Financial Review

Stagnation versus Innovation

Financial Review by Sinclair Noe

DOW – 5 = 17,875
SPX – 4 = 2076
NAS – 7 = 4910
10 YR YLD – .01 = 1.89%
OIL + .94 = 53.08
GOLD – 6.30 = 1208.70
SILV – .14 = 16.93


The stock market was in positive territory almost all day, right until the very end of the session; it just slipped away. And that coincided with an American Petroleum Institute report showing crude oil inventories increased by 12.2 million barrels in the last week, about triple estimates.
Not much economic news today. The Labor Department JOLT survey reports job openings rose to a 14-year high of 5.13 million in February from 4.97 million in January. There were 1.69 unemployed people for every opening in February. The quits rate slipped to 1.9% from 2%. This is good news; there are more jobs available, and people are quitting their current jobs because they have a level of confidence that they can find a new, better job.


Because this is a slow week for economic data, we will be hearing some opinions from the folks at the Federal Reserve. Minneapolis Fed President Narayana Kocherlakota laid out a case for waiting until the second half of 2016 to start raising rates, and to then raise them gradually so as to reach just 2 percent by the end of 2017. Some of the Fed’s more hawkish policymakers have even pressed for a rate rise as early as June, warning that waiting too long could force the Fed to hike borrowing costs sharply to head off a potential surge in unwanted inflation. Kocherlakota says it would be a mistake to raise rates this year, and the Fed “can be both late and slow in reducing the level of monetary accommodation.” Kocherlakota is one of the doves at the Fed, and as the Fed rotates voting among policymakers, it turns out he won’t be voting at FOMC meetings this year.


The Bank of England has asked British banks to put emergency plans in place to be able to absorb the potential shock from an escalation of the Greek debt crisis. Minutes from the Financial Policy Committee’s latest meeting show the central bank believes the current turmoil in Greece is one of the biggest external risks to the U.K’s financial stability. Because of this, it is already working closely with the Treasury and bank regulator the Financial Conduct Authority to make sure contingency plans are ready.


The Greeks are supposed to make a $500 million IMF loan repayment on Thursday. Prime Minister Alex Tsipras has gone to Moscow to beg for rubles. Putin is reportedly open to the idea of providing a line of credit, plus discounts on natural gas in exchange for… well, that’s the rub isn’t it. What will Putin demand? Greece has assets, including possible offshore oil. EU officials fear any Russian rescue loans or other sweeteners could persuade Athens to veto sanctions on the Kremlin over Ukraine; such sanctions require unanimity among EU members, so Greece could end sanctions on its own.


A deal with Russia might cause some irritation, and the Greeks seem ready to provoke; they keep demanding reparations from Germany for Nazi occupation and crimes. Meanwhile, the Greeks demand an investigation into the 2010 Greek bailout, which they are still paying for and which they believe might have been somewhat corrupted. And so we know Greece is ready to ruffle feathers. We’ve been waiting for a list of reforms from Greece. We never really got that. The Troika has glossed over that omission. It would be more difficult to gloss over a loan payment. What would happen if Greece doesn’t make its loan payment on Thursday? That would shake things up; even if they are a day or two late in making the payment; it would change the entire dynamics of negotiations moving forward. One thing is becoming obvious, the Greeks are not timid and they don’t have much to lose.


Even if Greece makes the loan repayment on Thursday, it will have to make payroll the following week; about $1.7 billion in wages and pension payments. Then there are more IMF payments due in May and June. And the problem is that the Greek economy is not getting better, so at some point there must be a deal or there will be a default.


The IMF and the World Bank hold their annual spring meeting next week; ahead of the meeting the IMF has issued a report on the world economy, entitled “Lower Potential Growth: A New Reality”, and the outlook is grim. The IMF says living standards may only rise slowly due to an aging population and lower capital and productivity growth. The IMF says the rapid pace of productivity growth in the late 1990s and early 2000s is unlikely to be restored in advanced countries. In emerging economies, the returns from education and innovation are unlikely to be as large as they were initially. The IMF expects potential growth in advanced economies to rise slightly, from an average of 1.3% during the period of 2008 to 2014, to 1.6% between 2015 and 2020. That’s well below pre-crisis rates of around 2.25%.


Now, move beyond the numbers and the IMF is saying the global economy is slowing down and it will stay down; this is a fundamental break from historic patterns.  For financial markets, this likely means that interest rates could settle in for an extended stay around the zero lower bounds; this also means that equity markets have likely moved higher despite a big decline in business investment since 2008. While we have seen more and more stock buybacks and M&A activity, there has been a chronic lack of spending on equipment and technology that drives gains in competitiveness and increases productivity. The IMF report says: “weak business investment has contrasted with the ebullience of stock markets, suggesting a possible disconnect between financial and economic risk taking.”


The great hope is that booming asset prices will trigger a surge of investment, allowing economic fundamentals to catch up with markets; that thinking is a variation on the theme of trickle-down economics; that hordes of corporate cash will rain down on the economy in a deluge of spending on research and infrastructure. The IMF report says it isn’t happening and it won’t happen. The productivity gains of the internet revolution have run their course; the world’s demographics are also changing and we are getting older and grayer and slower; the decline has begun. Economic growth as we have known it is a thing of the past. Get over it, get used to it.


It’s not all doom and gloom. The IMF suggests that there is still room for optimism—the future trajectory of potential output is not set in stone. And then they trot out some stale ideas for improving innovation; their big idea is to strengthen patent laws. And worker productivity could get a boost by improving education quality. True enough I suppose, but it lacks a sense of urgency. And the IMF analysis strikes me as superficial and shallow.


Economists sometimes forget what drives an economy, and so they can’t imagine what would drive change. Much of the world struggles to scrape out a day to day living, and that will become an even bigger challenge in the coming years. Innovation is not born of patent laws, just the opposite; innovation is born of necessity. Innovation comes from scientists and science fiction writers and tired workers looking for a break and daydreamers and shade tree mechanics and kitchen table tinkerers. And innovation answers questions. Right now the biggest questions for the coming years seems to be how we can provide food, water, housing, transportation, and health care to a global population that will soon top 9 billion; all without destroying the planet in the process.


The answer is likely to come from new sources of energy; at least that is my best guess. With enough energy we can clean fouled water, we can grow enough food, we can build enough housing, and we can move whatever needs to be moved. And it is my estimation that the next great advances in innovation must need be in energy.


Think about the innovations in technology that we’ve seen for computing and communication. One hundred years ago you could not have imagined the computing power you now have in your laptop or even your smartphone. Fiber optics and satellite communications were beyond the imaginations of the science fiction writers. Yet the car motor of 100 years ago is essentially unchanged; an internal combustion engine burning gasoline; carburation is improved and now it pounds out more horsepower but the principle hasn’t changed. Mr. Edison’s electric motor is essentially the same, slightly more efficient and bigger, but the same at its core. Nuclear power offered the prospect of tapping previously unseen sources of power, but we have never figured out how to do it without making an even bigger mess. Harnessing the power of the sun is an ancient idea but in 100 years it is likely that solar power will seem as quaint as the telegraph seems to someone using the internet. Morse code works to relay a message but Skyping someone halfway around the world is much better.


Whether the world really is nearing the end of its growth potential has been an ongoing economic theme for a long time. Ben Bernanke, the former chairman of the US Federal Reserve turned blogger for the Brookings Institution reminds us in his debut blog of another economist, Alvin Hansen, who coined the term “secular stagnation” back in 1938, arguing even then that population growth was slowing and the big advances in technology were mostly finished. Hansen might be forgiven his pessimistic outlook; in 1938 the economy was still a mess, the Dust Bowl was an ecological disaster, and World War was right around the corner. And it was out of crisis that innovation occurred. Of course, in the decades that followed Hansen’s argument, the postwar population boomed, there was rapid technological advancement, and the economy did not stagnate.


Bernanke believes that the US economy will right itself naturally, as so often before, if we only pay attention to the three most important objectives for economic policy: achieving full employment, keeping inflation low and stable, and maintaining financial stability. But I doubt secular stagnation can be beaten by low inflation. Innovation is born of necessity and forged in crisis. Only then do we open our minds to the unimaginable and determine that something is only impossible until it is done.








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