In response to an FT article by Larry Summers on 6th December 2015, entitled 'Central Bankers do not have as many tools as they think'
“While debate about the relevance of the secular stagnation idea to current economic conditions continues to rage, there is now almost universal acceptance of a crucial part of the argument. It is agreed that the “neutral” interest rate, which neither boosts nor constrains growth, has declined substantially and is likely to be lower in the future than in the past throughout the industrial world because of a growing relative abundance of savings relative to investment”
Firstly, we are not in a period of ‘secular stagnation’. We have been in the eye of a financial storm that started in 2007; we are we now entering the trailing edge, which will be presenting itself throughout 2016 in the form of state and municipal bankruptcies in the US, sovereign debt crises in emerging markets and increasing political disintegration in Europe.
Concentrating on the first of these - Municipal bankruptcies in the US: whilst the collapse of Puerto Rico finances has been partially reported, and the abysmal state of pension funds in Chicago and Illinois have received some scant media attention, these are the tip of the iceberg. On Thursday last week, Kentucky Retirement Systems announced that its public service pension pot contains a paltry 17% of what is necessary for full funding. This has fallen from 56% in 2007.
Here is what one interested party had to say about this - Jim Carroll, a member of an advocacy group called Kentucky Government Retirees:
“We’re in a disastrous cash position. We need help immediately from the next governor and the legislature. We’re in a fund that can’t afford any more market losses. There’s no cushion left. What happens if the market crashes is, we go flat busted, and then maybe a judge has to step in and order the state to make payments”
What does this tell us? It says if pension funds are this underfunded after seven years of a bull market in stocks and bonds, when the next downturn hits, it’s ‘game over’.
As an aside, it is interesting to note that Kentucky lawmakers keep their own state retirement accounts in a separate system, one that is 85 percent funded, and they have rejected calls to merge their pensions into the KRS. Politicians may be incompetent and ethically challenged, but no-one can ever accuse them of being financially illiterate when it comes to attending to their own bank accounts.
Secondly, there is no ‘abundance of savings relative to investment’ or ‘savings glut’ as Mr. Wolf prefers to call it. There is a massive surplus of leveraged credit built up throughout two decades of Ponzi finance from Central Banks, and facilitated by policy makers like President Clinton, Robert Rubin and Professor Summers, who gave the banks an unrestricted casino license when they abolished Glass-Steagall.
These aren’t ‘savings. They are gambling chips waived into existence by central bankers, used to purchase government debt and mortgage paper, and increasingly ETFs. The newly generated currency is then either deposited back at the Fed where it earns interest, or is leveraged to the sky at zero percent, where the ensuing credit, duly multiplied, is then channeled into the economy through, for example:
1. Carried to emerging markets to be ‘invested’ at much higher rates (and until recently at very favourable exchange rates)
2. Ploughed into developed stock markets where it has fuelled record share buy backs and other financial engineering
3. Used to front run the central banks by purchasing further government debt in the sure knowledge that the central bankers are ready and waiting to buy it at increasingly inflated prices
4. Used to create another bubble in property, this time predominantly at the high end…so far
These are not ‘savings’. They are leveraged casino chips – products of financial engineering and balance sheet chicanery. This ‘money’ has never been within a country mile of a productive enterprise. It was created to slosh around in financial markets and that’s exactly what it does. It does not find its way into capital investment. On the contrary, it withers the real economy, because it distorts the signals the economy needs in order to function healthily - I.E. Prices.
This article is right about one thing – we are going back into recession. The abysmal trade figures and other leading indicators have been saying this for the past 3 months at least, and now even the talking heads are starting to get it, or at least are starting to admit it. Last week Citi announced that given the turn in corporate profits and concerns over margins moving forward, the chance of a recession in the US has risen to 65%. A couple of days later JP Morgan jumped on board. From Mike Feroli:
Our longer-run indicators, however, continue to suggest an elevated risk that the expansion is nearing its end, and our preferred model now puts the probability of recession within three years at an eye-catching 76%.
So if the debate about ‘secular stagnation is indeed ‘raging’, it is merely a temporary blast of academic hot air, fuelled by an intellectual spat between Professors Krugman and Summers, and played out on the blog pages of the NYT and the FT. The real storm is coming, and there will be absolutely nothing stagnant about it.