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Drawing a line between pricey markets and globalization
By James Saft, Reuters
Thursday, June 26, 2014

If global policy makers are wrong about globalization, and they could be, we may be in for more low growth, low rates and the high asset prices they support.

At issue is the bedrock belief that globalization lifts all boats, making us all richer by allowing the flowering of individual countries' comparative advantage.

That some classes of people low-skilled workers in the West, for example have not done well out of globalization should by now be obvious.

The big question is whether this is a transitional problem, a distributional one or something closer to a permanent condition.

One person who has thought interestingly about these issues is Stephen Jen, a hedge fund manager at SLJ Macro Partners. Jen argues, picking up on points made by economist Paul Samuelson a decade ago, that lagged effects of globalization may be behind some of the peculiarities in both markets and economics we now observe.

"Traditional economists have been puzzled by the disappointing recovery in developed market employment and capital expenditure. Globalization, we believe, could help explain both puzzles," Jen and colleague Fatih Yilmaz wrote in a recent letter to clients.

While this is far from mainstream economics, it is worth considering this line of thinking, and the potential implications for financial markets.

One idea is that globalization, by introducing large new supplies of labor from emerging markets, has changed the relative supply and demand relationship between labor and capital. That helps to explain increasing wealth and income gaps and also wage growth suppression in the developed economies.

A supporting idea is that globalization is contributing to the so-called secular stagnation that developed market economies seem to find themselves in. With capital in demand and labor in plentiful supply in emerging markets, money, in the form of investment, flows to where it gets better returns. Developed markets as a whole have had strongly negative net foreign direct investment for decades, and even the U.S. has seen negative figures since the financial crisis.

That lack of capex in developed markets is, in part, a factor underlying both slow growth and poor job creation. Combine this with demographic headwinds, and you may have lower potential growth.

That, of course, is not how central banks see things, at least thus far. The result, and implication, is that the policy and growth mix we've seen very low rates, very low growth and very low inflation - are perhaps a feature rather than a bug.

Assets Supported

What this has meant for asset prices so far is that riskier investments have been very well supported by emergency policies which far outlast the emergency.

The puzzling inability of the economy to grow strongly, create jobs and drive wages higher is met by policy makers with low rates and easy liquidity.

"For the financial markets, rather perversely, as long as policy makers see the great financial crisis as an exogenous demand shock (like an earthquake), the low inflation and the still lethargic labor markets should allow the developed market central banks to persist with their extreme policies," Jen and Yilmaz write.

"In turn, financial repression ought to keep asset prices supported, all else equal."

Much depends on how central banks read the evidence around secular stagnation, and how their thinking evolves.

If central banks continue down the path they are now on, using asset markets as a means to stimulate growth which may not be all that responsive, you'd expect asset prices to remain high, and debt markets particularly to be welcoming places for borrowers.

That might seems like good news for investors, but it does raise the probability of financial overheating and instability. The market goes too far, too fast and eventually we find ourselves in another crisis akin to 2008.

More interesting, if not more likely, is what happens if the views of policy makers evolve more towards Jen's. If central bankers start to believe that low growth is here to stay, then monetary policy will need to be normalized, if only to give some leeway in advance of the next crisis or cyclical downturn.

That might prove good for the economy, in that it could encourage structural reform, but would be decidedly bad for asset prices.

The globalization debate won't be ended in the next year, but the one about when interest rates rise may well be.

James Saft

James Saft is a Reuters columnist. The opinions expressed are his own.

At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft.



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