The World Turned Upside Down

There is a story, possibly true, that when the British surrendered to American and French forces at Yorktown, effectively ending British rule of America, someone in the British army sang or played an old English folk song, “The World Turned Upside Down.”   (See https://en.wikipedia.org/wiki/The_World_Turned_Upside_Down)

I think I know how the British felt.  Many of the assumptions economists have made about economic reality and economic policies now seem out-of-date or even reversed.

UNITED STATES

The Fed fought inflation; now it sets inflation targets when there is no inflation.

The Fed worries about deflation even though the major source is a fall in energy and commodity prices. Another source is the fall in the prices of technology products.

There is a large increase in the money supply, large government deficits, a large trade deficit, and a large decrease in the unemployment rate. Economic theory and past experience says that there should be an increasing inflation rate. There isn't.

America is experiencing a long period of real economic growth without inflation.  Unemployment is as low as realistically possible.  Rather than rejoicing, economic, business and political commentators seem to believe there is something fundamentally wrong with this.

Since the end of World War II, a key part of American foreign policy has been the expansion of free trade.  Now presidential candidates of both parties, and over half the American people, want to reverse free trade.  Economic nationalism is rising at the same time as large American corporations are about to receive over half their sales and profits from overseas operations.

America worried about importing too much oil; now America is worried about producing too much oil.

Interest rates are important because they are the price of capital, which determines how capital is allocated.  Now interest rates are a policy tool of the Fed.  They are artificially low with no thought about how they are affecting capital allocation.

The stock market was a place where companies went to raise new capital.  Now, through massive share buybacks, it is a place where companies reduce equity capital.

It has been government policy that annual budget deficits are manageable as long as the national debt-to-nominal GDP ratio was low.  That is, as long as the national debt rose at a lower rate than nominal GDP.  But since 2008, the national debt has risen much faster than nominal GDP.  We are experiencing historically high and rising peacetime national debt-to-GDP ratios.  So far, there has been little consequence because of historically low interest rates.  If nominal interest rates rise, there will be larger budget deficits. 

Seven years into a recovery interest rates and inflation rates should be rising.  No one could conceive that central banks in the U.S., Europe, Japan and other countries would set zero short-term interest rates this far into the recovery.

        

Negative interest rates, both real and nominal, were considered possible but not realistic.  Most industrialized countries have had some negative interest rates.

The Fed stopped looking at the increase in the money supply as a policy tool about 30 years ago.  Now a huge increase in the money supply is being used to finance a huge increase in the national debt.

Tax cuts and a larger deficit are traditional tools to fight a recession. They are being advocated as sound fiscal policy at the top of a business cycle.

An economy can be in recession if private spending is too low (inadequate private aggregate demand).  This implies private saving is too high.  The solution is that government spending should be increased and/or taxes lowered.  The result is a larger government deficit, which is financed by private saving.  But with structural deficits at the national and state levels, private saving now has to be high to finance government deficits. Also, the United States has to continue to take in a high percent of cross-border financial flows.

CHINA

By some measures, using purchasing price parity (PPP) measurement, the Chinese economy is as big or possibly larger than the American economy.  (Although many analysts believe the past growth rates and the real economy of China are overstated.)

China has over half of the world’s high-speed railroad trackage and intends to increase it by two-thirds over the next 10 years.  By 2025, China intends to have every city in China with a population of at least a half a million to be connected to the high-speed rail network.  The point?  China spends substantially more on infrastructure than the United States does, and China uses more advanced technology. 

The U.S. high-speed rail mileage?  Zero.  Japan has offered to give the U.S. its high-speed rail technology.  I think that’s called foreign aid.

China is planning a high-speed railroad that will take passengers and freight from Beijing to Moscow in 33 hours and London in 48 hours.  Some sections of the railroad have already been built.  The geopolitical idea is to bypass American control of the world’s shipping lanes.

China has four times as many skyscrapers as the United States.

China has most of the long and high bridges in the world.

China has more cars than the United States. China has more smartphones.

China produces most of the world's solar panels. On the other hand, China emits more carbon into the atmosphere than any other country.

GLOBAL

Recessions were caused by rising global commodity prices.  Now there is a fear that a global recession could be caused by falling commodity prices and their longer-term consequences.

In the post-WWII period, there had never been a global recession.  Until 2007-2009.

At Japan's current rate of economic growth, their economy will double in size in 100 years. But by then there will be very few, if any, Japanese.

Almost all countries are experiencing rapidly rising national debt-to-nominal GDP ratios.  Economic history indicates bad things start to happen if the ratio goes over 90%. Many countries, including the U.S., are over 100%.  Japan has the highest ratio at 230%, a ratio no one thought could be possible without catastrophic economic consequences.   But this high and rising ratio is made possible because Japanese families are apparently willing to lend their government unlimited funds at zero interest.

For decades we have been told that we are running out of oil.  Now we are told there is too much oil.  Proven reserves have been greatly increased and because of improving drilling technology oil can be extracted at lower and lower marginal and average cost.

For four decades, Americans have been told that nuclear energy is bad and dangerous.  Now the world is planning on building hundreds of nuclear power plants using new technology. This is a major strategy to reduce global warming. But not in the United States.

Electric engines in cars will reduce carbon emissions and slow global warming. Unless the electricity is generated by burning coal or other fossil fuels.

The world faced a Malthusian future of exponential population growth caused by high birth rates, not enough food, and the depletion of energy and natural resources.  Since then, most of the world has birth rates below replacement and the rest of the world has falling birth rates. Industrial countries worry about future declining populations and labor forces.  Food production has undergone a series of technological revolutions that has greatly increased the quantity, if not the quality, of food.  Energy resources are almost unlimited with even more technological revolutions on the horizon.

Since the 1950s, Americans have been hearing how other forms of political economy would overcome the U.S.  First Russia, then Germany, then Japan, then the Four Dragons of Asia.    Behind all these predictions was the description of the advantages of socialism or state capitalism over our relatively autonomous capitalism.  Commentators suggested we adopt some of the government planning policies of these countries.  We didn’t.  These countries and their economic systems turned out not to be a threat to us but they are a warning to China.

MORE CONVENTIONAL WISDOM

Red wine, dark chocolate, and beer were bad for your health.  Now they are health foods.  This is my idea of progress!