Ambrose Evans-Pritchard looks at the failure of the industrialized countries to recover from the last recession.
The world remains in barely contained slump. Industrial output is still below earlier peaks in Germany (-2), US (-3), Canada (-8) France (-9), Sweden (-10), Britain (-11), Belgium (-12), Japan (-15), Hungary (-15) Italy (-17), Spain (-22), Greece (-27), according to St Louis Fed data. By that gauge this is proving more intractable than the Great Depression.
Evans-Pritchard looks at the huge debt build-up that preceded the recession as a major cause of slow recovery which is unlike recoveries from previous recessions. That debt built up over a period of decades. Check out US household debt as a percentage of GDP over a 50 year period ending in 2010. Corporate, federal, local, and personal debt reached over 3.5 times GDP by the end of 2009.
Find it hard to believe the total public and private debt is some multiple of GDP? Back in December 2009 Federal Reserve chairman Ben Bernanke laid out the basic facts in response to a question from Senator Bunning.
Bernanke: The current ratio of public and private debt to GDP, including not only the debt of the nonfinancial sector but also the debt of the financial sector, is about 350 percent. (Many analysts prefer to focus on the debt of the nonfinancial sectors because, they argue, the debt of the financial sector involves some double-counting--for example, when a finance company funds the loans it provides to nonfinancial companies by issuing bonds. The ratio of total nonfinancial debt to GDP is about 240 percent.)
Since personal bankruptcies have been made more difficult and the financial industry was bailed out by governments a natural liquidation by bankruptcy process has been slowed. So the debt burden has remained high. At the same time, over-promising on entitlements has governments running up more debt and this is made worse because sluggish economic recovery also means slower increases in tax revenues.
What matters about debt: Will profits and tax revenues rise fast enough to service the debt? When huge debts and growing entitlements expenditures exist an absolute decline in economic output is a recipe for disaster. Rising debt requires rising output to service the debt. Otherwise default (whether by official default or inflation) becomes inevitable.
Are the lingering effects of an excessive debt build-up our only problem? I don't think so as I'll explain below. But even if the debt burden is the only root cause of a weak economic recovery the debt burden shows no sign of lightening. Mortgage foreclosures and personal bankruptcies are cutting down consumer debt. But the increase in government debt shows no sign of abating. The US sovereign debt burden is not an isolated problem either.. Japan's 200+% GDP debt burden will cause a financial crisis in about 15 years, possibly sooner if the markets come to understand the approaching crisis. This could cause a US Treasury bond demand crisis. The US already faces a very serious fiscal solvency problem. Outside events (e.g. break up of the Euro zone, a Japanese sovereign debt crisis, much higher oil prices). could cause that developing problem to reach crisis stages much sooner than would otherwise be the case.
Europe might precipitate the next crisis. Europe has very large sovereign debt problems.
Germany can only go so far in bailing out Europe. The cost of recapitalizing European banks (despite overly optimistic stress tests), including those in Germany, is estimated to be €420 billion under an adverse scenario, just for non-performing loans. The cost of marking down — let alone writing off — sovereign debt would be much greater. As of last November, 20 of the largest banks in the European Union carried $4.2 trillion in PIIGS (Portugal, Ireland, Italy, Greece, Spain) sovereign debt, about seven times the amount of their $620 billion in equity.
What enabled debts to get so big? As memories of the Great Depression have faded and financial companies have become more adroit at assessing individual risk the trend has been to grant more consumer credit. Plus, the political class has to keep promising more goodies in each election. So the trend has been so spend more without taxing more. Plus, financial companies have created more complex debt instruments for corporations. The resulting pile of debt becomes a big house of cards.
What made industrialized civilization possible in the first place? Have we gotten so far way from the Malthusian Trap that perhaps we are hurting from loss of the benefits that the Malthusian Trap's selective pressured bestowed on us? Some people look around and see signs that a civilization that has peaked. The Derb and Bruce Charlton see slowing rates of innovation and other signs that our capabilities aren't increasing overall. Sure, we've got fancier smart phones and more powerful computer server farms. But where are the improvements that are as dramatic as electric power or the car or jet airplanes?
Forty-three years! Forty-three years before that, Lindbergh had not yet flown the Atlantic. Forty-three years before that, the only automated forms of transportation were the railroad and the steamship. Bruce Charlton:
That landing of men on the moon and bringing them back alive was the supreme achievement of human capability, the most difficult problem ever solved by humans. 40 years ago we could do it – repeatedly – but since then we have *not* been to the moon, and I suggest the real reason we have not been to the moon since 1972 is that we cannot any longer do it. Humans have lost the capability.
These melancholy thoughts of civilizational decline came to mind again when I heard on a news broadcast that it will take at least a year to bring the Colorado cinema mass murderer to trial. And even when the trial eventually gets underway, says TIME, “the case is shaping up to be a years-long criminal proceeding.”
Is the accumulation of bureaucratic crud and the gumming of government decision-making a major cause of a slowed rate of material progress? Or is the parasitism and imposed inefficiency just more noticeable because we've exhausted our ability to generate growth because the easy ways to cause growth have been basically used up? Tyler Cowen argues in the fast few hundred years we basically harvested the low hanging fruit of natural resources, scientific discoveries with great commercial value, and with mass education to raise skills levels. So progress is now harder to make. I agree with this argument.
I am less optimistic than Tyler about an eventual return of good times. I see three main possible ways that could happen. Maybe artificial intelligence will enable us to resume a sustained period of rising living standards. I'm skeptical on this point because over the last couple of centuries the number of working scientists and engineers has exploded by many orders of magnitude while the rate of discovery of fundamental enabling insights has dropped. This suggests there are fewer things left to discover and that AI won't change this. Name one discovery since 1960 as important as the laser (first proposed by Einstein in 1917 and initial demonstrations in 1947 and for optical pumping in 1952. Similarly, Bardeen, Shockley, and Brattain invented the transistor in 1948. Name an invention after 1960 that is as important.
Perhaps fusion energy will become feasible and also very cheap. With very cheap energy we can concentrate very low concentration elements into high and useful concentrations. Another possibility for enabling a return to a period of lots of low hanging fruit comes from genetic engineering once it becomes much easier to do. But none of these enabling technologies seem like good prospects to reignite growth in the next 10 years.
I see the Peak Oil theorists as addressing a subset of the problems which Tyler addresses (though Tyler doesn't really address how serious a problem we face due to Peak Oil). Writing from a Peak Oil perspective Fabius Maximus thinks our civilization peaked in the 1990s when oil prices fell to $12 per barrel. Since then rising natural resource costs, especially energy costs, have throttled growth. While the 1990s seem like the last good sustained party time that period still seems like a pale shadow to the 25 year period after WWII in terms of yearly sustained changes in quality of life.
UCSD energy economist James Hamilton (who I've linked to a few times above) questions whether we can have economic growth without growth in energy usage. I would extend that question and ask whether we in the industrialized world can have economic growth without growth in our use of assorted minerals such as aluminum, iron, platinum, and other elements.
"The question is, how much can we keep growing without a growing supply of energy?" said James Hamilton, a University of California-San Diego economics professor who has been on the leading edge of research into the impact of high energy costs.
"We've had temporary experiments with (oil supply) disruptions in the Middle East," he said. "We don't really have experience, if worldwide, we produce less oil year after year and have to deal with that on a longer-term basis. Certainly, the transition to dealing with that could be very disruptive."
What's your expectation for the major economies of the world over the next 20 years?
Bond giant PIMCO CEO Mohamed El-Erian seeexcessive contractual liabilities as one of our big economic problems.
I worry that, absent a dramatic change in policies in America and Europe, things will get worse before they get better. I fear that, given this possibility, it would then take years, if not decades, to repair the underlying damage done to economies, jobs and people’s lives around the globe.
We are here because of the interactions of three distinct, yet inter-related forces: poor economic growth, excessive contractual liabilities, and disappointing policy responses. The result is that western economies are getting trapped by the lethal combination of an unemployment crisis, a debt crisis, and mounting fragilities in the banking sector.
Too many institutions owe too much in debts and entitlements. The poor economic growth is in part due to high oil prices and high prices for other commodities. Jeremy Grantham's Peak Everything argument suggests our slow growth period will be long lasting. So the size of needed debt defaulting is gigantic.
In Grantham's December 2011 newsletter he says the continued slow growth we are seeing is par for the course of what he's expecting.
Sadly, I feel increasingly vindicated by my “seven lean years” forecast of 2½ years ago. The U.S., and to some extent the world, will not easily recover from the current level of debt overhang, the loss of perceived asset values, and the gross ﬁnancial incompetence on a scale hitherto undreamed of.
Separate from the “seven lean years” syndrome, the U.S. and the developed world have permanently slowed in their GDP growth. This is mostly the result of slowing population growth, an aging proﬁle, and an overcommitment to the old, which leaves inadequate resources for growth. Also contributing to the slowdown, particularly in the U.S. and the U.K., is inadequate long-term savings. As I write, the U.S. personal savings rate has fallen once again below 4%.
Grantham and El-Erian are ahead of the curve in understanding the depth of our problems and the poorer long term prospects we face. The party's over. Most people need to raise their game (more skills, try for better jobs, be willing to move for career opportunities, work harder) to keep their current living standards. Think about your options. How can you better equip yourself for hard times?
New York Times economics writer David Leonhardt points to an interesting aspect of our current economic downturn: some categories of consumer spending have fallen to levels not seen for 10 to 20 years.
But the real culprit — or at least the main one — has been hiding in plain sight. We are living through a tremendous bust. It isn’t simply a housing bust. It’s a fizzling of the great consumer bubble that was decades in the making.
It is good that Leonhardt makes reference to the decades long unhealthy trend in debt accumulation that got us where we are today. The end of the private debt binge has drastically cut into consumer spending.
The auto industry is on pace to sell 28 percent fewer new vehicles this year than it did 10 years ago — and 10 years ago was 2001, when the country was in recession. Sales of ovens and stoves are on pace to be at their lowest level since 1992. Home sales over the past year have fallen back to their lowest point since the crisis began. And big-ticket items are hardly the only problem.
Decades of rising consumer debt, a huge housing bubble, and persistently high oil prices have made the current economic recovery the weakest since World War II. Steve Keen asks "Dude! Where's My Recovery?". Good question.
But what Leonhardt advocates as a policy response does nothing to address underlying causes.
A more promising approach could instead offer a tax cut to businesses — but only to those expanding their payrolls and, in the process, helping to solve the jobs crisis.
Tax cuts for expanding your payrolls? Seriously? Those businesses that happen to already have plans to expand their payrolls would get a tax break. The incentive would be too small to make a big difference. So the vast bulk of the benefits would go to hiring that would have happened anyway. How is this a cost effective use of the taxpayer dollars?
His next proposal is telling: He really doesn't know what to do about our economic predicament (just like me btw) but wants government to do something. For those on the political Left economic problems demand policy responses. They need government to be efficacious in managing the economy.
Leonhardt advocates for more research. Even if that'll help in the long run it'll have no impact in the next 3 years and probably little in the next 5 or 6 years.
Along similar lines, a budget deal could increase funding for medical research and clean energy by even more than President Obama has suggested.
How about some root causes? We have too much consumer debt and government debt. That's a root cause. How about more bankruptcies to discharge some of this debt? Then there's Peak Oil. Sorry, its drag on the economy is going to grow with or without better energy policies. Get used to declining living standards. Then there's another root cause in the labor market: America's declining competitiveness due to demographic changes causing skill levels to decline. Well, the horse is out of the barn and isn't coming back. Though with better immigration policies (e.g. skills-based requirements) we could slow the decline in labor quality.
We need policies that reflect the deep long term nature of our problems and no attempted tricks to jump-start our return to business as usual (BAU). Fact is, BAU ended years ago and it is not coming back. Only in 2008 did the financial markets run out of capacity to paper over the depths of our economic problem as rising debt ceased to be a viable way to hide America's decline in competitiveness.
The pronounced weakness in personal consumption expenditures (PCE) for services has been an unusual feature of the 2007-09 recession and the slow recovery from it. Even in 2010:Q4, when real PCE increased at a relatively robust 4.1 percent annual rate, real PCE on services rose at only a 1.4 percent rate. This weakness has been especially evident in “discretionary” services (to be defined below), which fell more in the recent recession than in previous recessions and since have rebounded more sluggishly.
The drop in discretionary services expenditures in the last recession was much more severe than in previous recessions: the nearly 7 percent fall from the peak is more than double the percentage decline in the early 1980s recession (the previous “champion” in this dimension).
Debt-burdened consumer, suffering higher rates of unemployment and underemployment and cuts in compensation, naturally have cut out optional expenditures. They have to husband their diminished resources in order to spend on essentials. They've got more cutting to do.