Is the Bubble Economy
Set to Burst?
John Mauldin, Editor
Outside the Box
The bubble economy is set to burst, and US elections may well be the trigger

The tug of war grows more fraught for investors
The IMF and World Bank meetings mixed optimism about the global economy with plenty of concerns
by Mohamed El-Erian
.
© Bloomberg
A “Yes, but” emerged from last week’s global gathering of policymakers that provides a comprehensive check-up for the global economy. In Washington for the 2017 Annual Meetings of the International Monetary Fund and World Bank, officials from almost 190 countries mixed excitement about the improving prospects for the global economy with caution about a list of actual and potential challenges.
And with both sides of this ledger having grown during the past few months, it is a configuration that amplifies the contradictions that traders and investors have to navigate down the road but, for now, are comfortable to profitably ignore.
Four factors underpin the “Yes”:·
- A pick up in economic growth that is becoming broader and more durable. The IMF now projects global growth to increase from 3.2 per cent last year to 3.6 per cent in 2017 and 3.7 per cent in 2018.
- Loose financial conditions that support consumption, and do so without a worrisome increase in inflation and inflationary expectations.
- Very low financial market volatility that, now common to virtually all market segments, allows the wave of higher valuations to reach far and deep.
- Hope that economic growth could be turbocharged by long-awaited progress in implementing more pro-growth policies, particularly in Europe and the US.
The “But” list includes:
- Limited understanding of key economic relationships in advanced countries (such as productivity, wage determination and inflation dynamics), as well as the impact of technological innovation.
- The “hot potato” dimension of today’s foreign exchange markets in which virtually no country is able and willing to live with a sustainably stronger currency.
Uncertainties about the impact of an eventual normalisation of monetary policy in more than one systemically-important central bank, together with those relating to trading arrangements in Europe and North America.
- Growing backlash against big tech in the context of a catchup, both by governments and the companies themselves, to the sector’s systemic importance.
- An international economic order facing greater probability of fragmentation along national and regional lines.
- The geopolitics of North Korea’s brazen nuclear threats.
- Persistent inequalities that fuel the politics of anger, social divisions and party polarisation.
While both sides of this ledger have increased over time, traders and investors have been profitably focusing elsewhere — that is, applying a “buy-the-dip” (any dip) strategy that has served them well. It involves ever greater exposures to credit, liquidity and volatility risks that, over the past few months, have spread from advanced countries’ stocks and bonds to virtually every corner of the public markets around the world. And it is a phenomenon that is being structurally embedded through the proliferation of a growing array of low-cost passive products, notably ETFs, that implicitly promise investors instantaneous liquidity at reasonable bid-offer spreads in asset classes that, in the past, have suffered numerous liquidity strains.
Over time, this confluence of factors sets the global economy and markets on course for a tug-of-war among dramatically opposing possible outcomes. If the “Yes” prevails, the result would include higher and more inclusive growth, a validation of elevated asset prices, the orderly normalisation of unconventional monetary policy, reduced cross-border tensions and an improved environment for national politics. However, a decisive tip towards the “But” would threaten recession and unsettling financial instability, increase the risks of a policy mistake, worsen trade and currency tensions, and fuel more divisive national politics.
It is very hard to predict with a high enough degree of confidence the timing and direction of the eventual resolution. In the meantime, only major disruptions are likely to dissuade traders and investors to abandon what most dream of — a strategy that reliably rewards them and even has some legitimate justification (that is, the ample availability of liquidity from central banks and the corporate sector). In the meantime, both sides of the ledger will continue to grow.
Mohamed El-Erian is chief economic adviser to Allianz and author of the book ‘The Only Game in Town’
Buttonwood
Higher taxes can lower inequality without denting economic growth
A new study by the IMF finds no strong correlation between lower taxes and higher growth
INEQUALITY is one of the big political issues of the 21st century, with many commentators citing it as a significant factor behind the rise of populism. After all, nothing could be more indicative of the triumph of the common man than the elevation of a property billionaire to the American presidency.
A new IMF report* looks at how fiscal policy can help tackle inequality. In advanced economies, taxation already has an impact. The Gini coefficient (a standard measure of income inequality) is around a third lower after taxes and transfers than it is before them. But whereas such policies offset around 60% of the change in market inequality between 1985 and 1995, they have had barely any impact since.
That is because of a change in policy direction. Across the West, taxes on higher incomes have generally fallen. This could be for a number of reasons, the IMF says. The tax take from high earners could have become more “elastic” (ie, sensitive to rate changes); in a mobile world, the elite will move countries to reduce their tax bills. But there is no sign that elasticity has increased in recent decades. A second possibility, easily dismissed, is that the share of income taken by the rich might have fallen; it has, of course, increased. A third option is that society reached a consensus that tax rates needed to be cut to help the rich. In fact, surveys show that people are more in favour of redistributive policies than they were in the 1980s.
Another reason that governments might have driven down top tax rates could be to create greater incentives to invest, thereby boosting economic growth. That certainly seems to be the rationale behind the cuts being proposed by President Donald Trump.
But the IMF, after analysing tax rates in OECD countries between 1981 and 2016, found no strong relationship between how progressive a tax system is and economic growth. Indeed the study adds that for countries wanting to redistribute wealth, there may be “scope for increasing the progressivity of income taxation without significantly hurting growth”.
The latter sentence will be seized on by politicians on the left. But the argument works better in some places than in others. The IMF reckons that the optimal tax rate on higher incomes, assuming the aim is revenue maximisation, is 44%. Britain’s highest rate is already 45%. So the IMF study does not really provide much ammunition for Jeremy Corbyn, the leader of the Labour Party, the main opposition, who wants to raise it to 50%. It is a better argument, perhaps, for Bernie Sanders, the Democrat, since the top American tax rate, before any Trump cuts, is only 39.6%.
Even here, a note of caution is needed. Companies are inclined to move in search of more favourable tax treatment—hence the success of Ireland in attracting business with its 12.5% corporate-tax rate, and the row about “inversions” where American companies move overseas to lower-tax jurisdictions. In response, countries have steadily lowered corporate-tax rates; since 1990 the average rate in advanced economies has fallen by more than 13 percentage points (see chart).
Many rich individuals can choose to shift the way they report their income to take advantage of lower corporate-tax rates. So it is difficult to push up the tax rate on individual incomes while simultaneously lowering the corporate rate. As the IMF report drily remarks: “International tax co-ordination could potentially address this problem but has proved very difficult to implement.” So are there other ways to reduce inequality via the tax system? Another option discussed by the IMF is taxing property, which is an immovable asset. Inheritance taxes are another possibility, although they are costly to administer, and no G7 country raises more than 1% of GDP through this route.
Given the political clout of the rich, it seems unlikely that an international consensus on reducing inequality through higher taxes is going to emerge. In the absence of such a consensus, few governments will take the risk of raising their own rates unilaterally. Step forward, however, a future Corbyn government, which plans to increase the tax rate on companies as well as on individuals—all in the context of Brexit, when companies might in any case be reconsidering their decision to invest in Britain. It will be an economic experiment closely watched by other countries, suggesting a new national slogan: “Britain—we try policies so you don’t have to.”
Don’t Bank on Bankruptcy for Banks
Mark Roe
.
In China, a New Political Era Begins
By Matthew Massee
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And they cannot coordinate with foreign regulators.
Mark Roe is a professor at Harvard Law School. He is the author of studies of the impact of politics on corporate organization and corporate governance in the United States and around the world.