The Recent Economy up to Covid-19

In the previous post I noted that Keynesian economics tended to fail because governments overlooked the second half of the prescription: when the going got strong, it was necessary to “pay back” the debt, or at least reduce the money supply. That results in politicians being party poopers, restraining the good times and what politician wants that with an election coming? The net result was with too much money floating around, we had the rather unexpected result of inflation coupled with stagnation/recession. More money would not solve that. Friedman had the answer, perhaps: stop government priming the economy and correct structural deficiencies. That was not followed either – Friedman had no more success than Keynes in getting politicians to behave. What resulted was the likes of Reagan reducing government expenditure, lowering taxes, and maintaining and expanding the government deficit. Then the US Federal Reserve set the tone by reducing the money supply, even though it knew that would send unemployment soaring. They simply did not care. Anything went in the name of “economic efficiency”. 

What was undefined was “efficiency.” To answer that we have to ask what is the purpose of the economy? To the bankers it seems to be to make nice profits for banks, but surely it is more than the keeping of tidy books. For some, it is to maximize wealth, especially for themselves. For some it is to generate the means of enabling people to live in a pleasant place and live alongside nature. For others it is to enable all people to get the best out of life. Under the new economics of Reagan and others, the emphasis was on the “basics”: get the government out of the economy because they don’t know what they are doing, focus on low and stable inflation, let the rich get richer, following which the wealth would trickle down. Except the evidence is, it didn’t.  Then when it became clear that squeezing the money supply, while it might have helped make the books tidier, was generating unemployment that was too great, so central banks switched to using interest rates as their primary tool. Which gets us to where the bankers are now. Interest rates have got to the point where depositing in banks is only good for security, as long as the bank does not go belly up.

What actually happened was that when the corporations noted that the government did not care about employment it fired its workers, thereby saving money on benefits, etc. and moved manufacturing to low wage countries. Basic manufacturing, like clothes, were exported to places like Indonesia or Bangla Desh, and more difficult manufacturing to China. That undoubtedly increased the wealth of the rich, but it sent the workers into low-paying jobs in the service industries. Meanwhile, there was a somewhat unrecognized crisis in the academic community, and in particular the physics community. Funding had dropped and we had a large number of highly educated unemployed. The physicists, in particular, were good at computer modeling, and they got jobs in banks to create new “financial products”. The banks made huge profits until about 2008. The problem with these “products”. which were sliced and diced debt, were based on the assumption that nothing significant could go wrong, but in the US, for political reasons, a huge number of houses were sold to people who had no hope of repaying the mortgages. Oops. 

We have sort of recovered from that, but the legacy is that thanks to COVID 19 the debt levels of so many countries is extraordinarily high, interest rates are ridiculously low they cannot go lower, so there is no incentive to save. Money goes into assets, which merely inflates the price of the assets. Stock at $100 is worth that if you can sell it for that, but at the end of a period of time, you have to look at the overall returns on investment. In a bubble, everyone makes money until the music stops, then the losses are concentrated on the then holders. COVID has forced the nervous investors to cash out and the stock market fell, but it is coming back because of the quantitative easing. So what happens when the quantitative easing stops and the bonds are cashed out?What is clear is that we cannot look to the past for ways to get out of this. We have to try something new, but what? If you look at our leaders, do any of them have a solution to what happens after quantitative easing? Or do they have their heads in the sand and assume that will be for another electoral cycle?

Where to now, economy?

While I write futuristic novels, none of them involve trying to predict the future; rather I use the future as an excuse to formulate a situation that has little merit other than to be the background to a story that is really looking at something else. However, like most people, I am curious about what could be coming. That includes wondering where the economy is going.

Some time ago I saw an interview with Mervyn King, an ex-Governor of the Bank of England. According to him, in a market economy banking crises are endemic because a market economy cannot provide all the required price and investment signals. This is effectively a statement that there is an inherent failure in the market economy, and it arises because nobody can predict the future, and there are the problems of positive feedback (where the effects of the problem make it worse) and hunting (where the correction dramatically overshoots and causes the opposite problem). Thus suppose commodity A suddenly has a shortage. Prices rise, the masses start acquiring A and the price rises further, but there is no fundamental reason for the rise. When reality strikes, prices drop, and keep dropping.

I recall in my youth the price of potatoes tanked, and farmers found themselves dumping them. My father immediately began renting land, and with a trailer, went around the potato dumps and picked up free seed. Next season, because everyone had got out of potatoes, and also partly because of adverse weather in places, prices leaped five times above average. At that point, my father made a lot of money, but immediately got out of potatoes, on the grounds that next year everyone would be back into them. Now, King’s point is, bankers lend to farmers, but they cannot know what next season’s prices will be, and hence cannot know whether the farmer will prosper or go bust. In New Zealand there are a number of dairy farmers who got into it with expensive farm conversions when prices were very high a couple of years ago. When the world became swimming in milk, the debts still had to be serviced.

The question then is, can anything be done about this? My guess is, so far there are no signs that anything better would work. A long time ago I was in the old USSR, a command economy, and basically it was not working at all well. Prices were stable, by command. I went into a restaurant and picked up a menu that was printed twenty years before and the prices held! The problem was, I also went into a major store to see an array of empty shelves. The prices might have been stable, but if the goods were not available, their price was irrelevant. In one of my trilogies, I proposed an economy that was stable, BUT there is no evidence it would actually work. The proposal was simply background to make the rest of the story easier to follow, and in any case, there were price rises due to resource shortages. However, there was no possibility of major recessions, or major booms. Perhaps I was dreaming?

Another one of King’s points was that while central banks avoided a catastrophe in 2007 – 2008, since then, the basic fundamentals have not been corrected. In particular, there is a serious disequilibrium between saving and debt, largely due to very low interest rates. The problem is, the longer this goes on, the harder it will be to return to some desirable “normal”.

King was also somewhat skeptical about the European Union, and noted that a single interest rate imposed on countries with varying rates of wage and cost inflation leads inexorably to divergence in competitiveness. Well, yes, it would. German banks would seem to have to take some major losses, but they seem reluctant to do so. (Note that Germany itself has defaulted on debt before.)

King’s way out is to boost productivity and growth, and he was enthusiastic about the TPP trade agreement. My guess is that Trump will kill that option.

The problem I see with that analysis is that King thinks society in the future will be more or less the same as now. I am less convinced. In many western countries, the biggest problem is that local manufacturing has been exported, and this has led to the hollowing out of middle classes. While the very top corporations are raking in huge profits (and paying increasingly less tax) the wage earners tend to find their wages actually reduced. Governments are compensating by increasing their borrowing, thus taking advantage of lower interest rates. The problem here is, with the exception of the US and others undertaking quantitative easing, while central banks might offer low interest rates, they do not lend because to do so without borrowing is simply to enlarge the money supply. The US has got away with quantitative easing largely because trillions of dollars have been secreted away in foreign banks as a consequence of tax avoidance. However, the debts remain.

For the general economies of countries like New Zealand, while the Reserve Bank recently lowered interest rates, the commercial banks actually slightly raised them. The reason: they need deposits, and as interest rates have dropped, people have gone searching for yield elsewhere. Here, a lot has gone into housing, largely because there is a shortage of houses, but this has not created a lot of new houses. Instead, as King would have noted, this must lead to a bubble happily fermenting, although because of the underlying shortage (which is politician induced) it may not burst. Here, politicians are the problem through sending perverse signals and regulations to the market. Money has also fled towards stocks, but again that tends to raise the price when more money goes there than into new ventures. Now, what happens if this bubble bursts? Governments are in so much debt they have little room to maneuver. By itself, politicians might consider that as merely unfortunate, but the problem then is the consequences, one of which I included in my novel ‘Bot War. I hope that consequence does not come to pass, but I am far from confident.