Goldilocks & the Three Bears

In the fairytale of Goldilocks and the Three Bears, the young girl famously prefers the porridge, the chair and the bed which are “just right.” The Goldilocks Principle is now part of the economics lexicon describing an economy which is not too hot or too cold, but just right. She has made a few appearances over the years, and now, at the end of 2017, Goldilocks has, once more, returned.

MSCI World Index

A Goldilocks economy is broadly characterized as one that is not “hot” enough to fuel higher prices in consumer goods and services, nor “cold” enough to bring about a recession. It essentially features the conditions of a low unemployment rate, increasing asset prices, low interest rates, steady Gross Domestic Product (GDP) growth and low consumer price inflation. These conditions existed, for a time, during the 1990s, and the first use of this phrase is credited to David Shulman of Salomon Brothers who wrote “The Goldilocks Economy: Keeping the Bears at Bay” in March 1992. Goldilocks economic conditions were again evident in the mid 2000s, as the world recovered from the crash.

In 2017, the consensus is focusing on the fact that, despite employment levels being high, consumer prices are not accelerating. Growth is solid around the world with a “sweet-spot” being identified where all the major economies are growing together. Asset prices are higher and, even though the punchbowl of easy monetary policy is being taken away, it is going to be a slow process, and so interest rates should remain low for a long, long time to come.

Much of the recent hoopla has centered around the belief that technology, rather than create a monopolistic economy where exorbitant rents (prices) are paid by consumers, is instead enabling a fairer, egalitarian economy where opportunities are limitless and entry costs are low. Whether it’s driverless electric cars, ever lower prices created by the “Amazonification” of the globe or robots boosting productivity levels, the direction in which technology is going is seen as creating a new economy.

Or should that be a new, new, new economy? Because we have been here before. Whenever social mood trends positive, stock markets rise and sentiment fixates on whatever the new technology of the day is. Whether it be railways, the motor car, energy, the internet, financial innovation or robots, the narrative is always the same — the new way of doing things is creating a structurally better and more robust economy. Perhaps the most iconic example of this social mood is encapsulated by the words of the celebrated economist Irving Fisher:

“Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon, if ever, a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months.”

Fisher said this on 17 October 1929, a matter of days before the U.S stock market experienced the most famous crash in history.

Of course, not all prognostications are going to be so precisely ill-timed. It takes a while for social mood to get to the point where belief is so one sided. But for the Goldilocks economy, belief has already been growing. The chart below shows that interest in the phrase “Goldilocks economy” is now back to levels seen in the boom years of 2006-2007. After that shock, interest in the Goldilocks story tailed off, but now, social mood is once again positive enough for its return.

Goldilocks Economy Global Trends

Central banks thought that their quantitative easing (QE) policies, embarked upon after the financial crisis, would lead to higher consumer prices. QE operated by buying financial market assets with money created out of nothing. By printing more money, central bankers thought that the prices of goods and services would go higher. Instead, the printed money has remained in the financial system, fueling the natural recovery in social mood post-crisis and the gains in bonds, stocks and real estate. Seriously, what did they think was going to happen?

Central banks have thrown the proverbial kitchen sink at creating “inflation” in the form of rising consumer prices, and it hasn’t happened. They are blind to the fact that the monetary inflation channel has been directed towards assets instead. But with assets up and consumer prices still low, a belief system of continuance has now taken hold. As our chart at the top shows, conditions are ripe for the third bear in our story to make an appearance.

In the original version of the story, Goldilocks is not a young girl, but instead a grumpy, old woman. Before publishing the original, called “The Three Bears,” in 1837, Robert Southey was recounting the story orally to friends. In 1831, one of those friends, Eleanor Mure, handcrafted a booklet of the story as a gift for her nephew and, in her version, the infuriated bears take their revenge by first throwing the old woman (aka Goldilocks) into a fire and then into water, before finally impaling her on top of the steeple of St. Paul’s Cathedral in London. For ardent believers in the Goldilocks economy, by the time the next deflationary bear market is over, that may seem like child’s play.