After the panic button has been pushed

Virtue is not optional. In our financial markets, it was fascinating to see "outdated" virtues such as prudence, self-control, frugality, delayed gratification, honesty and humility suddenly gain more traction as the crisis intensified.

January 30 th 2009

"It is not true, as is sometimes said, that man cannot organize the world without God. What is true is that, without God, he can only organize it against man."

During 2008, this insightful statement of the late Henri-Marie Cardinal de Lubac was proven viciously true to investors around the world. The lack of ethics of too many financial market participants over the past few decades finally caught up with us, dramatically lowering nearly all asset values globally and freezing up trust (also known in the financial world as "credit"). It was fascinating to see "outdated" virtues such as prudence, self-control, frugality, delayed gratification, honesty and humility suddenly gain more traction as the crisis intensified.

Virtue is not optional. For its financial markets to function effectively while its governments submit to proper limits on their power, a civilization requires substantial reserves of moral capital.

The global financial markets, until recently propped up by an asset bubble, now attest to this fact. The credit crisis began in mid-2007, gathered steam until late 2008, and exploded into the world's greatest financial calamity since the Great Depression. Governments around the world responded with gargantuan financial institution bailouts, the nationalizing of corporations, aggressive and coordinated reductions in interest rates, and unequaled increases in money supply.

The consequences of asset bubbles are serious, and can be long lasting. The bubble that popped in recent months was fuelled by excessive liquidity, inappropriate global trading imbalances, and escalating debt funding unsustainable consumerism. Much of this debt was securitized by Wall Street and sold around the world—backed by non-credit-worthy consumers living in overpriced and overleveraged homes. In the United States alone, each $100 growth in total debt in the last decade was only supported by $19 of growth in GDP.

Because of the amount of debt now entering the global markets, central banks around the world have focused on avoiding a catastrophic deflationary spiral. As this excess debt is unwound, asset prices, along with investment and consumption, will continue to fall until they adjust to healthier, more sustainable levels. This adjustment process is painful, and will involve a period of falling industrial production, slowing retail sales, low consumer confidence, weak or declining housing prices, and—indeed—higher unemployment. But many of these adjustments are well underway as consumers and businesses responsibly bolster their balance sheets by saving more and reducing their debt.

How recklessly will governments around the world act, racking up large debts to justify large budget deficits, in order to "stabilize" economies that actually need downsizing? We do not need bigger, inefficient and nonproductive governments to continue their expropriation of increasingly larger portions of the global economy. We need leaner, more honest governments, along with citizens who will take increased responsibility for their own actions.

The impact of the adjustments in asset values around the globe in 2008 was dramatic. The global stock markets lost approximately half their value. In the United States, the Standard & Poor's 500 index experienced its largest annual drop since 1937. Many investors are wondering how to get asset values to go back up, and how to get out of the grips of this nasty bear and back into the arms of a bull.

Bull markets do not materialize from nothing; nor do they automatically appear after a downward move in the markets. Powerful bull markets are the result of a combination of several things: government policies that favour economic growth, stable or declining tax rates, limited government intervention in business life, prudent business practices, growing populations, product innovations, legal protection of property rights, fair competition, and access to capital generated by real savings.

If we want to grow our wealth, we must shape an economic sphere that will allow for sustained economic stewardship. We should be asking these kinds of questions:

  • What kinds of government policies favour economic growth? Which governments are adopting such policies?

  • How do we cope with the rising tax rates that will inevitably accompany rising government debt?

  • How are governments getting involved in the economy, locally and globally? Are governments paying heed to the proper and prudent limits to their economic interventions?

  • Do the cultures that have enabled the development of large economies retain the moral authority to inculcate the necessary virtues in their populations? Can we restore lost trust and confidence in our economies and their participants?

  • Where in the world are there vibrant, innovative and growing populations? How do we recover such populations in aging societies?

The last questions on my list are closely related to the unfolding of economic possibilities over the next two decades. Countries such as China and India will be most significantly affected by a drop in fertility as the world population ages. There has been a dramatic reduction in the number of children born per woman in the last three decades. A few decades ago, the average family had more than four children, but the increased ability to control pregnancies has led to a global birth rate between 1.2 to 1.6 children per woman. The sustainable level is 2.1. This means that with each generation, we will lose between 30 and 50 percent of the world's population. Although this will not cause an absolute drop in the world population for another 30 years, we cannot ignore the effect this will have on the world's economy.

Russia and Japan, each already experiencing more deaths than births, are in the grips of a death spiral that will reach country after country over the next 30 years. The European Union, next in line, will face tremendous difficulties, as its social welfare state system is unsustainable in the long run without a properly-sized next generation able to pay for the costs of that system.

Many economists view the drop in family size as a positive. They argue that families with fewer children can consume more goods and leverage themselves nicely with two incomes. The result is called the "demographic dividend." The way economists tabulate our GDP says that, in the short run, we are "better off" if we reduce the number of children per family. But this argument uncovers the short-term view of modern economics with regard to economic production. The current generations have significantly reduced family size while consuming at unprecedented rates. In our over-consumption, we have more than spent the "demographic dividend" by piling up irresponsible debt—and now it is payback time.

Fewer children means fewer people to pick up and pay for the accumulated debt. Population growth and the human capital it creates are the foundations upon which modern economies, as well as modern welfare states, are built. Our global financial system has become capitalized for prosperity and growth alone, and is not prepared for the alternative. The many under-funded private and public pension plans around the world, for example, will stay under-funded until they renege on current promises and redefine future obligations in light of the new reality.

Now that the panic button has been pushed, it's time for leaders to look honestly at the problem. We face grave challenges around the globe as we try to bring stability in the midst of a world swimming in debt and unsustainable promises. Growth in capital is a long-term process underpinned by discipline, hard work and sacrifice. True leaders must balance the needs of this generation with the needs of future generations. We need leaders with character, vision, integrity, courage, understanding, the power to articulate solutions, and a strong sense of providence.

In practical terms, this means we are to invest for the future, spending only what we have and avoiding the trap of consumerism and materialism. We must also remember that God is sovereign, and despite the challenges we face, Jesus Christ is on the throne and is moving history forward to its appointed end. And we must also produce children who will help, by God's grace, to extricate us from our longer-term predicament!

Topics: Culture Markets
 

Jonathan Wellum has a distinguished career in the financial industry, holding various positions including his present role as the CEO and CIO of RockLinc Investment Partners Inc. He was formerly the CEO and CIO of AIC Limited. He has twice been recognized as Fund Manager of the Year and in 1999, was recognized as one of the "top 40 under 40."

Bio