The stock market has been fairly calm.
Yesterday morning, Donald Trump tweeted: ‘VERY close to a BIG DEAL with China’.
Later in the day, a deal was confirmed. It wasn’t a big deal, but it was enough of a deal to stop Mr. Trump from going off the rails in his trade war with China…and to drive the Dow up 220 points.
Investors bought stocks, either on ‘trade optimism’…
…or because they knew the fix was in. The Federal Reserve promised to pump a few billion more into the markets. The Fed:
‘Overnight repo operations will continue to be held each day. On December 31, 2019 and January 2, 2020, the overnight repo offering will increase to at least $150 billion. In addition, on December 30, 2019, the Desk will offer a $75 billion repo that settles on December 31, 2019 and matures on January 2, 2020.’
So, our inquiring minds want to know. Are we in a New Era boom…funded forever by the Fed’s funny money? Or are we just waiting for stocks to crash?
Debt be damned
In the New Era camp are Summers, Krugman, Bernanke, and Powell — all of those who claim to know how to run an economy — with 2% inflation targets… negative rates and debt-be-damned policies.
What they really know, of course, is that it’s a case of ‘inflate or die.’ Either they continue to pump in new money and credit…or the whole thing falls in a heap.
They’re right about the inflate-or-die situation. But the more they inflate…the bigger the heap that the economy eventually falls into.
But there are other New Era dreamers who are smarter…and less easily dismissed…
For weeks now, we’ve been puzzling over the points made by George Gilder and economists Gale Pooley and Marian Tupy. If what they say is true, we’re headed for a glorious future of prosperity, longevity, and absurdity.
In this great future, we can forget our past…negative interest rates make sense…and all the negativity we’ve been peddling for so many years can be given the old heave-ho without a care.
They believe that technological progress trumps our natural capacity to make a mess of things.
They base their calculations on ‘time prices.’ That is, they figure out how many hours of work are required to earn, say, a loaf of bread. By their calculations, that number — the ‘time price’ of bread — has been falling at about 3.4% per year for the last 70 years.
So, 3.4% is the real rate of deflation…the rate at which we are all really getting richer…at least, according to their telling. Which leads to the rather shocking and delightful conclusion that nominal interest rates might very well be negative. Gale Pooley explains:
One of the first equations we learn in economics is:
Nominal Interest Rate = Real Interest Rate + Inflation.
If we assume the real interest rate is 3% and we have 3% inflation, then the nominal rate should be 6%.
But what if we have negative inflation or deflation?
If the real rate is 3% and we have 3% deflation, then the nominal rate could be zero.
If things are really getting cheaper at 3.4% per year, you’d need a negative nominal rate of MINUS 0.4% to give you a real interest of 3%.
And eureka! If the carrying cost of debt were negative…heck…the more debt the merrier. You’d get paid for borrowing.
Makes sense, right? But since we have a suspicious mind…and since real growth — measured in time prices — has been continuing for, say, 200 years…and since inflation most of that time was even lower than it is today…and since never once were interest rates negative…
…we assume there’s a fly in the ointment somewhere.
So, let’s take a closer look…
The trouble with time prices
On a global basis, there’s been a huge improvement in human wealth over the last two centuries.
The ‘poor’ in America today are more likely to die from obesity than from starvation. They live in air-conditioned houses, ride in automobiles, and have TV and Netflix.
But how often do you hear them say, ‘thank my lucky stars…I’m so rich’? Instead, they compare themselves to their better-off brothers-in-law and moan about how unfair life is.
That’s one trouble with time prices. They measure the real cost of things — in time. And they measure real wealth — over time. But who cares? It’s relative wealth that matters.
People don’t mind being poor, just so long as everyone else is poor, too. And being rich is no great pleasure either, not if others are richer.
Biggest wealth increase in history
About 200 years ago, machines began to replace the work done by humans; productivity and wealth increased. You can till more ground with a tractor than you can with a hoe. So, as tractors came into service, the costs of growing wheat went down. We humans were richer.
In the US, our grandparents saw the biggest increase in wealth in history. The doctor who delivered them arrived in a horse-drawn carriage. But a motorcade, following an automotive Black Mariah, escorted them to the graveyard.
We all got richer and richer as more and more machines did more and more of the work. GDP growth rates of 5% were common.
But then, GDP growth rates declined after the Second World War — even as technology continued to race ahead. Why? Three reasons…
From muscle to machine power
First, the Industrial Revolution — shifting from muscle power to machine power — was subject to the law of declining marginal utility. We see this on our own farm.
We have a 1952 Chevy truck and a 1999 Ford. Around the farm, one is as good as the other. The newer Ford does about the same work as the old Chevy. Out on the highway, though, the Ford goes almost twice as fast, with far greater comfort and safety.
These are important differences, but spread over half a century, they are incremental, not revolutionary.
In many countries, however, tractors came later. We saw this, too, with our own eyes in Argentina. Though common down on the pampas, when we arrived in the Calchaquí Valley 10 years ago, there were few machines. On our ranch, there were none.
Horses and humans did the work. The old Percheron pulled the blow and the scythe. And the gauchos raked up the hay and ricked up the haystacks.
We came and brought in a couple of tractors and a backhoe. Hay production jumped. But after we had introduced the new machines, what else could we do? Not much. Growth quickly leveled off.
Buffing up Wall Street
In the US, the second reason for the slowdown in growth was probably the ‘funny money’ introduced in 1971. It shifted the US financial system from supporting real Main Street output to buffing up Wall Street assets.
‘Financialisation’ is the word for it. It refers to the increase in stocks, bonds, and real estate with no corresponding increase in the real economy that supports them.
Instead of urging their sons to go into manufacturing, mommas wanted their babies to grow up to be stock promoters and hedge fund managers. Instead of moving to Detroit to get into the Motor City boom, ambitious young people moved to Manhattan to get into finance. And why not? That was where the money was.
Real money had to be earned by putting out real goods and services. It went to producers. But this new funny money would go where the speculators, insiders, cronies, and Wall Street hotshots wanted.
Naturally, most of it went into their own pockets. By the 21st century, much of the nation’s wealth gains were going to the top 10% of the population. But that left the bottom 90% — which produced GDP gains — with less and less to show for their time and effort.
Finally, the third reason for the decline in machine-age growth was that the feds were gunking up the gears. It got harder and harder to start a new business and compete with the big companies.
Day after day, laws and regulations were added to the books. Month after month, companies found they had more rules to comply with and needed more unproductive staff — lawyers, accountants, clerks — to keep them from running afoul of the regulators. Some estimates put the cost of this drag at about $50 trillion per year.
The numbers are all over the place… and very speculative. But there is little doubt that much of the economy is sinking into The Swamp of paperwork and regulation… and that it would be growing much faster if there were less of it.
What happened to the Brave New World? Where’s the New Era?
Isn’t new technology making us richer all the time and at a faster and faster rate? Won’t it make regulation, declining marginal utility, funny money, debt, dumb politicians, and negative rates all irrelevant?
Tune in next week for more.