A veteran Macquarie Group strategist says the coronavirus is accelerating the move towards a new world where whatever is left of free market signals disappear.
Ask Macquarie Group strategist Viktor Shvets to explain why he believes capitalism is dying, or at least mutating into something closer to a version of communism, and his answer will take about 40 minutes.
This is not because his theory is overly complicated. It's because he cannot resist weaving references to economic history into his defence of the argument that governments are replacing the private sector as the primary allocators of capital.
Shvets says the COVID-19 pandemic is accelerating the trend towards greater concentration of state power and the "massive extension" of central monetary levers to a point where most asset classes will be eventually supported by a fusion of financing from governments and central banks.
Controversially, Shvets foresees the typical capitalist economy morphing into one that resembles China's where fiscal policy is funded directly by the central bank.
He can envisage the pillars of the capitalist system, including commercial banking, being supplanted by all-powerful governments funded directly by central banks.
This would be a profound change because entire sections of the Western financial system would be disintermediated, starting with all parties involved in government bond issuance.
The Shvets theory does not contemplate the nationalisation of industries or an end to all private-sector signals. He says there will still be intermediaries between the state, central banks and corporations. But governments will have much more power and be able coerce businesses to do what they want.
"China’s state-capitalism and political economy offer a potentially attractive answer including an aggressively proactive public sector to soften transition pains," he says.
"Monetary and fiscal spigots simply open and funds flow. There is however, a price to pay – atrophy of free markets and private sector signals and ultimately further misallocation of resources. However, the alternatives could be worse."
Governments are now trialling numerous policies that we believe will constitute the essence of the future economies.
— Viktor Shvets
Shvets says the gradual death of capitalism has occurred because of the financialisation of the global economy. Excessive debt underpinned by easy monetary policy has hidden price signals, crunched down the cost of capital and injected bad incentives into capital markets.
He points to the surge in government and private sector debt from $US37 trillion in 1990 to $US167 trillion in 2007 and $US255 trillion in 2019. The numbers are $US20 trillion greater if you include gross derivative positions.
Shvets says this "cloud of finance", which includes banks, insurers, hedge funds, private equity and central banks, used to be the tail being wagged by the economic dog. Now the reverse is true.
The debt burden is rising fast. It is estimated central banks from the United States, the euro area, Japan and the United Kingdom will expand their balance sheets by $US7.2 trillion in response to the virus and governments will spend in excess of $US5 trillion in 2020.
"If you go back to 1950s and 60s and 70s this was a time when debt to GDP ratios basically were pretty much unchanged at about one to one-and-a-half times GDP," he says.
"You didn't need more than a dollar or 50¢ of debt for every dollar of GDP that you would generate. But then starting in the late 1980s things changed dramatically and we gradually required more and more debt in order to generate the sort of GDP growth rates that society was finding acceptable.
"So in other words, in order to satisfy the political requirements, we needed to continuously bring more and more future consumption to the present. We continuously needed to accelerate the growth rates beyond the productivity growth rates that our societies have."
He says it now takes about $4 of debt to generate $1 of GDP growth. The level of global debt is now about five times GDP.
It is no surprise, he says, that debt is at the core of the global response to COVID-19. This has been true of every other major dislocation since the "Greenspan put" in 1987, which refers to the US Federal Reserve propping up the stockmarket.
Shvets says easy monetary policy glossed over the deep seated problems inherent in many capitalist economies including low productivity growth, unequal distribution of income and excessive financial speculation.
This will change in a world where credit is nationalised.
"Governments are now trialling numerous policies that we believe will constitute the essence of the future economies, including basic or universal income guarantees, increased government funded health care, higher spending in research and development as well as infrastructure investment," he says.
Shvets draws on the work of economist John Maynard Keynes, who helped shaped the world economic order following World Ware II and later devised the building blocks of the international financial system.
Keynesian economics was derived from the seminal book, General Theory of Employment, Interest and Money (1936), which called for cyclically balanced budgets with governments incurring debt in a downswing and repaying debt in an upswing.
In 1937, Keynes also advocated in favour of permanently cheap money with short-term interest rates kept continuously low. He was successful in somehow convincing the political left that capitalism could be managed to further socialism's cause.
Shvets says the world is approaching a point where Keynesian economics will merge with modern monetary theory (MMT), which is defined as the issuer of fiat currency (the central bank) being able to print money to finance fiscal expansion.
But not every country can practise such powerful tools, according to Shvets. He says at least 75 per cent of global GDP resides in economies that satisfy all or most of his MMT preconditions.
So, what does all this mean for investment? Will shares do well in a world controlled by governments and central banks?
Over the past four years, Shvets has consistently recommended his clients invest in a portfolio of stocks he calls QSG or "quality, sustainable, growth". It is defined as companies that can lift return on equity at a minimum of 12 per cent a year, expand profit margins and do it without leverage.
He says this is not time to abandon an investment strategy based on the QSG portfolio, which comprises about 50 stocks. It is up 9.5 per cent this year and up 31.5 per cent since inception in February 2016. About 75 per cent of the companies in the portfolio are tech stocks.
Easy monetary policy was very conducive for the growth of technology companies, according to Shvets, because the speed with which technology progressed was dependent on the cost of capital, which was always falling because of cheap money.
He says this fuelled the disruption of old world businesses. It not only separated companes from their products, their brands and their distribution, it opened them up to competition from multiple new entrants.
The fusion of neo-Keynesian policies and MMT could result in an inflation breakout and it would mean investing in bonds would no longer be a one-way street. Shvets says there will be less incentive for financial speculation and excesses like the funding of tech unicorns.
Technology adoption will be somewhat slowed and that may affect technology companies. But productivity might start to improve which would be good for the corporate sector in general.
Shvets says the death of capitalism probably has to await another big dislocation similar to COVID-19.
"I think we need one more dislocation, which probably will happen in the next two, three or four years," he says.
"It could be manmade, it could be nature, it could be each of these. I don't know what it will be, but one more dislocation and the neo-Keynesian and MMT policies will fuse like a broken bone."
The lesson from China is to not necessarily apply investment fundamentals to share investments but simply to watch and understand what the government wants.