Thursday, November 27, 2014

The Great Disconnect

PARIS – Since the second half of 2012, financial markets have recovered strongly worldwide. Indeed, in the United States, the Dow Jones industrial average reached an all-time high in early March, having risen by close to 9% since September. In Europe, European Central Bank President Mario Draghi’s “guns of August” turned out to be remarkably effective. Draghi reversed the euro’s slide into oblivion by promising potentially unlimited purchases of member governments’ bonds. Between September 1 and February 22, the FTSEurofirst index rose by almost 7%. In Asia, too, financial markets are up since September, most dramatically in Japan.

Even the Italian elections in late February seem not to have upset markets too much (at least so far). Although interest-rate spreads for Italian and Spanish ten-year bonds relative to German bonds briefly jumped 30-50 basis points after the results were announced, they then eased to 300-350 basis points, compared to 500-600 basis points before the ECB’s decision to establish its “outright monetary transactions” program.

But this financial market buoyancy is at odds with political events and real economic indicators. In the US, economic performance improved only marginally in 2012, with annual GDP rising by 2.3%, up from 1.8% in 2011. Unemployment remained high, at 7.8% at the end of 2012, and there has been almost no real wage growth over the last few years. Median household income in the US is still below its 2007 level – indeed, close to its level two decades ago – and roughly 90% of all US income gains in the post-crisis period have accrued to the top 1% of households.

Indicators for the eurozone are even worse. The economy contracted in 2012, and wages declined, despite increases in Germany and some northern countries. Reliable statistics are not yet available, but poverty in Europe’s south is increasing for the first time in decades.

On the political front, the US faces a near-complete legislative stalemate, with no sign of a compromise that could lead to the optimal policy mix: short-term support to boost effective demand and long-term structural reforms and fiscal consolidation. In Europe, Greece has been able – so far – to maintain a parliamentary majority in support of the coalition government, but there, and elsewhere, hyper-populist parties are gaining ground.

The Italian election results could be a bellwether for Europe. Beppe Grillo’s populist Five Star Movement emerged with 25% of the popular vote – the highest support for any single party. Former Prime Minister Silvio Berlusconi, confounding those who had forecast his political demise, re-emerged at the head of a populist-rightist coalition that ended up only 0.3 percentage points away from winning.

In short, we are witnessing a rapid decoupling between financial markets and inclusive social and economic well-being. In the US and many other places, corporate profits as a share of national income are at a decades-long high, in part owing to labor-saving technology in a multitude of sectors. Moreover, large corporations are able to take full advantage of globalization (for example, by arbitraging tax regimes to minimize their payments).

As a result, the income of the global elite is growing both rapidly and independently of what is happening in terms of overall output and employment growth. Demand for luxury goods is booming, alongside weak demand for goods and services consumed by lower-income groups.

All of this is happening in the midst of extremely expansionary monetary policies and near-zero interest rates, except in the countries facing immediate crisis. Structural concentration of incomes at the top is combining with easy money and a chase for yield, driving equity prices upward.

And yet, despite widespread concern and anxiety about poverty, unemployment, inequality, and extreme concentration of incomes and wealth, no alternative growth model has emerged. The opposition to the dominant mainstream in Europe is split between what is still too often an “old” left that has trouble adjusting to twenty-first-century realities, and populist, anti-foreigner, and sometimes outright fascist parties on the right.

In the US, the far right shares many of the characteristics of its populist European counterparts. But it is a tribute to the American two-party system’s capacity for political integration that extremist forces remain marginalized, despite the rhetoric of the Tea Party. President Barack Obama, in particular, has been able to attract support as a liberal-left idealist and as a centrist-realist at the same time, which enabled him to win re-election in the face of a weak economy and an even weaker labor market.

Nonetheless, without deep socio-economic reforms, America’s GDP growth is likely to be slow at best, while its political system seems paralyzed. Nowhere is there a credible plan to limit the concentration of wealth and power, broaden economic gains through strong real-income growth for the poor, and maintain macroeconomic stability.

The absence of such a plan in the US (and in Europe) has contributed to the decoupling of financial markets from inclusive economic progress, because it suggests that current trends are politically sustainable. But, while this disconnect could continue for some time if no alternative program emerges, the huge gap between financial markets’ performance and most people’s well-being is unlikely to persist in the longer term. When asset prices overshoot reality, eventually they have nowhere to go but down.

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    1. CommentedParrain Boursorama

      It is instructive that Professor Rogoff cites Harmston. The value of gold is more discussed than the value of bread but there is no doubt which one is the more important and it is not the value of the mineral. Malthusian limits will devalue gold in the long run.

    2. CommentedPietro Donnini

      the sunto is: the world is going digital, in this world humans are simple financial alghoritms; and nobody care about the old world: is it a wise thing?

    3. CommentedRonald Abate

      An interesting perspective on Obama at African-American Conservatives blog talk radio. Link below:

      Then there is the fact that in America today for someone without job skills and at least a high school education, it does not pay to work when the government pays you so well not to work.

      I direct you to this interesting podcast at

      When this writer writes about how the lower middle classes have not kept up, he neglects to include all the benefits provided by government and company paid health insurance. When included the numbers don't look as bad, although nothing like the top 10%. But if these people had anything close to the top 10% job skills, the top 10% could not command such an income premium because there would be far more supply.

    4. Commenteddouglas ungredda

      This great disconnect is the Post Keynesian nightmare made reality
      As political stalemate drags on, and as plenty of productive capacity stilll lingers on job creation willl not pick up, even under the preence of excess liquidity. This is a perfect "Liquidity Trap" scenario compounded by the fact that at zero interest rates its easier to bet other people' s money in risky products (derivatives and in the stock market) , rather than additional productive capacity. Technological breakthroughs demand very high educational standards and few countries are pocsitioned well enought to reap the benefits that production gloablization brings.

    5. CommentedCarol Maczinsky

      I don't see a marginalisation of extremist tendencies in the United States. The last normal government was headed by Jimmy Carter. It is the US that struggles to get basic social policies, defends drone killings and still sticks with death penalty. All of that would be unthinkable in Europe. Our "right wing" politicians would not dare to argue in favour of torture in election campaigns. But worst of all the US nation is unable to keep its corporations and financial players in check and as a result we had the bubble exported to Europe. Now it is essential to reestablish market order and mitigate the systemic risks. For 'Europe the future is ordoliberal, not the corrupted softy regulation of the U.S. that ruined everything. Russia learned its lesson with softy regulation.

    6. CommentedJacque Vilet

      The Tea Party in the U.S. is not marginalized at all. In fact they are much of the cause of the stalemate in Congress even as we speak.

    7. Commentedradek tanski

      Uh. Read it on counterpunch. Seems like share prices are escalated because companies are using cheap debt to buy back shares. Much better returns than the debt.

    8. Commentedjames durante

      This is one of the very few articles to hit the nail on the head. What every champion of capitalism refuses to look at is inequality. They are allergic to it because their raison de etre is defense of that old time religion: "capitalism good, communism bad." But what the last thirty years show us is that de-regulation, low taxes and anti-unionism creates a perfect storm of corporate profits, baking excesses, and insane gini coefficients.

      The results are inescapable: stagnation, high unemployment, anomie at worst and rioting at best, fiscal logjams, monetary desperation, and the constant threat of another implosion.

      As Dervis correctly notes, what is needed is a political solution that addresses inequality. But the political system has become so dependent on ceo/bankster contributions and lobbying that such a solution seems highly unlikely. Probably only more crisis and the threat of fascism will waken political elites to the need for deep structural reforms.

    9. CommentedProcyon Mukherjee

      Shiller’s CAPE ratio or the cyclically adjusted P/E ratio is at 23.45 (in Dec’1999 it touched 44.20), with the distribution mean of 16.47 and a median of 15.88 can hardly be a cause for the current euphoria that S&P 500 have peaked; the real return over a period of 13 years if one starts from December 1999 would have shown a large negative. With forward earnings guidance negotiating troubled waters, it is only time for the next breather as all the other indices starting from the industrial metals, the precious metals, base metals or energy indices indicate a rather mellowed performance; the monetary transmission is in great need of support from fiscal responses, which going by the forward projections of debt servicing capacity, has some very strong headwinds.

    10. CommentedZsolt Hermann

      This disconnection originates from the completely unnatural socio-economic system we have been pursuing, where the goods, pleasures we are promoting and trying to consume, and make consumed are unrelated to natural desires, and true necessities.
      In such a twisted system basic components start to rise and fall in an abnormal fashion, taking over roles, areas they should not even enter.
      The banks, financial institutions in a such a way have become from simple facilitating services for a natural economy to king makers, the most important actors in today's excessive over production/over consumption system.
      In this system which is built on forced, artificial expansion, creating bubbles within bubbles the banks are necessary to keep on providing the financial support for this hysterical expansion.
      By now the wheels have come off, the system is collapsing, but like alcoholics, those on the top try to ignore reality and keep on riding the financial institutions, pouring all the resources into them to continue what cannot really continue.
      Of course judging the health of our world based on the health of the financial system is like judging the state of a terminally ill patient based on the clothes he is wearing.
      The big question is if the recognition of the true illness requires even deeper crisis, significant global suffering, or wisdom prevails over profit and people start changing before a complete meltdown.

    11. Commentedradek tanski

      Aren't the high share prices an indication that investors are desperate to buy any assets even if at low/decreasing returns?

        CommentedRonald King

        The price of a stock indicates the perceived value as determined by the most recent buyer, nothing more, and has no relation to the overall economy.