For more than a decade, central banks — particularly the US Federal Reserve and European Central Bank — have responded to major crises with the same playbook: the creation of more and more liquidity and near-zero, even negative, interest rates. This is evidenced by the huge, and continuous, rise in broad money — defined as the most inclusive amount of money circulating in the economy — as a percentage of GDP, after the 2007/08 global financial crisis and, again, since the Covid-19 outbreak (see Chart 1).
This article is the third and final (for now) instalment on our series related to the exponential speed at which money is being printed, enabled, to a large extent, by the demise of the Bretton Woods system. The US abandoned Bretton Woods in 1971 when it could no longer balance its budget deficit, owing to rapidly rising military spending for the Vietnam War. We wrote about this a couple of weeks ago. The resulting transition to a pure fiat money-based system — one backed by no real asset but only trust — released governments and central banks from the strictures of a gold standard.
And as we have previously explained, the US then successfully positioned itself as the biggest beneficiary of this new international monetary order — as the world reserve currency and primary medium of exchange. So much so that, the much-vaunted US exceptionalism was built, in part, on the savings of the poorer, developing world. To ensure stability of their own currencies and economies, emerging countries are compelled to maintain a major portion of their foreign reserves (hardearned export profits) in US dollar-denominated assets, primarily in US Treasuries — at the expense of reinvesting domestically. This made certain ever-rising demand for US Treasuries, which in turn drove borrowing costs lower and lower — funding US economic growth and raising American standards of living. (We believe there are better options for countries than simply investing in negative real yield US debts. We suggested some alternatives previously and will revisit this subject in the future.)
We understand that the ability to print money and the creation of credit through the world banking system was necessary — indeed, crucial — in driving global economic growth, well beyond what would have been possible under a gold standard. But we think there are limits, beyond which it so disproportionately penalises the masses and increasingly enriches the elites that the resulting income-wealth divide and inequality is so deep that it fosters unrest, which could, in the worst-case scenario, lead to a breakdown of society. Are we nearing those limits?
We know that much of the excess liquidity created over the past decade, and especially since the pandemic, has gone into financial assets, as evidenced by widespread speculative activities (even mania) and eye-popping gains. US stocks enjoyed the longest bull market in history, in the aftermath of the global financial crisis, before ending abruptly with the pandemic in March 2020. Shortly thereafter, however, prices for nearly all asset classes surged anew, in concert, as yet more liquidity was created. All this has been extensively articulated and widely publicised.
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Clearly, rising asset prices disproportionately benefit the rich, which own-control the majority of the world’s real and financial assets. According to Oxfam, as at January 2022, world billionaires’ wealth had risen some US$5 trillion (RM22 trillion) since the pandemic, the biggest surge on record — even as millions of people suffered economic hardship, many falling into poverty induced by stringent lockdown measures. There is no doubt that the pandemic has further widened the chasm between the world’s rich and poor.
But the fact is, inequality has been rising for far longer — even decades, well before the global financial crisis and Covid-19 pandemic. Ironically, we think this is due, in large part, to the very same exponential growth in financial assets that has also helped drive the global economy.
Globally, liquidity has grown rapidly since the 1970s, freed from the shackles of the gold standard under Bretton Woods. Total assets for the global financial sector nearly quadrupled in less than three decades — from roughly the equivalent of the size of world GDP in 1980 to 3.8 times larger at the eve of the global financial crisis. Since then, total financial assets have expanded further, to some 5.5 times global output today (see Chart 2).
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As we noted in our previous articles, the chief culprit is the US, which has been running larger and larger deficits over the years. Thanks to the US dollar hegemony, it is able to print money freely to fund this growing deficit without suffering negative consequences — even when this money printing is, increasingly, being underwritten by the Fed.
Yes, the US as a whole has benefited greatly from the resulting secular decline in interest rates. And, yes, US per capita income and living standards have risen across the board. Unfortunately, this massive wealth creation was not distributed equally and is, in fact, increasingly lopsided. None have profited as greatly as businesses, which individually are the largest borrowers in the economy, and their owners.
Cheaper and cheaper borrowings translate into a falling cost of capital and, therefore, rising profits for US corporates. Businesses grew in size, leading to industry consolidations. Increased market concentration for Big Business, inevitably, gave them more and more bargaining power vis-à-vis workers. Unionisation declined and growth in wages slowed, and even stagnated for some sectors.
Tellingly, labour productivity and compensation rose, more or less in tandem, until the 1970s. Since then, real hourly compensations for workers (wages) has increasingly lagged productivity gains — the difference of which now accrues to asset-capital owners.
This divergence — the widening gap between rich asset-capital owners and the working class — has only accelerated since the 1990s because of globalisation. It is unsurprising, given the relative “friction” of labour and capital. Capital is significantly more mobile; it can quickly and easily be deployed to the promise of highest returns. Conversely, labour is, by and large, constrained by international borders. Investments flowed to emerging countries where labour is cheap — boosting profits-returns for capital owners — while depressing wages domestically. Offshoring led to the hollowing-out in US manufacturing. Unless labour is as frictionless as capital — that is, labour can move as easily as capital — globalisation benefits will accrue largely to those few with capital, not labour (the people at large).
This productivity-wage growth disparity is then further compounded by the increasing application of, and advancements in, technology, which spurred productivity gains — and profits — but not worker compensations (see Chart 3). As a result, wages and salaries as a percentage of gross domestic income fell into a secular decline (see Chart 4).
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Cumulative income growth for the top 1% of earners has far outpaced that of the bottom 90%. As such, their share of income, relative to the bottom 90%, has been trending broadly for the past four decades (see Chart 5).
There is no question that free-market capitalism has created unparalleled wealth, opportunities and innovation that drove world economic growth and overall standards of living. Yet, unfettered capitalism is also the scourge of rising inequality and inequity. Clearly, the masses are getting a smaller and smaller slice of the pie while a correspondingly larger and larger share goes to the privileged few. Even though the overall pie is still growing, the reality is that satisfaction and happiness are relative concepts, not absolute. As this growing income-wealth divide becomes increasingly evident to all, it is fuelling widespread discontent.
The issue of inequality must be addressed at some point, sooner rather than later, whether through populist measures or more disruptive revolutions. Perhaps the current trend in deglobalisation or, at least slowbalisation, will help reverse some of the effects. Protectionism — both tariff and non-tariff barriers — is already on the rise across Europe and in the US. Prolonged disruptions due to the pandemic and Russia- Ukraine war have further exposed fault lines in complicated global supply chains. At the same time, intensifying strategic competition between the US and China is leading to a more polarised world. Supply security concerns for critical goods and services will reverse globalisation — to a certain extent — and drive the shift towards greater localisation and regionalisation, enabled by the next generation of technology advancements such as mass customisation.
The Global Portfolio closed higher for the week ended May 25, up 0.5%. Shares in CrowdStrike Holdings (+5.9%) recovered some lost ground from its recent sell-off. Other notable gainers were Postal Savings Bank of China Co (+3.5%) and Microsoft Corp (+3.3%). At the other end, Alibaba Group Holding (-8.5%) and Yihai International Holding (-2%) were the top losers. We disposed of all our holdings in Amazon.com and reinvested the proceeds into the iShares 20+ Year Treasury Bond ETF. We will write more on this switch next week. Last week’s gains lifted total portfolio returns to 25% since inception. The MSCI World Net Return Index is up 38.6% over the same period.
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