There are adjustments in the socio-political balance within a country that are ultimately more important for savers than the probable course of the economy.
These power shifts between capital and labor are usually slow, but even when they are slow, they are the dominant factor driving investment returns.
It’s easy to forget the importance of this structural shift, as most of the financial commentary bombarded every day focuses on the near-term issues that are part of the chain and woof of the business cycle.
Last week, one might have concluded that the only thing that investors care about is what central bankers report at their annual meeting in Jackson Hole, Wyoming.
As papers have been read and pronouncements made, the great shift leading to the firing of central bankers continues largely unnoticed. Central bankers have been, and will be, redundant because their power is the main casualty when the labor-capital balance shifts.
So what evidence is there of this increasing layoffs of central bankers and what might this mean for savers?
The age when it was thought best to let markets set prices is passing, and the age when governments set prices is coming. This isn’t the first time we’ve seen a move to an entirely different method of pricing.
After the combined horrors of the Great Depression and World War II, voters were poised to try to build a world in which the very visible hand of government replaced Adam Smith’s “invisible hand” in allocating resources. The move towards this seemingly fairer system of resource allocation was aimed at reducing wealth inequality and also at increasing overall wealth.
This new approach to resource allocation reduced inequality and improved the lives of most citizens for many years, fueled by a boom in post-war reconstruction, the rise of consumer society and access to consumer debt. This new balance between capital and labor was taken for granted, but of course it ended. It ended because the use of government dictates to determine resource allocation eventually led to a world where resources were so poorly allocated that inflation and unemployment were high at the same time.
This was a previously unknown phenomenon and a new word, stagflation, had to be invented to describe it. There was a downside to using the visible hand, but it only took voters a while to realize it. It was voters who rebelled against the combined misery of high inflation and high unemployment. To solve the problem, they elected politicians who set about restoring the power of markets to allocate resources and a new long cycle began.
The socio-economic price of this shift towards more markets and less government has been incredibly painful in the short run, and while the lot of many has then improved significantly, there has also been a significant growth in wealth inequality. A long cycle of more government and fewer markets, spanning from the election of FDR to the election of Ronald Reagan, was followed by a long cycle in which politicians from almost every party supported policies that strengthened the power of markets at the expense of government .
This long cycle, which lasted from the early 1980s to 2020, has also now come to an end. Investors who fail to recognize and adapt to this shift in power risk seeing the purchasing power of their savings eroded significantly. To look at Jackson Hole and central bankers is to look at a tantalizing mirage of how things used to be. It’s always comforting to think that things will still work the way they always have, but it’s also incredibly dangerous.
Look beyond the focus of the financial pages to the future path of interest rates and you will see the real story of how a new balance between capital and labor is unfolding. Governments around the world step in to suspend market forces and dictate prices. This is evident from the government raising the minimum wage, imposing rent controls, canceling student debt or attempting to control the price consumers pay for energy.
As regular readers of this column will know, governments also actively use their regulatory powers to control the price of their own debt. They also affect the amount and allocation of bank credit, allocating resources by dictate rather than price. A government that can determine the interest rates at which it borrows and how the proceeds are used to distort markets is a government that has stripped central bankers of their power.
How likely is it that a central banker, attempting to move an economy primarily with the leverage of short-term interest rates, can counteract government pricing to maintain the price stability that is their mandate?
The financial pages focus on the Jackson Hole meeting and show that investors, whether professionals or amateurs, have failed to notice that the power to influence prices has passed from the central bank to the government. As a citizen, you may welcome such government intervention, but as a saver, you need to understand the implications – both positive and negative.
The result of major government interventions in resource allocation can trigger a major sugar rush for an economy. In particular, it can lead to a huge investment boom as more investment is the answer to many of the crises governments are trying to solve – the energy crisis, the climate crisis, the defense crisis, the crisis of a cold war with China. Since the goal of such state intervention is also to blow away debt, there are also debtors, be they households or companies, who can also benefit in the early stages of this structural change.
An investment portfolio can benefit from the consequences of the visible hand movement of government resource allocation. There are many companies that will benefit from the great investment boom that is about to take place. There are many companies whose profits have been squeezed by Chinese competition that will see higher levels of profitability as the Cold War with China intensifies.
There are also highly indebted companies where the value of their equity increases when the real value of their debt decreases. Finding these companies is not easy and is best left to a professional investor who understands the new equilibrium that is developing in society and who has the courage to ignore the noise and drama of developments in the business cycle.
Next time you read The Star, pay attention to how many new initiatives are emerging that are leading to the government either setting or influencing prices. The greater the government intervention, the greater the distortion of corporate profits. While this could result in lower corporate earnings overall, there is also likely to be a significant redistribution of corporate earnings.
The assessment of these distribution forces will be much more important for every investor than the assessment of what the central bankers have in store for us in terms of the level of short-term interest rates. While most companies are likely to be losers in this major shift from market pricing to government pricing, some stand to gain.
It is highly unlikely that the companies that dominate the leading stock market indices will be able to benefit from this shift as they have been the winners of the long switch from government to market pricing.
A social structural change requires a structural change in the investment portfolio. Our last two long cycles lasted about 40 years. Even those who can successfully gauge the twists and turns of the business cycle now risk winning all the battles and still losing the war if they don’t adapt to our new long cycle.
Russell Napier is an asset allocation advisor to institutional investors. He’s a freelance columnist for the star. Reach him via email: [email protected]
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