In my view, the repeated monetary interventions of recent years have been an attempt to contain the unfinished effect of the 2008-2009 economic downturn. I believe that the global economy is moving into another recession because policymakers have not effectively addressed the debt problems that produced the first one, leaving the economy unusually vulnerable to aftershocks.
To understand where we are, it is helpful to understand how we got here. In the U.S., lawmakers repealed the Glass-Steagall Act in 1999, removing the firewall between traditional banking and more speculative activities, and allowing those activities to have the effective protection of the U.S. government. This combination, in my view, helped to encourage speculation that resulted in a U.S. housing bubble and subsequent mortgage crisis. In Europe, a currency union was created without adequate control on the government deficits of individual countries, allowing peripheral European countries to run large budget deficits and finance them at the same interest rates as their stronger neighbors. The global recession and collapse of employment in 2008-2009 increased the strains on government revenues, while governments attempted to avoid the restructuring of bad debt by rescuing private lenders at public expense. As a result, government debt has increased dramatically both in the U.S. and in Europe.
With regard to stock market valuations, we presently estimate that the S&P 500 is likely to achieve a total return (nominal) of only 4.5% annually during the coming ten years. While prospective returns have been lower at certain points in the past 15 years, these low prospective returns were invariably followed by steep market declines that ultimately provided better opportunities to accept market risk in the pursuit of longterm returns. Valuations appear less elevated on measures that emphasize near-term earnings estimates, but these estimates reflect corporate profit margins that are nearly 70% above their long-term norm (a fact that appears closely related to depressed savings rates and unsustainably large government budget deficits).
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