Sunday, October 26, 2014

The Great Malaise Drags On

NEW YORK – There’s something dismal about writing year-end roundups in the half-decade since the eruption of the 2008 global financial crisis. Yes, we avoided a Great Depression II, but only to emerge into a Great Malaise, with barely increasing incomes for a large proportion of citizens in advanced economies. We can expect more of the same in 2014.

In the United States, median incomes have continued their seemingly relentless decline; for male workers, income has fallen to levels below those attained more than 40 years ago. Europe’s double-dip recession ended in 2013, but no one can responsibly claim that recovery has followed. More than 50% of young people in Spain and Greece remain unemployed. According to the International Monetary Fund, Spain can expect unemployment to be above 25% for years to come.

The real danger for Europe is that a sense of complacency may set in. As the year passed, one could feel the pace of vital institutional reforms in the eurozone slowing. For example, the monetary union needs a real banking union – including not just common supervision, but also common deposit insurance and a common resolution mechanism – and Eurobonds, or some similar vehicle for mutualizing debt. The eurozone is not much closer to implementing either measure than it was a year ago.

One could also sense a renewed commitment to the austerity policies that incited Europe’s double-dip recession. Europe’s continuing stagnation is bad enough; but there is still a significant risk of another crisis in yet another eurozone country, if not next year, in the not-too-distant future.

Matters are only slightly better in the US, where a growing economic divide – with more inequality than in any other advanced country – has been accompanied by severe political polarization. One can only hope that the lunatics in the Republican Party who forced a government shutdown and pushed the country to the brink of default will decide against a repeat performance.

But even if they do, the likely contraction from the next round of austerity – which already cost 1-2 percentage points of GDP growth in 2013 – means that growth will remain anemic, barely strong enough to generate jobs for new entrants into the labor force. A dynamic tax-avoiding Silicon Valley and a thriving hydrocarbon sector are not enough to offset austerity’s weight.

Thus, while there may be some reduction of the Federal Reserve’s purchases of long-term assets (so-called quantitative easing, or QE), a move away from rock-bottom interest rates is not expected until 2015 at the earliest.

Ending low-interest-rates now would not be sensible, though QE has probably benefited the US economy only slightly, and may have raised risks abroad. The tremors in global financial markets set off by discussions earlier in 2013 of tapering QE highlighted the extent of interdependence in the global economy.

Just as QE’s introduction fueled currency appreciation, announcing its eventual end triggered depreciation. The good news was that most major emerging countries had built up large foreign-exchange reserves and had sufficiently strong economies that they could withstand the shock.

Still, the growth slowdown in emerging economies was disappointing – all the more so because it is likely to continue through 2014. Each country produced its own story: India’s downturn, for example, was attributed to political problems in New Delhi and a central bank worried about price stability (though there was little reason to believe that raising interest rates would do much about the price of onions and the other items underlying Indian inflation).

Social unrest in Brazil made it clear that, despite remarkable progress in reducing poverty and inequality over the past decade, the country still has much to do to achieve broadly shared prosperity. At the same time, the wave of protest showed the growing political clout of the country’s expanding middle class.

China’s decelerating growth had a significant impact on commodity prices, and thus on commodity exporters around the world. But China’s slowdown needs to be put in perspective: even its lower growth rate is the envy of the rest of the world, and its move toward more sustainable growth, even if at a somewhat lower level, will serve it – and the world – well in the long run.

As in previous years, the fundamental problem haunting the global economy in 2013 remained a lack of global aggregate demand. This does not mean, of course, that there is an absence of real needs – for infrastructure, to take one example, or, more broadly, for retrofitting economies everywhere in response to the challenges of climate change. But the global private financial system seems incapable of recycling the world’s surpluses to meet these needs. And prevailing ideology prevents us from thinking about alternative arrangements.

We have a global market economy that is not working. We have unmet needs and underutilized resources. The system is not delivering benefits for large segments of our societies. And the prospect of significant improvement in 2014 – or in the foreseeable future – seems unrealistic. At both the national and global levels, political systems seem incapable of introducing the reforms that might create prospects for a brighter future.

Maybe the global economy will perform a little better in 2014 than it did in 2013, or maybe not. Seen in the broader context of the continuing Great Malaise, both years will come to be regarded as a time of wasted opportunities.

Read more from "2013: Reversing Gears" here, or on Kindle and iBooks.

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  1. CommentedAvraam Dectis

    The Great Malaise could be eliminated by adopting bond funded government at the national level.

    This means abolishing personal and corporate income federal taxes and funding the government through floated bonds.

    Inflation could be controlled through interest rates, bank reserve requirements, spending restraint and the like.

    Demand would improve as the average worker enjoyed a significant income boost. Unproductive tax collecting and avoiding activities would be largely eliminated.

    Federal taxes have not truly been necessary since the gold standard and they are an obsolete device impeding economic efficiency.

    There would also be significant obvious political benefits.

    Avraam J. Dectis

      CommentedAvraam Dectis

      PS - Bond funded government only works for countries with their own currency.

  2. CommentedCarol Maczinsky

    First you need a stable order framework, and compliance, otherwise these solutions are suicidal: "For example, the monetary union needs a real banking union – including not just common supervision, but also common deposit insurance and a common resolution mechanism – and Eurobonds, or some similar vehicle for mutualizing debt." / as long as Southern nations don"t get real and blame creditors it is clear why we can't risk eurobonds. simply because these politicians are unreasonable and crazy. First the forgery and the governance issues have to be resolved.

  3. CommentedG. A. Pakela

    How can you say that the so-called austerity pared 1-2 percentage points of GDP growth in 2013, when GDP growth in 2013 has been roughly the same each year throughout the recovery? And, the deficit as a percentage of GDP is still significant even as it falls from levels not seen since WWII.

  4. CommentedPaul Mathew Mathew

    The great malaise is a prelude to an epic collapse - industrial society is about to end:

    Former BP geologist: peak oil is here and it will 'break economies'

    The decline of the world's major oil fields
    Aging giant fields produce more than half of global oil supply and are already declining as group, Cobb writes. Research suggests that their annual production decline rates are likely to accelerate.

    Toil for oil means industry sums do not add up (

    Rising costs are being met only by ever smaller increases in supply

    The most interesting message in this year’s World Energy Outlook from the International Energy Agency is also its most disturbing.
    Over the past decade, the oil and gas industry’s upstream investments have registered an astronomical increase, but these ever higher levels of capital expenditure have yielded ever smaller increases in the global oil supply. Even these have only been made possible by record high oil prices. This should be a reality check for those now hyping a new age of global oil abundance.

    According to the 2013 WEO, the total world oil supply in 2012 was 87.1m barrels a day, an increase of 11.9mbd over the 75.2mbd produced in 2000.

    However, less than one-third of this increase was in the form of conventional crude oil, and more than two-thirds was therefore either what the IEA calls unconventional crude (light-tight oil, oil sands, and deep/ultra-deepwater oil) or natural-gas liquids (NGLs).

    This distinction matters because unconventional crude has a higher cost than conventional crude, while NGLs have a lower energy density.

    The IEA’s long-run cost curve has conventional crude in a range of $10-$70 a barrel, whereas for unconventional crude the ranges are higher: $50-$90 a barrel for oil sands, $50-$100 for light-tight oil, and $70-$90 for ultra-deep water. Meanwhile, in terms of energy content, a barrel of crude oil is worth 1.4 barrels of NGLs.

    Threefold rise
    The much higher cost of developing unconventional crude resources and the lower energy density of NGLs explain why, as these sources have increased their share of supply, the industry’s upstream capex has increased. But the sheer scale of the increase is staggering: upstream outlays have risen more than threefold in real terms over the past 12 years, reaching nearly $700bn in 2012 compared with only $250bn in 2000 (both figures in constant 2012 dollars).

    Coinciding with the rise in US tight-oil production, most of this increase in upstream capex has occurred since 2005, as investments have effectively doubled from $350bn in that year to nearly $700bn in 2012 (again in 2012 dollars).

    All of which means the 2013 WEO has the oil industry’s upstream capex rising by nearly 180 per cent since 2000, but the global oil supply (adjusted for energy content) by only 14 per cent. The most straightforward interpretation of this data is that the economics of oil have become completely dislocated from historic norms since 2000 (and especially since 2005), with the industry investing at exponentially higher rates for increasingly small incremental yields of energy.

    The industry has been able and willing to finance such a dramatic increase in its capital investment since 2000 owing to the similarly dramatic increase in prices. BP data show that the average price of Brent crude in real terms increased from $38 a barrel in 2000 to $112 in 2012 (in constant 2011 dollars), which represents a 195 per cent increase, slightly greater in fact than the increase in industry capex over the same period.
    However, looking only at the period since 2005, capital outlays have risen faster than prices (90 per cent and 75 per cent respectively), while in the past two years capex has risen by a further 20 per cent (the IEA estimates 2013 upstream capex at $710bn versus $590bn in 2011), while Brent prices have actually averaged about $5 a barrel less this year than in 2011.

    Iran not a game changer
    That prices have fallen slightly since 2011 while capex has risen by a further 20 per cent is a flashing light on the industry’s dashboard indicating that its upstream growth engine may finally be overheating.

    Without a significant technological breakthrough reversing the geological forces that have driven the unprecedented increase in upstream investment over the past decade, prices will have to rise further in real terms from here or else capex – and with it future oil production – will fall.

    It should also be emphasised that this vast increase in capex has occurred during a prolonged period of record-low interest rates. Once interest rates start rising again, this will put further pressure on the industry’s ability to make the massive capital outlays required to keep supply growing.

    Of course, the diplomatic breakthrough achieved with Iran over the weekend could provide some much needed short-term relief to the market, as Iran’s exports could ultimately increase by up to 1.5m barrels a day if and when western sanctions were to be fully lifted. But this would not change the dynamics of the industry’s capex treadmill in any fundamental sense.
    Even if global oil demand only grows at 1 per cent a cent a year, those extra barrels would be would be fully absorbed by the market within about 18 months. And that is probably how long it would take for Iran’s production and exports to return to pre-sanctions levels in any case.

    Alternatively, if we take the IEA’s estimate that global production of conventional crude oil from all currently producing fields will decline by 41m barrels a day by 2035 (that is, by an average of 1.9m barrels a day per year), then Iran’s potential increase of 1.5m barrels a day would compensate for just 10 months of natural decline in global conventional-crude output.

    In short, behind the hubbub of market hype about a new age of oil abundance, the toil for oil is in fact now more arduous and back-breaking than ever.

    This should worry everybody, because with the evidence suggesting that consumers are reluctant to pay much above $110 a barrel, it is an open question what happens next to the industry’s investment plans and hence, over time, to the supply of oil.

    Mark Lewis is an independent energy analyst and former head of energy research in commodities at Deutsche Bank; Daniel L Davis, a lieutenant colonel in the US Army, is co-author

  5. CommentedJames Goodman

    It is far more appropriate to expect the current situation to continue to evolve far beyond 2014. The reason why equilibrium economic theory is struggling is because the economy appears to evolve as a complex adaptive system. In complexity economics and systems science, a CAS-economy is the norm and equilibrium is the exception (see W. Brian Arthur from INET and SFI, link 1). For example, Peter Turchin is a leading expert in population dynamics (and an authority in mathematics) who models and documents long opposing cycles of inequality and well-being (link 2). It would be timely indeed if economic theory started to pay more attention to economic evolution, rather than equilibrium scenarios.

  6. CommentedJose araujo

    Professor, something puzzles me, not so much the facts but the “current” interpretation of them, and maybe you could cast a light into my doubts.

    It’s my understanding that the current situation of low interest rates, the so called zero lower bound, its motivated by strong risk aversion or the liquidity preference.

    What puzzles me is that many still advoque the end of low interest rates, namely by intervention of the central banks, when it was my understanding from the beginning of the monetary easing, that those moves were designed more to provoque inflation through the change of expectations, and allow economies to move out of the liquidity trap situation.

    Are we, or are we not living in a world with strong risk aversion? All the evidence points to the fact we are in fact living in a world with strong preference for liquidity, where investments are stalled, risk free assets have negative yeld curves and sovereign debt rates are close to zero even in countries that never engaged in expansionary monetary policies.

    If that is true, why do people continue to write like the central banks are the ones causing low interest rates?

      CommentedStamatis Kavvadias

      Some people advocate stop of QE; not stop of low interest rates. Stop of low interest rates is already made irrelevant, since QE has overly destroyed the overnight market (i.e., all banks have more than adequate reserves for daily clearing). Maybe the people you refer to have in mind the central bank draining, somehow, banks reserves near their pre-crisis levels, so that the overnight market starts functioning again...

  7. CommentedWilhelm Röpke

    What you suggest would make a political union necessary at first.
    To draw parallels to the US, you must keep in mind that the US is a federal state. The eurozone is definitely not. The eurozone is a joint federation of (sovereign) countries. In the US there is a federal government, there is a constitution that says how "events" are to be handled. All these is simply not there in the eurozone. Moreover, even in the US states can go insolvent and no other states is obliged nor would jump in and inject fresh money into an insolvent state.

    What we have seen, in the eurozone, is that countries have run a beggar thy neighbour policy. The Northern countries have no power to have a word or a veto in the policy of the Southern countries. But your suggestion would mean that the Southern can decide to live further beyond their means and pass on their bills to the Northern countries to foot them.

    That is, for example, as Germany would urge the US to pay the debts for Greece leaving the US the only position of a financier.

    Europe's banking sector is too big and it holds too much risky assets.
    Alling banks need to be closed and sound banks recapitalised and equity must be much higher for banks and all the other companies and vehicles in the financial sector.

    To pool liability in addition for the financial sector as well would mean
    for the Northern countries a much higher stake of risk to finance. So, if the eurozone would be as you suggest the Northern countries would decide which bank is to close and which one is to be held alive.
    Anything else would again be a beggar thy neighbour policy. Again would the Southern countries be able to transfer their risk to the Northern countries.

    I would expect that your suggestion should consider more the de facto environment of the eurozone and the way this eurozone is build up. The point you do not consider nor do you stress is to put it in the spotlight. None of the Southern countries is willing to cede sovereignty. And exactly this is necessary to pool liabilities, budget...
    What you suggest would need, at first, United States of Europe or a Federal Republic of Europe.

  8. CommentedProcyon Mukherjee

    Why is the "private financial system" not able to recycle the surpluses to areas of need, or why are 'needs of large sections of people unmet', while resource utilization has miles to be achieved?

    The answer to this is no riddle, the choice between capital and labor, between stock holders and all other stakeholders, between zones of depravity to the islands of opulence, there is only one single determining factor, private capital's return expectation and its eventual fulfillment; there is no "public capital" and its altruistic goals.

    But even in this charade of financial wisdom, what stands out is that the holders of surplus capital today must realize that it would be to their best interest if capital moves from surplus areas to deprived areas, where institutions are built around the central idea that it must facilitate this movement to make it flourish as a business proposition, not as a philanthropic escapade.

  9. CommentedMr Econotarian

    Nonfarm Business Sector Real Compensation Per Hour has risen by 30% over 40 years in the US. Looking at wages is misleading because of the growth of non-wage benefits.

    Europe had high youth unemployment before the Great Recession. It is more likely too much labor regulation in Europe that makes employers scared of hiring untried workers that they would have to pay dearly to fire if they did not work out.

    Someone still needs to show me the scientific data that higher levels of government deficits raise private GDP.

    And even if you do believe that "austerity" is the cause of "malaise", one would have to explain the higher level of GDP growth and unemployment decreases in the US versus Europe. My personal feeling is that government spending of some level is necessary, but a stable regime of low labor and business regulation is required for private sector growth regardless of government spending levels.