Is the U.S. experiencing “secular stagnation” as former Treasury Secretary Larry Summers argues, or is the cause of our economic woes a “global savings glut,” as former Fed chair Ben Bernanke has argued?
That is the key debate among economists and investment strategists today, and each view carries with it distinctly different investment implications.
Not everyone falls within one of these camps, though even GMO’s James Montier, who casts doubt on the legitimacy of both, acknowledges that most everyone else aligns with one of those two positions.
As for Research Affiliates, its May newsletter leaves no doubt where it stands on the issue: firmly in Summers’ secular stagnation camp, which is why the Newport Beach, Calif. firm’s 10-year capital market return expectations are so low.
“We currently expect about 0.7% average annual real returns over the next decade for both core U.S. bonds and core U.S. equities,” writes Shane Shepherd, the firm’s head of macro research.
The reason for the firm’s low return expectationsessentially comes down to its belief in the persistence of the negative trends slowing down the U.S. economy as opposed to Bernanke’s view that what ails the global economy is of a more temporary nature.
To Summers, inadequate aggregate demand—i.e., slower consumer spending and tepid investment—is the source of the slow economic growth and low real interest rates we have experienced since 2008, launching a period that Pimco (presciently, in Shepherd’s view) dubbed the “new normal.”
Rates must remain low under these conditions.
Indeed, according to Summers the Fed is actually constrained in its ability to lower them to the rate (called the equilibrium real interest rate) that is consistent with full employment and stable inflation—(because the Fed can only go as low as 0 in nominal terms while the current equilibrium rate is negative).
Crucially, chief among the reasons Summers provides for weak demand are trends—for example, continuing deleveraging from the housing bubble and aging demographics— that could take decades to play out. That is why Research Affiliates return expectations are low within its 10-year investment horizon.
In contrast, Ben Bernanke is more upbeat because the savings glut he views as the source of our current low growth could be ameliorated by overseas investment. Viewing the current weak growth as cyclical rather than structural, Bernanke thinks it is just a matter of time before the savings glut dissipates.
Indeed, the former Fed chair even specifies in his new Brookings blog what will trigger the new uptick in capital flows: “when the European periphery returns to growth,” he writes.
But Shepherd, who argues that conditions of secular stagnation are if anything more deeply entrenched in Europe and Japan than in the U.S., views the Bernanke position as overly optimistic.
“The secular stagnation-based outlook may seem glum, but is it any better to pin hopes for stronger U.S. growth on the economic recovery in Greece and Italy and the savings of the emerging markets?” he asks.
And no is his answer. Structural problems like slower population growth, productivity growth and deleveraging from high debt ratios “will continue to exert downward pressure on demand.”
Shepherd agrees that the global savings glut will take less time to correct, but when it does, the longer-term problems will remain, as will correspondingly low interest rates.
“We see evidence of secular stagnation continuing in the long term, and the consequent dampening of growth, as our nation’s and the developed world’s inescapable destiny,” he concludes.
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