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Wake-up call

12 July 2016

Neil Woodford argues the referendum result should prompt a re-think on global economic policy.

Given recent political events, it feels strange to be writing about anything other than Britain’s relationship with Europe. However, I have been clear throughout the EU referendum campaign that there are many more important influences on the long-term outlook for the UK economy than the outcome and I continue to stand by that view now that it is known.

Globally, I see several interlinked challenges combining to exert downward pressure on economic growth rates and which look likely to continue to do so for some considerable time. The eurozone economy epitomises some of these issues with its sluggish growth, stagnant productivity, ideological conflicts, troubling debt dynamics and poor demographics.

Flaws in its monetary union have exacerbated some of these problems for Europe but the region does not have a monopoly on them. Wherever we look around the world, we see them. Additionally, with liquidity problems in emerging markets, a dangerous credit bubble in China and the continued threat of a prolonged period of deflation, it is clear investors have a lot to worry about.

One of the rare economic bright spots in recent years has been the US. Last December, the Federal Reserve raised interest rates for the first time in almost a decade in a valedictory move to declare victory over the stagnation that had afflicted its economy ever since the financial crisis. With relatively robust domestic growth and a job market deemed to be approaching full employment, the Fed judged a rate hike to be an appropriate move in monetary policy for the US economy. But it certainly was not what the rest of the world needed.

This is not a new phenomenon. In 1960, the Belgian American economist Robert Triffin argued the Fed could “either run policy that was right for the US or it could run policy appropriate for the rest of the world”. In benign economic times, he argued that one policy might suit all for a period but, in times of trouble, the US dollar’s dominant role in the Bretton Woods fixed exchange rate system would result in serious economic imbalances around the world. He was right. “Triffin’s dilemma” had identified a dynamic that would ultimately lead to the collapse of that system in the early 1970s.

The Bretton Woods agreement had originally come into force in the aftermath of World War II, when delegates from the 44 allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, to find a common and co-ordinated path towards global economic recovery. The result was a fixed exchange rate system in which each country’s currency was pegged to the value of gold, thereby preventing individual states from attempting to gain an economic advantage through competitive devaluation.

The US dollar’s pivotal role in this system was its ultimate undoing and, although we now live in a world of floating rather than fixed exchange rates, the US dollar’s status as “reserve currency” can continue to cause problems. When the dollar is strong, it effectively means global liquidity conditions become tighter. In turn, this causes problems, particularly for emerging markets, which are reliant on the flow of dollars to sustain their economic growth. Triffin’s dilemma is alive and well in modern financial markets.

Ironically, I believe it is a Bretton Woods-style accord that is required to enable the global economy to move on from the current period of stagnation. The policy outcomes would likely be somewhat different but it would be the concept of co-operation that would matter. These are multi-regional, global problems and their solution requires co-ordinated global policy action.

The prospect of such co-ordinated policy remains pretty remote but the longer economies remain mired in stagnation, the more plausible it becomes. Perhaps the voting behaviour of the British public recently could be seen as a wake-up call for policymakers, which hastens such an outcome.

In the meantime, the global economy is slowing and the US economy does not look as robust as it did. This is already having an impact on global earnings and is likely to continue. Not all companies are affected by the global economic challenges to the same extent, however, and this is why my investment strategy continues to favour businesses that are largely in control over their own destinies.


Neil Woodford of Woodford Investment Management is the manager of the St. James’s Place UK Distribution and UK Equity funds. The opinions expressed are those of Neil Woodford and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. Full advice should be taken to evaluate the risks, consequences and suitability of any prospective fund or investment. The views are not necessarily shared by other investment managers or by St. James’s Place Wealth Management.

Please be aware that past performance is not indicative of future performance. The value of an investment with St. James’s Place may fall as well as rise. You may get back less than you invested. Returns on equities cannot be guaranteed.

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.


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