Mainstream Economics Is Trapped In a Time Warp

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In May 2009, the Organization for Economic Co-operation and Development (OECD) published an extensive, exhaustive report on the then-plentiful incarnations of fiscal "stimulus." It was at the depths of the Great Recession and by then almost every country touched by it had to some extent responded to it. This was the first clue that it wasn't ever going to work, yet the fact of globally ubiquitous economic damage (all "unexpected", of course) was just set aside as if unimportant or irrelevant. The OECD publication itself only mentioned it in passing as just some further reason where "the high degree of synchronicity of the current downturn" justified coordination among various national "stimulus" policies.

Among the greatest considerations for policy harmonization was what these economists called "spillover effects." Very simply, it was a form of expected synergy or higher multiplier (in the parlance of orthodox economics) whereby every country recovering together would mean an even greater trade boost among them all. They were particularly enthusiastic about the US fiscal program, the largest in terms of GDP (about 5.5% they calculated). Because of it, their models expected that only the US and Australia would benefit from multiplier effects alone "clearly" exceeding 1% of GDP in both 2009 and 2010.

The one great caution they had at the time was typically ridiculous. The models were worried that it would all be too successful too soon. In other words, credit markets would easily forget the economic climate of the time and awakened by the recovery at hand begin to react negatively to what might have been viewed as fiscal profligacy.

"Secondly, it is assumed that there is no increase in interest rates in 2009-10 as a consequence of the fiscal stimulus, whereas if interest rates did increase this would also tend to dampen multiplier effects both at home and abroad, involving partially offsetting negative spillover effects. Further fiscal actions would raise positive trade spillover effects, but also increase the likelihood of an adverse reaction from interest rates."

This is, of course, backward. Higher interest rates are a welcome sign not one that reduces "multiplier" effects. The OECD may be forgiven for the timing of their concern given that recovery was even into 2010 by no means assured, but if fiscal "stimulus" did actually stimulate it would rightly lead to higher rates and a steeper yield curve. In the years since, however, bond markets globally (again uniformity) have gone in the opposite direction, if somewhat uneven in achieving the now low and shriveled (and often negative) "risk-free" curves.

Continued lower interest rates did not create further room for fiscal multipliers to gain ground. In its latest global economic update released at the start of June 2016, the OECD now complains that the global economy has fallen into a "low-growth trap."

"Global growth has languished over the past eight years as OECD economies have struggled to average only 2 per cent per year, and emerging markets have slowed, with some falling into deep recession. In this Economic Outlook the global economy is set to grow by only 3.3 per cent in 2017. Continuing the cycle of forecast optimism followed by disappointment, global growth has been marked down, by some 0.3 per cent, for 2016 and 2017 since the November Outlook."

This latest outlook projects the unemployment rate globally to fall to 6.2% in 2016, but that still means there are 39 million people out of work, "almost 6.5 million more than before the crisis." And those figures, as we know well from the perspective of American workers, are misleading as understated. The consequences are "muted wage gains and rising inequality" that will "depress consumption." Thus, there could not have been any multipliers at all, at least none that have lasted or overcome hysteresis boundaries.

And their answer to the quagmire is...more fiscal "stimulus." Given all this malaise, how are we supposed to square their call for more of it with their outlook for it from 2009? What happened? Why didn't it work?

You will find no answers from the OECD nor any mainstream institution or economist. Policymakers, especially on the monetary side, are stumped and have retreated. Their gathering at Jackson Hole at the end of August was essentially a brainstorming session for "what do we do now?" As the global economy gets worse, the only answers are more of the same?

The idea of a low-growth trap while accurate is still itself deceptive and perhaps disingenuously so; it is passive and thus attempts by its very phrasing to avoid providing any answers. The expression expects that you will just accept the current outcome as a matter of accident; the economy is growing just not quickly enough. Given that construction, it almost doesn't sound too bad, maybe even just positive enough so that nobody bothers to ask what it is. It is the latest equivalent of "jobs saved."

For the OECD, the trap itself is derived from more passive circumstances. Because of a "prolonged period of low growth... Business has little incentive to invest given insufficient demand at home and in the global economy, continued uncertainties, and a slowed pace of structural reform." That would certainly account for low and lower interest rates (with no opportunity, invest only in the riskless), but it still remains unanswered why the "prolonged period of low growth" in the first place. The trap part of it is straightforward, even if purely as a matter of expectations. But there are no answers as to why expectations would first have fallen to such a condition and then remain there year after year after year.

This is particularly troubling since one of the primary goals of any "stimulus" is to create positive expectations in the private economy. That is, essentially, what multipliers are; the entire idea is that "stimulus" creates positive activity which is viewed by private economic agents as a signal to go back to normal, if not do more than normal, under conditions of support. Not only was fiscal "stimulus" a heavy presence especially in the early stages, asset prices began to rise often precipitously (though also unevenly, which further reflect serious doubts from the beginning). That is why every economic model in the orthodox arsenal, some truly considerable and elegant statistics, expected positive multipliers until recently. It all "should" have worked.

So we are left back at Square One wondering why it didn't. Nobody will provide any answers beyond again the passivity of some variation of "it just is" or its cursed twin of "it could be worse." While the OECD has called it a low-growth trap, others have called it a balance sheet recession, and still others secular stagnation. However it may be described, the consensus has finally swung around to agree "something" isn't right. Secular stagnation is as the low-growth trap, meaning neither even bother to suggest causation apart from further non-specific allusions to demographics, productivity, or, when fashionable, inequality. Only the balance sheet recession hypothesis provides at least some kind of answer, but it doesn't fit these circumstances both in terms of time and why the economy is getting worse not better.

Industrial production in the United States was figured to have contracted year-over-year again in August, filling out a full year in the negative. This is a very serious indication of ill economic health that while not explicitly recessionary (yet) demonstrates an even more sinister possibility. In the seasonally-adjusted series, IP peaked in November 2014. Since then, it is down only a little more than 2%, but the true cost to the economy is not the level of the decline but rather the time in which it has taken.

Late last week, the Commerce Department reported that US factory orders had fallen rather sharply year-over-year in July, declining 6% after falling 5.7% the month before. Outside of a small increase in February earlier this year (due to its 29th day), factory orders have been contracting every month since October 2014. The seasonally-adjusted series places the peak a little further back into that summer, starting around July 2014 and thus two full years of retrenchment.

Earlier this week, the National Bureau of Statistics of China published estimates showing that Chinese exports in total fell by 2.8% year-over-year in August. Exports were down more than 8% when compared to August 2014. That is, as the US manufacturing sector, a huge cost in terms of time but more so for the Chinese whose economy is predicated on rather rapid expansion. Prior to 2008, Chinese exports consistently expanded by 20-30%.

Perhaps even more instructive, Chinese imports have been falling at a greater rate, more consistently, and for a longer period than exports. Chinese imports in August rose by 1.5%, the first positive number since October 2014. There is an unmistakable pattern, a global pattern whereby "low-growth" has become even lower if not any longer growth. All of it traces back to the summer/autumn of 2014 - the "rising dollar."

We can continue backward in this worldwide catalog of woe, adding additional geographies as well as expanding the list of economic accounts and they all filter in toward three prominent inflections. The first was, obviously, the Great Recession; the second in 2012, where the US economy suddenly and sharply slowed (panicking Bernanke into QE3 and then QE4), Europe fell back into "recession", while the Chinese economy decelerated considerably from what looked like more normal to a quasi-state between that and zero; the third inflection was the "rising dollar" of 2014, turning slow but seemingly steady growth into slow but seemingly steady contraction.

Therefore, all of these economic points of deceleration match exactly with quite prominent monetary problems; "dollar" problems. From that realization we can only conclude that a low growth trap is really a depression, it is just that properly categorizing the current condition moves beyond passively avoiding causation (and thus blame) and into the realm of actual solution. The OECD cannot say or write the word "depression" in its outlooks because it is committed to the idea of "stimulus" either monetary or fiscal, and thus cyclicality, even though it is quite conspicuously admitting to, and describing the effects of, depression.

Whenever you raise the possibility and use that specific word people have a tendency to lose their minds. The Great Depression of the 1930's looms large even today in popular imagination and not without good reason. It was a catastrophe that hugely altered the course of global history, bringing about suffering, misery, and death across two decades. Economists have dedicated themselves to ensuring it never happens again, empowering especially central banks to see to it.

And therein lies the very problem; central banks today are committed and intellectually armed to fight the Great Depression all over again, not a depression of the 21st century. First of all, that calamity is not the only form of or scale for one. A depression is in very simple terms two parts: a crash that creates severe economic dislocation and then an economy that following the crash does not resume its prior trend. Using only the OECD's two reports, the first in May 2009 and the second from June 2016, we have an orthodox institution in quite good standing (in the mainstream) describing exactly those two sides.

Even though the economic crash was large it wasn't 1929, and all expectations from "extraordinary" "stimulus" was still positive; all the math, both fiscal and monetary, held no illusions about the depth but still remained optimistic toward an eventual cyclical outcome. Seven years later, a more than sufficient amount of time, they have come back and finally admitted there was no such outcome, and furthermore there won't be. The only difference between "depression" and "low-growth trap" is recognizing causation since they both describe the same result; the latter passively avoids the issue, while the former identifies the obvious "dollar" connections from federal funds, LIBOR, and even T-bills on August 9, 2007, to CNH HIBOR, ¥ cross currency basis swaps, and US$ repo today (and T-bills now in the other direction).

That is where the "rising dollar" portion of it over the past two years is so compelling, if not dispositive. Again, a balance sheet recession would over time shake off the effects of "too much" debt so that after "enough" deleveraging the economy would begin to turn back toward normal. What has occurred over the past two years here, Europe, China, etc., is the opposite. The global economy has not slowly accelerated but instead slowly decelerated into (far too) often contraction. And that contraction part is being led by manufacturing and especially trade, two primary segments that are most affected (directly) by monetary conditions.

Denying the monetary connection(s) means to keep doing over and over the same things and kinds of things that haven't been successful and neve will be. The OECD slams fiscal authorities for not doing enough, leaving monetary policy somehow overburdened when just a few years ago they were sure monetary policy (in a second dose of "extraordinary") would be enough. And before that, fiscal and monetary policies combined were assured as sufficient, perhaps even too much so. The all fall far short because they can't solve the simple truth: the Great Recession was never a recession.

"Stimulus" in whatever form is an arguable and dubious proposition to begin with, but there is no argument that it was designed and figured for a cyclical world. More than that, however, the very idea of it is now exceedingly harmful. "We" have already squandered nearly a decade chasing the recession tale (pun intended), which has had the effect of leaving the economy to fall deeper into the depressed state - monetarily as well as economic expectations. Again, the OECD recognizes the result without seeing plainly the source; the trap isn't a mysterious result of accidental forces creating "low growth", it is economic agents finally coming to terms with the reality of this situation. People realize long before economists what is truly going on, the same as has been happening since early 2008.

Nowhere is that more evident than credit and funding markets. For more than two years, even before this "rising dollar" began, economists here in the US claimed that the unemployment rate indicated the vindication of especially QE while at the same time the bond market predicted the opposite. The bond market won the argument by knock-out. Some economists are ready to admit that the bond market was right, but still decline to see why.

That is what this whole "rising dollar" business has been about in the first place. Breaking it down into its constituent pieces, it was various "money" markets seeing the future for what it was about to become rather than what it "should" have been by reckoning of econometrics. Such an increasingly bleak economic landscape meant only greater risk with very little possible upside. Add the further pressure of more rigid regulatory constraints, and the internal workings of the global eurodollar system were just not worth the trouble. Global banks, that had been receding and shrinking also unevenly since 2008, accelerated their exit from all forms of money dealing activities (from the traditional sense of the effect to the more esoteric of derivative books and more implied forms of traded bank liabilities including collateral lending and transformation).

Depression is money; lack of money is depression. Without fixing the monetary issue, there is no solution, only wasted time. Central bankers cannot figure it out because they believe they have covered money by QE and other forms of "extraordinary" accommodations. Those are, again, appropriate only for a global system that hasn't existed in half a century. We cannot remain hung up on terminology. A low-growth trap is the same thing, and it needn't have anything to do with 1929.

Time is now our greatest enemy, as the clock has been ticking down to some unknown conclusion for more than nine years already. If policymakers refuse to budge from their passive position recognizing the depression for what it is but not why it is, then the clock will only continue toward zero. What happens at midnight cannot be predicted because we don't know how far these negative trends will progress before they become truly untenable. How long can the Chinese economy continue with contracting exports? It's been two years already, but now the core of China's economic engine is cracking - private fixed asset investment is now itself contracting, a hugely worrisome sign since FAI is urbanization and thus social stability there.

In pre-modern times economic stagnation meant literal starvation, so the torches and pitchforks weren't usually that far removed. I highly doubt we ever get that far, but are we so far now from the figurative forms? Social and political unrest are already indicated, if still at relatively low levels (unless you are apoplectic about Brexit). In fact, that was one of the OECD's purposes in its latest Outlook; to warn governments around the world to act (in the wrong way) because:

"The longer the global economy remains in this low-growth trap, the harder it will be for governments to meet fundamental promises. The consequences of policy inaction will be low career prospects for today's youth, who have suffered so much already from the crisis, and lower retirement income for future pensioners."

In other words, a recipe for greater social unrest. Mainstream economics is an impediment to avoiding that fate because it is trapped itself in a time warp. Economists spent decades studying every facet of the Great Depression so that they would be prepared the next time it might start to happen again. In those decades of focus on the past, however, took place some of the most extraordinary and truly mind-bending evolution of money and finance. Boundaries were smashed, limitations were left far behind, and even conception of what should be straightforward (money) no longer is. I have to yet again quote Alan Greenspan from the public transcript of the FOMC in June 2000:

"The problem is that we cannot extract from our statistical database what is true money conceptually, either in the transactions mode or the store-of-value mode. One of the reasons, obviously, is that the proliferation of products has been so extraordinary that the true underlying mix of money in our money and near money data is continuously changing. As a consequence, while of necessity it must be the case at the end of the day that inflation has to be a monetary phenomenon, a decision to base policy on measures of money presupposes that we can locate money. And that has become an increasingly dubious proposition."

His "dubious proposition" about money is our social unrest potential; one follows the other, especially aided by so much lost time. Greenspan was right about one part, as so often is the case in these complex matters: "inflation has to be a monetary phenomenon", which is why central banks can't seem to get any of it no matter how many trillions of 1930's-style "money" they throw into the mix. Instead, at the margins, modern money just disappears, and so does, little by little, the economy. For this one single variable, hostage to mathematical, ideological stubbornness, the whole world is stuck. Sometimes words really do matter.

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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