Steven Joyce: It's when, not if, world kicks our assets

Like Tony Stark in his Iron Man suit, investors seem to think they can take whatever the world throws at them right now. Photo / Marvel

Opinion

OPINION:

There is something weird about how we are collectively viewing economic risk right now.

The latest world news is grim. In the Northern Hemisphere, as temperatures drop and Covid-19 surges again, much of Europe is heading back into lockdown. It looks like being a tough northern winter, socially and economically.

The hope for a truly effective vaccine appears to be receding, with various authorities walking back their predictions on population-wide effectiveness, how speedily one could be rolled out, and even how long it might work for.

The world's biggest economy could be about to experience its most divisive election in living memory. The only thing the two septuagenarian candidates seem to agree on is how much they distrust China, which is increasingly both an authoritarian superpower and the world's economic engine.

World growth is down 8 per cent on what was expected a year ago; and whatever happens in the US election, rising protectionism and nationalism will be a further brake on world prosperity.

Huge job-rich service industries like travel, tourism and education have been decimated across the globe, including back here in New Zealand where what remains of our national airline has just laid off hundreds more staff, and plans to lay off many more.

And yet, here at home, it can seem sometimes like none of this is happening.

Much of our economy appears to be going absolute gangbusters. House prices are smashing records. People are queuing up to buy them anywhere in the country at almost any price, sometimes sight unseen. Construction firms are flat out. Share prices are near record highs. People are buying new cars, household appliances, and even golfing equipment like there is no tomorrow.

The disconnect between the way the world is, and the way we all are behaving, is huge.

The risks, as they say, are almost all to the downside. The question must be asked, are we all completely mis-pricing that risk?

Have we convinced ourselves that we are living in a hermetically sealed paradise, where nothing can touch us and what is happening in the rest of the world has no bearing on our jobs and livelihoods? If that is the case, we might be heading for a rude shock.

To be fair we are not alone in observing a disconnect between asset prices and economic reality. It is being driven globally by the highly unorthodox monetary policy of negligible or negative interest rates coupled with quantitative easing (money printing) by central banks, which started after the GFC and has been doubled down on with the pandemic.

Our own Reserve Bank successfully avoided that prescription after 2008 but has adopted it with relish this time around. Couple that with a world record-breaking level of fiscal stimulus from the Treasury, and we feel invincible.

Negligible interest rates mean nearly all investors are chasing yield. They want a return that's better than the nil or half a per cent they are getting for their deposits at their local bank. With the world awash in cash in the biggest social credit experiment history has seen, investors are competing to push asset prices to astronomically high levels, cos any return is better than nothing, right?

House prices are smashing records. Photo / Getty Images

Central banks for their part seem to think that printing money and holding up asset prices is a feature rather than a bug in their response to the Covid-19 pandemic, as I've noted previously.

And in the short term, their experimental monetary policy seems to be having the desired effect. Many people are feeling asset rich even if their job prospects are fragile, and some are partying with their credit cards and their bank balances as if they don't have a care in the world.

Yet there are plenty of future scenarios and storm clouds that point to a longer, deeper world recession than many people appear to be expecting; and if those risks start to play out, we can expect many of those investing on share apps and stretching their personal balance sheets to buy investment properties to start feeling a bit sick.

Let's face it, there isn't much point in celebrating yield if your asset is suddenly underwater by a large margin.

Interest rates usually have a role in signalling the riskiness of an investment. You got a higher interest rate for putting your money in a finance company, because it was riskier than a bank. Company bonds would command a higher risk premium if the company was seen as riskier.

But if interest rates are nearly nil, and central banks are buying corporate bonds, those signals don't work. Every asset seems worth a punt.

So how does this all end? Well, no matter what anyone says, there is no such thing as a free lunch. As the economic damage of Covid-19 plays out, asset prices will revert to more sensible numbers.

The only question seems to be whether it will happen gradually or suddenly. We will also pay for this massive fiscal and monetary stimulus in increased taxes, spending controls, higher inflation, more sluggish growth or a combination of all four.

Perhaps we should invest instead in a little more caution. Just because banks are throwing cheap money at everyone that moves, doesn't mean it is necessary or even sensible to borrow it. As many asset prices move further and further from valuations that make any sense, the risk that people start to look down and get giddy grows.

We are only partway through this Covid thing, and the world is currently very unstable politically, partly as a result of the pandemic. Perhaps we should all go and have a look at the world news again and ask ourselves how much risk we really want to take right now. Cash in the hand mightn't look very sexy, but it just might turn out still to be king.