The 2020s are likely to be much improved - with the recent strength of equity markets playing an important role.
"Banks in many countries have finished the crisis not with excess non-performing loans but with excess capital and the result is strong lending appetite.”
The robust foundations of this cycle are being laid early, most notably with fiscal support for the economy prioritising investment in sustainable projects rather than austerity. Over the coming year fiscal support in many economies is likely to shift from income and cash-flow support towards investment, particularly infrastructure and climate change mitigation. A firm push for austerity seems a long way off.
Banks are also supporting this cycle in a way that typically hasn’t occurred in recoveries. The post-GFC period was an extended period of balance sheet repair for many banks following the losses incurred in the crisis. It was also a period of sustained regulatory reform. Banks had to adjust to much higher levels of capital and regulatory oversight.
Conversely, the COVID-19 crisis in many cases resulted in eased regulatory requirements, for instance through loan forbearance and deferrals. Banks in many countries have finished the crisis not with excess non-performing loans but with excess capital and the result is strong lending appetite.
Importantly, business borrowing appetite is also likely to evolve quite differently. Equity markets are one reason. Strong equity markets benefit most directly those who hold more assets. They also, according to James Tobin in 1970, induce firms to invest by raising the market value of investment assets versus their replacement value.
Falling into place
Tobin’s Q is the ratio of these two variables. When the ratio is above 1, there is an inducement for firms to invest as the market value of assets is higher than the cost of building them.
Across 14 advanced and Asian economies, Tobin’s Q is above 1 in all but four. Crucially, eight have a Tobin’s Q value that has risen to pre-GFC levels, the last period of strong global investment growth. In five it has fallen short. An important pre-condition for investment would seem to be falling into place.
A range of studies, including from the International Monetary Fund (IMF), the US Bureau of Labour Statistics and the Bank of Canada, suggest the primary driver of business investment is demand. The demand chicken is needed before the investment egg. Notably other IMF research, in considering the 2017 US corporate tax cuts, also suggests investment became less sensitive to tax policy changes as demand wilted.
There are a range of reasons for optimism on demand relative to the post-GFC period, not least the radically different approach to fiscal policy. Consumers in many economies are beginning this cycle in a substantially better position. The Financial Times suggests consumers have saved an additional $US5.4 trillion over the past year and all of the 22 economies examined are reporting materially higher household saving rates.
Unemployment in many economies has fallen much more quickly than during the recovery from the last crisis. The result is much less labour market scaring, on this occasion.
In some economies, such as the US, Australia and New Zealand, interest rate cuts have also reduced the household interest burden (as a share of disposable income) to among the lowest level in decades.
Central bank policy itself has rebased. The Fed has shifted its policy framework and committed not to tighten ahead of inflation returning to 2 per cent. The Fed is operating a policy bias that is the most permissive since the 1970s. Higher wage growth will need to be welcomed to reach central banks’ more active inflation goals.
Notably, demand after the GFC was generally not sufficiently strong nor sustained enough to return capacity utilisation to pre-crisis levels in a range of economies where this data is available – including the US, Australia, Canada, UK, Korea, EU and Japan.
Sustained investment upswing
A lack of spare capacity is likely to be one of the most important pre-conditions for a sustained investment upswing. While this cycle is also falling short, so far, the V-shaped recovery in capacity utilisation is promising.