As an economist by training, I'm always interested in looking at financial markets from a policy perspective. How are policy makers influencing the global economy and how do their policies affect the environment in which long-term investors like Swiss Re operate? Particularly the low interest rate environment is having a big impact.
In the last two years, we've actually researched the cost of what we call "financial repression", meaning the unconventional, loose monetary policies by policy makers and central banks globally of keeping interest rates low to help to finance the public sector’s debt burden. To say the last, that cost turning out to be much higher than the benefit.
Now, we also want to better understand of how financial markets are distorted by this financial repression. Therefore, I recently made a trip back to my alma mater, the London School of Economics and Political Science (LSE), to take part in a roundtable discussion on structural reforms and capital markets. Swiss Re and the LSE have teamed up in a research partnership to investigate the stability of financial market and the health of private capital markets – specifically looking at the environment in which long-term investors operate.
During the conference, which was held on 14 November, we already presented some first, very preliminary results of our research collaboration, mainly looking at the role of central-bank balance sheets for capital markets and the effect of loose monetary policy on structural reforms. The common theme is that understanding the potential consequences of today's macro and policy environment on long-term investment is crucial for safeguarding financial market resilience – so watch this space!
Just look at the subdued economic growth over the last few years: GDP growth in advanced economies dropped from 2.8% pre-crisis to 1.9% post-crisis. Also consider the high public debt: government debt in advanced economy grew from 71% of GDP in 2007 to 105% of GDP in 2015. Lastly, government debt with negative rates today stands at about USD 9 trillion (this number was zero back in 2007).
These figures show the dialogue around sustainable, economic growth-enhancing recipes needs to continue. Today's macroeconomic environment is weak and unstable. The level of global debt is at record highs, while interest rates are at record lows.
Central banks have become part of the problem. For example, with the four largest central banks currently holding between 20-40% of their domestic government bond markets, central banks have become a dominant player in financial markets. This dominance, however, has important unintended consequences: financial markets are not functioning as well as they should, while economic and financial risk taking are out of sync.
In addition, inflated asset prices and lower liquidity in previously liquid markets put financial stability at risk. With the effectiveness of central bank policies approaching their limits, the question of "What's next?" often arises. To make the world more resilient, Swiss Re wants to play its role and contribute to the global policy dialogue through proposing approaches to strengthen private capital markets and increase economic growth.
When it comes to central bank, I think less would be more. Low interest rates are an implicit tax on savers, they harm financial market functioning and weaken the stabilising role of long-term investors. The point where the benefits of central bank actions outweigh the costs is behind us.
In addition to a monetary policy normalisation, a comprehensive policy reform agenda is needed to lift economic growth more sustainably. Concrete structural reform priorities would ideally be coupled with targeted fiscal spending into productivity enhancing infrastructure. To finance the emerging infrastructure gap, Public-Private Partnerships could take a more prominent role.
Meanwhile, more risk-sharing sovereign bonds could help deal with the enormous amount of debt and give governments more fiscal flexibility, making the implementation of longer-term and growth friendly policies easier. I think the time has come to depart from the "more of the same" policy approach.
To strengthen private capital markets, to sustainably lift potential economic growth and to have a more inclusive economic environment, innovative private sector solutions are needed. Long-term investor need to better access risk pools and finance the real economy. It is a "win-win".
As you can probably see, I'm passionate about this topic and I'm happy to say that Swiss Re and LSE will continue their research programme well into 2017 to help figure out a road ahead, away from this "big ease" of loose monetary policy.
If you'd like to find out more, please drop me a line or feel free to comment, I look forward to hearing your thoughts.
Location: London, United Kingdom