An Alternate Reality
Imagine you lived your life as a passenger on a ship. The ship is managed in two ways. Direction and planning is controlled by the Captain as a representative of the passengers and the speed of the ship is controlled autonomously by the Engine Controller. The ship has a dubious safety record, having experienced an accident of varying severity about once every seven years. However, the thrill and enjoyment passengers get when the ship sails freely on the open ocean allows passengers to forget about these recurrent safety issues. Additionally, in the past the ship has managed to avoid total disaster by being well requisitioned with Life Boats which do their best work in turbulent waters.
In the past when safety incidents arose, the Captain would almost always put Life Boats Out, keeping passengers safe until calmer waters prevail. The ship's Engine Controller would also work hard through this period, providing Extra Fuel to all vessels. When comfortable, passengers would then clamber back aboard the rebuilt ship and once settled the Captain would then order a Hauling in of Life Boats. The Engine Controller during periods of calm remains focussed on Replenishing Fuel supplies and keeping the ship at a sustainably safe speed. In the last ten years the ship has updated its P.A. System giving passengers greater ability to be communicated to by other ships and passengers. The most popular P.A. announcers tended to be those that focussed on any negatives arising from the Captain's ongoing management.
About six years ago the ship underwent some pretty significant safety scares in very turbulent water. As is expected the Captain used most of the ship's Life Boats to secure the safety of its passengers. The Engine Controller also responded quickly by providing excess fuel to the life boats to help ride out the choppy weather for longer. This safety scare left some long lasting damage to the main ship and it has taken a change in Captain to get the ship back in shape and towards relatively safer waters. Although there is still a bit of swell around, about a year ago this new Captain decided that it was time to begin Hauling Life Boats back up on to the ship. Hauling in Life Boats requires some extra work from passengers, making their time on the ship a little more... taxing. Due to the P.A System now vocally jumping on any sign of passenger discomfort, the Captain is re-considering the decision to Haul in Life Boats in a bid to not cause passenger discomfort.
Moving forward to today, the Captain, concerned about being perceived as unfair in the eyes of P.A. System announcers, formally opted-out from any real passenger discomfort earlier this month. Unfortunately for the Engine Controller there remains some serious safety concerns on board the ship. With the Captain now without any real means of securing its passengers in the event of further rough waters. The Engine Controller is now using almost all its excess fuel to maintain the ships speed in the hope of riding out turbulent waters. With negligible additional fuel capacity and no life boats left for the Captain to deploy, should serious turbulence arise, neither Captain nor Engine Controller will be able to help passengers. If the ship were to sink, only the strongest swimmers will survive.
The above article is analogously written to emphasise the risks associated with our current economic state of affairs. The corresponding players between our economy and the above story are outlined in the key below.
- The Ship - Economy
- Water and weather - Economic conditions
- Passenger - Market participants (individuals and businesses)
- The Captain - Government
- The Engine Controller - Central banks
- Life Boats - Fiscal policy
- P.A. System - Media scrutiny
- Life Boats Out - Expansionary fiscal policy (increase government spending/lower taxes i.e. running deficits)
- Haul in Life Boats - Contractionary fiscal policy (reducing spending/higher taxes i.e. running surpluses)
- Extra Fuel - Expansionary monetary policy (lowering official cash rate)
- Replenishing fuel stocks - Contractionary monetary policy (raising official cash rates)
- Strong Swimmers - Quality companies and defensively positioned investors
It is nearly seven years since the last major economic downturn and we are still reeling from the legacy of the Global Financial Crisis (GFC). Governments that drastically increased spending to soften the downturns of the GFC have not shown the political fortitude to make the tough decisions necessary to re-stock their fiscal arsenal. Stubbornly high government debt, greatly reducing fiscal stimulus opportunities and stubbornly low inflation forcing central banks to keep cash rates at record lows, provide limited scope to engage in offsetting stimulus activities when the next economic downturn occurs.
Off the back of continued easy money via quantitative easing and sustained low cash yields, asset prices have boomed undeservedly against their fundamentals. A market correction occurring has stacked the possibility of an economic downturn (although predicting the catalyst and timing of a correction is an unknown). The current economic conditions are akin to a boat a drift on a turbulent ocean nearly out of fuel and without any life-boats. We can only hope that the weather doesn't turn sour any time soon. Governments now more than ever need to demonstrate the fiscal fortitude necessary to introduce structural changes (like increasing retirement age) and/or quickly restock their fiscal stimulus capacity.