Our Perspective.
Over the course of 2023 many investors misjudged the multiplier effects from fiscal policy and the benefits this brings from a liquidity perspective. The cherry on the cake was the long-awaited and much anticipated Fed-Pivot as the global economy benefitted from disinflation, robust labour markets, and continued upside surprises to consumption.
This month we ask, are the benefits from fiscal and monetary policy sustainable?
The benefit from monetary policy is really the marginal change in interest rates – or more specifically: the cost-of-capital – relative to the absolute level, and the resulting benefits this has on credit creation. However, one needs to also consider the incremental Capital-Output-Ratio which highlights the number of units of investment (think debt!) required to generate one unit of GDP growth. Chart 1 highlights the level for the U.S, China and South Korea. The point is, an enormous amount of debt is needed and the cost of this debt is paramount. At prevailing market rates, further credit creation is problematic at all levels: corporate, government and household debt.
From a fiscal perspective, monetary policy has knock on effects given the amount of debt in the system, the cost of debt and already large deficits. An even bigger concern is Net National Saving. Net Saving (different from savings) comprises three elements: private saving (from households and businesses), foreign saving (inverse of the current account), and government saving (the inverse of government spending). Adequate saving is essential for the sustained growth of a country’s capital stock. It is crucial for budget deficits to be reduced during economic expansions so that when bad times hit, we are able to fight back. Typically, when a downturn occurs, private saving declines whilst government dissaving increases due to a surge in spending and a drop in tax collections.
Chart 2 highlights that Net National Saving in the US has gone negative only twice before in history, during the GFC and Covid. Both of these were driven by surges in government dissaving. The fact that we are already at negative levels today is a significant concern and will not only impair economic growth well after the Fed start to cut policy rates, but our ability to support a recovery.
Tread cautiously!
To view our graphs and data tables, please download the full article above.
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