Yet Again?

By Howard Marks


Excerpted from the memo originally published here



There They Go Again . . . Again” of July 26 has generated the most response in the 28 years I’ve been writing memos, with comments coming from Oaktree clients, other readers, the print media and TV. I also understand my comments regarding digital currencies have been the subject of extensive – and critical – comments on social media, but my primitiveness in this regard has kept me from seeing them.

The responses and the time that has elapsed have given me the opportunity to listen, learn and think. Thus I’ve decided to share some of those reflections here.

Media Reaction


The cable news shows and blogposts delivered a wide range of reactions – both positive and negative. The best of the former came from a manager who, when asked on TV what he thought of the memo, said, “I’d like to photocopy it and sign it and send it out as my quarterly letter.” Love that guy.

I haven’t spent my time reveling in the praise, but rather thinking about those who took issue. (My son Andrew always reminds me about Warren Buffett’s prescription: “praise by name, criticize by category.” Thus no names.) Here’s some of what they said:

  1. “The story from Howard Marks is ‘it’s time to get out.’ ”

  1. “He’s right in the concept but wrong to execute right now.” 

  1. “The market is a little expensive, but you should continue to ride it until there are a couple of big down days.”

  1. “There are stocks that are past my sell points, and I’m letting them continue to burble higher.”

  1. “I appreciate Howard Marks’s message but I think now is no more a time to be cautious than at any other time. We should always invest as if the best is yet to come but the worst could be right around the corner. This means durable portfolios, hedges, cash reserves . . . etc. There is no better or worse time for any of these things that we can foresee in advance.”

I take issue with all these statements, especially the last, and I want to respond – not just in the sense of “dispute,” but rather to clarify where I stand. In doing so, I’ll incorporate some of what I said during my appearances on TV following the memo’s publication.

Numbers one and two are easy. As I explained on CNBC, there are two things I would never say when referring to the market: “get out” and “it’s time.” I’m not that smart, and I’m never that sure. The media like to hear people say “get in” or “get out,” but most of the time the correct action is somewhere in between. 

I told Bloomberg, “Investing is not black or white, in or out, risky or safe.” The key word is “calibrate.” The amount you have invested, your allocation of capital among the various possibilities, and the riskiness of the things you own all should be calibrated along a continuum that runs from aggressive to defensive. 

And as I told CNBC, what matters is “the level that securities are trading at and the emotion that is embodied in prices.” Investors’ actions should be governed by the relationship between each asset’s price and its intrinsic value. “It’s not what’s going on; it’s how it’s priced. . . . When we’re getting value cheap, we should be aggressive; when we’re getting value expensive, we should pull back.” 

Here’s how I summed up on Bloomberg: 

It’s all about investors’ willingness to take risk as opposed to insisting on safety. And when people are highly willing to take risk, and not concerned about safety, that’s when I get worried.

If it’s true, as I believe, that (a) the easy money in this cycle has been made, (b) the world is a risky place, and (c) securities are priced high, then people should probably be taking less risk today than they did three, five or seven years ago. Not “out,” but “less risk” and “more caution.”

And from my visit to CNBC:

All I’m saying is that prices are elevated; prospective returns are low; risks are high; people are engaging in risky behavior. Now nobody disagrees with any of the four of those, and if not, then it seems to me that this is a time for increased caution. . . . It’s maybe “in, but maybe a little less than you used to be in.” Or maybe “in as much as you used to be in, but with less-risky securities.”

Numbers three and four – arguing that it’s too early to sell even if the market is expensive or holdings are past their sell point – are interesting. They’re either (a) absolutely illogical or (b) signs of the investor error and lack of discipline that are typical in bull markets.

  • If the market is expensive, why wouldn’t you lighten up?

  • Why would you prefer to sell after a few big down days, rather than today? (What if the big down days are the start of a slide so big that you can’t get out at anything close to fair value? What if there’s a big down day followed by a big up day that gets you right back where you started? Does the process re-set? And is it three big down days in a row, or four?)

  • And if you continue to hold past your sell points, what does “sell point” mean?

Bottom line: I think these things translate into “I want to think of myself as disciplined and analytical, but even more I want to make sure I don’t miss out on further gains.” In other words, fear of missing out has taken over from value discipline, a development that is a sure sign of a bull market. 

The fifth and final comment – that one should exercise the same degree of care and risk aversion at all times – gives me a lot to talk about. In working on my new book, I divided the things an investor can do to achieve above average performance into two general categories:

  • selection: trying to hold more of the things that will do better and less of the things that will do worse, and

  • cycle adjustment: trying to have more risk exposure when markets rise and less when they fall.

Accepting that “there is no better or worse time” simply means giving up on the latter. Whereas Buffett tells us to “be fearful when others are greedy and greedy when others are fearful” – and he’s got a pretty good track record – this commentator seems to be saying we should be equally greedy (and equally fearful) all the time.

I feel strongly that it’s possible to improve investment results by adjusting your positioning to fit the market, and Oaktree was able to do so by turning highly cautious in 2005-06 and highly aggressive in 1990-91, 2001-02 and immediately after the Lehman bankruptcy filing in 2008. This was done on the basis of reasoned judgments concerning:

  • how markets have been acting,

  • the level of valuations,

  • the ease of executing risky financings,

  • the status of investor psychology and behavior,

  • the presence of greed versus fear, and

  • where the markets stand in their usual cycle.

Is this effort in conflict with the tenet of Oaktree’s investment philosophy that says macro-forecasting isn’t key to our investing? My answer is an emphatic “no.” Importantly, assessing these things only requires observations regarding the present, not a single forecast. 

As I say regularly, “We may not know where we’re going, but we sure as heck ought to know where we stand.” Observations regarding valuation and investor behavior can’t tell you what’ll happen tomorrow, but they say a lot about where we stand today, and thus about the odds that will govern the intermediate term. They can tell you whether to be more aggressive or more defensive; they just can’t be expected to always be correct, and certainly not correct right away.

The person who said “there is no better or worse time” was on TV with me, giving me a chance to push back. What he meant, he said, was that the vast majority of people lack the ability to discern where we stand in this regard, so they might as well not try. 

I agree that it’s hard. Up-and-down cycles are usually triggered by changes in fundamentals and pushed to their extremes by swings in emotion. Everyone is exposed to the same fundamental information and emotional influences, and if you respond to them in a typical fashion, your behavior will be typical: pro-cyclical and painfully wrong at the extremes. To do better – to succeed at being contrarian and anti-cyclical – you have to (a) have an understanding of cycles, which can be gained through either experience or studying history, and (b) be able to control your emotional reaction to external stimuli. Clearly this isn’t easy, and if average investors (i.e., the people who drive cycles to extremes) could do it, the extremes wouldn’t be as high and low as they are. But investors should still try. If they can’t be explicitly contrarian – doing the opposite at the extremes (which admittedly is hard) – how about just refusing to go along with the herd?

Here’s what I wrote with respect to the difficulty of doing this in “On the Couch” (January 2016):

I want to make it abundantly clear that when I call for caution in 2006-07, or active buying in late 2008, or renewed caution in 2012, or a somewhat more aggressive stance here in early 2016, I do it with considerable uncertainty. My conclusions are the result of my reasoning, applied with the benefit of my experience (and collaboration with my Oaktree colleagues), but I never consider them 100% likely to be correct, or even 80%. I think they’re right, of course, but I always make my recommendations with trepidation.

When widespread euphoria and optimism cause asset prices to meaningfully exceed intrinsic values and normal valuation metrics, at some point we must take note and increase caution. And yet, invariably, the market will continue to march upward for a while to even greater excesses, making us look wrong. This is an inescapable consequence of trying to know where we stand and take appropriate action. But it’s still worthwhile. Even though no one can ascertain when we’re at the exact top or bottom, a key to successful investing lies in selling – or lightening up – when we’re closer to the top, and buying – or, hopefully, loading up – when we’re closer to the bottom.
 
FAANGs

There’s been a lot of discussion regarding my comments on the FAANGs – Facebook, Amazon, Apple, Netflix and Google – and whether they’re a “sell.” Some of them are trading at p/e ratios that are just on the high side of average, while others, sporting triple-digit p/e’s, are clearly being valued more on hoped-for growth than on their current performance.

But whether these stocks should be sold, held or bought was never my concern. As I said on Bloomberg:

My point about the FAANGs was not that they are bad investments individually, or that they are overvalued. It was that the anointment of one group of super-stocks is indicative of a bull market. You can’t have a group treated like the FAANGs have been treated in a cautious, pessimistic, sober market. So that should not be read as a complaint about that group, but rather indicative [of the state of the market].

That’s everything I have to say on the subject.
 
Passive Investing

Passive investing can be thought of as a low-risk, low-cost and non-opinionated way to participate in “the market,” and that view is making it more and more popular. But I continue to think about the impact of passive investing on the market.

One of the most important things to always bear in mind is George Soros’s “theory of reflexivity,” which I paraphrase as saying that the efforts of investors to master the market affect the market they’re trying to master. In other words, how would golf be if the course played back: if the efforts of golfers to put their shot in the right place caused the right place to become the wrong place? That’s certainly the case with investing.

It’s tempting to think of the investment environment as an unchanging backdrop, that is, an independent variable. Then all you have to do is figure out the right course of action and take it. But what if the environment is a dependent variable? Does the behavior of investors alter the environment in which they work? Of course it does.

The early foundation for passive or index investing lay in the belief that the efforts of active investors cause stocks to be priced fairly, so that they offer a fair risk-adjusted return. This “efficiency” makes it hard for mispricings to exist and for investors to identify them. “The average investor does average before fees,” I was taught, “and thus below average after fees. You might as well throw darts.”

There’s less talk of dart-throwing these days, but much more money is being invested passively. If you want an index’s performance and believe active managers can’t deliver it (or beat it) after their high fees, why not just buy a little of every stock in the index? That way you’ll invest in the stocks in the index in proportion to their representation, which is presumed to be “right” since it is set by investors assessing their fundamentals. (Of course there’s a contradiction in this. Active managers have been judged to be unable to beat the market but competent to set appropriate market weightings for the passive investors to rely on. But why quibble?)

The trend toward passive investing has made great strides. Roughly 35% of all U.S. equity investing is estimated to be done on a passive basis today, leaving 65% for active management. However, Raj Mahajan of Goldman Sachs estimates that already a substantial majority of daily trading is originated by quantitative and systematic strategies including passive vehicles, quantitative/algorithmic funds and electronic market makers. In other words, just a fraction of trades have what Raj calls “originating decision makers” that are human beings making fundamental value judgments regarding companies and their stocks, and performing “price discovery” (that is, implementing their views of what something’s worth through discretionary purchases and sales). 

What percentage of assets has to be actively managed by investors driven by fundamentals and value for stocks to be priced “right,” market weightings to be reasonable and passive investing to be sensible? I don’t think there’s a way to know, but people say it can be as little as 20%. If that’s true, active, fundamentally driven investing will determine stock prices for a long time to come. But what if it takes more?

Passive investing is done in vehicles that make no judgments about the soundness of companies and the fairness of prices. More than $1 billion is flowing daily to “passive managers” (there’s an oxymoron for you) who buy regardless of price. I’ve always viewed index funds as “freeloaders” who make use of the consensus decisions of active investors for free. How comfortable can investors be these days, now that fewer and fewer active decisions are being made?

Certainly the process described above can introduce distortions. At the simplest level, if all equity capital flows into index funds for their dependability and low cost, then the stocks in the indices will be expensive relative to those outside them. That will create widespread opportunities for active managers to find bargains among the latter. Today, with the proliferation of ETFs and their emphasis on the scalable market leaders, the FAANGs are a good example of insiders that are flying high, at least partially on the strength of non-discretionary buying.

I’m not saying the passive investing process is faulty, just that it deserves more scrutiny than it’s getting today.
 
The State of the Market

There has been a lot of discussion about how elevated I think the market is. I’ve pushed back strongly against people who describe me as “super-bearish.” In short, as I wrote in the memo, I believe the market is “not a nonsensical bubble – just high and therefore risky.”

I wouldn’t use the word “bubble” to describe today’s general investment environment. It happens that our last two experiences were bubble-crash (1998-2002) and bubble-crash (2005-09). But that doesn’t mean every advance will become a bubble, or that by definition it will be followed by a crash.

  • Current psychology cannot be described as “euphoric” or “over-the-moon.” Most people seem to be aware of the uncertainties that are present and of the fact that the good times won’t roll on forever.

  • Since there hasn’t been an economic boom in this recovery, there doesn’t have to be a major bust.

  • Leverage at the banks is a fraction of the levels reached in 2007, and it was those levels that gave rise to the meltdowns we witnessed.

  • Importantly, sub-prime mortgages and sub-prime-based mortgage backed securities were the key ingredient whose failure directly caused the Global Financial Crisis, and I see no analog to them today, either in magnitude or degree of dubiousness.

It’s time for caution, as I wrote in the memo, not a full-scale exodus. There is absolutely no reason to expect a crash. There may be a painful correction, or in theory the markets could simply drift down to more reasonable levels – or stay flat as earnings increase – over a long period (although most of the time, as my partner Sheldon Stone says, “the air goes out of the balloon much faster than it went in”). 
 
Investing in a Low-Return World

A lot of the questions I’ve gotten on the memo are one form or another of “So what should I do?” Thus I’ve realized the memo was diagnostic but not sufficiently prescriptive. I should have spent more time on the subject of what behavior is right for the environment I think we’re in.

In the low-return world I described in the memo, the options are limited:

  1. Invest as you always have and expect your historic returns.

  1. Invest as you always have and settle for today’s low returns.

  1. Reduce risk to prepare for a correction and accept still-lower returns.

  1. Go to cash at a near-zero return and wait for a better environment.

  1. Increase risk in pursuit of higher returns.

  1. Put more into special niches and special investment managers.

It would be sheer folly to expect to earn traditional returns today from investing like you’ve done traditionally (#1). With the risk-free rate of interest near zero and the returns on all other investments scaled based on that, I dare say few if any asset classes will return in the next few years what they’ve delivered historically.

Thus one of the sensible courses of action is to invest as you did in the past but accept that returns will be lower. Sensible, but not highly satisfactory. No one wants to make less than they used to, and the return needs of institutions such as pension funds and endowments are little changed. Thus #2 is difficult.

If you believe what I said in the memo about the presence of risk today, you might want to opt for #3. In the future people may demand higher prospective returns or increased prospective risk compensation, and the way investments would provide them would be through a correction that lowers their prices. If you think a correction is coming, reducing your risk makes sense. But what if it takes years for it to arrive? Since Treasurys currently offer 1-2% and high yield bonds offer 5-6%, for example, fleeing to the safety of Treasurys would cost you about 4% per year. What if it takes years to be proved right?

Going to cash (#4) is the extreme example of risk reduction. Are you willing to accept a return of zero as the price for being assured of avoiding a possible correction? Most investors can’t or won’t voluntarily sign on for zero returns.

All the above leads to #5: increasing risk as the way to earn high returns in a low-return world. But if the presence of elevated risk in the environment truly means a correction lies ahead at some point, risk should be increased only with care. As I said in the memo, every investment decision can be implemented in high-risk or low-risk ways, and in risk-conscious or risk-oblivious ways. High risk does not assure higher returns. It means accepting greater uncertainty with the goal of higher returns and the possibility of substantially lower (or negative) returns. I’m convinced that at this juncture it should be done with great care, if at all.

And that leaves #6. “Special niches and special people,” if they can be identified, can deliver higher returns without proportionally more risk. That’s what “special” means to me, and it seems like the ideal solution. But it’s not easy. Pursuing this tack has to be based on the belief that (a) there are inefficient markets and (b) you or your managers have the exceptional skill needed to exploit them. Simply put, this can’t be done without risk, as one’s choice of market or manager can easily backfire.

As I mentioned above, none of these possibilities is attractive or a sure thing. But there are no others. What would I do? For me the answer lies in a combination of numbers 2, 3 and 6.

Expecting normal returns from normal activities (#1) is out in my book, as are settling for zero in cash (#4) and amping up risk in the hope of draws from the favorable part of the probability distribution (#5) (our current position in the elevated part of the cycle decreases the likelihood that outcomes will be favorable). 

Thus I would mostly do the things I always have done and accept that returns will be lower than they traditionally have been (#2). While doing the usual, I would increase the caution with which I do it (#3), even at the cost of a reduction in expected return. And I would emphasize “alpha markets” where hard work and skill might add to returns (#6), since there are no “beta markets” that offer generous returns today.

These things are all embodied in our implementation of the mantra that has guided Oaktree in recent years: “move forward, but with caution.” 

Since the U.S. economy continues to bump along, growing moderately, there’s no reason to expect a recession anytime soon. As a consequence, it’s inappropriate to bet that a correction of high prices and pro-risk behavior will occur in the immediate future (but also, of course, that it won’t). 

Thus Oaktree is investing today wherever good investment opportunities arise, and we’re not afraid to be fully invested where there are enough of them. But we are employing caution, and since we’re a firm that thinks of itself as always being cautious, that means more caution than usual. 

This posture has served us extremely well in recent years. Our underlying conservatism has given us the confidence needed to be largely fully invested, and this has permitted us to participate when the markets performed better than expected, as they did in 2016 and several of the last six years. Thus we’ll continue to follow our mantra, as we think it positions us well for the uncertain environment that lies ahead.


Financial Globalization 2.0

Hans-Helmut Kotz, Susan Lund

Credit Suisse CEO and chairman


WASHINGTON, DC – In the decade since the financial crisis began in August 2007, the contours of global finance have shifted dramatically. The total value of cross-border capital flows has shrunk by 65% over the last ten years, a decline that reflects, in particular, the sharp reduction in international banking activities.
 
The question for us is what figures like these can tell us about the health of global finance today. Are they evidence that “financial globalization” – the international movement of capital – has lurched into reverse? And if it has, would that be such a bad thing?
 
The current retrenchment reflects greater risk aversion and awareness since the bubble began to burst in late 2007. But, according to new research from the McKinsey Global Institute, what is emerging is a more resilient version of global financial integration.
 
Before the crisis, cross-border banking surged as many of the world’s largest banks expanded internationally, lending more to one another and investing in other foreign assets. After the creation of the euro, for example, eurozone banks expanded significantly. Foreign claims held by eurozone banks (and their subsidiaries) soared from $6.6 trillion in 2000 to $23.4 trillion in 2007. Most important, a majority of that growth was within the eurozone itself, where an integrated European banking market was emerging, leading some to believe that a common currency and shared rules meant country risk had almost disappeared.
 
foreign claims eurozone banks
 
What is clear today is that many institutions were simply engaging in herd mentality, rather than executing prudent business strategies. Then, stung by the financial meltdown in the United States, and subsequently by the eurozone’s own crisis, the major global banks reduced their foreign presence, selling off some businesses, exiting others, and allowing maturing loans to expire. Since 2007, global banks have sold at least $2 trillion of assets.
 
Swiss, British, and American banks have all been part of the retreat, but eurozone banks are at its epicenter. Since the crisis began, eurozone banks have reduced foreign claims by $7.3 trillion, or 45%. Nearly half of that is a shrinking portfolio among eurozone borrowers, particularly banks. The perception that lending within the currency area was quasi-domestic has fallen apart.
 
As the financial crisis evolved, private-sector involvement – through “haircuts” and “bailing in” – became a threatening option. From a risk perspective, domestic markets – where banks had the advantage of scale and market knowledge – became comparatively more attractive. In Germany, for example, the ratio of foreign to total assets at the three largest banks flipped, from 65% in 2007 to 33% in 2016. This was not simply a matter of shrinking the overall balance sheet; domestic assets grew by 70% during the same period.
 
What has emerged in the eurozone and beyond is a potentially more stable financial system, at least where banking is concerned. Banks have been required to rebuild their capital, and new rules on liquidity have reduced leverage and vulnerability. Stress testing and resolution preparedness – the sector’s so-called living wills – have created significant disincentives to complexity. All of this has made foreign operations less attractive as well.
 
A more diverse mix of cross-border capital flows also indicates greater stability. While total annual flows of cross-border lending have fallen by two thirds, foreign direct investment has held up better. FDI is by far the most stable type of capital flow, reflecting long-term strategic decisions by companies. Equity-related positions (FDI plus portfolio investments) now account for 69% of cross-border capital flows, up from 36% in 2007.
 
global imbalances
 

One final measure of stability is that global imbalances, including aggregate capital- and financial-account balances, are shrinking. In 2016, these imbalances had fallen to 1.7% of global GDP, from 2.5% in 2007. Moreover, the remaining deficits and surpluses are spread over a larger number of countries than before the crisis. In 2005, the US absorbed 67% of global net capital flows. By 2016, that share had fallen by half. China, meanwhile, accounted for 16% of the world’s net capital surplus in 2005; last year it was only 1%. And, with only a few exceptions, like Germany and the Netherlands, imbalances have also declined within the eurozone. Today, developing countries have become capital importers once more.
 
None of this should invite complacency. A more tightly woven global financial system inevitably comes with a higher risk of contagion. Excesses can always return; indeed, equity and real-estate markets in some advanced economies are rising to new highs, despite mediocre growth prospects.
 
Volatility in gross capital flows also remains a concern. Since 2010, one third of developing countries and two thirds of advanced economies have faced large fluctuations in total capital inflows. Lending flows are particularly unstable; more than 60% of countries have experienced some degree of annual fluctuation, with the median shift equal to 7.7% of GDP for advanced economies, and 3% of GDP for developing countries.
 
Some observers argue that more should be done to contain risk in the system; to the extent that risk has simply shifted from banks to shadow banks, they may be right. But, overall, signs of greater resilience and increased stability are everywhere. Actions taken over the last ten years therefore imply less fragility when the next crisis hits, as it surely will.
 
 


Ignore the Fed’s Yield Sign at Your Peril

If the Federal Reserve’s rate projections come true, the yield curve is bound to get flatter

By Justin Lahart
.



The Federal Reserve is telling investors it will flatten the yield curve. They should listen.

Last week, policy makers stuck to a projection that they will raise their target range on rates by another quarter point this year. But they also lowered their median projection of where they think rates will eventually be to 2.75% over the longer run versus their June forecast of 3%.

That matters to the bond market because Treasury yields reflect investors’ expectation of what overnight rates will average across the maturity of Treasurys, plus the “term premium,” the extra yield investors demand for the risk of lending over a longer term. Historically, term premiums have been positive but lately have been negative.

Based on the Fed’s projected rate path and current term premiums, the 10-year Treasury yield seems about right. Nor should yields rise much as the Fed raises rates, because those rate increases would only raise the average level of short-term rates over the 10-year’s maturity slightly. Average rates over shorter maturities, such as for the 2-year Treasury, would rise more. The Fed’s projections suggest the yield curve will flatten.

LOWERING THE BAR
Median projection for the longer-term federal-funds rate





Fears that a flat curve is an economic distress signal may not pan out, but it does lead equity investors to reduce risk, points out Cornerstone Macro’s Roberto Perli. Shares of banks and credit-dependent firm often underperform.

The Fed’s expected rate path might not come true. Low inflation could lead it to raise more slowly. High inflation could do the opposite. And even if the Fed turns out to have been right, an increase in term premiums could alter the curve’s shape. But for now, investors should be careful not to get flattened.


How Australia broke the record for economic growth

Twenty-six years and counting
 

THE last time Australia suffered a recession the web browser had just been invented and Bryan Adams topped the charts. Figures released today will show that its economy has racked up the longest stretch of growth in modern history: 104 quarters. The Netherlands, the previous title-holder, dipped into recession—defined as two consecutive quarters of contraction—after 103. In these 26 years, Australia has navigated the Asian financial crisis, the collapse of the dotcom bubble and the Great Recession, largely without scars. Its once-in-a-generation mining boom ended in 2014. Yet it has managed to avoid a bust. How did it break the record for economic growth?

Its success was built on the structural reforms of the 1980s and ’90s, when trade barriers crumbled and foreign-exchange controls were removed. A floating dollar cushioned the economy against external aches; inflation stabilised around a target band of 2-3%; and government finances greatly improved. By the time the global financial crisis hit, Australia had enjoyed over a decade of budget surpluses and net debt had been eliminated. It helped that China’s demand for commodities was fuelling a mining boom that created jobs and pushed up wages. Australia’s terms of trade soared as it churned out coal and iron ore to feed its neighbour’s factories. By 2013 household incomes were about 13% higher than they would have been without the bonanza.

History suggested that the rush would be followed by a bust. As prices and investment fell, debt and unemployment rose in resource-dependent parts of the country like Queensland and Western Australia. But the Reserve Bank responded by slashing cash rates to lows of 1.5%, where they have remained for the past year, allowing the diverse economies of Victoria and New South Wales to pick up the slack. A weaker currency boosted agricultural exports and drew students and tourists in growing numbers. Cheap loans and rapid population growth prompted an explosion in demand for housing. Last year Australia’s population swelled by 1.6%, over double the average of the OECD, a group of mostly rich countries. To accommodate its intake of foreign migrants, Australia must build a city roughly the size of Britain’s Birmingham every five years.

The luck seems set to continue. The central bank predicts that GDP growth will pick up to about 3% in the next couple of years. But families have reason to feel less optimistic.

Unemployment rates have flat-lined above their equivalents in America, Britain and Japan.

Underemployment (the number of people who would like more work) is close to record highs.

Rising national income is not trickling down to workers: wage growth has fallen to about 1.9%, its slowest pace since the last recession.

This is all the more uncomfortable because household debt has ballooned. Its ratio to GDP is close to 190%, one of the highest in the world. If the central bank raises interest rates, many families will have difficulties repaying their mortgages. For now, it is likely to do nothing—and the growth will go on.


Supply-Side Amnesia

J. Bradford DeLong
. US Tax reform briefing

BERKELEY – In the spring of 1980, Harvard University economist Martin Feldstein taught (alongside Olivier Blanchard) one of the best macroeconomics classes I ever took. Two and a half years later, Feldstein joined US President Ronald Reagan’s cabinet, where he chaired the Council of Economic Advisers until July 1984.
 
While in the White House, Feldstein waged a persuasive but lonely bureaucratic campaign against the Reagan administration’s 1981 income-tax cuts, arguing that they had been too big, and would prove economically painful if not corrected.
 
Feldstein’s position was not popular among other Reaganites. Rather than heed his warnings, Reagan’s chief of staff, James Baker, convinced others in the administration to stay the course, so that they would not have to admit that the president’s signature tax-cutting initiative had been a mistake.
 
Baker and his cohort won the political debate. The Reagan tax cuts remained in place, and created a federal budget deficit that would not be tamed until President Bill Clinton started to bring spending and revenues back into line in 1993. Clinton accomplished this feat despite unanimous objections from every Republican in the US Congress.
 
The Reagan-era deficits helped the US economy recover from the 1981-82 recession. But after 1984, growth slowed, because resources that should have been allocated for investment were instead spent on consumption, particularly among higher-income earners.
 
Ultimately, the Reagan tax cuts hammered manufacturing in the Midwest, creating what is now known as the “Rust Belt.” As it happened, this is precisely what Feldstein had warned about.
 
He had argued that prevailing economic conditions implied that wider budget deficits would result in higher interest rates and a stronger dollar, making it harder for US manufacturers to compete with imports.
 
I believe that if Feldstein’s warning had been heeded in 1982-84, America would be stronger and happier today. I was thus dismayed at his recent expression of optimism that under today’s Republican-led Congress, “a tax reform serving to increase capital formation and growth will be enacted,” while arguing that “any resulting increase in the budget deficit will be only temporary.”
 
I would respond to Feldstein with three questions. First, when in recent memory has a Republican-sponsored tax cut not created a deficit? Second, when have those deficits been “temporary,” apart from the occasions when later Democratic administrations reduced them by reversing the underlying tax cuts (as Clinton did after Reagan, and Barack Obama did after George W. Bush)? And, finally, when have investments stemming from Republican tax cuts ever raised more in national savings than has been depleted by the ensuing budget deficits?
 
The answer to all three questions is simple: never.
 
A pro-growth, revenue-neutral tax-reform package might be possible in the United States if it were designed by a bipartisan group of centrists, which is what happened with the Tax Reform Act of 1986. Such a bill today would need to promise lower tax rates for those who are heavily taxed, and only limited tax increases for those who are lightly taxed. And any changes made would need to translate into relatively large growth benefits.
 
Unfortunately, the tax-reform effort currently underway in the US is not backed by a group of bipartisan centrists, but by right-wing Republicans who believe that taxes are an affront to billionaires’ liberties. Rather than starting from the center and making appeals to both sides, congressional Republicans are starting from the right and feinting toward the center. At the end of the day, cutting taxes for the wealthy is their top priority, regardless of whether such cuts lead to more domestic investment.
 
Feldstein’s language in describing the current Republican tax-reform effort is telling. “The House Republican plan would cut the top tax rate back to 30% or lower,” he writes, before listing a few “mights”: the bill “might…eliminate the estate tax”; and it “might eliminate tax deductions for state and local taxes, and tax some of the fringe benefits that are currently excluded from taxable income.”
 
Further down, he claims that the bill “would reduce [the corporate-tax] rate to 25% or less,” which, he asserts, is “likely to boost domestic corporate investment.”
 
But whether the Republican plan “would” do something depends largely on those “mights.” The bill might yield a net benefit for all or most Americans, or it might be a handout to the super-wealthy.
 
Given that the effort is being led by hard-right Republicans who care more about cutting taxes than holding down deficits, my bet is on the latter outcome – the one Feldstein warned about in the early 1980s.
 
 


British society deserves an economy rooted in the common good

The UK has to make generation-defining choices about its path beyond Brexit

by: Justin Welby
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The Archibishop of Canterbury, Justin Welby, says that inequality must be redressed as the poor live in the shadow of London's wealthiest companies © FT montage; Tolga Akmen; Getty Images



Britain stands at a moment of significant economic uncertainty; a watershed moment where we need to make fundamental choices about the sort of economy we need for the way we want to live.

I am convinced that most people in Britain want the same things from the economy: a system in the service of human flourishing and the common good, where all are valued and all have a stake, regardless of their perceived economic worth and ability. That is the heritage of our culture, the outcome of our great historic values, and emerges for me from the teaching of Jesus Christ.

So why are we hearing so many questions about the economic settlement that older generations are soon to bestow upon the country? Questions like, “Why are so many people so poor when others are so rich?” and “Why are young people going to be poorer than their parents?”

Our economic model is broken and we are failing those who will grow up into a world where the gap between the richest and poorest parts of the country is significant and destabilising. Half of all households have seen no meaningful improvement in their incomes for more than a decade.

Thirty years ago, when I worked in business, company chief executives were paid on average around 20 times the salary of the average worker — and people were worrying about the gap.

CEO pay in the FTSE is now more than 150 times average salary.

Between 2010 and 2015 alone, while many workers were seeing their pay fall in real terms, the median pay for directors in FTSE 100 companies rose 47 per cent. The seemingly runaway nature of high pay among the richest and most powerful bears little relation to the experience of the majority of people.

The deeper question this raises is: whose economy is it? Some have argued that the results both of the EU referendum in 2016 and the general election of 2017 were in some way an expression of this question. The fundamental problem is simple: headline performance numbers do not reflect many people’s experience of the economy. Our economy is no longer working for everyone, if indeed it ever has.

And for some groups of people and some parts of the country, it doesn’t seem to be working at all. In communities where I have worked in Liverpool and the north-east of England, living standards have actually fallen. What we are seeing is a profound state of economic injustice.

So what are the building blocks that we need to put in place now if, by 2030, we want those young people to experience an economy that is wired for both success and justice?

First, we need an education and skills system that equips people for a tumultuous job market dominated by technology, and employers who are prepared to develop the skills of their employees.

Second, we need a fairer tax system where those who benefit most from the economy — whether through income, wealth or investment — pay their fair share.

Third, a way of using growth to decarbonise the economy, significantly reducing its dependence on fossil fuels, and look after citizens in old age.

Fourth, new ways to improve pay in both the public and private sectors; and fifth, a programme that expands the housing stock at price levels that are genuinely affordable and builds genuine, sustainable community.

I believe that the country must renew its values so as to face up to the problems honestly, find the courage to confront them boldly, and act with vision and determination effectively to seize the opportunities that lie ahead.

We can shape our economy through the active choices we make as a society. The incremental effect of wise and good small decisions can transform us. The next generation deserves an economy where abundance and prosperity are joined with justice. We all have a part to play, and an interest in delivering it.


The writer is Archbishop of Canterbury and a member of the IPPR’s Commission on Economic Justice, whose interim report is published today