Is There A New Global Consensus About Cheating Investors To Reboot Employment?

By Daniel R. Amerman, CFA

If a new collaborative document had recently been released in which some of the world's most influential economists were urging the nations of the world to force negative returns on savers as a long-term matter of policy – might this be of importance to you?

What if many of the world's leading economists believed that the path for the economic future could be one that directly contradicts the assumptions upon which traditional stock and bond investing is based? Might that be an important development to consider as you decide how to invest your retirement assets?

Neither of the above questions are hypothetical, unfortunately, but in fact relate to the contents of an extraordinary e-book titled, "Secular Stagnation:  Facts, Causes and Cures", edited by Coen Teulings and Richard Baldwin.  In this publication, a number of prominent economists discuss a possible state of "secular stagnation" (with "secular" in economics jargon meaning the long term – typically at least 10 years and more).

As presented in this book, we are now six years into a period of economic stagnation, and there are serious concerns that we are just getting started.  Indeed there is the fear that this may be the beginning of a "new normal", in which we never do reach full employment or fully reboot economic growth again, but instead are stuck in a world of low economic growth, very low interest rates and persistent high unemployment rates.

The Urgent Need To Take Wealth From Savers And Investors

Published by the Centre for Economic Policy Research (CEPR), the document is remarkable in both its purpose and its contributors.  That is, the explicitly-stated purpose is not to discuss academic theory, but rather to put information into the hands of policy makers so that actions can be taken.  Contributors to the book include Lawrence Summers and Paul Krugman, as well as numerous economists from such institutions as Harvard, MIT, Oxford, Cambridge, the International Monetary Fund and also the Principal Economist for the Executive Board of the European Central Bank.

While there are a diversity of views expressed on some matters, there are other areas in which the contributors are in strong consensus.

And the first area of "strong consensus" is the following, from the top of (document) page 2:

"First, a workable definition of secular stagnation is that negative real interest rates are needed to equate savings and investment with full employment."

Now what does "negative real interest rates" mean? Quite simply it means that interest rates are held down to beneath the rate of inflation. Which further means that the purchasing power of saver wealth steadily erodes each year rather than growing and compounding.

The second part of this statement is also very important.

Across Europe in particular but also in the United States, when we get away from calculations for the "headline" unemployment rate and we look to full unemployment which includes people who haven't looked for some time (as covered here), there is a major problem with structural unemployment and underemployment, particularly among the young.

And in the opinion of this prominent group of economists from around the globe – with that opinion forming the basis of the very specific policy advice that they're giving to national governments – the best way for addressing these stubborn unemployment issues is through forcing negative real rates of returns onto savers and investors, potentially for year, after year, after year.

Now again, this is secular economic stagnation that is being discussed, meaning long term.

This then creates the astonishing situation where tens of millions of people continue to save and invest in the belief that they will be getting positive wealth creation through the compounding of interest income in their savings and investments – even while some of the globe's leading economists urge the world's governments to make sure that doesn't happen, because of the quite direct linkage they draw between negative real returns and the goal of rebooting employment.

Secular Stagnation And Stock Market Values

In very short form, the theoretical underpinnings for why it has been so widely recommended that all of us invest in stocks over the long-term is quite simply that investing in stocks is how we all participate in a growing economy.

Average dividend ratios are currently below 2%. That means therefore that the primary source of the compounding of real wealth – and the fundamental motivation for investing in stocks – effectively must come from economic growth driving price appreciation.

And with stock market levels at some of their highest points in history, this necessarily means that a great deal of economic growth has to occur, if these prices are to be justified.

Yet at the very same time, what is the rationale for this book? It is the question about whether the past applies anymore at all, or whether we have instead entered into a long term period of economic stagnation where growth either does not exist or it is greatly reduced.

And what does that mean for stock market investors?

If in fact these economists are correct, it means that the floor just dropped out from underneath the primary reason for long term investment in stocks.

The Dilemma For Savers And Investors

Does this mean that we know for sure that we face an environment of secular economic stagnation that will transform the investment world and quite possibly lead to long-term negative returns on an inflation-adjusted basis for both bonds and stocks?

I would suggest that we don't know that for certain at all – because if this elite group of economists were really that good, they would've called this whole current situation in the first place. But they didn't.

Leaving specific individuals out of it, as a group these leading economists failed to anticipate the damage that would be inflicted by the creation and subsequent collapse of the US stock bubble of the late 1990s; they then failed to see that lowering interest rates in the early 2000s in an attempt to contain the damage from the stock bubble would help to create a real estate bubble; they further failed to anticipate that a real estate bubble growing and then popping would contribute to – and help trigger – the global financial crisis that came to a head in 2008, and for a number of years afterwards they did not understand that years of economic stagnation rather than normal recovery would follow.

So the overall track record isn't exactly stellar, particularly when we take into account that some of these economists were the same ones who recommended the failed policies that helped create this toxic array of new problems in the first place.

Perhaps the real bottom line is that we face a deeply uncertain future.  It could be secular stagnation and a continuation of the path of recent years.  Or it could be eventual financial crisis and potential currency and economic meltdown.  Or it could be technological advances finding an alternative path out of secular stagnation, through the creation of prosperity.

Nonetheless, there is still enormous information value in this new book, which arguably is neither currently understood nor being taken into account by the great majority of investors on a global basis.

That is, when we consider the full implications of what is being discussed in the document, it goes to the very heart of what underlies modern financial theory – and effectively cuts the foundation out from beneath what is by far the most popular school of investment thought, which is that of traditional stock and bond-based financial planning.

Many of the world's savers and investors have been receiving near-zero interest rates for going on four years now – and we have a group of world-renowned economists recommending to their governments that this be continued on an indefinite basis.

Meanwhile, tens of millions of people continue to purchase stocks and invest in their retirement accounts on the basis that they expect the past to continue to repeat itself – even as these economists are suggesting that we many now be in a very different world than we were in the 20th century, and that our issues with very low economic growth rates may be continuing on an indefinite basis.

Now without future high rates of economic growth – all we're left with is a highly overvalued current stock market.

And there's no particular reason to believe that a strategy of pure precious metals investment will necessarily do well in this environment either, given that long term economic stagnation does not necessarily produce high rates of inflation or financial crisis.

And the longer the world carries on without financial crisis – then potentially the lower the current strong "insurance premium" component that is going into precious metals valuation, meaning ongoing likely negative returns in inflation-adjusted terms.

Unfortunately, then, "secular stagnation" would seem to destroy the rationale for all three of these traditional forms of investment whether we're talking about stocks, bonds or precious metals.

In light of this potential "new norm" of very low economic growth, high unemployment and near zero interest rates, the question must be asked:  

Okay, if the long term future does turn out to be economic stagnation, then what exactly do I do about it?

Wealth Flows and Currents Analysis

The following is a discussion of the above article within the framework of the "Flows & Currents of Wealth" system for financial and economic analysis, with references to particular chapters which discuss each flow of wealth in more detail (learn more here about a free book on the Currents of Wealth).

Wealth Outflows

Perhaps the most direct and easily seen wealth current is the one that steadily erodes bond holder and saver wealth. It also invalidates many of the assumptions in modern financial theory and conventional financial planning (Chapter Six). 

Current Central Bank strategies also create a secondary but still significant resulting wealth current which reduces the net worth of precious metals and stock investors (Chapters Two &Three).

Wealth Inflows

Of further crucial importance, these Central Bank-created currents also dramatically increase the effectiveness of "back door" methods for reducing government debts (Chapter Five).

That is, secular stagnation essentially offers a very attractive political cover, even as it serves two purposes: 

1. To attempt to boost employment, which may or may not be successful, but this objective will dominate the speeches and press releases.

2. To slash the costs of government liabilities and reduce government debt costs and levels.  And, unlike job creation, the resulting silent transfer of wealth from savers to governments is almost guaranteed of success.

Regardless of whether one believes governments have more than one agenda, however, what is certain is that the wealth outflow of "negative real interest rates" is taking wealth from global savers and investors on a wholesale basis, even as it creates a lucrative current of wealth inflows for banks and other institutional investors (Chapter Seven).

For individual investors who instead pursue a select group of non-traditional strategies, however, then the higher the degree of "negative real interest rates" and the longer they last, the greater and more stable the wealth inflows are likely to be (Chapter Eight).

Wealth Inflows & Outflows Conclusion

In the world of finance, the expression, "One person's loss is another person's gain" rings true more often than many people realize.

In the global effort to fight secular stagnation, the overwhelming majority of publicly released information concentrates solely on the goals of creating badly needed jobs and stimulating economic growth.

What is very rarely addressed is the resulting extraordinary damage to saver and retiree income on a global basis. And to the extent it's addressed at all, it is treated as sadly unavoidable "collateral damage".

What is never discussed are the extraordinary financial fringe benefits for heavily indebted governments and major global financial institutions, as a direct result of the chosen strategies for fighting unemployment. 

Indeed, most people may find it surprising that there is anyone who is benefitting financially from the efforts to fight secular stagnation, but as reviewed in the wealth outflows and inflows analysis above, there are some major financial beneficiaries of these policies.

The implications for individual investors so powerful that they are likely to determine retirement dates and lifestyles for millions of people, as those following traditional investment strategies must go up against an enormously powerful current of wealth that has been created as a matter of policy, potentially for many years to come.  To reverse this situation and turn fundamental outflows of wealth into inflows requires the utilization of non-conventional strategies.