The solo becomes a duet

The world economy is a bit like my early love life – long periods or inactivity and boredom interspersed with rare flashes of excitement.  Growing up in rural England with no Facebook, mobile phone, nor any natural ability to chat up girls made things pretty dull!  The same is true of the world economy - one minute we are in a world of dull stagnation and deflation and the next we are in mortal danger, thanks to Greece.

The excitement of a good riot

Demand for the old normal

For the last six years the developed world has been suffering from a chronic shortage of demand: demand for goods, demand and services, demand for investment.  The need to deleverage personal, corporate and government debt has meant that there has been massive excess capacity and a huge shortfall in aggregate demand.  This lack of demand has been driving up unemployment and driving down prices.  All this has been complicated by the fact that we in the West are at the zero bound of interest rates this nasty cocktail has been characterised as secular stagnation.  Over the last six years wages in all normal income groups have flat-lined and living standards will now be lower at the end of this economic cycle than they were in 2008 – this is extraordinary, almost unheard of in the developed world.  Or is it?  Thomas Piketty, the French Rock Star Economist (is that an oxymoron as the French have no rock stars?) would have us all believe that we are now returning to a more normal state of affairs, where vast pools of wealth lie idle in the hands of a financial elite and the rest of us jog along at a steady but uninspiring rate.

A French Rock Star??

Solving Secular Stagnation

There is now a sense of gloom that pervades the corridors of power in the developed world, six years on from the Lehman Brothers' default and the ensuing “great recession” we are still in the economic dead-zone.  In particular Europe is marred by low growth, high unemployment, falling prices and the worry is that this is the “new normal”.  Most economist are satisfied that the problem is poor aggregate demand, caused by falling investment in both the private and public sectors combined with diminishing disposable income - wages have been flat for years.  This malaise has been characterised as “Secular Stagnation” (SS), a term made famous by Larry Summers a former Head of the US Treasury department.

Larry Summers - feeling the torpor of Secular Stagnation

Germany's most important export is unemployment

Some time ago I posted a short piece entitled Austerity may be Wunderbar, the simple message in this blog was that Germany was the problem in the EuroZone not the solution.  Having joined the Euro at a grossly undervalued rate the German economy has been on the PIIGS back for the last fifteen years.  The net result of this competitiveness advantage was that in the years 1999-2008 German was able to re-boot its ailing economy by exporting cheaply to its European Partners where all control of credits markets had lapsed.  

It's not just cars, but unemployment, that Germany exports

Central Bankers - from heroes to zeros

The Bank for International Settlements (BIS), the only institution to call the financial crisis in 2007, has weighed back into the macro economic debate in the last few days in its annual report.  The report sets out a significant criticism on the current crop of central bankers, in essence the BIS lays the blames Yellen and Co for the falling: growth, demand and employment.  The expansion of national balance sheets and negative real interest rates are now the problem not the solution. The Keynesian approach that all central bankers have followed is now coming under close scrutiny as the global economy struggles to gain economic momentum. The process of piling the "cart" with more and more debt means Central Bankers are running a huge risk as the road ahead may not be as smooth as the would like!

Let's hope there are no pot holes ahead

A sticky mess for economists

I have spent a fair amount of my leisure time racing on sailing boats, where one becomes paranoid about wasting the wind, the tide or ones position on the water.  This is in stark contrast to the rest of my life where waste is everywhere; I waste time in mindless meetings and commuting, I waste money on an over indulged family and some would argue that I am wasting my life away writing this blog!  But all that is going to change; waste is out and utilisation is in – or so says the Governor of The Bank of England (BoE).

Having spent the last five years providing as much slack as possible to keep the banking system on its feet and the economy off its deathbed, there is now a new mood and doctrine.  When Mark Carney arrived in the UK in July last year he promised us Forward Guidance on interest rates – he would hold rates at 0.5% until we achieved full employment.  So like a seasoned skipper he turned the yacht downwind and let all her sails out.  The economy (helped by a friendly gust of overseas investment) has picked up speed, employment rates have shot up and people are wondering when we will need to tighten things up.  If we don’t tighten things up and the economic tail-winds pick-up we could get into a real mess.

He should have tightened up a bit earlier

Debts Still Matter

The mind of George Osborne works in a strange and Machiavellian way.  His announcement today that austerity will continue unabated into 2016 - 17 was greeted with howls of protest from all sides, could it be that the British Chancellor knows something that we don't?  

which one is George?

Five years after the default of Lehman Brothers and three year since taking office the world is still a dangerous place even after years of pain.  What is now clear is the history of this crisis; and most developed countries have faced a number of distinct phases in this recession.

1. The credit crunch caused by a lack of liquidity in the banks 2008

2. Falling growth and a deep recession, caused by the banking failure and the subsequent free fall in asset prices in 2009

3. A false recovery 2009 – 2010 temporarily fuelled by growth in the Commodities, BRIC economies and emerging markets

4. The sovereign debt crisis triggered the very high public spending required to off-set recession (centred on the EuroZone) that rumbled on over 2011 -12

5. (Secular) Stagnation – weak growth in demand and GDP and deflationary pressure on prices in 2012-14?

As I have discussed in a recent blog there have been a number of strategies that have been deployed since 2008 with varying degrees of success.  These strategies (Abenomics, austerity, QE, etc.) have been blurred and muddled by the realpolitik of the day and no country has been able to pursue a fundamentalist approach, not even the UK under Osborne's guidance.  The main policy argument has been around the need for and the pace of debt reduction.  In a nutshell, can advance economies grow whilst carrying substantial levels of public (or private) debt?  There are good reasons for thinking that high levels of debt will be a drag on growth and these are pretty obvious:

Economists playing with fire

I have a sixteen year old daughter who is working hard on her final secondary school exams (UK ‘A’ levels) the results of which will determine the type of degree and which university she will attend – these are important times!  Being a more focused individual than her father she is already weighing her options and it’s straight fight between Economics and History.  Over the Christmas holiday we had a number of discussions around the relative merits of these options; initially I supported the view that Economics would be a more relevant and “useful” degree but now I am not so sure.
Having missed the vital signs of the credit crunch and the ensuing recession in 2008/09 economists around the world are red faced again and having to play catch up on the startling and unexpected rebound that the US and UK economies kicked off in 2013.  Not a single note-worthy economist was able to forecast up-tick in GDP growth or the stellar year stock markets enjoyed in 2013!   Famously, Olivier Blanchard (the International Monetary Fund's chief economist)  warned George Osborne that his austerity programme was "playing with fire" just as the UK emerged into recovery!

Economists playing with fire  

So if they can't tell us what is going to happen what are economists for?  It's a legitimate question to ask - if economist can’t forecast what is going to happen do they have any practical use? Being increasingly unsure of the future, they spend their days trying to piece together the past and polishing their excuses.  But why should economists worry about the past - as James Buchan told us “Economists, like royal children, are not punished for their errors”.

Where have all the bubbles gone

The UK economy may be in the midst of a stellar year in which growth has returned, most unexpectedly, but there are special circumstances that have benefited us.  Elsewhere in the developed world, we face a persistent economic stagnation. Across the developed world employment rates are low, wages and disposable income are depressed; real interest are still negative; government debt is staggeringly high and rising; companies and individuals prefer to hoard cash than invest and to cap it all it looks like deflation is now stalking the planet. 

Despite extraordinary efforts by the world’s central bankers in the aftermath of the Lehman’s default, which has included the massive increase of liquidity (QE) and negative real interest rates, five years on the outlook is pretty poor.  Larry Summers re-coined the term secular stagnation to characterise the economic landscape and went on to float the idea that the west has grown on the back of asset bubbles for the last 20 years (Property, DotCom, Emerging markets, Sub-prime, etc) and that any return to pre-2008 levels of growth will demand some new bubble to help us along.  Larry Summers suggests the level of real interest rates required to generate full employment might be, say, -2 or -3 per cent.  More practically bankers in both the Fed and the ECB are now contemplating negative interest rates on short term money they hold over-night as a way of stimulating demand.  

Where have all the bubbles gone

The world's economy is off-balance

Economists around the world are dusting themselves off after a bruising few years of terrible forecasts, messed up assumptions and missed diagnosis.Whether you have been on the Rogoff / Reinhart or Krugman side of the argument there are red faces all around. The simple problem is that economies are not meant to behave in the way they are.  We have got to a point where old models (classical, Keynesian or monetarist) don’t work and excuses just don’t wash.  The problem is that after five years of negative realinterest rates the world’s economy has been unable to return to “historic trend” levels of growth – we are still bumping along the bottom.  Most economists believe that interest rates can be set to create a sustainable equilibrium in the economy where growth, employment and inflation can be held in a positive balance.  The absence of the interest rate equilibrium after years of interest rates set near or at the lower bound of zero raises the question as to what the alternatives are to negative real interest rates might be?  Larry Summers the former Secretary of the Treasury of the United States made  an important speech on this subject a couple of weeks ago.



Larry Summers - tired of waiting for the recovery

Austerity may be wunderbar

Five years on from the tsunami of the Lehman’s default and subsequent recession it’s probably a good moment to assess the relative merits of the monetary and fiscal strategies that developed countries have deployed to reboot their economies.  There have been a range of initiatives that have been tried but the “standout” response has been austerity, which can also be derived as a noun – austerian and there is even an antonym – Krugman!

Abenomics on the ragged edge

Economist around the world watch Japan with baited breath, there is much at stake for the both sides of the argument, The Keynesian wing have their fingers tightly crossed hoping that Abenomics will finally  be the solution to kick starting the world third largest economy, that has been moribund for years. Others on the monetarist wing believe that it will end in tears, and it looks like the markets are voting in favour of the monetarist.

Abenomics is in fact a sort of con-trick, the Bank of Japan (BoJ) is trying to break a deflationary cycle but massive doses of Quantitative Easing (QE) alongside a huge increase in government spending on capital projects.  It is hoped that these two levers will prize economic growth out of an economy that has been going sideways for 20 years.   What everyone knows, is that the moment inflation resurfaces and growth returns, the BoJ will return to a more prudent approach.  This highly transparent strategy has now turned into a game of cat and mouse between the BoJ and the markets.  This week bond yields rose (higher interest rates expected), stock prices fell and the yen rose a little against the dollar last week.  Paul Krugman argues that higher bond yields, a weaker stock market and a stronger exchange rate are all in response to a tighter monetary policy than the one now promised (a broken promise).  The markets don’t believe the Haruhiko Kuroda the new governor at the BoJ is going to be as mad as he says he will be!  The big questions are:

1. Will the markets believe that the policy to risk all for 2% inflation is real or just a short term con-trick 

2. Will interest rates remain lower enough to see this policy through
3. Will the fourth arrow of increase sales taxes to fund the capital spend programme actually be delivered

It’s difficult to believe that the BoJ will be utterly reckless for much longer, everyone knows that Mr Kuroda is trying a form of blind man’s bluff.  The markets will take a medium term view so this promise ‘to be reckless for a little while’ doesn’t cut much ice.  

A further difficulty is that the whole plan depends on low interest rates, to force down the value of the Yen (supporting export growth) and to drive up consumer spending in Japan.  But low interest rates are going to be dependent on the level and expectation of government debt, which already unsustainably high.  If interest rates rise then the need slash capital spending would create a very swift about turn in policy and this is what the markets believe will happen – this could become one-way bet.  

In addition to the interest rate time bomb another problem is that Abenomics has weaken the Japanese banking sector, which is now sitting on Y821tn ($8tn) of government bonds (the result of government debt and QE) and the bottom is falling out of this market.  This is making it very difficult for the Banks to lend money to new and growing businesses.   

The net result of all of this is that Shinzo Abe is on a tightrope above a shark infested river.  He needs to tread a fine line between a credible reflationary policy and need for low interest rates to manage the crippling public debt.  He might just totter across the ravine and receive a hero’s welcome but my money is on him ending up in the torrent with the short sellers enjoying a tasty lunch.