What Washington and Frankfurt should learn from New Delhi’s doctors
Eastern hemisphere doctors and Europe’s central bankers are world’s apart, and not just geographically, says Pimco’s Neel Kashkari.
Their philosophies are also diametrically opposed to one another, says the head of global equities in Pimco’s Newport Beach office.
One uses Eastern treatments to prevent an illness like the common cold.
The other, in Europe’s central bank uses Western remedies (cheap credit) to try to fix the symptom of the illness of banks and nations (too much debt), but this fails to tackle the cause.
The European Central Bank offering almost unlimited three year loans at 1% to banks “takes the risk of default for a European bank virtually off the table”, says Kashkari.
“But by itself it does nothing to cure the underlying disease.”
The same is true for the eurozone’s most indebted countries – “Their underlying sickness is they have taken on too much debt, their societies are spending more than they can afford and their economies are growing too slowly to support their debt loads. Liquidity is buying them time, it is a bridge.”
And the same is also true for America, Kashkari says.
“The disease is a 30-year addiction to debt-fuelled consumption and we do not know hot to quickly create new sustainable engines for economic growth.”
Most economic policy since 2009 from Washington, like most from Frankfurt, has just bought time, Kashkari says.
He then highlights how important consumption – with or without a credit card – is to US economic activity, growing from 62% of GDP in the 1960s to over 70% now.
The stimuli to spend offered by Washington – think of ‘Cash for Clunkers’, payroll tax holidays, low rates and printing money – “have been effective and the economy has almost returned to normal”, Kashkari says.
But has private indebtedness returned to normal?
The percentage of disposable income US households have will have to fall by 15 percentage points to return to its long-term average between 1955 to 2000. Since 2000 it ballooned sharply above this long-term average.
McKinsey Global Institute said last month this long-term trend line would be reached again by mid-2013, when Americans have debt to income of 100%.
Kashkari then asks, is the trend of the US household debt ratio to grow good, and sustainable?
From 1960 to the mid-1980s Americans saved on average 8% of income, but then spent more than they earned in the mid-2008s, then went back to ‘only’ zero savings by 2008.
Now that went back to around 6%.
The problem is Americans have fuelled increased consumption in recent quarters by cutting saving rates – dangerous in Kashkari’s opinion.
He says we will have to see four factors at the same time before we know American consumers have been ‘cured’ of their using debt to fuel consumption:
Total consumption dollars go up while…..
The unemployment rate falls…….
The savings rate stays high, and……
Consumption as a percentage of GDP stays flat, or falls.
“Increased consumption spending fuelled by more Americans working and saving is a good thing and should be a goal of policymakers. Consumption fuelled by temporary stimulative policies or reduced savings is just a nasal decongestant. It makes the headline economic data look better, but it doesn’t move us closer to actually healing the economy.”
Until we see this, says Kashkari, equity investors should favour global companies with strong balance sheets selling to growth economies.
And “carefully scrutinize the assumptions underlying consumer discretionary stocks. Markets are used to assuming companies and industries can automatically return to trend growth once an economic shock has passed.
“Just as there is no reason to assume household debt levels will continue to climb, there is also no reason to assume companies that benefited from that debt fuelled spending will grow at historical rates.”