Drawing a line between pricey markets and globalization: James Saft

June 26, 2014

June 26 (Reuters) – If global policy makers are wrong about
globalization, and they could be, we may be in for more low
growth, low rates and the high asset prices they support.

At issue is the bedrock belief that globalization lifts all
boats, making us all richer by allowing the flowering of
individual countries’ comparative advantage.

That some classes of people – low-skilled workers in the
West, for example – have not done well out of globalization
should by now be obvious.

The big question is whether this is a transitional problem,
a distributional one or something closer to a permanent

One person who has thought interestingly about these issues
is Stephen Jen, a hedge fund manager at SLJ Macro Partners. Jen
argues, picking up on points made by economist Paul Samuelson a
decade ago, that lagged effects of globalization may be behind
some of the peculiarities in both markets and economics we now

“Traditional economists have been puzzled by the
disappointing recovery in developed market employment and
capital expenditure. Globalization, we believe, could help
explain both puzzles,” Jen and colleague Fatih Yilmaz wrote in a
recent letter to clients.

While this is far from mainstream economics, it is worth
considering this line of thinking, and the potential
implications for financial markets.

One idea is that globalization, by introducing large new
supplies of labor from emerging markets, has changed the
relative supply and demand relationship between labor and
capital. That helps to explain increasing wealth and income gaps
and also wage growth suppression in the developed economies.

A supporting idea is that globalization is contributing to
the so-called secular stagnation that developed market economies
seem to find themselves in. With capital in demand and labor in
plentiful supply in emerging markets, money, in the form of
investment, flows to where it gets better returns. Developed
markets as a whole have had strongly negative net foreign direct
investment for decades, and even the U.S. has seen negative
figures since the financial crisis.

That lack of capex in developed markets is, in part, a
factor underlying both slow growth and poor job creation.
Combine this with demographic headwinds, and you may have lower
potential growth.

That, of course, is not how central banks see things, at
least thus far. The result, and implication, is that the policy
and growth mix we’ve seen – very low rates, very low growth and
very low inflation – are perhaps a feature rather than a bug.


What this has meant for asset prices so far is that riskier
investments have been very well supported by emergency policies
which far outlast the emergency.

The puzzling inability of the economy to grow strongly,
create jobs and drive wages higher is met by policy makers with
low rates and easy liquidity.

“For the financial markets, rather perversely, as long as
policy makers see the great financial crisis as an exogenous
demand shock (like an earthquake), the low inflation and the
still lethargic labor markets should allow the developed market
central banks to persist with their extreme policies,” Jen and
Yilmaz write.

“In turn, financial repression ought to keep asset prices
supported, all else equal.”

Much depends on how central banks read the evidence around
secular stagnation, and how their thinking evolves.

If central banks continue down the path they are now on,
using asset markets as a means to stimulate growth which may not
be all that responsive, you’d expect asset prices to remain
high, and debt markets particularly to be welcoming places for

That might seems like good news for investors, but it does
raise the probability of financial overheating and instability.
The market goes too far, too fast and eventually we find
ourselves in another crisis akin to 2008.

More interesting, if not more likely, is what happens if the
views of policy makers evolve more towards Jen’s. If central
bankers start to believe that low growth is here to stay, then
monetary policy will need to be normalized, if only to give some
leeway in advance of the next crisis or cyclical downturn.

That might prove good for the economy, in that it could
encourage structural reform, but would be decidedly bad for
asset prices.

The globalization debate won’t be ended in the next year,
but the one about when interest rates rise may well be.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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