Economists Are the Barrier to An America That Is Great

Economists Are the Barrier to An America That Is Great
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At the Royal Institution of Great Britain on Friday, April 30, 1897, many in the audience who were in attendance to hear mathematician and physicist JJ Thomson speak on the serious science of the day thought he was instead telling them a joke. Thomson was, after all, the director of the prestigious and venerable Cavendish Laboratory at Cambridge University. He had been awarded the Adams Prize in 1884 for his Treatise on the Motion of Vortex Rings and his 1892 work Notes on Recent Researches in Electricity and Magnetism, which had covered the results of James Clerk Maxwell’s groundbreaking experiments, so insightful that it was and is often referred to as “the third volume of Maxwell.”  Therefore it was simply absurd that someone as renowned and acclaimed as Thomson would try to state to his educated audience at the tail end of the 19th century that there were pieces of fundamental nature smaller than an atom.

Had the assembled guests at the Royal Institution more fully understood Thomson’s prior research history, maybe they wouldn’t have been so surprised at his announcement (though in fairness, many, perhaps most, weren’t).  Science had been working in that direction for some time, Thomson just the last who was insightful and brilliant enough to take the final completed step. Electrons had been theorized as far back as the 1830’s, but they could never be proven and established.  Thomson was awarded the Nobel Prize in Physics in 1906 for estimating the ratio of its relative mass and charge, and finding that it was a universal constant and thus a fundamental part of the universe.

Having “discovered”, definitively, the electron, Thomson was heard to wonder what it could possibly be good for. Had he only known that it was everything the modern world has come to depend upon.  At the end of the 19th century, only the greatest minds contemplated a universe beyond atoms, just over a century later that opened up universe is the fundamental reality behind our daily lives and most of its commerce.  And there are still as-yet undiscovered layers where the electron might still be applied – or even surpassed.

Innovation is not a single thing or event, it is string of theory and experiment, often informal and accidental, pieced together over sometimes great stretches of time.  In 2012, to great pomp and circumstance, a similar breakthrough was made at the Large Hadron Collider (LHC) at CERN. Like the electron, the Higgs boson had been theorized decades before, but it wasn’t until the LHC that enough energy could be utilized in particle collisions to actually “see” it (meaning detected in the statistical analysis of millions of decay channels).  Its formal discovery at around 126 GeV has had already great theoretical implications, though maybe not so great for SUSY (supersymmetry) and the multiverse Theories Beyond the Standard Model, or even if it suggests the universe might only be metastable, but who knows what in the rest of this century might be made from a more elegant and comprehensive knowledge of the inner workings of all fundamental creation.

Just as Thomson pondered what an electron could do, we can similarly contemplate what a Higgs (or five) might do in and for the future.  It is obviously far more complex still in turning theoretical innovation into functional economic patterns and even revolutions, but innovation itself is always ongoing; it is perhaps the only constant of human nature, but especially of modern humans.  If it is interrupted as an economic matter, it doesn’t stand to reason why that would be considered a problem of innovation.

Yet, economics as a supposed science has turned back in that direction all over again.  Economists have no idea why the economy, quite frankly, sucks, and does so all over the world and all at the same time.  In order to attempt what may appear a legitimate and plausible explanation, they have turned more and more toward the resurrected idea of a discredited economist of the past.  The idea behind the modern appeal of secular stagnation is quite simply economists claiming “it isn’t our fault.”

Alvin Hansen first proposed the idea, giving economics the specific term, in 1938.  Though the world was progressing beneath his feet, you can at least understand why in that year he might not be so sure of it. The Great Depression is often thought of as just the first part, the immense crash from 1929 until, as is often stated wrongly in the mainstream, FDR got the country out of it.  Rather than being a single downturn, what made the Great Depression was a second nearly as harsh downturn starting in 1937 that essentially removed all ideas about recovery.  The economy globally would only appear to be moving forward, but by many if not most accounts it was a full departure from the past experience and expectations.  Why, then, might it not be permanent?

For Hansen, there had to be a reason, so he proposed three.  The first was demographics, where the 1930’s like the 2010’s was thought to be the start of a lasting population decline.  The second was lack of territorial expansion, which the US by then had run out of places on the continent to move in to; Manifest Destiny was not just past tense but had already been surpassed and connected by rail and then telephone almost everywhere. The last of Hansen’s propositions was an apparent lack of innovation.

You can make arguments for the first two, though economists should have known by the 1930’s the dangers of extrapolating in straight lines forever forward (a lesson, apparently, still not learned). Territorial expansion might have been one of the factors driving economic growth in the 1800’s, but that doesn’t necessarily require its commitment to determine growth through all time.  As to population, Hansen would get his answer in less than a decade.  He apparently could not have, and clearly did not, foresee the Baby Boomers, but that is precisely the point. 

In especially 21st century economics, it has truly become the “dismal science” as now a creature of almost total econometrics.  By being based on statistical models, its predictions are grounded entirely in the past, unable to gain any semblance of the future that isn’t a straight line (or at most a curve) shooting out of it.  Thus, as things look so very bleak right now economists are led to believe they will be so very bleak forever (only slight hyperbole).  The “greatest” contribution from economists in the past few years has been to redraw long-term trend-lines for economic potential down to where most people already know the current economy exists.   

We have arrived at the 2 and 5 point for central banks, and since central banks set all economic agendas, as Milton Friedman pointed out last decade, that is the political reality as well.  The dual mandate of the Federal Reserve is stable inflation and full employment (not in those exact terms).  The Fed has defined those more loosely as a 2% inflation target and an unemployment rate at around 5%, so long as that 5% doesn’t create more than 2% (sustained) inflation.  If there is very little actual growth at that intersection point, then for central bankers that is a “supply” issue beyond their paygrade. 

Due to the concept of monetary neutrality, economists have become convinced that nothing monetary policy (or money itself ) does can affect potential or the long run trend. But already there is problem of inconsistency; for almost all of the past ten years economists have claimed that the prior economic trend was unbroken, and therefore recovery expectations were to be taken literally.  QE and ZIRP were programs designed to “aid” “demand” so that economic growth would be nudged back to that prior trend.  To find instead the 2 and 5 point at a far lower growth state is not just a serious quandary, it is, in fact, potentially disqualifying about a great deal of orthodox economic theory.

Having resisted this very idea year after year, wasting enormous time as well as resources of trillions in the form of useless, idle bank reserves, very quietly in 2016 central bankers have begun to accept this discrepancy.  “Something” changed global economic potential, meaning “supply” side, quite drastically from before the Great “Recession.”  To believe that means to admit it was never a recession; it also means that there will have to be answers as to how that could have happened (before questions arrive from the roused public as to why economists never saw it coming, denied it vehemently while it happened, and only now have vague responses for it). 

And so Alvin Hansen has been proposed for a second try of secular stagnation.  To many inside, he wasn’t wrong, just early.  Those who have suggested this explanation are probably not at all aware of the irony in making Hansen a lower order Karl Marx. 

Among the institutions that are of late seriously considering this belated intellectual examination is the Banque du France. On Monday, Banque held a conference on secular stagnation but more so with regard to how a central bank might conduct its operations and mandates from within it.  Forgive the cheap and easy joke here, but it is shocking to me how the French appear so willing to contemplate surrender.  Central bankers should not be dedicating so much time and effort (after wasting so much time and effort) to becoming so desensitized to an economic paradigm or trajectory that through all human history has led only to the worst outcomes. 

Hansen’s theory being proposed in 1938 perfectly exemplifies this danger.  We should not so meekly just accept this fate (even as just a possibility).  And it isn’t just the French who are moving to do just that, as secular stagnation will gain even further acceptance the more 2 and 5’s are reached without actual recovery. It is a kind of “get out of jail free card” for central bankers, a way for them to say, “see, it’s not our fault QE didn’t succeed, it never could have.” 

But while they make this attempt, we must be vigilant to demonstrate, relatively easily, all the serious holes in the argument.  In reality, it isn’t actually a plausible explanation at all, starting first and foremost with the timing.  There is absolutely no reason to believe demographics or innovation suddenly became overriding “supply” factors that all-at-once in the fourth quarter of 2008 predominated upon the global economy’s future path and status.  When Janet Yellen says Baby Boomer retirement, she needs to be made to answer why they would have as a group decided the worst panic since Alvin Hansen’s day was the best time to start retirement; to begin utilizing 401k’s while they were still, as the uneasy joke of the time described it, 201k’s. 

The time and attention of the United States in terms of economic policy has been frivolously abused trying to make recovery where one wasn’t possible, and now I fear it will be wasted some more trying to live without one.  Central banks should not be squandering what little opportunity there may be left, in relative terms, trying to work out how to operate inside secular stagnation, they should instead be made to understand that is really never an option.  Priorities need to be refocused to getting out of it, not getting comfortable with it. 

I have maintained all along that the possibility for the election of Donald Trump was a positive sign in that it showed Americans after exercising enormous patience aren’t going to forever blindly follow economists into just accepting zero growth.  The economy, or lack of it, no matter how close to 2 and 5, was the driving force in his election.  Real average weekly earnings in December 2016 were a paltry 5.2% more than the peak in 2007, working out to about half a percent per year “growth.”  And the only reason wages were measured to have been that far was that starting in the middle of 2014 oil prices crashed.  In other words, the biggest “raise” in real terms for American workers over the whole of the post-crisis period was not provided by looming recovery as they claimed but in actually moving farther (and conclusively) from it. 

Having finally elected Mr. Trump, we have to face up to the next step in the search for answers, the possibility that he may not actually hold them.  I have to confess that before he even takes office I have been forced to downgrade my optimism as to whether anything will meaningfully change. His comments this week about the dollar being “too strong”, combined with what looks to be an early administration priority to label the Chinese as currency manipulators, are to me far more important and self-defeating than whatever good (and these are good) will come out of fewer regulations, better tax policy, and an end to Obamacare.  To believe that the Chinese are deliberately weakening CNY against the dollar and that their intermittent and desperate attempts at stability are the disingenuous part betrays a dangerous misunderstanding. 

This isn’t surprising, of course, as by and large even the Trump administration will be run and guided by economists (though, so far, his at least seem to be aware of the fault in the unemployment rate).  Economists still think of global money as if it was 1955, and will therefore analyze these sorts of behaviors as if Robert Triffin’s ideas were still (or ever) relevant.  Ideology prevails despite the fact it actually takes less than 5 minutes to see what China’s problem actually is. 

If anything in China has been conducted by stealth, monetarily speaking, it has been what looks very much like QE.  The PBOC’s balance sheet has swelled, especially in 2016, on the RMB side (assets).  Because of how China’s monetary system was modernized in the 1990’s, RMB is for all intents and purposes “backed” by “dollars” (meaning foreign wholesale currency, primarily denominated in dollars).  The monetary base for Chinese money in bank reserves has been “covered” by these forex assets in superior proportion – until the last few years. In 2009, it was about 2 to 1, meaning for every RMB in bank reserves (money) there were 2 RMB in forex assets.  By 2012, that ratio had deteriorated to 4 to 3.

As of the latest figures from the PBOC for December 2016, bank reserves in China are now uncovered by forex assets as the Chinese central bank has been forced to de-dollarize.  Total bank reserves had risen to RMB 23.4 trillion in December, up by RMB 1.35 trillion in just that one volatile and excruciating month, while forex assets fell to just RMB 22.98 trillion.  They have been offering in increasing doses term funding to large Chinese banks, expanding the asset side in these channels so as to increase bank reserves and therefore Chinese RMB money.

The numbers are still astonishing, even in a world where QE’s have regularly run into the trillions.  From a RMB balance sheet base of about RMB 4.5 trillion at the end of 2013 (when the currency started its decline) the PBOC has added RMB 6.9 trillion in these other measures of internal RMB funding with which to try to regulate positively bank reserves.

And yet, it hasn’t been near enough.  A far greater monetary force has swallowed up all that “money printing.”  Total assets are up just RMB 2.6 trillion during that time, and are only fractionally higher than March 2015 despite all the RMB infusions.  The reason is quite simple, meaning that the Chinese are not intentionally de-dollarizing but doing so because there aren’t any “dollars” for them.  The flow of “dollars” off the PBOC’s balance sheet is an attempt to fill in what is an enormous and growing private “dollar” gap, one that is actually driving the direction and intensity of China’s currency exchange. 

The major difference between the PBOC and the Fed is that the former has its “dollar” problem listed right on its balance sheet, while the latter denies there is even such a thing, or that such a thing is even possible.  The Chinese are living the reality that the Fed will only ignore so long as it and its global orthodox kin are allowed to contemplate secular stagnation as an alternative explanation for that reality. 

Ultimately that is what all this reduces down to, distilled in depression the monetary difference of actual global money.  The amount of “dollar” destruction since 2007 is staggering and in most ways unquantifiable.  That is one primary reason I personally spend so much time researching and writing about China, because it is the one place, ironically, where the world’s “dollar” problem isn’t so obscured and disguised. There is much more to it than what is going on in the Chinese end of the eurodollar system, of course, but for once there is an open and applicable proxy that takes very little time and effort to measure, understand, and analyze. 

Alvin Hansen was wrong because innovation never truly stopped (or stops) but there are times when the economy does.  The trick is to not confuse one for the other.  What was wrong in the 1930’s was that the global monetary system remained imbalanced and disorderly going all the way back to 1914 when all the world’s powers went off the gold standard and never really went back.  While most economists at that time despised gold, and almost all still do, at least enough of them, including no less than John Maynard Keynes, realized that despite their loathing they needed to at least copy and replicate the essence of gold as a stabilizing force for global monetary affairs, which would therefore allow global growth to once again take root.  As it did.

Just a few years later population expansion followed.  Innovation moved back into the economic realm as technologies that had been developing for years and years were given the opportunity finally to become mainstream. The decade of the 1950’s was once remembered nostalgically and so fondly not because technology was restarted during that time but because the economy was.  From JJ Thomson to Howdy Doody in 50 years, and an enormous, costly (unnecessarily ignorant?) mess in between. 

World War II was never the economic answer; it was the great and truly catastrophic economic mistake.  To follow Alvin Hansen is to make it all over again. The economy cannot and will not be defined solely by 2 and 5.  There is great opportunity still to be unleashed, if only we would stop listening to economists.  They have spent the better part of the last ten years peddling only false hope, only to now turn around and suggest because they, specifically, didn’t succeed there is no hope. The variable to be excised from the equation isn’t optimism, it is Economics.  

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

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