Reserve Bank governor Glenn Stevens avoided discussing the Australian economy when he addressed the Anika Foundation luncheon in Sydney on Tuesday, but he did shed light on the wall of worry that the markets are climbing.
Subscribe now for unlimited access.
$0/
(min cost $0)
or signup to continue reading
Stevens said he had observed a number of economic and financial "episodes" over his career that were claimed to have been the worst since the 1930s Great Depression. One of his earliest pieces of research for the Reserve Bank looked for evidence to support the risible claim that the 1983 economic downturn in Australia was akin to the Big One. "It wasn't of course – not even close. Almost all such claims are greatly exaggerated," he said.
The events of 2008 and 2009 were an exception, however. Accounts of the global crisis by key decision makers gave a sense "of how close to the edge they thought the system came, and how difficult the task was of stopping it going over", Stevens said.
He said he thought the 2008-2009 global crisis had been well handled, partly because lessons from the 1930s were remembered.
Central banks added enormous amounts of liquidity to the system, banks and other financial groups were rescued to interrupt feedback loops that could have magnified the downturn, and just about every country adopted more expansionary fiscal settings.
Rescuing global financial giants raised a moral hazard and potentially encouraged market players to take on excessive risks again in the belief that they were "too big to fail", he said, "but it wasn't a basis for policy when facing imminent disaster ... the alternative was worse".
Stevens said coordinated fiscal stimulus was a crucial part of the response, but in the northern hemisphere it involved gearing up national balance sheets that were already debt-burdened.
There was not as much scope for fiscal stimulus as there could have been and pressure for balance-sheet repair arrived before economic recovery was entrenched. The central banks came under added pressure to provide monetary stimulus as a result and they had their own difficulties.
Official short-term interest rates sank quickly towards the "zero lower bound". Key central banks including the US Federal Reserve, Bank of England and Bank of Japan then bore down on longer-term rates with quantitative easing.
The aim was to get the cost of money down and encourage risk taking, Stevens said, and in the markets, it has worked. The "risk-off" bull market that began at the end of 2011 has been underpinned by cheap money.
The key question however, not just for central banks and governments but for investors, is whether or not monetary policy is working as effectively as it should be beyond the financial sector. As Stevens put it on Tuesday, whether monetary accommodation was making businesses in the real economy "more prepared to take a risk – on a new product, a new factory or process, an innovation, a new market or a new employee".
Citigroup's influential global strategist Robert Buckland argued recently that the bull market in shares still had legs.
Global real GDP was 8 per cent above its pre-global crisis high and nominal GDP was about 20 per cent higher but global earnings per share were still only 2 per cent higher, he said. Earnings yields (earnings per share as a percentage of share prices) had fallen as the bull market expanded, but still comfortably exceeded bond yields, which had plunged. Merger and acquisition activity was 32 per cent below its pre-crisis peak.
Buckland conceded that sharemarket floats had boomed, a traditional sell sign. BetaShares chief economist David Bassanese has also pointed out that while price earnings multiples on shares are broadly in line with long-term averages, the internet boom pumped multiples up to unrealistic highs between 1996 and 2002. Present multiples are above average if that period is excluded.
The fact that analysts disagree about how high the market really is in itself encouraging. Markets usually make tops when all the doubters have disappeared and hit bottom when pessimists are omnipresent.
The question Stevens raised on Tuesday about the breadth of risk taking is absolutely central to the bull market's durability, however.
Increased risk taking in the markets was probably could be "a trade off worth making" if the monetary policy that was fuelling it was also encouraging risk taking across the economy, he said. If however some years from now "we find ourselves looking back and concluding that such 'real economy' entrepreneurial risk taking has not really taken place, and all that has happened is that financial risk taking and leverage have risen, we would be disappointed".
Those who have been buying shares and other financial assets would be disappointed, too. The market is not stretched on all measures, but it is priced for a broadening of the economic recovery and Stevens says evidence of risk taking that would deliver it remains hard to read.
Trends for business investment and mixed to weak. Stevens also said on Tuesday that businesses seemed to be still be "more conscious of risk" than they were, something that undermines the power of cheap money. Their mood would hopefully change "at some stage", he said - but he did not put a deadline on it.