Sir Isaac Newton’s third Law of Motion states:
‘When one body exerts a force on a second body, the second body simultaneously exerts a force equal in magnitude and opposite in direction to that of the first body.‘
This law of physics has been widely interpreted as ‘for every action there is an equal and opposite reaction’.
Newton’s laws of motion have been in existence since 1687. Therefore it’s reasonable to assume they’ve passed the test of time and are in the irrefutable category.
The law of gravity is also irrefutable. Sadly poor old Sir Isaac Newton forgot this one when he invested in the early 18th century South Sea Bubble.
Reports suggest Sir Isaac lost a £20,000 (£268 million in today’s money) fortune in the bursting of the South Sea Company share bubble. Reflecting on the catastrophic loss, he remarked, ‘I can calculate the movement of the stars, but not the madness of men.‘
Newton was obviously a seriously smart man but the ‘need for greed’ overrode rational thinking. Therein lies the lesson for those of us who have much lesser IQ’s. Don’t think you’re smarter than the market and don’t let greed blind your objectivity.
Newton could easily apply his theory and personal lessons to the economic malaise we find ourselves in today.
- For every action there is a reaction
- What goes up must come down
- Smart people do dumb things
From 1980 to 2007, the western world (not just an isolated country) went through a credit expansion unmatched in the history of money.
Questions That Need Answering
The Great Credit Expansion of 1980 to 2007 lifted all boats. Share markets posted 1,500% returns; property values increased ten-fold (based on Melbourne median house prices); GDP rose; government revenues increased; household incomes rose; the financial sector ballooned.
When you hear economic commentators saying ‘we are waiting for a return to normal conditions’, they must truly believe the 1980 to 2007 period was ‘normal’.
If that’s true, then in 2040 the All Ords index will be 75,000 points (15x current level) and the average home in Melbourne will be worth over $5 million (10x current median value). That’s possible, but it’s not certain.
In some ways 27 years is a long time – for instance, a jail term or a marriage (in some quarters these are one and the same). However, in the context of life on earth 27 years is a blink of the eye.
The first Industrial Revolution in northern England began around 1750. The second Industrial Revolution (coming mostly from the US) started around 1870.
For the tens of thousands of years that preceded these dates, the global economy made glacial progress. In the pre-Industrial Revolution days, some estimates say it took up to 300 years for living standards to double.
Mechanisation and electricity were major game changers. Better sanitation led to longer life expectancies; electrical appliances allowed women to leave household chores and enter the workforce; and machinery enabled more food production, leading to population growth.
Was the 1980 to 2007 period simply the ‘cherry’ on a productivity cake that was 250 years in the baking?
For those looking for a return to ‘normal’ here are some questions to ponder:
- Will the workforce get another productivity boost from women entering it?
- Can the world’s resources support a global population rising at the rate of the past century?
- Will we see another baby boomer generation or are families opting for fewer children?
- If life expectancies continue rising, where will governments find the resources for healthcare and welfare?
- Do governments have the capacity to increase public debt from current levels?
- If robotics is in our future, what will this do to unemployment levels in the unskilled and semi-skilled workforce?
- Each generation has wanted to educate their children to a higher standard. What happens when all youth have tertiary qualifications (and the debt to go with it)? Where to after university?
Perhaps we’ve seen the best of times as far as global growth is concerned – peaking with the baby boomers’ three decade long credit binge.
I concede there may be something in our future that turns all this on its head. Another Industrial Revolution type event that is such a game changer it enables the world to power ahead.
But even if there is, you can measure in decades the lead-time for the benefits of these rare and momentous events to eventuate.
According to historians it took well over thirty years for the economy to register the impact of the Industrial Revolution. Even with technology beginning in the 1980′s it’s only recently we’ve witnessed its impact on global commerce.
So unless the next big thing happens soon, all the pointers suggest global growth has run into severe headwinds. Nearly three hundred years of continuous growth may have reached an end.
This is where the equal and opposite theory kicks in.
The laws of physics tell us contraction follows expansion.
My belief is history will record the GFC as the official start of The Great Credit Contraction.
The bell rang on credit fuelled consumption and investment in 2008. In the five years since the GFC, the private sector hasn’t strayed from its chosen path of debt reduction and/or saving.
Any GDP ‘growth’ in the past five years has been quantitative, not qualitative. The Botox of government deficits has masked the ugliness of the underlying economic numbers. The US Government runs an annual budget deficit over $1 trillion (money they don’t have by the way). This is 7% of their $15 trillion economy.
Take out the printed $1 trillion and the numbers look awfully saggy. The injection of $1 trillion is quantity NOT quality.
The Great Credit Contraction is a far more powerful force than a handful of central banks. It’s the collective decision making of hundreds of millions of people to not only change their consumption habits but also how they fund their reduced consumption.
How the Economic Landscape is Changing
A recent Boston Consulting Group survey on consumer habits prompted the following headline: ‘Retailers now facing jaded consumers’. The article went on to say: ‘Australian retailers are facing critical challenges as more and more people spurn commercialism and choose to save for retirement, research shows.‘
There are two things at play here that could worsen this already dire prognosis:
- Each year, as wave after wave of baby boomers reach retirement, consumption numbers could soften further.
- Another GFC-like (or worse) downturn (which on balance is a 50/50 bet) would make consumers even more cautious – worsening the already soft consumer numbers.
These altered spending habits aren’t unique to Australia. This is a global trend. Charles Gave of GK Research recently produced the following chart on US job creation – full-time and part-time employment – since 1976.
Since the Tech Bubble peaked in 2000, full-time employment has gone down and part-time employment has gone up.
Note the big peaks in US full-time employment came during the 1980 to 2000 US share market boom. That’s when the S&P 500 increased from 100 points to 1,500 points, and spread around the paper wealth. But as soon as the music stopped, the trend changed.
Guess what? Do you think part-time employees earn as much as full-time workers? Not on your nelly. This next chart tracks the net losses of full-time vs part-time (red line) and the decline in income levels (black and dotted lines).
While the headlines shout about an increase in US employment (again this is quantitative) the reality (qualitative) is different. More lower-paid employees don’t build the foundation for economic recovery.
And with statistics worse than the Great Depression, Southern Europe is an unemployment wasteland.
The Great Credit Contraction is altering the employment and remuneration landscape.
The central bankers are looking for consumer revival, when in reality it’s all about consumer survival at present.
That leads us to the second theory – what goes up must come down.
We’ll continue that tomorrow…
Vern Gowdie
Editor, Gowdie Family Wealth
From the Archives…
Is This the Spark to Send Australian Property Crashing?
26-07-2013 – Kris Sayce
Why it’s Deflation…Not Inflation, that’s Heading Our Way
25-07-2013 – Vern Gowdie
Why You Must Avoid This Big Investing Mistake…
24-07-2013 – Kris Sayce
The Dark Side of Technology: Part 2
23-07-2013 – Sam Volkering
The Dark Side of Technology: Part 1
22-07-2013 – Sam Volkering
