Living Life Near the ZLB

Doug Nolan


There must be members of the FOMC that feel they are about to be railroaded into a 50 bps cut a week from Wednesday. Chairman Powell essentially pre-committed to a reduction last week in testimony before Congress. For a Federal Reserve preaching “data dependent” for a while now, the less dovish contingent at the Fed must be asking, “But what about the data?”

It was interesting to see headlines Thursday afternoon from a speech by the President of the New York Fed, John Williams: “Williams: Lesson With Zero Rates is to Take Swift Action,” “Williams: Currently Estimates Neutral Rate in U.S. Around 0.5%.” Soon afterward, headlines from Fed vice chair Richard Clarida reinforced the point: “Fed’s Clarida: Central Bank Needs to Act Preemptively,” and “Clarida: You Don’t Necessarily Want to Wait Until Data Turns.” Things turned rather boisterous ahead of the Fed’s “quiet period.”

Markets were all ears. The implied yield on August Fed Funds futures dropped a quick nine basis points to 1.98%, a full 43 bps below the current rate. The Market’s Thursday afternoon pricing of a high probability of a 50 bps cut elicited an unusual backtrack: “Fed Says William’s Speech ‘Not About’ Potential Policy Actions.” (The President tweeted he liked Williams’ “first statement much better than his second.”) The implied rate on August Fed Funds futures closed the week at 2.10%, with market odds (60%) back to favoring a 25 bps cut. Ten-year Treasury yields dropped seven bps this week to 2.06%, with bund yields down 11 bps to negative 0.32%.

William’s speech, “Living Life Near the ZLB,” deserves of some attention: “My wife is a professor of nursing, and she says one of the best things you can do for your children is to get them vaccinated. It’s better to deal with the short-term pain of a shot than to take the risk that they’ll contract a disease later on. I think about monetary policy near the zero lower bound—or ZLB for short—in much the same way. It’s better to take preventative measures than to wait for disaster to unfold… Over the past quarter century, a great deal of research has gone into understanding the causes and consequences of the zero lower bound.”

[Note to PhD economics students: the clearest path to the upper echelon of the Federal Reserve System is to formulate some crackpot theory justifying aggressive monetary stimulus] How much “ZLB” Fed research has been conducted for environments characterized by record stock prices, strong Credit growth, booming corporate Credit markets, and a world with $13 TN of negative-yielding debt? Williams references a 2002 paper (co-authored with Dave Reifschneider) that evaluated “effects of the ZLB on the macro economy and examined alternative monetary policy strategies to mitigate the effects of the ZLB.”

“This work highlighted a number of conclusions based on model simulations. In particular, monetary policy can mitigate the effects of the ZLB in several ways: The first: don’t keep your powder dry—that is, move more quickly to add monetary stimulus than you otherwise might… When you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress. …My second conclusion, which is to keep interest rates lower for longer. The expectation of lower interest rates in the future lowers yields on bonds and thereby fosters more favorable financial conditions overall… Finally, policies that promise temporarily higher inflation following ZLB episodes can help generate a faster recovery and better sustain price stability over the longer run. In model simulations, these ‘make-up’ strategies can mitigate nearly all of the adverse effects of the ZLB.”

There would be outrage if the Fed was using similar “model simulations” to justify a policy course at odds with the markets. In a world of unprecedented complexity, model simulations are basically worthless. If the Fed cannot even effectively model consumer price inflation from actual policy measures, how are models simulating impacts on future economic and inflation outcomes (from untested experimental policy) supposed to be credible? Besides, how have the ZLB experiments been progressing in Europe and Japan?

Williams: “An added impetus to this research has been the growing evidence that the neutral rate of interest rate has fallen significantly. I... have devoted a significant chunk of my academic career to studying r-star, or the long-run neutral rate of interest, and its implications for monetary policy. Our current estimates of r-star in the United States are around half a percent.”

What happened to the traditional central bank focus on money and Credit? This “natural rate” framework is problematic – and particularly so in Bubble environments. What was the estimate of r-star last November with 10-year Treasury yields at 3.24% and December ’19 futures implying a 2.93% Fed Funds rate? R-star is defined as the “interest rate that supports the economy at full employment/maximum output while keeping inflation constant.” In a world where loose financial conditions and booming securities markets are required to sustain the global Bubble, one can indeed make the argument that r-star is quite low. R-star is today only relevant in the context of a policy objective of sustaining the Bubble.

I thought it was outrageous in 2013 when chairman Bernanke stated the Fed was ready to “push back against a tightening of financial conditions”. It was as if I was the only analyst that had an issue with Bernanke essentially signaling that the Fed would not tolerate risk aversion or market pullbacks. Now the Fed and global central banks are taking another giant leap – the latest iteration of New Age experimental central banking: The “insurance rate cut” – “an ounce of prevention is worth a pound of cure.”

This is not about prevention, and William’s vaccine analogy is misguided. The world is suffering from chronic (debt) illness. An individual with diabetes, heart disease or cancer will find a cure in a vaccine. Over the years, activist monetary policies have been likened to giving an alcoholic another shot of whiskey or a drug addict another hit of heroin. While these have obvious merits, to counter Williams analogy I’ll instead use antibiotics. Global central bankers have been fighting the world’s chronic debt and economic maladjustment disease with steady doses of antibiotics. Not surprisingly, these pathogens have built up strong resistance to medication.

More stimulus at this point in the cycle is not for prevention – but instead a narcotic for sustaining unsound financial and economic booms (i.e. “extend the expansion”). The Fed and central bankers are again crossing a dangerous red line – compelled to aggressively administer antibiotics hoping to prevent a plague that has evolved to the point of thriving on antibiotics.

It wasn’t that long ago that Fed policy stimulus operated through a mechanism of adding reserves directly into the banking system, with additional reserves working to reduce rates while encouraging borrowing and lending. Policy would act to provide a subtle change in lending conditions that over time would reverberate throughout the economy. The Federal Reserve under Alan Greenspan increasingly shifted to using the markets as the mechanism to loosen financial conditions and stimulate the economy. The 2008 crisis unleashed the policy of direct market intervention, with Bernanke later doubling-down with his “push back” comment.

The U.S.’s coupling of market-based finance with market-directed monetary stimulus created a powerful – seemingly miraculous - combination. Others wanted in on the action. It was pro-Bubble for the U.S., but nonetheless took the world by storm. It became Pro-Global Bubble, and the world today is engulfed in historic market and financial Bubbles.

What is the “r-star” for economic equilibrium today in China? Chinese Bubble finance evolved to become the marginal source of finance globally and the Chinese economy the marginal source of global demand. With Aggregate Finance expanding almost $2.0 TN during the first half, Chinese Credit is again leading a global Credit upsurge.

July 16 – Bloomberg: “China’s efforts to shore up sagging economic growth are leading to a resurgence in indebtedness, underlining the challenge President Xi Jinping’s government faces in curbing financial risk. The nation’s total stock of corporate, household and government debt now exceeds 303% of gross domestic product and makes up about 15% of all global debt, according to a report published by the Institute of International Finance. That’s up from just under 297% in the first quarter of 2018.”

July 15 – Bloomberg (Alexandre Tanzi): “Global debt levels jumped in the first quarter of 2019, outpacing the world economy and closing in on last year’s record, the Institute of International Finance said. Debt rose by $3 trillion in the period to $246.5 trillion, almost 320% of global economic output, the Washington-based IIF said… That’s the second-highest dollar number on record after the first three months of 2018, though debt was higher in 2016 and 2017 as a share of world GDP. New borrowing by the U.S. federal government and by global non-financial business led the increase.”

July 15 – Financial Times (Jonathan Wheatley): “Debt in the developing world has risen to an all-time high, adding to strains on a global economy flagging under the weight of rising trade protectionism and shifting supply chains. Emerging economies had the highest-ever level of debt at the end of the first quarter, both in dollar terms and as a share of their gross domestic product, according to… the Institute of International Finance. The figures include the debts of companies and households. The IIF said that lower borrowing costs thanks to central banks’ monetary easing had encouraged countries to take on new debt. In recent months the US Federal Reserve has changed its policy outlook and a string of emerging market central banks have cut interest rates… ‘It’s almost Pavlovian,’ said Sonja Gibbs, the IIF’s managing director for global policy initiatives. ‘Rates go down and borrowing goes up. Once they are built up, debts are hard to pay down without diverting funds from other goals, whether that’s productive investment by companies or government spending.’”

Only “almost Pavlovian”? I’ve been closely monitoring Bubbles going back to Japan’s late-eighties experience. It’s always the same: Everyone is happy to ignore bubbles when they’re inflating. Bubble analysis, by its nature, will appear foolish for a while. But bubbles inevitably burst. There is no doubt that China’s historic bubble will burst, and I expect this will prove the catalyst for faltering bubbles across the globe – including here in the U.S.

The obvious transmission mechanism will be through the securities markets. Global markets have become highly synchronized – across asset classes and across countries and regions. Market-focused monetary stimulus has become highly synchronized, essentially creating a singular comprehensive global bubble.

July 18 – Bloomberg: “A cash crunch at one of China’s best known conglomerates is getting worse as the company said it will not be able to pay its upcoming dollar notes. China Minsheng Investment Group Corp.’s offshore unit said in a filing that it won’t be able to repay the principal, as well as the interest on the 3.8% $500 million bond due August, after considering its liquidity and performance. On Thursday, the property-to-financial conglomerate announced it only managed to repay part of the principal on a 6.5% 1.46 billion yuan note. The development underscores the liquidity crisis that has been pressuring the… company that aspired to become China’s answer to JPMorgan... It will be the first time that the firm’s dollar bond creditors will miss out on repayment.”

“Repo Rate on China’s Govt Bonds Briefly Hits 1,000% in Shanghai,” read an eye-catching early-Friday Bloomberg headline (picked up by ZeroHedge). Repo rates were back to normal by the end of the session, yet it sure makes one wonder… Aggressive PBOC liquidity injections have for the past several weeks calmed the Chinese money market after post Baoshang Bank government takeover (with “haircuts”) instability. The implicit Beijing guarantee of virtually the entire Chinese Credit system is now being questioned. This greatly increases the risk of Chinese money market instability – with ominous ramifications for China and the world.

With this in mind, there’s a particular circumstance that could catch global markets and policymakers by surprise: A dislocation in China’s “repo” securities lending market that reverberates throughout repo and derivatives markets in Asia, Europe and the U.S. This latent risk, in itself, could help explain this year’s global yield collapse and market expectations for aggressive concerted monetary stimulus. When Chairman Powell repeats “global risks” in his talks these days, I think first to global “repo” markets, global securities finance and global derivatives.

Markets are these days are luxuriating in impending Fed rate cuts and global rate reductions that have commenced in earnest. Liquidity abundance as far as eyes can see… What could go wrong? It’s already started going wrong. The flow of Chinese finance to the world is slowing.

July 18 – CNBC (Diana Olick): “Challenging conditions in the U.S. housing market, along with tighter currency controls by the Chinese government, caused a stunning drop in foreign demand for American homes. The dollar volume of homes purchased by foreign buyers from April 2018 through March 2019 dropped 36% from the previous year, according to the National Association of Realtors. The decline was due to a drop in the number and average price of purchases. Foreigners bought 183,100 properties with a total value of about $77.9 billion, down from 266,800 valued at $121 billion in the previous period. They paid a median price of $280,600, which is higher than the median for all existing homebuyers ($259,600), but it was down from $290,400 the previous year. ‘A confluence of many factors — slower economic growth abroad, tighter capital controls in China, a stronger U.S. dollar and a low inventory of homes for sale — contributed to the pullback of foreign buyers,’ said Lawrence Yun, NAR’s chief economist. ‘However, the magnitude of the decline is quite striking, implying less confidence in owning a property in the U.S.’”

Trade War Casualty: Why the Days of Cheap Chinese Goods Are Over

Flexport’s Phil Levy and Mary E. Lovely from Syracuse discuss what’s ahead in the U.S.-China trade dispute.



As President Trump and his Chinese counterpart, Xi Jinping, are set to meet at the G20 summit in Osaka, Japan, on June 28-29, expectations are low for a meaningful truce on the trade war that has defined their relationship over the last three years. More than 640 U.S. businesses and trade groups — including giant retailers like Walmart and Target — sent a letter to President Trump on June 13 asking him to cancel his threat to increase tariffs on some $300 billion worth of imports from China. That is on top of tariff increases the U.S. imposed in May on $200 billion worth of Chinese imports, after several attempts to forge a trade deal.

The U.S. has had several sticking points in its negotiations with China, such as Chinese government subsidies to local enterprises, controls on U.S. businesses operating in that country, and China’s laws on intellectual property rights. China has attempted to placate the U.S. on some fronts. In March, it announced a new foreign investment law where it promises a level playing field for foreign investors.

The businesses that wrote to Trump — organized under a group called Tariffs Hurt the Heartland — warned of disruptions to supply chains, higher consumer prices and erosion of U.S. competitiveness in global markets if the Trump administration goes ahead with its threat to extend tariffs.

If the Trump administration proceeds with higher tariffs on the remaining $300 billion worth of imports from China, the damage to businesses and consumers would be greater than in earlier rounds of such tariff increases, said Phil Levy, chief economist at logistics firm Flexport.

“When the Trump administration was putting its tariffs on China, it went first with the products that were supposed to be least painful and easiest to handle,” Levy pointed out. “That means the stuff that is left is harder and more painful. That is what these companies are describing as serious interruptions to supply chains, which will really hit consumers in the pocketbook.”

Numerous companies are set to give their testimonies before the U.S. Trade Representative beginning Monday to protest the proposed tariff extensions. Those testimonies are important because they explain “how they’re using these complementary inputs and how difficult it is to find alternative supplies,” said Mary E. Lovely, economics professor at Syracuse University’s Maxwell School of Citizenship and Public Affairs; she is also a nonresident senior fellow at the Peterson Institute for International Economics.

In earlier rounds of the trade dispute, the administration’s belief that firms would be able to find alternative suppliers was not entirely accurate, which is why it attempted “to reduce the pain” with some rollbacks, Lovely said. “One can very glibly say, ‘Well you can just get it someplace else,’ and that just seems to be completely ignorant of the reality that there aren’t alternative suppliers.”
 
The U.S. was comfortable with China in earlier years as long as it produced low-cost goods for U.S. consumers, said Wharton emeritus management professor Marshall W. Meyer, who is also a longtime expert on China, in a separate interview. “However, once China announced that it would compete at the high end of the value chain and directly with us, U.S. policy shifted sharply and the Trump administration took actions aimed at thwarting Chinese aspirations.”

The current tariff war and U.S. actions like declaring that Chinese firms like Huawei are agents of the Chinese government are manifestations of that shift, he explained.

Erosion of Business Confidence

If the proposed new tariffs take effect, the biggest impact would be on U.S. “business confidence and business expectations,” said Lovely. In the initial stages of the tariff moves against China, U.S. businesses viewed them as “preliminary and temporary,” she recalled. “The administration has always promised us a big win and a reset of the relationship [with China] that would open up new opportunities for American businesses. As it gradually becomes clearer that that’s not where this is going to end up, businesses start to rethink investments and they see their costs going up.”

As businesses pull back on their investments, U.S. economic growth could also slow down and have ripple effects elsewhere in the world, she warned. Some of that may also have been deliberate, Lovely suggested. “Making the Chinese economy grow more slowly may be part of a ‘make them-hurt-until-they-give’ strategy,” she said. “But it’s also bad for the global economy. We have to remember that the U.S. is the second-largest exporter in the world. So what happens outside of U.S. borders still remains important to U.S. businesses.”

Levy explained why businesses are also complaining that the new tariffs will hurt their competitiveness. “The secret to how many American businesses have managed to be competitive is that they do parts of the production process in the U.S. using those skills we have and the capital we have. But they complement that with work that occurs in other countries. You put it together and have a competitive product. If you cut the second part out of that, you don’t have a competitive product and you’re in serious trouble.”

Hastening China’s Slowdown

An escalating dispute with the U.S. would of course hurt China as well. However, China’s economy would hit headwinds even without a trade war, said Meyer. “The trade war makes the nearly inevitable slowdown in China a little more inevitable,” he added. The slowdown is inevitable because “China’s episode of high growth, above 6%, has been unusually long. Sooner or later, the law of regression to the mean operates and growth decelerates dramatically.”
Secondly, China’s GDP growth has been driven “as much or more by investment than by consumption,” said Meyer. He noted that investment as a percentage of GDP has remained above 40% since 2004 or 2005; a stimulus program now underway may increase that share. By contrast, private consumption as a percentage of GDP has dropped steadily since the 1970s and has remained below 40% since 2007, he added. “Excessive investment leads to declining returns on investment and declining productivity.”

According to Meyer, China’s growth has been at the expense of productivity in most sectors. Barring select industries such as information and communication technology, productivity has declined across industrial sectors, he said. “Sustainable economic growth isn’t possible without productivity growth. You can juice up GDP by injecting a lot of capital into the economy.” As returns on capital and productivity start to erode, China’s debt will increase, he warned.

Threat of Chinese Tech Leadership

That setting explains why the Chinese government is pushing investments in advanced technologies like AI, 5G, genomics and green energy, where there are opportunities for productivity improvement, he explained. “This shift, called Made in China 2025, is the source of the trade war,” he said. Through that program, China aspires for technological leadership, using tools like subsidies and acquisition of intellectual property rights

“If China becomes a global leader in advanced technologies, this will go hand in hand with developing sophisticated capabilities in the likely tools of 21st century warfare,” Wharton Dean Geoffrey Garrett wrote in Knowledge@Wharton last December when Huawei’s CFO Meng Wanzhou was arrested in Canada at the request of U.S. authorities. “This is why Huawei is so central to U.S. concerns. Huawei is poised to be a world leader, if not the world leader, in the rollout of 5G digital networks in the next few years — not American companies like AT&T and Verizon.” The U.S. has charged Wanzhou with multiple offenses including bank fraud and wire fraud; she faces extradition hearings in Canada beginning January 2020.

Do Business Protests Work?

Lovely said that in the first rounds of tariff increases, protests by U.S. businesses did result in some “very small adjustments” to placate them, but other than that, their complaints have been “largely ignored.” Trump has often looked at stock market sentiments as endorsement of his policies. He may feel emboldened this time around, too, as the markets have stayed “fairly steady” while businesses oppose the tariff moves, she added.

At the same time, as business testimonies are heard on Capitol Hill, members of Congress sometimes are moved to intervene, Lovely noted. She pointed to the recent threat by the Trump administration to impose 5% tariffs on all imports from Mexico unless it complied with U.S. demands on curbing illegal immigration. That prompted opposition from members of Congress, especially behind-the-scenes moves by Republicans to speak directly to Trump, and he eventually “found an alternative route,” she added.

Nine days after it made the threat to impose those tariffs on Mexican products, the Trump administration dropped the plan, and Trump claimed a victory in securing an immigration agreement. As Levy saw it, the probability of Congress acting similarly on the proposed China tariffs is “significantly higher than six months ago.”

All the same, it is unlikely that Trump would fundamentally changes his views on tariffs, Levy said. “When he speaks out about this, he says our best solution is to bring in many billions of tariffs revenue from abroad. Never mind that that’s not quite how it works.”

What the Talks Could Produce

Meyer saw two likely outcomes of the current trade dispute – one later this month and another over the long term. At the upcoming meeting in Osaka, “Trump and Xi may announce a face-saving trade ‘deal’ but it’s likely to be little more than a temporary truce since the larger strategic issues won’t be addressed,” he said. He also foresaw longer-term price impacts for businesses and consumers. “Business people will grasp that the days of China as synonymous with cheap are over, and supply chains and prices will adjust accordingly.”

Lovely also did not expect the issues to be meaningfully resolved in the Trump-Xi meeting. “We see these high level meetings creating a lot of heat but very little light in it,” she said. She noted that “very little” has come out of other high profile meetings Trump has had with world leaders in the past. “You cannot negotiate a trade agreement or fundamental changes on very difficult issues like the role of state-owned enterprises in international trade with simply a meeting between the two heads of state.”

Lovely is not optimistic about a breakthrough deal also because she did not see the right atmosphere for backroom negotiations. “What has transpired over the last six months has had a chilling effect on relations between the two countries,” she pointed out.

Typically, government officials do much of the spadework before such meetings between heads of state. “You have a lot of staff working for a long time setting everything up and then the leaders come together and they remove a few brackets and they close the deal,” said Levy. He added that it is not clear that such activity has occurred or is occurring now ahead of the Trump-Xi meeting. 
The stakes have also risen as the trade dispute has gathered momentum. Last month, it appeared that China might strike a deal by promising “some new market access, some purchases of liquid natural gas and stuff like that, but basically just accept something and call it a win,” said Levy. There was no sight of a solution that would address “deeper, structural issues,” he added.

Meanwhile, the dispute has gained other layers that make it more “compounded,” such as nationalism, animosity and national security risks, Levy noted. The U.S. had made the first move by voicing its concerns over security issues such as cyber espionage using Chinese telecom equipment, for example, and China responded that it would not be pushed around by U.S. aggression, he said. “Those [issues] are hard to peel back quickly,” he added.

Levy pointed out that no easy answers exist for issues like how China treats foreign investors, its plan to deal with cyber attacks or the acceptable level of government subsidies. For instance, with government subsidies, ”there is no chance that we’re going to snap to a right answer in six months even if we had one,” he said.

Previous U.S. administrations have attempted to achieve “slow and steady progress” to resolve those issues, but “with mixed success,” Levy said. “The Trump administration has been noted for a different approach [with China] which is, ‘We’ll hold the big stick and we’ll hit you with it if you don’t agree to the right answer.’” Lovely added: “Unfortunately, the big stick doesn’t work with big countries and particularly not with China.” According to her, that strategy is “doomed to failure.” She expected the Trump-Xi meeting to produce “a little bit of window dressing if there’s even any sign of a victory.”

Other countries are unlikely to support the U.S. strategy on China, nor are U.S. businesses, said Lovely. “It’s almost absurd on its face to think that the rest of the world will not want to be part of the growth of the Chinese economy,” she added. Along with China, businesses also have to take note of India, which is set to grow rapidly. “Businesses have to be looking at where they’re going to get their global sales and profit growth. American companies want to have better conditions for their businesses inside China. Unfortunately, they’re going to be sadly disappointed by what comes out of this in the end.”

Fresh Approaches

According to Levy, the correct approach would probably be a series of steps, such as “patient commercial diplomacy,” even if such tactics do not necessarily achieve dramatic results overnight. Here, he noted that the U.S. might have had better negotiating power with China had it stayed within the Trans-Pacific Partnership. The Trump administration pulled the U.S. out of the TPP in January 2017, shortly after Trump assumed office.

The upcoming U.S.-China talks could also cover issues such as China’s requirement that U.S. firms that desire to operate in the country must form joint ventures with local entities, instead of creating wholly owned subsidiaries. Lovely said the ability for U.S. companies to form wholly owned subsidiaries would also help address issues relating to intellectual property protection.

The U.S., on its part, must also refresh its thinking on some issues, such as government subsidies, said Lovely. “We need to have a clear view of what we think is fair trade,” she added. “Saying that all goods will be produced by private companies that have no subsidies from the government is on its face a nonstarter.” She pointed out that the U.S. might find fingers pointing at itself, where defense contracts to a company like Boeing might be characterized as a form of subsidies.

Sputnik Moment?

Meyer saw an opening for the U.S. to reclaim the narrative with China. “Why can’t the U.S. recognize that this is another Sputnik moment — that China is challenging the core of our economy, and that the U.S. will need to respond competitively rather than coercively?” The answer to that lies in the country’s leadership, he added.

According to Meyer, the immediate issues the U.S. and China are trying to resolve are merely the early signs of a larger contest. Describing them as a trade squabble is “our mis-framing of the problem,” he said. “It is a race for leadership in what are likely to be the critical technologies of the 21st century and beyond.”

Are Central Banks Losing Their Big Bet?

Following the 2008 global financial crisis, central banks bet that greater activism on the part of other policymakers would be their salvation, helping them to normalize their operations. But that activism never came, and central bankers are now facing a lose-lose proposition.

Mohamed A. El-Erian

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ZURICH – In recent years, central banks have made a large policy wager. They bet that the protracted use of unconventional and experimental measures would provide an effective bridge to more comprehensive measures that would generate high inclusive growth and minimize the risk of financial instability. But central banks have repeatedly had to double down, in the process becoming increasingly aware of the growing risks to their credibility, effectiveness, and political autonomy. Ironically, central bankers may now get a response from other policymaking entities, which, instead of helping to normalize their operations, would make their task a lot tougher.
 
Let’s start with the US Federal Reserve, the world’s most powerful central bank, whose actions strongly influence other central banks. Having succeeded after 2008 in stabilizing a dysfunctional financial system that had threatened to tip the world into a multiyear depression, the Fed was hoping to begin normalizing its policy stance as early as the summer of 2010. But an increasingly polarized Congress, exemplified by the rise of the Tea Party, precluded the necessary handoff to fiscal policy and structural reforms.

Instead, the Fed pivoted to using experimental measures to buy time for the US economy until the political environment became more constructive for pro-growth policies. Interest rates were floored at zero, and the Fed expanded its non-commercial involvement in financial markets, buying a record amount of bonds through its quantitative-easing (QE) programs.

This policy pivot was, in the eyes of most central bankers, born of necessity, not choice. And it was far from perfect.

The Fed knew it had no power to promote genuine economic recovery directly via fiscal policy, ease structural impediments to inclusive growth, or directly enhance productivity. This was the preserve of other policy actors, which, lacking the Fed’s political autonomy, were sidelined by the inability of a deeply divided Congress to approve such expansionary measures. (These disagreements subsequently led to three US government shutdowns.)

Faced with this unfortunate reality, the Fed tried to support growth in indirect, experimental ways. By injecting liquidity using multiple means, it raised financial asset prices well above what the economy’s fundamentals warranted. The Fed hoped that this would make certain segments of the population (asset holders) feel richer, enticing them to spend more and encouraging companies to invest more.

But such “wealth effects” and “animal spirits” proved quite feeble. So the Fed felt compelled to do more of the same, which led to a host of unintended consequences and risks of collateral damage that I discussed in some detail in my book The Only Game in Town.

The European Central Bank – second only in systemic importance to the Fed – has followed a similar path, though with even more unconventional monetary policies, including negative interest rates (that is, charging savers rather than borrowers). Again, the impact on growth has been rather subdued, and the costs and risks of such measures are mounting.

Both central banks – and especially the ECB under outgoing President Mario Draghi – have stressed the importance of a timely policy handoff to more comprehensive pro-growth measures. Yet their pleas have fallen on deaf ears. Today, neither the Fed nor the ECB is anticipating that other policymakers will take over any time soon. Instead, both are busy designing another round of stimulus that will involve even more political and policy risks.

Other risks are already giving central bankers headaches. The protracted Brexit process is hampering the Bank of England’s longer-term policy strategy, while the short-term impact on global growth of governments’ weaponization of trade tariffs is complicating the task of both the Fed and the ECB.

Meanwhile, some pro-growth policies currently being mooted could, if not well designed, increase the risk of disruptive financial instability and thus further complicate central bankers’ task. The notion of a “people’s QE” – that is, a more direct channeling of central-bank funding to the population – is getting more attention from both sides of the political spectrum. So is the related Modern Monetary Theory, which would explicitly subjugate central banks to finance ministries at a time when the concept of a universal basic income is also attracting growing interest and there is a need to reassess the wage determination process.

Furthermore, some on the political left are exploring the extent to which returning to greater state ownership of productive assets and control of economic activity could improve prospects for faster and more inclusive growth. And populists in European countries with more fragile debt dynamics, including in the Italian government, seem willing to retest the markets’ vigilance by running larger budget deficits without a concurrent focus on balancing pro-growth initiatives.

Such policy proposals are the tip of a political iceberg that has been enlarged by fears about the impact of technology on the workplace, climate change, and demographic trends, as well as concerns about excessive inequality, marginalization, and alienation. These developments highlight how newly salient political issues are impinging on policymaking, rendering economic prospects even more uncertain. And with central-bank activism intensifying, the gap between asset prices and underlying economic and corporate fundamentals is likely to widen further.

Central banks bet that greater activism on the part of other policymakers would be their salvation. But these days, they are facing an increasing probability of a lose-lose proposition: either a policy response materializes but turns out to be one that risks eroding central banks’ credibility, effectiveness, and political autonomy; or nothing materializes, leaving central banks shouldering a policy burden that is already too heavy and exceeds the remit of their tools. Like seasoned gamblers, central bankers may soon discover that not all bets pay off over the longer term.


Mohamed A. El-Erian, Chief Economic Adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-Chief Investment Officer, was Chairman of US President Barack Obama’s Global Development Council. He is President Elect of Queens’ College (Cambridge University), senior adviser at Gramercy, and Part-time Practice Professor at the Wharton School at the University of Pennsylvania. He previously served as CEO of the Harvard Management Company and Deputy Director at the International Monetary Fund. He was named one of Foreign Policy’s Top 100 Global Thinkers four years running. He is the author, most recently, of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse.

A long economic recovery is not necessarily a better one

Recessions are a natural part of capitalism, not something to be avoided at all costs

Rana Foroohar




At the beginning of July, the US’s current economic expansion will officially become its longest one since 1854, the year National Bureau of Economic Research data on business cycles started. Unemployment is at a 49-year low. Asset prices are near record highs. And the US Federal Reserve signalled yet again last week that it was leaning towards lowering rates due to “uncertainties” in the economic outlook and muted inflation.

That intuitively makes sense when you consider how rocky geopolitics are at the moment, and how bifurcated this recovery has been, mostly favouring large multinational companies and individuals with lots of assets.

But it is also rather stunning how quickly the Fed has gone from tightening monetary policy to preparing to ease it, and concerning that the central bank will be working from a historically low rate base as it attempts to navigate the next recession, whenever it comes.

Even more disturbing, this oddly long economic cycle is not singular. A Deutsche Bank research paper looked at 34 US economic expansions over the past 165 years and found that the past four business cycles have been longer than average. In fact they account for four of the six longest cycles. Since 1982, longer cycles have become the new normal.

Why is this? Optimists would say that less frequent recessions are a result of positive structural shifts and better policy choices that have made the US economy less prone to downturns. A January Goldman Sachs research paper points to better inventory and supply chain management (much of it the result of technological improvements) and the declining share of the US economy that is linked to more cyclical sectors, thanks partly to offshoring of manufacturing. At the same time, the growth of the US shale industry has reduced the risk and impact of oil price shocks, once a major recession trigger.

Other explanations of the lengthening economic cycle highlight the ways the world economy has evolved. Technological advances and globalisation, particularly China’s reintegration into the market system and higher levels of cross-border trade, have increased productivity and growth while dampening inflation.

Meanwhile, the end of the Bretton Woods exchange rate system gave US central bankers more freedom to extend economic cycles, because they no longer had to worry about maintaining a fixed relationship between gold and the dollar.

The result was fewer recessions but also a rise in both public and private debt, as governments worldwide were able to fund more deficit spending, and companies took advantage of low rates set by central bankers who could be less focused on price stability, once Paul Volcker tamed inflation in the 1980s.

Debt has papered over myriad problems in the US economy in recent years, from rising inequality to stagnant wages. It also helps mediate squabbles between various political interest groups. Both Republicans and Democrats have largely embraced a “markets know best” approach since the 1980s because it allowed them to avoid making unpopular choices about dividing up the national wealth pie.

Why choose between guns and butter when you could simply deregulate markets, unleash the financial sector, and hope rising asset prices would let you turn the other way?

All this begs the question of whether longer really is better when it comes to business cycles. Recessions are a natural and normal part of capitalism, not something to be avoided at all costs. Indeed, the Deutsche Bank economists argue that productivity would be higher and American entrepreneurial zeal stronger if the US business cycle had not been artificially prolonged by monetary policy.

But the longer the period of expansion, the harder it is to take away the punch bowl. I agree that policymakers did have to intervene after the 2008 collapse of Lehman Brothers to avoid a bigger downturn — the human costs were already too high. But I also do not believe, as some optimists do, that “this time is different”.

Long periods of expansion invariably result in too much leverage, followed by a correction, and usually a recession. Non-financial corporate debt, which tends to rise until a recession hits, has exceeded prior peaks and gone from 35 per cent of US gross domestic product in 1985 to 46 per cent today. Yet corporate bond default rates have been at very low levels for a decade and a half.

I worry about what will happen when investors and traders put those two facts together and start pricing in a rise in defaults. It makes me wish that perhaps US policymakers had opted for smaller, more frequent doses of pain rather than brewing up history’s longest expansion.

The White House wants to keep the music playing at least through the 2020 election. President Donald Trump this week blasted the European Central Bank head Mario Draghi on Twitter for “unfairly” promising “more stimulus” and then hinted he might demote Fed chair Jay Powell if he failed to do the same. Mr Trump’s tirades remind me of my kids when I’ve let them stay up too late and eat too much ice cream. Maybe a tech productivity surge will eventually come along and turn this market-driven recovery cycle into something that spreads prosperity more widely. More likely there will be hell to pay for leaving the lights on too long.

Why Gold and Gold Mining Stocks Are Appealing

By Andrew Bary 


Photograph by Michaela Handrek-Rehle/Bloomberg



Gold prices hit their highest level since 2013 this past week, an indication that investors increasingly view the often-maligned metal as a good alternative to paper money and government bonds at a time of accommodative monetary policies around the world.

Gold climbed to $1,446 an ounce before ending on Friday at $1,425. The metal is up about 1% on the week and 12% so far this year, but remains well below its peak of $1,900 an ounce in 2011.

With gold rallying, gold stocks got a lift. The VanEck Vectors Gold Miners exchange-traded fund (GDX) gained 7% for the week, to $27.98. It is up 32% this year, outperforming gold.

Mining stocks tend to be more volatile than gold because their earnings are sensitive to changes in the price of the metal. The largest two stocks in the Van- Eck ETF are Barrick Gold(GOLD) and Newmont Goldcorp(NEM).

Barron’s argued in a cover story last September that gold, then trading near a low for 2018 at around $1,200, looked appealing, as did depressed gold stocks.

Gold tends to do well when inflation-adjusted interest rates are low. That is the case now, with $13 trillion of government bonds (mostly in Europe) carrying negative interest rates and the benchmark 10-year Treasury note at just 2.06%. The Federal Reserve, meanwhile, appears certain to cut short rates later this month; the only question seems to be how much.

Ray Dalio, founder of the world’s biggest hedge fund, Bridgewater Associates, recently promoted gold as an investment that does well “when the value of money is being depreciated and domestic and international conflicts are significant.”

Gold is also the anti-dollar. President Donald Trump wants a weaker dollar to make U.S. exports more competitive. And gold looks cheap relative to Bitcoin, which has more than doubled this year, to around $10,000.



Historically, gold has been a store of value and a reasonably good inflation hedge. There are an estimated six billion ounces of gold in the world, worth more than $8 trillion. Gold newly minted each year represents less than 2% of the total supply. Many major producers are struggling to maintain output given a dearth of world-class projects and political and environmental obstacles. Central banks led by Russia had their highest first-quarter purchases of gold since 2013.

Gold stocks aren’t cheap, but they rarely are. Investors typically give them “option” value, as earnings tend to get a boost when gold prices rise. Barrick Gold, at $17, is up 27% this year and now trades for 39 times projected 2019 earnings of 44 cents a share, while Newmont, at $39, changes hands at 28 times estimated 2019 earnings of $1.39 a share.

Barrick could be the better bet. Both companies are benefiting from the combination of their large Nevada operations, which should produce $500 million in annual benefits, with Barrick getting more than 60%.

CIBC analyst Barron’s argued in a cover story last September that gold, then trading near a low for 2018 at around $1,200, looked appealing, as did depressed gold stocks.

Investors may want to get direct exposure to gold through ETFs like the SPDR Gold Shares(GLD). Then there are mining-stock ETFs like the GDX and the VanEck Vectors Junior Gold Miners ETF (GDXJ), as well as individual stocks.

Gold exposure of 5% to 10% in a portfolio might not be a bad idea now.

US & Global Markets Setting Up For A Volatility Explosion – Are You Ready?

Chris Vermeullen

Today, we are going to share with you some incredible charts that highlight why we believe all traders and investors need to stay keenly aware of the potential for very explosive moves over the next 6 to 12+ months.  We’ve authored a number of articles about super-cycles, Gold, Oil and dozens of other symbols suggesting that a deeper and more complicated economic shift is taking place throughout the world.  We’ve been following the trail of money and investments for many months and attempting to map out what we believe will happen in the future with our proprietary predictive modeling systems and adaptive learning utilities.  Get ready for some crazy price ranges and a big move in the markets over the next 30+ days.

Right now, we believe the US stock market is poised for another attempt to move briefly higher as a flood of earnings hits the news wires next week.  We are confident that the US stock market will attempt a move higher based on our predictive modeling systems and other technical analysis tools. 

We want to warn you that this upside move will likely become a “wash-out high” price rotation where price rallies briefly, stalls, then reverses back to the downside fairly quickly.  We believe this “wash-out high” price pattern will set up and execute before August 5th or so.  Be prepared as this move may sucker in a number of new long traders just before it breaks lower.

I highlighted the August 19th date (+/- 5 days) as a key inflection point/date in the markets. 

This is when we believe the US stock market may break down and when we believe a new price trend will attempt to establish.  We are concerned the US stock market may break downward fairly aggressively based on our super-cycle research and predictive modeling research – causing traders to panic slightly.

Our expectations are that the US stock market may fall as the global markets collapse is warranted by a number of factors: the US Presidential election, global trade issues, global credit issues, weakening economic data throughout the globe and lofty price valuation levels within the US stock market.  We believe a “price revaluation event” is the most likely outcome because of these factors and we believe the event will align with historical price patterns related to the US Presidential election cycle.

Weekly chart of the Transportation Index

This Weekly chart of the Transportation Index highlights the Volatility Range our Fibonacci price modeling system is suggesting.  The support level near $10,400 is key to understanding what to expect from the markets going forward.  This level is critical and when price breaks below this level, our researchers believe the TRAN will breakdown below the recent base near 9715 and continue much lower. 

We don’t believe any upside price advance that takes place right now has any real momentum behind it. In fact, if you look at this historical chart of the trans, industrials, and small-cap sectors, we have seen a spike in price in these groups just for a week before a new bear market starts. This setup is identical to the 2007/08 top, so check out these charts here.




VIX Daily Chart Expectations

This VIX Daily chart highlights what we expect to happen over the next 10 to 15+ days.  We expect earnings to continue to deliver near expected results with a few bumps here and there. 

We do believe some forward guidance revisions will create some shocks in the market going forward, but we don’t believe these guidance levels will present any real panic event until closer to the end of July.  This is why we believe the VIX will continue to move near recent lows for another 7+ days, then start a mild upside move near the last week in July before breaking higher with an explosive upside move setting up in very late July or early August.

This upside spike in the VIX will more likely be the result of the “wash-out high” rotation pattern that we suggested above. If you have been taking advantage of the perpetual short trade on UVXY where you can earn 20-45% a month the past 10 years, well that gravy train may be over soon, at least until the next bull market starts in 8-24 months from now. I’ll go into more detail on this in a future article.



Dow Jones (YM) Weekly chart

This Dow Jones (YM) Weekly chart paints a very clear picture of what we are expecting to see happen.  7 to 10+ days of moderate upside price activity creating the “wash-out high” price pattern where the YM trades near the $27,725 level (key resistance).  Once that “wash-out high” pattern is set up, we expect a moderate downside price rotation toward the $25,800 level. 

This is the move that will prompt a VIX Spike and begin a “shake out” price move.

After that, brief support will create an opportunity where traders may consider a “buy the dip” entry before a deeper and more aggressive downside move begins near Mid August.  This is the August 19 Price Peak call that we initiated a few weeks ago.  We believe this move is already in the process of setting up based on our predictive modeling tools, the pre-election year cycle, and the decade cycle as seen here. We are alerting skilled traders so they can prepare for this setup.


 

CONCLUDING THOUGHTS:

In short, the opportunities for skilled technical traders over the next 16+ months is incredible.  Huge price swings, incredible trends, big rotations and 20%, 40%, 60%+ profits to be had if you know what to trade and when.  These types of stock market rotations are perfect for skilled technical traders like us and we want to help you prepare for and trade these opportunities.
 
This bear market has been a long time coming, but finally, almost all the signs are showing that it’s about to start. As a technical analyst since 1997 having lost a fortune and making a fortune from bull and bear markets I have a good understanding of how to best attack the market during its various stages.

Gold and US Stock Election and Decade Cycles



Recently I have been trying to show all the different angles to look at and analyze the US stock market and the precious metals sector. At the end of this report, I will share with you several other crucial angles and charts you must see for our self.  There are several very intriguing things unfolding right now which are interconnected in ways you may not have known.

Gold Years and Seasonality

Let’s start off with the price of gold and what it typically does each month during the presidential election year, which is this year 2019. The graph below shows the average price movement during the elections since 1971 and I think the chart speaks for its self.

What I get from this, is that investors become uncertain with the future and accumulate gold.

This years election I feel is much like a Midterm election. With recent past presidents, they have been in for two terms so this election, in my opinion, is much like a Midterm election if Trump stays in power.



This next chart is the seasonality of gold. Meaning which direction gold trades during each month on average every year. This second chart along with the election chart above both show gold tends to pull back the second half of July, so don’t be alarmed if it happens.


 

Dow Jones Election Years

The US stock market in general, but in this case, I’m using the Dow Jones industrial average you can see where stock prices should move during the rest of this year as we go into the November election.



Dow Jones Decade Cycle

As you may or may not know, I have a thing with cycles when it comes to trading. Yes, it seems a little far fetched and can be perceived as Voodoo to some people but statistics don’t lie and I have made an incredible living from the financial markets incorporating cycles in all my trades from long term investing right down to my 30-minute trading charts.
 
The website SeasonalCharts.com shares this really interesting information and chart about the decade cycle and I want to share it with you here:
 
“The stock market appears to follow a 10-year cycle. During the first half of the decade, equity prices on average do not increase, however in the second half they clearly do. In addition, U.S. equities have demonstrated very good performance in years ending with the number 5 (e.g. 1995 or 2005).
 
Their average profit amounted to 30 %. That equals 40% of the average profit for the entire decade! 
 
The decade-cycle chart of the Dow Jones shows the average 10-year trend of the index over the last more than 100 years.”

 

As you can see from those four graphs the odds are pointing towards a market top in the US stock market based on statistics and long-term cycles. And for gold to become the investment of choice and rally the second half of this year.

Below are several other eye-opening charts about gold and US equities. You should take a quick look at each because what I’m sharing in this post and links below is more than enough to know where the markets are headed next. No need to look anywhere else and I think you will agree after you review each section. My analysis is logical, proven, and easy to understand the big picture trends no matter if you are a total newbie to the trading and the financial markets.

Top 5 Important Gold And Stock Market Analysis Posts

In early June I posted a detailed video explaining in showing the bottoming formation and gold and where to spot the breakout level, I also talked about crude oil reaching it upside target after a double bottom, and I called short term top in the SP 500 index. This was one of my premarket videos for members it gives you a good taste of what you can expect each and every morning before the Opening Bell. Watch Video Here.

I then posted a detailed report talking about where the next bull and bear markets are and how to identify them. This report focused mainly on the SP 500 index and the gold miners index. My charts compared the 2008 market top and bear market along with the 2019 market prices today. See Comparison Charts Here.

On June 26th I posted that silver was likely to pause for a week or two before it took another run up on June 26. This played out perfectly as well and silver is now head up to our first key price target of $17. See Silver Price Cycle and Analysis.

More recently on July 16th, I warned that the next financial crisis (bear market) was scary close, possibly just a couple weeks away. The charts I posted will make you really start to worry. See Scary Bear Market Setup Charts.

On June 17th I showed my chart of the transportation index forming a double top formation. It’s known that the transportation index leads the broad stock market and if the transports are breaking down then we must expect the bear market is close. I then went on to talk about the precious metals breakout with silver and silver miners leading the way. Gold miners broke out as well while gold continued to hold its bullish formation. See Transportation index double top.

Concluding Thoughts:

In short, this years election I feel is much like a Midterm election in terms of what stocks and gold should do. With recent past presidents, they have been in for two terms so this election, in my opinion, is much like a Midterm election if Trump stays in power. you should now have a firm grasp of where stocks are headed along with precious metals for the next few months and beyond. The next step is knowing when and what to buy and sell as these turning points take place, and this is the hard part. If you want someone to guide you through the next 12-24 months complete with detailed market analysis and trade alerts (entry, targets and exit price levels) join my ETF Trading Newsletter.

This bear market has been a long time coming, but finally, almost all the signs are showing that it’s about to start. As a technical analyst since 1997 having lost a fortune and made fortunes from bull and bear markets I have a good understanding of how to best attack the market during its various stages. 

China’s Inward Tilt Could Cripple It

By Nathaniel Taplin


As Chinese leaders head to the G-20 meeting this weekend, they’re in a confident mood. A trade deal with President Trump would be nice, but they seem to think it would do just fine without one.

That is probably right for a little while. The long-term outlook is far less positive. Without continued rapid export growth, China will struggle to achieve high-income status.

China has sturdy bulwarks against trade pressure at the moment: Consumption drove 65% of growth in the first quarter, despite recent hints of weakening. As Wang Jinzhao of the Beijing-backed Development Research Center pointed out in mid-June, exports just aren’t as big of a factor in China’s growth machine any more. They were 18% of gross domestic product in 2018, down from 35% in 2006.

This apparent strength, however, conceals big weaknesses. China still hasn’t proven that it can grow at close to current rates without strong exports or falling deeper into debt. Beijing is counting on its large domestic market to nurture new technology titans and boost productivity to ward off a debt crisis, but it is rife with local protectionism, hostage to an inefficient financial system, and offers questionable legal protection for innovators.

Export markets are important not just for growth, but to compensate for the inherent weaknesses plaguing China’s “socialist market economy” by enforcing market discipline. Without that discipline, the results often aren’t pretty.

Houze Song, at the Paulson Institute, cites the example of Liaoning, one of China’s slowest-growing and most indebted provinces. The rust-belt region lagged behind new economic powerhouses such as Guangdong province in the early years of China’s reforms, but was still a substantial exporter to the rest of China and the world in the early 2000s, with a trade surplus of about 12%. In recent years that has evaporated. Liaoning’s market share for a range of industrial goods within China—from air conditioners to beer to chemical fibers—has collapsed.

Mr. Song pins much of Liaoning’s malaise specifically on the pernicious combination of overinvestment and protectionism. Liaoning companies such as Brilliance Auto have stumbled, according to Mr. Song, in part thanks to pressure to buy from indebted local firms—and easy sales to the government, which discouraged a focus on exports.

It isn’t hard to see echoes of this in China’s much-maligned industrial upgrading plan, formerly known as China 2025, which emphasizes state investment and high targets for local content. The Huaweis of the future might be real technology leaders, but they also could be weighed down purchasing expensive, inferior Chinese chips or robotics from state-backed companies that need to recoup massive investments.




A statue of Mao Zedong looms outside the railway station in Dandong, Liaoning province. Photo: Dake Kang/Associated Press


Protected industries with a large captive market, rather than innovate, often simply restrict output growth and jack up prices. Chinese pharmaceuticals are one example. Price liberalization in 2015 was meant to trigger an investment and research boom, aided by China’s vexing foreign drug-approval process. Investment did accelerate, but the main effect was spiraling price inflation, which hit nearly 7% in 2017 and drove listed firms’ returns sharply higher. A huge public outcry eventually forced Beijing to reverse course and start speeding foreign approvals again.

An independent judiciary enforcing tough antimonopoly laws can mitigate such problems. Instead, economic policy has moved in the opposite direction, promoting industrial consolidation in sectors from banking to steel. Antitrust enforcement has tended to target foreign companies. Of the more than 2,000 deals reviewed by regulators in the decade following China’s antimonopoly law’s passage in 2007, only two were officially rejected. Both involved foreign entities.

Tilting toward an import-substitution rather than export-led growth strategy has real costs. Capital Economics finds that countries sustaining rapid productivity growth above 3% unaccompanied by double-digit export growth are essentially unheard of. China could conceivably replace lost U.S. exports with a surge to the rest of the world. That risks a strong political pushback from those countries, though.

The implications for debt are also worrying. China has managed over the past two years to slow—if not entirely halt—its inexorably rising debt burden. But that limited victory was achieved with the help of export growth approaching 10% in 2018—the fastest pace since 2011. That also was the last time that Chinese indebtedness actually fell on the year. Stabilizing debt without the spur to productivity and growth from robust exports may prove impossible.

The U.S. too, has a problem with industry concentration and rising protectionism. But it also has strong courts and a more efficient financial system to help entrepreneurs—not to mention a free press to call out companies and local governments that collude to protect themselves.

In the absence of those things, China’s deep integration with global export markets has been a critical ingredient in its progress. If that goes into reverse, the nation’s economic miracle may too.

How to Renew the Social Contract

Democratic governments face two main challenges in trying to revive their post-World War II social contracts. They must ensure a strong and efficient social safety net for the digital age, while taking concrete steps toward providing global public goods such as tackling climate change.

Kemal Derviş , Caroline Conroy

dervis89_CarlosAndreSantos_handdigitalsocialworld


WASHINGTON, DC – The success of Western-style democracy after World War II was based on national social contracts: citizens paid taxes, and the state provided the conditions for steady economic progress, along with secure jobs, a social safety net, and redistributive policies that narrowed the income gap between owners and workers. Although the degree of redistribution and the availability of secure jobs varied among countries, the vast majority of citizens bought into the arrangement.

In recent decades, however, globalization has eroded the postwar social contract by weakening the nation-state. Increased global trade and financial flows have contributed to prosperity, but have also created losers. Income inequality has widened in many countries, and the concentration of wealth at the very top no longer seems tolerable. Moreover, the 2008 global financial crisis dented public confidence in steady economic progress.

Democratic governments now face two main challenges in trying to revive their countries’ social contracts. They must ensure a strong and efficient safety net by adapting social and labor-market policies to the new world of work. And they must take concrete steps toward providing global public goods – such as tackling climate change – by securing domestic support for international cooperation.

That will not be easy. Economic disruption, along with concerns related to migration and refugees, has helped to bring neo-nationalist populists to power in several countries. US President Donald Trump’s contempt for global rules and multilateral institutions, for example, is compounding other national governments’ difficulties in making progress on economic and security matters.

Although unemployment has generally decreased, new technologies and increasing competition from China have created a strong feeling of insecurity in advanced economies. True, the digital economy holds great promise. But it, too, is disruptive and is changing the nature of work – by making jobs less secure and increasing the need for continuous learning. This is also true for emerging countries.

Governments’ first priority, then, must be to update their social and labor-market policies to reflect these digital shifts. In particular, social benefits must become fully portable and “owned” by workers, rather than being linked to a specific job.

Some advocate renewing the social contract through a universal basic income (UBI) paid by the state to every adult citizen. Advocates often do not specify clearly the size of the UBI they have in mind and what exactly it should replace, but schemes to provide it to all citizens, even the well-to-do, are simply unaffordable. In the United States, for example, a $1,000 per month UBI would cost as much as the entire federal budget.

A better option would be a generous negative income tax, or “guaranteed basic income.” Unlike a UBI, a GBI could be more affordable, and it would give people below a certain income level an incentive to work while having a redistributive effect.

In addition, employees could have individual digital accounts in which they earn points over time to spend on retraining and further education. Such a scheme already exists in France, and could be extended to include unemployment insurance, personal leave, and even retirement benefits. The French think tank Terra Nova, for example, envisages a comprehensive points system that would allow citizens to choose a package of social benefits suited to their individual circumstances.

A system like this would require safeguards to protect individual privacy and prevent personal information being used for political purposes. And although individual choice is a key attraction of such a system, some protection against imprudence is also desirable. But with these caveats, a points system with fully portable benefits would fit the new world of work – and could become a cornerstone of a renewed social contract.

The second priority for societies is to include elements in renewed social contracts that facilitate the provision of global public goods and prevent “beggar-thy-neighbor” policies, which produce short-term domestic benefits by harming others, and invite retaliation. Although most policies have primarily domestic effects, globalization has reached a stage where some outcomes can be achieved only through international cooperation.

These global public goods can be of the “weakest-link” type: non-compliance by one or a few countries could undermine global efforts to address a problem that affects all. Examples include preparing for epidemics, preventing nuclear proliferation, and avoiding a race to the bottom on national tax rates. Other public goods are “additive.” Effective climate protection, for example, depends on the sum of all countries’ efforts to reduce carbon dioxide emissions.

Providing global public goods is a huge challenge, because there can of course be no social contract between citizens and a non-existing global authority. But the adequate provision of global public goods requires that national governments be held accountable for the extent and success of their international cooperation in delivering such goods.

We are seeing the beginnings of such a link between the domestic and the global with climate protection. In the recent European Parliament election, millions of citizens voted for Green parties that have made combating global warming their top priority. Leaders such as French President Emmanuel Macron have committed themselves nationally to cooperating internationally to tackle climate change. This suggests that cooperation on providing a global public good can become part of a national social contract.

The difficulty of building a new social contract based on these two pillars should not be underestimated. Taxpayers may balk at the cost of providing comprehensive and flexible social policies for the digital age. And expecting citizens to demand that their governments cooperate more internationally may sound naive, given the apparent rise of neo-nationalism.

But a renewed social contract that responds to the new nature of work and globalization is essential to reducing current widespread insecurity and anger, and ensuring the future of democracy. In that regard, the support of young voters around the world for political programs incorporating both pillars provides a strong reason for hope.


Caroline Conroy is a senior research analyst at the Brookings Institution.

Kemal Derviş, former Minister of Economic Affairs of Turkey and former Administrator for the United Nations Development Program (UNDP), is Senior Fellow at the Brookings Institution.

Trump’s Art of the Spin

Policy blunders of epic proportions have become the rule, not the exception, for the US administration. The toxic combination of ill-timed fiscal stimulus, aggressive imposition of tariffs, and unprecedented attacks on the Federal Reserve demands a far more critical assessment of Trumponomics.

Stephen S. Roach  

roach103_WinMcNameeGettyImages_trumpsmugsideprofile

NEW HAVEN – Blinded by a surging stock market and a 50-year low in the unemployment rate, few dare to challenge the wisdom of US economic policy. Instant gratification has compromised the rigor of objective and disciplined analysis. Big mistake. The toxic combination of ill-timed fiscal stimulus, aggressive imposition of tariffs, and unprecedented attacks on the Federal Reserve demands a far more critical assessment of Trumponomics.

Politicians and pundits can always be counted on to spin the policy debate. For US President Donald Trump and his supporters, the art of the spin has been taken to a new level.

Apparently, it doesn’t matter that federal deficits have been enlarged by an estimated $1.5 trillion over the next decade, or that government debt will reach a post-World War II record of 92% of GDP by 2029. The tax cuts driving these worrying trends are rationalized as what it takes to “Make America Great Again.”

Nor are tariffs viewed as taxes on consumers or impediments to global supply-chain efficiencies; instead, they are portrayed as “weaponized” negotiating levers to force trading partners to change their treatment of the United States. And attacks on the Fed’s independence are seen not as threats to the central bank’s dual mandate to maximize employment and ensure price stability, but rather as the president’s exercise of his prerogative to use the bully pulpit as he – and he alone – sees fit.

There are three basic flaws with Trump’s approach to economic policy. First, there is the disconnect between intent and impact. The political spin maintains that large corporate tax cuts boost US competitiveness. But that doesn't mean deficits and debt don’t matter.

Notwithstanding the hollow promises of supply-side economics, revenue-neutral fiscal initiatives that shifted the tax burden from one segment of the economy to another would have come much closer to real reform than the reduction of the overall revenue trajectory has.

Moreover, the enactment of fiscal stimulus in late 2017, when the unemployment rate was then at a cyclical low of 4.1% (headed toward the current 3.6%), added froth to markets and the economy when it was least needed and foreclosed the option of additional stimulus should growth falter.

Similarly, Trump’s tariffs fly in the face of one of the twentieth century’s greatest policy blunders – the Smoot-Hawley Tariff of 1930, which sparked a 60% plunge in global trade by 1932. With foreign trade currently accounting for 28% of GDP, versus 11% in 1929, the US, as a debtor country today, is far more vulnerable to trade-related disruptions than it was as a net creditor back then.

Ignoring the cascading stream of direct and retaliatory taxes on consumers and businesses that stem from a tariff war, Trump extols the virtues of tariffs as “a beautiful thing.” That is painfully reminiscent of the 1928 Republican Party platform, which couched tariffs as “a fundamental and essential principle of the economic life of this nation … and essential for the continued prosperity of the country.” Trump ignores the lessons of the 1930s at great peril.

The same can be said of Trump’s recent Fed bashing. The political independence of central banking is widely regarded as the singular breakthrough needed to achieve price stability following the Great Inflation of the 1970s. In the US, passage of the so-called Humphrey-Hawkins Act of 1978 gave then-Fed Chairman Paul Volcker the political cover to squeeze double-digit inflation out of the system through a wrenching monetary tightening. Had Volcker lacked the freedom to act, he would have been constrained by elected leaders’ political calculus – precisely what Trump is doing in trying to dictate policy to current Fed Chair Jerome Powell.

The second critical flaw in Trump’s economic-policy package is its failure to appreciate the links between budget deficits, tariffs, and monetary policy. As the late Martin Feldstein long stressed, to the extent that budget deficits put downward pressure on already depressed domestic saving, larger trade deficits become the means to fill the void with surplus foreign saving. Denial of these linkages conveniently allows the US to blame China for self-inflicted trade deficits.

But with tariffs likely to divert trade and supply chains from low-cost Chinese producers to higher-cost alternatives, US consumers will be hit with the functional equivalent of tax hikes, raising the risk of higher inflation. The latter possibility, though seemingly remote today, could have important consequences for US monetary policy – provided, of course, the Fed has the political independence to act.

Finally, there are always the lags to keep in mind in assessing the impact of policy. While low interest rates temper short-term pressures on debt-service costs as budget deficits rise, there is no guarantee that such a trend will persist over the longer term, especially with the already-elevated federal debt overhang projected to increase by about 14 percentage points of GDP over the next ten years. Similarly, the disruptive effects of tariffs and shifts in monetary policy take about 12-18 months to be fully evident. So, rather than bask in today’s financial-market euphoria, politicians and investors should be thinking more about the state of the economy in late 2020 – a timeframe that happens to coincide with the upcoming presidential election cycle – in assessing how current policies are likely to play out.

There is nothing remarkable about a US president’s penchant for political spin. What is glaringly different this time is the lack of any pushback from those who know better. The National Economic Council, established in the early 1990s as an “honest broker” in the executive branch to convene and coordinate debate on key policy issues, is now basically dysfunctional. The NEC’s current head, Larry Kudlow, a long-standing advocate of free trade, is squirming to defend Trump’s tariffs and Fed bashing. The Republican Party, long a champion of trade liberalization, is equally complicit.

Trump’s vindictive bluster has steamrolled economic-policy deliberations – ignoring the lessons of history, rejecting the analytics of modern economics, and undermining the institutional integrity of the policymaking process. Policy blunders of epic proportion have become the rule, not the exception. It won’t be nearly as easy to spin the looming consequences.


Stephen S. Roach, former Chairman of Morgan Stanley Asia and the firm's chief economist, is a senior fellow at Yale University's Jackson Institute of Global Affairs and a senior lecturer at Yale's School of Management. He is the author of Unbalanced: The Codependency of America and China.