We recently received a newsletter from John Mauldin, an economist based out of Dallas that we follow very closely. In his piece, he outlined how several different nations have responded to struggling domestic economies and what the impacts of those actions were. We found his assertions to be quite interesting and wanted to touch on those this week.
When a country faces economic problems, ranging from stalling GDP growth to unsustainable federal debt, there are many routes that can be taken to counter these problems. Unfortunately, there is no one clear path that allows all parties involved to avoid any negative repercussions. Once all factors have been properly analyzed, nations must decide which route is best for them and their economy, which involves allocating financial hardship to the public sector, the private sector or personal savings. Mauldin outlines 3 separate models in his newsletter; The Swedish, the Finnish and the Japanese.
Japan has been in a deflationary economy since the late 80’s, which can take a devastating toll on a nation’s GDP. Between the Late 80’s and 2011, Japan’s economic policy involved protecting equity and debt stakeholders via government funds (i.e. bailouts), and their economy has failed to fully recover for over 20 years. These bailouts protect equity and debt stakeholders, but hurt the overall economy as the recovery time takes far too long. Recently, Japan has elected to double the size of their monetary base in an attempt to fix their problems (see Japan’s Double Down). This falls more closely in line with the Finnish model, which we will get to shortly.
The Swedes have pursued a policy of allowing business winners to thrive and allowing business losers to go through a structured bankruptcy proceeding. The US clearly has bankruptcy courts and proceedings as well, however over the last 2 decades we seem to have fallen in love with the idea of structured federal bailouts as opposed to Chapter 7 and 11 bankruptcies. While the Swedish model has proven time and again to be the best long term solution, wiping out bond and stock holders of business entities can have a negative short term impact on the perceptions of nation’s economy to investors.
Finland’s policy involves a sharp devaluation of their currency. While this results in a decrease in the nation’s debt burden by whatever percentage the currency is devalued, it also encourages exporting as domestically produced goods become more affordable on a global scale. While the exporting industries benefit (assuming you have other nations to export to), personal savings are negatively impacted.
The US has attempted a combination of the 3 models in recent years, with the Swedish model being most prevalent pre-2008, the Japanese model from 2008-2010 and the Finnish model from 2008-present. Unfortunately for our economy, another policy that has been pursued is the Zero Interest Rate Policy, or ZIRP. In this policy, banks can borrow from the Federal Reserve for nothing and loan to consumers or even back to the Fed and profit on the rate spread. However, those holding CDs and fixed annuities are hurt by falling interest rates, while tradable debt (i.e. long term fixed rate government debt) benefits from falling rates. Retirees who rely on fixed rate income (i.e. CDs) have seen their lifestyle devastated by falling rates in an effort to save the lending institutions.
By allowing rates to increase, it signals to the private sector that money is no longer as cheap as it once was, and we will likely see corporations and individuals rushing to lock in low interest rate loans. This would be one surefire way to spark a stagnant economy.
One thing is for sure, the economic policies that the US has attempted since the 2008 crisis have proven ineffective at increasing domestic GDP. Unless something is done, we can expect to see what Japan has seen for the last 20 years, stagnant economic growth.