First, let's understand the current economic picture that Deutsche Bank's Jim Reid is describing. We have five major economic indicators at historical extremes:
1) Corporate profits are running at 9-11% of GDP, far above their historical range of 5-7% that persisted from WWII until 2000
2) Asset prices (particularly stocks) are near all-time highs
3) Federal budget deficits are at historic levels
4) Trade deficits are also at historic levels
5) Wages as a share of GDP are near historic lows
What makes this situation particularly interesting is how these extremes are interconnected and have managed to persist together, despite economic theory suggesting they shouldn't. Let's examine why:
Traditionally, high government deficits would lead to higher interest rates as the government competes with private borrowers for funding. These higher rates would typically reduce corporate profits by increasing borrowing costs. However, this hasn't happened because of two key factors: the global savings glut (excess savings looking for investment opportunities) and quantitative easing by central banks, which have kept interest rates artificially low.
The globalization of business has also played a crucial role. It has allowed companies to:
- Access cheaper labor markets, keeping wage costs down
- Tap into broader profit opportunities beyond domestic markets
- Take advantage of international tax competition, reducing their effective tax rates
The sustainability question arises because these conditions represent a significant deviation from historical norms and create potential pressure points in the economy. Reid identifies several possible catalysts that could force a reversion:
The most immediate threats appear to be:
- The persistence of higher interest rates, which will eventually force companies to refinance debt at higher costs
- Rising wages, driven by either de-globalization or political pressure
- Supply chain disruptions from geopolitical tensions
The less likely but still possible threats include:
- Increased corporate taxation
- Stricter regulation and antitrust enforcement
Understanding this situation through a historical lens is important. The post-WWII period saw a more balanced distribution of economic gains between labor and capital, with corporate profits typically ranging from 5-7% of GDP. The current situation, with profits at 9-11% of GDP and wages at historic lows, represents a significant shift in how economic gains are distributed.
This imbalance raises questions about economic stability and social sustainability. High corporate profits combined with low wages could eventually lead to reduced consumer spending power, which might ultimately hurt corporate profits themselves. Similarly, persistent trade and budget deficits might eventually require adjustment, either through currency movements or changes in domestic saving and consumption patterns.
To understand why timing the "turning point" is difficult, consider that these trends have persisted longer than many economists expected, supported by structural changes in the global economy (like the savings glut) and policy choices (like quantitative easing). The system has shown remarkable stability despite being far from historical norms.
The key insight is that while these extremes may not be sustainable indefinitely, the forces maintaining them are powerful and deeply embedded in the current economic structure. Any significant change would likely require either a major policy shift or an external shock substantial enough to overcome these stabilizing forces.