Recent share market rallies in developed economies have many analysts arguing that the worst of the global financial crisis (GFC) is behind us. It’s not just equities; there are straws in the wind that the United States economy is slowly picking itself up off the floor. In Australia, it now seems likely we won’t slip into a technical recession – two consecutive quarters of negative growth.
Whether these analysts prove prophetic or not, no-one should underestimate the enormity of the financial crisis that was sparked by the US sub-prime debt market, nor the ramifications that will unfold in the months and years ahead.
For trustees and fund managers alike it will not be business as usual going forward. The fundamentals that powered nearly two decades of economic growth – political, social, economic and regulatory – are changing, and that will have profound implications for all asset allocation strategies. Although this column remains uncertain how it will unfold, it can ponder the many questions that will arise post-GFC.
There can be little argument that the GFC was the most severe economic crisis since the Great Depression of the 1930s. For a short period, the developed world was on the cusp of seeing a complete meltdown of the financial system. In a matter of months, major investment banks crashed, the world’s biggest insurer had to be bailed out, Fannie Mae and Freddie Mac were effectively nationalised in the US, and worldwide governments were forced to shore up their banking systems.
In this environment, governments and their central bankers responded quickly; aggressive fiscal and monetary policies were implemented, including stimulus packages, there were manufacturing rescue packages seemingly being announced every second week, and governments significantly increased infrastructure spending.
In the short term there can be no doubting these rescue packages helped bring the developed world’s economies back from the brink. But what will the cost be? Make no mistake: there will be a price to pay for being rescued.
Governments have accumulated debt at levels never seen before; in Australia, it will be years before the budget returns to surplus. But the size of Australia’s debt pales into insignificance compared with the US. More than ever before, the US, still engaged in two significant overseas military operations (Afghanistan and Iraq), is relying on other countries to buy its debt.
Surely this begs the question: will the US, the world’s economic powerhouse post-1945, again be the country to lead the world out of recession? Will a lower US dollar allow for a renaissance of its manufacturing base or is that industry sector in terminal decline? How long before its housing industry begins a sustained recovery?
After World War II, it was the US economy that played such a pivotal role in rejuvenating the economies of Europe, Japan and Asia’s ‘little tigers’ – South Korea, Taiwan, Singapore and Hong Kong. Today, sound arguments can be mounted that it has passed the economic ‘silver bullet’ to an emerging China with its massive surpluses, and, to a lesser degree, India. What will be the geopolitical ramifications of the world’s pre-eminent military power, the US, losing its economic dominance?
The role of the central banks will be critical. Can they engineer a non-inflationary recovery or are we about to enter a period of inflation, stagflation or deflation? What will be the impact on currencies, especially in the developed world?
Suddenly leverage has become a dirty word in the investment lexicon. What will be the longer-term implications as investors adopt a far more conservative approach to gearing?
Increased government regulation of the financial system will inevitably flow from the GFC. Will this stifle innovation in the capital markets or will it bring in its wake more disciplined structures that will allow us to avoid the excesses of the past?
I have no doubt we are facing a new world order in economic, social, financial, regulatory and political terms, and this will leave an indelible mark on the capital markets. For the industry, it will inevitably mean fresh approaches to investment strategies, governance models and risk management to ensure it is attuned to the needs of fund members and stakeholders in this brave new world.
