Completing a review of last week not just inside economic performance but extended to the realm of theory landed on an article written by Brad DeLong about his changing characteristic of the US and global landscape. Mr. DeLong is noted for being a Keynesian of the first order, a fellow traveler and compatriot to Paul Krugman among others. So it was very noteworthy just in that context to see this UC-Berkeley professor and research associate of the NBER to proclaim what he calls the “Lesser Depression.”
This is not some historical exposition of a time well past but of intriguing interest, rather his evolutions now center on right here, right now.
Finally, in mid-2009, it was dubbed the “Great Recession.” And, with the business cycle’s shift onto an upward trajectory in late 2009, the world breathed a collective a sigh of relief. We would not, it was believed, have to move on to the next label, which would inevitably contain the dreaded D-word.
But the sense of relief was premature. Contrary to the claims of politicians and their senior aides that the “summer of recovery” had arrived, the United States did not experience a V-shaped pattern of economic revival, as it did after the recessions of the late 1970s and early 1980s. And the US economy remained far below its previous growth trend.
He makes some rough calculations about the extent of “lost” economic activity in this lackluster and deficient “recovery”:
Cumulative output losses relative to the 1995-2007 trends now stand at 78% of annual GDP for the US, and at 60% for the eurozone. That is an extraordinarily large amount of foregone prosperity – and a far worse outcome than was expected. In 2007, nobody foresaw the decline in growth rates and potential output that statistical and policymaking agencies are now baking into their estimates.
By 2011, it was clear – at least to me – that the Great Recession was no longer an accurate moniker. It was time to begin calling this episode “the Lesser Depression.”
That, unfortunately, isn’t the end of it. Now, “unexpectedly”, economic traction appears to be stubbornly absent even after numerous and global interventions. With Yellen’s Fed deceptively moving toward the end of QE, what was once unthinkable has become the most likely case. Using his former calculations as a base line, DeLong now believes that if it takes another five years to return to “potential” the total cost to the “North Atlantic” economy would be about $20 trillion in lost output. If that trend persists, the total cost might reach $35 trillion.
Those are staggering figures that speak about the true “cost” of this recoveryless age – the downside of compounding. The longer it takes to return to the prior trend, or what he calls potential, the worse off it gets not just in pure dollars and cents of opportunity costs but in the bend of actual trajectory of potential itself. The economy isn’t just malfunction, it is malforming to a massive degree, reducing the capacity to grow not just in the immediate period but further and further into our dimming future.
This has become quite a topic of late, something that was never much believed to be even a trivial possibility. The current wording for it is secular stagnation.
It is very interesting that Brad DeLong is raising just this possibility since there is much about what is transpiring now contained in a detailed (and, of course, regression-laden) paper he published in 1988, co-authored by, who else, Larry Summers (Mr. Secular Stagnation himself).
Previous explorations of macroeconomic performance in historical perspective have focused either on the volatility of output about trends or on the volatility of changes in output. But volatility is not the relevant measure if, as Keynes and the early Keynesians believed, successful macroeconomic policies fill in troughs without shaving off peaks. [emphasis added]
That characterizes very well the current orthodox view on “proper” responses to what DeLong and Summers call “volatility” in the economic cycle. Because the variation in cycle is temporary and contains nothing of longer-term implications for economic trend and potential, the government response of “automatic stabilizers” (deficit-financed spending for the sake of spending) as well as coupling “stimulative” monetary policy can, they assume, reduce the volatility of the cycle and produce much benefit – fill in troughs without shaving off peaks.
That sentiment was not uncontested, and certainly remains so. Opposed to the idea is the realization that the economy interrupted by such waste can and does experience long-term erosion. Give any plant artificial stimulus and it will bend over backwards to grow towards it; remove the artificial source and the plant will die if bent too far , too long. The modern economist sees nothing of value in the natural view as extended into the economy. Again DeLong and Summers:
That the business cycle consists of repeated transient and potentially avoidable lapses from sustainable levels of output is a major piece of the Keynesian view: there is often room for improvement, and good policy aims to fill in troughs without shaving off peaks. This Keynesian view stands in opposition to the natural rate view that the business cycle is due to expectational errors that alternately push the economy above and below its sustainable growth path. This natural rate view implies, even in its variants most hospitable to Keynesian concerns, that the scope for macroeconomic policy to affect welfare is small. [emphasis added]
I suppose there is some comic irony in having both Larry Summers and Brad DeLong in 2014 being the most prominent and visible economists openly opining about a “Lessor Depression”, including some eye-opening (if valid) estimates for lost economic opportunity. They are, after all, two of the most prominent and visible economists that made the argument compelling for mainstream adoption that “shaving off the peaks” was not a realistic danger or downside to policy intrusion. Yet, here they are talking specifically about exactly that!
Despite all of it there is no connecting of the dots, at least not externally (perhaps internally there is much more honesty and fewer convolutions). They wrote more than a quarter of a century ago that the Great Depression “proved” the artificial view.
The Great Depression alone provides sufficient evidence to reject the claim that the canonical shock to production is a permanent one. Changes in potential output are presumably permanent and persistent, while changes in the output gap are likely to be ephemeral and transitory.
Innovation in no uncertain terms clearly has that effect on economic potential; at least productive innovation. Once adopted broadly, advances in technology and processing provide a lasting boost to productivity and efficiency, as well as creating new outlets for resource utilization and opportunities for additional advance and adoptions – including the birth of brand new industries never before imagined. That is the power of true capitalism, to create something that never existed and then deliver it in the form of not just goods and services but widespread, strong and, most critical, sustained societal advance.
In the past forty years it should be of much more noteworthy consideration that innovation has taken a new course. Something other than productive innovation has transplanted itself, almost like an artificial infection upon the global edifice of commerce. Many people like to think that we are not very long removed from great innovation, the internet and computer revolutions that permanently altered, for undoubted good, the economic trajectory much like Summers and DeLong described above. However, the innovations that made the computer and internet possible occurred in the 1950’s and 1960’s, taking decades to work their way into full and broad adoption by the 1990’s.
What has occurred in the 1980’s and forward in terms of innovation? About the only revolutionary advance to bend the world’s trajectory has been the death of traditional banking and its replacement via modern shadow means – wholesale money that transcended banking to the point of completely altering the means of global trade. The replacement of gold via debt-based “money” in eurodollars is the only revolutionary advance to have such a great effect.
Unlike productive innovation, though, financial innovation contains that drive for debasement and monetarism, the corruption of natural function with artificial activity for the sake of activity – waste. It makes intuitive sense that the accumulation of so much waste and wasted activity would be so harmful to a system that depends (or used to) on profitability. From that observation there is no great leap to seeing how economic potential might, like the artificially stimulated plant, become curtailed.
It has to be more than a little unnerving for these men to make these observations. It seemingly violates the very tenets that they laid out to justify the increasing intrusions of “stimulus”, and thus leaves behind now, going all the way back really to 2000 in terms of obvious bends, great difficulty in maintaining logical consistency – no matter how statistically valid their regressions (and they presented a few). To them, the natural view was easily dismissed in 1988:
It is plausible to argue that policies aimed at filling in troughs might impart to the economy an inflationary bias that may well have costs. If that is so and if demand management policies cannot provide significant and have not provided positive welfare benefits, macroeconomic policy should ignore indicators of economic slack and instead strive for “sound finance,” should attempt to do no more than provide a stable and predictable environment in which private agents can make their economic decisions, and should leave the unemployment rate to find its own natural level.
This line of argument is compelling if one accepts the premise that demand management policies affect not means but only variances. But we see no reason to have confidence in the correctness of this largely unexamined underlying premise.
The first paragraph in the quoted passage above feels so very much right at home in 2014. I cannot help but wonder if their rejection of it in the second paragraph is more than a little uneasy right now given all that has transpired. And really the basis for that rejection boils down to the lack of regressions (“unexamined”) that “prove” what is really common sense.
That is the state of modern economics, where common sense is rejected in actual observation because it is not made within a statistical computation. Pity the state of the world turned upside down, this new age of “science” where regression is believed as such and observation instead just an excuse to deliver “unexpected” excuses.
Click here to sign up for our free weekly e-newsletter.
“Wealth preservation and accumulation through thoughtful investing.”
For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, contact us at: [email protected]