The weak growth, large output gap, low return on capital, and a host of other economic malaise are widely recognized. There seem to be two main schools. One is associated with Reinhart and Rogoff. They argue that “this time is not different” and that much of disappointment with economic performances are what should be expected given the end of a historic credit cycle and debt crisis.
The other is associated with Summers, who resurrected the Alvin Hanson’s 1938 secular stagnation hypothesis. The basic concern here is that the effective demand for capital is not sufficient to absorb the large pools of savings. This drives down the price of money (interest rates), which risks fueling bubbles. Summers advocates a large public investment campaign to deploy the savings.
The two camps debate the issue on op-ed pages, think-tanks, the internet, and social media. Both sides make interesting points though it is difficult to see closure anytime soon. In the interim, perhaps we can offer a less grand theory but what might prove perhaps more relevant in the short and medium terms.
Sometimes what is once considered a single ailment is revealed to be a combination of illnesses. We wonder if that is not the case today with the sickness of the economy and financial system. We suggest that there may be four separate crisis taking place presently. To appreciate the argument think of SHOE.
Sovereign Crisis–This refers to the rise of non-state actors that limit the ability of governments to secure their national frontiers. Raymond Vernon’s book “Sovereignty at Bay” is 45-years old this year and the challenge has multiplied. Vernon focused on multinational corporations, and if anything they have grown in size and complexity. Henry Kissinger has suggested that we have a crisis of the Treaty of Westphalia (1648), which established the principle of the nation-state and non-interference in the internal affairs of another state. Many issues, such as climate change, immigration, terrorism require cooperation between competing countries. In Europe, there is a push-back against the persistent erosion of sovereignty that is rekindling nationalism on different levels, including against the EU and/or EMU.
Hegemonic Crisis–Few observers refer to it by name, but frequently the issue of the ability and willingness of the US to set and enforce broad international rules of economic and political engagement is discussed. Some have argued that the increased US financial statecraft, such as denying Russia access to the dollar funding market as part of the package of sanctions for its annexation of Crimea and its efforts to destabilize east Ukraine only encourages others to develop alternatives. The dollar, and US capital markets more broadly, were provisions of a public good and the commitment to continued providing those public goods has been questioned.
If the US is unwilling or unable to continue to provide the public goods the international system needs, there does not appear to be a compelling candidate to replace it. This gives rise to Bremmer, Roubini and others idea of a “G-Zero World”. There is no hegemon and the world is less stable because of it.
On the other hand, several of the key challenges facing global investors does not appear to be due to a failure of the US hegemony, but the failures of the local or regional hegemons. Germany, for example, has been unable to deliver prosperity and security to its region. It quasi-mercantilist, exporting 45% of all the goods and services it produced in 2014. Its strategy not only dampens its own domestic demand, aggravating social stresses but forces others to experience trade deficits. Just like many argued the US exercised influence through the multilateral institutions like the IMF and World Bank, many argue that Germany projects its power through various European institutions, even though at the ECB it does not always get exactly what it wants.
There are other areas where a local power, or regional hegemon, is being challenged. Saudi Arabia is being challenged by Iran. Its oil strategy is hurting all OPEC members, and many do not have the resources, Saudi Arabia. The disputes in the South China Sea seem to reflect a recognition of China’s rising power. Chinese officials were content to let sleeping dogs lie, feeling confident they will have more power in the years to come, which would facilitate more favorable outcomes for it. Other countries realize the same thing and are more anxious to push their claims before then.
Oder-Neisse Treaty Crisis— Narrowly the Oder-Neisse refers to the fixing of the Geman-Polish border, but more broadly, it refers to the acceptance of the post-WWII borders. The idea is that wars are frequently about changing national borders. Accepting existing borders as immutable removes a potential flash point. There are a few exceptions. Palestine and Bosnia come to mind. When Russia annexed Crimea, it claimed the reunification of Germany was another exception. China and Russia do not accept the territorial settlement. ISIS does not respect borders.
Expectations Crisis–The slowing of population growth and productivity translates directly into slower growth. It also contributes to the disparity of wealth and income. These considerations mean that returns on investments will likely be lower than what some pension funds or investors anticipate. It is difficult to see how the generation that is reaching maturity now in the US will, on average, live as good as their parents. Education used to be a vehicle for class mobility. It is not clear that is still the case. From one perspective, the large debts accumulated by many countries is a generational transfer. This is partly what the continued debate over pension reform in Europe is about. Increasingly countries in Europe are joining Japan with shrinking populations. In this year’s US national election the Millenniums will outnumber the Baby Boomers.
These thumbnail sketches are meant to be suggestive, not comprehensive. The value lies in trying to untangle different elements a multidimensional challenge. Over the coming weeks and months, we’ll flesh out some of the investment implications of the SHOE Crisis.