Several
people have asked me to clarify my position on US politics, specifically the US
presidential election. This election year has been fascinating to me, as I
think it has unveiled many of insidious underlying issues affecting our
country. My fundamental concern for several years now has been the ability of
politicians to shift from populist/corrupt bargain tactics of higher growth
decades, to the present period of steady state global global growth (often
referred to as “run-rate”) and demographic shift. It is absolutely imperative
that politicians come to together to resolve an econopolitical status quo which
will, with near certainty, turn to a structural trap without careful
reform.
A structural
trap is defined by Angel Ubide and Robert Dugger as an economic condition under
which capital is unable to shift from unproductive to productive uses due to
exogenous constraints rather than lack of liquidity (for non-finance people:
ease of convertibility to cash). Dugger and Ubide described correctly our
global economic conditions nearly 10 years ago in the paper Structural Traps, Politics and Monetary
Policy (http://www.hanoverinvest.com/pdf/StructuralTrapINFI_00701007.pdf). In simplest form, a structural gap
is unique in the sense that it confuses central bankers, investors and other
parties and bears similarity to a liquidity trap where an economy slogs around
at low growth and low inflation perpetually, perceptually because of an
inability of the monetary authority to lower interest rates without creating
dis/deflationary expectations. A liquidity trap may be resolved fairly simply through
a combination of monetary and fiscal measures including lower benchmark interest
rates (through unconventional policies), open market operations/lower required
reserve ratio, and larger fiscal deficit. A structural trap is a condition
under which any of these factors are immutable due to outside constraints-
principally politics. Political obstruction has the incredibly deleterious
effect of maintaining structural imbalances right at the times where they are
gathering the most steam.
In the US,
political obstruction is mostly a recent phenomenon and if one were to look at
global political history the same analogue would tend to hold true. The
government is least effective when forced to tread the line between what is
good for the country and what is desired by its citizens (policy versus voter
interests). Political obstruction is
particularly common within countries approaching a crossroads between periods
of high growth, political corruption, and public ambivalence, and the problem
tends to compound the longer the growth period. Dugger and Ubide use the
example of the Japanese Lost Decade, as an instance of a structurally trapped
econopolitical system and I have summarized their case below.
Post WWll, Japan
was a benefactor of (a) global destruction of productive capacity (b) western
allegiance against the growing fear of communism and (c) enormous government
rebalancing towards infrastructure and R&D investment away from military
spending. Originally an unskilled exporter, Japan carefully worked up the
productive ladder as real household incomes increased over time. By 1985, Japan
saw diminishing returns from labor arbitrage as the corresponding rise in
incomes and inflation began to pressure corporate operating margins. Following
the Plaza Accord, the Japanese Yen began a sharp period of appreciation further
accelerating capital inflows leading to a highly risk seeking climate of
malinvestment in other lower order producers and a domestic asset price bubble
which popped when the Bank of Japan ultimately chose to increase interbank
lending rates in 1989. As asset prices fell, the government was
forced to step in and monetize failing state owned banks, who then bailed out
other “too big to fail” enterprises on their balance sheets, in turn creating a
vast array of unprofitable zombie companies employing many but producing little
value. The government was caught in a structural
trap as it could not allow state banks to collapse and spark a collapse in credit
and surge in unemployment, but inadvertently kept unprofitable low yielding
assets alive in an undead state, crowding out private investment and
inefficiently allocating tax revenues.
The
corresponding decade is often referred to by economists as “the lost decade”
where the Japanese government attempted a number of alternative monetary and
fiscal policies but was unable to spark pre-1980s growth levels principally due
to demographic shift and resulting effect on lending practices. Paul Krugman argued that Japan’s aging
population and preference for saving only cozied existing undisciplined
relationships between corporations and commercial banks, who then engaged in
moral hazard with the implicit backing of the Japanese government. He argues
that Japan was stuck in a liquidity trap, or a condition in which nominal
interest rates could not be lowered due to proximity to the zero bound and
investor expectations of deflation (as had caused the spiral of the Great
Depression). In this circumstance, the best course of action would be a
combination of quantitative easing and running a larger fiscal deficit in order
to expand money supply and increase inflation.
Yet these
very policies have done little to resolve Japan’s prolonged growth crisis. In
recent years the obstacles faced by the Japanese government have yet to fade.
The Bank of Japan has engaged in enormous monetary easing going so far as
setting a negative discount rate in January 2016 along with enormous liquidity
injection via continued quantitative easing programs, yet core inflation has remained
muted along with 26 quarters of negative GDP growth since 1990 (or 6.5 years of
recession over a 20 year span, or once every 3 years versus the US, once every
9 years over same span).
Unlike
Krugman, Dugger and Ubide suggest the entire problem is circular in nature. The
aging of the Japanese population led to the election of “senior-friendly”
politicians who promised to keep pensions and retirement benefits intact,
necessitating the bailout of unprofitable zombie companies, and encouraging
bankers and corporate executives to continue borrowing frivolously without fear
of consequence. Additionally the story
for the Japanese now is no longer purely physical effects of poor governing,
but dangerous ideologies absorbed by people who have seen real wages decline
15% since 1997 peak levels. Working age
people who have seen incomes fade as goods and services remain prices remain
stable to rising feel compelled to save more given the rapid turns of the
business cycle over the last 20 years. Moreover, the working age population has
been forced to shoulder a progressively larger tax burden as the government
committed to accrued benefits (pensions, healthcare, social security etc.) even
in a period of slow growth. As a consequence, the marginal value of additional
policy has perpetually diminished as residents have internalized a
de/disinflationary low growth environment.
Lastly, the summation of rising liabilities and falling real wages has
dramatically decreased household formation and birthrates within the country as
these are both factors which an individual controls.
In a
structural trap, the econopolitical system collapses in a manner which perpetually
limits potential GDP, real wage growth and prosperity for vast majority of the
population. Though this may not be recessionary in a conventional sense,
structural gaps tend to shorten business cycles and further income inequality
allowing for the further mobilization of radical ideology by free opposition. I
want to dismiss any accusation that I am a doom and gloomer of any variety. I
actually believe Japan is close to emerging from its structural trap as its
population rebalances and the government is able to relax 20 years of
regressive tax and benefit policies. What worries me is that the US stands on
the opposite side of the cycle and has compounded substantially more wasteful,
corrupt, and unproductive expenditure and policy through 50 years of post-world
war boom.
The United
States government has for years followed a clandestine conman strategy of selling
people values in exchange for monies in form of special interests. Suddenly we
are hearing about this issue from every candidate as if paying lip service and
tabling personal paper trails will somehow convince voters with more
information at their fingertips than any other electorate in history. The issue
is that politicians for a large part have a dual mandate of inefficacy: (1) pay
masters for campaign contributions and assistance in getting elected (2) pay
lip service to voters and maneuver around taboo issues which destroy future
electability. Masters are largely a group on high net worth and powerful
corporate leaders and their vestiges, and paying lip service to issues such as
abortion, LGBT rights, gun rights, and amnesty is easy.
Structural traps tend to fall into the
category of taboo issues which destroy future electability. The big three are
(1) Interest on debt (2) Social Security (3) Medicare and Medicaid expense. Together
these three expenditures accounted for 61% of the Federal budget as of October 2015,
and holding a gross government expenditure levels constant, will account for 82%
of the total budget by 2024 (based on my models).
This entails an increase of roughly $836 billion dollars, or roughly 5% of GDP, which can either be collected via digging the hole deeper (1) more debt or (2) spreading the cost across the powerless electorate.
For political conmen (and women) the trap lies in the need to both appease
interest groups while simultaneously keeping voters satisfied enough to
maintain popularity. Funding liabilities with higher taxes and or more
restrictive breadth of services (defined time period for draws, raising social
security cap etc) while seemingly easy solutions, are a near political
impossibility in the current state of the major political parties. Democrats
(especially the common denominator) will never cut programs or reform their
application and risk losing minority and low income voting blocks. Republicans
will never raise taxes or reform existing program conditions asymmetrically
against the wealthy (e.g. making top 1% benefit exempt) creating a deleterious
standoff with citizens ultimately footing the bill.
We have
already seen this standoff rear its ugly head with the Federal Budget Crisis in
2012. It would be easy to blame this fiasco on the lunatic fringe which
ultimately administered the holdout, but this would be both incomplete and
ignorant of the equally nefarious nature of prevailing Democrats who squeezed
every ounce possible out of the lemon leading into office. The same concept of
politicization is the status quo in establishment politics – pit the President against
the ebbs and flows of economic noise (but noise within a 50 year positive macro
trend) while simultaneously either riding coattails or repudiating the success
or error of government intervention. As simply charted below, presidential
legacy is nothing more than a function of output, inflation, and required
government adjustment within context of party identity.
For example
the true reason Jimmy Carter’s legacy is viewed so poorly is mainly because he adopted
Nixon’s low rate budget deficit government AND expanded expenditure and
installed higher interest rates via Paul Volcker. He was ultimately martyred by
the Iranian revolution during which oil prices skyrocketed and inflation followed,
though he was a key motivator in finally electing and backing an independent
monetary authority unlike the corruption of Arthur Burns.
Consequently,
Reagan adopted a world of high inflation, with a couple quarters of hawkish
monetary policy (from Carter appointee Paul Volcker) which gave merits to
cutting government expenditure (money supply) and mild recession in 1982-1983
could be conveniently blamed on the Carter administration while the proximate
20 quarters of real GDP growth greater than 4.5% could be claimed entirely as
his. Obama has found himself in a
Carter-like situation in that while government expenditure has on balance grown
below historical average rates, real GDP growth has been weak. The media and
his opposition seized the moment to rail against nominal spending, largely
ignoring that Obama actually scaled back growth in discretionary non-defense
spending (the Neocon central component of wasteful big government)
significantly. Meanwhile cutting programs exclusively is not a Democrat forte,
and as such the big expansions have largely been watered down and ineffectual
government program reforms that even Democrats have shied from in recent weeks.
While Obama may be the most recent
example of political martyrdom, absent a political détente, the US faces a
difficult future with potentially persistent output gap which confusing central
bankers and eating disproportionally into the wealth of the middle class. While the manifestation of this gap
will be different than Japan due to cultural values and proclivities, it
nonetheless will fundamentally change the nature of the easy business cycles
the US has been used to following World War ll. I think there is only one character among the
group of Presidential candidates who can unpredictably grapple with opposition
and reverse momentum. I leave it to you
to think about this carefully. Masters would prefer to keep things the same and
so would the crony establishment who despite words are ultimately who they are.
