Interest rates will eventually rise without an even more devastating policy of financial repression. When they do, rising interest costs will produce a vicious cycle of ever more borrowing. We are already approaching the “event horizon” of spinning into this black hole of an inflationary spiral and economic collapse from which few countries historically have escaped. A substantially higher rate of growth is the only way to break free.
National economic growth is typically measured by the growth of GDP, and citizen well being by the growth of per-capita GDP. The long run trend of GDP growth reflects labor force participation, hours worked and productivity as well as the rate of national saving and the productivity of investments, all of which have been trending down.
The population grows at about 1% annually and actual GDP growth averaged 2% overall for 2010-2016 (using the new World Bank and IMF forecast of US GDP at 1.6% for 2016), hence per capita GDP grew at only 1%. Moreover the income from that 1% growth went primarily to the top one percent while 99% stagnated and minorities fell backwards.
Why we are approaching the Event Horizon
The Obama Administration annually predicted a more historically typical 2.6% per capita growth rate, consistent with the historical growth in non-farm labor productivity. How could their forecasts be so far off?
The Obama Administration pursued the most massive Keynesian fiscal and monetary stimulus ever undertaken. Such a policy generally at least gives the appearance of a rise in well being in the near term, as the government GDP statistic (repetitive, as the word “statistic derives from the Greek word for “state” ) reflects final expenditures, thereby imputing equal value to what governments “spend” as to the discretionary spending of private households and businesses in competitive markets. But labor productivity gains stagnated at only about 1%, most likely reflecting the cost and uncertainty of anti-business regulatory and legislative policies that dampened investment, something the Administration denied, trumping even a short term boost to GDP.
As a result the national debt approximately doubled from $10 trillion to $20 trillion, with contingent liabilities variously estimated from $100 to $200 trillion, putting the economy ever closer to the event horizon. Breaking free will require reversing the highly negative trends by reversing the policies that caused them.
Technology alone isn’t sufficient
Obama Administration apologists argued that stagnation is “the new normal” citing leading productivity experts such as Robert Gordon who dismissed the potential of new technologies. Many disagree, but Gordon’s findings imply even greater reliance on conventional reform.
Fiscal policy won’t be sufficient
Raising taxes may reduce short term deficits but slows growth. Cutting wasteful spending works better but is more difficult.
The list of needed public infrastructure investments has grown since the last one trillion dollar “stimulus” of politically allocated and mostly wasteful pork that contributed to the stagnation of the last eight years. Debt financed public infrastructure investment contributes to growth only if highly productive investments are chosen over political white elephants like California’s bullet train, always problematic.
Major cuts in defense spending are wishful thinking as most geopolitical experts view the world today as a riskier place than at any prior time of the past century, with many parallels to the inter-war period 1919-1939.
The major entitlement programs Social Security and Medicare for the elderly need reform. But for those in or near retirement the potential for savings is slight. Is Medicare really going to be withheld by death squads? Are benefits for those dependent on social security going to be cut significantly, forcing the elderly back into the labor force? Cutting Medicare or SS benefits for those with significant wealth the equivalent of a wealth tax won’t affect their consumption, hence offsetting the fall in government deficits with an equal and offsetting liquidation of private wealth. Prospective changes for those 55 years of age or younger should stimulate savings and defer retirement, improving finances only in the long run.
The remaining bureaucracies are in need of major pruning and in numerous cases elimination but they evaded even budget scold David Stockman’s ax during the Reagan Administration.
Americans will have to work more and consume less
That is the typical progressive economic legacy of excessive borrowing from the future.
The first Clinton Administration created the crony capitalist coalition of the political elite and the politically favored, e.g., public sector employees and retirees, subsidy recipients and low income home loan borrowers. The recent Clinton campaign promised to broaden this coalition, which would have accelerated the trip over the event horizon.
Reform that taxes consumption in favor of savings and a return to historical real interest rates could reverse the dramatic decline of the savings rate. Regulations redirecting savings to politically popular housing or environmental causes need to be curtailed in favor of market allocation to productive business investment.
Repeal and replace of Obama Care could reverse the trend to part time employment. Unwinding the approximate doubling of SS Disability payments and temporary unemployment benefits could reverse the decline in labor force participation.
Service sector labor productivity has been falling since 1987, the more politically favored the faster the decline. Legal services are at the bottom, partly reflecting political power of rent-seeking trial lawyers, followed by unionized health and then educational services. Union favoritism through, e.g., Davis Bacon wage requirements and “card check” increases rent seeking, particularly rampant in the unionized public sector.
Competition, of which free but reciprocal trade has historically been a major component, has traditionally provided the largest boost to well being by realizing the benefits of foreign productivity in a lower cost of goods while channeling American labor into employment where their relative productivity is highest. The transition is often painful, but paying people not to work long term is counterproductive. Immigration of both highly skilled and low cost labor (but not dependent family) generally contributes to per capita labor productivity in the same way as free trade.
None of this will be easy. The alternative is Greece without the Mediterranean climate or a sufficiently rich benefactor.
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Kevin Villani, chief economist at Freddie Mac from 1982 to 1985, is a principal of University Financial Associates. He has held senior government positions, been affiliated with nine universities, and served as CFO and director of several companies. He recently published Occupy Pennsylvania Avenue on the political origins of the sub-prime lending bubble and aftermath.
No. Next question—
Agreed. And it’s such a cluster I don’t know if anyone can. It’s just a question of how many people get hurt how badly in the collapse.
“How could their forecasts be so far off?” Because macroeconomics is essentially a vacuous discipline.
“The Obama Administration pursued the most massive Keynesian fiscal and monetary stimulus ever undertaken.” Perhaps it’s all a matter of Keynesian Economics vs The Economics of Keynes. But although Keynes really was a very clever chap, that needn’t mean that he was right either.
“most geopolitical experts view the world today as a riskier place than at any prior time of the past century”: I snort in derision.
I’m not persuaded that anything the federal government might do will work, short of an eventual default. But various things might be tried, including a rationalisation of the tax system, massive removal of regulatory burdens, severe cuts in their civil service, cuts in that part of “defense spending” that consists of buying hi-tech weapons that won’t work properly, using the armed forces for defence rather than offence, huge reform of the US health “system” (a crony capitalist insult to the idea of free markets), and so forth. Meantime stop some costly social problems growing by defending your borders from illegal immigration.
It’s hard to se that the great vested interests will let much of this happen – you only have to look at their attempt at a slow-motion coup d’état against Trump to see the scale of the problem of getting reform.
“There’s a great deal of ruin in a nation” said Adam Smith. How much have you chaps got left? Or Germany, Sweden, France, the UK, Italy, Japan ……….?
“Obama Administration apologists argued that stagnation is “the new normal” citing leading productivity experts such as Robert Gordon who dismissed the potential of new technologies. Many disagree, but Gordon’s findings imply even greater reliance on conventional reform.”
On the one hand, we have Gordon and others who believe all the low-hanging productivity fruit has been picked and we are in for an era of productivity stagnation. On the other hand, we have a lot of people asserting that machine learning and robotics will *raise* productivity to the point that jobs will become rare and the government will have to pay people not to work.
Both these things cannot be correct. I’m pretty confident that the truth lies somewhere in between.
Since the recession, population growth in the United States has fallen below 1%. It’s at 0.7% as of 2013. Declining immigration, lower birth rates, and decreasing life expectancy are all the reasons. The news last week was that life expectancy declined for the first time since 1993. Our American culture is already deep in the hole.
The need to work harder will be universal and will increase the pressure on those who are “protected” such as government or favored industry workers. Reducing the awful mass of business regulations and reporting will help more than you might think. Permitting and approval delays have virtually stopped productivity enhancing work. Unfortunately, Trump seems to believe in stimulus spending on infrastructure rather than the role of that in improving economic performance. A resurgent US economy with a free trade environment will help spark worldwide economic growth that feeds back positively to our economy.
PE Trump has experience with bankruptcy. PE Trump has the US file Chapter 11, all debts are settled for 40 cents on the dollar, and we’re good to go.
Great analysis by Kevin Villani.
Keynes was clever, but not as much as he or his devotees thought. Keyes theory was inconsistent with Says Law (the act of producing creates the means to exchange or supply creates its own demand). His false proposition (demand creates its own supply) was rooted in his failure to understand the determinants of investment. He also equated government spending as at least equal to private spending in efficiency and satisfying human wants with scarce resources. The application of Keynesian theory never performed as expected and a major issue was the long term effect of government deficit spending crowding out private investment, thus slowing long term productivity increases and technology advancement. Typically this was viewed as the effect of observing available savings and increasing interest rates (given a stable money supply). The Keynesians viewed this as an insignificant factor because the demand for investment was the most volatile part of national income spending (more properly aggregate demand) so there was plenty of saving to fund the government deficits.
The anticipated economic recovery from Keynesian fiscal policy was anticipated to be the effects of the increased government spending and transfer payments to those groups receiving financial help. A net increase in aggregate demand. Keynes seems to have assumed that aggregate supply was a given or was determined by aggregate demand. But aggregate supply is highly dependent on investment as well as the risk taking calculations in business operations.
Investment was not only based on the immediate cost of borrowing measured by the interest rate in the investment-saving market, but on the expected future return of that investment. With the growth of government as a proportion of the demand for goods and services, the types of investment undertaken shifted to less efficient and less productive areas where fewer human needs were being met. When the inefficiency (dead weight loss), of government spending is driving a larger proportion of demand for goods and services, resources are being redirected to lower priority uses and the incentive for innovation and increase in capital is reduced in the long run.
Regulation, political volatility in priorities and political barriers to entry increasingly substitute for market driven decision making. This increases uncertainty in private production and decreases the demand for net investment. The impetus for investment of increased government demand for goods and services does not fully replace the offsetting private demand in either quantity or character. This a more subtile understanding of the crowding out defect in Keynesian theory that predictably leads to a steady need for an ever larger government proportion of the aggregate demand and lower long term productivity.
A major factor that can partially obscure this defect are windfall technology leaps. Given the magnitude of some of these over the past five or six decades, it would be interesting to know what our economic growth rate might have been without the fiscal policy drag that our government growth and deficits over this period.
Death6
Turning this around requires a vast number of people, who are the least virtuous among us (the cronies, parasites, etc.), suddenly to start being virtuous. Ain’t gonna happen. Has it ever happened historically? Not that I am aware of. The question answers itself. We are on the Titanic, and there is no missing that iceberg.
While I do agree the economic challenges are large, the economic theories offered in this piece seem to be contrary to observed economic cause-effect pairings.
Rising interest rates in general tend to dampen overall borrowing, not increase it.
The one area where it does impinge is Sovereign Borrowings, those monies borrow by the state. But then these are a special case as the payback is a complex mixture of money, inflation, risk management, and liquidity in reference to alternative places to put money.
It is also improper to isolate a codependent economy, rather one should evaluate its relative performance compared to alternatives.
Does the Trump team have a hard task? Sure do after eight plus years of socialism. Someday the price must be paid for socialism largess, though there is no requirement that it happen in one instance.
I’m curious how germane the singular formula for recovery applies to a pre-crisis situation, and one where few better alternatives for the flight of capital seem obvious?
There is little logic that achieved growth by definition benefits only the top 1%, as the relative economic well being of the component sub-populations within most economies varies relative to each other over time for a variety of reasons.
Let us not forget that what a middle class person enjoys in lifestyle, mobility, and many other axis is a privileged level of comparative wealth when contrasted to how the top of society lived just 4-5 generation before.
And most importantly let us remember that if the collapse of an institution, economy or currency does come that there is much to benefit from being in the least constrained part of an economy. It is a lack of economic freedom rather than poor aggregate personal performances that does the deep damage to a stressed economy.
The change in economic direction that Trump for the first time in many Presidencies at least says he is pushing for, is a solid reason to hold off “Going Galt” here and now. If the elections had favored Killary I would argue that no time was too soon to “Go Galt” given the economic mischief she would continue and then magnify.
A bit of Galt-in-Place is still wise, but never give up when there isn’t an even equal alternative to move to.
Sam
Imagine that the United States is the three towers in NYC. Trump will be given command of them just prior to 9/11. The pending suffering will be Biblical.
However, more and more people are now aware of who the real enemies are. It won’t be nearly as easy to blame Trump for collapsing the US as Muslims were blamed for 9/11.
Perhaps the GOP and the DEM colluded for Trump to win the election. When the economy implodes they will try to say that they are not to blame. Unfortunately most people will believe them since most do not want to think for themselves.
Most people in the US will walk around in a daze not comprehending why or how the economy has crashed, nor will they understand that this cataclysm was many years in the making.
The economy crashing will accomplish practically overnight what Trump would not be able to do in two terms. The Gordian knot will be severed.
So lets walk this through on a simple level:
All deposits are nothing but digits on a database, many ones but thousand of zeros. The deposits are going to go “poof”
Cash will be the only acceptable payment. When the cash runs out, gold and silver will take over as will some other metals.
Public and private sectors will shut down. No one will get paid. Everyone goes home or into the streets. Commerce will grind to a halt.
This epidemic will be world-wide. Anyone dependent on the state will be on their own. Anyone in the cities will be lucky to get out. Historically, those living in rural areas fared better but not by much. Food and water will be scarce, many will die.
When the gravy stops flowing, the entitlements, waste, etc dry up.
The government becomes obsolete. Too many holes to plug up, too many fires to put out, no one for damage control and gold or silver won’t be pay enough.
Start fiddeling and watch Rome burn.
It will be a small trigger that will cause a tsunami overnight.
I predict that 90% of world population will cease to exist within the first 90 days.
The entire current ‘paradigm’ is; ‘money’ = Debt…
Donald Trump is a ‘master of debt’.
Is he the Right One for the Right Time?
A dollar to a donut… he will pull the either the Lincoln or FDR Card.
Lincoln printed Greenbacks. FDR disconnected gold from the dollar… The Executive, evidently, HAS this ‘invisible’ power against The Bankers…
The Donald will tell the Fed, and the International Bankers to go to hell, and make them want to go…
It is the only way out…
Think about it.