Voodoo (Macro)Economics

Viewing the state of economic policy in the developed world these days, one is reminded of the old joke about the gentleman drunk  stumbling around under the lamppost looking for his lost keys. A policeman comes to help and after some time asks the gentleman if he is sure he lost his keys here. “No”, replies the drunk, “I lost them some way back”. The policeman then asks why they are searching this spot. “Well, this is where the light is”, is the definitive answer.

Using quantitative easing, the Central Banks of the developed world mostly conform to this old joke. In response to stagnant or worse economic growth they are creating money at a rate unprecedented in modern economics. Puzzlingly, this has seemed to have no inflation effect. That fact alone suggests that they resemble the above gentleman more than we should be comfortable with.

The rich world has seen an astounding explosion of debt in the last 30 years. By injecting new money into the financial system in the hope that lending (debt) will resume, policy-makers are ignoring the issue of too much debt to begin with. But, Central Banks have only monetary tools and can’t really be blamed for trying to use them. 

Richard Koo has termed the current state of affairs a “Balance Sheet Recession”. The private sector needs to deleverage and can’t be expected to take on more debt. He makes the point that only fiscal policy can be effective at the moment, putting to rest any argument about austerity in the short to medium term. Additionally, quantitative easing is having noticeable negative consequences. Due to cheap money available to the financial sector, it is blowing new bubbles in the world economy (stock markets, real estate markets yet again, etc.). The real economy remains dormant. Another effect is that pensioners cannot make adequate returns on their savings due to very low interest rate environment. This will drive many into near poverty and mean that working lives will be extended everywhere. It is an intergenerational transfer from the old (savers) to the young (borrowers) limited only by the pool of retirement savings. And in the end, we leave it to our grandchildren to repay (or not) all of the accumulated debt.

In addition to the gigantic growth of total debt over the last 30 years, two other evolutionary changes have taken place in the global economy
with revolutionary implications. First, China has brought about the modern labor pool, adding at least 300 million workers to the previous pool. It has been joined by other nations attempting to follow in its footsteps. Wages in the developed world have not grown and cannot grow under these conditions. Add to the pool all those retirees who can’t retire. Secondly, technology and innovation have continued to improve making the new members of the labor pool more productive than we have ever imagined. The combination of both of these
developments means that global economies face a permanent shortage of demand. In other words, stagnation looks to be the norm for the foreseeable future, as incomes continue to increase for the top 10% and decline for the 90% in the rich world. Given the debt burdens of all rich economies, with few exceptions, this implies then that fiscal policy solutions are limited in duration and effectiveness.

The result must be the downsizing of expectations and lifestyles. This is bad news, and not the type of news that Central Bankers can be
outspoken about. Officials running for office, or in office, are in the same bind. The public will not react kindly to this sort of forecast. The
implications of growth of merely 1% for 10 years are not appetizing. Deeper recession, even less so.

So we are left with looking under the lamppost and pretending that the keys might be there.

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