Will secular stagnation bring down investment? The analysis by Stephen Dover, Chief Market Strategist and Head of Franklin Templeton Institute
Today's high inflation stems from severe supply-triggered shocks and disruptions to supply chains, coupled with large but temporary increases in spending.
Focusing on inflation, the longer-term factors affecting growth, prices and interest rates can be overlooked. With rising inflation and record drop in unemployment, discussions of "secular stagnation" have faded into the background over the past 18 months. However, today's high inflation stems from severe supply-side shocks (war, sanctions) and disruptions to supply chains (due to the pandemic), coupled with large but temporary increases in spending (fiscal stimulus, pent-up demand after the end of the pandemic). In light of these factors, the centrality of inflation, while justified by its acceleration and magnitude, could nevertheless divert attention from the longer-term factors affecting growth, prices and interest rates. In short, secular stagnation may still be the driving force affecting asset value evolution over the long term.
What is secular stagnation?
Secular stagnation is a prolonged period of chronic underinvestment in productive enterprises (investments in plants, equipment and new technologies) in relation to the level of savings in the economy. Secular stagnation leads to both a lower trend growth rate, as supply tends to slow down, and a shortage of demand, as excess saving implies a shortage of spending in the economy. As a result, the economy tends to produce underemployment, low inflation, and very low real and nominal interest rates.
A closer look can reveal worrying signs that confirm secular stagnation as a credible hallmark of general economic trends. For example, since the 1970s, gross fixed investment as a percentage of gross domestic product (GDP) – a measure of total investment spending in the economy – has been declining in advanced economies (i.e. the United States, Germany and Japan) and despite the partial recovery that took place in the last decade, they remain below the average investment rates recorded in the 1980s, 1990s and early 2000s. century, investment rates peaked nearly a decade ago and have gradually declined since then. The world is certainly not experiencing a capital spending exploit.
Indeed, in large swaths of the global economy – and perhaps also in China – there is a weakness in capital formation.
Why is investment spending relatively low?
The decline in capital expenditure appears incomprehensible to many. After all, we live in a world of extraordinary inventions and innovations. Furthermore, in the 21st century, in many advanced economies (especially in the United States) the profitability of companies reached levels never seen in the second postwar period (think of the ratio between profits and GDP). Are you certain that innovation and profits should stimulate capital spending? Maybe it isn't. Much of the innovation that amazes us today is aimed at consumption (think video streaming services, social media, games or smartphone applications), for speculative purposes (for example, cryptocurrencies) or does not improve in a way the efficiency of our daily activities is substantial (alternative energy, battery-powered cars). These inventions may please us, occupy our minds, make our hearts beat faster, or make us feel better about the planet, but they don't allow the masses to produce more with less – the essence of productive investment.
Furthermore, high profits may partly reflect greater concentration of industry, and not the production of higher-value goods and services. Among other things, technology enables companies in the IT, consumer discretionary and other key sectors to create monopolies or oligopolies protected by high barriers to entry. Instead of stimulating new investments, the presence of market power discourages them. Furthermore, as Alvin Hansen, who coined the term secular stagnation in the late 1930s * noted, low rates of business investment spending relative to savings can be determined by demographics (stagnant or declining population growth, peak participation to the workforce), income inequality (which leads to high savings on the part of the very rich and limited demand on the part of those who live on the margins) and high levels of indebtedness (which limit the ability and willingness to borrow and spend). Secular stagnation could resurface for another reason as well: the need to contain and ultimately reduce the mountains of public debt created during the pandemic, which implies higher taxes and fewer public services over the next decade. This ultimately implies a further brake on the total expenditure of the economy.
What are the implications for growth?
If secular stagnation remains the long-term key to understanding the world economy, global growth will slow down to a weaker trend growth rate.
As we have seen, the key drivers of trend growth – the expansion of the workforce, the rate of business investment, the pace of technological change – all appear to be in trouble.
For a few decades, for example, US labor growth has slowed as the positive sprint resulting from female participation and the baby boom generation fades and sometimes reverses its trend. Capital expenditures and innovation, as noted above, fail to bridge the gap. Furthermore, the slowdown and possible reversal of the globalization process could erode business investment spending and growth. Despite negative judgments, postwar globalization made economies more efficient and productive.
Trade is positive-sum. As supply chains are shortened and, in some cases, re-internalized, global economic activity will be adversely affected. The same goes for immigration. When borders are sealed and labor mobility is limited, economic activity is damaged over time.
What are the implications for monetary policy?
Secular stagnation implies a very low or even negative equilibrium real interest rate. In fact, to achieve full employment, the financial burdens must be low enough to stimulate business investment which – otherwise – could fail due to negative demographic dynamics, lack of innovation or the general perception of a declining future. The Federal Reserve and other central banks are raising interest rates to reduce current high inflation rates, but they cannot completely ignore the repercussions of very low long-run equilibrium interest rates. Slowing demand and curbing the surge in inflation is needed today, but an excessive correction could do serious damage. It is increasingly believed that the interest rate needed to slow growth and reduce inflation could be much lower than a federal funds rate of 3.5% -4.0%. In my opinion, a rate hike up to these levels could be excessive.
What are the implications for capital markets?
If continued, secular stagnation presents investors with significant challenges, many of which have already been known over the past decade. After the recent jump, interest rates on risk-free assets such as US Treasuries are likely to return to much lower levels and, as a result, again create challenges for Eastern income investors. Low GDP growth is also holding back earnings. Furthermore, if the share of profits remains high in relation to GDP, the political pressures stemming from income and wealth inequality will only increase. Growth styles that favor the relatively few companies capable of sustaining high earnings over time (even through the power of a monopoly or oligopoly) seem set to overcome once again the value and cyclical styles that offer fewer profit opportunities in a world of secular stagnation. Finally, low interest rates could again spur unproductive speculation in the usual areas, such as real estate or cryptocurrency markets, or in new ones designed to capture the appeal of high yields. This conclusion – that secular stagnation drives a focus on longer duration assets – may surprise some but highlights the constant push and pull that drives economic forces and capital markets.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/stagnazione-secolare/ on Sun, 02 Oct 2022 06:04:30 +0000.