The New Normal

We may have mentioned the New Normal already a couple of times in our previous newsletters. The term was first introduced by Mohammed El-Erian, co-CIO of Pimco, in May and has triggered a debate among economists on what this means for the long future.

Let us first explain what is meant with this New Normal. Before the Great Credit Crisis broke out in 2007 we were used to robust economic growth numbers north of 3% year on year and a labour market which was close to full employment. The private sector was flourishing and benefitted from a world that got more interconnected.

Since the Great Credit Crisis 2007-2009 all this has come to an end and we will have to adjust ourselves to a new equilibrium which is created by more regulation, higher taxes, less leverage, lower growth and higher unemployment.

There are a number of valid reasons why it will be hard to return to the Old Normal for the next 10 or even 20 years.

The cycle of cheap credit, which was the fuel of the economic growth engine, is definitely behind us. The Shadow banking system collapsed and quite rightly regulators are looking at ways to shut that door for good. Of course markets move in cycles, and there will be again a period in the future where banks will be able to loosen their credit standards. But this will take time. The first phase of deleveraging of the banking sector is behind us. This was an abrupt and disruptive one. Now the second phase has started and should be more orderly. Nevertheless after the residential property market, commercial real estate and credit card write downs will force banks to deleverage their balance sheets further. This means that in the years ahead the supply of credit will be limited and this will be reflected in economic growth numbers.

Then there was the global imbalance of Asian and oil exporting countries that were funding the American spending spree. Although nothing fundamentally has been done yet about this problem, recent rhetoric from the BRIC countries (Brazil-Russia-India-China) shows there is growing caution to invest in US paper which is printed to finance the public household deficits. The Old Normal was based upon a model where the rest of the world was producing cheap products to satisfy American Consumerism and in return received US fixed income paper for it. THE solution to this problem would be that emerging market economies start buying the products that they produce themselves but this is not going to happen immediately and therefore growth will be at a much lower pace.

After the Lehman collapse the private economy imploded and governments all over the world had to issue rescue packages to avoid the global economy coming to a complete stand still. Apart from the banking sector which needed to be rescued anyway for the sake of the deposits of the public, the manufacturing industry needed a helping hand too. The US car industry for example was almost nationalised. Other industries got all kind of life lines and stimulus packages as well and most of them are still in place. Withdrawing these incentives would trigger a new turmoil. As Bill Gross, CEO of Pimco would say, the invisible hand of Adam Smith has been replaced by the visible hand of the public sector.

The US housing market could be considered as the crucial cylinder of the economic growth engine. After the collapse of the dotcom bubble the American consumer used his house in stead of the stock market to keep on spending via several creative refinancing techniques. As a consequence homeownership rose to approximately 70% in the US, but we now know that a lot of people should never have qualified for a home in the first place. At least not if prudent lending practices would have been applied by banks. Under the New Normal homeownership will drop again to pre-housing bubble levels of around 65%. As a consequence, this will not be a driving force for economic growth and the economy will grow at a lower pace as mentioned previously.

The gigantic stimulus and rescue packages issued by governments across the world have derailed the public finances and the taxpayer will eventually pick up the tab. In Europe everybody remembers a similar episode during the early eighties where tried to deal with the aftershocks of the Oil Crises. Fortunately they had the Maastricht Stability Pact to bring their finances back under control. However the problem now is the threat of the aging population in the Western World which is further going to jeopardise the public household deficits of European, American and Japanese governments. This environment will also contribute to lower economic growth.

We concur therefore with Bill Gross’s conclusions that the outcome of this New Normal will be an environment where rates will remain low for a considerable period of time, the USD will face serious difficulties, above average growth will come from new economies in Asia. He even adds two more valid points to this New Normal to be taken into account:
“The extent and duration of quantitative easing, term financing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories, both domestically and globally. Investors should continue to anticipate and, if necessary, shake hands with government policies, utilizing leverage and/or guarantees to their benefit.” (1)



(1)Bill Gross “On the course to a New Normal” Investment Outlook, Pimco, Sep 2009