With interest rates negative in many parts of Europe and Japan, and with the US also possibly lining up, it is clear that the decline in the value of capital is rapidly accelerating.
In days of yore (as recently as the 1980s), capital could best be caricatured as an elegant, elderly gent of impeccable integrity, in a grey suit sipping brandy at the club. He never touched capital unless there was—heaven forbid—a crisis. From the 1990s onwards, however, capital began to change—dot coms, as they were called, started talking proudly about the rate at which they could burn capital. Granted that some of them did come up trumps, but the conceptual shift was too much for our elegant gent, who fell out of his chair and turned to pink shirts, suspenders and much unspeakable conduct (both in and out of the office).
By 2000, by which time a lot of capital had been burned, the market fell out of bed and the US Fed rode to the rescue cutting interest rates sharply, driving the risk-free return on capital lower. This decline in the real value of capital accelerated over the past twenty years, courtesy regular market crises and monetary policy—and, more recently, printing money as a cover for monetary policy—as the one-trick pony to tide them over.
So, here we are today at the start of 2016, and markets appear to be signalling we are at the end of the line. Capital is and is being seen as less and less valuable—the old gent’s grey suit is torn and tattered and the rags used to mop up some of the blood on the street—and the first chinks in the asset superstructure are becoming more and more visible. Some high-end paintings (including a Picasso) recently sold for 30-40% less than they had been bought for just a few years ago; hedge funds (swollen with much of this cheap capital) are shorting the largest companies that invest in high-end London real estate; luxury goods makers are quietly cutting budgets.
Capital is definitively declining in value, and, perhaps as part of a long-term natural cycle, the balance is shifting towards—what else—labour.
We are clearly in uncharted territory which is why markets are in such a funk right now. At the boundaries, the markets’ job has always been to set limits on government—to tell them when things have gone too far. And, certainly in this era of freer the better, markets have always had the power to sustain the pressure till the problem is acknowledged and fixed.
The last loud example of this was in 1992, when the market recognised that the UK economy was in pretty bad shape and there was no way the Treasury could raise interest rates; at the time, sterling was locked into the ERM snake, which limited how far it could move about a central rate. So, the market—and this is when Soros made a billion and a reputation—sold sterling and sold sterling and sold sterling till the government had no choice but to leave the ERM. It also explains why the UK did not join the Euro.
The next time distortions started building up—the dot com boom—the regulators were asleep at the wheel. In 1996, Alan Greenspan spoke of “irrational exuberance” but he did nothing to halt it—in 2000, as we know, the market crashed. By this time, however, another problem arose which prevented the market from doing its job (of signalling distortion)—this was the new mantra of “central bank transparency”, by which the central banks co-opted the market, telling them what they were going to do. Easy money is a sure way to contain morality, and sure enough, the market went along, till 2008, when everything went bust.
Shockingly, the new transparency persisted and central banks continued to debase capital leading to yet another huge build up in asset prices and the current hugely volatile collapse. Over the past two months, the Dow has seen 100 point moves on nearly 60% of all trading days, the longest such period since 2009. But now, with negative interest rates in many economies, there is nothing left to feed the markets and—you guessed it—it is time to pay the piper, to address the real issues.
Enter Piketty, who in the role of the patron saint of the inequality argument, has defined the problem: beyond a point, inequality leads to lower demand which leads to lower growth which leads to deflation which leads to lower returns on capital. If it runs for too long, the returns get lower and lower and finally—boom—turn negative!
In terms of a solution, Bernie Sanders is certainly talking the talk. Perhaps his good showing thus far may give the market a little comfort; this may explain its pause at the end of last week. However, the big question is whether he will be able to walk the walk. And certainly, over the next few months both his chances of winning and the likelihood that he will be able to do something meaningful will come into question.
Thus, it is likely that markets will remain in high-alert jitters—there are any number of eminent triggers (China, renewed oil weakness, almost anything the central banks say or do)—before too long. I would use the current hiatus to reduce risk.
The author is CEO, Mecklai Financial