So Many Economic Problems and No Easy Solutions

June 29, 2010

The U.S. economy performed worse during the past thirty years than between 1950 and 1980 even though the more recent bloc of time had two fewer recessions.  The table below compares growth in real GDP, jobs, and consumer prices in the two periods and additionally isolates the past ten years.  All three economic variables have slowed.  Greater price stability failed to improve growth.

% per annum U.S. GDP Jobs CPI
Last 10 Years 1.6% -0.1% 2.4%
Last 30 Years 2.7% 1.2% 3.3%
Prior 30 Years 3.5% 2.4% 4.2%

Wealth creation has become a very difficult process.  Let’s first examine the squeezed scope for asset appreciation.

  • Interest rates on short- and long-dated fixed income securities are very low. 
  • Equities are very volatile and remain in long-term downtrends.  Japan’s Nikkei advanced 15.5% per annum in the twenty years before peaking at 38,916 at end-1989 and would now be valued at 741,888 if that vector of appreciation had continued.  The actual level of the Nikkei-225 index at present is 75.4% below its 1989 peak.  If the Nikkei instead had continued to rise 15.5% per annum, it would be 77.5 times higher than where it now trades.
  • The stock markets of other advanced economies seem to be following in the Nikkei’s footsteps.  The DJIA rose 16.9% per annum between from a low of 777 in mid-August 1982 to a peak of 11723 in January 2000.  If that vector of appreciation had persisted, the DOW would now be at 59,748, slightly more than six times above the actual level.  The DOW lost 31.2% between January 2000 and September 2001, 32.6% between March 2002 and October 2002, and 53.8% between October 2007 and March 2009.  A drop of almost 12% in the past two months could be the start of a fourth big sell-off.  
  • Commodities show better long-term directionality but also move very erratically.  Real estate is associated with debt, which is presently excessive at all levels.

Let’s now turn to wealth creation through the old-fashioned process of deferred consumption.  That can be managed only by people with an income-generating job.  These days, labor markets face severe conditions in most advanced economies.  Employment is lower than a year ago in the United States, Euroland, and Japan, and the jobless rate in each of those instances is at or within 0.5 percentage points of the cyclical peak.  With real economic activity again slowing, the labor market skies are darkening.

Advanced economies have too much debt (this week’s Economist includes a special report on debt, with many insightful facts and opinions) .  The public debate is unfortunately hung up on the components of debt held by households, private businesses and the public sector.  Halting the rise of one type of debt often deflects the problem to another form, as we saw after governments in unison counter-punched the recession in late 2008 and 2009.  Fiscal hawks in Europe and the United States now want to pull back.  Others like New York Times columnist Paul Krugman warn that such a strategy would replicate the policies that transformed a recession into a depression 70 years ago.  Most sides agree that fiscal and monetary policies need to be normalized eventually, but some insist doing so now would be premature.  That line of logic needs to be taken further to gain public acceptance.  Nobody knows for sure when  policy-makers will know that it’s safe to tighten?  Can this be quantified in months or years, or perhaps qualified by conditions to be met like a jobless rate of less than 7.0%?  I’m skeptical that even this approach would succeed.  Roosevelt erred by tightening in 1937.  That’s four whole years after the trough in 1933, so should governments wait at least until 2014 before taking their foot off the accelerator?  Would five years be enough?  How about six? 

World War 2 cleansed recessionary propensities from the world economy once and for all.  And that can’t be tried again in a nuclear era.  The twenty-first century instead has settled into something more akin to a thirty-years war, with the United States bearing major responsibilities and absorbing huge expenses in the endless fight.  When I attended public school in the 1950’s and early 1960’s, the lesson was not lost on every proud student that America was undefeated in war just like the wrestling or football teams.  Vietnam shattered that streak, and subsequent U.S. wars ended another myth that war is good for the U.S. economy or for U.S presidents.   The enemy has meanwhile become more poorly defined.  But make no mistake, both international terrorists aligned with Al Qaeda and violent anarchists who turn out at every Group of Twenty event are so far achieving their central goal of a weaker U.S. economy.

It is ironic that advanced economies have become more and more reliant on demand from other parts of the world economy in order to dig out from the Great Recession.  Market attention to the different speeds of recession and recovery among the big industrial economies misses the bigger point that those nations as a whole have followed similar trajectories.  Their business cycles are more synchronized than would be ideal.  The breakdown last decade of multilateral trade liberalization after several decades of progress was extremely ill-timed.  A view has developed that very dynamic Chinese growth is the last hope of advanced nations coping with the hangover of the 2008-9 recession.  Policy stimulus by Beijing played a critical role in ending the recession sooner than feared, but China’s policies will become less supportive for domestic reasons.  More generally, U.S.-Sino relations are presently more confrontational than friendly.  The transfer of policy-coordinating duties from seven key advanced economies to the more inclusive Group of Twenty nations exchanged one set of shortcomings for another.  The bigger group is more unwieldy and less prepared to make concrete policy recommendations for each member.  A vacuum now exists in the area of currency policy .  When this was tried in the earliest days of floating exchange rates, chaos ensued.

Since China represents only 11% of world GDP, a 1 percentage point reduction in that country’s growth rate would trim global growth directly by just 0.1 percentage points.  However, what happens in China ripples outward to other Asian and non-Asian economies.  Over half of global GDP is accounted for by countries other than the United States and euro area, so a 1 or 2 percentage point cooling of China might conceivably impact global growth by 0.5-1.0 percentage points.

Long-run solutions to the present economic problems will require steady improvement in competitiveness. Peripheral nations in the euro bloc are now learning that it was a huge miscalculation to give up sovereignty over interest rate policy and the ability to depreciate their currencies when that strategy is the least painful and most politically feasible route to take.  Now they are stuck, since EMU was designed to make it extraordinarily costly for members to leave the plan.  Unless German officials modify their rigid priorities, it will not be possible for the others to catch up.

Cost competitiveness requires steps that are much more enduring than currency manipulation.   Better education is essential, but the best education that money could buy in the twentieth century will not work with technology changing now at light-speed.  Measured by test scores, the United States commanded a decisive edge in education until about 30 years ago but is now narrowing.  A second problem concerns the affordability of education.   Soaring property taxation is strangling many localities.   The breakneck climb of higher education costs appears unsustainable, too, especially because of the urgency to reduce debt at all levels.

Politics has become more partisan in North America, Japan, and Europe.  One element of the blame game is that either the public sector or private sector is entirely at fault.  In fact, both have dropped the ball repeatedly.  Legislatures do the bidding of interest groups that impose the will of a few on the many.  A who’s who of household corporate names have betrayed the public trust.  In hindsight, the most profitable sectors such as financial services and smart phones, have not exactly promoted the best allocation of resources from a broader standard of living perspective.  Healthcare has lengthened life spans, straining pension and ecological systems.  The advent of Tea Party chapters in the United States is a symptom of rising frustration.  A willingness to put ends above means suggests that this movement introduces a new irritant rather than a constructive plan of action against very daunting challenges.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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