Arun Abey: Getting used to the 'new normal'

After the storm that passed through financial markets in 2007-09, the rebuilding is under way. But what will the economic landscape look like in this "new normal" environment and what does it mean for personal finances?

The coming 10 years will be different from the past decade. There will still be plenty of opportunities for us to invest and more importantly thrive as people. But we need to learn the new rules.

First, the bad news

You could easily write a horror story (some journalists have made careers from it) about the challenges we face. These include:

The great belt-tightening
Households, banks and governments need to cut back debt. To return the economy to a sustainable footing requires a collective belt-tightening. Many households in the United States, parts of Europe and Britain owe more than their house is worth.

New Zealanders are also feeling the pain as they grapple with high levels of debt and the threat of record mortgagee sales. That means buying less and saving more for years. Reducing debt is not a bad thing but if everyone does it at once, it does impact on growth.

Running out
With the rapid industrialisation and growth of economies such as China and India, the strain on natural resources has grown significantly. Jeremy Grantham, founder of fund manager GMO, points out that production of hydrocarbons (including oil) and many metals has peaked. It used to take 30 tonnes of ore to produce one tonne of copper; it now takes 500 tonnes of ore because the purity of remaining supplies is much lower. Some countries are even running out of workers as populations age.

Governments - solution or part of the problem?
Governments now confront huge issues such as fixing financial regulation and climate change. They did a good job intervening in the financial crisis but governments are usually far better at dealing with quick fixes than longer-term issues. They like to be re-elected, after all. As a result, they often promise too much to today's voters and let future generations sort out the mess.

The world economy is highly adaptable but the reality of these challenges is likely to be a period of slower and less consistent economic growth than in the past 20 years.

So what's the good news?

The biggest single factor that will prevent bad news from dominating is technology. The world is experiencing three parallel revolutions:

* The electronics revolution began in the 1960s and produced a huge increase in computing power that seems set to continue for decades.

* Advances in materials have always been crucial to economic progress. A quiet revolution in materials science has transformed our lives including the clothes we wear, our communication and transport systems, medicine and our ability to build more powerful computers. In the coming decades this revolution will help us to use scarce natural resources more efficiently, while advancing living standards.

New lightweight alloys, polymers and composites which increase the strength of vehicles, while reducing their weight and energy use are one example. Advances in ceramics that allow power plants to increase electricity production from fuel while reducing carbon dioxide emissions are another.

* The biotechnology revolution is the most recent but will have the greatest impact. Enabling life to be manipulated at its most basic level, the genes, has myriad ethical issues but has resulted in cloning, production of bacteria that "manufacture" human pharmaceuticals such as insulin, and IVF technology. The interaction of this revolution with those in materials science and electronics will see the emergence of the ultimate worker: the human-like robot.

While it won't be a smooth process, these interacting revolutions will help us overcome the problem of resource shortage, and enable us to maintain living standards.

Other investing themes also expected to pay off over the next decade include emerging markets, water resources, commodities and clean energy.

The bond market vigilantes

Bill Clinton, to the surprise of many, oversaw one of the most successful eras of strong US growth, with low inflation and a substantial reduction in the government deficit.

White House insiders say a key factor that helped to discipline economic policy during this time was Clinton's realisation that to be re-elected, he needed interest rates to be low. This led Clinton to focus on the reaction of the bond market to his policies.

One of the benefits of deregulation of the financial markets is that the freeing of interest rates has allowed the bond market to become a key force in disciplining economic policy. Governments have become aware of the high economic, and ultimately political, cost of losing a high credit rating and presiding over an economy where the market has lost confidence in government policy.

The rush to cash and government bonds because of the global financial crisis distorted bond prices, but this was temporary and we can expect the bond market to resume its role as an automatic check on discipline in government policy.

What does the new normal look like?

There will be no shortage of investment opportunities in the next decade, not least in the technology-related arena, although we can expect considerable volatility in markets. Technology change will produce both winners and losers.

Anything reliant on hydrocarbons and oil will struggle; for example property prices in outer suburbs with poor public transport are likely to be affected. Better video-conferencing and communications technology may partially offset this.

In short, to thrive financially in the "new normal" we need to:

* Get back to basics, increase our savings, reduce debt and plan our cashflows for the likelihood of rising interest rates over the next 18 months.

* Include shares in long-term investment portfolios to protect our savings against inflation, but be realistic - reduced growth means moderate returns

* Recognise that the biggest attribute an investor can have is not stock-picking skill but emotional fortitude to hang on to a well diversified portfolio through volatile periods

* Accept that there will be asset price bubbles in future and avoid falling into the traps of chasing "super-charged" returns - in some cases it may be worth paying for protection against falls in markets.

Expecting moderate rather than spectacular growth returns from investments will not significantly affect the affluence our society enjoys. However one benefit of the financial upheaval we've been through is to cause many people to take stock.

One of the best street signs in recent years was outside a church. It included a line chart of the stock market falling and the caption: "And this changes everything, does it?"

Money is very important, yet when we ask people to reflect on what gives them the most life satisfaction, it's usually the simple stuff: chatting to a friend over a pot of tea, dinner at a local restaurant, a cheap and cheerful family holiday. By taking us back to basics, the greatest benefit of financial turbulence may be to allow us to regain perspective and refocus us on what's important.

Let's not waste the opportunity.

Arun Abey is executive chairman of financial planning firm ipac, head of strategy for AXA in the Asia Pacific and a director of the Spicers Portfolio Management advisory board. He is also the author of How Much is Enough?

www.howmuchisenough.net