In economy-land these days, nothing’s quite the way it’s supposed to be.
Economists, by training, believe that certain sequences of events will lead to predictable outcomes. Such a comforting thought is no longer assured.
Dorothy keeps dropping in on the citizens of Oz, unexpected and uninvited, and even the Wizard no longer knows where to turn.
I suspect the tornado in Kansas that has blown the system furthest off the beaten path has been the wide and unprecedented divergence between fiscal and monetary policy.
Government budget setters in most industrialized countries, for a decade, have fixated on austerity. Maybe they’ve been right to do so. The thought of what the aging of baby boomers will mean for the costs of pensions and health care is frightening. Belt tightening at this point in time might well be better than massive shortfalls in ten or 20 years from now.
The side effect, though, has been that all responsibility for providing economic stimulus has fallen on the shoulders of central bankers. Their responses to that burden have caused some of the most jarring diversions from what used to be.
The following catalogues seven glaring departures from standard economic causes and effects.
We’ll begin with the banking system.
(1) A depositor is supposed to be able to walk into a bank branch and earn a small rate of return on a checking or savings account while the financial institution lends out those same funds to someone else (who is in need of a mortgage or a corporate loan, etc.) at a higher rate of interest, thus earning a good profit. That’s always been the basic principle behind most financial sector transactions.
No more. In a number of countries and economic regions (e.g., Japan and the Euro zone), there’s a new phenomenon, negative interest rates. This implies a great risk of loss if your money is held anywhere but in the most secure of storehouses. The proposition is that in today’s shaky circumstances, you’ll want to pay a bank to hold your cash. Some government bonds are also yielding negative returns.
Great-aunt Hazel probably wasn’t so crazy when she stuffed banknotes in her mattress. At least that was a safety measure she could do for free. Incredibly, negative interest rates put safeguarding money in the same category as renting a storage locker to preserve a hideous old shag rug you once used to love. A consensus vote among family members has decreed it must be moved out of the house. Maybe your five year old son, when he grows up, will be delighted to find it in storage. It can form the centerpiece for his new bachelor pad.
(2) This far along in the recovery, central banks are supposed to be ‘normalizing’ their interest rates. In theory, the new level should be around 2.50%, down from a range of 3.50% to 4.00%.
Among international monetary authorities, the Bank of England appeared most hopeful in pursuing that goal. That quest has proven to be illusory. Along came Brexit.
The Federal Reserve and most other central banks have key policy-setting interest rates that are only marginally on one side or the other of zero. They aren’t even close to 2.50%, nor are they expected to approach that level for another two years.
(3) At various times since the Great Recession, several central banks have printed money as fast as they can. They’ve given the exercise a fancy name, ‘quantitative easing’, but it’s the equivalent of ‘cranking up the printing presses’ just the same. Such a course of action was supposed to light a fire under inflation.
Hasn’t happened. What it has done is cause instances of excessive asset appreciation, for example in many stock market equities and in some regional resale home prices (e.g., San Francisco and Vancouver).
It has barely caused international Consumer Price Index (CPI) measures to budge. Inflation remains a villainous dude that would like to lurk around in the back yard, but is having trouble scaling the fence.
(4) Even if it wasn’t going to keep on stepping upwards forever, the global price of oil was supposed to stay steady at a level offering producers a decent return. Saudi Arabia, it was assumed, would adjust production levels to ensure such an outcome.
Sorry, that hasn’t been the case. Instead, hydraulic fracturing came along, seemingly from out of nowhere, and dramatically raised supplies. To maintain market share, the princes of Riyadh dropped their per-barrel selling price of crude to a bargain-basement level. Other commodity prices headed south as well, kicking inflation further down the basement stairs.
(5) Consumers, enthralled by the enormous drop in what they were paying for petrol at gasoline station pumps, were supposed to take those cost savings and spend them lavishly elsewhere.
Nope. To their credit, they have been doing their part to keep economies alive, but not in an over-the-top or shopaholic way. As a wordier Rodney Dangerfield might have said, if he’d been an economist, “That’s the problem with you and me. We never act like frivolous wastrels when, collectively, it might actually do us some good.”
American consumers, especially, have been behaving responsibly to manage and reduce their legacy debt loads.
(6) The unemployment rate in the U.S. has dropped to an impressively low level, below 5.0%. A minimal jobless figure is supposed to act as a spur to wage hikes. There, in the background noise, am I hearing derisive laughter and a few outbursts of “Yeah, right …”?
A low unemployment rate usually leads to labor market unrest, accompanied by strikes. There have been some glimmers of this occurring (e.g., picket lines against Verizon in May), but certainly no evidence of waves sweeping across America. Employees remain hyper-aware that under globalization, many of them are still in danger of seeing their jobs outsourced.
(7) There was supposed to be an upside for other countries in the turbo-charged vitality of the U.S. dollar. The inverse of the rise in value of the greenback would provide key sectors of other countries with a price advantage when attempting to make export sales.
Canadian manufacturing was certainly targeted for a big lift. The Bank of Canada was counting on it early. Then the BOC moved its high expectations a little further down the road.
The BOC is still standing at a curb waiting for a bus that has changed its route. Manufacturing employment in Canada in May was -1.4% year over year.
Some Canadian manufacturing has received a boost, but it’s been mainly in product areas (e.g., in auto and parts exports) where U.S. consumer demand has been obeying a cyclical rather than a price imperative.
A large number of manufacturing firms departed from north of the border over the past decade and enticing them back will be no easy process.
Regardless of all the above, I’m pretty sure my colleagues and I will continue to connect dots in ways similar to what we have always done – in the hopes that the whirligig machinery will eventually slip back into a smoother running gear.
This will also mean, however, that we’ll frequently stub our toes on and off the Yellow Brick Road as we stumble on in search of the Emerald City.