, September 28, 2021

The markets are terrified of technology creating a productivity boom


  •   3 min reads
The markets are terrified of technology creating a productivity boom

They don't realise it yet, but markets are terrified of technology, creating a productivity boom, creating higher interest rates; market valuations are built on a Luddite philosophy.

Stock markets have got it back to front: they have given asset prices, including shares and bonds, huge valuations based on 20th-century logic. The reason lies with a simple piece of logic that has almost perverse implications for stock markets.

As this paper explains, low growth in productivity and low-interest rates are correlated in the long run.
The narrative that low-interest rates is a good thing is wrong because low-interest rates are a symptom of an underlying problem.

Why have interest rates been so low this century and especially since 2008? Answer because productivity growth has been so low.

Let me define a few concepts

When I say interest rates, I refer to real rates (that's the interest rate minus inflation.)

By productivity, I mean output per hour worked. The hourly productivity rate of the economy is total output divided by total hours worked. Growth in productivity per hour is a function of growth in output relative to growth in hours worked
Productivity matters; in fact, Nobel winning economist Paul Krugman once said, "productivity isn't everything, but in the long run, it is almost everything."

By asset prices, I refer to, among other things, equities, bonds and house prices. (But you could include art, digital art, Bitcoin, wine and a first edition comic collection, etcetera under the heading asset prices, too.)

Bond prices and bond yields have an inverse relationship. When you buy a bond, you receive a regular payment or coupon. The lower this payment, the higher the bond price, as you have to pay more to receive a certain level of income. So, if bond yields start to rise, which they have been doing of late, bond prices have fallen.
Equities are meant to be valued by projecting future profits (or dividends) into perpetuity and discounting them by a rate of interest to get a net current value. In other words, a company's valuation is meant to be a function of future predicted success and interest rates.

The perverse relationship

You would expect stock market valuations to reflect the economy. If the economy is strong, one could be forgiven for assuming stock markets will be strong. Sometimes this relationship works, but a strong economy often means higher interest rates, which the markets hate.

The result can be a disconnect between Real Street and Wall Street.

The panic over good news

Technology should lead to higher productivity.

Remote working means output can be achieved by spending less money on travelling — that's good for productivity.

Technology Boom Beats Inflation!

Technologies such as RPA should automate many of those time consuming, monotonous tasks most of us hate — that's good for productivity.

Is RPA really a trillion-dollar market?

Everything is good then

If technology creates productivity growth, then, to use Paul Krugman's dictum, doesn't that mean everything is good?
Well, that depends on jobs. If productivity growth leads to job cuts that will hurt if we can maintain productivity growth and high employment, that is wonderful.

Times of high productivity growth almost certainly need to be accompanied by government stimulus, maybe in the form of spending on infrastructure, perhaps even in universal basic services, such as free healthcare or universal basic income.
But as I said above, high productivity should lead to higher interest rates.

And that's the problem. If technology does indeed create a productivity boom, interest rates should go up. Markets are currently confused. One moment they buy in a celebratory mood over technology; the next moment, they sell in fear of higher interest rates.

But the logic is perverse. The markets are effectively saying we are selling over the prospect of good news.

What does this mean?

If productivity growth is high, this means:

  • higher interest rates;
  • and if markets don't like higher interest rates,
  • and higher interest rates make it more expensive for governments to borrow
  • and if higher productivity leads to job losses without government spending
  • and market panicking over higher interest rates make it harder for companies to raise money... we have managed to let the good news about productivity growth create an economic crisis.

The government could solve this by resorting to the money printing print and scatter money across the land as if from a helicopter— what they call helicopter money.

But such an approach is only viable if we see a productivity boom.
Helicopter money, or it's close cousin, modern monetary theory is viable if the fourth industrial revolution turns out to be as innovative as its supporters say.

This debate boils down to technology, creating growth in productivity, plus, just as important, that policymakers understand this.

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