#133: An American hypothesis

IS DONALD TRUMP THE FIRST ‘ECONOMIC REALIST’?

When the historians of the future get around to writing up our current era, one of the things likeliest to strike them will be the difference between what is actually happening and what most decision-makers think is happening. Historically, it is fascinating to speculate on how many of the worst decisions of governments have sprung from false interpretation and incorrect information.

From a contemporary perspective, what is evident now is an ever-widening chasm between conventional economic evaluation and the actual trend of events. Where conventional interpretation sees growing prosperity and contained financial risk, you don’t have to step very far outside the box to see a process of economic deterioration, elevated risk and, most seriously of all, a growing threat to the stability of currencies.

For regular readers, of course, this is familiar fare. We know that an economy hampered by a rising trend in the energy cost of energy (ECoE) is being subjected to an ultimately-futile process of denial based on credit and monetary adventurism.

Rather than revisiting this strategic theme, the aim here is to pose a theoretical question, and see where it leads.

Here is the question – what would a government do if it did recognise these realities, and came to understand that prosperity is already declining in the West, and may, before long, turn downwards in the emerging market (EM) economies, too?

It is beyond doubt that such a recognition would bring about drastic changes, both in assumptions and in policy. What follows is an examination of what those changes might be. It’s also safe to assume that these changes would be resented by those still wedded to the conventional, and that their mystification would lead rapidly to anger, suspicion and hostility.

It is suggested here that, if any government anywhere in the world is behaving in ways which are consistent with this pattern, it is the Trump administration. To what extent can Mr Trump be credited with – or, by some, accused of – acting on the basis of ‘new reality’?

What if understanding dawned somewhere?

If a government did discover the processes that are at work in the economy, the first conclusion that such a government would reach is that prosperity has become, at best, a zero-sum game. This would mean that, instead of the world becoming more prosperous in shared progression, the prosperity of one country can only be enhanced at the expense of others.

This, of course, is anathema to conventional economics, which pins its faith in David Ricardo’s “comparative advantage” theory. Essentially, Ricardo argues that we all get richer if we all concentrate on what we’re, so to speak’, ‘most best at’. From this, it follows that maximising trade between nations is to the benefit of all. This has long been an article of faith for economists.

What Ricardo did not have to consider, though, was the concept of a world with finite characteristics. It’s a reasonable hypothesis that constraints on the maximum availability of resources (such as land, water and, above all, energy) might render the law of comparative advantage inoperable. In short, once you postulate limits to potential prosperity, ‘all in it together’ quickly becomes ‘every man for himself’.

Trade, currencies and national advantage

If a government did arrive at the ‘zero-sum prosperity’ conclusion, it would concentrate on pursuing national advantage in trade. Governments already do this, of course, but they are in general influenced sufficiently by the Ricardian calculus to pursue national advantage in a mutual context. Whilst they want to skew trade agreements in their own favour, they do so from an assumption that there are mutual benefits to be accrued from such agreements.

The various trade deals pursued by the Obama administration illustrate this. Though these deals undoubtedly had a pro-American bias, they were nevertheless framed in an ‘internationalist’ way, based on assumptions of potential mutual benefit.

Our imaginary zero-sum prosperity government would differ radically, because its disbelief in mutual advantage would result in an instinctive preference, if not for outright protectionism, then at least for blatantly one-sided arrangements. The result would be a more aggressive stance on trade, characterised by an undisguised pursuit of national benefit, almost heedless of what the consequences for other countries might be.

This government would also want to leverage whatever benefits it might get from the relative strength of its currency. Under normal circumstances, a strong currency is bad for trade, making home-produced goods costlier than foreign alternatives. That matters a lot less, though, if you use tariffs to decide what you do and do not want to buy from overseas. For example, you might decide that a strong currency helps you purchase resources from abroad, but the strength of the currency needn’t suck in more manufactured goods because, if this starts to happen, you simply stick tariffs on them.

It need hardly be stated that the politics and the rhetoric accompanying this stance would be nationalist in tone. Moreover, this nationalist approach towards trade would be certain to show up, too, in other, non-trade aspects of foreign policy, including areas such as diplomacy and the management of alliances. Neither is it at all fanciful to assume that this nationalism would be replicated in domestic policies. Politicians often ‘wave the flag’ in pursuit of votes – the only difference about a government founded on a zero-sum prosperity assumption would be that the nationalism invoked would be the real thing.

The emphasis on nationalism described here need not, though, result in bellicosity. Indeed, it is likelier to take the form of isolationism or, at least, of a reluctance to expend “blood and treasure” in ways that do not benefit the country’s prosperity.

Thus far, we have envisaged a government determined to use trade to pursue national prosperity – and, implicitly, broader national advantage as well – on the basis of zero-sum world potential. As well as being implicitly inimical to free trade in goods and services, this argues for an equally restrictive attitude towards the movement of capital and labour.

For a start, the government we are envisaging would not want foreign investors acquiring domestic assets. At the same time, it would not want to see its businesses investing overseas rather than at home, something which they might well be inclined to do if costs elsewhere were lower, a differential that would be exaggerated by a strong currency.

Likewise, such a government would be inimical to the free movement of labour. If its preference was for businesses to invest at home – rather than moving their operations to lowest-cost locations – then it would be equally opposed to that cheap labour being imported through immigration. It would see large-scale immigration as the domestic face of a globalist calculus that it wished to disrupt.

Battle lines

What we are envisaging here is a government which – by interfering with the flow of trade, capital and labour – is challenging the most treasured objectives of the ‘globalists’.

In critical ways, some demarcations are being drawn here between our theoretical government and those who, either in principle or in pursuit of profit, work from diametrically opposite assumptions. A nationalist stance, reinforced by opposition to immigration, plays to a domestic audience often branded “populist” by its increasingly unpopulist opponents.

Essentially, then, any government operating on the premise of nationalism founded on a zero-sum prosperity calculus would face fervent opposition, both at home and abroad. Opponents would fall into two main categories – those who benefit from the globalist model, and those who are internationalist out of conviction. Those persuaded by internationalism out of conviction overlap extensively with those whose policies are self-defined as ‘liberal’.

What emerges from this is that the opponents of our theoretical government might be defined as ‘liberal globalists’. Since this essentially defines the long-established political and economic consensus of the Western world’s ruling elites, the government that we are envisaging would, of necessity, be ‘anti-establishment’, challenging both the vested interests and the conventional assumptions which favour globalism.

Donald Trump – theory into practice?

Just to recap, then, a government which became persuaded about zero-sum global prosperity could be expected to ditch huge swathes of what has been the economic consensus for more than three decades.

It would pursue policies of national advantage which would be hostile to free trade, and opposed to the free movement of capital and labour. It would abandon the substance (and, very probably, the rhetoric, too) of mutuality. It would face very stiff, often visceral opposition both from internationalist and from globalist persuasions.

So much for theory – what about practice?

The government which comes closest to our theoretical outline is the Trump administration. Mr Trump’s political platform can be described as ‘populist-nationalist’, and his opposition to globalisation is palpable. If Mr Trump has an identifiable enemy, that enemy resides, not in Beijing or in Moscow, but in Davos.

This interpretation has been influenced by a two-part essay by analyst Thierry Meyssan. His argument is that Mr Trump’s political stance, developed over the fifteen years before he entered the White House, is based on opposition to American ‘imperial’ behaviour and a renewed focus on domestic prosperity alone. As Mr Meyssan puts it, Mr Trump is “a politician who refuse[s] to engage his country in the service of transnational elites”.

It is certainly striking that, unlike his predecessors, Mr Trump shows no appetite for military interventions, in the Middle East or anywhere else. He certainly does not want America to be ‘the world’s policeman’, especially if what is being policed benefits globalist corporates a lot more than it benefits Americans

Ideologically, some of this puts Mr Trump in some positions which, at first sight, can look pretty bizarre. For example, it seems unlikely in the extreme that Lenin was ever one of the President’s favourite authors, but Thierry Meyssan is surely on to something when he cites this passage by the Soviet leader at the start of his second essay:

 

“Imperialism is capitalism which has arrived at a stage of its development where domination by monopolies and financial capital has been confirmed, where the export of capital has acquired major importance, where the sharing of the world between international trusts has begun, and where the sharing of all the territories of the globe between the greatest capitalist countries has been achieved”

 

Brought forward into the circumstances of today, references to monopolies, the dominant role of international capital and the free flow of capital between countries are indeed redolent of what Davos likes, and Mr Trump, instinctively and perhaps calculatedly, does not.

According to Mr Meyssan, the President’s election was based on a “promise to return to the earlier state of Capitalism, that of the ‘American dream’, by free market competition”. Thus interpreted, Mr Trump opposes the small number of “multinational companies [which] gave birth to a global ruling class which gathers every year to congratulate itself, as we watch, in Davos, Switzerland. These people do not serve the interests of the US population, and in fact are not necessarily United States citizens themselves, but use the means of the US Federal State to maximise their profits”.

Synthesis

Thus far, we have been examining two distinct issues.

The first is an interpretation of what a government might do, if it became persuaded that the scope for growth in global prosperity has been exhausted.

The second is Thierry Meyssan’s acute interpretation of Donald Trump as a nationalist opponent of globalisation and its attendant ideologies and policies.

What is surely very striking is how these two strands intersect. It’s doubtful if Mr Trump and his advisors are familiar with the energy-based interpretation of economics, certainly as discussed here, and modelled by SEEDS. But it’s by no means improbable that he has arrived at similar conclusions by different routes.

It certainly seems apparent that the consensus symbolised by Davos is vehemently opposed to Mr Trump’s apparent agenda. Moreover, if he has indeed picked a fight with “Davos man”, he could hardly have chosen a more formidable opponent. What we do know is that he has already thrown some big spokes into the wheel of a model which favours the global flow of goods, capital and labour on a basis geared towards the maximisation of the share of GDP which goes into corporate profits rather than labour.

If this interpretation is correct, we should anticipate efforts to break up some of the most powerful global corporations with large shares in their respective markets. Mr Trump might not have read Lenin, but he certainly seems to understand Adam Smith’s emphasis on the primary importance of competition, free, fair, and unfettered by excessive concentration. Once that is understood, trust-busting becomes logical.

Outcomes

Fascinating though the politics of all this undoubtedly are, the decisive issue is likely to be economic. Essentially, can nationalism deliver more for American voters than globalisation has achieved?

The reality is that, in pure economic terms, globalisation isn’t a hard act to follow. The essential premise of globalisation is that profits can be increased by locating production in the cheapest places, whilst continuing to sell goods and services in the (relatively) wealthy West.

There was always a huge contradiction at the heart of this philosophy – essentially, if well-paid jobs are shipped out of Western markets, how are Western wage-earners supposed to carry on with high levels of consumption? Thus far, the answer has been to make credit cheaper, and more readily accessible, than it has ever been before. This strategy has landed us with extraordinary levels of debt, unprecedentedly cheap money, and all of the risks associated with financial adventurism.

According to SEEDS, the United States has not bucked the trend towards lower prosperity in the West. Whilst not as badly affected as, say, Britain or Italy, SEEDS indicates that the average American is 7.7% ($3,380) poorer than he or she was back in 2005.

Though GDP data appears to contradict this calculation, two factors can be cited to support it. First, an overwhelming majority (93%) of all growth in American GDP in recent years has come from internally-consumed services (ICS) – such as finance, real estate and government – whilst the aggregate contribution to growth of hard-priced, globally marketable output (GMO), such as manufacturing, construction, agriculture and the extractive industries, has been zero. (The other 7% came from increased exports of services).

Second, growth in GDP has been far exceeded by an ongoing escalation in debt. Comparing 2017 with 2005, GDP has grown by $3.25tn, but debt has expanded by $14tn, a ratio of $4.30 of new debt for each $1 of reported growth. By definition – and, latterly, based on experience as well – pouring cheap credit into the system to sustain consumption in the face of deteriorating wages is not a sustainable way of running the economy.

In short, there is a compelling case to be made that Americans are significantly poorer now than they were twelve years ago – and, were this not the case, there has to be a strong possibility that Mr Trump would not have become President.

The first conclusion we can reach seems to be that, in linking prosperity with nationalism, Mr Trump has been pushing at an open door. We cannot know whether his policies can deliver more for Americans than globalisation, but it won’t be all that long before we find out. Obviously, nobody should underestimate the opposition that Mr Trump will go on encountering from those whose economic interests he threatens.

 

#132: The revenge of the spider

ECONOMIC RECKLESSNESS AND GFC II

If you’re a regular visitor to this site, you’ll know that we’ve covered a lot of themes, varying from the plight of individual economies to the madness of economic policy both before and – especially – since the 2008 global financial crisis (“GFC I”). You’ll probably know, too, that the expectation here is for “GFC II”, a far larger sequel to the events of 2008.

You might also know that the coming autumn sees the opening of a window in which this second crisis might take place (though, in their very nature, the timing of such events cannot be predicted). So the aim now, with autumn approaching, is to summarise how things stand.

Let’s start with the economy. Ever since the late 1990s there have been clear signs of deceleration in the pace at which underlying economic output has been growing. The interpretation put forward here is that this deceleration has been caused by an exponential uptrend in ECoE (the energy cost of energy). At least two other material headwinds can be identified – environmental stress, and mistaken economic policy – but a worsening in the energy equation has been the critical factor undercutting the potential for growth.

As modelled by SEEDS, these trends in energy have already put prosperity growth into reverse in the majority of Western economies, where prosperity per person generally peaked between 2000 and 2007. On this basis, the average Italian has become 12.3% poorer since 2001, the average American is 7.7% less prosperous now than he or she was back in 2005, and prosperity in the United Kingdom has fallen by 10.3% since 2003.

Where the West is concerned, the outlook is for more of the same. Mr Trump may or may not be able to “make America great again”, but neither he nor anybody else can ‘make Americans prosperous again’. Much the same, varying only in rapidity of deterioration, applies to virtually all developed economies.

In recent years, the Emerging Market economies (EMs) have become more prosperous, though sometimes at rates nowhere near claimed expansions in GDP per capita. According to SEEDS, this improvement in EM prosperity looks likely to continue, albeit at fading rates. In theory, this leaves global prosperity pretty flat, with progress in the EMs offsetting impoverishment in the West. In practice, though, EMs may not be able to carry on growing their prosperity at all in a world in which their Western trading partners are becoming poorer.

Unfortunately, policymakers have never understood the processes undermining prosperity. Worse still, any concept of coming to terms with deceleration is wholly unacceptable, not least because the financial system is predicated entirely on perpetual growth. Of course, you might think that basing anything on perpetual economic expansion in a finite world is pretty crazy – but whoever said that either politics or finance has to be limited by rationality?

A direct consequence of the collision between resource reality and a commitment to growth in perpetuity has been an attempt to ‘cheat’, using financial adventurism in an ultimately futile attempt to get around the ending of growth.

This has taken two main forms. The first, adopted in the years before GFC I, was “credit adventurism”, making credit cheaper, and easier to obtain, than ever before. Since GFC I, this has been compounded by “monetary adventurism”, which has involved pouring mind-boggling amounts of liquidity into the system.

To a certain extent, the latter was a consequence of the former. By 2008, “credit adventurism” had created debt of a magnitude that was impossible to service under “normal” monetary conditions. Barring “reset” – ruled out because of the short-term pain that it would have caused – the only way to cope with such gargantuan debts was to make them ultra-cheap both to service and to roll-over.

Just as there have been two forms of adventurism, there are two forms of crisis. “Credit adventurism” led naturally to a credit (debt) crisis, which was why banks were in the eye of the storm in 2008. “Monetary adventurism”, on the other hand, leads to a monetary crisis, which is why fiat currencies will be at risk in GFC II.

These forms of adventurism have succeeded in creating an illusion of growth, convincing enough so long as we wear blinkers where underlying fundamentals are concerned. World GDP increased by 35% in the seven years between 2000 and 2007, and by 31% in the decade between 2007 and 2017.

But the escalation in debt alone gives the lie to any claim that this “growth” has been genuine or sustainable. Between 2000 and 2007, growth of $25.5 trillion (at 2017 values) was accompanied by a $52tn increase in debt, meaning that just over $2 was borrowed for each $1 of “growth”. Since 2007, the ratio has worsened markedly, with “growth” of $29.8tn accompanied by $99tn in borrowing, a ratio of $3.30 of new debt for each growth dollar.

Escalating indebtedness has not been the only consequence of financial adventurism, of course. The crushing of returns on invested capital has created huge shortfalls against the amounts that we ought to have put aside for retirement, all but destroying the viability of pension provision for all but a wealthy minority. Monetary adventurism may not – yet, anyway – have created a spike in consumer inflation, but it has led directly to massive bubbles in asset prices.

Critically, the worsening ability of the economy to carry these excesses has been disguised by the phoney “growth” created by the simple spending of borrowed money. Everyone appreciates that an individual does not become more prosperous simply because he or she runs up an ever-bigger overdraft, and spends it. Unfortunately, observers – including policymakers – do seem to believe that economies can prosper by racking up ever bigger debts, and mortgaging the future, and then pushing the proceeds through consumption.

There are even those who believe that the inflated prices of stocks, bonds and property constitute “wealth”, even though the only people to whom such assets can be sold are the same people to whom they already belong.

If we strip away the simple spending of borrowed money, SEEDS calculates that claimed “growth” (of $55tn, or 76%) since 2000 falls to less than $21tn, with the remaining $34tn an illusion conjured out of adventurism. Meanwhile, the deterioration in trend ECoE, from 4.0% back in 2000 to almost 8% now, means that aggregate prosperity increased by just $16.4tn, or 24%, over the period as a whole.

Unfortunately, world population numbers expanded by 22% over the same period, so growth in average prosperity has been just 2.3%, over seventeen years. All and more of that increase has gone to the EMs, leaving the average Western citizen poorer.

What we are left with, then, is deteriorating Western prosperity, faltering underlying output in the world as a whole, unprecedented levels of debt, grotesquely inflated asset markets, and huge hostages to fortune, not least in the destruction of pension provision.

In simple mathematical terms, SEEDS estimates that “reset” in 2008 would have required ‘value destruction’ – a fall in the aggregate prices of assets – of the order of $84tn, equivalent to almost $100tn today. Of course, monetary adventurism was used to avoid reset in GFC I – carrying that value overhang forwards – and we’ve gone on adding to it, at steadily rising rates, ever since. SEEDS puts scope for value destruction today at over $400tn, which should be treated as a (very approximate) order of magnitude of the extent to which asset values have to fall.

This, of course, is ‘first order’ value destruction. If the prices of your shares, bonds and property fall, you still own them, and no money has actually flowed out of your bank account. The real problem is ‘second order’ value destruction, which is what happens when the value of your assets falls to a level lower than the sum you borrowed to acquire them.

Though the scale of the sums involved is almost impossible to calculate, we can conclude that the world will face vast ‘second order’ value destruction when GFC II happens.

We can be equally certain that, rather than accept the necessity of value destruction on a scale roughly four times larger than 2008, the authorities will resort again to adventurism, pouring liquidity into the economy at rates which dwarf anything experienced during and after GFC I. The strong likelihood has to be that adventurism on this scale will undermine the value of fiat currencies, destroying many whilst inflicting hyperinflation on those which survive.

The public, on the other hand, can hardly be expected to like getting ever poorer, especially whilst the distortion of the relationship between incomes and asset values seems to have made a minority wealthier whilst imposing austerity on everyone else. Whether, during GFC II, they will turn increasingly towards insurgent (“populist”) politicians, or opt instead for the collectivist offer of a Left made resurgent by popular adversity, is a second-order question. What we can anticipate, with high levels of confidence, is political and social change at least commensurate with the scale of economic and financial upheaval.

Those with long memories might remember a song for children called “there was an old lady who swallowed a fly”. After the fly, she swallowed a spider (“that wriggled and jiggled and tickled inside her”), the point being that she swallowed the spider in order to catch the fly. Thereafter, ever larger animals were ingested to catch the one swallowed previously – “she swallowed the bird to catch the spider”, and so on – finishing up with swallowing a horse (“she’s dead – of course”).

By this analogy, the system “swallowed a fly” in the years before 2008, then “swallowed a spider” during GFC I in an attempt to deal with it. In real life, swallowing a fly can happen to anyone, and swallowing a spider is at least feasible. Swallowing a bird, however, is not.

In this sense, GFC II is set to be the spider’s revenge.