Broken Bonds and World Economies

The current world is one in which lenders are actually paying large amounts of people to borrow money from them. On first glance this use of negative interest rates sounds like a terrific thing — debt caused by high interest rates remains a crushing force and notable source of human suffering. Upon closer look, however, the reason that lenders are actually paying people to borrow their money for a return is due to economic weakness and some pessimistic expectations that it’ll continue into the future. It is in some sense a major anticipation of a bleak future, and it’s related to what’s known as an inverted yield curve, a term that’s being used much more frequently in the news these days.

An inverted yield curve basically means that a long-term return (yield) on a bond is less than the short-term return. (This turns the supposed logic of the system on its head since we’d naturally expect someone who puts their money away for a longer period of time to be rewarded more.) It has long been a signal that a recession is coming, although the annual revision to the monthly jobs data by the Bureau of Labor Statistics has historically tended to be a more reliable indicator of recession or economic weakness, and many news outlets don’t mention that historically an inverted yield curve has preceded a recession by about 22 months.

A recession is what many people rightfully understand as bad or at least not so good economic times, but the more technical definition is at least two consecutive quarters where the economy contracts rather than grows. More sensibly, a recession is a lack of demand (where demand is people’s ability to purchase goods and services), and the sensible governmental officials among us have for decades understood this and how to escape or mitigate recessions. It’s simple enough — if a recession is a lack of demand, demand must be boosted, such as through increasing government spending and/or cutting taxes. This creates more ability for people to make purchases, which has a positive effect on important economic indicators such as employment.

Accompanying the inverted yield curves of today is negative interest rates, something that has gone from — in the words of one commentator — a curiosity to a market mainstay. As even university business professors are admitting, this is a sign of something seriously wrong with the economies of the world. They are basically dysfunctional in some sense and seriously flawed to create such a structure. To keep economies moving along decently, interest rates now often have to be negative to keep enough money flowing in the system (in people’s pockets) and demand at somewhat acceptable levels. High interest rates are of course a problem for the burden they tend to cause the vast majority of people, but negative interest rates are an indication that the economies of the world have very fundamental problems.

The market structures of many world economies has been deliberately structured in ways that benefit the upper class at the expense of everyone else. The propaganda is regularly that inequality was caused by a natural outcome of the market, but that is the opposite of the truth. Policies such as rules on copyrights and patents aren’t the free market at work — they’re government intervention, aka structuring of the market. It is simple enough to prove in example after example how the markets were rigged to redistribute income upward and create unjust outcomes. Patents on goods such as prescription drugs increase their prices significantly, which takes too much money from the pockets of many people and redistributes it to the the upper class people who own stock in pharmaceutical companies. There is an immense barrier to entry for foreign doctors in the U.S. (one has to complete a U.S. residency program to practice medicine there), which pushes the wages of U.S. doctors to twice what doctors make in other countries and adds up to over $500 per family annually (while there is a shortage of doctors). Public pension funds in the U.S. have been structured to provide too many fees to high class managers. The list goes on — there are lots of ways that markets were deliberately structured against the benefit of the majority of the population.

What happens when too much money flows to the top is that the upper class — the now famous 1 percent — tend to spend much less of it as a percentage than the average person would. Saving money is to a significant extent a virtue, but what happens when the 1 percent (who spend less as a percentage of their income than working-class people) don’t spend all that money is that much of the money then sits idly, not purchasing goods or services and therefore not creating jobs. There is less demand in the economy this way, and the 1 percent benefiting from a market rigged in their favor means less money for everyone else to spend, and it of course creates the curious to mainstay phenomena such as negative interest rates.

It’s becoming more well-known all the time that the system isn’t right, and there are those that argue to reform it and those who argue that fundamental change is needed. The lack of real democracy in the economic system is an interesting note for countries such as the United States that supposedly value democracy so much. The economy is valuable to discuss in politics because it is fundamental and covers much of life, and its current indicators are revealing that it needs change that’s truly fundamental.

Examining the Possibility of Bubbles on the Horizon

Predicting the future is often difficult and regularly produces failures due to the sheer amount that’s happening in the world, but I think this op-ed by one of the few economists who spotted the significant housing bubble is worth reading.

Ever since the collapse of the housing bubble in 2007–2008 that gave us the Great Recession, there has been a large doom and gloom crowd anxious to tell us another crash is on the way. Most insist this one will be even worse than the last one. They are wrong.

Both the housing bubble in the last decade and the stock bubble in the 1990s were easy to see. It was also easy to see that their collapse would throw the economy into a recession since both bubbles were driving the economy. We are in a very different place today.

The stock market is high. By any measure, price-to-earnings ratios are far above historic averages, but they are nowhere near as out of line as they were in the 1990s bubble.

The current value of the market is roughly 24 times after-tax corporate profits, based on the first quarter’s data. This compares to the historic average ratio of 15-to-1. But at the peak of the bubble in 2000, the ratio was over 30-to-1.

[…]

It is true that profits are unusually high as a share of national income. This reflects a big increase in the profit share in the weak labor market following the Great Recession, and more recently the Republican tax cut passed last fall.

It can be hoped that labor regains some of its lost share and pushes profits downward. But there is no guarantee that this will happen, and stock prices that reflect current profit levels can hardly be said to be in a bubble.

House prices are also well above trend levels. Inflation-adjusted house prices are around 30 percent above their trend levels. But they are still about 14 percent below bubble peaks. Here too, the higher than normal level seems to reflect the fundamentals of the market.

Unlike the housing bubble years, rents have been rising far more rapidly than the overall rate of inflation over the last five years. This indicates that there actually is a shortage of housing pushing up house prices, not a speculative bubble.

[…]

Not only is there little evidence of bubbles just now, there also is no case to be made that bubbles are driving the economy. In the late 1990s, it was clear that the stock bubble was driving the economy. Through the stock wealth effect, the run-up in stock prices led to a consumption boom that pushed the savings rate to then-record low levels. In addition, investment surged as this was a rare period in which start-ups were actually financing investment by issuing shares of stock.

When the bubble burst, investment plunged, and consumption fell back to more normal levels. This gave us the 2001 recession. While most economists see this as a short and mild recession, we actually did not recover the jobs lost until January of 2005, which at the time was the longest period without net job growth since the Great Recession.

In the housing bubble years, the consumption triggered by the run-up in house prices sent the savings rate even lower than at the peak of the stock bubble. In addition, housing construction rose to 6.5 percent of GDP, compared to an average of roughly 4.0 percent.

Not surprisingly, when the bubble burst consumption fell back to more normal levels. The overbuilding of the bubble years led construction to fall far below normal levels, bottoming out at less than 2.0 percent of GDP in 2010. This enormous loss of demand was the cause of the Great Recession.

High stock and housing prices are not driving the economy in the same way as they did in the 1990s stock bubble or the housing bubble of the last decade. Investment remains modest by any measure. Housing construction is getting stronger, but very much in line with longer-term trends.

Consumption is high as a result of stock and housing wealth. But even in an extreme case, where the savings rate rose back to Great Recession levels, it probably would not be sufficient by itself to cause a recession and certainly not a severe one.

The Potential Carbon Bubble of the Future — Possibly Immense Damage to the Global Economy If It Bursts

Another reason to switch to renewable energy as quickly as possible. Bubbles can drive economies forward and actually produce some positive results (which was seen with the investment boom from the stock bubble in the 1990s in the U.S.) due to the increase in the wealth effect generating more demand, but if that demand isn’t compensated for with the burst of large bubbles, recessions happen. There is today a tremendous amount of wealth directly because of fossil fuels, and if that wealth sharply drops in value and isn’t replaced, there might be a shock to the world economy.

Several major economies rely heavily on fossil-fuel production and exports. The price of fossil-fuel companies’ shares is calculated under the assumption that all fossil-fuel reserves will be consumed. But to do so would be inconsistent with the tight carbon budget set in the 2015 Paris Agreement, which limits the increase in global average temperature to ‘well below 2°C above pre-industrial levels’. So far, this prospect has not deterred continuing investment in fossil fuels because many believe that climate policies will not be adopted, or at least not in the near future.

However, and crucially, researchers now show that ongoing technological change, by itself and even without new climate policies, is already reducing global demand growth for fossil fuels, which could peak in the near future. New climate policies would only aggravate the impact. Continuing investment in fossil fuels is therefore creating a dangerous ‘carbon bubble’ that could burst, with massive economic and geopolitical consequences.

[…]

The scientists conclude that further economic damage from a potential bubble burst could be avoided by decarbonising early. “Divestment is a prudential thing to do. We should be carefully looking at where we are investing our money.”

The Sham of “Fiscal Responsibility” in Public Policy

The budgets of a government are different in nature than the budgets of a family, yet it seems that few media and political elites seem to understand this. A sovereign government can for example create more currency (which doesn’t necessarily lead to more inflation, per the quantity theory of money) for various initiatives, an option legally unavailable for personal families.

It’s official: New York Times columnist David Leonhardt pronounced the Democrats as the party of fiscal responsibility. In contrast to three of the last four Republican presidents who raised deficits with big tax cuts for the rich and increases in military spending, the last Democratic presidents sharply reduced the budget deficit during their term in office.

Leonhardt obviously intends the designation to be praise for the party, but it really shows his confusion about budget deficits and their impact on the economy. Unfortunately, this confusion is widely shared.

Contrary to what Leonhardt seems to think, the economy doesn’t get a gold star for a balanced budget or lower deficit. In fact, lower deficits can inflict devastating damage on the economy by reducing demand, leading to millions of workers needlessly unemployed.

This has a permanent cost as many of the long-term unemployed may lose their attachment to the labor market and never work again. Their children will also pay a big price as children of unemployed parent(s) tend to fare worse in life by a wide variety of measures, especially when unemployment is associated with family breakup, frequent moves and possible evictions. Also, lower levels of output will mean less investment, making the economy less productive in the future.

We actually have some basis for estimating the cost of long periods where the economy suffers from insufficient demand. If we compare the Congressional Budget Office’s (CBO) projections for potential GDP in 2018 made before the Great Recession, with their current projections, the gap is more than $2 trillion, or 10 percent of GDP.

That loss comes to more than $15,000 a year for every household in the country. In other words, the CBO’s projections imply that if we had managed to sustain high levels of demand in 2008 and subsequent years, rather than falling into a severe recession with a weak recovery, the annual income of the average household would be $15,000 a year higher.

Balanced Budget Amendment Would be a Disaster

If you want to see how horribly austerity works for the general population, look what’s happened to Europe. Deficits create demand somewhere in the economy, and removing the ability to run them would be horrifying, especially in recessions.

The House is set to take up a balanced budget amendment this week, which would limit federal spending in each fiscal year to federal receipts in that year. Putting aside for a moment the chutzpah of House Republicans trying to pass a balanced budget amendment (BBA) just a few months removed from their passage of a $1.5 trillion tax cut that went largely to the richest households and big corporations, the simple fact is that the economic consequences of a balanced budget amendment range from extremely bad to catastrophic. The reason for this is that a BBA would amplify any negative economic shock to the economy and would thereby turn run-of-the-mill recessions into disasters.

When the economy enters a recession, government deficits increase as tax revenues decline and government spending on programs such as unemployment insurance increase. These “automatic stabilizers” are incredibly important as they cushion the blow to the economy from a recession. For example, researchers at Goldman Sachs found that the shock to private sector spending from the bursting of the housing bubble was larger than the shock that led to the Great Depression of the 1930s. Given this larger initial shock, why didn’t we have another Great Depression, with unemployment rates approaching 20 percent and beyond, in 2009–10? The simple reason is that the mechanical increase in the deficit from tax reductions and increased transfer payments absorbed a lot (not enough, but a lot) of this shock, and automatic stabilizers were either non-existent or a lot smaller in the 1930s. Having these programs in place to absorb recessionary shocks is one of the great economic advances of the past 80 years—and getting rid of them by imposing a BBA makes as much sense as outlawing computers or antibiotics.