Capitalism has always had its critics, but its ability to harness innovation and economic growth is unsurpassed. – Straight Talking

Welcome again to our regular Straight Talking column – written by senior financial planner at ipac WA, Bob Miller

Capitalism has always had its critics, but its ability to harness innovation and economic growth is unsurpassed. Some critics point out capitalism’s income and wealth inequality, but supporters can claim that appropriate government taxation and spending plans can be implemented to achieve an acceptable degree of economic security, for all members of society.

Capitalism’s most severe failures were on display during the 1930s Depression and in the Global Financial Crisis of 2007 – 2009. Notwithstanding, while Australia and most of the rest of the world have largely recovered from the worst GFC, capitalism is finding new critics. One group, a hard-left faction of the Greens Party is even dedicated to fight to bring the end of capitalism!

Perhaps the surge of criticism can be explained this way: it is intertwined with globalisation, the free movement of capital, goods and people.

While globalisation, with its free-trade ethic, has undoubtedly served to substantially increase total world wealth, and drag a fair proportion of the world’s  population out of abject poverty, it has also created some economic losers, especially in the US.

Direct competition with China has cost numerous US factory jobs. But it goes further than this. Wages in US labour markets exposed to Chinese competition have kept wages (and subsequent purchasing power)  lower than otherwise… a development well noted by Donald Trump.

Let’s consider the role of confidence in a capitalist economy. In many occupations, ability alone is no guarantee of success. But confidence plus ability is a priceless package,

Cricket lovers may remember such a package: the gum-chewing Vivian Richards, casually strolling out to face, without a helmet, the most terrifying bowlers. Richards’ confidence doubtlessly played an important part in instilling team belief and ensuring West Indies’ dominance of Test cricket for more than a decade.

Likewise, confidence is crucial to the well-being of any modern economy. Unless consumers have job security and confidence to spend and business operators the confidence to invest is productivity-enhancing plant and equipment, the economy will limp along, at best.

Sustained economic growth demands an appropriate amount of confidence about the future. The trouble is determining what is an appropriate amount of confidence? Too little is probably easier to identify than too much. It’s fairly easy to see when consumers aren’t spending much and retailers are forced to discount constantly, to generate revenue … or when businesses defer expansion plans.

But over-confidence is harder to read. Just when does confidence become euphoria, a condition known to warp one’s judgement? Assisted by ratings agencies which gave a triple-A rating to bundles of mortgage securities, US housing lenders had sky-high confidence in the years leading up to the GFC. Ignorance of the dangers of sub-prime mortgage securities allowed confidence to become euphoria and even more lending occurred, ensuring the subsequent crash was nastier than otherwise

It’s been a long haul recovery since the GFC of 2007 – 2009. In a bid to get economies back on track, central banks around the world forced interest rates to record low levels. This tactic failed to generate the expected surge in business investment. The likely explanation is that potential investors were more worried about the reasons for the decline in interest rates, sluggish economic conditions, than they were excited about cheaper borrowing costs. Business operators were worried because they felt central banks were worried enough to slash interest rates.

Significantly, it seems that economic confidence is returning. Both US and China appear to be in much better shape than expected by many. And in Australia there are three good reasons to believe that the economic fundamentals are becoming stronger. First business confidence in the somewhat battered but key state of Western Australia has risen to its highest level in nearly four years. Second, at the national level, mining and energy exports are set to hit a record $204 billion in 2017. Third, there is ample evidence to suggest that our agricultural sector is entering a new and more prosperous era, on the back of higher prices driven by export demand. Higher prices have coincided with the end of drought and money is starting to flow to rural centres and just about every rural business. At last, confidence has returned to the rural community.

Capitalism requires the willingness of some people such as Steven Jobs and Bill Gates to take risks and engage in innovation. It also needs a much larger number of established business operators to have sufficient confidence in the future of the economy to expand operations and hire more workers.

It will be fascinating to see if American capitalism can maintain its vitality in the face of threats from President Trump, in the name of US job protection, to slow down imports of Chinese goods. There are fears that such interference in free markets will lead to a trade war.

One of the benefits of studying history is that it gives us an insight into an understanding of the present. But is there anyone in the past who can give us an insight into how Donald Trump’s presidency might g? Donald Trump appears to be both unorthodox and unique.

In an economic environment where orthodox monetary policy has been generally ineffective, it is quite possible, in the absence of the trade war with China, that Donald Trump’s bag of economic tricks may end up giving the US and the rest of the world a dose of its most important economic medicine: confidence.

If you would like to discuss anything that you read here, feel free to contact an ipac WA financial planner today to meet with us in our Perth offices and see how change can impact you.

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