Ray Dalio – John Mauldin Conversation, Part 6

By John Mauldin

 

This is the final letter of the six-part series of my reply to Ray Dalio’s essays.

Here are some links to help you wrap it all together.

As Ray notes, the problems he describes really are existential. He and I agree more than we disagree, but our responses differ.
 
I think that we both agree that the wrong answers will cause much angst and pain for most of our fellow citizens (and that is a severe understatement). And given his reply to me in Forbes, I think Ray would agree with me there are no easy solutions, only very difficult choices vs. disastrous ones. The longer we wait to deal with the problems, the more painful resolving them will be.
 
And make no mistake, the existential problems we are talking about (and neither of us use the word “existential” lightly) will resolve themselves in a highly tumultuous manner if we as a society don’t face them directly and soon.

They are mostly problems of our own making, and since there are no time machines, we must deal with the reality which we created.
 
Today in my final reply to Ray I sum up my previous letters and describe one possible path for dealing with these problems. My idea will be controversial for most people. I am totally open to another, better solution if anybody knows one.
 
Ray started his letter as an invitation to a dialogue/conversation. I hope we can continue our conversation and others will join in. And with that, let’s finish my open letter to Ray…

No Easy Solutions
 
Dear Ray,
 
Let me see if I can summarize my writing so far and what I believe to be your main concerns, which I share. I do welcome a response.
 
Last week I focused primarily on the US deficit and debt situation. Total federal debt is now $22.5 trillion plus another $3 trillion of state and local debt. Annual deficits are running at an average of $1.2 trillion and growing. As I demonstrated, in a recession the annual deficits will likely rise to $2.5 trillion, and certainly no less than $2 trillion, simply using CBO projections and assuming that revenues would drop and then slowly recover similarly to the last recession. I think that is a more-than-reasonable forecast.
 
That means total US government debt will be at $44 trillion plus maybe $6 trillion of state and local debt by the end of the 2020s, just a decade from now.

Not to mention unfunded liabilities, corporate debt, etc. Of course, that assumes no tax increases and no budget cuts. Significant spending cuts are unlikely as the deficits are mostly entitlements, interest, and defense spending.

So-called “non-defense discretionary” spending is actually a small part of the total budget. And while deficit hawks might find $100 billion to cut here and there, that wouldn’t affect the grand scheme of things. There is little political will to cut entitlement spending, and to your point, Ray, we may actually need more spending in order to solve the growing wealth and income disparity problem.
 
That brings us to taxes. Most tax increase proposals would raise rates on “the rich.” Using government data, I showed that a 25% increase on the top 10% of US income earners (roughly those making $120,000+) would produce only $250 billion per year. Ray, I am not certain what you think it will cost to reduce income disparity, but it would certainly eat up a good portion of that $250 billion, leaving little for deficit reduction.
 
Any such tax increase will be even more difficult if we enter recession within the next few years, which the New York Fed’s forecast shows is not far-fetched. Here is their latest data showing a roughly 33% probability of recession within 12 months.
 


The longer the yield curve stays inverted and the more it inverts the more probable a recession is. We have now had an inverted yield curve for three+ months and as I write are still in that situation. The New York Fed’s model has never reached a probability of 100% prior to any recession. But if memory serves, there has always been a recession anywhere from nine to 18 months after the model reaches its current level. The timing isn’t precise, but it’s close enough for our discussion.
 
[Sidebar: To my regular readers, I will further discuss this and other recession indicators next week, plus the political and economic ramifications. Please be patient.]
 
In any case, at some point there will be a recession, the Fed’s rate cut plans notwithstanding. I think they will keep cutting at least back to the zero bound.

You indicate that you believe, and I agree, that it won’t put the economy back on track. Then they will start with quantitative easing.
 
You also feel that QE won’t help and will likely cause even greater income and wealth disparity. I agree. But I have sat in meetings with participants in the Fed thought process. Confronted with the probability that their actions won’t deliver the desired results, they simply reply that we have to “do something.” I’m sure you’ve had that experience more times than I.
 
No matter how ineffective we might believe it to be, they are going to keep rates at or below the zero bound and ratchet up quantitative easing, building the Fed’s balance sheet up to levels that today would seem mind-numbing.
 
I think Japan is the model here. Like the BOJ, the Fed will keep rates ultra-low and buy bonds until there are no more bonds to buy. The government will run massive deficits as long as the market lets them get away with it. And in Japan and apparently Europe, at least, the market seems to have quite a deal of tolerance in that regard. I call it Japanification and it will have roughly the same results here: extremely low growth, if any growth at all, tending towards deflation. Except that the deflation, at least in the price of things government doesn’t affect like healthcare, will likely be worse in the 2020s because of technology.
 
That’s not the end of the world, but it is certainly not a world that compares favorably to the 1950s, 1980s, or 1990s. You argue that we need to engage in a new combination of fiscal and monetary policy, something you called Monetary Policy 3, or MP3. Modern Monetary Theory (MMT) may or may not be part of that, and you caution that MMT has significant negative consequences and that you are not endorsing it. Again, I would totally agree. I want to come back to MP3 a little later…

A Radical Restructuring of the Economy

and Tax Code
 
You’ve laid out what you believe to be the basis for how the economy and markets work. Let me offer a few simple assumptions of my own.
 
1.   There is no political will in either the Republican or Democratic party to reduce entitlement spending, and entitlement spending is on an ever-increasing path.
2.   There is simply no way that we can raise income taxes enough to close the deficit to within striking distance of nominal GDP growth (where debt relative to GDP growth is equal).
3.   As long as debt is expanding as it is now, we will stay in a slow-growth economy at best, if not in recession. Much research shows that increasing debt beyond today’s level will reduce GDP growth.
4.   What we need to do is very difficult: balance the budget, bring deficits and debt under control, so that we can begin to grow our way out of the crisis. But we can’t do that while thinking about revenues as we do now.

So what can we do? The first step toward getting yourself out of a hole is to stop digging.
 
I would suggest that the US adopt a Value Added Tax or VAT, excluding food and certain other basic necessary items. I would make the VAT high enough to completely eliminate Social Security taxes on both the individual and businesses, giving lower income earners a significant tax break. We could also compensate those below the poverty line for their VAT costs.
 
Ironically, you and I will both qualify for Social Security benefits soon. I daresay you need it even less than I do. We aren’t the only ones. I think we should consider means-testing Social Security, and the same for all entitlements.
 
Consumption taxes like the VAT are the least economically damaging of all taxes, at least according to most of the research that I have read. While I personally (or at least the economist in me) would like a VAT high enough to get rid of all other taxes, I just don’t know if it would be politically posible.
 
One attraction should be that, if the VAT is high enough, say in the 17 or 18% range, we could have much lower income taxes. Just for illustration, maybe there could be…
  • No income tax below $50,000,
  • A 10% income tax on incomes from $50,000–$100,000,
  • A 20% tax on all income between $100,000 and $1 million,
  • A 25% tax on incomes between $1 million and $10 million,
  • and a 30% tax on incomes over $10 million.

… all with no personal deductions for anything. Period. That should certainly produce enough total revenue (along with corporate taxes) to fund the government as currently configured. It might even allow a little bit more for important needs we have deferred (like infrastructure) as well as medical and scientific research.
 
I totally understand that conservatives are uncomfortable opening the door to a VAT when a future majority might raise income taxes on top of it. I would be among them. In the spirit of compromise, we could amend the Constitution to require 60% majorities in both House and Senate to pass any tax increases. Of course, that would have to be passed by 37 states in order to become part of the Constitution, but that can be part of the negotiation process. Perhaps the new tax regime’s launch could be contingent on adoption by 37 states, which would encourage a more rapid adoption process.
 
I would also suggest that the tax changes be phased in over three or four years to allow for individuals and businesses to adjust.
 
This plan would eliminate the need for higher debts and quantitative easing, and would let the Fed keep interest rates at a more normal level.

Retirees could once again look for an actual return on their savings, instead of the brutal punishment of financial repression. (We can have a whole separate conversation on allowing the market to set interest rates rather than 12 individuals sitting around a table.)

MP3?
 
I would welcome a further explanation of what you mean by Monetary Policy 3.

I agree we need to do something far different than we are now. If we continue down this same path, at some point a more left-wing government will come to power, raise taxes and increase spending, but not really deal with deficits or the burden of ever-increasing entitlement spending. That will not work as well as they hope. I can totally foresee a movement back to the right, which would want to repeal those same policies. Neither side would actually come close to dealing with the real problems. We would remain in a regime of ever-increasing deficits, accompanied by growing debt and quantitative easing.

The simple fact of the matter: We don’t know how much debt the markets will be willing to give to the United States. As in actually having the cash, not to mention the willingness, to buy government debt. $44 trillion is a lot of money, which is why I think we will be encumbered with quantitative easing and zero interest rates until there is a significant structural change in how we manage revenue and spending.
 
We simply don’t want to know what the limit is on the amount of debt the United States can sustain. If we ever find out, it will be too late. We will be in a crisis.
 
Unfortunately, I think my proposal or any other compromise solution is simply not possible in today’s partisan world. That being said, I think this is an important conversation to have. When that crisis does happen, maybe somebody will pull one of the compromise plans off the shelf and say, “Let’s try this.”
 
What I don’t want to see is a repeat of what happened at the beginning of the Great Recession. When the powers that be finally realized the financial world was collapsing down around our ears, they had no plan.

They were making it up as they went along. While they put out the fire, they also did a great deal of damage. This was not the best way to deal with the problem. But it was probably the best they could do at that moment, given the realities on the ground.
 
That’s why it is important to make this discussion become both public and national. I would hope that others will join us in thinking about how to restructure the US economy into a more self-sustaining and hopefully more equitable system. Having plans available for consideration in the next crisis will help create a willingness to compromiso.
 
I think this may be the most important decision that our nation makes in my lifetime. If we continue down this path, at best we are consigning ourselves to more of the same meager growth. At worst, we will have a crisis that ends with what I call The Great Reset, where the world has to radically restructure its debt in ways that will not be pleasant. (That is an understatement along the lines of calling the Great Depression merely “unpleasant.”)
 
All this will be happening as technology improves our lives but also slowly eliminates higher-paying jobs, causing many people to earn less than they thought their education would justify. We will see more become “underemployed,” creating a great deal of political and social frustration.

I hope we can avoid this type of Blade Runner outcome. There is the potential for a far more abundant and pleasant future for everyone, if we can reconcile these economic conundrums.
 
This has been a conversation well worth having. Ray, I want to sincerely thank you for starting what could be a very, very important national engagement. And politely ask for a little bit more elucidation on what you mean by MP3.

Seriously… I really want to know.

A Brief Commercial
 
I know that many readers are small business owners, especially investment advisor/broker-dealer firms. One of the problems in the investment advisor business (as well as others) is that many of us are getting older and need to transition our businesses to younger successors who need financing. One of the partners in my network of recommended services is a national bank called T-Bank, which specializes in SBA (Small Business Administration) loans. They have done numerous SBA loans for small businesses that are transitioning to the next generation.
 
SBA loans also have other purposes and T-Bank is an excellent source. T-Bank also develops cash balance retirement plans that let owners save more tax deferred income (I have a cash balance plan and it indeed works!).

New York, Maine, and Montana
 
Early August sees me in New York for a few days before the annual economic fishing event, Camp Kotok. Then maybe another day in New York before I meet Shane in Montana to spend a few days with Darrell Cain on Flathead Lake.
 
I met with my partners Olivier Garret and Ed D’Agostino in Boston two weeks ago. We were making longer-term plans for Mauldin Economics, as we do from time to time. They have done a very good job of growing the business and I am happy with it. But they also expressed very clearly that I need to stop talking about writing a book about the future and actually begin writing. I am mentally ready, but structurally I am not always the most organized.
 
Writing a book is simply a massive undertaking, especially when it is as all-encompassing as “the future,” whatever that is. But to underline their insistence, they laid out a plan and offered help. It made sense and I am now actually beginning to write. The goal is to have a book in our hands sometime in the spring.
 
Much of the writing has already been done in one form or another; the problem is pulling it together, not to mention sorting through the thousands of pages of research on my computer and in links that I have saved, and much that has been sent to me by teams of my readers (thank you!). The good news is my travel schedule is not all that demanding over the next five to six months. And if Puerto Rico can avoid another debilitating hurricane, this is a great place to write.
 
Years ago, I took my family to Venice where a reader graciously offered to be our guide for a few days. He took us out to one of the small islands nearby where Ernest Hemingway actually wrote some of his novels. It was quite the idyllic location. I can’t complain in the least about my own location and circumstances, so I simply need to get on with it and crank out a chapter or two a week for the next five months. Plus my regular letters.
 
As my dad would say when we started a big project, “Son, that’s no hill for a stepper.” And with that, it is time to hit the send button. Let me wish you a great week.
 
Your getting ready to step up analyst,


John Mauldin
Chairman, Mauldin Economics
 

Psychology of wealth: Do rich people deserve to be rich?

Although inequality is growing in many western countries, concern about it is not

Rhymer Rigby


Increasingly we are less likely to meet people in neighbourhoods who are not like us © Getty


Here’s a topical question. Do rich people deserve to be rich? If so, how rich?

You might think this is worth asking because concern about inequality is growing everywhere.

But actually, this is not true. Although inequality is growing in many western countries, concern about it is not. In fact, according to new research by Jonathan Mijs, a sociologist at the International Inequalities Institute at the London School of Economics, inequality and belief in meritocracy may go hand in hand. The more unequal a society, the more likely people are to believe the rich have earned it.

Such thinking is hardly new. “Socialism never took root in America because the poor see themselves not as an exploited proletariat, but as temporarily embarrassed millionaires,” is a quote popularly attributed to John Steinbeck, the author of The Grapes of Wrath.

This is probably an oversimplification of what Steinbeck actually said. But it is often cited as a reason for the persistence of the American Dream. The poor are OK with enormous inequality, the thinking goes, because they believe — or hope — that one day they will be rich too.

Mijs suggests there are other factors at work here also. One is the extent to which people have self-segregated in the past few decades. We increasingly spend time with our own economic kind in places ranging from neighbourhoods to workplaces (education has been a key driver here), meaning we are less likely to meet people who are not like us.

Thus, if we are rich, our idea of a poor person may simply be someone further down the social strata who may one day earn what we do. If we are poor this may mean that we are unaware of the structural barriers that prevent us from climbing the ladder.

Meanwhile, thanks in part to the cult of Silicon Valley entrepreneurs, we now see businesspeople treated like athletes. You’re either a superstar or a nobody and the super-rich deserve it because they are the brilliant innovators our economy relies upon. Without them we would all be poorer.

But would we really? In his 2018 book Winners Take All: The Elite Charade of Changing the World, Anand Giridharadas writes: “A successful society is a progress machine. It takes in the raw material of innovations and produces broad human advancement. America’s machine is broken.” The fruits of recent change, he adds, have been largely captured by the very fortunate — in a way that would not have occurred 30 years ago. So perhaps, without them, we would all be a bit better off.

One place where the problem of inequality is arguably at its starkest is chief executive pay. In the US, the ratio of chief executive to average worker pay has risen from about 30 times to more than 300 times, according to the Economic Policy Institute, a Washington DC think-tank.

This raises several questions. First, does what the individual is being paid reflect what they bring to the table? Or are they simply in a position where they marshal the efforts of others? Is corporate endeavour about superstars or group effort? Is Tim Cook worth the $136m he took home in 2017?

The mutability of the notion of being paid what you are worth is also illustrated by national differentials. According to Willis Towers Watson, a consultancy, median chief executive compensation in large companies in 2016 was around $1.2m in Japan, compared with $11.7m in the US and $5.3m in the UK. As chief executives often argue that theirs is a global market for talent, it is hard to see why a Japanese boss “deserves” a 10th the pay of their American counterpart.

This is before we even look at inherited wealth and advantage. According to the OECD, a child born into a poor UK family would take five generations to get to the average income.

Conversely, the UK’s top tier shows that many of its members haven’t had far to climb. Here, the idea of pure meritocracy is sometimes held up as an ideal. But really? As the coiner of the word warned, an effect of meritocracy can be to make those at the top think they deserve it.

In Capital in the Twenty-First Century, Thomas Piketty says the way these factors work together can create the worst of all worlds for those who are neither top income earners nor top successors: “They are poor and they are depicted as dumb and undeserving.” Referring to the French Revolution, which was partly driven by inequality, he notes tartly that “at least, nobody was trying to depict Ancien Régime inequality as fair”.

So does this mean western societies are nearing a breaking point? Pointing to the CIA’s World Factbook, Mijs argues: “You only have to look at Latin American countries to see how much further inequality can go.”

The US Economy’s Strange Decade

Weak productivity growth helps to explain the continued robust rates of job creation in the United States, as well as workers’ sluggish wage gains. If left unresolved, the productivity malaise will ensure that the current expansion remains uniquely unbalanced and unhealthy.

Larry Hatheway

lhatheway6_FabrikaCrGettyImages_rolleddollarrisinggraph


ZURICH – The current US economic expansion is extraordinary. Not only does it rival the longest on post-war record, but, unlike previous periods of sustained growth, it has not unleashed much inflation. Corporate profits have soared to unprecedented levels. And economic inequality in the United States is at its most extreme in a half-century.

Each of these unique features is paradoxically linked to another oddity: despite a mostly lackluster expansion since 2009, the US unemployment rate has fallen significantly further than would have been predicted by GDP growth alone. But perhaps the defining aspect of this strange decade-long expansion, and the one that helps to explain its main anomalies, is weak productivity growth.

Consider, first, the jobs phenomenon. Using a simple model relating unemployment to GDP growth – similar to Okun’s Law – indicates that the jobless rate has fallen by half a percentage point more per year during this expansion than history would have suggested. Since 2014, the rate of US employment growth has exceeded what GDP growth would have predicted by nearly one million jobs per year.

Even as unemployment has fallen to historic lows, job creation remains more than double the rate of increase of the labor force. Firms are hiring strongly despite tepid growth, a dwindling pool of productive workers, and troubling political and policy uncertainty. The soft May jobs report, alone, does not change the decade-long phenomenon of robust employment growth.

One plausible explanation is that firms are substituting cheap labor for expensive capital. The share of total worker compensation in US national income has fallen steadily this century, reaching a low of 60% in late 2014, before edging back to its current level of 62%. Yet that is still three full percentage points below its average level between 1965 and 2000.

On the other hand, returns on capital are exceptionally high. Since 2010, the share of corporate profits in GDP has reached average levels that are unrivaled in the post-war era. One might think, therefore, that firms would prefer to invest in high-returning capital rather than in labor. But that is not the case. The average annual rate of non-residential gross fixed capital formation since 2009 has been 5.3%, more or less the same as it was in the expansions of the early 2000s and the 1980s, and well below the rate in the investment-led boom of the late 1990s.

Why is cheap labor so abundant? Perhaps workers are willing to sacrifice higher wages in return for job security. That’s understandable, given the painful memories of the 2008-2009 recession. Wage demands may be restrained by fears of losing jobs to China, Mexico, or machines. Yet a rising “quits rate,” which is now back to levels seen prior to the financial crisis, suggests that workers are perhaps less excessively cautious than they once were.

Another factor is declining union membership. In the early 1980s, nearly one-quarter of the US labor force was unionized. Today, that figure has fallen to about one-tenth. Non-union workers earn, on average, about 20% less than their unionized counterparts. A less unionized labor force works more cheaply and, perhaps, more flexibly, making it more attractive for companies to hire.

But the most important factor behind sluggish wage growth is probably weak productivity growth. Average labor productivity in the US (and in most other advanced economies) has slumped in the past decade. Despite the explosive growth in information technology, the average worker is not becoming more productive.

If output per hour worked is not rising much, then the number of hours worked must increase to ensure adequate provision of goods and services. This is why US job creation remains robust, despite pedestrian GDP growth.

In addition, firms cannot raise wages by more than the increase in the marginal product of labor. Low productivity growth therefore explains sluggish wage increases. It also makes firms less willing to invest. The resulting capital discipline contributes to high returns on capital, which underpin soaring profits and yawning income inequality.

US policymakers must try to ensure that the benefits of growth are more equally distributed. Populist proposals from both ends of the political spectrum, such as calls for protectionism or a universal basic income, are unlikely to do the trick. Such measures would simply result in Americans fighting over shares of a shrinking pie.

Rather, the key is to raise average levels of productivity. For a variety of reasons, including the current political and social backlash against capitalism, the US cannot address its productivity challenge solely with 1980s-style deregulation, lower taxes, and less government. Economic efficiency will have to be augmented by improvements to energy and transport infrastructure, along with better access to quality education, worker training, and health care.

America’s growth over the past decade has been unique in many ways. But if its productivity malaise is allowed to persist, the expansion will remain uniquely unbalanced and unhealthy.


Larry Hatheway is Group Head of Investment Solutions and Group Chief Economist at GAM.

Hong Kong, Taiwan and the hope for a better China  

There is no reason why an ethnic Chinese society cannot also be a democracy

Gideon Rachman




Nothing better captures the difference between Hong Kong and mainland China than the annual commemoration of the Tiananmen Square massacre that takes place on June 4 every year in Hong Kong’s Victoria Park.

In mainland China the memory of the crushing of the pro-democracy movement in 1989 is ruthlessly suppressed. But Hong Kong has been allowed to continue to mark the anniversary. That kind of freedom matters not just to the 7.4m inhabitants of Hong Kong. Potentially, it is also of great importance to the future of China itself.

Put simply, Hong Kong is acting as a guardian of China’s memory and of the hope that a more liberal China could one day replace the current one-party state. The “one country, two systems” arrangement put in place when Britain handed Hong Kong back to China in 1997 has allowed the territory to continue to preserve vital freedoms, such as an independent judiciary and a free press.

Hong Kong is not a full democracy. Its chief executive is elected by a tiny group from a Beijing-approved list. But, nonetheless, since 1997 the territory has provided room for ideas, people and organisations banned from mainland China. I know of well-connected Beijing families who have taken their children to Hong Kong for the June 4 commemoration — just to ensure that the memory of Tiananmen is passed down through the generations.

Hong Kong’s peculiar role within China makes the current struggle over its legal system of global significance. If Hong Kong’s freedoms can be protected, that will also help to preserve breathing room for liberal ideas within the Chinese state. That matters not just to the Chinese people, but to a wider world that will increasingly be shaped by the power of a rising China.

At the moment, the situation is finely poised. Mass demonstrations on the streets of Hong Kong have led to the temporary withdrawal of a proposed law on extradition from Hong Kong to China. That law had threatened to break down the firewall between the territory’s independent judicial system and the one-party state in Beijing.

The announcement by Hong Kong’s chief executive Carrie Lam that she was suspending the proposal surprised many China-watchers, who had assumed that President Xi Jinping in Beijing would be reluctant to back down and lose face. The fact that Mr Xi decided to hit the pause button suggests that the Chinese president and the Hong Kong government have collectively realised that the greatest risk facing them now is not perceived weakness, but chaos and violence on the streets of Hong Kong that could have significant domestic and international repercussions.

Their restraint is wise. But it could well just be a tactical retreat. On Sunday demonstrators took to the streets of Hong Kong again, to press for the definitive withdrawal of the extradition law.

One reason that Hong Kong citizens have demonstrated in such numbers is the growing evidence, in recent years, that the “one country, two systems” settlement is being eroded in dangerous ways. Students who led pro-democracy protests in 2014 have been given jail sentences; elected members have been barred from the Hong Kong legislature; a political party has been outlawed; and a bookseller and a billionaire have been abducted to the mainland. The fact that the Chinese government is pressing for Hong Kong to push through new national security laws has increased fears about the future of freedom of speech.

The increased pressure from Beijing on Hong Kong is of a piece with increasing authoritarianism within China itself. Over the past two years, “Xi Jinping thought” has been incorporated into the Chinese constitution and presidential term-limits have been abolished, potentially allowing Mr Xi to rule for life.

The belief that Hong Kong’s freedoms are under threat from the growing authoritarianism of Mr Xi’s China is supported by the increasing pressure that Beijing is exerting on Taiwan. The People’s Republic of China has always claimed that Taiwan is an integral part of its territory. But for decades it has had to tolerate Taiwan’s continuing existence as a de facto independent country that is also a prosperous and vigorous democracy.

Over the past year, however, Beijing has ratcheted up the pressure on Taiwan, flexing its military muscle and moving to curtail any form of international recognition for the Taiwanese government. One common theory in Beijing is that Mr Xi has decided that finally achieving reunification between Taiwan and the mainland should be his legacy. Some hotheads in Beijing even talk of invading Taiwan in the next five years.

Fortunately, geography and politics ensure that Taiwan is much better placed than Hong Kong to keep Beijing at arm’s length. Its continuing political and economic success is vital because it serves as a potential model for modern China, demonstrating that, whatever the Communist party says, there are no cultural or historical reasons why an ethnic Chinese society cannot also be a democracy. Some of the many millions of Chinese tourists who have visited Taiwan and Hong Kong must return home with new ideas about politics and press freedom.

With luck, persistence and international support, Hong Kong and Taiwan may be able to keep the flame of a more liberal China alive until the mainland itself begins to change.

Darker horizon

China’s growth is the slowest in nearly three decades: get used to it

The trade war with America hurts, but the government is wary of stimulus




CHINA’S ECONOMY is slowing, again. After a good start to the year annual growth slipped to 6.2% in the second quarter, the country’s weakest expansion in nearly three decades. But that is hardly cause for panic. For an economy now worth nearly $14trn, such a growth rate is impressive. As the trade war with America hurts exporters, it also underlines the extent to which China’s economy is now fuelled by domestic demand. The question for the coming months is whether that domestic strength will remain sufficient to offset the trade turmoil.

The export picture has clearly taken a turn for the worse. Last year, when America’s president, Donald Trump, first levied tariffs on China, the country still managed to increase its exports by 10%. This year Chinese exports have all but stopped growing.

Moreover, the fight with America is getting more serious. In May Mr Trump ratcheted up tariffs on Chinese goods, and he has threatened to hit it with yet more duties if trade negotiators fail to resolve an impasse in the talks. The uncertainty is already taking a toll: foreign companies have started to shift more operations away from China.

So far China has looked rather well insulated from all these troubles. Activity actually accelerated towards the end of the second quarter. Investment in factories, roads and other fixed assets increased 6.3% in June compared with a year earlier, up from 4.3% in May. Retail sales also were robust, rising 9.8% in June compared with a year earlier, up from a year-on-year increase of 8.6% in May.

Yet there are doubts about how long this resilience will last. Some of the apparent strength is transient. Car sales, which have been in the doldrums for a couple of years, surged in June to double-digit growth, pushing up retail sales more broadly. But that was largely because dealers had slashed prices to run down inventories before tough new emission standards were imposed in July. The property sector, a bellwether for the economy, also seems set to soften.




The government, anticipating a slower patch, has started to spend more on infrastructure, a tried-and-tested method in China for revving up growth. Having tightened its purse strings for a couple of years, in recent months it has made it easier for municipal officials to raise funds for building railways and highways.

But there are limits as to how far it will go. China’s president, Xi Jinping, has declared that containing financial risks is a matter of national security. The odds of another giant stimulus, routine in the past whenever growth slowed, are much lower this time around. And in any case the government has less money to work with, having already racked up so much debt over the past decade.

It also wants to conserve its limited fiscal firepower in case the trade war turns uglier. In the meantime, get used to headlines about Chinese growth dipping to its lowest in nearly three decades: they are likely to appear again in three months and, again, three months after that.

After Fed Euphoria, Weak Earnings Could Bring Down the Mood

Earnings season could be a wake-up call to investors when it begins next week

By Justin Lahart

 
Apple, hobbled by its flagging iPhone business, is expected to report a 16% decline in net income for the latest quarter. Photo: Kirsty O'Connor/Zuma Press 



Second-quarter earnings reports are going to be weak. Investors should be prepared for that, but many of them aren’t.

Earnings season kicks off next week, with a number of big companies in the S&P 500 slated to release results. Given the litany of problems they recently have faced, the news won’t be good.

Economic weakness abroad has cut into business at many multinational companies, while the strength of the dollar—which was up 6% against other currencies in the second quarter from a year earlier on a trade-weighted basis—will further damp profits generated overseas. Costs for labor and other inputs are running higher at a time when companies are struggling to raise prices, putting the squeeze on profit margins. Trade tensions have been hampering business investment, weighing on sales of technology firms and other makers of capital equipment.

Then there is a slew of company-specific issues. The grounding of the 737 MAX has hit Boeing ’s business for example, and analysts polled by FactSet estimate its net income fell by nearly half, or about $1 billion, in the second quarter from a year earlier. That amounts to about 0.3% of overall S&P 500 earnings. Apple ,hobbled by its flagging iPhone business, is expected to report a 16% decline in net income. That is more modest than Boeing’s expected drop, but because Apple’s starting level of earnings is so much higher it will have a more pronounced effect on S&P profits.

Overall, analysts expect earnings per share at companies in the S&P 500 to log a decline of 0.3%, according to Refinitiv. It would look worse if companies hadn’t been buying back stock, reducing their share count. Net income for the S&P 500 is expected to post a 2.4% decline.



Chances are earnings won’t be quite as bad as analysts say; by the time earnings season rolls around, they usually have set the bar low enough for many companies to easily clear. That said, at the start of the year, analysts thought second-quarter earnings per share would be up by 6.5%, and that isn’t going to be a mark that companies achieve. Moreover, an unusually large number of companies already have issued warnings that their results will fall short.

Yet even as the earnings picture has deteriorated, stocks have been pushing higher in a rally that has sent them into record territory. Much of that is due to enthusiasm over the increasing likelihood that the Federal Reserve will cut rates later this month. As a result, many investors may have lost sight of the earnings headwinds many companies face—even though some of those headwinds count as reasons for the Fed to loosen.

When results start coming out, investors could be in for a jolt.


Global Economic Growth Is Already Slowing. The U.S. Trade War Is Making It Worse.

President Trump’s trade war with China and other partners is exacerbating a global economic slowdown.

By Jeanna Smialek, Jim Tankersley and Jack Ewing


President Trump’s trade war with China and other partners is exacerbating a global economic slowdown.CreditCreditReuters


WASHINGTON — President Trump’s trade war is chilling business investment, confidence and trade flows across the world, a development that foreign leaders and business executives say is worsening a global economic slowdown that was already underway.

Recent softening in Europe, Australia and other parts of the world coincides with Mr. Trump’s intensified trade fight with China and other partners. Economists warn that further escalation by Mr. Trump — like tariffs on more Chinese goods or levies on foreign autos — could slow global growth to a crawl.

“With these trade tensions, the global economy, in a sense, is getting close to a crossroads,” said Ayhan Kose, the director of the World Bank’s Prospects Group.

Weakness in China, driven in part by fallout from the trade war, has spread to Germany, Australia and other nations, raising supply chain costs, chilling exports and worrying political and economic leaders.

On Tuesday, Mario Draghi, the president of the European Central Bank, said the bank was prepared to inject more stimulus into the eurozone economy to combat the economic slowdown.

The effects of Mr. Trump’s trade war have been particularly hard on Germany, Europe’s largest economy, which has been bracing for a decision about whether the United States will impose tariffs on auto imports. Trade anxiety has led to a decline in business sentiment and spending: Overall German industrial production contracted sharply in April, falling 1.9 percent on the month versus the 0.5 percent analysts expected.

“The risks that have been prominent throughout the past year, in particular geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets, have not dissipated,” Mr. Draghi said in a speech on Tuesday. “The prolongation of risks has weighed on exports and in particular on manufacturing.”

Mr. Trump lashed out at Mr. Draghi by name on Twitter, accusing him of trying to weaken Europe’s currency to get a leg up in global trade by making its goods cheaper
to buy overseas.

“Mario Draghi just announced more stimulus could come, which immediately dropped the Euro against the Dollar, making it unfairly easier for them to compete against the USA,” Mr. Trump wrote on Twitter. “They have been getting away with this for years, along with China and others.”

The president’s aggressive approach to trading partners comes as developed and developing nations are already pulling back on the rapid globalization that dominated two decades of economic policymaking. Global flows of foreign direct investment fell by 13 percent last year, to their lowest level since the financial crisis, the United Nations Conference on Trade and Development reported last week.

It was the third consecutive annual decline, which officials blamed on multinational corporations bringing cash back to the United States after Mr. Trump’s 2017 tax overhaul.

Officials warned that trade tensions posed a “downward risk” for a rebound in investment growth this year.

Mr. Trump has made steady use of tariffs to punish trading partners, like China, Europe, Canada and Mexico, that he says have destroyed American jobs by flooding the United States with cheap products and erecting unfair economic barriers at home. The president and his top officials insist that the trade war is lifting the American economy and that any slowdown in global growth is not related to the administration’s trade policies.

Treasury Secretary Steven Mnuchin said in an interview this month that he did not “think in any way that the slowdowns you’re seeing in parts of the world are a result of trade tensions at the moment.” He noted that growth in Asia and Europe had been tapering off before trade talks between the United States and China broke down in early May.

Mr. Trump has repeatedly cited China’s slowdown as proof that his trade war is working, telling reporters last week that the United States has “picked up $14 trillion in net worth of the United States.”

“And China has gone down probably by $20 trillion,” he continued. “There’s a tremendous gap.”

But a slowdown in the world’s second-largest economy — one that’s deeply enmeshed in global trade networks — affects other economies.

“China is the biggest trading nation in the world,” said Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington. “The idea that you could slow down the global growth engine and not affect other countries is just not credible.”

Multinational companies are already shifting supply chains and delaying capital spending in response to Mr. Trump’s tariffs on Chinese goods and foreign metals.

Tom Linebarger, the chairman and chief executive of diesel engine manufacturer Cummins, said last week that his company had lost business for part of its operation in China as a result of the trade war. The Indiana company is changing its sourcing practices to minimize exposure to China, and Mr. Linebarger said its costs from tariffs now exceeded the benefits from the corporate tax cuts Mr. Trump signed in 2017.

“The tariffs that are in place now, and which may be in place for some time, are a significant burden on U.S. businesses and farms,” Mr. Linebarger said.

Data increasingly suggest trade tensions are weighing on economic confidence, globally and in the United States.

A Federal Reserve Bank of New York manufacturing survey registered its worst drop ever on Monday, which many economists blamed on Mr. Trump’s threats this month to impose tariffs on Mexican imports as punishment for failing to curb illegal immigration. While those tariffs were averted, the chance that Mr. Trump could make a similar move against another trading partner has caught the attention of global companies and foreign leaders.

The trade war is having “a much bigger impact” on business hiring and investment in the United States than most analysts think, Deutsche Bank wrote in a research note on Monday. Several measures of policy uncertainty, compiled by economists Scott R. Baker of Northwestern University, Nicholas Bloom of Stanford University and Steven J. Davis of the University of Chicago, have spiked with the increased tensions.

On Tuesday, Mr. Trump said on Twitter that he had spoken by phone to President Xi Jinping of China and that the two leaders would have an “extended” meeting next week at the Group of 20 summit in Japan. Those comments could help calm global trade fears, which had risen after the United States accused China of breaking a trade deal last month and Mr. Trump raised tariffs on $200 billion worth of Chinese goods as punishment.

But no agreement is guaranteed, and Mr. Trump has threatened to impose tariffs on an additional $300 billion of Chinese goods if Mr. Xi does not agree to the original deal. The president has already placed import taxes on $250 billion worth of products from China and has hit trading partners with steel and aluminum tariffs and threatened tariffs on foreign autos from Europe and Japan.

The World Bank cut its forecast for global growth by 0.3 percentage points for this year in response to unexpected weakness in trade and manufacturing across advanced and developing economies. Global trade growth has slowed to its lowest rate since the 2008 financial crisis as exports from Europe and Japan have plummeted, particularly to China.


The bank noted that heightened policy uncertainty, including trade tensions, had been accompanied by slowing global investment and weakening confidence. It warned in a report this month that risks to its outlook were “firmly on the downside, in part reflecting the possibility of destabilizing policy developments, including a further escalation of trade tensions between major economies.”

International Monetary Fund economists estimate that if Mr. Trump follows through on his threat to broaden the Chinese trade spat, tariffs added this year alone will subtract 0.3 percent off global gross domestic product in 2020, with an additional 0.2 percent drag coming from tariffs the administration put in place last year.

Manufacturing, which is especially vulnerable to trade, is slowing across advanced economies even as service industries hold up. Factory gauges have dipped lower across Europe and are wavering in Japan. In the United States, the Institute for Supply Management’s factory index dropped to its lowest reading of Mr. Trump’s presidency in May.

Trade policies aren’t the only culprit behind slowing production. A continuing, structural slowdown in Chinese growth and tensions from Britain’s attempted exit from the European Union are among other factors.

China posted its weakest economic growth in 28 years in 2018, a pullback that analysts blame partly on structural reforms and long-running trends and partly on the trade spat. Analysts at Moody’s Investors Service expect a further slowdown in 2019, to 6.2 percent from 6.6 percent, amid continued trade uncertainty.


Europe, where the I.M.F. estimates 70 percent of exports are links in global supply chains, is particularly sensitive to trade disputes. And Germany highlights how the trade war between the United States and China can spill over.

The nation’s car industry is the backbone of its economy and is dependent on China for growth. As trade tensions exacerbate China’s economic weakening, manufacturers in Germany pay the price.

Volkswagen, the world’s largest carmaker, said last week that sales in China fell 7 percent from January through May, to about 1.2 million vehicles. Largely because of China, Volkswagen’s global sales fell 5 percent during the same period.

“We are experiencing the biggest decline in the world auto market in 20 years,” Ferdinand Dudenhöffer, a professor at the University of Duisburg-Essen, said in a report. If Mr. Trump follows through on threats to impose further tariffs on China, Mr. Dudenhöffer said, “there is danger of a global auto crisis.”

Germany’s central bank has slashed its forecast for growth this year to 0.6 percent from 1.6 percent. That bleak change was “mainly due to the downturn in industry, where lackluster export growth is taking a toll.”

“The fear factor, the uncertainty, is denting willingness to spend, willingness to invest,’’ said Carsten Brzeski, chief economist for Germany and Austria at ING in Frankfurt. “It’s therefore undermining growth in the eurozone.”

And in Australia, where an almost 28-year-old expansion is looking less secure and the central bank recently cut rates for the first time since 2016, economic officials are watching trade wars warily. The governor of the Reserve Bank of Australia, Philip Lowe, called international trade disputes “the main downside risk” in a recent news conference.

If coming trade negotiations don’t end in a resolution, the United States and its companies could also pay a price, leaders of the Business Roundtable, a corporate lobbying group in Washington, warned last week.

“The biggest self-inflicted risk to growth today would be trade going south,” said Jamie Dimon, chief executive at JPMorgan Chase.


Jeanna Smialek and Jim Tankersley reported from Washington, and Jack Ewing from Frankfurt. Alan Rappeport contributed reporting from Washington.


An awfully long expansion

For how long can today’s global economic expansion last?

The world’s business cycles are lengthening, but not abolished




IT IS HARD to summon significant optimism when looking at the world economy. As the trade war between America and China grinds on unresolved, indices of business confidence in America and elsewhere have been falling fast (see chart 1). Surveys suggest that, as trade growth slows, global manufacturing is shrinking for the first time in more than three years. Services have begun to follow manufacturing’s downward trend as domestic demand falters, even in economies with strong labour markets, such as Germany.

Long-term bond yields have been tumbling. Having started the year around 2.7%, on July 2nd America’s ten-year Treasury yield fell below 2% for the first time in Donald Trump’s presidency. Yields on ten-year German debt fell below -0.4% earlier this month. Low long-term rates signal that investors expect central banks to keep short-term rates low for a long time. Yet differences in yield between regular bonds and inflation-indexed ones suggest that they will undershoot the inflation targets they are meant to hit—presumably because their various economies will grow too weakly to generate much upward pressure on wages and prices (see chart 2). 
On top of all that, there is the simple fact that the current economic expansion is unprecedentedly long in the tooth. If, as is almost certain, America’s economy proves to have grown throughout the second quarter of 2019, it will have matched the record for the longest unbroken period of rising GDP set in the 1990s. Europe has enjoyed 24 consecutive quarters of rising GDP. As these years of growth have dragged on, it has become increasingly easy to find people sure they will soon come to an end. And yet they have not.





If economists took one firm lesson from the financial crisis of 2007-09, it was to refrain from celebrating long periods of growth. In the good years before that crash the dismal science turned chirpy, talking of a “Great Moderation” that had tamed the boom and bust of the business cycle. The high point of hubris, for many, came in 2003 when Robert Lucas, making his presidential address to the American Economic Association, boasted that the “central problem of depression-prevention has been solved.” When the second half of the decade saw the most severe downturn in the world economy since the 1930s, pointing out that it had been merely a great recession, and that an actual depression had indeed been prevented, looked pettifogging.




But the length of the current expansion suggests that Mr Lucas and the colleagues he spoke to and for had a point. Modern economics says business cycles are caused by changes in total spending which outpace the ability of prices and wages to respond. Recessions happen when, faced with lower spending, firms sell less and shed workers, leading spending to fall yet further, rather than adjust prices and wages so as to balance supply and demand. The Great Moderation was marked by changes in the economy that made spending less volatile, and by a greater willingness on the part of central banks to promptly increase demand when things looked dicey. A financial crash could still end an expansion, and the crisis that scuppered that of the 2000s was a doozy. But over the long term, stretches of economic growth in America have got longer and longer (see chart 3).




Thus this expansion’s remarkable longevity does not mean it will die of old age. It just means that none of the things which usually bring expansions to an end—busts in industry and investment, mistakes by central banks and financial crises—has yet shown up with scythe in hand. Why not? And is their arrival merely delayed, or becoming genuinely unlikely?

First, take downturns in manufacturing. In the second half of the 20th century, people serious about predicting recessions learned to pay a lot of attention to manufacturing inventories; Alan Greenspan, before he became chairman of the Federal Reserve, specialised in forecasting their ups and downs. They mattered because, in the days when companies planned production months in advance, a modest drop in demand often led manufacturers to cut production abruptly and run down their stocks, deepening the downturn.

This factor now seems genuinely less important. Better supply-chain management has reduced the size and significance of inventories. And manufacturing has been shrinking both as a share of rich-world economies and of the world economy as a whole. As the current situation demonstrates, this makes it easier for the rest of an economy to keep going when factories slow down. Manufacturing has swooned in the face of the trade war; but service industries have held up, at least so far, and with them the economy as a whole. The same pattern was seen in 2015, when a slowdown in the Chinese economy led to a manufacturing slump.

Some of the shift from manufacturing to services may be an illusion. Services have replaced goods in parts of the supply chain where equipment is provided on demand rather than purchased. At the same time, some firms that appear to produce goods increasingly concentrate on design, software engineering and marketing, with their actual production outsourced. Such firms may not play the same role in the business cycle that metal bashers did.

This blurring of manufacturing and services has been accompanied by changes in the nature of investment. America’s private non-residential investment is, at about 14% of GDP, in line with its long-term average. But less money is being put into structures and equipment, more into intellectual property. In America IP now accounts for about one-third of non-residential investment, up from a fifth in the 1980s (see chart 4); this year private-sector IP investment may well surpass $1trn. In Japan IP accounts for nearly a quarter of investment, up from an eighth in the mid-1990s. In the EU it has gone from a seventh to a fifth.





Recently, this trend has been reinforced by another: investment as a whole is increasingly dominated by big technology firms, which are spending lavishly both on research and on physical infrastructure. In the past year American technology firms in the S&P 500 made investments of $318bn, including research and development spending. That was roughly one-third of investment by firms in the index. Just ten of them were responsible for investments of almost $220bn; five years ago the figure was half that. A lot of this is investment in cloud-computing infrastructure, which has displaced in-house computing investment by other firms.

In general, the rate of investment in IP tends to be more stable than that of investment in plant and property. When low oil prices led American shale-oil producers to pull in their horns in 2015-16, business investment fell by 10%, which in the past would have set off imminent-recession claxons. But investment in IP mostly sailed on regardless, and although GDP growth slowed, it did not stop. Philipp Carlsson-Szlezak of Bernstein, a research firm, cites this episode as evidence that physical investment simply no longer carries the economic significance that it used to.

The persistence of memory

Whether or not that is the case, it would be wrong to think that IP investment can be relied on come what may. When the dotcom boom of the late-1990s went bust IP investment was one of the first things to fall, and it ended up dropping almost as much as investment in buildings and kit. With tech companies increasingly dominating investment of all sorts, it is worth worrying about what could now lead to a similar drop. One possibility might be a crunch in the online advertising market, on which some of the biggest tech firms are highly reliant. Advertising has, in the past, been closely coupled to the business cycle.

It would also be wrong to think that the world weathered the incipient bust of 2015-16 purely because of changes in the investment landscape. The effects of a flood of stimulus to credit in China and a change of tack by the Fed were important, too.

The swift action by the Fed was particularly telling. Central banks’ tendency during expansions has long been to continue raising rates even after bad news strikes, cutting them only when it is too late to avoid recession. Before each of the last three American downturns the Fed continued to raise rates even as bond markets priced in cuts. In 2008, with the world economy collapsing, the ECB raised rates on ill-founded fears about inflation. It repeated the mistake in the recovery in 2011, contributing to Europe’s “double-dip”.

But since then there has been no such major monetary policy error in the rich world. Faced with the economy’s current weakness, the ECB has postponed interest-rate rises until mid-2020 and is providing more cheap funding for banks. It will probably loosen monetary policy again by the end of the year. In March the Fed postponed planned rate rises because of weakness in the economy. Markets are certain it will cut rates at its next meeting on July 31st; it may do so by double the usual quarter-of-a-percentage-point.

America’s monetary loosening allows central banks in emerging markets, many of which are also reeling from the trade slowdown, to follow suit. With America cutting rates they need not worry about lower rates pushing down the value of their currencies and threatening their capacity to service dollar-denominated debts. The Philippines, Malaysia and India have already cut rates in 2019.

Normally, as an expansion wears on, central banks face the fundamental trade-off between keeping rates low to aid growth and raising them to contain prices. But over the past decade that trade-off has rarely been a vexed choice, because inflationary pressure has stayed oddly low. This may have been because labour markets are not as tight as people think; it may be because profits have a long way to fall before rising wages force firms to raise prices; it may be because the globalisation and/or digitisation of the economy are suppressing prices in ways that are still obscure.

Whatever the reason, the only time inflation made interest rates a genuinely hard call was in 2018, when the American economy was revved up by Mr Trump’s tax cuts. But the trade war warmed, the world economy cooled and the inflation risk the Fed had worried about subsided. In America core inflation, which excludes energy and food prices, is just 1.6%; in the euro zone, it is 1.1%.

If central banks are not worried about letting inflation rip when they loosen policy, they are distinctly worried about what might happen if they didn’t. It is not just that an ounce of prevention is worth a pound of cure. It is that the rich-world central banks may only have ounces to administer. Only the Fed could respond to a recession with significant cuts in short-term rates without moving into the uncertain and contested realm of negative rates. The question of how much damage negative interest rates do to banks is under increasing scrutiny in Europe and Japan.

In the face of a significant shock, the Fed and other central banks could restart quantitative easing (QE), the purchase of bonds with newly created money. But QE is supposed to work primarily by lowering longer-term rates. As these are already low, QE might not be that effective. And there is a limit on how much of it can be undertaken. In Europe the ECB faces a legal limit on the share of any given government’s bonds it can buy. It has set this limit at 33%. In the case of Germany it is already at 29%. If the ECB were to restart QE—as many expect it to—that limit would have to be raised. But it probably cannot rise above 50%, because that could put the ECB in the awkward position of having a majority vote in a future sovereign-debt restructuring.

Their lack of sea room puts a premium on central bankers’ demonstrated good judgment; an unforced error like that of the ECB in 2011 could have dire consequences. Unfortunately, the top of the profession is in flux. Christine Lagarde, who will take over the ECB from Mario Draghi in November, lacks experience of setting monetary policy. The successor to Mark Carney, who will leave the Bank of England in January, is as yet unnamed. Mr Trump’s recent nominees to the board of the Fed have for the most part been unqualified and eccentric. And having relentlessly criticised Jerome Powell, the Fed’s chair, for raising interest rates in 2018, Mr Trump might well, should he win re-election next year, replace Mr Powell with someone more of his mind when his term ends. A candidate remotely as left-field as Mr Trump’s nominations to the board so far would badly damage the Fed’s credibility.

The treachery of the image

After busts and central banks, the third killer is the one that struck so emphatically a decade ago: financial crisis. Manias and crashes are as old as finance itself. But during the Great Moderation, the financial sector grew in significance. The enhanced role of an inherently volatile sector may offset the stability gained from the shift from manufacturing to services, according to research by Vasco Carvalho of the University of Cambridge and Xavier Gabaix of Harvard University. The size of the financial sector certainly served to make the crash of 2007-09 particularly bad.

In America, finance now makes up the same proportion of the economy as it did in 2007. Happily, there is no evidence of a speculative bubble on a par with that in housing back then. It is true that the debt of non-financial businesses is at an all-time high—74% of GDP—and that some of this debt has been chopped up and repackaged into securities that are winding up in odd places, such as the balance-sheets of Japanese banks. But the assets attached to this debt are not as dodgy as those of a decade and a half ago. In large part the boom simply reflects companies taking advantage of the long period of low interest rates in order to benefit their shareholders. Since 2012 non-financial corporations have used a combination of buy-backs and takeovers to retire roughly the same amount of equity as that which they have raised in new debt.




Low interest rates also go a long way to explaining today’s high asset prices. Asset prices reflect the value of future incomes. In a low-interest-rate world, these will look better than they would in a high-interest-rate world. It may look disturbing that America’s cyclically adjusted price-earnings ratio has spent most of the past two years above 30, a level that was last breached during the dotcom boom. But the future income those stocks represent really should, in principle, be more valuable now than then. Higher interest rates would knock this logic over. But higher interest rates are not on the menu.

The apparent lack of speculative action is a problem for economists. People with very different ideas about the role of central banks and the fundamental drivers of the economy can nevertheless agree that, in the long term, low rates produce financial instability. So after a long period of low rates, where is it?

One answer is that it is following a cycle of its own. Analysis by the Bank for International Settlements shows that since the 1980s the financial cycle, in which credit growth fuels a subsequent bust, has grown in amplitude but has kept its length at about 15-20 years. In this model, America is not yet in the boom part of the cycle (see chart 5). America’s private sector, which includes households and firms, continues to be a net saver, in contrast to the late 1990s and late 2000s, note economists at Goldman Sachs. Its household-debt-to-GDP ratio continues to fall. It is rising household debt which economists have most convincingly linked to finance-sector-driven downturns, particularly when it is accompanied by a consumption boom. America and Europe had household debt booms in the 2000s; neither does today. The most significant run up in household debt in the current cycle has taken place in China.




The world economy’s unprecedented expansion hardly looks healthy; the trade war may have dampened animal spirits to an extent that cannot be offset by the highly constrained amount of stimulus available to the apothecaries of the central banks. But it remains possible that it will plod on for some time. The longer it does so, the more it will look like the world really has made a change for the moderate.