That the economy needs such large stimulus in the sixth year of an expansion is unprecedented. Usually by now the economy has overheated from too-fast growth (inflation!), and economists are worried about the next recession.
By Editor, Fabius Maximus, a multi-author website with a focus on geopolitics. This article originally appeared here.
I don’t believe I’ve successfully communicated to our readers the extraordinary nature of our times. We too often focus on the details, but ignore this essential aspect of our situation. Since the crash (perhaps starting even before) we’ve sailed beyond the edges of the known economic “space”. We can no longer even see the edges of the map.
Normal science, the activity in which most scientists inevitably spend almost all their time, is predicated on the assumption that the scientific community knows what the world is like. Much of the success of the enterprise derives from the community’s willingness to defend that assumption, if necessary at considerable cost. Normal science, for example, often suppresses fundamental novelties because they are necessarily subversive of its basic commitments.
— Thomas Kuhn’s Structure of Scientific Revolutions (1962)
Look at the US economy. Marvel at the oddness.
- Near-zero interest rates since December 2008 — almost 6 years — scheduled to end in Q2 or Q3 of 2015.
- Three rounds of quantitative easing (ending this month) taking the Fed’s balance sheet from $800 billion to $4,500 billion.– a trillion dollars added in the past year.
- A mind-bending expansion of the Federal public debt, taking it from $5.1 trillion to $12.9 T (x2.5) — with $809 billion added during the fiscal year just ended (a 6.8% increase, equal to 4.7% of GDP).
That the economy needs such large stimulus in the sixth year of an expansion is unprecedented. Usually by now the economy has overheated from too-fast growth (inflation!), and economists are speculating about the next recession.
How we got here is equally strange. Like the Harry Potter books, since 2007 life has been a series of random plot twists. It will make a great novel; the film adaptation might be even better.
- The long-expected housing bust,
- followed by the collapse of some US investment banks,
- then the collapse of the US banking system, shaking banks around the world,
- followed by the collapse of world trade and a global recession in late 2008 (worst since the 1930s),
- met by near-zero interest rates, a first round of quantitative easing (QE), and fiscal stimulus,
- sparking a “v” shaped bounce in 2009, amidst predictions of return to normal growth,
- which by late 2010 faded into another slump (real GDP in Q1 2011 was -1.5% SAAR),
- successfully met by another round of fiscal stimulus and a second round of QE,
- followed by predictions of return to 3% GDP in 2012,
- which didn’t happen (GDP peaked in Q4 2011 at +4.6%),
- followed by GDP slowing to near zero in Q4 2012,
- met by a third round of QE in September 2012 (ending this month),
- and more forecasts of big growth in 2014, which didn’t happen (current estimates for 2014 are slightly above 2%).
Plus we saw a series of equally astounding events in Europe starting with the Greece bust starting in March 2010. And the July 2012 announcement that the ECB would “do whatever it takes to preserve the euro”. And the December 2012 “hail Mary” pass of Abenomics in Japan, attempting to end their quarter-century slump before the government goes bust.
No economists (and probably nobody else) predicted most of this, despite their confident forecasts (economists often write as if they’re the voice of God). But the persistent failure of their forecasts since 2007 does not mean they should abandon their theories. Kuhn explains why:
If all members of a community responded to each anomaly as a source of crisis or embraced each new theory advanced by a colleague, science would cease. If, on the other hand no one reacted to anomalies or to brand-new theories in high-risk ways, there would be few or no revolutions. In matters like these the resort to shared values rather than to shared rules governing individual choice may be the community’s way of distributing risk and assuring the long-term success of its enterprise.
Our reactions to these astounding events
The cumulative effect on me of these years has been disorienting, like Dorothy’s visit to Oz. We’ve enjoyed talking with the Lion, Tin Man, and Scarecrow. The yellow brick road is fun. We survived the flying monkeys and the Wicked Witch. When do we go home?
Most people have reacted differently to this series of events. They pretend that we’re still in Kansas, and this is just a New Normal. It’s a consensual hallucination, allowing these people to retain a feeling of stability and comfort. How long can they maintain this illusion, assuming we don’t return to Kansas?
There is a more important group struggling to understand these events. How have economists, as a profession, reacted? At what point do they decide their theories need radical revision? The re-thinking has already begun. It’s a slow process, a form of scientific revolution, as Kuhn tells us:
{W}hen the profession can no longer evade anomalies that subvert the existing tradition of scientific practice — then begin the extraordinary investigations that lead the profession at last to a new set of commitments, a new basis for the practice of science. The extraordinary episodes in which that shift of professional commitments occurs are the ones known in this essay as scientific revolutions. They are the tradition-shattering complements to the tradition-bound activity of normal science.
That slow process requires a spark of creativity that comes only in its own time. Until then mistakes will be made as economists cope with our rapidly changing world.We have to work with the theory we have today, just as the Great Depression occurred because nobody had read Keynes “General Theory” — published in 1936.
Worse, having the solution is only half the cure. We often recognize genius only too late, as Europe’s leaders ignored Keynes’ insights on the Versailles peace treaty, which might have prevented the Great Depression and WW2 (The Economic Consequences of the Peace, 1919).
We can only wait for economists to produce new insights that generate operationally useful theories, and hope that we recognize them when hey arrive. Until then we should embrace the weirdness of our world, not ignore it. By Editor, Fabius Maximus
Now in its sixth year, this sorry excuse for an expansion is ready to boom — accelerating to “escape velocity” — according to many economists. But the consensus of economists never sees a recession until after it begins. Read… Listen to the Slowing US Economy, Hear Echoes of Japan
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
“But the persistent failure of their forecasts since 2007 does not mean they should abandon their theories.”
I disagree.
I have a graduate degree with a minor in Economics.
I think economics is a pseudo-science, masquerading as a science. Economists may try to emulate scientific principles, but they often fall short when trying to repeat scientific experiments and obtain results that are identical to past experiments.
In basic chemistry, you can combine specific quantities of two chemicals and obtain identical reactions over and over and over again. That is not always true of economic theories.
In a graduate class about 25 years ago, one of my economics professors explained “equilibrium” in the US economy as “We import goods and export IOUs.” I asked: “What happens when the creditors want to collect on the IOUs?” The professor’s response: “That’s not our problem.”
Perhaps 15 of the approximately 15,000 economists in the world accurately predicted the onset of the global financial crisis in 2008. That’s a pretty dismal success rate in my book.
Economics is a disapline that attempts to describe economic behavior, that is all. Under every system there is a presumption that the participants are behaving rationally in relation to the principles underlying their system. When participants don’t behave there are bad consequences for the behavior. We now have a global system with no bad consequences for bad behavior. Only the good guys lose. There is no confidence in finance anywhere and that is what is being reflected in the financial markets. The parasites have eaten the host.
Petunia, you’re right… “descriptive economics” works that way. It’s just trying to describe what is actually happening (figuring all kinds of economic measures, such as GDP) and what might be happening (forecasts).
But there is a big anthill of economists out there who practice “prescriptive economics” – so what governments, central banks, and other entities SHOULD do to accomplish certain results. And that’s where much of economics gets into hot (nay, boiling) water.
These prescriptive economist as you call them have been influenced by the financial engineers on Wall St who think they can create a product to “fix that” which is why the markets are so disconnected from reality. I saw this first hand when I worked on Wall St. Guys like Summers are really scary because they believe the bs coming from the quants.
Yes. This writer assumes economics is based on reason and facts/data, and that economists will come around eventually. It’s no more a science than reading entrails.
And again, the S&P closed at its low.
Makes me really wonder what Monday will bring.
The VIX is still only 20.95 > still no fear..
I don’t see any real support until we get to the top of the old channel around 1860. Even then that isn’t much.
We sure live in interesting times.
If the govt wasn’t supporting the market I doubt the Dow would even be at 5K.
You are absolutely correct.
A stock is basically a security with a 50-year duration. So current stock prices only make sense if you believe (1) that interest rates will stay at 0% for the net 50 years or so and (2) that corporate profits will continue to run at 11% of GDP for the next 50 years or so, despite a hundred years of historical results that show corporate profits average 6% of GDP.
My first point is that if interest rates rise it won’t be good for corporate profits. There is a literal tsunami of low-rate corporate debt that would have to be rolled over at higher interest rates, lowering profits. Also, in term of risk, higher bond yields could become more attractive relative to stocks.
The second point (on which the math is complicated) is that if Federal deficits were to decline dramatically, corporate profits as a share of GDP would likely decline as well. We should note that, as Wolf pointed out a couple of days ago, the increase in the national debt year-over-year was actually over $1 trillion, despite the fraudulent CBO report that the 2014 deficit was “only” $486 billion.
So it is easy enough to construct a scenario where the S&P/Dow/Nasdaq all could decline 65-80% from current levels. That kind of decline would turn the peoples’ 401Ks into 101Ks.
And, at an 80% decline, the 5000 Dow level you suggested would be more like 3300…
My own personal view is that it would take a Depression-style decline of 90% or so to wring the fraud/lies/deception/dishonesty out of the economy and put it back on a path to something sustainable.
Vegas… I was being generous when I estimated the Dow at 5k and think your 3K estimate is more realistic. I disagree with your view that a share of stock is in anyway connected to the production of the company or the economy anymore. That has not been the case for decades. The price of a share is simply based on the “demand” for that share as a commodity in the market. It has been a speculators market for a very long time.
Petunia,
I have a sad tale of woe. I’m a licensed securities professional. My spouse has a 401k of several hundred thousand back in 2010 or so. The Dow was at 12,000 something. I hated liberalism and Obama back in 2008. I thought the whole damn thing was going to crash and hyper-inflation would ensue. Put the whole 401K into cash.
Had no idea that QE would send the stock market soaring. I thought printing more money meant more inflation. And stocks would do badly in an inflationary environment. Of course, I knew about stock buyback and repurchase programs by corporations from my finance course, but I had no idea to the level that it would be used as a means of financial market engineering.
Lo-and-behold, I’ve lost out on a 40-50% gain over the last 4-5 years because I thought it was crazy and went to the sidelines.
I even lost a few clients because I was bearish.
I feel awful. I still think I’m right, but my timing could not have been worse. And I hate sometimes feeling that I think it’s going to collapse because when/if it does, people will think I want it to collapse to be vindicated. And maybe they’re right. It’s no fun being an eyes-wide-open Eeyore.
Unfortunately the popular media and almost all the blogposts you see are populated by Keynesian semi-socialists and their assertions are taken for granted as facts in economics. So many people are not aware that their exists a far more sophisticated and realistic school of Austrian thoughts who predicted the housing and dot com bubbles with varying details and are still continuing to educate the mass about dangers of Keynesian stimulus and socialist experiments. They can explain the current scenario, they are doing it every single day, just look around. It is great to see the author questioning the Keynesians but sad to see that the word Austrian does not feature even once in the article, when those are the guys who deserve to be heard. The alternative already exists, you just have to look around beyond Greenspan, Yellen and Krugman.
The Austrians schol of economists are like stern parents telling us to eat our broccoli and finish our homework before we can go play. But we are, collectively, not even well behaved children, let alone adults. We want instant gratification, no work, no pain, just fun fun fun…
The Federal Reserve needs to come clean and admit they are out of ammunition. They need to admit that the system has gotten too complex- there are experts in every part of the financial industry but no one who is able to understand how they all work together. The big picture is neglected. It is like Newtonian mechanics versus Quantum mechanics. Newtonian is based on reductionism- understand the parts and you can understand the whole whereas Quantum is based on holism. Basically they accept there is no way to study anything outside of energy and accept the Heisenberg or uncertainty principle. There is energy in an economy, whether local or global. In the case of markets I believe Keynes described it as animal spirits. I do not believe this has been quantified but could be wrong. My contention is we have not hit escape velocity due to demographics. Look at Japan and the United States- both aging populations. As we age we replace materialism (Newtonian mechanics) with energetics (Quantum mechanics.) In other words we stop accumulating things and put our energies into family. Another aspect of this aging population is the change from determinism (Newtonian mechanics) to uncertainty (Quantum mechanics.) We move from feeling able to determine our future to being uncertain. None of us know what our health will be like or the age at which we will pass. This uncertainty will alter our appetite for risk. Bottom line if physicists can change their thinking and embrace they will never be able to determine it all so should economists. Physicists still study but they haven’t the egos of economists. A little humility by those who hold the purse strings would go a long way in regaining trust in the system.
“We can only wait for economists to produce new insights that generate operationally useful theories, and hope that we recognize them when hey arrive” I don’t see anything that would not fit into a traditional economic framework. The problem is that the US, as all current states, have made their national currency legal tender. That way there is no competition. When you have no competition but a true monopoly (which under normal circumstances, like e.g. with commodities, flour, water etc.) is not even possible due to substitution, the “thing” gets out of hand. The break and paradigm shift came in 1971 when the US dollar as the peg for world currencies bound to gold was taken off the gold standard. If you look at ANY chart of monetary expansion you can clearly see it started back then. And if there were no binding legal tender laws, then the process of substitution would have set in in, say, 1973.