The "Do-Over" - Groupthink, Mass Delusion, And "Hell To Pay"
Authored by Paul Singer, excerpted from Elliott Management's latest letter to investors,
As this letter is written, stock markets around the world are at or near all-time nominal highs, while global interest rates hover near record lows. A flood of newly-printed money has combined with zero percent interest rates to keep all the balls suspended in the air. Nonetheless, growth in the developed world (U.S., Europe and Japan) has been significantly subpar for the 5-1/2 years following the financial crisis. Businesses have been reluctant to invest and hire. The consumer is still “tapped out,” and there are significant suppressive forces from poor policy, including taxes and increased regulation. Governments (which are actually responsible for the feeble growth) are blaming the shortfall on “secular stagnation,” purportedly a long-term trend, which enables them to deny responsibility. As long as the politicians who encouraged and enabled consumers to take on too much debt before 2008 think they can ascribe the failure of bad government policies to the market system or exogenous factors, there will be an ample supply of such theories, which in all likelihood will lead to more bad government policies.
The orchestra conductors for this remarkable epoch are the central bankers in the U.S., U.K., Europe and Japan. The cost of debt of all maturities issued by every country, corporation and individual in the world (except outliers like Argentina) is in the process of converging at remarkably low rates. In Greece (for goodness sake), long-term government debt is trading with a yield just north of 5%. In France, 10-year bonds are trading at a yield of 1.67%.
Are these (and other) financial asset prices the result of the final and conclusive achievement of knowledge by world leaders about how to achieve strong, sustainable economic growth with uniformly low inflation and continued unshaken confidence in paper money into the long mists of the future? Wouldn’t that scenario be wonderful, and wouldn’t it be a perfectly justified extrapolation of the miraculous modern scientific wizardry that has given us tiny devices that fit in the palms of our hands and can tell us the history of the Spanish Civil War, make movie reservations and hail a cab while showing us on our little screen as it approaches?
Sadly, financial market conditions are not the result of the advancement of human knowledge in these matters. Rather, they are the result of policymakers engaging in groupthink and suffering from a mass delusion. By reducing interest rates to zero and having central banks purchase most of the debt issued by their respective governments, they think that inflation can be encouraged (but without any danger that it spins out of control) and that economic activity can thereby be supported and enhanced. We are 5-1/2 years into this global experiment, the kind that has never been tried in its current breadth and scope at any other time in history. Excuses by government leaders for the meager growth are easy to make (and some even contain nuggets of truth), but the bald fact is that the entire developed world is growing at a sluggish pace, if at all. But governments, media, academics politicians and central bankers refuse to state the obvious conclusion that their policies have failed and need to be revised. Instead, they all state, with the kind of confidence only present among the truly clueless, that in the absence of their current policies, things would be much worse.
This is ridiculous, but this is the state of affairs in this enlightened internet age when about a billion people around the planet are never more than ten seconds away from access to all the books ever written. The voices arrayed against the fetid mix of developed world policies are few, and they are drowned out by the loud roars of approval. After all, who does not like rising stock and bond prices and a recovery in real estate markets? And when the government tells you that this excess is all necessary and “working,” and central banks with their impenetrable and obscure verbiage lend an academic gloss to the tale, there is a hypnotic and tranquilizing effect that results from the seeming stability of it all. To be sure, the current comatose volatility in global markets all but whispers, “What are you worrying about?” to anyone who thinks something is deeply wrong with the combination of growth-suppressive policies, open-spigot money-printing and zero percent interest rates.
But it is worth worrying about the economy and the global financial system. The apparent stability of the world financial system is superficial – financial asset prices are not real, the equilibrium is temporary, the lack of volatility is a trap, and when the whole thing goes haywire, there will truly be hell to pay. Investors are “seeking yield” now in assets of lower and lower quality, with more and more leverage, and with less and less yield to compensate for risk. At the moment, investors engaging in this endeavor do not see any clouds on the horizon, and there is no major currency that has (yet) lost the confidence of investors, no major country which has (yet) lost the confidence of its people, and (despite the fact that some marginally-radical groups have gained a little bit of traction) nothing that would qualify as major social unrest in the developed world.
The policies that could generate much stronger growth are not unknown, nor are they complicated or arcane. Attractive tax regimes, understandable and efficient regulatory designs, the rule of law, solid infrastructure, low corruption and crime, a population of educated and willing workers, reasonable employment rules, low tort litigation risk, good educational systems, intelligent approaches to energy and the displacement caused by technological advancement, and policies that foster entrepreneurship, create attractive places to live, work and form or expand businesses. Progress in these areas creates virtuous cycles, attracting people who can reinforce and amplify the positive results.
None – we repeat, none – of the leaders of the developed world are pursuing the policies described in the preceding paragraph. The explanation for this failure involves plenty of blockheadedness and myopia, but there are two additional poisonous elements at work here: arrogance and ideology.
As for arrogance, the notion that their countries may be coasting on the glories of the past while heading for dim futures does not seem to occur to these policymakers. They point to the structures and forms built stone by stone in the construction phase of their civilizations as if those elements do not need protecting and refurbishing – and as if other people, countries and cultures were not breathing down their necks, wanting the same standard of living and competing in the same global markets for the growth that can generate those standards of living. All of the developed countries (either now or soon) need to compete in the global marketplace and not just rely upon cloistered internal markets for growth and prosperity. Furthermore, every country should provide the conditions for giving its citizenry the best chance possible of generating growth through the miracle of human creativity – the growth that comes from nothing more than a spark of invention or entrepreneurship.
The lack of sensible pro-growth policies would be bad enough for the developed world, but the more important reality is that things are a lot worse than we have illustrated above. For some time now, in a trend that has rapidly accelerated in the last few years, the developed world has granted (and keeps granting) a set of promises for payments in the future that cannot possibly be fulfilled regardless of future GDP growth or income tax rate hikes. Candidates for public office have had such success buying votes with these promises (in conjunction with short-term pledges to public-sector employees for pay, benefits and working conditions which are more generous than that of their private-sector counterparts) that these strategies generate value for such politicians ostensibly “gratis.” “Ostensibly” is the operative word here, of course, since there is nothing gratis about it. Indeed, the cost will be more than any citizen would voluntarily choose to pay, but it is hidden at the moment. In the near-to-medium term, the cost will take the form of higher inflation and lower growth than would be the case if good policies were pursued. Longer term, the impact will be far more insidious.
As for ideology, many of the current leaders of the developed world appear to be motivated by ideologies according to which wealth is not created by effort, entrepreneurism or creativity. Rather, they believe that wealth held by private individuals is either ill-gotten or should be redistributed, as a matter of “social justice,” to groups that do not have it.
Let us skip over the moral piece of this equation, in which effort and achievement exist on the same moral plane as dependency, and in which wealth is deemed undeserved whether it was stolen, acquired by birth or stolen. Instead, we will move right to the practical aspects of this governing philosophy, which prescribes a government fiat solution to the problem of inequality. This so-called solution always seems to leave government cronies swimming in wealth. Practically speaking, countries that welcome investors and workers with supportive policies (tax, quality of life, rule of law, labor, education, regulatory and others), will attract people who work, achieve and build. The corollary is that those governments that think their citizens have no choice other than to “stay and pay” are being really shortsighted as well as venal. As and when some of this latter group’s most productive citizens move themselves, their families and their capital offshore, those remaining will likely simply say “good riddance.” In fact, as the real standard of living suffers, the blame for the failure to grow and for the shortfall of good jobs will probably be ascribed to everything except the counterproductive policies that drove out those who created both jobs and demand for goods and services. By contrast, the places where capital and ambitious people are welcomed will be doing better and will be providing brighter prospects for their people.
Of course, all of these observations are relative, not absolute. There is no place that is purely “free” in the developed world. There are taxes and rules everywhere, and there is no “pure” modern developed society where all income is retained and where those who cannot (or do not want to) provide for themselves are left to fend for themselves. Nor should there be. The “relative” aspects of the “attractiveness” scale is why apartment and house prices in London, New York, Miami, Aspen and the Hamptons have leaped to the moon and beyond, despite their poor policy landscapes. Why do Latin American, Russian and Middle Eastern investors pay top dollar to buy properties in those places? Because they are afraid of the rule of law (or lack thereof) in their own countries. But American politicians do not draw sensible conclusions from this phenomenon. Instead, they act as if no amount of hostility toward capital will cause businesspeople and/or investors to take their capital elsewhere. The reality is that this current “safe haven” status for the U.S. (and U.K.) is not permanent, and politicians who think it is may be in for a rude awakening.
Groupthink in the current coalescence of views as to which places are safe and which are not is a complicating factor. An important corollary is that the conclusions of groupthink are unanimous, and when they shift, they shift abruptly and uniformly. In the era of modern communications, this phenomenon has broad implications for financial markets. If and when the prices of highend assets (stocks and bonds, homes in Aspen, “contemporary” art created by unknowns and costing millions) change direction, they will likely all change direction at the same time, like the Rockettes – except rather than pirouetting gracefully around the stage, they will be tumbling in unison into the orchestra pit.
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We will now pull together the elements described above and hold them to the light to see what they may mean.
The leaders of the developed world have eschewed policies that would make their economies grow at acceptable/historical rates, resorting instead to encouraging their “independent” central banks to reduce interest rates to zero and print money. The money printed by the central banks is used to buy up bonds, public and private, and recently also to purchase stocks. At the same time, politicians in these countries, far from getting a grip on the unsustainable promises of benefit payments that have been made to their citizens, have allowed those promises to accelerate dangerously. Such promises are a powerful form of debt that is growing exponentially, adding to collective government balance sheets that are already severely overleveraged. Simultaneously, the ability of the developed world (particularly America, the Power Formerly Known As “Super”) to impose order on the global geopolitical and military matrix has meaningfully declined, and is in the process of diminishing further.
In America, people who own financial assets are spending stock market gains on high-end goods, while many middle- and lower-income people are either borrowing to maintain current spending or becoming/remaining dependent on the government. This pattern is unsustainable from both a moral and practical standpoint. And the country’s long-term entitlement obligations are utterly unpayable as currently structured.
Your guess is as good as ours as to how this fantastic mix of elements and policies comes undone, but it is not rational to think that the current apparent stability and low volatility will go on forever. Nobody can predict when things will unravel, how the unraveling will take place, or what the world will look like after the next crisis. But the numbers (debt, derivatives, and promises) are extraordinarily large, the dysfunction very powerful, and the leadership throughout the developed world very weak.
We state this case not to be provocative or colorful. We are trying to figure it out, because we think that what happens next has the potential to challenge the historical episodes of the most transformational vector changes in modern times. Investors need to try to understand how to survive the evolution of these factors into financial, economic or societal changes. After all, the reason that nobody has been able to compound money over the last 300 years or so at even a mere 3% return through generations and generations is quite simple: There is always some war, invasion, collapse, confiscation, tyranny, revolution or inflation to reshuffle the deck and require a “do-over.” We may be close to such a transformational period.
Freedom, technology, entrepreneurship and the human brain and spirit are forces that could bring human societies to more widespread and powerful growth and prosperity.
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