As economic growth and inflation remain sluggish, many are asking: What’s the next stimulus tool in policymakers’ toolboxes? Bruce Cooper, Chief Investment Officer, TD Asset Management, explains how investors can prepare their portfolios in a challenging market environment. For more on Forward Perspectives click here.
Well, as you know, since the financial crisis, the world has been mired in this very low-growth trajectory.
And that's true whether it's the United States, whether it's Europe, or even the emerging world.
We've been on this kind of decelerating path.
And the pace of growth is pretty lackluster today, as it's been for many years.
And so I think a question has been for policymakers, how do we stimulate growth?
And the main lever that's been pulled has been monetary policy.
And we've been pulling on that lever for many years.
And we may be kind of close to the end of that, given where interest rates are.
And so I think a lot of eyes are trained on the next phase.
What else can policymakers do?
And one thing we think is that you could get into a round of fiscal policy measures around the world, governments spending more money in an attempt to boost growth.
Let's revisit just what exactly has happened on the monetary front.
And you've got a chart here that shows what the lever, so to speak, that's been pulled and pulled and pulled and pulled and probably built on more levers on the side of it.
So tell me a bit about what's happened and what the impact's been.
I think there's been two elements to monetary policy, broadly.
One is that short-term interest rates have been brought down to incredibly low levels.
And you can see a chart there.
And there are three lines.
There's a blue line, an orange line, and a green line.
And really, those are just different geographies, Japan, US, and Europe.
And what that shows is, short-term rates have been brought down to around zero across the world since the financial crisis.
That's one part of the monetary policy story.
The other part has been quantitative easing.
And that's the grayish bar you see in the background there, which is assets on central bank balance sheets.
And what that is is central banks buying bonds in an effort to push down long-term interest rates.
And the reason they've been doing that is to try and stimulate either investment by corporations or spending by individuals to try and spur growth.
So the two parts of monetary policy, in my view, have been lower short-term interest rates and lower long-term interest rates, both in an effort to drive growth.
And having said that, so it's all happened.
It's pretty much all out there in terms of what they can do.
And I guess the impact, what you're saying, is we're not seeing the impact of this anymore.
If you look at the second quarter in the United States, nominal GDP is as low as it's been in 30 years.
Sorry, nominal GDP growth is as low as it's been in 30 years, outside the financial crisis.
So we've got these incredibly low interest rates.
We're trying to stimulate investment and consumption.
But as we look at growth rates around the world, it doesn't seem to be working.
The US is growing with a one handle, whether it's 1 and 1/2% or something like that, Europe in the range of 1%.
Canada, we're in the range of 1%.
And in the emerging world, it's a pretty heterogeneous story.
But taken as a collective, growth in the emerging world is much slower now that it would have been 10 years ago.
So when you come to today-- and maybe I say the recent history.
We've seen some governments starting to say, OK, now is the time.
We're going to start spending.
This is the fiscal stimulus and not just leaving it up to the central bank.
So you're saying this policy phase right now is aggressive fiscal stimulus.
So what I'm saying is we need to watch for aggressive fiscal stimulus.
So I think we've seen the early signs of some of this.
So in Canada we've seen the Liberal government.
They campaigned on a platform of fiscal stimulus.
And we've seen some of that implemented in Canada.
In China, we've seen pretty aggressive fiscal action in the last year, particularly, for example, on infrastructure spending.
We've seen announcements out of Japan.
So I would say these are some early signs that some significant economies are starting to pull that lever.
But there's still some notable absentees in this as well.
And I think the two big ones would be the United States, the largest economy in the world, which has not been aggressively spending on the fiscal side.
And the other would be Germany, amongst the largest economies in the world, which still believes quite strongly in balancing budgets not just in Germany, but across the eurozone, and restraining the fiscal impulse as opposed to endorsing it.
So we should be watching, as you're saying, for some of these bigger players starting to come in.
I think with the US election, that could be something-- that could do something.
The next piece you have here in the paper.
I'm going to quote the words here because I think it's a great quote.
"You can see policy--" meaning fiscal policy-- "take an even more exotic turn and move beyond aggressive fiscal stimulus to unfunded fiscal stimulus known as helicopter money." Right.
Can you explain this in terms of just what this actually means?
Because it's a hybrid, is it not?
The way I think of helicopter money.
There's been a lot written about helicopter money in the last six or nine months.
And the way I think of it, it's really a combination of fiscal and monetary policy.
And it's fiscal policy in a sense.
Helicopter money is endorsing fiscal spending, which can take probably many forms.
Let's give a couple of examples.
It could be government spending on infrastructure.
That would be an example of the form of fiscal spending that could come through helicopter money.
Or it could be literally writing checks to every citizen in the hope that they'll go out and spend.
Try and stimulate growth by just putting money in people's pockets.
So what separates helicopter money from conventional fiscal policy is, in order to fund that-- so if you're going to give every citizen money or you're going to build infrastructure, you need to fund that.
One way to do that would just be to run up the deficits, run up government deficits.
But in this case, the idea would be to fund those deficits using the central bank.
And so the central bank would lend the government money.
And the interest rate on that borrowing would be zero.
And the maturity on those bonds would be never.
And so the idea is, you've basically created money, which the government then uses to stimulate growth.
And you're talking about this because you think this is something that could happen.
We believe it could happen in Japan.
We think it's the most likely place where you would see helicopter money.
And part of the reason for that is, growth in Japan is particularly poor and they've exhausted a lot of other policy avenues.
Obviously, they've gone into negative interest rates.
They've tried QE.
They've tried the government's three arrows.
None of it has worked particularly well.
And so it could be an act of desperation.
They try helicopter money, spending money funded by the central bank.
And then beyond that, we think if Japan did that, you could get it talked about in other areas.
We don't necessarily see helicopter money being used in the next 12 to 18 months in Europe or the United States.
But the market could speculate that Japan goes and then others go.
And so as investors, we need to think about what the consequences of that debate would be.
So what are the consequences?
If helicopter money did happen in Japan and others start to think about it, what does it mean for an investor?
Well, stepping back.
One message we've had is that the range of possible outcomes is very wide.
Unfortunately, this is not a definitive answer.
But I think what investors need to do is prepare themselves for a wide range of outcomes.
So we could get helicopter money, in which case, if it was adopted more broadly, that could signal a bottom in the decline in bond yields, which have been going down for 30 years.
It could stimulate inflation.
Maybe we'd get a bit more economic growth.
That could be better for equities, for example, than bonds.
It could be very good for gold, because it could bring a bit of inflation back but keep real interest rates low.
So that's one side of the equation.
On the other hand, helicopter might come in and might not be successful.
It might be brought in in rather a lackluster way.
It's not done very strongly.
And then the deflationary forces that are out there persist.
And so, unfortunately, I can't give you an answer as to what will happen.
But we feel most comfortable with this idea that the range of possible outcomes is wide and, therefore, you need to prepare for that as an investor.
So given all of that, then, what will this mean for fixed-income investors?
What will this mean for the elderly, for example, who have fixed incomes?
And what kinds of things should people be thinking about?
Well, for people who have had big parts of their portfolio in fixed income, if helicopter money came or aggressive fiscal stimulus came and it was enough to drive up growth and inflation, that could cause interest rates to go up a little bit.
We don't think it would cause interest rates to go up a lot.
But it could be challenging for fixed-income-oriented portfolios.
And I think what we're really recommending is, people focus on the merits of diversification.
That's the kind of follow-on from this idea that the range of possible outcomes is wide.
You want to have some fixed income in your portfolios because there are some deflationary forces in the world.
And interest rates, amazingly, to think it could actually go lower from here.
You want to make sure you've got some very high-quality equities, because if fiscal stimulus comes in and inflation comes back into the system a little bit and growth comes back, you want to have some equities there.
And we think gold can play a role in providing protection against either inflation or deflation and this kind of policy exoticism.
We think there are a lot of scenarios in which gold could provide protection.
So it's really this idea of diversification, which is leading to capital preservation.
We think capital preservation is absolutely crucial in this environment of very high uncertainty.
Bruce, thanks very much.
Great to be here.