The Bear’s Lair: The secular stagnation of Keynesian economics

Larry Summers recently reiterated his assertion that we are in an era of secular stagnation, suggesting in a new paper that low interest rates and an aging population may have caused this. However, the U.S. economy has recently shown substantial signs of growth, which appears sustainable. If President Trump can restrain his enthusiasm for low interest rates, Summers and his neo-Keynesian colleagues may definitively be proved wrong.

Summers’ thesis is that the aging population in the West has a positive effect on output while real interest rates are positive, because the stock of capital increases. However, when real interest rates go negative, the aging comes to have a negative effect on productivity, because the additional capital (as older people save more) subtracts from output.

Summers assumes however that the negative real interest rates are an Act of God, that the equilibrium market interest rate suddenly for some unknown reason turns negative. He suggests this may be caused by the aging itself, and by the increased saving it causes, but elementary market theory suggests that this is nonsense. Increased saving would indeed reduce the return to saving, but under no plausible supply/demand curve could it make the return to saving negative unless savings became essentially infinite.

The real culprit was Summers himself and his little friends in the world’s central banks, who, faced with a medium sized financial crash in 2008, decided to take Keynesian theories of interest rates to their extreme, force interest rates below the rate of inflation and keep them there. It was this, not any excess saving among the impoverished pensioners of the Western world, which took away the productivity growth in the global economy. Not only in the United States, but in Britain, the Eurozone (but not in those parts of Central and Eastern Europe sensible enough to resist the euro) and Japan did productivity growth, in varying states of health before 2007, disappear almost completely thereafter.

To any competent non-Keynesian economist, it is clear why this happened. With real interest rates set below zero, all investments became profitable, and so the markets’ normal discrimination between them disappeared. Over time (and this lunatic policy was given a decade in which to operate) the good productivity-enhancing investments were swamped by the rubbish. Pointless real estate projects, hopelessly loss-making virtue-signals in the “clean technology” area, tech ideas generated in a basement and inflated to the mega billions of dollars, and share repurchases that left the companies concerned bereft of capital and horribly vulnerable to the next downturn in their business: all have successfully competed for investment dollars, there being no rigorous way of excluding them. The result was productivity growth that first turned sluggish, then disappeared altogether. Contrary to Professor Robert Gordon’s thesis, the death of productivity growth had nothing to with humanity having exhausted the possibilities of technological innovation.

Keynesians do not understand this. Keynes himself did not understand interest rates and the role of capital markets; they were an annoying extraneous irritant in his plausible but fallacious economic system. That’s why he wanted to euthanize all the rentiers, to get rid of the problem. It is also why, when he was barred from insider information in 1931-36 by the great Chancellor of the Exchequer Neville Chamberlain, who with some reason regarded him as a charlatan, Keynes’ investment performance took a nosedive, so much so that he was removed from all his investment posts except that at Kings College Cambridge. Presumably at Kings the disappearance of the endowment would set the college up nicely for the Communist revolution for which most Kings’ dons of the 1930s were vainly hoping.

That is not to say there were not other factors zapping productivity growth. You cannot impose regulations with the crazed enthusiasm of the Obama administration and not expect those regulations to ding productivity growth. By definition, each regulation makes some set of businesses do things in a way they would not choose in a free market. Simply the volume of regulations imposed by Obama must thus have affected productivity badly. What’s more, it appears from the data that the sheer blessed regulatory silence in the early months of the Trump administration – suddenly, there were no new regulations, only tweets denigrating other politicians and sundry figures – had a benign productivity effect. After all, a vulgar tweet can be read much more quickly than a regulation and is very unlikely to force you to change your business practices.

This week’s second quarter of 2018 productivity data, with non-farm labor productivity rising at a rapid 2.9% annual rate, is another indication that the U.S. economy is back on a better track. President Trump’s policies should receive only modest credit for this – it is really too early to expect his business tax cut to have had much effect.

Moreover, Trump’s tariffs have the potential to affect productivity growth adversely, especially if he alters them frequently. The U.S. economy can adapt to any trade regime, much more easily than to an extreme regulatory regime, because the cost of altering the supply chain dynamics is one-off and modest, but continually changing tariffs would be a considerable burden for internationally-oriented businesses to bear. However, Trump is quite right to point out that the American economy was built on tariffs, and a steady, moderate tariff regime, producing large revenues which would go towards balancing the budget, is much more beneficial than a program of unilateral free trade, where other countries flout the agreed tariff rules and impose hidden barriers against U.S. exports. Unilateral free trade destroyed Britain’s industrial superiority against other nations in 1846-1914, and Trump has more sense than see America continue down the same road.

What Trump needs to remember, and what Obama was incapable of remembering, was that the best governments from a productivity viewpoint are those which take the “laissez-faire” principle most seriously. From the primitive figures available, it appears that the highest productivity growth figures ever achieved in U.S. history may have been registered during the Coolidge administration of the 1920s, when although tariffs (taxes on foreigners) were substantial, taxes on the domestic economy were low and the administration in the persons of Coolidge and Treasury Secretary Andrew Mellon elevated laissez-faire economic policy into an art form.

The most important factor restoring productivity growth in the U.S. since January 2017, however, (because productivity growth has not recovered elsewhere) has not been Trump’s policies but the gradual return of U.S. interest rates to a level that, when risk premiums are included, is positive in real terms. Each 0.25% rise in interest rates that is not matched with an equivalent increase in inflation increases the differentiation between worthwhile and worthless investment projects, focuses decision makers on projects that make economic sense, deters boondoggles and thereby restores productivity growth to historic levels. It is thus unsurprising that productivity growth has since the beginning of 2017 left Summers’ “secular stagnation” behind.

A recent calculation by the San Francisco Fed showed that the average American will miss out on about $70,000 in lifetime income if the sluggish decade after the 2008 crash is not made up. In practice, current policies seem to be leading to at least a short period of above-trend economic growth and productivity growth, which will reduce that figure a little. Still, as a first approximation it is a fair estimate of the cost to the average American of the policies pursued by Obama, but more especially by the Fed under Ben Bernanke and Janet Yellen.

Even if policy is optimal from here on out, only part of the $70,000 will be restored to the average American. Productivity may grow more rapidly than the normal trend for a year or two, but there are some improvements that have been lost forever, as scientists who should have been working in U.S. manufacturing facilities were diverted into useless software, into driving Ubers, or, worst of all, into attempting to run hedge funds that beat the market. The clever chief investment officer of the unsuccessful hedge fund may walk away from its bankruptcy in 2022 with a nice pot of money, but the productivity-enhancing invention that, given sensible interest rates, he would have made as a young engineer in 2012 will never appear, and the benefit of that invention to the economy will be lost forever.

Such is life. Some bad policies have permanent costs to all those subjected to them, and a Keynesian belief in secular stagnation, and the policies to which such a belief inevitably leads, will blight everybody’s existence until it is reversed.

Mr. Summers was a tolerably good Treasury secretary in the 1990s boom. He is alas less capable as an economic prognosticator today. Both the policies he recommends and the economic gloom which they bring about should be avoided.

(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.)