After the GFC, amid all the doom and gloom theories, there was one idea that got a lot of attention: The New Normal.
The phrase, coined by celebrity fund manager Bill Gross from PIMCO pushed the idea that the world had changed forever. The good ‘ol days were gone, lower returns were now the order of the day, and we just had to learn to live with it.
Gross argued that from now on, there’d be three major headwinds holding back returns and keeping a lid on asset prices – deleveraging, de-globalisation and re-regulation.
But 5 years on, how has it actually played out?
The deleveraging thesis picked up on the idea that households and businesses had gorged themselves on easy credit from the 90s onwards, and now they had to have a good lie down on the couch. They would need to deleverage out of their current positions, and this would inhibit consumption and investment, and put a drag on growth going forward.
And you can add public deleveraging in here as well. Australia’s doing ok, but many countries, including America, are running public deficits that are unsustainable. As they wind that back, either by raising taxes or cutting spending, there will be consequences for growth in the short term.
The de-globalisation thesis argues that national countries will respond to the mess they’re in by debasing their currencies and reimposing trade barriers. They’ll do this to try and protect domestic industries, but will only succeed in making the whole world a more difficult place to do business.
The final element, the re-regulation thesis, argues that the excesses of a lazy (and probably criminal) financial sector would push governments to come back and crack down on the financial sector – tying up credit markets with red tape and ratcheting up loan standards. The fall in lending and credit would ultimately put a brake on potential growth rates across the world.
And with these super-trends in place, double digit growth rates were a thing of the past. Lower returns were simply here to stay.
This was the new normal.
And for some reason, this became a very popular idea. It spread faster than a picture of Justin Beiber holding a kitten on facebook.
Partly it came from Gross’s celebrity status, but I think a lot of it had to do with lazy fund managers trying to justify some pretty ordinary performance.
But it’s 5 years now since the GFC broke. How has the new normal thesis played out in practice? We’ve certainly seen some lower returns in the years following the GFC, but are they locked in?
First, let’s take a look at the deleveraging story. There has been some scaling back of credit and debt in recent years, but as the chart below shows, debt to GDP in the US (like it is here) is starting to level out, and we’re seeing the first signs of a pick-up in lending.
US HOUSEHOLD DEBT AS % OF GDP
As I’ve argued before, there are reasons to believe that we’re not heading back to 1990s levels of debt and credit. Fundamental changes to the financial sector over the past 20 years can explain the current levels of debt.
That’s not to say that debt to GDP can keep increasing like it did prior to the GFC, but I don’t think it will unwind either. I expect it will reverse a bit of the overcorrection we’ve seen in the past couple of years, before finding a new stable level.
At any rate, it now seems clear that the headwinds it’s generating for asset prices aren’t as bad as a lot of people thought they might be.
In terms of public sector deleveraging, it also isn’t appearing to have as big an impact as a lot of people worried it would. In large part this is because tighter fiscal policy is being balanced out by looser monetary policy. This, it turns out, is actually a plus for investors.
And so far, it seems that tax hikes in the US haven’t had an impact on consumption spending, and saving rates have actually picked up (see chart).
In terms of de-globalisation, it doesn’t seem to me like the global economic order of the past 20 years or so has broken down. There have been some complaints about Japan tinkering with the Yen, but there’s nothing new here. They’ve been getting their fingers dirty for 15 years.
If anything, on balance, global exchange rates have become freer as China takes steps to liberalise the Yuan.
And there seems to be a growing global consensus around the use of quantitative easing policies, with Japan becoming an eager participant last week. Central banks are, at least on the face of it, working together.
I think this is actually one of the reasons gold got knocked on the head this week. Those hedgers betting on US collapse saw that the ‘radical’ QE polices were now becoming consensus. They were reminded that America might be having a rough trot, but it was far from the bottom of the league table.
And in terms of re-regulation, we’ve seen governments give the banks and financial institutions a wrap on the knuckles, but it was nothing radical (and nothing like what they actually deserved!) It certainly didn’t create any fundamental changes to the way banks did business.
And I’d actually argue that the financial sector is getting more, not less, competitive.
And so what do we have? The new normal was a dog whose bark was much worse than it’s bite. It was a good description of some important correction dynamics, but not an accurate picture of the long run – and not an accurate picture of where we’re at right now.
Sure, the wild and crazy years just before the GFC might not be repeated (probably best if they’re not!), but the new normal looks like it’s not going to be as bad as a lot of people feared.