The insurance industry is hurting. This is nothing new. With low interest rates, a lagging economic recovery and tighter capital regulations, the industry as a whole must look outside the box — and comfort zone — to other opportunities for revenue and growth if it is to remain a viable player in the world economy. And sometimes, that takes us far from home.
According to Eric Chaney, chief economist, AXA Group, “growth, return on assets, everything is going to come from emerging markets in the next several years. Emerging markets will always be at the center of the global economic development.” Speaking at the annual international media seminar last week in Bordeaux, France, Chaney also noted that cheap valuations provide rich soil for upward market sentiment gyrations.
But the crux of Chaney’s insights focused on the top three risks to the global economy. Those being:
- Fiscal dominance — According to Chaney, “blowing up balance sheets was politically easy, deflating them won’t be. The risk is monetary policy becoming an instrument of debt management.”
- Asset price bubbles — “If ‘low inflation’ has structural causes other than a lack of aggregate demand, liquidity injections may inflate asset prices instead of real demand.”
- Japan-ization – “In highly intermediated regions, flooding banks with liquidity may delay restructuring and therefore keep the economy in a slow growth trap.”
Chaney noted that fiscal dominance was the most likely (though not for two-to-three years) and a real threat to economies while Japan-ization was the lesser-likely, but still plausible, of the three.
When speaking about fiscal dominance, Chaney refers to inflation and how keeping short, real interest rates negative for long periods is a way to enforce Keynes’ “euthanasia of the rentier,” or to tackle fiscal issues by simply printing money. He also noted that friendly monetary policies give the incentive for governments to issue ever more debt. The risk of this is higher inflation, “even if central banks eventually react,” Chaney said.
As for the dreaded asset price bubbles, the economist noted that excessive cumulated monetary policy stimulus should raise inflation by stimulating demand beyond capacity. Bond vigilantes, as Chaney referred to them, should prevent that but it may not happen, he warns.
Chaney presented two cases: 1) Central banks may target bond prices, “thus inhibiting market signals” and 2) structural changes may destabilize the Philips curve (the relationship between the rate of inflation and the unemployment rate). The risk of asset bubbles is most concentrated in the U.S. (with high yield bonds) and the U.K. (with the housing market).
With Japan-ization, Chaney points to Milton Friedman, who said central banks should provide unlimited liquidity to prevent money contraction. “Taken too long, however, the medicine is likely to backfire,” Chaney notes. He also declared that liquidity may prevent restructuring and create “zombie companies” kept alive by banks becoming themselves zombie banks. Chaney says the antidote is for policymakers to force bank restructuring, therefore doing away with potential zombie banks. The risk of Japan-ization is low inflation, slow growth and low yields with casualties being equities and housing.
One risk not on his list but still an important factor to consider, according to Chaney, is the possible fragmentation of Europe. “There is a risk, some people say, of Balkinization in Europe,” he said. “Progressively, what has been built since 1948 can be destroyed.”