Can investors still rely on economics in today’s world?

There’s no question global economies and markets have been under pressure in recent times. Australia has undergone crippling drought, bushfires and the COVID-19 pandemic, with other countries also experiencing similar pressures. The old mainstays of economic theory seem to no longer apply, opening a new world where investors may need to think differently to stay ahead. ETFS Capital founder and Chairman, Graham Tuckwell, recently spoke to Bill Evans, Chief Economist for Westpac, on the changing dynamics in this space.

The traditional view of monetary and fiscal policy

The textbook approach to monetary and fiscal policy ties heavily to interest rates. For Mr Evans, the challenges started long before the COVID-19 pandemic.

Mr Evans says, “the old model was that fiscal policy is slow-moving, don't move taxes too much, takes a long while to change government spending, so steady as she goes. The economic cycle is really dominated by monetary policy. So when things are heating up, you raise rates, when things are slowing down, you cut rates. And that was the model that we were pretty much used to, but then came the GFC, and interest rates collapsed.”

With negative interest rates in some countries, zero in the US and extreme lows in most nations, it is clear the model hasn’t worked as anticipated – lower rates have not re-stimulated growth in the way expected. Rates continued at lows in the decade following the GFC meaning that central banks entered the COVID-19 pandemic without their traditional tools to manage the crisis.

“We have to realise that monetary policy can’t do a lot more and we have to rely on fiscal policy to really drive the economic cycle. Now, the risk, of course, is that at some point down the track, what they’re saying now is that the risk of a debt crisis is not as great as the cost to the economy of lowering the deficit. As governments are boosting their debt, the IMF expects that global government debt will lift from 80% of GDP to over 110% of GDP in the next few years,” Mr Evans says.

He notes that at some point, government fiscal spending, and in turn, debt, will come into conflict with monetary policy causing pain points down the track. It is a challenge for governments and central banks alike, not just in terms of spending but also where to source the money from – internal money printing or overseas loans.

Building debt

Both options have different risks. In terms of money printing, Mr Tuckwell says, “there can’t just be an infinite fruit tree at the back of the garden of free money”.

This is a distinctly modern problem.

Mr Tuckwell points out that historically, the Romans and Greeks were able to cover their costs with their own production and still rise to run empires.

“The Greeks financed themselves early on by producing silver out of silver mines, just near Athens, which is how they had enough money to build the Parthenon etc. And then the Romans in the Punic Wars took over the Iberian Peninsula and that gave them access to Rio Tinto {river} and the silver, lead, and copper mines in the south and then the gold mines in the north,” he says.

In terms of overseas borrowing, Mr Evans says, “Overseas borrowings aren't so bad in their own right if you're issuing the money in your own currency. We've only ever seen one debt crisis where a country defaulted on bonds that were issued in their own currency, and that was Russia in the late '80s. Every other time, if you're sharing in your own currency, you're fine. You can just print your way out of the people that want to be repaid. The problem comes when you start borrowing in US dollars, and we've seen the Latin financial crisis, we've seen the Asian financial crisis. The smaller countries that play that game and find that people aren't prepared to fund them in their own currency, they're the ones that really risk the issues.”

He adds that Australia has been fortunate to fund its debt in Australian dollars and continues to benefit from resources demand, particularly iron ore for China, while the US benefits from having the ‘reserve currency’ allowing both economies to print and borrow rather than being forced to rely on just one option.

Winners and losers in the current market

In the challenging market context, investors may wonder where to put their money. In some cases, the answer may seem obvious.

Mr Tuckwell says, “Over 2003 to present, the Nasdaq has done brilliantly compared to the S&P, in other words, technology stocks have done well, but I think that's pretty obvious to everybody. Since 2003, gold has actually outperformed the equity market. So these little gold bars sitting there doing nothing, minding their own business, but being a discipline on financial markets, to some extent has outperformed the equity markets. It's only by a bit, but it's enough.”

Mr Tuckwell launched the world’s first gold-backed ETF, the ETFS Physical Gold (ASX:GOLD) in 2003 in Australia, which still trades today.

Similarly, Mr Evans says, “if we're looking at this long period of extraordinarily low-interest rates, I want to be in physical assets, particularly property and in particular residential property. For the next few years, central banks will be focused on restoring labour markets and jobs. And they'll be prepared to be a lot more patient with asset markets. When we reach that point where central banks lose patience with asset markets and they start to do something about it, then that’s when I want to go back into something that protects me against that sort of risk explosion, which would be gold.”

Both advocate that investors looking at equities should look at the themes and trends as part of deciding exposures. For example, in the COVID-era, Mr Evans says, “if we think about anything that people can do at home, technology, of course, has been a big winner, home appliances have been a big winner.” He also thinks activity in Asia, particularly China, will continue to be influential in the coming years.

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