Friday, January 16, 2015

The Way Forward

Here I explain the likely path from our current dysfunctional political-economic system to a new paradigm.  With the first 6 items below, I describe the factors that make the present system unstable.  Then I will make a brief comment on what might be possible after the next political-economic shock.
  1. Reaganomics (the" ownership society") has the prevailing political-economic paradigm for the last 33 years in the United States, and for the last 25 years globally (coinciding with the fall of Communism and the Soviet Union).  This paradigm has been characterized by freeing business from regulation and an increased pace of economic globalization.
  2. The share of income going to capital has increased (in the U.S. and other developed economies), while the share of income going to labor has decreased.  Consequently, asset prices (stocks) have appreciated faster than wages.  This has been a self-reinforcing phenomenon, as capitalists take their increased profits and reinvest them, thus boosting shares even higher.
  3. As the process described above (increasing asset prices, stagnant labor income) has continued for over 3 decades, it has become hard to find reasonably valued investment opportunities.  Assets are far overvalued in comparison to consumption.  We are now in the midst of the 3rd major stock market bubble in the last 15 years (tech bubble, housing bubble, energy bubble (?)).  Stock valuations currently are on a par with 1929, ahead of housing bubble valuations and behind only the tech bubble of the late 1990s.  
  4. Consumer prices continue their 33 year disinflationary trend.  This is the logical consequence of the phenomenon described above -- more money being spent on investment, with less being spent on consumption.
  5. Overinvestment and bubbly asset prices are corrected via dramatic price declines (as happened in 2000 and again in 2008).  There is no other likely scenario in the global economic paradigm, where capital continually moves to cheaper locations, and countries devalue their currencies to become more competitive.
  6. To change the fundamental 30+ year trend, political changes are required.  These changes are most likely to happen following one of the periodic stock market crashes, especially now that a substantial portion of middle class savings is held in the stock market. 
There are several camps as to how to get to a more stable society:
  1. Further reduce the size and power of government.  The Austrian school of economics falls in to this camp, believing that we should return to the gold standard and the laissez-faire economics of the gilded age.  
  2. The Monetarist (neo-classical) camp that believes in the preeminence of monetary policy (tinkering with interest rates) as a tool to manage the economy with a minimum of government involvement.
  3. The Keynesian camp that believes government action, including fiscal policy (taxing and spending) is needed to manage the economy.
Within the Keynesian camp, the conventional wisdom is with the NewKeynesians.  The NewKeynesians accommodated their Keynesian views with those of the pre-Keynesian neoclassical economists, whose modern day successors are the Monetarists.  In other words, the conventional wisdom is more monetarist than Keynesian.

My favored camp is the PostKeynesians, or Modern Monetary Theorists (MMT) in particular.  In a hopeful sign, MMT economist Stephanie Kelton has been appointed by Bernie Sanders, the ranking member of the Senate Budget Committee, as his new chief economist -- See Bernie Sanders opens a new front in the battle for the future of the Democratic Party.  Excerpt:
Usually, when Democrats hire economists, they hire nice, respectable Keynesians, who use mainstream economic models and often agree with conservative economists on a lot of theoretical matters while drawing different policy conclusions from them. For example, Greg Mankiw, who served as George W. Bush's top economic advisor, and Christina Romer, who served as Obama's, were both influential in developing New Keynesianism, a macroeconomic theory that emerged in the 1980s and arguably dominates the field today. What really set Romer and Mankiw apart was policy, not economic theory.

Kelton disagrees with Romer and Mankiw on economic theory. In fact, she disagrees with just about every economist Bush or Obama ever hired about economic theory. Kelton is among the most influential advocates of Modern Monetary Theory (MMT), a heterodox left-leaning movement within economics that rejects New Keynesianism and other mainstream macroeconomic theories.

The Conventional Wisdom

In my previous post, I noted that something seems to be horribly wrong, in that 100% of economists were completely wrong in a prediction last year.  And now professional forecasters on Wall Street are unanimous in seeing U.S. equities climbing by the end of this year, by an average of 11%.  Let's dig a little deeper to see what is wrong and why.

My initial thought is the "professional forecasters on Wall Street" are hacks.  They are boosters, and should be ignored.  While this is true, there are two more fundamental factors:

  • It would be extremely risky for a professional forecaster to go against the conventional wisdom.  
  • It is not only "professional forecasters on Wall Street" who have been dramatically wrong about the economy, but also the professionals in government including, especially, the Federal Reserve.
No one in the "financial establishment" has explained why the disinflationary trends of the past 30 years should be expected to turn around.  The obvious driving force is globalization and the accompanying weakening of the bargaining power of labor.  The Fed ignores this and believes that their ineffective monetary policies will result in a return to "normal".  The Wall Street forecasting professionals repeatedly predict a return to "normal", again ignoring the ongoing fundamental weakness of labor.

Thursday, January 15, 2015

Something's Rotten

In a poll of 67 economists in April 2014, every single one of them predicted that the 10-year Treasury yield (U.S. government bonds) would rise in the next six months.  Every one of them was extremely wrong.  The 10-year yield fell sharply for six months (and has fallen even more steeply in the 7th - 9th months).  I have invested my life savings in long term U.S. Treasury bonds, and saw these predictions when they were made.  Yet I never seriously considered changing my position.  I was somewhat intimidated, but after a bit of thought concluded that I was right to believe that the 10-year yields would move in the opposite direction of 100% of economists.

The U.S. stock market was extremely overvalued by all serious measures, and the U.S. economy had just experienced a quarter of negative GDP.   This seemed like a no-brainer, and my rationale has been rewarded handsomely, as yields have plunged, and my investment (PRULX - a long term U.S. Treasury bond mutual fund) has soared.  Either I am a freak genius, or there is something dreadfully wrong with "economists".

Today I read the following:
While it may not be an easy ride, professional forecasters on Wall Street are unanimous in seeing U.S. equities climbing by the end of this year. None of the stocks strategists tracked by Bloomberg predicts a retreat in 2015, with the average estimate calling for a 11 percent advance from yesterday’s closing level.
To me, this seems horribly absurd.  U.S. stocks are at 90th percentile levels of overvaluation, according to all reasonable measures of valuation (documentation available upon request).  The global economy is clearly entering recession.  The U.S. economy is sending mixed signals.  Yet every single professional forecaster on Wall Street sees U.S. equities climbing this year.  Moreover, the average increase predicted is 11% -- approximately 4 times the rate of growth of nominal GDP in recent years.

Something is horribly wrong.

Wednesday, January 14, 2015

The Economic and Political Outlook for 2015


The global economy is entering a deflationary recession, and the United States will not be immune.  We live in a financially and economically integrated era, and only concerted action can bring an economic recovery.  Unfortunately, the political will is lacking, as the United States is dominated by anti-government Republicans, and other countries practice austerity and currency devaluation in a deflationary spiral. 
The political consequences will result in a paradigm shift to a new model of governance with regard to the economy.  This will be somewhat similar to the way in which the Great Depression of the 1930s resulted in the New Deal and a much bigger role for government in the economy for the next 50 years.  The current era of Reaganomics began around 1980 and enjoyed considerable success for about 20 years.  However, beginning in the year 2000, this era of globalization of the economy, with reduced government regulation and a porous safety net, has been wobbly.  The stage is set for a new era.
Of immediate concern is the direction of governance in the United States.  If I am right and the economy tanks in 2015, the allure of Hillary Clinton, and more of the same from the Reagan-Clinton-Obama era, will be nil.  Either Clinton will have to make a sharp turn to the left, or she will face a populist backlash.  If I am wrong and the tanking of the economy doesn’t occur until mid-2016 or later, this will be bad news for Democrats who will own the crappy economy in the eyes of voters.  This could be similar to the situation faced by Republicans in 2008 as economy crashed shortly before the elections that year.
On the Republican side of things, I have much less certainty.  Republicans seem more likely to do a 180° pivot and boost their favorite parts of the economy (big corporations and other Republican interests).  I can imagine them passing massive tax cuts as well as subsidies to businesses, and such measures could prove effective.  They are equally likely to worry about the deficit in Hooveresque fashion, thereby prolonging the depression.    If Republicans gain more power there will be conflict between the anti-government and pro-business wings, as business will need government help.

Current State of the Economy

The following factors form the basis for my belief that the economy is in the process of tanking:
  • The United States stock market is massively overvalued by all reasonable measures.
  • The middle class in the United States is heavily dependent upon the stock market for retirement saving.  This situation is similar to the 1930s, when life savings were held in uninsured bank deposits.  Now life savings are held in uninsured 401k-brokerage accounts.
  • The global economy is slumping.  Japan is in recession, emerging markets are crashing, Europe is slipping into deflation.
  • The global economy is interconnected, and the U.S. is in the center of it all.  Deflation in other countries is resulting in deflation in the United States, as gas and import prices fall.  Similarly, the rising value of the U.S. dollar is making U.S. labor comparatively more expensive, despite the actual fall in U.S. wages in the latest employment report.
  • The global financial system is interconnected.  The rising value of the U.S. dollar is squeezing emerging markets that have borrowed trillions of U.S. dollars.  Thus, credit markets around the globe are tightening, while the safe haven of U.S. Treasury bonds is soaring.
  • The United States economy has been weak for the last decade.  This was disguised by a housing bubble and, more recently by an energy boomlet.  But labor force participation and wages have stagnated.  There is little room for a slowdown, as evidenced by interest rates approaching zero all around the world.
  • Expectations are wildly out of whack.  In spite of all the factors noted above, consumer confidence is up and the conventional wisdom among both Republicans and Democrats is that the United States economy is taking off.

In short, the perfect storm is coming.