gone anywhere (it had moved from $31/32 to $35 an ounce), suddenly shot up to $850 an ounce in the Summer cycle. At the end of Summer, we got high interest rates and high inflation, and that tends to lead to what we call the Autumn phase of the cycle, which is where we see disinflation coming in. That is a slowdown in the inflation rate and a slowdown in the rate of leverage. It is a very healthy period for stocks, but it is quite a bad period for precious metals and commodities, so from 1980 to around 2000, we saw the Dow Jones go from 838 points up to almost 12,000 points, which is a huge leap, but we saw the price of gold fall back from $850 to $250 an ounce.
Since 2000, we have been fairly sure that the western world is in what we call an economic Winter. This is a really deflationary time and a very difficult time for most asset classes. Certainly for stocks and real estate it is not very positive, and the deflationary impact can sometimes be pretty negative for commodities as well. We think that is the phase of the cycle that the western world is in right now, but what we are not sure about is how much longer this is going to last.
We think ASEAN economies entered the economic Winter, the deflationary part of the cycle, in around 1996/97, and we think that they took a lot of the right measures. They actually dealt with a lot of the debt problems, and we think South East Asia is actually exiting the Winter cycle and will soon start a whole new Spring cycle and take off and do really well again, but we think the western world is still somewhere in the Winter cycle. Trying to understand what the global economy is going to do really depends on how close you think we are to the end of Winter and the start of Spring, or whether you think we have still got some long dark winter days ahead for the global economy.
One thing that we are very aware of is that sometimes, even in the middle of Winter, you can get one or two really nice days and you start to think that maybe Spring is starting, but then all of a sudden you find yourself out without a coat and you get drenched with rain and freezing cold. So we are a little bit worried about the effect of the QE policies the US and UK governments have been adopting and the bail-ins and bail-outs the European governments have been adopting. We are concerned that what they are doing is hiding the symptoms without really dealing with the problems or curing the disease and, therefore, it might look like we may be further ahead with the recovery and further through the Winter period and getting into Spring than we really are.
There is a very good precedent for that historically in 1931, when everyone celebrated the end of the Great Depression in the States and in the western world, and then in 1932, they had what is called the ‘Tragic Year’ when they actually found out that it really was every bit as bad, if not actually far worse, than they had anticipated. I think there’s a little bit of a note of caution that people should be sounding about the western economies. We do not really understand how we could be coming out of the Winter cycle when there is still so much of a debt burden still hanging around those economies, and we think that they have still got a lot of work to do. Thus, we are concerned about the impact that those economies are going to have on the global economy moving forwards.
We are still concerned that the Winter for western economies looks like dragging until the end of the decade. Japanese-style lost decades or 1930/40s Great Depressions are recurrent phenomena throughout history - and generally they are made far worse by the involvement of megalomaniac politicians like Hoover, Roosevelt, Merkel and Sarkozy who cast themselves in the role of an economic King Canute, hoping to stay the economic tide simply by commanding it, but doomed to embody the inability of man to hold back the forces of (economic) nature.
“You say I can do anything,” Canute said to the courtiers. “Very well, I who am king and the lord of the ocean now command these rising waters to go back and not dare wet my feet.” But the tide was disobedient and steadily rose and rose, until the feet of the king were in the water. Turning to his courtiers, Canute said: “Learn how feeble is the power of earthly kings. None is worthy the name of King but He whom heaven and earth and sea obey.”
It can only be hoped that those in charge will learn from history.