Christine St Anne: Bloomberg recently awarded former banker Satyajit Das among the 50 most influential people in the finance world today. Das is also an author and his most recent book 'Extreme Money' looked at the culture of risk. Today we welcome him back to talk to us about three emerging risks for investors.
1) Secular stagnation
Satyajit Das: The interesting thing there is, if you look around the different regions, what's actually happening to growth, the U.S. I think is doing a lot better than everybody else, but the interesting thing about that is they would have been assuming that foreign growth, which is another sectors of the world, would sort of perhaps not reach U.S. levels but would trail along and particularly, emerging market growth would continue to be strong. But the problem now is we are seeing the U.S. dragged into this vortex of problems elsewhere, particularly in Europe, in Japan and in the emerging markets.
So, let's cover each of those in turn. The first one is Europe. I mean, Europe is managed with a mixture of German flexibility, Italian self-discipline and French humility. So, under those circumstances it's not surprising that none of their policies have really worked. And effectively they are now trapped I think in a Japan-like scenario of low growth, low inflation and essentially the political infrastructure is so inflexible and the economic infrastructure is so inflexible they cannot do what, say, Japan is trying to do which is devalue substantially.
And the problem with the strategy that Europe is following and Japan is following which is an export-led recovery on the back of very, very sharp devaluations of their currencies actually now poses a risk for the U.S. because the problem for U.S. in terms of its recovery is twofold; one is foreign demand for their exports is slowing because the economy is weak; but on the other side, if they try to devalue their currencies and the U.S. dollar rises, one of the impetuses for U.S. growth over the last two or three years disappears entirely.
And the last problem for global growth I think is the emerging markets. I mean, the famous BRIC story has sort of run into a quagmire because if you look at the Latin countries, they all essentially have huge amounts of problems; Brazil is flat, Eastern Europe is flat and you look at countries like Russia which has its own geopolitical and other problems. But the most important story is the Chinese story where clearly they are now caught between a rock and a very hard place. If they continue to stimulate with more debt, the problem becomes they have a banking and a financial bubble. But on the other side, if they don't do that, growth comes off laying bare huge social problems. So, I don't think you can look at any of those as giving you growth. So, under those circumstances I think we are now trapped in what the new buzzword is secular stagnation or what Christine Lagarde from the IMF calls the new mediocre which is a period of low growth which in itself would not be problematic, but low growth combined with low inflation and a high level of debt is a particularly toxic problem.
2) Policy impotence
There are some interesting signs about policy impotence. The first is, Mario Draghi when he was announcing both in June and subsequently when he loosened policy even further in September, he made it very clear that they didn't have many more cards left in the pack and he basically saying, well, the only thing we can do now is basically to inflate the balance sheet which is 'for' I'm going to buy government bonds. But the Bundesbank and the studies by the ECB show very clearly that even if you pump $1 trillion into the European economy, the effects on growth and inflation are very marginal.
So, I think there is huge policy impotence and I think one of the things is, the investors around the world seem to assume there is going to be some magic or some rabbit pulled out of the hat here and there are no rabbits and there is no magic. And when they start to realize that and they realize that we are trapped in this period of low growth and low inflation and few policy options, they may start to reassess where assets are priced. And I think that risk is very, very real and in financial markets the hurting behavior means that inevitably everybody will decide this almost simultaneously and then everybody will head for the exit simultaneously. And the problem is liquidity in terms of trading liquidity has dried up in the global markets because the number of market makers have fallen, all sort of structural changes have taken place. So, if they head for the exit at the same time, it will well be an interesting stampede to watch.
3) A political stalemate
We now have a resurgence of political risk and particularly, at the geopolitical level, there are considerable things going on which are very, very interesting. The first of course which is very, very high on people's agenda is the Middle East with the rise of ISIL. Now, the problem with the rise of ISIL is people think it's a very recent event. It actually shows that we were never ever able to deal with the threat posed by Islamic fundamentalists in the form of al-Qaida. al-Qaida was created by the west when they basically were fighting the Russians in Afghanistan. And if you go back through history, the whole problem in the Middle East relates to what's known as a Sykes-Picot agreement which is basically how the colonial powers divided up the Middle East and the Balfour Declaration, the creation of Israel. But there is not actual resolve to actually tackle any of those problems.
So, I can see the Middle East becoming a completely unruly place for the foreseeable future like Somalia. It will be a warlord type of situation. And given that essentially there is a lot of oil there and the world is still at varying degrees reliant on that and the unwillingness to tackle the fundamental issues like these borders, like the Saudi Arabian Fahd regime, it's impossible to solve this problem. So that's going to linger.
We also have Russia with the problems in the Ukraine. Then of course there is the North African Arab Spring which has turned into winter without actually going through summer or autumn. And then in the Far East you have the border disputes between China and Japan, China and Korea, China and just about everybody else and those things are not going to be easy to reconcile in this environment.
So there is going to be a huge amount of stalemate around the world and at the same time in political terms, we are seeing the rise of both the extreme right and the extreme left which we've seen in the European elections and also what we saw as a result of the Scottish vote is more interest in, I would call, tribalism where countries have these secessionist movements internally. So, politically, the risks are extremely high.
The most interesting thing is it seems to be that investors have decided, hear no evil, see no evil, speak no evil as far as those risks go and the essential assumption is, central banks with their (least) monetary policy will continue to basically ease the way and they will. But the fact of the matter is, they cannot actually stage a magical recovery which is what everybody needs and is looking for and there is a fundamental dichotomy.
If you look at the financial markets, they are priced on the basis of perfection. Everything is going to go right. And the problem is, if you look at the real economy, nothing very much is going right. So, at some point in time these two have to meet and the only way they can meet is either real economy fixes itself, which I think is highly unlikely, or alternatively, the financial markets particularly the pricing and equity market and the pricing and credit markets, adjust to the reality and that adjustment will be extremely painful.