Voting with their eyeballs

The biggest indictment of Donald Trump’s sham trial is that most Americans have ignored it



 

FOR METROPOLITAN trendsetters and the masses, the impeachment trial of Andrew Johnson was the great event of 1868. The Senate galleries were crammed for it, with “the most lovely as well as the most distinguished ladies of Washington...in daily attendance”, according to one record.

Police officers meanwhile struggled to control the crowds that heaved outside the Capitol, “continually asking questions, making appeals and muttering threats”. Entering the Senate this week, by contrast, your columnist spotted a single, lonely protester wearing a sign that read: “Donald Trump is going to pee on you.”

Considering the passions that the president stirs, for and against, most Americans’ lack of interest in his trial may be its most remarkable feature. The public gallery has been half-empty for most of it. The few dozen anti-Trump protesters who have gathered outside the Senate are nothing to the hundreds who flocked to Justice Brett Kavanaugh’s confirmation hearing. The trial’s opening two days drew a modest prime-time TV audience of 7.5m.

That is similar to the audience for Bill Clinton’s trial, once an increase in average viewership is factored in, though Mr Trump’s is taking place in a far more feverishly politicised environment. It is also more popular than Mr Clinton’s trial was. Only a minority of Americans thought Mr Clinton should have been impeached for lying about sex; a small majority think Mr Trump should be sacked for trying to extort personal favours from his Ukrainian counterpart.

Even Republican senators who denounce Mr Trump’s impeachment as a “political sham”, in the phrase of James Inhofe of Oklahoma, seem slightly piqued by the public’s disregard. Quizzed on the thin showing in the gallery, the Oklahoman hyper-partisan told one newspaper he was “really surprised…because this is kind of historic”. He shouldn’t have been. The reason most Americans find Mr Trump’s trial tedious is because they know how it will end: with the president, though guilty—as even some Republicans acknowledge in private—nonetheless acquitted by them.

A last-ditch wrangle—as this column went to press—over whether Mitch McConnell might allow testimony from John Bolton, a former national security adviser, would make that scarcely less likely. It raises no prospect of the requisite 20 Republicans joining the Democrats in a vote to remove Mr Trump. Immaterial to the outcome, the kerfuffle is therefore mainly indicative of the extent to which the Republican Senate leader has otherwise controlled the trial and so predetermined its outcome.

Mr McConnell claims to have modelled it on Mr Clinton’s trial, which relied almost exclusively on evidence sent up by the House of Representatives. Yet the circumstances of the two trials are quite different. The evidence against Mr Clinton was gathered during a nine-month-long criminal probe, backed by a grand jury, which allowed its investigators to secure the testimonies of nearly a hundred witnesses, thousands of documents, and a sample of the president’s blood.

The evidence against Mr Trump consists of an edited White House transcript of a phone call between him and Volodymyr Zelensky, testimonies from the handful of mostly mid-level officials who were prepared to defy the administration’s non-co-operation order, and the president’s Twitter account.

Additional evidence against Mr Trump is available—including a leaked account by Mr Bolton, first reported by the New York Times, which appears to demolish the president’s defence. But, as Mr Trump’s lawyers noted this week, it is inadmissible. Testimony from the former national security adviser, a plain-speaker with a grudge against Mr Trump and a book to sell, would be more informative—and probably fraught for some, such as Vice-President Mike Pence, allegedly complicit in Mr Trump’s ruse.

Yet a single explosive testimony would probably leave little mark on Mr McConnell’s whitewash. The fact that a few moderate Republicans may demand to hear from Mr Bolton should be understood in that context. Were they also to request testimony from Mr Pence, half a dozen other cabinet members and, naturally, the president, it would look like a serious bid to uncover the truth and confront their voters with it. Inviting only Mr Bolton, on the legally irrelevant basis that he is willing to testify, would look like virtue-signalling to the independent voters they fear to alienate.

It is of course no mystery why that is as much as they may be willing to contemplate. To stand against the president is suicidal in the Trump cult their party has become. Mr Bolton, a feared baby-eating bogey of the left for over three decades, has already been denounced on Fox News, his former employer, as a “tool for the left”. It should also be acknowledged, as is so often the case, that while Republicans may be setting new records for shamelessness, the Democrats are not blameless either.

Chuck Schumer is also trying to extract political benefit from the trial, by trying to force Republicans up for re-election this year to make embarrassing defences of the president. Having largely achieved this, some suspect, he may be quietly willing to bring the trial to its inevitable conclusion rather than risk damage to his party by prolonging it. In that case, neither party would be committed to its oath to try the president and hold him to account.

Running down the Capitol

No wonder Americans seem disengaged from the Senate trial. Indeed, though you would not know it from the polished grandeur of its atriums, or the lofty bonhomie with which its members, of both parties, still hail each other there, the Senate is an institution hurtling towards irrelevance. Its tradition of debate is long dead. Under Mr McConnell, it barely passes bills; this Congress could be the most unproductive in half a century.

And meanwhile the populist furies that propelled Mr Trump, and which he has done so much to exacerbate, are not dissipating. Dissatisfaction with democracy was reported this week to have increased by a third in America since the 1990s. It will have gathered more steam last month.

The costs of a declining population

Some of the economic consequences are obvious: fewer people make and consume less stuff

Robin Harding

Population Decline Graph
© James Ferguson


In 1937, John Maynard Keynes gave a lecture on “Some Economic Consequences of a Declining Population”.

Many at the time felt the world was overpopulated and fewer people could only be a good thing, a view that Keynes himself shared. But the purpose of his lecture was to issue a warning: declining populations come with nasty economic side effects.

Keynes, it turned out, was worrying a couple of generations too soon. Births jumped in the postwar baby boom. Today, though, his warning reads like a prophecy.

Population is already falling in countries such as Japan and a future global decline is more plausible than ever before. As in the 1930s, many welcome the prospect — largely for environmental reasons — but the economic downside may be more severe than even Keynes anticipated.

Future populations will reflect a truly remarkable fall in global fertility. In rich countries, fertility rates have hovered below replacement levels of 2.1 children per woman for decades, but they are now below that threshold in middle-income countries across the world, from Iran to Thailand to Brazil. In South Korea, the fertility rate dipped to just 0.98 last year, and even in the US it hit an all-time low of 1.73 births per woman.

Given parental desire to invest in each child, a fertility surge in rich countries is improbable. According to the latest World Population Prospects from the UN, 27 countries have fewer people now than in 2010, and it expects 55 nations — including China — to experience declines between now and 2050. In the 21st century, falling populations will become normal.

Some of the economic consequences are obvious: fewer people make less stuff, so a declining population means slower economic growth or even falls in output. But fewer people also consume less stuff: what matters for living standards is output per person, and the crucial question is whether declining population can affect it. There are at least theoretical reasons to think the answer is yes.

Bar chart of Fertility rate (children per woman), selected countries showing Declining fertility rates are not just a problem for developed economies


Keynes’s main concern was weak demand for investment in a world where companies expect a falling population of customers. That, he feared, would lead to deficient demand and thus high unemployment.

Demography was closely linked to Alvin Hansen’s original 1930s theory of “secular stagnation” — a situation of entrenched low growth and interest rates — which has been revived in recent years.

The solution Keynes proposed was strikingly similar to modern debates: “With a stationary population we shall, I argue, be absolutely dependent for the maintenance of prosperity and civil peace on policies of increasing consumption by a more equal distribution of incomes and of forcing down the rate of interest.” The latter has certainly come to pass.

For Keynes, the risk from a falling population was unemployment — he did not see any reason why it should affect living standards or the advance of new technology. Modern economics, which tries to explain the pace of scientific discovery, is less sanguine.

In a new paper, provocatively titled “The End of Economic Growth?”, Stanford University economics professor Charles Jones models what might happen in a world of declining population. Rather than per capita growth chugging along, even as overall output declines, Mr Jones argues that living standards would stagnate as the population gradually vanishes.

He assumes that economic growth ultimately comes from new ideas, and the discovery of new ideas depends on the number of people researching them. If population began to decline at the global level, it would mean ever fewer people devoted to research and thus ever slower progress, at a time when new technologies already seem to have become harder to find.

Mr Jones’s work suggests falling population could cause slower growth in living standards. But there is an even more alarming possibility: a vicious cycle in which low fertility in one generation causes low fertility in the next, leading to a downward spiral in population. That is the scenario that demographer Wolfgang Lutz and colleagues call the “Low-Fertility Trap Hypothesis”.

They propose a set of mechanisms whereby low fertility can pass itself from generation to generation. In particular, they suggest that willingness to marry and have children depends partly on whether a couple can meet their material aspirations. But low fertility goes hand-in-hand with ageing populations and a rising tax burden to pay for pensions and healthcare. In places with low housing supply, falling interest rates also lead to high house prices, putting even more pressure on the finances of the young.

There is reason to suspect these mechanisms are already at work in suppressing fertility. In Japan, for example, almost all recent income growth for people of working age has been soaked up by tax rises and social insurance premiums.

Keynes concluded: “I only wish to warn you that the chaining up of the one devil [of population growth] may, if we are careless, only serve to loose another still fiercer and more intractable.” It is time to take that warning to heart.

U.S.-China Trade Détente, but a More Dangerous World

Some of the trade war’s aims were accomplished, but many weren’t

By Nathaniel Taplin




Two years, innumerable late-night tweets and reams of newspaper articles later, the U.S.-China trade battle royale of 2018 and 2019 is winding down. A few of its purported aims were accomplished. Many weren’t.

The most lasting impact is a marked, rapid deterioration in Sino-U.S. relations overall. Overt trade hostilities might remain on hold for now as the U.S. election season approaches, but technological, security and ideological competition, always undercurrents to Sino-U.S. relations, have been supercharged by the bitter conflict.

Investors will be dealing with the consequences for years to come as economic “decoupling” raises costs, cooperation on issues like carbon emissions becomes harder, the risk of military conflict in Asia rises and technology buyers increasingly need to choose between competing U.S. and Chinese systems and standards.

The deal itself is both less and more than it appears. Most tariffs will remain in place for now. U.S. exporters, mainly farmers, will gain, to an extent, from big additional Chinese purchases.

But trying to fix a country’s overall trade deficit by focusing on just one partner is a lot like trying to fix a very leaky dike with one finger. China can buy a lot more U.S.-produced pork or manufactured goods, but that will push up U.S. prices, making such goods less attractive at home and in other markets abroad. That means more exports to China, but probably far less to other places and, in some cases, offsetting imports.


President Donald Trump, right, speaks before signing a trade agreement with Chinese Vice Premier Liu He at the White House, Wednesday. Photo: Evan Vucci/Associated Press


The way targeting China worked out last year illustrates this well. In the 12 months ended in November 2019, the U.S. deficit with China was $56 billion lower than in the 12 months ended in November 2018, data from CEIC shows. But the deficit with the rest of the world rose $49 billion, offsetting nearly 90% of that drop.

The overall U.S. goods deficit only dropped $7 billion, and much of this was due to a falling bill from net oil imports. The biggest near-term impact of the deal is simply removing some of the pernicious uncertainty created by the trade conflict itself.

And the conflict is far from over.

Even as negotiators sign off on the trade deal, Washington is considering measures to further restrict sales of U.S. equipment to Chinese 5G telecommunications champion Huawei and boost federal funding for U.S. 5G research. As the trade fracas has dragged on, it has metastasized into a broader deterioration in relations.

Some aspects of the U.S.’s more combative stance—condemning human-rights abuses and Beijing’s attempts to silence critics or spread disinformation overseas—are overdue and welcome. Others, such as efforts to restrict U.S. semiconductor sales, risk backfiring as U.S. firms lose revenue or shift production abroad.

One thing the trade conflict has noticeably failed to accomplish is any serious commitment from Beijing to abandon its own state-led industrial policy. Instead, China’s leaders have received the message that the U.S. doesn’t welcome its technological rise—and redoubled their determination to promote domestic champions.

Deteriorating relations have spilled over into the security realm as well, most obviously with the Trump Administration’s designation of China as a strategic competitor and statements by top U.S. officials warning of a “clash of civilizations.” Tariffs now in place look unlikely to be scaled back substantially.

That means economic decoupling will continue—just as China’s military is nearing the point where it could plausibly prevail in conflicts near China’s periphery. The risk of mistakes and miscalculations is rising at the same time economic interests in avoiding confrontation are disengaging.

Investors are used to thinking of the Middle East as the real hot spot for political risk. Over the next decade, it seems increasingly likely to be Asia.

Democratizing the ECB

Recent tensions within the European Central Bank's Governing Council have underscored the need to manage disagreement better. The status quo, whereby the president presents a policy decision as a consensus, after which one or more Governing Council members may issue a dissenting statement, makes everyone look silly.

Barry Eichengreen

eichengreen136_Thomas LohnesGetty Images_christine lagarde

AMSTERDAM – The European Central Bank is undergoing a changing of the guard: a new president, a new chief economist, and two new Executive Board members. And the ECB’s new leadership is facing a contentious year in 2020.

For starters, former ECB President Mario Draghi’s last policy meeting was marked by disputes over quantitative easing and the president’s role in decision-making, underscoring disagreement within the Governing Council (comprising the Executive Board and national central bank governors) about monetary strategy. Should the ECB retain its point target for inflation but make that target symmetrical, in contrast to the present “below but close to 2%”? Or should it abandon all hope of coming close to 2% and settle for 1.5%?

Then there is the assertion by Draghi’s successor, Christine Lagarde, that the ECB should focus on climate change, even though the issue is not part of the central bank’s mandate (and even though monetary policy is not an obvious instrument for tackling it).

It is timely, therefore, that the ECB has launched a comprehensive review of its policy strategy. Frank discussion of alternatives, buttressed by systematic staff analysis, can only help. But while pondering alternatives is all well and good, the idea that a strategic review should produce a consensus on targets, instruments, and strategies is misguided. Even well-informed people can disagree about the nuances of policy, because, as often happens, they weight different variables differently. Consensus can reflect groupthink, and groupthink can cause policy committees, which are strengthened by a diversity of views, to overlook important risks.

The question is how to manage disagreements. The status quo, whereby the president holds a press conference and presents the policy decision as a consensus, after which one or more Governing Council members may issue a dissenting statement, makes everyone look silly. It undermines the legitimacy of policy, because the ECB provides only partial and conflicting information about decision-makers’ views and the rationales underlying them.

Recently, Ignazio Visco, the governor of the Bank of Italy, proposed that the Governing Council should vote on consequential decisions and announce the results. The Fed, the Bank of England, the Bank of Japan, and the Sveriges Riksbank, among others, already do so. Dissent, when it occurs, shows that policymakers are engaged in a healthy exchange of ideas. When their votes are announced, they feel pressure to explain why they have chosen to side with the majority or dissent from it.

Central bank independence is tenable only when policymakers are accountable for their actions. And they will be accountable only if they are compelled to defend their decisions in the court of public opinion. If transparency is essential for accountability, then the release of votes, together with minutes – and, with a delay, transcripts – is the ultimate form of transparency. Today, with central bank independence under threat, it is all the more essential.

Moreover, announcing votes has other advantages. It helps to signal future monetary policy. In other words, it acts as a sort of forward guidance, which is an essential tool in a low-interest-rate environment. Votes are also a source of information about policymakers’ macroeconomic outlook, which is helpful for investors.

The argument against releasing votes is that the ECB’s Governing Council is numerically dominated by central bank governors who are appointed nationally, and who thus will feel pressure to support policies that are in the national interest, rather than that of the eurozone. This is different from the situation of other central banks. In the United States, Reserve Bank presidents are selected by directors residing in their districts. But some of those directors are appointed by the Federal Reserve Board – that is to say, nationally. Since the enactment of the Banking Act of 1935, which reformed the Fed, it has been understood that members of the Federal Open Market Committee vote with the interests of the entire US economy, not their home region, in mind.

Evidently, this is not the attitude of Europe’s national leaders, who worry that ECB policy affects different countries differently. Were their votes released, Governing Council members would be more likely to cater to narrow national priorities. Otherwise, they would risk replacement by more pliable lackeys.

Such cynicism underestimates Europe’s central bankers. They may have made mistakes, but they have not shown a readiness to bend to popular opinion in order to retain their jobs. As important as their vote, moreover, is their ability to convince their colleagues of the validity and integrity of their arguments. Blindly obedient central bankers who lack this integrity will be unable to persuade their colleagues. They will find themselves isolated and consistently in the minority.1

Voting, it is said, is a duty in a democracy. Unlike in democratic elections, however, those who set the ECB’s monetary policy should not only vote, but also reveal how they cast their ballots.


Barry Eichengreen is Professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His latest book is The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era.

Returning to the Beginning

By: George Friedman



In recent weeks, I have been writing on the very ordinary but precious moments of my life. I wrote about the complexity of my family’s holidays and of a vacation, with what I hope came across as humor.

All this is in preparation for my return to my original project: to place geopolitics in the philosophical tradition. There may seem to be no connection between the ordinary moments of life and something as exalted as philosophy, but they are intimately connected.

Ordinary life is extraordinary.

The task of philosophy and geopolitics is to find the sacred in everyday life, and to do so with deep irony, which requires being able to laugh heartily. For who are we humans to speak of our lives and the sacred?

Anyone who tries must do so with a deep sense of its pretentiousness. In elevating a rum punch during a beach vacation to a subject worthy of deep thought, we do three things: We elevate the ordinary, force ourselves to realize that there is little that is ordinary there, and face the chasm separating our attempt to understand the world and the absurdity of the attempt.

But in that rum punch, in the game it plays with your mind, there is a freedom to both elevate yourself and mock yourself.

The problem of philosophy is that it tends to be boring. It is boring because it is complex and because it is abstracted from the lives that people live. The great philosophers give you a window through which to see yourself. That window is irony or, for those of us less elevated, humor.

The entire idea of philosophy is humorous.

Here we are, human beings who know many things, being told that we do not know the most important things. But humans know well the most important things: doing one’s duty, nurturing children, battling nature and society to provide for them, being just without being a martyr, being kind and being forgiving, even to those who won’t forgive.

This is a random list, and many things can be refined and added, but if philosophy is the study of the true and beautiful, then it at best makes elegant the things we already know. Philosophy holds no surprises, except for one profoundly important one: that human beings, in the course of their lives, should contemplate such matters without holding an advanced degree. And with that, philosophy contributes its most important gifts: irony and caution.

Irony is telling a truth in such a way that we can see it through the veil of laughter. As Plato infers, who are we mere humans to dare to think such exalted thoughts? I think of my father, who survived the Mauthausen concentration camp and a Soviet occupation, whom life had crushed too many times, who still had the ability to hope for something better and laughed at me, saying I was such a scrawny child to place his hopes in. He had faced Hitler’s and Stalin’s ideas directly and survived them, yet could still know that all homes, especially the most urgent, must be clothed in laughter.

Philosophy must also cloak the best and worst from the world. A philosopher is not someone with an advanced degree. It is someone who has confronted the best and worst of the world, and discovered that it takes courage to face both. I have an advanced degree and wrote books and articles that were designed not to enlighten but to demonstrate my brilliance through their obscurity. Later, doing other work, I discovered that philosophy does not live in the academy where justice is discussed but in the world, where justice must be lived.

Geopolitics is not recognized as a field, so I made it a business. But geopolitics is at the heart of philosophy. If we agree that all the examples I cited can be summed up by the question “who is man?” then the first answer is that humanity is divided into two parts: man and woman, and all that follows from this. The first discussion of duty must somehow revolve around this.

Geopolitics is a field that tries to define, explain and forecast the relationship among communities. The story it tells is a story of greatness and horror, but it begins in the simplest things that make us human.

The first question I have raised in other places is, what creates a community or nation?

The answer is the love of one’s own, the love of the things you were born to, and being brought up to know that their loves are yours and their hates are yours as well. But where does the love of one’s own come from?

The irreducible truth is that the love of one’s own must be preceded if not with love then at least with lust. To have a child you must have sperm and an ovum. However we reengineer the human being and reproduction, and whatever journey in life the child undertakes, it begins with the sperm and ovum, and most usually the man and woman, retelling the oldest story there is.

Philosophy ought not to be about pontificating, and certainly not advocacy of policies, although listening to a professor discussing the just war is a hoot. But it is a hoot meant not to reveal hidden things but to set rules unrelated to reality. He is saved by the grace of indifference.

This may strike you as pointless or obvious.

But that is the purpose of philosophy, to hold up to the light things that you are intimately familiar with and suddenly see something you never imagined you would see there. And those things are easiest to see when you see how preposterous it is for you to be seeing them.

Next week, I will try to start climbing the mountain.

Australia is no longer the lucky country

Blessed by economic good fortune, it now faces a future blighted by climate change

Gideon Rachman

Australia
© James Ferguson


The book The Lucky Country was written about Australia in the 1960s, and since then the label has stuck. For anyone slogging their way through a British winter, the image of Australians on the beach seemed impossibly alluring.

On my first visit to the country, 25 years ago, a Sydneysider teased me: “You guys used to deport your convicts here. Now what do you think?”

Naturally, we were sitting outside at a barbecue with beers in our hands.In the decades afterwards, Australia’s luck seemed only to improve. Asia’s boom created huge demand for the country’s commodities.

For the past three decades, Australia has not suffered a single recession — a unique record in the developed world. With a population of just 25m to share the riches of an entire continent, prosperity seemed guaranteed long into the future.

While the US and the UK fretted about the erosion of middle-class lifestyles, the “Australian dream” powered ever onwards.

But by participating so eagerly in the mining boom, Australia might also have been helping to dig its own grave. Fossil fuels are driving climate change; and, as the government now accepts, global warming is a major factor behind the fires, water shortages and record temperatures that are ravaging the country.

The statistics of homes destroyed and lives lost are tragic but do not, in themselves, suggest that a whole society is at risk. Some 27 people have so far been killed and more than 1,800 homes have been lost. But the ecological toll is horrifying.

In the state of New South Wales alone, it is feared that more than 1bn animals may have been killed by the fires or have had their habitats destroyed, including a third of the state’s koalas — devastating an animal that has become a symbol of the country and its unique wildlife. The coral of the Great Barrier Reef, another of Australia’s great natural wonders, has already been severely damaged by climate change.

The fires have not ravaged the major urban areas, where the majority of Australians live. But daily life has been severely affected by the haze from the fires. Air quality in Canberra, the federal capital, was for a while the worst in any city in the world, causing the national art gallery to close, postal services to be suspended and some embassies to shut down. In Sydney last week, pools and tennis courts, those symbols of an Australian summer, were also temporarily closed. There is anxiety about the Australian Open — the first grand slam tennis tournament of the year — which is due to start in Melbourne on January 20. (Last year play had to be suspended for a time because of extreme heat, which touched 44C).

The fires could rage in Australia for a couple more months. But the greater fears must be longer term. Average temperatures in Australia are rising, with successive summers setting new records. Last year was the hottest and driest in the country’s recorded history, with rainfall 40 per cent below average. Australians, who used to look forward to the summer, are beginning to dread it — both because of the heat and because of the foreboding about the future that it inspires.

But these fears are by no means universal.

The last Australian election saw a victory for rightwing parties which had pooh-poohed the need for drastic action on climate change, portraying climate activism as a fetish of rich urban liberals, happy to deprive ordinary Australians of their jobs, pick-up trucks and Sunday roasts.

The political right’s complacent stance about climate change, along with a series of errors, has led to a backlash against Scott Morrison, the prime minister, who once waved a lump of coal around in parliament, urging his audience not to be frightened of the stuff.

But the fact that Australia is still so dependent on coal for its energy generation and exports no longer seems like something to laugh about. The country’s go-slow approach to international climate negotiations also looks increasingly like an act of self-harm, rather than a shrewd defence of the national interest.

The government responds to its critics by pointing to an inconvenient truth. Australia accounts for just 1.3 per cent of global carbon emissions. If you include the country’s coal exports in the calculation, the figure rises to 4 per cent. Still, it is clearly true that Australia could shut its entire coal industry down without having a transformative impact on global emissions.

Australians who want to see the country take more urgent action respond that if even rich Australia fails to change its ways, it cannot expect countries with lower living standards, such as China, to rein in emissions. That may well be true. On the other hand, even if Australia does take action, there is clearly no guarantee that others will follow its example.

In their different ways — and for understandable reasons — Australian climate activists and their opponents are indulging in forms of wishful thinking. Conservatives argue that the facts around climate change are still contested and that nothing much needs to change. Those on the left argue that if the country summons up the will to take drastic action, it can make the future less threatening.

But this Australian summer suggests that the future may already have arrived.

And it looks frightening.


Technically Speaking: This Is Nuts - Part Deux

by: Lance Roberts



Summary

- In this past weekend's newsletter, we discussed the exceedingly deviated price, and overbought conditions, not to mention valuations, as key reasons why we slightly reduced risk in our portfolios.

- We remain primarily long-biased in our portfolios, but given the extreme technical overbought, and deviated conditions, it was prudent to raise some cash and protect our gains.

- Given the current momentum of the market, combined with the Fed's ongoing liquidity interventions, we only expect a correction of 5-10% to reset the overbought, optimistic, and deviated markets.

     
- This idea was discussed in more depth with members of my private investing community,Real Investment Advice PRO. 
    
 
In this past weekend's newsletter, we discussed the exceedingly deviated price, and overbought conditions, not to mention valuations, as key reasons why we slightly reduced risk in our portfolios.

"On Friday, we began the orderly process of reducing exposure in our portfolios to take in profits, reduce portfolio risk, and raise cash levels. 
In the Equity Portfolios, we reduced our weightings in some of our more extended holdings such as Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), UnitedHealth Group (NYSE:UNH), Johnson & Johnson (NYSE:JNJ), and Micron (NASDAQ:MU). 
In the ETF Sector Rotation Portfolio, we reduced our overweight positions in Technology (NYSEARCA:XLK), Healthcare (NYSEARCA:XLV), Mortgage Real Estate (BATS:REM), Communications (NYSEARCA:XLC), Discretionary (NYSEARCA:XLY) back to portfolio weightings for now."
 
Not surprisingly, I received more than a few emails chastising me for "bailing on the bull market, which is clearly going higher."
 
Such is hardly the case. We simply reduced our weighting in some of the companies which have had substantial gains over the last year. We remain primarily long-biased in our portfolios, but given the extreme technical overbought, and deviated conditions, it was prudent to raise some cash and protect our gains.
 
However, it wasn't just the conditions we discussed which have us concerned about the markets in the short term. Investor positioning has also reached rather extreme levels. As Bob Farrell once wrote:

"When all experts agree, something else is bound to happen."
Currently, with investors all extremely long equity exposure, the risk of a correction has become elevated.
 
 
 
 
Our composite "fear/greed" indicator, which is comprised of investor positioning, shows much the same as "bullish sentiment" has become rather extreme.
 
 
 
 
Every week, we provide RIAPRO subscribers with the latest updated technical composite score as well. This composite gauge combines extension, deviation, and momentum into a single weekly measure. Readings above 90 (Currently 92.31) are always associated with corrective actions in the market.
 
 
 
With all of these conditions aligned, the "probability" of a short-term correction has increased.
 
Given that risk outweighs reward in the short term, we decided it was prudent to reduce the numerator of that equation.
 
Why We Reduced Risk
 
It may seem irrational that we would reduce our risk exposure as the market continue to rise. Less exposure to equities means less upside performance of the portfolio, or rather, "opportunity cost." As
 
I noted:
"While the markets could certainly see a push higher in the short-term from the Fed's ongoing liquidity injections, the gains for 2020 could very well be front-loaded for investors. Taking profits and reducing risks now may lead to a short-term underperformance in portfolios, but you will likely appreciate the reduced volatility if, and when, the current optimism fades."

However, the problem for the majority of investors is the inability to predict whether the next correction will be just a "correction" within an ongoing bull market advance or something materially worse. Unfortunately, by the time most investors figure it out - it is generally far too late to do anything meaningful about it.
 
By reducing risk now it provides us three benefits for the future.
  1. Less equity risk, and higher cash levels, lowers the volatility of the portfolio which will allow us to navigate a correction process and protect our investment capital.
  2. It gives us capital to reinvest back into positions we currently own at better prices; or,
  3. Buy new positions which have corrected in price.
 
While it is entirely true that "you cannot time the market," you can do some analysis and make deliberate changes to avoid problems.
 
As shown below, price deviations from the 50-week moving average have been important markers for the sustainability of an advance historically. Prices can only deviate so far from their underlying moving average before a reversion eventually occurs. (You can't have an "average" unless price trades above and below the average during a given time frame.)
 
 
 
 
Notice that price deviations became much more augmented heading into 2000 as electronic trading came online, and Wall Street turned the markets into a "casino" for Main Street.
 
At each major deviation of price from the 50-week moving average, there has either been a significant correction or something materially worse. Currently, the deviation from the 50-week moving average is the second-highest level in history, next to the 1999 "dot.com" mania.
 
How bad could it be?
 
Measuring The Mean Reversion
 
Given the current momentum of the market, combined with the Fed's ongoing liquidity interventions, we only expect a correction of 5-10% to reset the overbought, optimistic, and deviated markets. Such a correction can be used to increase equity exposure and bring equity holdings back to target weights.
 
However, there is a risk of a larger mean reverting event, yet this is a possibility completely dismissed by the mainstream media under the guise of "this time is different."
 
With the market trading more than 3-standard deviations above the 50-week moving average, historical reversions have tended to be more brutal. I have laid out support levels below.
 
 
 
At this juncture, a correction back to the 2018 lows would entail a 25% decline. However, if a "bear market" growls, the 2015-16 highs become the target which is 34% lower. The lows of 2016 would require a 43% draft, with the 2008 highs posting a 52% "crash."
 
That can't happen you say?
 
We had two 50% declines since the turn of the decade, and the next major market decline will be fueled by the massive levels of corporate debt, underfunded pensions, and evaporation of "stock buybacks," which have accounted for almost 100% of net purchases since 2018.
 
Then there is also the other possibility as noted by technical analyst J. Brett Freeze, CFA:
"The Wave Principle suggests that the S&P 500 Index is completing a 60-year, five-wave motive structure. If this analysis is correct, it also suggests that a multi-year, three-wave corrective structure is immediately ahead. We do not make explicit price forecasts, but the Wave Principle proposes to us that, at a minimum, the lows of 2009 will be surpassed as the corrective structure completes."
 
Anything is possible, and if he is right, such a decline will eclipse the 85% decline of the Dow following the 1929 peak when stocks last reached what seemed to be a "permanently high plateau."
 
We Play The Probabilities
 
The probability is that we will see the 5-10% correction which will be used to increase our exposure.

Just don't dismiss the possibilities.
"You play the probabilities; but prepare for the possibilities."
 
No one knows with certainty what the future holds which is why we must manage portfolio risk accordingly and be prepared to react when conditions change.
 
While I am often tagged as "bearish" due to my analysis of economic and fundamental data for "what it is" rather than "what I hope it to be," I am actually neither bullish or bearish. I follow a very simple set of rules which are the core of my portfolio management philosophy which focus on capital preservation and long-term "risk-adjusted" returns.
 
As such, let me remind you of the 15-Risk Management Rules I have learned over the last 30 years:
  1. Cut losers short and let winners run. (Be a scale-up buyer into strength.)
  2. Set goals and be actionable. (Without specific goals, trades become arbitrary and increase overall portfolio risk.)
  3. Emotionally driven decisions void the investment process. (Buy high/sell low)
  4. Follow the trend. (80% of portfolio performance is determined by the long-term, monthly, trend. While a "rising tide lifts all boats," the opposite is also true.)
  5. Never let a "trading opportunity" turn into a long-term investment. (Refer to rule #1. All initial purchases are "trades," until your investment thesis is proved correct.)
  6. An investment discipline does not work if it is not followed.
  7. "Losing money" is part of the investment process. (If you are not prepared to take losses when they occur, you should not be investing.)
  8. The odds of success improve greatly when the fundamental analysis is confirmed by the technical price action. (This applies to both bull and bear markets)
  9. Never, under any circumstances, add to a losing position. (As Paul Tudor Jones once quipped: "Only losers add to losers.")
  10. Markets are either "bullish" or "bearish." During a "bull market" be only long or neutral. During a "bear market" be only neutral or short. (Bull and Bear markets are determined by their long-term trend as shown in the chart below.)
  11. When markets are trading at, or near, extremes do the opposite of the "herd."
  12. Do more of what works and less of what doesn't. (Traditional rebalancing takes money from winners and adds it to losers. Rebalance by reducing losers and adding to winners.)
  13. "Buy" and "Sell" signals are only useful if they are implemented. (Managing a portfolio without a "buy/sell" discipline is designed to fail.)
  14. Strive to be a .700 "at bat" player. (No strategy works 100% of the time. However, being consistent, controlling errors, and capitalizing on opportunity is what wins games.)
  15. Manage risk and volatility. (Controlling the variables that lead to investment mistakes is what generates returns as a byproduct.)
The current market advance both looks, and feels, like the last leg of a market "melt up" as we previously witnessed at the end of 1999. How long it can last is anyone's guess. However, importantly, it should be remembered that all good things do come to an end. Sometimes, those endings can be very disastrous to long-term investing objectives.
 
This is why focusing on "risk controls" in the short term, and avoiding subsequent major draw-downs, the long-term returns tend to take care of themselves.
 
Everyone approaches money management differently. This is just the way we do it.

Palace Intrigue and Paranoia in North Korea

By: Phillip Orchard


Two years ago, during his annual New Year’s Day address to the nation, North Korean leader Kim Jong Un effectively declared that the North was ready to shed its moniker as the Hermit Kingdom.

The North, according to Kim, had “completed” its nuclear deterrent against the United States. Kim hinted at a new openness to diplomacy and economic integration with the outside world.

Three months later, he announced a landmark shift away from Kim Il Sung’s 1960s-era “byungjin” policy, which called for parallel development of the military and economy, in favor of one focused primarily on restoring national prosperity.

A string of historic summits with the South Korean and U.S. presidents quickly followed, as did a two-year freeze on nuclear and long-range missile tests. But, critically, what didn’t follow was relief from the crippling U.S.-led sanctions regime, much less an end to joint U.S.-South Korean exercises – nor even lower-hanging fruit like an official declaration ending the Korean War.

As a result, Pyongyang welcomed the 2020s by turning back the clock – but also by displaying signs that something wasn’t quite right in the capital.

In a speech at the Dec. 28-31 Workers’ Party of Korea’s Central Committee plenum, Kim restored the byungjin doctrine, announced the end of Pyongyang’s moratoriums on nuclear and long-range missile tests, boasted about a “new strategic weapon” and warned of hard times to come in the “long-term confrontation with the U.S.”

He also presided over a sweeping politburo reshuffle, reportedly dumping economic reformers and diplomats who had been central to negotiations with the United States in favor of figures whose backgrounds point to a renewed emphasis on weapons development and ties with countries like Russia.

Curiously, he then ghosted on his New Year’s Day address for the first time, drawing parallels to 1957, when his grandfather skipped the speech following a major purge of political opponents.

Kim then disappeared from what passes as the public eye in North Korea for more than a week – coincidentally, the same week that the U.S. killed Iranian Gen. Qassem Soleimani, the U.S. reportedly increased surveillance flights over the North, and reports emerged in South Korean media that the U.S. had deployed Reapers to the South ahead of purported decapitation strike drills in the fall.

North Korean state media barely mentioned the killing, something out of character for a propaganda machine wired to seize any opportunity to paint the U.S. as the demogorgon. All the while, the North's repeatedly threatened “Christmas surprise” – expected to be some kind of missile test if the U.S. didn’t meet Pyongyang's end-of-year deadline for progress in negotiations – never arrived.

The curious confluence of events fueled all sorts of regional speculation about chaos in Pyongyang. Had divides in the North over the path forward ruptured, leading to a paralyzing power struggle that sent Kim scrambling for cover? Had the Soleimani killing put Kim on notice? North Korean palace intrigue is simply too murky to say much definitively.

But Pyongyang has good reasons to think a window of opportunity to begin integrating with the international community has closed. Just don’t expect Pyongyang to be content with staying out in the cold for long.

Threats at the Door

To discern the state of play in Pyongyang, it’s worth examining each of the recent developments individually, starting with the hot topic of the day: Is a decapitation strike against Kim by the U.S. or its allies a real possibility?

The Kim regime is famously paranoid about assassination. This is partly why Kim Jong Un refused for six years to leave the North after taking power and still does so only swaddled in bubble wrap. It’s not completely unfounded; South Korea has for years been boasting about a plan known as “Kill Chain,” involving new capabilities to launch surgical preemptive strikes if war appears imminent.

And the Trump administration openly debated plans for a “bloody nose” strike against the North in 2017. Kim, meanwhile, likely ordered the execution of his uncle, Jang Song Thaek, in 2013 out of fear he might plot with Beijing to oust the young leader. Similar fears compelled him to dispatch a pair of unwitting, VX-toting femme fatales to take out his brother, Kim Jong Nam, at the Kuala Lumpur airport in 2017.

Shortly after Kim Jong Nam’s demise, evidence emerged of a foiled assassination plot against Kim Jong Un being staged out of Chinese and Russian border regions. Pyongyang, moreover, is no stranger to the assassination game itself; in 1983, it attempted to kill South Korean President Chun Doo-hwan during a visit to Burma.

The question really comes down to U.S. capability and interest. The U.S. could certainly use a number of precision-guided missiles to go after Kim. But succeeding would hinge on targeting intelligence that the U.S. is highly unlikely to have in all but a narrow set of circumstances. U.S. Reapers can’t just hang out above Ryongsong waiting for a kill shot the way they could in Baghdad.

And even if the U.S. did have an opportunity to take Kim out, it would be exceedingly risky to use it. To be sure, North Korea could experience a dramatic transformation following the death of Kim, whose cult of personality is central to the regime’s legitimacy. But taking out Kim wouldn’t do anything about the North’s nukes, nor the thousands of missiles and conventional artillery within range of Seoul. And it would risk kicking off a civil war in a nuclear state known for institutionalized paranoia and questionable command and control structures.

Either way, what matters most here is that Kim, like his father and grandfather, consistently behaves in ways that suggest he believes the threat of decapitation is real. This fear was illustrated by state media’s silence on Soleimani; the Kim regime evidently can’t even stomach public awareness of the fact that assassinations happen. And for any number of reasons, this has only deepened their conviction that regime survival requires both a viable nuclear arsenal and a willingness to use it if an attempt to end the Kim era appears nigh.

Threats From Within

The second question worth investigating is: Do the Central Committee purges, doctrine reversal, and evidence of internal divides suggest that pressure on Kim is approaching a breaking point?

Kim was taught from a young age that the best way to navigate the ruthless political environment in Pyongyang was to eliminate potential rivals long before they become an actual threat. As a result, shake-ups, purges, rehabilitations and executions at senior levels are fairly routine in Pyongyang.

Still, the fact remains that the North has failed to get out from under excruciating sanctions pressure, and it’s now facing contentious decisions on, for example, whether or how much of its nuclear and missile programs to bargain away in pursuit of relief – plus likely divides over Kim’s outreach to the South, his efforts to keep China and Russia at arm’s length, and his nascent steps toward economic liberalization.

As noted, the North Korean government’s legitimacy, and thus the fortunes of the North Korean elite, is deeply tied to the Kim family’s cult of personality.

And by assassinating his brother, Kim likely eliminated the only realistic replacement – though his sister, Kim Yo Jong, is worth keeping an eye on. She was promoted at the plenum and has reportedly been issuing orders to the military. The two siblings are believed to be close, with Kim Jong Un keeping her in the spotlight during high-profile summits with South Korean President Moon Jae-in and U.S. President Donald Trump, for example. Still, whether her promotion is evidence that the North Korean leader is merely tightening his inner circle and short on loyalists or that he’s unwittingly grooming a potential successor is impossible to say.

Most likely, the dynamic in Pyongyang is a more extreme form of the one surrounding Chinese President Xi Jinping, who has succeeded in intertwining his fate with that of the Chinese Communist Party more broadly. Kim probably cannot be ousted altogether, but he can be gradually stripped of powers and relegated to figurehead status.

If such a scenario comes to pass, managing relations with the North would become ever more complicated.

‘Eating Grass’ vs. Playing Hardball

The developments of the past few weeks likely point to a somewhat more mundane reality: Pyongyang is simply digging in for another spell of belt tightening in the endless campaign to “defeat imperialism” – or, as Vladimir Putin put it, “eating grass” if that’s what it takes to hold on to its nukes.

Absent a willingness to risk the staggering costs of attempting to eliminate North Korea’s nuclear program by force, the U.S. just doesn’t have the leverage to force Pyongyang to budge.

But Pyongyang likewise hasn’t demonstrated the capability to force the U.S. to give up its demand for complete, verifiable and irreversible dismantlement. And until the U.S. backs off from its maximalist demands, there won’t be much room for Pyongyang to open up to the world on its own terms or force other regional powers to play ball.

The North will push Russia and China to continue their nascent efforts to unwind U.N. Security Council sanctions. If the international sanctions regime were to collapse, the U.S. would likely keep its sanctions in place – not to mention its troops within striking distance. But with the North capable of finding relief elsewhere and holding a major military deterrent, it could live with a quiet impasse with the U.S. and refrain from provocations aimed at pushing Washington back to the negotiating table.

Thus, the U.S. may eventually be inclined to tacitly consent to such a move by Moscow and Beijing. But for the time being, Moscow and Beijing both have bigger fish to fry with the U.S. and are unlikely to act on Pyongyang’s behalf unless doing so strengthens their position somehow in other negotiations with Washington.

The North will also continue probing for ways to deepen the wedge between South Korea and the U.S. (One official who survived the recent politburo reshuffle was an architect of the North’s outreach to the South.) Reunification is an imperative for both Koreas, and Seoul has been openly frustrated at the lack of progress on cross-border economic measures aimed at coaxing Pyongyang out of its shell.

But meaningful reconciliation with the South would be exceedingly fragile even in the best of circumstances. As it stands, the South remains unwilling to defy the U.S. by embracing Pyongyang too closely, and it needs the leverage it derives from its alliance with the U.S. to manage the rapprochement.

Perhaps the only real card the North has to play, then, is a resumption of long-range missile testing. There are any number of plausible explanations for why Pyongyang stood pat over the holidays. It’s possible that the lack of a test is the result of internal divides. It’s possible that Pyongyang thought twice about provoking the U.S.

It’s possible that it felt it succeeded in getting Washington's attention – or that it received a small concession from, say, China in exchange for holding off. It’s also possible that the “new strategic weapon" just isn’t ready for testing yet. (The North has far more ambitious goals for its missile program than the Hwasong-15 intercontinental ballistic missiles it tested in 2017, and systems like solid-fuel long-range missiles, particularly submarine-launched ballistic missiles, are an order of magnitude more difficult to develop.)


Missile Launches in North Korea, 1984-Present
(click to enlarge)


Whatever the case, don’t be surprised when North Korea starts back down this road.

The foremost risk of crossing the U.S. red line by testing another ICBM is that it provokes a U.S. military response. Just how big this risk is depends on how willing you think the U.S. is to go to war with a country that would, at minimum, impose staggering casualties on U.S. and allied troops – and that may very well be capable of plopping nukes down on U.S. bases around the region and beyond.

The game has changed since the days of endless fruitless negotiations with the “ferocious, weak and crazy” country led by Kim’s father. To be clear, war with the U.S. is a big enough risk that the North likely won’t jump straight to ICBM tests.

The primary goal for the time being will remain getting the U.S. to put sanctions relief on the table in exchange for a permanent freeze. So expect it to toe the line with, say, shorter-range tests or other demonstrations of new capabilities before crossing it.

Even then, it would leave the U.S. room to convince itself it need not retaliate, for example by leaving doubt about whether it has finally mastered the all-important issue of ICBM reentry and targeting systems. But the lesson from 2017 for the North was that high-profile tests are the only way to get the U.S. to the table. And it won’t be content to eat grass forever.

Trump’s Iranian Precipice

Under President Donald Trump, the United States has no clear objectives regarding Iran, and hence no clearly defined strategy. In the Middle East, the US should have learned by now, that is a recipe for disaster.

Javier Solana

solana113_JIM WATSONAFP via Getty Images_trump iran


MADRID – The new year began with yet another senseless foreign-policy decision by US President Donald Trump. The assassination of General Qassem Suleimani, who led the extraterritorial operations of Iran’s Revolutionary Guard, was a reckless, provocative, and shortsighted move.

Suleimani no doubt had an extremely pernicious influence in the Middle East. But he also was the leader of an armed branch of the Iranian state and enjoyed obvious personal popularity in his country, no matter how much Trump pretends otherwise.

Once again, the United States has acted excessively and set a dangerous precedent that its adversaries could use as an excuse to carry out similar operations. After the attack on Suleimani, Trump went so far as to threaten Iran repeatedly with the destruction of some of the country’s precious cultural sites, which would constitute a war crime.

Although Trump seems to have reconsidered, his chronic impetuosity only highlights the lack of proper planning. The assassination of Suleimani was a sensationalist move, probably intended mainly for domestic consumption. Yet, in the long term, will it be effective?

Obviously, the answer will depend on Trump’s objectives vis-à-vis Iran. His administration has argued that the president’s drastic intervention will have a deterrent effect on the Iranian regime, to which Suleimani was an absolutely indispensable asset.

That assumption is questionable. Although Iran’s retaliation – in the form of missile attacks against two Iraqi bases that house US troops – has so far been relatively subdued, the regime will stick to its guns. Nor can it be supposed that the loss of Suleimani, for all his importance, will be insurmountable for the regime, which has already named Suleimani’s trusted deputy as his successor.

The crux of the problem for the US is that it has no clear objectives regarding Iran, and hence no clearly defined strategy. In the Middle East, the US should have learned by now, that is a recipe for disaster. Today’s tensions do not imply that either Trump or Iran’s leaders are seeking war.

Yet, on many occasions, states have stumbled into unwanted conflicts, especially when overconfidence makes them reckless. With his wild swings, Trump has managed to force not only Iran into a corner (which could prompt its leaders to adopt a more aggressive stance), but has also painted himself into one.

In the absence of a plan, it is no surprise that his administration constantly contradicts itself.

Just when Iran was feeling the effects of a wave of brutally repressed domestic protests, the US relieved the pressure on the Iranian leadership. The huge crowds that turned out to mourn Suleimani do not lie. With Iran’s legislative elections just a few weeks away, the US offered the most conservative and anti-American elements in the country a golden opportunity.

Now, however, the spotlight has returned to the Iranian regime, owing to its own mistakes. After Iran’s leaders admitted – following three days of official denials – that Iranian missiles accidentally downed a Ukrainian civilian airplane, killing all 176 people aboard, the regime has once again become the target of popular outrage. The way the situation has played out serves as a reminder of Iranian citizens day-to-day troubles, which reflect the effects of domestic and foreign negligence.

The anti-regime protests roiling Iran are being echoed in other Middle Eastern countries where it wields notable influence. Overcoming their respective religious differences, both Lebanese and Iraqis have in recent months risen up against Iran’s meddling, much of which was orchestrated by Suleimani himself.

But Trump ignored Napoleon’s famous maxim: “Never interrupt your enemy while he is making a mistake.” Now, the Iraqi parliament has demanded (albeit symbolically) the withdrawal of US troops stationed in the country – which would be in Iran’s interest. The Trump administration has responded chaotically, by mistakenly announcing a troop withdrawal and then denying that a pullout was imminent.

Nonetheless, the possibility that Trump might end the US military presence in Iraq is not to be dismissed, even though the withdrawal would likely be rather undignified. For now, NATO forces fighting the Islamic State have suspended their operations, and some US allies have begun to evacuate their troops from Iraq.

But this does not mean that the US is leaving the Middle East: on the contrary, the number of American troops in the region has increased by 15,000 over the last six months. And while US energy dependence on the Middle East may have diminished, the “pivot” toward Asia, announced by the Obama administration, hasn’t happened yet. Obviously, a larger conflict with Iran would hamper US efforts to contain China, America’s main global competitor.

To the long list of US follies must be added the perverse incentives that Trump has highlighted with his latest blow against Iran, which has raised an uncomfortable question: Would the US have acted the same way toward nuclear-armed North Korea?

Iran fulfilled, to the letter, the 2015 nuclear deal signed by the main global powers – formally known as the Joint Comprehensive Plan of Action (JCPOA) – and continued to fulfill it for a year after Trump unilaterally withdrew the US from the pact. And yet, while Trump held amicable meetings with North Korean leader Kim Jong-un, his administration subjected Iran to crushing economic sanctions – treatment that is unlikely to encourage the Kim regime to stake its future on denuclearization.

Although Iran has announced that it will now stop abiding by the JCPOA’s restrictions on its nuclear program, it has not closed the door on the possibility of salvaging the deal. Moreover, US-Iranian tensions seem to have diminished slightly in recent days. But this may be a mirage: the downing of the Ukrainian plane has added a new element to the equation, which the Trump administration appears all too eager to exploit. Furthermore, Trump has not abandoned his intolerable demands and continues to pressure the JCPOA’s other signatories to abandon the agreement.

In the end, the US will have to recognize an indisputable reality: in situations as critical as this one, which was created unnecessarily, diplomacy is not an option, but an obligation. To avoid catastrophe, which should be the top priority for all parties involved, this is without doubt the road that must be taken.


Javier Solana, a former EU High Representative for Foreign Affairs and Security Policy, Secretary-General of NATO, and Foreign Minister of Spain, is currently President of the Esade Center for Global Economy and Geopolitics and Distinguished Fellow at the Brookings Institution.

Economists cannot agree on what ails the global economy

The leading industrialised nations are suffering from both supply and demand problems

Megan Greene

An employee scans toys at a Walmart Inc. store in Burbank, California, U.S., on Monday, Nov. 19, 2018. To get the jump on Black Friday selling, retailers are launching Black Friday-like promotions in the weeks prior to the event since competition and price transparency are forcing retailers to grab as much share of the consumers' wallet as they can. Photographer: Patrick T. Fallon/Bloomberg
Average hourly earnings growth remains below previous cycle peaks © Patrick T. Fallon/Bloomberg


A depressing consensus prevailed among economists at the recent American Economic Association annual meetings: the developed world is stuck with low growth, low inflation and low interest rates for years to come. Even worse, there is no consensus on why.

Supply and demand for goods and services are basic economic concepts. But when it comes to interpreting shocks to either in the real world, things get murky. Some economists blame prevailing conditions in the industrialised world on flagging supply, others on weak demand.

The supply siders argue that demand in the American economy is robust, propelled by a strong labour market. There is some evidence for this in the US, where unemployment has fallen to 3.5 per cent. The employment-to-population ratio, a measure comparing those employed to the total working-age population, is at its highest level since the dotcom era for those between 25 and 54 years old.

There are only two ways to boost potential growth: increase the number of workers, or improve workers’ capacity for production through technological advances. While unemployment is low, the labour force participation rate has been declining. The burden for boosting productivity and potential growth therefore falls mainly on technological innovation. Trend growth is weak, supply advocates say, because low productivity growth keeps companies from being able to supply enough goods and services.

Another group disagrees with this supply side analysis and blames the economic environment on weak demand. They subscribe to the theory of secular stagnation, resuscitated by former US Treasury secretary Lawrence Summers. Secular trends in industrialised countries — such as ageing populations and rising inequality — have caused desired savings to increase above the level of investment. This pushes down interest rates, giving central banks less room to cut rates to encourage consumption and investment.

Evidence of a savings glut and dearth of demand abounds. If the labour market were near full employment and supporting consumption, wage pressures should mount. Yet average hourly earnings growth remains below previous cycle peaks. If there were demand for new investment, we would not see savings flow into existing capital in the form of share buybacks and higher dividends.

So, do we have a supply problem or a demand one? The answer is probably both. A lack of demand could prompt companies to cut back on investment, which would undermine productivity and supply. One data point suggests that the demand-side effect may be stronger, however. When there is a negative supply-shock in the economy, inflation should accelerate. Instead, the industrialised world has witnessed feeble inflation since the financial crisis.

The good news is that both sides tend to agree on potential solutions. It starts with the view that central banks cannot carry the entire load, so fiscal stimulus should be deployed as well. On the supply side, governments could support research and development and improve education and skills training to boost productivity growth.

Public investment could also stimulate aggregate demand by addressing some of the structural drivers of secular stagnation. Stronger social insurance could reduce the propensity for people to hoard savings. Not all public investment need blow out the budget deficit. For example, a more progressive tax agenda could mitigate rising inequality.

The task now is for governments, whether they believe in the supply-side or demand-side arguments, to accept the role they must play. That, or accept the consensus that the current economy is as good as it gets, and the risk is on the downside.


The writer is a senior fellow at Harvard Kennedy School

Investors seek clarity from Fed on balance sheet expansion

Jay Powell set to address questions about market intervention at press conference

Brendan Greeley in Washington and Colby Smith in New York


Jay Powell and the Federal Reserve have managed to avoid fresh instability in the repo market © FT montage; Bloomberg


Investors are seeking more clarity from the US Federal Reserve this week on how much it may expand its balance sheet following the central bank’s efforts to restore order to short-term funding markets.

The Fed has been buying US Treasury bills at a rate of $60bn a month since a big jump in overnight borrowing costs last September and chairman Jay Powell is set to face sharp questions about how its actions are affecting markets on Wednesday.

Mr Powell will speak at a regular press conference after the Federal Open Market Committee’s two-day meeting, which is expected to result in a tweak to a key tool it uses to implement monetary policy with US interest rates close to the bottom of the Fed’s target range.

He is likely to have to address criticism from some market participants that the Fed’s actions have been pushing up asset prices.

“What the market really wants is to know what the medium-term game is,” said Mark Cabana, head of US rates strategy at Bank of America.

After September’s leap in the overnight “repo” rate, policymakers concluded that they had gone too far in withdrawing their post-crisis stimulus, allowing banks’ excess reserves held at the Fed to fall too low.

The Fed reversed course and began expanding its balance sheet again by buying short-dated Treasury bills, crediting banks with reserves and driving up the level of cash in the system. It said the bill buying would continue into the second quarter of 2020 but declined to offer a level of bank reserves it would consider sufficient.

The level had fallen as low as $1.4tn in September; it is now at $1.6tn.


Line chart of Bank reserves held at the Fed ($bn) showing Just don't call it QE


Since September, the Fed has also been intervening directly in the repo market. Originally it said those operations would continue until at least January, but Mr Powell and Richard Clarida, his vice-chairman, have more recently indicated they could continue until at least April.

“The Fed’s extremely aggressive response to the repo blowout in September, as well as their timidity in pulling back from that response . . . could be signalling to markets that this is a Fed with a very low tolerance for market fluctuations,” noted Blake Gwinn, head of front-end rates strategy for the Americas at NatWest Markets.

The turmoil in short-term funding markets reflects how the Fed, like other central banks, continues to wrestle with how to implement monetary policy in financial markets transformed by the financial crisis.

After almost two years of effort to keep the fed funds rate, its favoured policy interest rate, from bumping against the top of its target range, the Fed now finds it uncomfortably close to the bottom of the range — at 1.55 per cent, just 5 basis points above the low end.

Having previously cut the interest the Fed pays on banks’ excess reserves — something which acts as a magnet for other short-term rates such as the fed funds rate — the FOMC is expected to raise it on Wednesday by 5 basis points, according to analysts at multiple banks.

A graphic with no description



“The Fed is worried right now about losing control of fed funds, but to the downside,” said Mr Cabana at Bank of America.

Mr Powell has been at pains to say that none of its actions, in particular the decision to expand reserves held at the Fed, have added up to quantitative easing, the post-crisis stimulus programme in which the Fed expanded its balance sheet with longer-dated Treasuries.

But as the equity markets in the US continued to rise over the past few months, analysts have become sceptical that there is a difference.

“The market mythology has become the stock market can’t go down when the Fed is adding reserves,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics.

When it last met in December, the FOMC signalled that it did not intend to make any changes to interest rates in 2020. According to investor bets compiled by the CME Group, markets see a 90 per cent chance that the fed funds target range will be held at 1.5 to 1.75 per cent on Wednesday.

The Fed will not be publishing a new set of economic projections at this week’s meeting and analysts do not expect a change to the committee’s monetary policy statement.