In the day’s first panel, Jay Clayton led a fireside chat centering on macroeconomic developments, risks in the system, and the outlook for our capital markets.
The SEC recently brought together current and former government officials and experts from different areas of the private sector to explore and discuss the ever-changing economic, risk and market environment at The State of Our Securities Markets conference. Areas of focus included global macroeconomic trends, and their impacts on our capital markets, as well as changes to the global equity and credit markets, including how today’s markets differ from those of the early 2000s.
In the conference’s first panel, Chairman Clayton was joined in a fireside chat to discuss current global macroeconomic trends affecting the capital markets by Gary Cohn, a former Director of the National Economic Council, and Glenn Hutchins, Co-founder, Silver Lake Partners, a $39 billion private equity firm with a focus on technology investments. Their discussion covered a wide range of topics including monetary policy and deflationary trends, the recent tax legislation, trade policy and tariffs, structural changes to the economy and the impact of technology change, Brexit, and the role of regulation in the U.S. capital markets.
Where we’ve been and where we might be going. Jay Clayton led off the questioning by asking his fellow participants how technology is impacting the markets today and how they think things might look ten years hence. Hutchins observed that a stock transaction 20 years ago cost the customer a 1/8 to 1/4 spread, a commission charge, and then took five days to settle. Today, trades can be executed in microseconds and the costs of transacting are negligible. He sees the changes coming in the next ten years to be just as dramatic, if not more so, noting the only constraint with respect to timing issues will be the speed of electrons.
Cohn, while generally agreeing with Hutchins’ views, expressed concerns that the U.S. was on the fringe of losing its leadership position with regard to technological innovation. Specifically, he pointed to payments technology in China and more generally to the increased digitization of assets. While noting the that the U.S. still dominates world markets, he observed that we can’t be the slowest animal in the pack and survive. "The regulators have to lead," Cohn proclaimed as he not so subtly directed his gaze towards SEC Chairman Clayton. Cohn added that we need to figure out how to use the internet to move value at the speed of light and come up with a regulatory paradigm that facilitates that. "We cannot require new technologies to accommodate to old regulatory structures," he noted.
Growing the economy in deflationary times. Cohn noted that in response to the 2008 financial crisis governments tried everything to introduce liquidity into the system and we continue to suffer from that overhang. He pointed to negative interest rates in Japan and extremely low interest rates in other industrialized countries. He observed this has had unintended negative consequences including disincentives to save and invest. Cohn also pointed to what he views as tremendous regulation thrown at the financial industry in the wake of the financial crisis. As a result, Cohn observed that many financial service jobs have been exported to Bangalore, the Philippines, Poland and other lower cost jurisdictions in search of cheaper and cheaper labor. "We need to figure out how to take liquidity out of the system," Cohn stated. He noted shrinking the Fed’s balance sheet is a good start and serves this end.
Hutchins conceded that demographic trends and lower productivity are obstacles to growth but challenged the assertion that we are properly measuring productivity. He noted our transition from an industrial to an information economy has resulted in inherent difficulties in measuring associated productivity changes. He pointed to the iPhone which has dramatically reduced costs on many fronts but which don’t necessarily make it into the economic statistics.
Cohn added that 80 percent of our economy is devoted to service activities. He pointed to the outsized role played by airplane tickets, Moore’s law and real estate being devoted to service activities (as opposed to manufacturing). He noted all of these have deflationary impacts on the economy.
Risks in the system. All of the parties concurred that the financial crisis of 2008 centered around duration mismatches on a grand scale where securities firms borrowed short and lent long. Essentially, everyone said "I want my money back" in unison, noted Hutchins. That problem is unlikely to rear its ugly head any time soon, but the question arises: where is the risk in the system today?
According to Hutchins, risks associated with climate change and cybersecurity are two of the chief potential culprits. He noted that the insurance markets in London are continuing to develop to address climate related losses, and further observed that Mark Carney, Governor of the Bank of England, has called for regulators worldwide to make sure companies are adequately climate associated risks. In response, Chairman Clayton noted this is an ongoing and continuing conversation. In his view, the key question is whether companies have the resiliency to move forward in light of these risks.
According to Cohn, one of today’s bubbles revolves around index funds which represent one of the largest transformations in the flow of funds in recent times. He noted that once a stock is included in an index, the price can increase from two to 12 percent. Chairman Clayton observed people will pay a lot to be in an index.
Looking to the future. Cohn remains cautiously optimistic as he looks to the future. "The consumer continues to do what he’s good at—spending money," observed Cohn. He noted whether it’s wage growth, tax reductions or reduced energy costs, the consumer has found a way to spend those extra dollars. Notwithstanding, Cohn is concerned with the lack of corporate spending, but he is sympathetic to companies not wanting to buy raw materials at world prices, plus tariffs, to invest in the U.S. He observes these companies can build overseas and import.
Hutchins is more worried. In his view, U.S. relations with China are changing for the worse with China moving towards becoming an authoritarian state economy. Additionally, the latest tax legislation has not been productive in his view. He is concerned with the country taking on massive deficits during peacetime and recovery. He also notes that while the economy is growing, there is a pronounced sense of economic insecurity among U.S. households. On a positive note, Hutchins is optimistic about the emerging 5G broadband infrastructure in the U.S. which will provide 50 to 100 times more internet capacity. In his view, this will lead to a whole new layer of economic growth, activity, and investment opportunities.
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