#145: Fire and ice, part two

“THE JUGGERNAUT EFFECT”

Although it was something of a detour from the theme of fire and ice, our previous discussion about “Brexit” does have one point of relevance to that theme. Here’s why.

All things considered, there seems to be an utterly compelling case for intervention in the dysfunctional “Brexit” process by the “adults” in European governments. Yet, even at this very late stage, no such intervention has happened. Governments seem to see no alternative to letting London and Brussels – but mostly Brussels – make a complete hash of the whole process. Indeed, only now do the governments of the countries most affected (Ireland and France) seem even to be implementing contingency plans for an adverse outcome.

Of course, you might jump to the conclusion that irrationality reigns in European capitals, and especially in Dublin and Paris. But it’s surely obvious that this is part of a much wider process, one which we can think of as a form of shock-paralysis.

Essentially, the idea explored here is that governments around the world have been paralysed into inaction, not so much by fear alone as by a simple inability to understand what’s happening around them. Nothing, it seems to them, is happening rationally. They don’t really understand why so many amongst the general public are so angry – and they certainly don’t even begin to understand what’s happening to the economy.

I call this shock-paralysis “the juggernaut effect”.

Shock-paralysis

The word “juggernaut” seems to derive from Sanskrit, and refers to an enormous waggon carrying the image of a Hindu god. The figurative meaning is of an irresistible force, flattening anyone foolish enough to stand in its way.

Rationally, you’d think that anybody standing in the path of a “juggernaut” ought to be making every effort to escape. But it’s quite likely that shock, fear and incomprehension will have a paralysing effect, overwhelming rational faculties, leaving him or her rooted to the spot.

That’s a useful way to describe the effects that current economic (and broader) trends are having. It doesn’t just apply to governments, of course, and it’s prevalent amongst the general public, too.

Just as the person standing in front of the “juggernaut” is all too well aware of its lethality, today’s leaders and opinion-formers surely know at least something about the financial, economic, political and social forces converging on them.

But they seem incapable of doing anything about it.

A big part of this paralysis is incomprehension – any problem becomes infinitely harder to tackle if you don’t understand why it’s happening. And there are reasons enough for policy-makers, and ‘ordinary’ people too, to feel completely baffled.

The irrational economy

You don’t need to be a committed Keynesian – indeed, you need only numeracy – to understand the basic principles of economic stimulus.

If economic performance is sluggish, activity can be stimulated by pushing liquidity into the system, either through fiscal or through monetary policy. If too much stimulus is injected, though, there’s a risk that the economy will overheat, with growth exceeding the sustainable trend. Rising inflation is one of the most obvious symptoms of an over-heating economy.

Here, though, is the conundrum, for anyone trying to understand how the economy is performing.

Since the 2008 global financial crisis (GFC I), the authorities have pushed unprecedentedly enormous amounts of stimulus into the system.

We ought, long before now, to have experienced overheating, with growth rising to levels far above trend.

This simply hasn’t happened.

This should have been accompanied by surging inflation, most obviously in commodities like energy, minerals and food, but across the whole gamut of goods and services, too, with wage rates rising rapidly as prices soar.

Again, this simply hasn’t happened.

To be sure, there’s been dramatic inflation in asset prices, and that’s both important and dangerous. But the broader point is that neither super-heated growth, nor a surge in price and wage inflation, have turned up, as logic, experience and basic mathematics all tell us that they should.

Pending final data for 2018, it’s likely that global GDP last year will have been about 34% higher than it was back in 2008. Allowing for the increase in population numbers, GDP per capita is likely to have been about 20% larger in 2018 than it was ten years previously. This isn’t exactly super-heated growth. According to SEEDS, world inflation stands at about 2.5% which, again, is nowhere near the levels associated with an over-heating economy. Far from soaring, the prices of commodities such as oil are in the doldrums.

Price (and other) data is telling us that the economy has stagnated. But the quantity of stimulus injected for more than a decade says that it should be doing precisely the opposite.

There can be no doubt whatsoever about the scale of stimulus. The usual number attached to sums created through QE by central banks is in the range $26-30 trillion, but that’s very much a narrow definition of stimulus. Ultra-loose monetary policy, combined with not inconsiderable fiscal deficits, have been at the heart of an unprecedented wave of stimulus.

Expressed in PPP-converted dollars at constant values (the convention used throughout this analysis), governments have borrowed about $39tn, and the private sector about $71tn, since 2008. On top of that, we’ve wound down pension provision in an alarming way, as part of the broader effects of pricing money at negative real levels, which destroys returns on invested capital.

Even if we confine ourselves to QE and borrowing, however, stimulus since 2008 can be put pretty conservatively at $140tn.

That’s roughly 140% of where world PPP GDP was back in 2008. You might think of it as the injection of 12-14% of GDP each year for a decade.

That’s an unprecedentedly gigantic exercise in stimulus.

And the result? In contrast to at least $140tn of stimulus, world GDP is perhaps $34tn higher now than it was ten years previously. Price and wage inflation is subdued, and the prices of sensitive commodities have sagged. The prices of assets such as stocks, bonds and property have indeed soared – but one or more crashes will take care of that.

By now – indeed, long before now – anyone in government ought to have been asking his or her expert advisers to explain what on earth is going on. Assuming that Keynes wasn’t mistaken (and simple mathematics proves that he wasn’t), the only frank answer those advisers can give is that they just don’t understand what’s been happening.

Questions without answers?

The utter failure of gigantic stimulus to spur the economy into super-heated growth (and surging inflation) is reason enough for baffled paralysis. But there are plenty of other irrationalities to add to the mix.

If you were in government, or for that matter in business or finance, then as well as asking your advisers about the apparent total breakdown in the stimulus mechanism, you might want to put these questions to them, too:

– Why has a capitalist economic system become dependent on negative real returns on capital?

– Why, since the shock therapy of the 2008 global financial crisis (GFC I), have we accelerated the pace at which we’re adding to the debt mountain?

– Why, seemingly heedless of all past experience, have we felt it necessary to pour vast amounts of cheap money into the system?

– Why have the prices of assets (including stocks, bonds and property) soared to levels impossible to reconcile with the fundamentals of valuation?

– Why has China, reputedly the world’s primary engine of growth, found it necessary to resort to borrowing on a gargantuan scale?

This last question deserves some amplification. Pending final data, we can estimate that Chinese debt has increased to about RMB 220tn now, from less than RMB 53tn (at 2018 values) at the start of 2008. These numbers exclude what are likely to be very large quantities of debt created in what might most politely be called the country’s “informal” credit system.

So, why does an economy supposedly growing at between 6% and 7% annually need to do much borrowing at all?  Put another way, how meaningful is “growth” in GDP of 6-7%, when you have to borrow about 25% of GDP annually, just to keep it going?

And this prompts several more questions. For starters, why are the Chinese authorities, hitherto esteemed for their financial conservatism, presiding over the transformation of their economy into a debt-ponzi? Second, can ‘the mystique of the east’ explain why the world’s markets are seemingly either ignorant, and/or complacent, about the creation of a financial time-bomb in China?

The juggernaut effect

Even these questions don’t exhaust the almost endless list of disconnects in our increasingly surreal economic plight, but they surely give us more than enough explanations for the paralysing “juggernaut effect” in the corridors of power.

Put yourself, if you will, into the shoes of someone trying to formulate policy. Two things are obvious to you, and either one of them would be a grave worry. Together, they’re enough to overwhelm rational calculation.

First, you know that there are some very, very dangerous trends out there. In the purely financial arena, you’re aware that debt has become excessive, whilst the system seems to have become reliant on a never-ending tide of cheap credit.

If your intellectual leanings are towards market economics, you’ll also have realised that pricing money at rates below inflation amounts to an enormous subsidy. Politically, that subsidy is going to the wrong people. If you came into government with business experience, you’ll also know that we’ve witnessed the destruction of returns on capital, which makes no kind of sense from any business or investment point of view.

You might know, too, that the viability of pension provision has collapsed, creating what the World Economic Forum has called “a global pensions timebomb”. If the public ever finds out about that, the reaction could dwarf whatever political travails you might happen to have at the moment.

Lastly – on your short-list of nightmares – is the strong possibility that some event, as yet unknown, will trigger a wave of defaults and a collapse in the prices of property and other assets.

Your second worry, perhaps even bigger than your list of risks, is that you don’t really understand any of this. Your economic advisers can’t explain why stimulus, though carried to (and far beyond) the point of danger, hasn’t worked as the textbooks (and all prior experience) say it should. If there’s anything worse than a string of serious problems and challenges, it’s a complete lack of understanding.

Without understanding, the policy cupboard is bare. You don’t know what to do next, because anything you do might have results that don’t match expectations, making matters worse rather than better.

It might be better to do nothing.

In short, you feel as though you’re making it up as you go along, in the virtual certainty that something horribly unpleasant is going to hit you, with little or no prior warning.

Welcome to “the juggernaut effect”.