(September 11, 2013) — Investors have been told to not be fooled by recent improvements in the economy, as structural reasons for why GDP growth will be low for some time remain.
Speaking at a 24 Asset Management bond conference on September 10, Jim Reid, global head of fundamental credit strategy at Deutsche Bank, said too many investors were being taken in by the growth story on both sides of the Atlantic. He warned that many were ignoring the fact that nominal GDP growth is still worryingly low.
“Nominal GDP growth is important because of the level of debt we still have in the system,” he told an audience on asset owners and their advisors.
“At an aggregate level, we’re still on a huge pile of debt: if there’s little growth, there’s little chance of eroding that debt. And that makes us vulnerable to market shocks.”
Western GDP five-year averages are at 80-year lows, Reid said. In the US, GDP levels haven’t been this low since the 1930s.
“Everyone talks about the US being in recovery mode, but in nominal terms GDP is pitiful when compared to its past levels, especially in the last two quarters, which have seen pretty weak activity,” he said.
Part of the situation has been caused by monetary policy interventions being directed at the wrong end of the market, Reid continued.
Quantitative easing (QE) has resulted in an inflation in asset prices, but the money isn’t trickling down into the public’s pockets, making those wealthier people with assets better off, and the poorest people worse off, Reid said.
This led to an effective propping up of the inefficient resources in our economies, instead of a radical redesign, he said.
One partial consequence of QE and the greater access to refinancing methods is a decade of record-low default rates, making credit an attractive asset class for investors seeking greater returns in a low-yielding environment.
Under normal circumstances, withdrawal of QE should lead to default rates increasing, as money is removed from the refinancing pool.
But Reid argued central banks and governments won’t be able to accept a rising default rate as they want to keep markets calm. This will force central banks to put yet more unconventional monetary policies back on the table.
Even worse, this will in turn hamper GDP growth by allowing bad companies to continue running, blocking more efficient, better performing new companies from breaking through.
“The authorities are trapped,” he said. “I predict this low default rate environment will stay that way for a couple of years. But this isn’t a free market, it’s not capitalism.
“A normal default cycle is good: if companies go bust it cleanses the system and allows entrepreneurial spirit to come through. I expect that default rates will be kept artificially low to keep the markets calm… it will get to the point where it chokes off economic activity.”
Related Content: What’s Killing Growth? Pensioners and Birth-Rates, Research Claims and Is the ABS Market Making a Comeback?