This is what depression era politics looks like

As I’ve mentioned before, for the past several years I’ve been working as a sell-side macro strategist in the banking world. All this means is that I help clients of the bank I work for to better understand the financial markets and make good investment decisions.

Oftentimes the most stimulating aspect of the job entails having broad conversations with clients about the global economy, given that what happens on that level weighs so heavily on the price of pretty much every financial asset. Right now there is a clear sense of pessimistic resignation among most of the clients I speak to, as more and more of the investment community comes to grips with the frustrating reality of the post-crisis economy. Europe and Japan appear to be dealing with a perennial threat of deflation. China is, at best, gradually slowing from its previously unsustainable pace of growth. Even the US, a relative shining light among developed country economies in recent years, is struggling with stagnating wages, especially for the poor and the middle class. Though few think to use the term, I personally think the period we’re in now may be classified by future economic historians as a global depression, one milder than what we experienced in the 1930s, but with the same features of sluggish demand and weak growth and inflation for years on end.

Lately these conversations have steered towards the question: How do we get ourselves out of this mess? There are no easy answers. That’s mostly because, like many things in life, the technical solutions are relatively straight forward, but the social and political backdrop makes those solutions essentially impossible.

To take an example, since the crisis in 2008, central banks have pulled out all the stops in an effort to boost growth and prevent inflation from turning negative. The first step was to cut their key interest rates in an effort to encourage investment and spending. But eventually many central banks hit zero or close to it, and the conventional wisdom was that banks’ target interest rates couldn’t go negative. So a number of central banks tried pulling other levers, given that cutting rates alone wasn’t doing the job, only to find that even this mix of policies wasn’t enough. Now policy makers are debating whether or not to cut interest rates deep into negative territory, an uncharted policy territory which may finally ward off deflation and kickstart the economy, but may also risk destabilizing banks and making the whole problem worse.

You get the point. There is a sense of desperation on the part of many of the officials around the globe in charge of monetary policy. Their bullets have essentially been fired, their caches emptied. And now they are scrambling for whatever other flotsam and jetsam they can throw at the problem.

So what is the solution when the usefulness of monetary policy is all but exhausted? For most of the clients I speak to (and I would agree), it’s fiscal expansion. As the argument goes, if loose money policies aren’t enough to get demand going, then maybe some combination of cutting taxes and increasing government spending should be next. Most economists see this as reasonable; these policies would increase debt levels, but then again, so would lackluster growth in a scenario in which we tried nothing. And besides, rather than expressing concern about too much debt, markets these days are practically begging governments to borrow and spend more; at the time of writing, Japan — a country with a debt level double its GDP — can borrow at negative interest rates going out ten years.

Here is the point: Politics makes a badly-needed policy intervention such as this one essentially impossible. As economic outcomes stagnate — unemployment remains high, real wages fall, etc. — democracies don’t tend to sway towards loosening the fiscal reins. Canada under its new prime minister, Justin Trudeau, is a notable exception to this. But it is very much an exception. In Europe, the UK, and the US, major political movements have emerged urging governments to tighten their belts, rather than let loose. You can blame part of this phenomenon on the preferences of very wealthy individuals with disproportionate political power, who might push policy away from anything that risks expanding the size of the state or making the tax code more progressive. But I’m convinced this isn’t the whole story. The concepts of belt-tightening and “making due in tough times” are easily understood by the typical democratic voter; the concept of a fiscal multiplier for economic output is not. So when economies face those tough times, politicians can signal their credibility, trustworthiness, and discipline by extolling the virtues of fiscal modesty and “pulling ourselves up by the bootstraps”. That such austerity actually drives an ailing economy further into the abyss is seen only as a minor nuisance along the road to political victory.

As if this reality — that politics seems intrinsically biased towards pulling back on the fiscal  reins at exactly the wrong moment — wasn’t depressing enough, the case of migration gives us another example. As I discussed in a recent post, all developed economies need some influx of workers, including the unskilled. The cases of Europe and Japan are especially dire; as the working age population shrinks in these places, generating demand and fighting deflation become considerably more difficult. Yet, the common response within democratic societies during bad times is to restrict the inflow of workers rather than expanding it, as we commonly rush to point the finger at immigrants and other foreign governments for our economic problems. Europe is nearly fracturing over this issue as swaths of Syrian and other refugees flood into the continent. Despite the continent’s desperate need for more young workers, it is abundantly clear how the European electorate feels about immigration. From the UK’s flirtation with exiting the European Union, to Germany’s recent regional election results, to the multitude of countries within the EU openly challenging its principle of free movement, the writing is on the wall. Here in the US the situation is somewhat similar, even as our population issues are less dire. It’s not a coincidence that both major American parties now feel more emboldened to rail against globalization and free trade, and that one particular party’s front runner has made building walls between us and them — in quite literal terms — the flagship idea of his campaign.*

Things are getting particularly scary, I think, because people are slowly coming around to the reality that democracy lacks built-in mechanisms to deal with these phenomena. A lot of investors had this feeling, as did I, in mid-2011 when a handful of US politicians nearly crashed the world economy by refusing to allow a rise in the nation’s technical debt ceiling. This near-catastrophe was brought together by a match made in hell: voters who didn’t understand the debt ceiling concept, wrongfully assuming it to be associated with government profligacy using the simple logic of “more debt equals bad”; and politicians eager to capitalize on this misunderstanding, willing to vote for economic calamity in an effort to ingratiate them to their constituents. The crisis was averted at the last minute, but the episode sent a chilling message: There truly are no adults in charge.

Our current economic challenges are creating a similar dynamic, but one that is much more permanent in nature. After a generation of stagnant wages and nearly a decade of post-crisis economic malaise, voters are understandably mad as hell, with that anger now able to be sharpened into a devastating weapon in an era of instant communication and ubiquitous social media. In previous eras, perhaps, business elites and captains of industry might have been able to rein in this type of destructive populism. That effort is very much in full force this time around, in both the US and Europe, but this time voters don’t seem so easily pacified. How could they, after so many years of failed economic promises that seemed only to line the pockets and strengthen the influence of the wealthy and powerful? To suggest that elites must now wrest democratic control from the angry mobs now seems laughably naïve at best, and suspiciously nefarious at worst.

Now more than ever, the combination of dishonest, opportunistic politicians; poorly-educated, apathetic, and easily distracted voters; and a feckless, click-baiting press threatens to render democracies powerless to solve their most urgent problems, and the issue of the economy is now serving as a perfect illustration. There is no Superman swooping in to deliver us to safety, no handsome and charismatic politician who promises to make it better, if only we might give him our vote. The solution will take something deeper, a personal and moral accounting on the part of every citizen, as we decide what kind of voters we want to be, what kind of elected officials we deserve, and what kind of journalists we entrust with the truth. That is, it requires an honest look in the mirror on the part of all of us about the ruptures in the democratic fabric and the personal efforts we must all make to repair them. Otherwise, years from now we may look back at this moment as the good times, when the cynical spiral of economics and politics was just getting underway.


*Turning more protectionist towards trade or restricting immigration isn’t necessarily a cyclical economic issue the way fiscal policy is. The point is that to avoid long-term stagnation related to an aging population and a shrinking workforce, Europe and Japan need more young people coming from foreign countries, not fewer.


The fine line between risk and patriotism

NYSE American flagWhen my dad asks me what he should invest in, I answer as I would for any man in his early 70s: Anyone of retirement age (in my dad’s case, gradually easing into a kind of semi-retirement) should take very little risk. If you’ve worked your whole life to build enough money for your golden years, the last thing you want to do is risk it all. So safe things like short-term Treasury bills make a lot more sense than going all in on stocks.

I learned this basic truth when I was a twenty-year-old one summer working for a retail brokerage office. I also learned that if a financial advisor failed to recognize his client’s proper risk profile and was too reckless with his recommendations, that financial advisor and his firm could be sued for damages. This point was further pounded into my brain several years later as I earned my regulatory certifications to work in the financial industry, and went through tireless bank compliance modules. You get the point: It’s kind of a big deal not to take risks with the money of a person who doesn’t fit the risky profile.

For that reason, when I overheard the following conversation on a financial news show one morning, blaring in the background from one of the trading floor TV monitors as I settled in to work, something didn’t feel quite right. The conversation was between one of the show’s regular anchors and its guest for the day, a former top executive of a major American auto manufacturer who was preaching optimism over the US stock market.

Host: How old are you?

Guest: 82.

Host: You’re 82 and you’re investing in equities! Every financial advisor in the world, right, says that you’ve gotta buy bonds when your sixty-plus because, God forbid, you lose your capital. Eighty-two years old and you’re confident enough to invest in the stock market.

Guest: I’ve got a very good investment advisor, my father lived well into his mid-90s, I’m healthier at this point than my dad was…

Host: You’re not afraid of the capital risk?

Guest: No, hell no. Nothing ventured, nothing gained. I have a fairly expensive lifestyle. I’ve own airplanes and a lot of cars, stuff like that, so I’ve gotta keep the money flowing.

Host: I’m gonna rip my shirt off and paint an American flag on my chest right now. That’s great.

The most remarkable thing about this conversation is not that a man in his early 80s with, I assume, hundreds of millions of dollars in net worth, feels he has to stay invested in risky assets to fund his “fairly expensive lifestyle”. No, the most remarkable thing is the host’s “American flag on my chest” response. What, exactly, does an old man taking on an unusual amount of financial risk have to do with America?

I suppose there is a spirit of risk-taking and pushing the envelope that’s part of our historical narrative as a country — from Colombus, to the Puritans, to the Western settlers, to Neil Armstrong, to Steve Jobs. But at what point does good-old-fashioned American risk-taking become good-old-fashioned American financial recklessness?

The Chinese boogeyman is too poor to be scary

Yasheng Huang is one of my favorite voices on China, and his recent Foreign Policy op-ed is a must read. In it, he makes the case that democratization is not only a moral imperative, but is in the best interests of both the larger Chinese populace and the Communist Party elite.

One of the things that Huang does in this piece is to dispel the notion that the Chinese government has discovered some superior economic formula. Sure, the market reforms of a generation ago set China up for decades of near double-digit growth. But as Huang lays out, that’s mostly a function of the fact that at the start of that period, China had a lot of catching up to do after years of stagnation. And Huang also reminds us that the typical Chinese citizen remains extremely poor as of today, even after so many years of rapid economic expansion. Here’s an excerpt:

Yes, in the last 30 years, China has done a remarkable job of lifting hundreds of millions of people out of poverty, but we must keep this achievement in perspective. One reason the post-Mao leadership lifted so many people out of poverty is because Mao Zedong kept so many Chinese poor. (In 1979, showing remarkable candor, the Chinese Communist Party itself publicly acknowledged that per capita grain consumption of Chinese remained stagnant between 1957 and 1978.) Second, the poverty threshold is commonly defined as living under $1 a day. Living above that line is an improvement — not prosperity. Based on data provided by the World Bank in 2008, roughly 30 percent of China’s population, or 390 million people, lived below $2 a day. By this measure, China has a comparable percentage of people living in poverty as Honduras, a country that never experienced China’s rapid GDP growth.

Besides, China’s overall performance in the last 60 years does not stack up well against its neighbors. Since World War II, the most successful economies have all been in East Asia: Japan, South Korea, Taiwan, Hong Kong, and Singapore. There are three exceptions to this East Asian rule of success: China, North Korea, and Mongolia. The first two are led by communist parties, while Mongolia was communist from 1924 until 1993. So the appropriate question is not why China has grown so fast in the last 30 years, but why it is still so poor compared with other countries in the region.

This point appears to have been lost on most people here in the US, who seem to believe that China is growing faster than we are because it is either working harder, cheating, or benefitting from the government’s more active role in the economy.

There is some truth to the cheating thing, but it is overblown. There are legitimate issues with regard to how the Chinese government addresses intellectual property and how it deals with foreign companies operating onshore. But the “currency manipulator” thing is no longer relevant; China’s trade surplus of recent years (the point of maintaining an artificially weak currency) has essentially vanished, and policymakers there are actually moving deliberately from a fixed to a floating exchange rate regime. You can comfortably make the case that Brazil is twice the currency manipulator that China is at this particular juncture. The notion of “declaring China a currency manipulator on day one”, as we in the US became accustomed to during this recent Presidential campaign, sounds catchy but doesn’t have much substance.

The point is, theory suggests that poor countries are supposed to grow faster than rich ones, and this is exactly what we see in real life, at least in the case of China and other less developed countries that have functioning free market economies. To ignore this reality, as many politicians and even some academics tend to do, would be to tacitly accept a world where the gap in living standards between rich and poor remains in place forever. That’s not the world that I, or most people I know, want to live in. And it’s certainly not consistent with the Baha’i vision of a world without today’s extremes of wealth and poverty.

Though it’s important to note that Chinese growth has slowed in recent years (the consensus is about 7.5-8.0% for 2012), we should be celebrating, not decrying, the fact that it is outpacing that of the US and other more developed economies. This is not just a matter of economic principle, but the right of the world’s poor to achieve something better than they have today, either for themselves or for the generations that follow.

Democracy can not save you now

From the famous film “Mr. Smith goes to Athens, Subsequently Disappointed by Lack of Governing Coalition in Favor of Austerity Measures”

(I was going to add a “muhahaha” to the end of the title of this post for dramatic effect, but figured that would be overkill.)

One of the excellent news shows on TV here in the US is Fareed Zakaria GPS, which airs on CNN on Sunday mornings. I don’t always agree with Fareed on everything, and a couple of his regular guests make me want to throw the remote at the TV sometimes, but more often than not the show tackles important global issues better than any other on American TV.

Last Sunday Fareed started off the show talking about the European sovereign crisis. One thing he said in particular caught my attention:

This is a sad state of affairs because what many people are worrying about, at root, is whether democracy has become part of the problem. After all, politicians have gotten elected over the last four decades in the West by promising voters more benefits, more pensions and more health care. The question is can they get elected offering less? That’s what stops many Europeans from abandoning austerity and embracing another round of stimulus spending. And I think these worries are shared by many in the United States as well.

This is basically a reaction to the French and Greek elections from a couple of weekends ago. If you’re not up to speed, here’s the gist of what happened: Recently the most seriously indebted European country, Greece, was granted a write-down of its debt financed in large part by the other Eurozone economies, notably Germany and France. In exchange, the Greeks were required to write into their constitution certain painful “austerity” measures, basically aggressive tax hikes and budget cuts that are making the current recession there worse. This is in hope that Greece will be able to, down the line, pay the portion of debt it still owes after the write-down.

So what happened? Earlier this month French President Nicolas Sarkozy, who along with German Chancellor Angela Merkel made up a powerful political duo in favor of keeping the Eurozone together via this sort of austerity-for-bailouts strategy, failed in his reelection campaign against the Socialist challenger, Francois Hollande. Meanwhile, the governing coalition in Greece which originally agreed on the painful austerity measures as part of the debt deal lost a significant number of seats to parties which openly reject the plan, and the coalition in favor of staying on course has fallen apart for now.

This is a long-winded way of explaining what Fareed means: In Western democracies, politicians get elected and stay in office by offering more, not less. So even if harsh austerity measures enacted in hopes of getting a country’s fiscal house in order are the right way to go, they may be politically impossible to see through to the end. (Whether or not such austerity will in fact allow countries like Greece to achieve a sustainable debt path is subject to it’s own debate.)

The broader point about democracy’s inadequacy to deal with these problems is extremely valid, and that’s the whole point of this post. There’s a key flaw in the argument above, however.

Here it is: Greece was pretty much the only Eurozone country where politicians lavishly showered voters with goodies in hopes of getting re-elected, at the cost to the nation’s balance sheet (and hiding the extent of debt with the help of a major US investment bank). The other countries were not in bad shape prior to the 2008 crisis; it was the crisis and the subsequent recession that caused the debts of these countries to explode via lost government revenue, automatic payments to the swelling ranks of the unemployed and the poor, and bank bailouts. I get the point that no politician wants to pull the plug on the party, but the rest of Europe is very different from Greece.

This is an important point, and the reason why is not because, outside of Greece, democracy has functioned well. It’s that what occurred in Greece pre-crisis — dishonest, reckless spending for the purpose of political gain — is not the only type of democratic failure that has gotten us into this mess, and is making the apparent prospects of digging ourselves out of the hole so dismal.

This whole European sovereign saga makes more sense (and is unfortunately more depressing) when you recognize what it really is: a horrible aftershock of the 2008 banking crisis. And that crisis tells us a lot about where democracy went, and is still going, wrong.

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Amid the European turmoil, another chapter in unavoidable unity

This guy is probably not thinking about the oneness of mankind

There has been some major nail-biting in the past several weeks over fears of a financial crisis emanating from Europe. This is not new; for more than a year we’ve had some understanding of Greece’s dismal fiscal outlook, as well as the possibility for a dangerous contagion to other vulnerable peripheral Eurozone countries. But in the past several weeks these fears have worsened amid concerns that a Greek sovereign default is imminent, and that European banks are more exposed and less well capitalized than previously thought. This situation is frightening to say the least, especially as government balance sheets around the world are so stretched that the type of massive fiscal response that we saw in 2008 is pretty much out of the question. Now there is legitimate chatter about the possibility of a crisis worse than the one we just experienced. Continue reading