Over the last decade, the world has witnessed monetary policy that has aimed for aggressive growth in the aftermath of the global financial crisis in 2008. This drive for central banks to generate this growth has had enormous implications for the global economy. As the state opened the floodgates for cheap capital to roll out, the private sector’s decision making when investing has been impeded. This has been displayed by many enormous asset bubbles in various markets, as state driven market characteristics are becoming prominent in the world’s largest economies. The United Kingdom is no stranger to this, with interest rates at near record lows and one of the largest housing bubbles on the planet. The overarching problem with this is the increased incentive to leverage, rather than to enter markets with greater earning opportunities through low tax rates.
Leverage in the UK’s private sector has grown considerably due to aggressive state-driven monetary policy which has incentivised borrowing. Private sector debt as a % of GDP has increased significantly across the OECD countries, with the UK private sector’s debt as a % of GDP increasing from 153% to 230% in the last 20 years. Credit has been abundant and this has allowed businesses to invest and expand. The issue with this is that the more aggressive the public sector becomes with this policy, the less visibility the private sector has in the way they spend and invest. This has been particularly favourable to those market participants who possessed collateral assets against which they could borrow, meaning those without the collateral are disadvantaged. To the government’s credit, they have combined this monetary policy with decreases in the corporate tax rate over the last decade. However, the result has still been a private sector with a balance sheet loaded up with debt.
The growth in borrowing has also flowed through to rapid increases in household debt and the price of housing in the UK. When compared to wage growth, the average home is over 7 times the average annual salary. In the book, Between Debt and the Devil, by Lord Adair Turner, bank mortgage lending secured on housing collateral is described as pro-cyclical. This means the more home values rise, the more the collateral is worth and banks will lend more against it. Lord Turner goes on to say “Lending against real estate generates self-reinforcing cycles of credit supply, credit demand and asset prices”. Gross household debt to income in the UK is predicted to continue to rise towards pre-2008 crisis levels. The average household owes a record amount of £12,887, even before mortgages are taken into account. This increases vulnerability to an economic shock, as households focus on their debt relative to their incomes and cut spending heavily. There is generally no spending to counterbalance this in a period of uncertainty and the economy is hit hard.
This has all contributed to a situation where public sector announcements have become the primary triggers that move markets. Central banks and governments around the world are able to move markets with announcements more than earnings data can. The public sector doesn’t have cycles like the private sector. Investment theory evolved around private sector cycles. If these cycles are thrown off and dominated by the public sector’s activities such as, investment in infrastructure and central banks printing money, then true and unhindered investment by the private sector cannot happen. It almost gets to the point where the state decides where capital goes. When the current wave of populist sentiment around the world is factored into the situation it paints a scary picture. An attitude of “we are not happy, so we shall use the state to take control and make changes” is resonating strongly in both Europe and the United States. This is eerily creeping towards a similar situation to the 1930s in Europe, which saw a movement towards more power to the state.
So what need to be done to get on the right track? The private sector is inflated and won’t recover until most of the debt gets written off. Nobody wants this, as it wipes away years of potential growth and significant defaults are likely to be necessary. Even if populist-elected governments come into power they tend to always avoid radical solutions, even if they were promised. The incentive to leverage must be discontinued and the private sector must be allowed to readjust with time, while having an incentive to expand through the generation of earnings. This means incentivising new entrants to marketplaces by lowering taxes and providing an opportunity to earn. Lower tax rates allow businesses to reinvest their own profits towards the expansion of operations, rather than through borrowing. Decentralisation of taxation zones is one way to go. This means splitting up larger regions that operate under a single corporate tax rate into a group of smaller regions to compete for market participants through lower tax rates. The goal of this decentralisation would be the creation of a marketplace in taxation which allows regions to attract investment and economic activity through the establishment of attractive economic environments.