Try to disconnect, for a moment, from all the fallout talk following the Brexit referendum result.
I believe that both the UK and indeed the world are facing far bigger economic and political problems right now. I’ve been writing about “secular stagnation” and potential deflation for ages. Today I want to look again at these issues and also at a possible solution.
Here’s a recent Bloomberg piece on the subject:
“Crazy things are happening in the world economy. In Europe and Japan, interest rates have turned negative, something long thought impossible. In the US, workers’ productivity is improving at the feeblest five-year rate since 1982. China is a confusing welter of slumping growth and asset bubbles.
“Through it all, Federal Reserve Chair Janet Yellen practices the central banker’s art of draining the drama from any situation. She insists that conditions are returning to normal, albeit slowly. Her favoured approach, “data dependence,” is non-predictive and non-committal, like finding your way in the dark by pointing a flashlight at your toes”.
If you’re also seriously unimpressed by the US Fed constantly changing its mind about the timing of the next move in interest rates, you’re in good company.
The guy who nearly became the head honcho at the Fed – and who would have done a much better job than Yellen, in my view – is Harvard economist Lawrence Summers. He’d agree with you, hands down. He reckons that central banks are out of their depth.
The term “secular stagnation” isn’t, of course, my invention. It was devised in the Great Depression by another Harvard economist called Alvin Hansen to describe “sick recoveries which die in their infancy, and depressions which feed on themselves and leave a hard and seemingly immovable form of unemployment.”
It implies that we can’t simply look forward to a cyclical recovery in growth: the problem is much deeper-rooted that that.
And in November 2013 it was Lawrence Summers who told the IMF in Washington all about modern-day secular stagnation.
While the world economy is struggling along, the onus of generating a sustainable pick-up in GDP growth has almost entirely been entrusted to central banks such as the Fed, Bank of England, European Central Bank (ECB) and the Bank of Japan.
Their approach continues to be one-dimensional: cut interest rates to the bone, or even encourage negative levels, while monetising debt and maybe equity too via quantitative easing (QE). We saw the latest dose of this last week from the Bank of England.
Secular stagnation spreads between countries via currency wars as exporters try to gain an edge by lowering the value of their currencies.
Trouble is, present policies aren’t likely to work any better going forward than they have so far. Something extra is needed. Governments need to up the ante.
Why growth remains weak
Cue Larry Summers’s view. He reckons that global growth remains sluggish because there’s a chronic shortage of demand for goods and services while there are excess savings.
It largely boils down to demographics. As the population in Western countries ages, it saves more. As the rich get richer due to QE, they save more.
Everyone’s chasing ever-lower yields, which lowers returns made on capital. As the latter are also declining due to diminished growth in output and productivity, investment is reduced below the level needed to soak up those savings.
Meanwhile the US, for example, has the lowest infrastructure investment rate since WWII. The answer, says Summers, is that fiscal policy needs to play a much bigger role than it has done so far. That means far more state spending on the likes of repairing existing roads and building more carriageways.
Sounds familiar? It will do to Strategic Intelligence readers. The need for more infrastructure spending is one of our key themes right now.
Just in case this sounds too much like Keynesian theory – i.e. lots of economic management – free market solutions would be export promotion, removing useless/bureaucratic rules and regulations, encouraging higher levels of corresponding private sector investment as well as creating fiscal incentives to induce companies to build factories.
Tax cuts for lower earners would result in higher consumer spending rather than more saving.
Is any of this likely to happen?
To be fair to the Fed, Bloomberg notes that Janet Yellen “has tiptoed around secular stagnation, referring to the theory but not endorsing it”.
But, it adds:
“…her right-hand man, Vice Chair Stanley Fischer, who taught Summers, Bernanke, and ECB President Mario Draghi at MIT and once ran Israel’s central bank, seems more open to the idea that something fundamental has changed.
“Speaking to academic economists in San Francisco in January, he referred to “the secular stagnation hypothesis, forcefully put forward by Larry Summers in a number of papers.” He even entertained one of Mr Summers’ solutions for the savings/investment imbalance: government spending on long-term projects.”
I don’t like economic lectures any more than I suspect you do. So to sum this up: Larry Summers strongly believes that bolstering demand can reverse the vicious circle of excess saving and chronic under-investment.
Gradually, productive potential can be boosted.
At Strategic Intelligence, we reckon this makes good sense. And as I’ve previously noted, far from crowding out private sector investment, higher government infrastructure spending could pay for itself and actually induce more of it.
This has to be the way forward for the post-Brexit UK economy.