Updated: May 19, 2022
As many will know from bitter experience, a crisis often has two stages. The first is the crisis itself, whether a natural disaster that wreaks havoc for many or, at a more intimate level, a car accident, or a house fire.
"Jobs lost on the high street are just one but visible example"
The second stage is the aftermath, in which one picks up the pieces, literally or metaphorically. The current crisis is no different, though we have yet to get through stage one. In light of what stage two might look like, as well as the various other structural forces, good and bad, that the world is undergoing, where might one put one’s money?
The Bank of England’s bloated balance sheet, as well as those of other central banks, are a stark sign that there has been something not quite right with the world for a little while now. Quantitative easing, the process which causes a central bank’s balance sheet to rapidly expand, is required when weakness in the economy or financial system become so pronounced that interest rates become useless as a policy tool. Broadly speaking, this has occurred only twice in the last hundred years: the 1930s; and since 2008. What has caused the recent weakness and, more importantly, will it continue?
An economy is an example of a non-linear complex adaptive system. In other words, it is hard to understand, let alone predict. Nevertheless, there are some key underlying trends that can be invoked as having played a role.
The first is technology. It is pretty clear that technological advances, notably the internet, have made life easier for many. But the process of creative destruction it has wrought has been so extreme that the widespread creation of new, higher paid, more satisfying jobs has struggled to keep pace with the destruction of old ones – jobs lost on the high street are just one but visible example.
The second is globalisation. The shift in manufacturing jobs to the developing world over the last few decades has been a double-edged sword. It has clearly been beneficial to those newly employed in factories in China or India, but more broadly it has brought problems. As with technology, the developed world has not been able to create more productive jobs to replace those lost.
The third is wealth and income inequality. A certain level of wealth and income inequality is desirable, meaning that offering financial incentives to the naturally able among us is in everyone’s interests. However, beyond a certain point it becomes counterproductive, even for those with outsized wealth and income – members of the 18th century French aristocracy might have wished they had been a little more proactive as they knelt on the guillotine.
Whether or not you agree that the above three factors have played a significant role in shaping the global economy in recent decades, you cannot argue with the symptoms – the persistent decline in interest rates since the early ’80s and, over the last 10 years, the need for massive central bank intervention across most of the developed world.
As for covid-19, stage one of the crisis is requiring governments and their central banks to support economies on a scale never before witnessed. Stage two will require more, given the damage that stage one continues to inflict.
Thus, whether because of the virus, or the aforementioned structural trends, substantial public sector support will likely be with us for a while. This could mean real interest rates, short and long, remaining negative for years to come, as was the case for much of the ’40s and ’50s, a period which in some ways should be seen as the aftermath of the ’30s.
In such an environment, cash sitting in the bank is going to continue to lose its value in real terms. It also means that longer term safe haven assets such as gilts can only produce positive real returns if yields continue to fall.
Gold and other precious metals should never, in my opinion, be thought of as investments, but as currencies that tend to more than hold their own when paper currencies are being debased.
They have acted both as currency as well as protected against debasement for millennia, though from time to time have been subject to confiscation as well as their own debasement when mixed with less valuable heavy metals such as lead. If you think these latter two risks are things of the past, and can see past the institutional derision hurled at so-called gold bugs, putting a sizeable portion of your cash allocation into a precious metals fund could well be a good move.
Published in What Investment
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.