Secular Stagnation, QE and Quitting the Fake Stuff
April 29, 2015
It is the era of the endless reboot. That is all the reason needed to rehash the theme of “secular stagnation”—a reboot of an idea by Alvin Hansen in the 1930s—despite the shimmering, innovative, genius retelling of it by the likes of Larry Summers and Ben Bernanke. Yes, I managed to say this with a straight face.
Secular stagnation is at its essence the implication and explanation for über-low interest rates. Start with the belief that underlying changes in saving and investment fundamentals cause a chronic shortfall in aggregate demand by lowering the “natural” rate of interest (perhaps a bogus concept) below zero. This natural interest rate is the interest rate consistent with full employment. The fall of the natural interest rate into negative territory is an obstacle to recovery because it prevents monetary policy from being effective, given there is a zero lower bound on nominal interest rates. Consequently, the actual real rate of interest remains persistently above this hypothetical natural rate, causing chronically depressed investment demand that plunges the economy into a low growth equilibrium trap.
Alvin Hansen posited that this was ultimately due to declining population growth. When this base growth rate goes negative, expansion goes into reverse. This has some appeal intuitively. If there are less ant running around in the colony, there is less need to forage all over the place feed larvae and such. The energy level declines as the count declines. All magnitudes related to this energy level—such as interest rates—drop through the floor.
Other variations on the root cause of secular stagnation center on productivity (read labor-saving technology advances) outstripping the need for labor and capital. This depresses wages, interest rates, and ultimately demand. Like a Luddite’s worst nightmare, parts of the economy feed on other parts—making the howl thing suffer in a rheumatoid way.
There is something to the point. Even 100 years ago 'labor saving machinery' was moving productivity far beyond outputs needed simply to survive. And if productivity increases at 3% per year, it doubles in 24 years. So over the 80 year life expectancy of an American, the implication is that life has pretty thoroughly changed in its external modes. This also explains why we are so saturated with goods that are increasingly pretty much useless. I mean, seriously, the difference between an ipad 6 and a 7 is pretty miniscule objectively speaking, save the margins are fatter on version 7. My point here that an endless stream of such luxury purchases of “crap” may not in the end be self-sustaining, especially when costs of production are lowered to next to nothing and there are fewer consumers to go around.
The gap between cost and price has to date been filled by increasing scale. Say my grandparents lived in a 900 square foot house with asbestos shingles as siding. Say my parents lived in an 1800 square foot house with vinyl siding. Say someone is trying to sell me a 3200 square foot brick house. One day my kids may decide that enough is enough and decide they can live quite comfortably in 1800 square feet. At that point all the banks that would be loaning me money are basically trying to sell a 2015 product to a 1970s consumer. An economic dislocation to be sure, but one of right-sizing to changed lifestyles and expectations of what life is all about, yes?
So now we get to the essential features underlying it all. The problem is not secular stagnation as much as the problem is with the belief in some sort of "natural" equilibrium rate of interest in the first place, some market-based center of gravity to which markets gravitate too in spite of all the efforts of men to fight it. Sure feedback loops exist, but these are a far more general and more model-free concept consistent with the observed facts.
There is a far simpler, verifiable, and ultimately more meaningful explanation for the yarn called secular stagnation. Central banks have bought huge stocks of existing government debt at the short end. For instance the Fed owns 70%+ of all maturities for some years on the shorter end. The effective pricing power in bonds is thus derived from the cumulative QE measures that have taken supply out of the market. For lack of available short-term paper to buy (and arguably to create some breathing space for money markets before they completely asphyxiate) central banks proceeded to buy up the long-end for lack of other paper to buy. Any flight to Treasuries due to Yellen talking rate hikes or carry trade unwinds from EM into USD, rate drive even lower (especially on the shorter end) because of the constrained supply.
This explains the term premium being so low (measured by 2s10s or 10s30s) far better than more elaborate theories like secular stagnation. Rational bond buyers are far more willing to lose some compensation for term risk in exchange for deeper liquidity once rates do rise. It is arguable that you will receive enough credit risk compensation to lure buyers into less deep markets such as HY or EM debt. Gradual withdrawal does not affect all sectors evenl and treasuries are time and again the safest place to put money.
The ultimate explanation driving the overwhelming efforts to keep interest rates pegged so low is not due to Hansen or any of those retelling his original story. It is summed up in the first sentence of Keynes’ Economic Possibilities for our Grandchildren: “We are suffering just now from a bad attack of economic pessimism.”
This is as simple as it is true. Population growth low? Diminishing number of consumers to fill the void
Keynes inveighs that all these events are in aggregate about people not feeling go about themselves, their future, or each other to make babies. We need some change in mode fo being to pull us all out of Bummerland. Something bigger than the umptennth rendition of the ipad. Perhaps it is as simple as a good night's sleep instead oftaying up late to catch something on cable. Exercise and sunshine instead of candy crush. Manners and ways that foster the likelihood of meaningful communication instead of watching porn.
Maybe I sound like a pie-in-the-sky goofball. Weaving a tale of endemic stagnation around central banks cornering the market sure is just as goofball.