Last updated:December 21, 2011 2:50 pm

Sinking into the ‘great stagnation’

By Martin Wolf

Ingram Pinn illustration

The future is not what it used to be. Nor is the present. This is the theme of The Great Stagnation by Tyler Cowen of George Mason University. This is an influential, albeit depressing, little book, first published on the internet.* Its theme is in its subtitle: “How America ate all the low-hanging fruit of modern history, got sick and will (eventually) feel better.” The book is a model of popular writing: lucid, brief and provocative. But is the argument also true? If so, what might it imply?

America is in disarray,” states Prof Cowen, “and our economy is failing us.” He points to the slow growth of median wages since the 1970s, the illusions of the 2000s and the absence of “new net job creation in this last decade”. Moreover, “we face a long-run fiscal crisis, driven by the increasing cost of entitlements, our reliance on debt, and our willingness to let matters slide rather than face up to paying the bills”.

Click to enlarge

So far, so familiar. More novel is how Prof Cowen explains the US predicament: “the American economy has enjoyed ... low-hanging fruit since at least the 17th century, whether it be free land, ... immigrant labor, or powerful new technologies. Yet during the last 40 years, that low-hanging fruit started disappearing, and we started pretending it was still there. We have failed to recognise that we are at a technological plateau and the trees are more bare than we would like to think. That’s it. That is what has gone wrong.”

The role of both cheap resources and the import of labour in past US growth is clear. But Prof Cowen adds an important point. In 1900, only 6.4 per cent of Americans graduated from high school. In the late 1960s, this ratio peaked at 80 per cent. Similarly, by 2009, 40 per cent of 18-24 year olds were already enrolled in college. Improving labour force quality has become far harder.

Much the most important cause of sustained economic growth is new ideas. Unfortunately, rates of invention and innovation have also slowed. The high point was the late 19th and early 20th centuries, which produced: modern chemicals and so artificial fertilisers; electricity and so the electric motor, light, refrigerator, vacuum cleaner, air conditioner, radio, phonograph and television; the internal combustion engine and so the automobile; the aeroplane; pharmaceuticals; and, not least, mass production. These transformed lives.

Today, in contrast”, argues Prof Cowen, “apart from the seemingly magical internet, life in broad material terms isn’t so different from what it was in 1953.” I would add the computer and the mobile phone. But it is hard not to agree that the flow of fundamental innovations slowed. It is harder and more expensive to innovate today. (See charts.)

To justify his pessimism, Prof Cowen relies on the stagnation of median family incomes since the mid-1970s. But shifts in income distribution – a distinct, phenomenon shape this picture. Nevertheless, data on income per head and on “multi-factor productivity” – the part of economic growth not explained by rising inputs of labour and capital support his point. In the first quarter of 2007, real gross domestic product per head was 13 per cent less than it would have been if the 1947-73 trend had continued. By the third quarter of 2011, it was 22 per cent less. In a thorough study, Robert Gordon of Northwestern University similarly concludes that the growth of multi-factor productivity in the non-farm business sector peaked in the first half of the 20th century and collapsed between 1972 and 1996.** It then surged in the “new economywave. But this impulse has faded. It is possible to imagine another surge in economy-wide innovation from biotechnology or nanotechnology. But, today, this is not to be seen.

It is possible to quibble with Prof Cowen’s thesis in detail. He exaggerates the negative role of a larger government and understates its positive one: the role of the Defense Advanced Research Projects Agency in creating the internet is a compelling example. But the broad picture he paints seems right.
So what does the stagnation imply for the US and the wider world?

Prof Cowen draws two conclusions. The first is that “politics is very difficult in an America without much low-hanging fruit”. The second is that the explanation of the financial crisis is that “we thought we were richer than we were.” In effect, he believes that Americans have made demands, both collectively and individually, that they could not afford. It may well be true that the desire to borrow so much and to resist both higher taxes and lower spending reflects the disappointing rises in real incomes. The rent-extraction apparent in the explosive growth of the financial sector is another consequence and a cause of the “great stagnation”. Prof Cowen even believes that the US economy is close to full employment. I disagree with that. Nevertheless, long-term trends are somewhat disappointing.

Now consider the wider world. Here we can see good news and bad news. One bit of good news is that the great majority of human beings live in economies that are far indeed from the economic frontier. China’s real output per head is about a fifth of US levels and India’s less than a tenth. So improvements in education and adoption of already existing knowledge offer huge opportunities. The second bit of good news is that the potential for incorporating a far greater number of people in scientific discovery, invention and innovation is also huge. It may be ever harder to win new knowledge. But the resources devoted to this task can also be far greater than ever before.

The bad news is that the era of cheap resources is not just vanishing for the US. What was once treated as free is costly. This is another – probably far more dangerousform of zero-sum politics than that within the US. Confronted with painful choices, human beings choose denial. That may not matter so much where resources are marketed. It matters a great deal more when they cannot be, as with the oceans and the air. Here, too, a great deal of innovation will be needed. But for that to happen, the world must offer the right incentives and that, in turn, requires recognition of constraints.

I like this book: it starts from provocative theses and ends with a plea for investment in science. I do not agree with all of it, far from it. But it is good to remember that there are far bigger economic stories than the failure of finance or the appeal of austerity. In the long run, our future depends on good ideas. These may not be ours to determine. But they remain ours to influence.

* Dutton, New York, June 2011.

** “Revisiting US Productivity Growth”, March 2010,

Copyright The Financial Times Limited 2011

The New International Economic Disorder

Mohamed A. El-Erian


NEWPORT BEACH – A new economic order is taking shape before our eyes, and it is one that includes accelerated convergence between the old Western powers and the emerging world’s major new players. But the forces driving this convergence have little to do with what generations of economists envisaged when they pointed out the inadequacy of the old order; and these forces’ implications may be equally unsettling.

For decades, many people lamented the extent to which the West dominated the global economic system. From the governance of multilateral organizations to the design of financial services, the global infrastructure was seen as favoring Western interests. While there was much talk of reform, Western countries repeatedly countered serious efforts that would result in meaningful erosion of their entitlements.

On the few occasions that such resistance was seemingly overcome, the outcome was gradual and timid change. Consequently, many emerging-market economies lost confidence in the “pooled insurance” that the global system supposedly put at their disposal, especially at times of great need.

This change in sentiment was catalyzed by the financial crises in Asia, Eastern Europe, and Latin America in the late 1990’s and early 2000’s, and by what many in these regions regarded as the West’s inadequate and poorly designed responses. With their trust in bilateral assistance and multilateral institutions such as the International Monetary Fund shaken, emerging-market economies led by those in Asiaembarked on a sustained drive toward greater financial self-reliance.

Once they succeeded in overcoming a painful crisis-management phase, many of these countries accumulated previously unthinkable levels of international reserves as precautionary cushions. They extinguished billions in external indebtedness by generating and sustaining large current-account surpluses. And they increased the scale and scope of domestic financial intermediation in order to reduce their vulnerability to external storms.

These developments stood in stark contrast to what was happening in the West. There, unprecedented leverage, massive debt creation, and a seemingly infinite sense of credit entitlement prevailed. Financial excesses become the rule rather than the exception, facilitated by financial innovation and the erosion of lending standards and prudential regulation.

Suddenly, the world turned upside down: “richcountries were running large deficits and, in some cases, tipping from net creditor status to net indebtedness, while “poorcountries were running surpluses and accumulating large stocks of external assets, including financial claims on Western economies.

Little did these countries know that their divergent paths would end up fueling large global imbalances, and eventually trigger a financial crisis that has shaken the prevailing international economic order to its foundations.

There is no restoring fully that order. Rather than recovering strongly, sluggish Western growth is periodically flirting with recession at a time of high unemployment and multiplying debt concerns, particularly in Europe. In an amazing turn of events, virtually every Western country must now worry about its credit ratings, while quite a few emerging economies continue to climb the ratings ladder.

We can now consider the image of Western delegations heading to emerging countries to plead, cap in hand, for financial support, both direct and through the IMF.

At first blush, this unusual convergence between Western and emerging countries seems to reflect what advocates of a new international economic order had in mind. But appearances can be misleading, and, in this case, they are misleading in a significant way.

Advocates envisaged an orderly process in which economic convergence accompanied and facilitated global economic growth. They foresaw a collaborative process guided by enlightened policymaking. But what is occurring is far different and more unpredictable.

Rather than exhibiting enlightened leadership, Western policymakers have consistently lagged realities on the ground, with a bewildering mixture of denial, misdiagnosis, and bickering undermining their responses. Rather than proceeding in an orderly manner, today's global changes are being driven by the disorderly forces of de-leveraging emanating from a Europe in deep financial crisis and an America seemingly unable to restore sustained high rates of GDP growth and job creation.

Multilateral institutions, particularly the IMF, have responded by pumping an unfathomable amount of financing into Europe. But, instead of reversing the disorderly deleveraging and encouraging new private investments, this official financing has merely shifted liabilities from the private sector to the public sector. Moreover, many emerging-market countries have noted that the policy conditionality attached to the tens of billions of dollars that have been shipped to Europe pales in comparison with what was imposed on them in the 1990’s and early 2000’s.

Fortunately, despite having lagged rather than led this process of consequential (and increasingly disorderly) global change, it is not too late for policymakers to catch up. But doing so requires more than just better national policymaking in Europe and America; it is also time for urgent and deep reform of the multilateral system and its main institutions. That process requires joint leadership by the emerging world as a true equal and partner of Western powers.

Mohamed A. El-Erian is CEO and co-CIO of PIMCO, and author of When Markets Collide.

Gold and Silver on the Verge of a Big Move

December 21st, 2011 at 7:47 pm

The past few months have been tough for those holding precious metals stocks, PM futures contracts or physical bullion. With silver is trading down 41%, precious metals stocks down 30% and gold 15%. It has people scratching their head.

The question everyone keeps asking is when can I buy gold and silver?

Unfortunately that is not a simple answer. With what is unfolding across the pond and the bullish outlook for the US Dollar index the next move is a coin toss. That being said, I do feel a large move brewing in the market place so I am preparing for fireworks in the first quarter of 2012.

If you step back and look at the weekly trend charts of the dollar index and the SP500 index you will see the strength in the dollar along with a possible stop in equities forming. What these charts are telling is that in the next 3 months we should know if stocks and commodities are going to start another multi month rally or roll over and start a bear market selloff.

With the holiday season nearing, hedge fund managers sitting on the sidelines just waiting for their yearend performance bonuses, I cannot see any large selloff start until January. Selloffs in the market require strong volume and the second half of December is not a time of heavy trading volume.
This leaves us with a light volume holiday season, major issues overseas and no big money players willing to cause waves.

So let’s take a quick look at the charts as to where the line in the sand is for the dollar index, gold and silver.

Dollar Index Daily Chart

This week we have seen a strong shift of money out of risk off assets (Bonds) and into risk off (Stocks). This shift is happening before the dollar has broken down indicating the dollar may be topping and could be an early warning of higher stocks prices going into year end. Also note that light volume market conditions also favour higher prices.


Gold Price Daily Chart

Gold could still head lower but at this point it is holding a key support level. If we see the dollar breakdown below its green support trendline then I expect gold to have a firm bounce to the $1675 – $1700.


Silver Price Daily Chart

Silver continues to hold a key support level. If the dollar breaks down the silver should bounce to the $31.50 – $32 area. But if the dollar continues to rally then silver and gold may drop sharply.


Mid-Week Trend Conclusion:

In short, I think the best thing to do is enjoy the holiday season with family and friends. Trading right now is not that great and with the market giving mixed signals. I am keeping my eyes on the market in case it flashes a low risk setup and I will keep you informed if we get one.

I am still bearish on gold and silver longer term but the next week or so its likely we see higher prices.

Be aware that Monday is a holiday and once January arrives the market could go crazy again.

Happy Holidays to you and your loved ones!


Chris Vermeulen


DECEMBER 21, 2011, 3:05 P.M. ET

Euro-Zone Banks Tap Big ECB Loans


Hundreds of euro-zone lenders took out a total of €489.19 billion ($639.96 billion) in low-interest loans from the European Central Bank on Wednesday, as the currency area extended a massive financial lifeline to its struggling banking industry.

The ECB said 523 banks borrowed under the central bank's newly activated three-year lending facility. The unexpectedly heavy demand for the loans highlighted the severity of the funding crisis, but simultaneously stirred hopes that the rescue will help defuse Europe's two-year financial crisis—or at least prevent it from getting worse.

Through the loan program, the Frankfurt-based ECB is trying to address a crucial weakness in the euro zone's financial system. Nervous investors have essentially stopped lending to banks, fearful of their heavy holdings of government bonds and other assets that appear to be at growing risk of default.

If the dry spell persists into 2012, it could become a major problem. European banks face more than €700 billion in debt maturing next year, including more than €200 billion in the first three months, according to regulators and analysts.

ECB officials had feared that without intervention, many banks would cut lending to small businesses and households, strangling Europe's already weak economy. The three-year loans, another batch of which will be available in February, are intended to avert such a scenario.

"It's much better to have this funding locked in rather than praying the market reopens," said John Raymond, an analyst with CreditSights in London. "I don't think you can say it's a game-changer but it sort of slows down the vicious circle."

The loan program appears to be the ECB's main weapon, at least for now, in combating Europe's crisis. The central bank has resisted pressure from politicians and market participants to aggressively buy euro-zone government bonds, arguing that such a move is outside its purview. But if the ECB eases fears about the Continent's banks, that would go a long way toward relieving anxiety about many countries' overall financial health.

Still, the lofty hopes of some leaders might be disappointed. Politicians including French President Nicolas Sarkozy have floated the concept of banks using the new ECB cash to snap up government bonds in financially shaky countries, where lackluster demand for their bonds in recent months has pushed their borrowing costs to unsustainable levels. But bankers and analysts play down the odds of that happening on a large scale, given the perceived riskiness of such bonds.

And the loan program isn't without risks. Some experts and regulators worry that banks are growing even more addicted to central-bank assistance, making it harder for them to eventually stand on their own. At the same time, the loan program encourages banks in countries like Spain and Italy to grow

While the banks on Wednesday borrowed €489.19 billion, much of that was simply replacing other outstanding ECB loans that were coming due. Analysts estimated that Wednesday's loans injected about €190 billion of new liquidity into the banking system.

Some experts said Wednesday's ECB lending isn't likely to fully quench European banks' immediate funding needs. Nick Matthews, an economist at the Royal Bank of Scotland, said European banks face about €230 billion of debt maturing in the first three months of 2012 alone.

"This operation is not going to cover all the maturities," he said.

Another €250 billion of European government bonds also need to be refinanced in the first quarter.

Traditionally, banks satisfied much of their day-to-day financing needs by issuing unsecured bonds to institutional investors around the world. But the market for such debt largely evaporated in July, when Europe's crisis intensified. Investors haven't regained their appetite.

In the second half of 2011, European banks have issued about €80 billion of senior unsecured bonds, according to data provider Dealogic. That compares with €240 billion in the same period last year and €257 billion in 2009.

So far, that hasn't been an acute problem. Most banks satisfied the bulk of their 2011 funding needs in the first half of the year. They have been able to close any gaps by issuing safe but expensive secured bonds or by borrowing on a short-term basis from the ECB.

The decision by the ECB's new president, Mario Draghi, to offer an unlimited supply of three-year loans reflects the growing recognition among regulators and bankers possibility that funding markets could remain shut well into the new year. If banks can't replace their maturing debts, they are likely to compensate by reducing lending and other activities.

The ECB's loans are attractive largely because of their price. The ECB will charge an interest rate that is the average of its benchmark rate over the three-year life of the loans. That rate is currently 1%. It's likely to remain well below what most banks would have to pay to borrow from market sources.

The ECB didn't disclose which banks borrowed under the new program, hoping to shield them from any potential stigma associated with the loans. "It appears that a very large majority of the large financial institutions" in Europe participated, said Laurence Mutkin, head of European interest-rate strategy at Morgan Stanley. "They've taken a lot of their issuance needs out of the market."

One of the few banks to publicly confirm its participation was Italy's second-largest lender, Intesa Sanpaolo SpA, which said it borrowed €12 billion. Ireland's finance ministry said its banks also participated.

The loan program could further entwine the fortunes of Europe's banks and governments.
In Spain on Tuesday, the government sold €5.6 billion of bonds in an auction that saw interest rates dive to 1.7% from 5.1% a month earlier. That is a sign of surging demand, which analysts say most likely stemmed from small and midsize Spanish banks buying the bonds in order to use them as collateral for this week's ECB loans.

Such a trade could prove lucrative for the banks, given the considerable gap between the interest rates the Spanish bonds generate and the amount the banks are paying to borrow from the ECB. But it also means that Spanish banks are even more vulnerable to the Spanish government's financial woes.

A similar phenomenon occurred in Italy. Fourteen banks this week issued a total of €38.4 billion of government-guaranteed bonds that will be eligible to serve as collateral with the ECB, according to a document released on Wednesday by the Italian stock exchange.

Those banks already have seen their stocks and bonds battered this year by investors who worry that they are holding excessive quantities of potentially risky Italian government debt.

"The bank-sovereign nexus still has not been successfully broken and if anything is being reinforced," said Mr. Matthews, the RBS economist.

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