“The Gods of the Copybook Headings, I notice, outlast them all” wrote Rudyard Kipling in 1919. He also made the point that there are frequent periods when those gods appear to be asleep. There are a number of copybook headings that sensible policymakers consistently followed before 2008, which have systematically been ignored since. They are about to wake and “with terror and slaughter return.”
Before 2008, various bad monetary, fiscal and regulatory policies were tried by various governments, but only occasionally was there a consensus on stuff that really didn’t work. In the 1930s, Britain under Neville Chamberlain was a notable dissenter from the proto-Keynesianism of the New Deal and its militarist version attempted by Hitler’s Germany and Mussolini’s Italy. Thus Britain during the decade achieved notably better results than its competitors, a truth that was swamped by World War II, by the failure of Chamberlain’s foreign policy, and by clever propaganda from the British left conflating 1930s foreign policy with its economic policy and branding both as failures.
In the 1950s and 1960s, there was consensus among the major economies that tax rates above 90% were sensible at very high incomes. The entirely predictable and justifiable consequence of this was the rise in Swiss and other banking secrecy laws and tax haven bank accounts. In the 1960s and 1970s there was a consensus that inflation didn’t matter too much and that actuarially unsound welfare schemes could easily be paid for. This led to the stagflation of the 1970s and a 20-year reaction under Ronald Reagan, Margaret Thatcher and to a large extent Bill Clinton. In the early 2000s, there was a largely global consensus that low interest rates and the consequent housing bubble could be used to reflate after a stock market crash – and we all know how that ended.
Nevertheless, while the occasional copybook maxim has been flouted in the past, even on a more or less worldwide basis, the wholesale flouting of “the Gods of the Copybook Headings” since 2008 has been on a wholly different and epic scale.
For a start, the world was supposed to have learned again in 2008 the copybook maxim that overleverage is bad for you. Yet at least in the United States, that lesson appears to have been sadly missed. Total credit outstanding in U.S domestic non-financial sectors increased by 30% from 2007 to 2014, on Federal Reserve data, whereas nominal GDP increased by only 20%. In other words, the total of U.S. credit outstanding has increased half again as fast as output since the top peak of what had previously been thought the greatest credit bubble in history.
Of course, the distribution is different in 2014 from in 2007. Business credit outstanding increased only 19% from 2007 to 2014, slightly slower than GDP, as sluggish growth resulted in a dearth of capital investment and mild deleveraging, in spite of ultra-low interest rates and a spate of private equity deals. Frankly, that in itself is an indictment of Fed policy – if ultra-low rates do not produce higher capital investment by business, then what the hell is their purpose?
Households even deleveraged slightly between 2007 and 2014, with their overall debt decreasing by 2%. However while home mortgage debt decreased by 12% (mostly due to defaults and restructurings), other consumer debt increased by 27%, faster than GDP. Thus once the worst of recession had passed there was a reversal in overall consumer retrenchment. State and local government debt increased by 3%, much less than GDP, while Federal government debt increased by a huge 154% between 2007 and 2014.
Thus Fed policies had no effect on the debt markets other than encouraging consumers into further witless credit card, auto and student debt, while the gigantic Federal deficit left the U.S. economy as a whole with a higher total indebtedness to GDP ratio (238% versus 220%) than even at the height of the 2007 credit boom. The change in mix from home mortgage and corporate debt to more consumer credit and government debt is also hardly a sign of economic good health, as unproductive uses of credit have been favored over productive ones. With consumer non-mortgage leverage and total leverage in the economy sharply up, the Gods of the Copybook Headings will have their revenge at some point.
A second copybook maxim that has been neglected is that economic growth is not possible in the long term without productivity growth. Commentators often use Japan’s experience since 1990 as a dreadful example of what fate might await the West without monetary stimulus. However the Japanese post-1990 recession at least until 2009 was accompanied by decent productivity growth, within a couple of tenths of a percent of that in the United States and higher than in most of Europe.
On the other hand, in the U.S. and Britain in particular, productivity growth in the last few years has been far below at least post-World War II historical experience. The outright decline in U.S. productivity in the fourth quarter of 2014 was startling, and seems likely to lead to further spectacularly poor performances, as employment figures continue to behave much better than growth figures. Funny money and huge government deficits are distorting the global economy, pushing it further and further from an optimal allocation of resources. Productivity inevitably suffers.
A third copybook maxim that has been flouted in recent years, perhaps the most important, is that savings must be nurtured and savers protected. Middle-class savings are the basis of business formation, because they form the capital nexus of almost all start-up businesses (even “angels” have to get their money from somewhere.) Third-world countries expropriate savings, by looting, excessive taxation or uncontrolled inflation, and so stay poor. Weimar Germany wiped out savings through inflation, and so caused the political upheaval that produced the Third Reich. For seven years now, in almost all the Western world, savings have received risk-free rates of return below zero in real terms. This is decapitalizing the Western economies and must inevitably impoverish them in the long run, probably through a collapse in asset and share values once the bubble bursts.
In terms of policy, the copybook holds that fiscal and monetary policies should be balanced against one another. Certainly the current posture, with public sector deficits larger than ever before in peacetime human history over so long a period accompanied by real interest rates below zero for seven long years accompanied by money printing on an unprecedented scale, is so far outside the copybook recommendations that if Kipling’s poem has any validity at all, a record-breaking crash must follow.
Finally, the copybook would hold that regulations should be light and even-handed, with no political favoritism. The current posture in financial services, energy and healthcare is of regulations of unprecedented severity accompanied by exemptions that can be purchased for cash or favors. This was previously unknown in any advanced economy. Clement Attlee’s Britain had rationing and overregulation, for example, but was remarkably honest in their administration.
Certainly a society is unsustainable in which the largest U.S. reinsurance company, Warren Buffett’s Berkshire Hathaway, is exempt from the strictures of the “Systematically Important Financial Institution” morass while Buffett himself is a major friend and donor of the President’s party. The damage done by these regulations is exemplified by New York Governor Cuomo’s whimsical decision to ban fracking, condemning Binghamton to an unemployment hell worsened by the casinos which Cuomo apparently prefers as a development strategy.
Latin America and Africa, in which such arrangements are common, have never managed to become rich, unlike societies such as Singapore in which they are avoided. In U.S. history, the unhappy history of the railroads after the creation of the Interstate Commerce Commission in 1887 is clear evidence that heavy regulation can destroy industries on which it is imposed. Forcing heavy and distorted regulation onto almost half the economy, along with allowing ambitious prosecutors to launch bizarre lawsuits demanding prison sentences and billion-dollar fines for offenses either incomprehensible, trivial or normally both, is a surefire recipe for long-term economic failure.
The Gods of the Copybook Headings have never before been flouted to the extent and in so many ways as in the past seven years. Their revenge will be highly painful, the more so the longer that revenge is delayed.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)