Economic Growth Won't Improve With Current Government Policies
Fifty-five years of credit inflation and the world finds itself in a position where economic growth is basically pathetic, labor productivity growth is nil, and inflationary expectations are low and tending to fall.
The Keynesian idea of inflating the economy with credit created spending, at first, to shorten recessions, and then to spur on faster economic growth appears to be bankrupt.
Budget deficits in the United States, and elsewhere, reached record levels during the Great Recession and the following period of economic recovery. Monetary ease has experienced three rounds of quantitative easing in which more base money has been injected into American banks by the Federal Reserve System than even before in the central banks' history.
Yet, economic growth over the past seven years of the current recovery has only achieved a compound annual rate of increase of slightly more than 2%. The increase in labor productivity in recent years is around zero. And, inflationary expectations, as estimated from bond markets, are only around 1.4%-to-1.5%. Business capital expenditures during the current economic recovery have been anemic, at best.
Still money flows, not only in the United States, but throughout the world, are humongous and have distorted interest rates in major ways.
During the financial disturbances at the start of the year, so much risk-averse money flowed into U.S. Treasury notes seeking a safe haven that the yield on the 5-year Treasury's Inflation Protected securities, dropped below zero in late February. The yield on the 5-year TIPs has remained negative up to the current time. Less than a week following the British vote to leave the European Union, yield on the 10-year TIPs fell below zero and remained there for about two weeks.
The experience this year was not unlike what happened to financial markets during the early stages of the current economic recovery as risk-averse monies fled Europe and elsewhere and found a safe haven in the United States. The yield on the 5-year TIPs dropped into negative territory in September 2010 and mainly remained there until September 2014. The yield on the 10-year TIPs dropped into negative territory in April 2011 and stayed there until June 2013. Huge amounts of money were transferred internationally during this time.
Then, there have been concerns during the period of the economic recovery about asset bubbles in commodity prices, in the stocks and bonds of emerging nations, and in housing.
The point is that there is lots and lots of money floating around the world, but it seems to be flowing towards assets and not toward the investment in business capital in order to improve labor productivity and production.
In fact, much of the money flowing into corporations these days seems to be going to buy back stock or to increase dividends, efforts to inflate a company's stock price.
The point is this: Governmental policy of credit inflation has produced incentives that have encouraged the practice of financial engineering and financial innovation and distracted businesses from their previous focus -- producing goods and improving productivity.
Unfortunately, if governmental efforts to continue policies that create credit inflation, money will only continue to flow around the financial circuits of the economy and remain outside the industrial circuits where goods are produced.
Investors have learned over the past fifty-five years that credit inflation can produce returns that are more certain than the returns earned by investing in physical capital. This is particularly true if you have a central bank, like the Federal Reserve System, that places a "put" under asset prices, like, for example, the so-called "Greenspan put" for stock prices. Certainly, years of experience stand behind the investor's mantra, "don't fight the Fed."
It is a fact of market behavior that if something can be predicted, like the continued presence of the government and the economic policy of credit inflation, that businesses and investors will come to expect this perpetual support and will place their bets accordingly.
But we see that this economic policy has led to an economy that only produces mediorce economic growth, declining increases in labor productivity, the stagnation of wage income, and low rates of labor force participation.
These were exactly the things that continuous credit inflation was supposed to eliminate.
Now, however, we are in a tough economic spot. Businesses and investors have built up expectations over the past fifty-five years that government will continue to press forward with more credit inflation. But, if the government continues to do so, it will only exacerbate the current situation.
However, to break these expectations will be very difficult. And, in breaking these expectations, the economy and the people that work within the economy will have to go through an extended period of restructuring. This restructuring will result in a lot of pain.
Breaking expectations is not an easy thing and cannot really be done gradually. Politicians just do not want to be held responsible for this kind of economic stress and pain.
That is why economic restructuring usually takes place after an economic collapse that follows some kind of market break, like the disturbance produced by the sub-prime mortgage market in 2007. And, even such a market break may not produce a change in focus. Policymakers responded to the Great Recession with basically a policy of more of the same.
One can only concluded, therefore, that continued mediorce economic growth can be expected in the future, until, of course, there is a market break leading to another severe economic disturbance.
This article is commentary by an independent contributor. At the time of publication, the author held TK positions in the stocks mentioned.