Why has this world order been so benign?
Our story begins in the early 1980s. Inflation and interest rates began falling, underpinning a Golden Age of Capital. For nearly 40 years, assets from equities and bonds to art and classic cars have delivered substantial real returns. Buy and hold – with some teeth-gritting in bear markets has worked.
Two tectonic shifts in world order have shaped this era: the (re-)emergence of China, and the end of the Cold War. China and the former USSR added massive new productive capacity to global markets. If you add India which began dismantling its regulatory Licence Raj in 1990 – the three blocs added nearly half the world’s population to global markets in the historical blink of an eye.
US President George H W Bush heralded a “new world order”, in which American power would secure the world for capitalism, markets and democracy.
Great Power conflict was over, and defence spending – often inflationary – plummeted. A peace dividend freed funds for more productive ends. Rapid technological advances – particularly in computing power, communications and the internet – enabled businesses to take full advantage of the increasingly open world order. These political and economic shifts delivered an economic boom, lower inflation and unprecedented international peace and stability. Higher returns to capital followed.
President Bush was realising an American dream dating from the foundation of the Republic. On the 1782 Great Seal of the United States, beneath the unfinished pyramid, runs a proclamation: Novus Ordo Seclorum, a new order of the ages. The proclamation’s author, Charles Thomson, saw this as “the beginning of a new American Æra”. Hovering over the pyramid, the eye of providence casts its shimmering approval. Bush Senior was involved perhaps more than anyone else in cementing the US- led world order as the Cold War ended. The pyramid reached higher. His recent death comes just as the order he championed faces its own existential questions. The pyramid remains unfinished, and under renewed threat.
World order is now changing fast and not necessarily to investors' advantage.
Back to the 1990s, and dangerous currents are building. As capital chased higher returns in emerging markets, upward pressure on local currencies grew. Policymakers resisted, to keep exports competitive. Holding exchange rates artificially low, they recycled money back into global markets – especially US Treasuries and other dollar debt.
These price-insensitive purchases pushed down bond yields in the developed world. This drove both hunting and borrowing. Hunting on the part of income-hungry investors, who went seeking income elsewhere, including in the sub-prime securitised products that were at the epicentre of the Great Financial Crisis. Borrowing across the developed world, by households and governments. Much of this borrowed money flowed back into emerging markets, chasing returns and cheap goods. Which put upward pressure on emerging currencies. And so the cycle continued.
In this world of greatly expanded supply, inflation was naturally lower. But rather than adjust their newly minted inflation- targeting regimes for a world of disinflation - as opposed to inflation - Western central bankers kept monetary policy inappropriately loose, encouraging higher asset prices and more debt.
At least two asset bubbles inflated: dotcom in the late 1990s, and the Credit Crunch in the mid-2000s. With each crisis, interest rates have been cut to new lows, creating fresh credit and asset bubbles, and encouraging further debt and fragility. When rates hit zero in the late 2000s, unconventional measures such as quantitative easing were used. Interest rate distortions rippled through the financial ecosystem. Risk became widely mispriced. After a decade of extreme monetary distortions, it is likely that we are now in an ‘everything bubble’.