17/2/16: The Four Horsemen Of Economic Apocalypse Are Here

Recent media and analysts coverage of the global economy, especially that of the advanced economies has focused on the rising degree of uncertainty surrounding growth prospects for 2016 and 2017. Much of the analysis is shlock, tending to repeat like a metronome the cliches of risk of ’monetary policy errors’ (aka: central banks, read the Fed, raising rates to fast and too high), or ‘emerging markets rot’ (aka: slowing growth in China), or ‘energy sector drag’ (aka: too little new investment into oil).

However, the real four horsemen of the economic apocalypse are simply too big of the themes for the media to grasp. And, unlike ‘would be’ uncertainties that are yet to materialise, these four horsemen have arrived and are loudly banging on the castle of advanced economies gates.

The four horsemen of growth apocalypse are:

1. Supply side secular stagnation (technology-driven productivity growth and total factor productivity growth flattening out);
2. Demand side secular stagnation (demographically driven slump in global demand for ‘stuff’) (note I covered both extensively, but here is a post summing the two: http://trueeconomics.blogspot.com/2015/10/41015-secular-stagnation-and-promise-of.html)
3. Debt overhang (the legacy of boom, bust and post-bust adjustments, again covered extensively on this blog); and
4. Financial fragility (see http://trueeconomics.blogspot.com/2016/01/19116-after-crisis-is-there-light-at.html)

In this world, sub-zero interest rates don’t work, fiscal policies don’t work and neither supply, nor demand-side economics hold any serious answers. Evidence? Central bankers are now fully impotent to drive growth, despite having swallowed all monetary viagra they can handle. Meanwhile, Government are staring at debt piles so big and bond markets so touchy, any serious upward revision in yields can spell disaster for some of the largest economies in the world. More evidence? See this: http://trueeconomics.blogspot.com/2015/10/101015-imf-honey-weve-japanified-world.html.

To give you a flavour: consider the ‘stronger’ economic fortress of the U.S. where the Congressional Budget Office latest forecast is that the budget deficit will rise from 2.5 percent of GDP in 2015 to 3.7 percent by 2020. None of this deficit expansion will result in any substantive stimulus to the economy or to the U.S. capital stocks. Why? Because most of the projected budget deficit increases will be consumed by increased costs of servicing the U.S. federal debt. Debt servicing costs are expected to rise from 1.3 percent of GDP in 2015 to 2.3 percent in 2020. Key drivers to the upside: increasing debt levels (debt overhang), interest rate hikes (monetary policy), and lower remittances from the Federal Reserve to the U.S. Treasury (lower re-circulation of ‘profits and fees’). Actual discretionary spending that is approved through the U.S. Congress votes, excluding spending on the entitlement programs (Medicaid, Medicare and Social Security) will go down, from 6.5 percent of GDP in 2015 to 5.7 percent of GDP by 2020.

Boom! Debt overhang is a bitch, even if Paul Krugman thinks it is just a cuddly puppy…

Recently, one hedgie described the charade as follows: ”I like to use the analogy that the economic patient is riddled with cancer — central banks are applying a defibrillator, but there's only so much electricity the patient can take before it becomes a burnt-out corpse.” Pretty apt. (Source: http://www.businessinsider.com/36-south-four-horsemen-2016-2?r=UK&IR=T)

My favourite researcher on the matter of financial stability, Claudio Borio of BIS agrees. In a recent speech (http://www.bis.org/speeches/sp160210_slides.pdf) he summed up the “symptoms of the malaise: the “ugly three”” in his parlance:

• Debt too high
• Productivity growth too low
• Policy room for manoeuvre too limited

Source: Borio (2016)

The fabled deleveraging that apparently has achieved so much is not dramatic even in the sector where it was on-going: non-financial economy, for advanced economies, and is actually a leveraging-up in the emerging markets:

Source: Borio (2016)

And these debt dynamics are doing nothing for corporate profitability:

Source: Borio (2016)

Worse, what the above chart does not show is what the effect on corporate profitability will interest rates reversions have (remember: there are two risks sitting here - risk 1 relating to central banks raising rates, risk 2 relating to banks - currently under severe pressure - raising retail margins).

Boris supplies a handy chart of how bad things are with productivity growth too:

Source: Borio (2016)

The above are part-legacy of the Global Financial Crisis. Boris specifies: Financial Crises tend to last much longer than business cycles, and “cause major and long-lasting damage to the real economy”. Loss in output sustained in Financial Crises are not transitory, but permanent and include “long-lasting damage to productivity growth”. Now, remember the idiot squad of politicians who kept droning on about ‘negative equity’ not mattering as long as people don’t move… well, as I kept saying: it does. Asset busts are hugely painful to repair. Boris: “Historically there is only a weak link between deflation and output growth” despite everyone running like headless chickens with ‘deflation’s upon us’ meme. But, there is a “much stronger link with asset price declines (equity and esp property)”, despite the aforementioned exhortations to the contrary amongst many politicos. And worse: there are “damaging interplay of debt with property price declines”. Which is to say that debt by itself is bad enough. Debt written against dodo property values is much worse. Hello, negative equity zombies.

But the whole idea about ‘restarting the economy’ using new credit boost is bonkers:

Source: Borio (2016)

Because, as that hedgie said above, the corpse can’t take much of monetary zapping anymore.

Hence time to wake up and smell the roses. Borio puts that straight into his last bullet point of his last slide:

Source: Borio (2016)

Alas, we have nothing to rely upon to replace that debt fuelled growth model either.

Knock… knock… “Who’s there?” “The four horsemen?” “The four horsemen of what?” “Of debt apocalypse, dumbos!”

30/11/15: WarningSignals on Secular Stagnation Threats

The readers of this blog know that I have been covering the twin theses of Secular Stagnation (long-term trend in slowdown of global growth) consistently over recent years.

Here is an interesting summary of the theses and literature on it, with extensive references to this blog (among other sources): http://www.warningsignals.org/#!Where-are-we-on-Secular-Stagnation/covf/565464fb0cf29e70f2253e70.

My own view summarised most recently here: http://trueeconomics.blogspot.ie/2015/10/41015-secular-stagnation-and-promise-of.html.

24/11/15: Europe's Dead Donkey of Productivity Growth

Remember the mythology of European productivity miracles:

1. The EU is at least as competitive as the U.S. (with Lisbon Agenda completed, or rather abandoned);
2. The EU growth in productivity is structural in nature (i.e. not driven by capital acquisition alone and not subject to cost of capital effects); and
3. The EU productivity growth is driven by harmonising momentum (common markets etc) at a policy level, with the Euro, allegedly, producing strong positive effects on productivity growth.

Take a look at this chart from Robert J. Gordon's presentation at a recent conference:

The following observations are warranted:

• EU convergence toward U.S. levels of productivity pre-dates major policy harmonisation drives in Europe and pre-dates, strongly, the creation of the Euro;
• EU productivity convergence never achieved parity with the U.S.;
• EU productivity convergence was not sustained from the late 1990s peak on;
• The only period of improved productivity in the EU since the start of the new millennium was associated with assets bubble period (interest rates and credit supply).

Darn ugly!

But it gets worse. Since the crisis, the EU has implemented, allegedly and reportedly, a menu of 'structural' reforms aiming at improving competitiveness.  Which means that at least since the end of the crisis, we should be seeing improved productivity growth differentials between Europe and the U.S. And the EU case for productivity growth resumption is supported by the massive, deeper than the U.S., jobs destruction during the crisis that took out a large cohort of, supposedly, less productive workers, thereby improving the remainder of the workforce levels of productivity.

Here is a chart from the work by John Van Reenen of LSE:

Apparently, none of this happened:

• EU structural reforms have been associated (to-date) with much lower productivity growth post-crisis than the U.S. and Japan;
• EU jobs destruction during the crisis has been associated with lower productivity increases than in the U.S. and Japan;
• All EU programmes to support growth in productivity, ranging from the R&D supports to investment funding for productivity-linked structural projects have produced... err... the worst outcome for productivity growth compared to the U.S. and Japan.

And the end result?

I know, I know... a Genuine Productivity Union, anyone?...

10/10/15: IMF: "Honey, we've Japanified the World"

Much has been written this week about IMF’s World Economic Outlook and the belated catching up the IMF are performing to the reality of

1. Faltering Emerging Markets, but improving Advanced Economies
2. Flattening Global growth, but momentum recovery in the Euro area (that depends on the World demand for its exports); and
3. Largely still-ignored, but nonetheless hanging like a dark shadow over the IMF's forecasts, secular stagnation.

Now, with some time lapsed over all that media circus, let’s take a look at hard numbers.

Here is the breakdown of IMF changing forecasts.

First up, World real GDP growth forecasts. How did these evolve over the recent years?

Yep, that’s right. Back in October 2012, IMF was projecting 2015 growth to come in at 4.418%. This gradually fell back to 3.847% forecast in October 2014. This week outlook for 2015 full year global economic growth is 3.123%. All along, the IMF has been signing praise to structural reforms, ownership of various programmes (IMF-run programmes) and monetary policies efforts. Year after year, after year cheerleading the world to ‘next year things will be great’. Do observe how every forecast starts with the premise that "next year, there will be an uptick in growth". And the end game is 1.295 percentage points lower growth outrun for 2015 in October this year than back in  October 2012.

Guess what, every year from 2015 on, current forecast shows lower growth than that expected in the earliest WEO report containing such a forecast.

Ditto for the Advanced Economies, as shown in the chart below

Things are no better for the Euro area, despite the already low aspirations that the IMF had for the common currency area from the start:

And for the Emerging Markets - ditto.

You wonder how on earth can these 'rosy forecasts --> ugly reality' picture can be consistent with IMF ever-expanding 'sustainable' lending to the states in trouble? It doesn't, of course, for IMF growth projections simply do not support the lending the Fund is doing. Instead, it is the efforts of the Central Banks at printing money to monetise debt that make this pile of Government-backed junk 'sustainable' for now.

Now, 2010-2011 were pretty awful years overall for the global economy. Still, it managed to squeak out 4.828% average rate of growth in these gloomy days. Now, we have a global recovery, and volumes of structural reforms written, re-written and re—re-written. IMF is now virtually running half the planet and majority of Government are obligingly ‘owning’ their programmes. Beyond, we have tens of trillions of printed/minted/QEd/instrumented/engineered debt and cash instruments flooding the markets.

And yet:

• In 2015-2020, per IMF latest projections, Global economic growth is going to be lower than 2010-2011 average in every year.
• The same is true for the Advanced economies;
• The same is true for the Euro area; 
• The same is true for the Emerging Markets.

Actually, the rot has been ongoing since 2012. Here is the cumulative growth that has been achieved (through 2014) and is forecast to be achieved (from 2015 through 2020) since 2010 across the main regions:

You can’t make this up: even with the Euro area contained within it, Advanced Economies group outperforms Euro area group by almost 3/4rs.

The chart below slices the same data slightly differently, by looking at cumulative growth the IMF projected for 2015-2017 period.

Abysmal? You bet.

Based on 2010-2011 average, we should see Global economy expanding by 15.2% over the three years of 2015-2017. Instead, IMF projects growth of 10.86%. Advanced economies should grow by 7.4% based on 2010-2011 averages, but current forecast implies growth of 6.58%. Euro area economy should grow by 5.6% based on 2010-2011 averages, but current outlook implies growth of 4.87%. Emerging Markets should be growing by 22.1% under 2010-2011 average rates, and are now projected to expand by 14%.

Amidst all this, talking about Governments around the world ‘owning’ more reforms, as the IMF continues to do might be as close to Einstein’s famous dictum about insanity as one can get.

In the entire IMF review of the Western Hemisphere (that includes NAFTA states), there is only one, cursory mentioning of the phrase “secular stagnation” even though the entire WEO database published by the Fund screams it from every data set imaginable. But there are plenty of mentions in the WEO and the Fiscal Monitor and the GFSR for the need for the Euro area to harmonise more. Presumably because all this harmonisation before has not led us to where we are today - running an economy that is growing by margins statistically pretty darn indistinguishable from zero. There are admonitions by the IMF for the Emerging Markets to get onto the bandwagon of structural reforms too. Because the IMF prescriptions have worked so well in Europe, the dynamism of the continent is now overwhelmingly... err... what's the word here?... suffocating?..

Truth is, folks, we are now all Japanified. Time for the IMF to catch up with that trend and think up real reforms, such as

• Dealing with debt overhangs not by bleeding households and companies dry, but by restructuring these, 
• Dealing with slacked investment and enterprise creation not by shoving more cheap funds into the banks, but by using monetary firepower (the little that is still left floating around) to free households from debt and giving them lower taxation burdens, while providing proper risk and tax treatment of debt,
• Dealing with excessive policies harmonisation and coordination by encouraging the states to take the route to greater financial, fiscal and economic management independence, and
• Promoting not the divisive, Us-vs-Them types of quasi-regional trade deals recently welcomed by the IMF under the US-led TPP and TTIP, but inclusive trade negotiations under the WTO umbrella.

Because, as Japan's example has taught us so far, Japanification can't be cured by printing presses and fiscal stimuli. And it is sure as hell can't be cured by the IMF 'structural reforms'...

9/10/15: Quantitative Scaring & Secular Stagnation

One very important point being raised in this article from the Economist: "Controlling for the range of things that influence interest rates, from growth to demography, economists have attempted to gauge the impact of reserve accumulation. Francis and Veronica Warnock of the University of Virginia concluded that foreign-bond purchases lowered yields on ten-year Treasuries by around 0.8 percentage points in 2005. A recent working paper by researchers at the European Central Bank found a similar effect: increased foreign holdings of euro-area bonds reduced long-term interest rates by about 1.5 percentage points during the mid-2000s."

Which brings us to the idea of the 'savings glut' over the 2000s. I covered this in this article concerning the twin threats of supply and demand side-driven secular stagnation.

The Economist give us one side of that equation: Sovereign Reserves

All of which has two implications:

1. The commodities bubble bursting will have a second order effect on longer-term expected cost of Government borrowing in the advanced economies by removing the surplus of savings accumulated in the official accounts in the Emerging Markets. Which makes unwinding monetary policy excesses (from the balancesheets of the Central Banks in the advanced economies) so much harder. The knock on effect of this will be lower solvency of the Western pensions funds in the longer run; and
2. Depletion of savings on the sovereign side will require increased savings on the private sector side. Which will have compounding effect on demand.

Both points reinforce the adverse impact on global growth prospects.

4/10/15: Secular Stagnation and the Promise of the Recovery

An unedited version of my recent requested guest contribution for News Max on the issue of secular stagnation (July-August 2015).

Secular Stagnation and the Promise of the Recovery

Recent evidence on economic growth dynamics presents a striking paradox. As traditional business cycles go, recovery period following a prolonged recession should follow certain historical regularities. Shortly after exiting a recession, growth in productivity, output, investment and demand accelerates and exceeds pre-crisis growth.

These stylized facts are absent from the data for the major advanced economies to-date, prompting three distinct responses from the economic growth analysts. On the one hand, there are proponents of two theories of secular stagnation – an idea that structurally, long-term growth in the advanced economies has come to a grinding halt either due to the demand side collapse, or due to the supply side exhausting drivers for growth. On the other hand, the recovery bulls continue to argue that the turnaround reflective of a traditional recovery is likely to materialize sometime soon.

In my opinion, neither one of the three views of the current economic cycle is correct or sufficient in explaining the lack of robust global recovery from the crises of 2007-2009 and 2011-2014. Instead, the complete view of today’s economy should integrate the ongoing secular stagnation thesis spanning both the supply and the demand sides of the global economy.

The end game for investors is that no traditional indexing or asset class approach to constructing investor portfolios will offer a harbor from the post-QE re-pricing of economic fundamentals. Instead, longer-term strategy for addressing these risks calls for investors targeting smaller clusters of opportunities in sectors that can be viewed as buffers against the secular stagnation trends. Along the same lines of reasoning, forward-looking economic policymaking should also focus on enhancing such clustered opportunities.

Investment-Savings Mismatch

The demand-based view of secular stagnation suggests that the global growth slowdown is linked to a structural decline in consumption and investment, reflected in a decades-long glut of aggregate savings over investment.

This theory, tracing back to the 1930s suggestion by Alvin Hansen, made its first return to the forefront of macroeconomic thinking back in the 1990s, in the context of Japan. By the early 1990s, Japan was suffering from a demographics-linked excess of savings relative to investment, and the associated massive contraction in labor productivity. During the 1980-1989 period, Japan's real GDP per worker averaged 3.2 percent per annum. Over the following two decades, the average was 0.81 percent. Meanwhile, Japan's investment as a percentage of GDP gradually fell from approximately 29-30 percent in the 1980s to just over 20 percent in 2010-2015.

The Great Recession replicated Japanese experience across the majority of advanced economies. Between 1980 and 2014, the gap between savings and investment as percentage of GDP has widened in North America and the Euro area. At the same time, labor productivity fell precipitously across all major advanced economies, despite a massive increase in unemployment.

Some opponents of the demand side secular stagnation thesis, most notably former Fed Chairman Ben Bernanke, argue that low interest rates create incentives for investment and reduced saving by lowering the cost of the former and increasing the opportunity cost of the latter.

However, this argument bears no connection to what is happening on the ground. Current zero rates policies appear to reinforce the savings-investment mismatch, not weaken it, rendering monetary policy impotent, if not outright damaging.

How can this be the case?

Today's pre-retirement generations are facing insufficient pensions coverage. For them, lower yields on retirement investments, tied to lower policy rates, are incentivizing more aggressive savings, further suppressing returns on investment. Meanwhile, middle age workers face severe pressures to deleverage their debts accumulated before the crisis, while supporting ageing parents and, simultaneously, increasing numbers of stay-at-home young adults.

To address the demand-side of secular stagnation in the short run, requires lifting the natural rate of return on investment, without increasing retail interest rates. This will be both tricky for policymakers and painful for a large number of investors, currently crowded into an over-bought debt markets.

The only way real natural rate of return to investment can rise in the environment of continued low policy and retail rates is by widening the margin between equity and debt returns for non-financial assets and reducing tax subsidies awarded to physical and financial capital accumulation. In other words, policymakers must rebalance taxation systems to support real enterprise formation, entrepreneurship and equity investment, while reducing incentives to invest in debt and financial assets.

Good examples of such policy tools deployment can be found in the areas of gas and oil infrastructure LLPs and property REITs used to fund long-term physical capital investments via tax optimized returns structures. Transforming these schemes to broader markets and to cover non-financial, technological and human capital investments, however, will be tricky.

From the investor perspective, the demand-side stagnation thesis implies that  longer-term investment opportunities will be found in allocations targeting entrepreneurs and companies with organic growth that are debt-light, technologically intensive (with a caveat explained below) and human capital-rich. There are no real examples of such companies currently in the major stock markets’ indices. Instead, the future growth plays are found in the high risk space of start ups and early stage development ventures in the sectors that bring technology directly to end-user engagement: biotech, nanotechnology, remote health, food sciences, wearables, bio-human interfaces and artificial intelligence.

Tech Sector: Value-Added  Miss

The caveat relating to technology investments briefly mentioned above is non-trivial.

Today, we have two distinct trends in technological innovation: technological research that leads to increased substitution of labor with technology and innovations that promise greater complementarity between labor and human capital and the machines.

The first type of innovation is what the financial markets are currently long. And it is also directly linked to the supply-side secular stagnation thesis formulated by Robert Gordon in the late 2000s. The thesis challenges the consensus view that the current technological revolution will continue to fuel a perpetual growth cycle.

Per Gordon, "The frontier established by the U.S. for output per capita, and the U. K. before it, … reached its fastest growth rate in the middle of the 20th century, and has slowed down since.  It is in the process of slowing down further." The reason for this is the exhaustion of economic returns to technological innovation.  Financial returns are yet to follow, but inevitably, with time, they will.

Gordon, and his followers, argue that a sequence of three industrial or technological revolutions explains the historically unprecedented pace of growth recorded since the mid-18^th century. "The first with its main inventions between 1750 and 1830 created steam engines, cotton spinning, and railroads. The second was the most important, with its three central inventions of electricity, the internal combustion engine, and running water with indoor plumbing, in the relatively short interval of 1870 to 1900.” However, after 1970 “productivity growth slowed markedly, most plausibly because the main ideas of [the second revolution] had by and large been implemented by then.” Thus, the computer and internet age – the ongoing third revolution – has reached its climax in the late 1990s and the productivity gains from the new computer technologies has been declining since around 2000.

Gordon’s argument is not about the levels of activity generated by the new technologies, but about the declining rate of growth in value added arising form them. This argument is supported by some of the top thinkers in the tech sector, notably the U.S. tech entrepreneur and investor, Peter Thiel.

The older generation of players in the tech sector attempted to challenge Gordon’s ideas, with little success to-date.

A recent study from IBM, titled "Insatiable Innovation: From sporadic to systemic", attempted to show that technological innovation is alive and well, pointing to evolving ‘smart’ tech, globalization of consumer markets, and universal customization of production as signs of potential growth capacity remaining in tech-focused sectors.

However, surprisingly, the study ends up confirming Gordon’s assertion. Tech industry today, by focusing on substituting technology for people in production, is struggling to deliver substantial enough push for growth acceleration. The promise of new technologies that can move companies toward more human capital-intensive modes of production remains the stuff of the future. Meanwhile, marginal returns on investment in today’s technology may be non-negligible from the point of view of individual enterprises, but they cannot deliver rapid rates of growth in economic value added over time and worldwide.

Disruptive Change Required

In my view, the reason for this failure rests with the nature of the modern economy, still anchored to physical capital investment, where technology is designed to replace labor. As I noted in a number of research papers and in my TED presentation a couple of years ago, long-term global growth cycles are sustained by pioneering innovation that moves economic production away from previously exhausted factors (e.g. agricultural land, physical trade routes, steam, internal combustion, electricity, and, most recently capital-enhancing tech) toward new factors.

Thus, the next global growth cycle can only arise from switching away from traditional forms of capital accumulation in favor of structurally new source of growth. The only factor remaining to be deployed in the economy is that of human capital.

Like it or not, to deliver the growth momentum necessary for sustaining the quality of life and improvements in social and economic environment expected by the ageing and currently productive generations will require some radical rethinking of the status quo economic development models.

The thrust of these changes will need to focus on attempting to reverse the decline in returns to human capital investment (education, training, creativity, ability to take and manage risks, entrepreneurship, etc) and on generating higher economic value added growth from technological innovation.

The former implies dramatic restructuring of modern systems of taxation and public services to increase incentives and supports for human capital investments and their deployment in the economy.  The latter requires an equally disruptive reform of the traditional institutions of entrepreneurship and enterprise formation and development.

From investor perspective, this means seeking opportunities to take equity positions in companies with more horizontal, less technocratic distributions of management and ownership. Cooperative, mutual, employees-owned larger ventures and firms offer some attractive longer term valuations in this context. Entrepreneurs who are not afraid to allocate wider ranges of managerial and strategic responsibilities to a broader group of their key employees are also interesting investment targets.

Within sectors, companies that offer more flexible platforms for research and development, product innovation, customer engagement and are design and knowledge-rich will likely outperform their more conservative and rigid counterparts over the long run.

The new world of structurally slower growth does not imply lack of opportunities for investors seeking long run returns. It simply requires a new approach to investment allocation across asset classes and individual investment targets. When both, supply and demand sides of the economic growth equation face headwinds, safe harbours of opportunities lie outside the immediate path of disruption, in the areas of tangible real equity closely linked to the potential drivers of future growth.

3/8/15: Secular Stagnation: Some [Still] Ask if It is Monetary or Technological...

So, is "Secular Stagnation" a Monetary-Financial Problem or a Fundamental-Technological Problem? asks Brad DeLong in his post for Washington Center for Equitable Growth http://equitablegrowth.org/2015/08/01/secular-stagnation-monetary-financial-problem-fundamental-technological-problem/ @equitablegrowth.

Of course, I already tried to answer that question and it is... both. Read here: http://trueeconomics.blogspot.ie/2015/07/7615-secular-stagnation-double-threat.html.

The reason why this makes things uncomfortable for normal economists is that admitting that the problem is two-sided makes it impossible to suggest a solution for dealing with it, except a default one of "let the time heal". And the problem with that is the pesky, nagging suspicion that time can both heal and hurt: if (or when) the next recession, however mild, strikes, in the dual demand- and supply-side secular stagnation scenario, there won't be any bullets left in the Central Banks and fiscal authorities policy 'guns' to fire at the approaching bear. The perceived omnipotence of either 'borrow to spend', 'borrow to invest' and 'print to stimulate' schools of economic thought will be going nowhere.

2/8/15: Global Trade: Welcome to the Economic ICU

An interesting, if short, note on woeful state of global trade flows from Fitch (link here).

The key point is that:

1. Subject to all the talk about the Global recovery gaining momentum; and
2. Under the conditions of unprecedented past (and ongoing) monetary policy accommodation around the world'

global trade remains severely compressed from mid-2011 forward.

Most importantly, the rot is extremely broad - across all major regions, with no base support for trade flows.

One of the drivers - EMs lack of internal demand:

However, the EMs are just one part of the picture. Per Fitch, "Since 2012, global export volumes have consistently grown by less than 5%. Performance by value has been even worse due to the fall in global trade prices, again led lower by commodities. In April 2015, global export prices were down 16% year on year."

"There are several structural explanations for the continued weakness in global trade in addition to the GFC’s cyclical effects":

• Shift toward domestic growth in China - previously thought to be a catalyst for growth in trade via stimulating demand for imports - has had an opposite effect: Chinese producers and consumers are now increasingly sourcing goods and services internally. This was not predicted by the analysts, though I have been warning that this will be a natural outcome of the continued maturing of the Chinese economy away from producing low value added goods toward producing higher value added output. Thus, reliance of Chinese economy on capital and investment goods and services imports from Advanced Economies has declined. And we are witnessing an ongoing emergence of higher value added consumer goods manufacturing in China, which will further compress imports demands by Chinese markets. More significantly, over time, this will lead to even more complex regionalisation of trade, with trade flows becoming increasingly locked within the Asia-Pacific region, leaving more and more producers in the Advanced Economies facing an uncomfortable choice: shift production to the region or witness decline in imports demand. In line with this, there will be losses of jobs in the Advanced Economies and gains of activity in Asia-Pacific. 
• Fitch points to a policy driver for global trade slowdown: "According to the World Trade Organisation, the use of trade restrictions has been rising since the crisis and trade liberalisation initiatives have slowed relative to the 1990s. Together, these developments may be contributing at the margin to the reduction in elasticity of trade with respect to GDP." Nothing new here, as well. The world is amidst continued debt deflation cycle, with debt-linked protectionism on the rise. This is not just about currency wars, but also about financial repression and structural decline in overall growth.
• Fitch notes a third driver for trade decline: "There has been a change in the relative weights of domestic demand components, with investment falling compared with consumption and government spending… As investment spending is the most pro-cyclical and import-intensive component of domestic demand, a decline in investment tends to have a larger effect on trade." Again, I wrote before extensively on investment collapse in the Advanced Economies, and the fact that the main drivers for this are not a business cycle nor the Global Financial Crisis, but rather a structural decline in long-term growth (secular stagnation). You can read on this more here: http://trueeconomics.blogspot.ie/2015/07/7615-secular-stagnation-double-threat.html.

Fitch note, while highlighting a really big theme continuing to unfold across the global economy, misses the real long-term drivers for the collapse of trade: the world is undergoing deleveraging cycle in terms of Government and private debt, reinforced by the structurally weaker growth environment on both demand and supply sides of the growth equation. The result is going to be much more painful that Fitch (and majority of analysts around) can foresee.

7/6/15: Secular Stagnation: A Double-Threat

Recent evidence on long term growth dynamics and drivers decomposition across the advanced economies presents a striking paradox relating to the post-recessionary experience around the world. In a traditional business cycle, recovery period growth exhibits certain historical regularities, that are no longer present in the current cycle. These regularities involve the following stylised facts:

1) Following a recessionary contraction in aggregate output, advanced economies enter a stage of recovery associated with strong growth in investment and domestic demand;

2) Gains in factors' productivity, especially in labour productivity, are amplified in the early stages of post-recessionary recovery compared to their pre-crisis trend levels; and

3) Rates of growth in the recovery cycle are in excess of pre-recessionary growth.

These facts are patently absent from the data for the major advanced economies today, some four to five years into the recovery. This realization has prompted some economic and financial analysts to speculate about the potential structural decline in long term growth rates, the thesis commonly termed "secular stagnation".

Currently, there are two prevailing theses of secular stagnation, linked to two long-term cycles gaining prominence in the global economy: the demand side and the supply side theses.

Investment-Savings Mismatch

The first theory suggests that secular stagnation is linked to a structural decline in aggregate demand, manifesting itself though a decades-long mismatch between aggregate savings and investment and more broadly related to the demographic effects of ageing.

This theory traces back to the 1930s suggestion by Alvin Hansen that the U.S. Great Depression aftermath was coinciding with decreasing birth rates, resulting in oversupply of savings and a fall off in demand for investment. The thesis was salient throughout the 1930s and the first half of the 1940s, but was overrun by the war and subsequently forgotten in the years of the post-WW2 baby boom and investment uplift. Large scale increase in public investment, linked to rebuilding destroyed (in Europe and Japan) or neglected (in the war years in the U.S.) public infrastructure, helped to push Hansen's forecasts of a structural growth slowdown aside.

The thesis of demand-driven secular stagnation made its first return to the forefront of macroeconomic thinking back in the 1990s, in the context of Japan. As in Hansen's 1930s U.S., by the early 1990s, Japan was suffering from a demographics-linked glut of savings, and a structural drop off in investment. Suppressed domestic demand has led to a massive contraction in labour productivity. During the 1980-1989 period, Japan's real GDP per worker averaged 3.2 percent per annum. In the following decade, the rate of growth was just over 0.82 percent and over the period of 2000-2009 it fell below 0.81 percent. Meanwhile, Japan's investment as a percentage of GDP fell from approximately 29-30 percent in the 1980s and the 1990s to under 23 percent in the 2000s and to just over 20 percent in 2010-2015.

Following Japan's experience and the shock of the Great Recession, the theory that the entire developed world is set for a structural growth slowdown has gained traction. Between 1980 and 2014, the gap between savings and investment as percentage of GDP has widened in Canada, Japan, and the Euro area. Controlling for debt accumulation in the real economy, the widening of savings surplus over investment over each decade since the 1980s is now present in all major advanced economies, including the U.S.

In line with this, labour productivity also fell precipitously across all major advanced economies. As shown in the chart below, even a period of unprecedented rise in unemployment in the U.S. and the euro area over the recent Great Recession did not shift the trend for declining labour productivity growth.

CHART: Five-year Cumulated Growth in Real GDP per Employee

Percentage Points

Source: Author own calculations based on data from the IMF

Worse, current zero rates monetary policy environment is reinforcing the savings-investment mismatch, rendering the monetary policy impotent, if not damaging, in stimulating the return to higher long term growth.

Traditionally, low interest rates create incentives for investment and reduced saving by lowering the cost of the former and increasing the opportunity cost of the latter.

However, today's ageing demographics and rising dependency ratios offset these 'normal' effects. This means that for the older generations, retirement pressures work through both insufficient reserves built in pensions portfolios, and also through lower yields on retirement portfolios, incentivising more aggressive savings.

For the working age population, the pressures are more complex. On the one hand, middle age workers today face severe pressures to deleverage their balance sheets, aggressively reducing liabilities accumulated before the crisis. On the other hand, growing proportions of middle-age adults are facing twin financial pressures from the rising demand for support for ageing parents and, simultaneously, for increasing number of satay-at-home younger adults who continue to rely on family networks for financial and housing subsidies. A recent Pew Research study found that 64 percent of Italian middle-aged generations find themselves sandwiched between ageing parents and children. In the U.S. this proportion is 47 percent and in Germany 41 percent. All along, the same households are under pressure to build up their pensions, as retirement security and social provision of pensions are now highly uncertain.

In his speech to the NABE Policy Conference in February 2014, Lawrence H. Summers (http://larrysummers.com/wp-content/uploads/2014/06/NABEspeech-

Lawrence-H.-Summers1.pdf) outlined six  core sources of this demand side-driven slowdown:

1) Existent legacy of the private debt overhang;

2) Demographics of ageing;

3) Rising income inequality that induces greater financial insecurity today and into the future, thus creating incentives for increased ordinary and precautionary savings;

4) Access to low cost capital;

5) Positive real interest rates that continue to prevail despite historically low policy rates; and

6) Large scale holdings of banks' reserves on central banks balance sheets.

All of these factors are currently at play in the U.S., UK and the euro area, as well as Japan. With a lag of about 3-5 years, they are also starting to manifest themselves in other advanced economies.

Tech Investment: Value-Added  Miss

The supply side of secular stagnation thesis is a relatively new idea coming from the cyclical view of historical development of physical and ICT-linked technologies. First formulated by Robert Gordon some years ago it is summarised in his August 2012 NBER paper, titled "Is the US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds" (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2133145).

Gordon looks at long-term - very long-term - trends in growth from the point of challenging the traditional view of macroeconomists that perpetual economic progress is subject to no time constraints. In Gordon's view, U.S. economy over the period through the 2050s is likely to face an uphill battle. Per Gordon, "The frontier established by the U.S. for output per capita, and the U. K. before it, gradually began to grow more rapidly after 1750, reached its fastest growth rate in the middle of the 20th century, and has slowed down since.  It is in the process of slowing down further."

The reason for this, according to the author, is the exhaustion of economic returns to the most recent technological / industrial 'revolution'.  "A useful organizing principle to understand the pace of growth since 1750 is the sequence of three industrial revolutions. The first with its main inventions between 1750 and 1830 created steam engines, cotton spinning, and railroads. The second was the most important, with its three central inventions of electricity, the internal combustion engine, and running water with indoor plumbing, in the relatively short interval of 1870 to 1900.  Both the first two revolutions required about 100 years for their full effects to percolate through the economy. …After 1970 productivity growth slowed markedly, most plausibly because the main ideas of [the second revolution] had by and large been implemented by then. The computer and Internet revolution began around 1960 and reached its climax in the dot.com era of the late 1990s, but its main impact on productivity has withered away in the past eight years. …Invention since 2000 has centered on entertainment and communication devices that are smaller, smarter, and more capable, but do not fundamentally change labor productivity or the standard of living in the way that electric light, motor cars, or indoor plumbing changed it."

Gordon’s argument is not about the levels of activity generated by the new technologies, but about the rate of growth in value added arising form them. In basic terms, ongoing slowdown in the U.S. (and global) economy is a function of six headwinds, including the end of the baby boom generation-linked demographic dividend; rising income and wealth inequality; factor price equalisation; lower net of cost returns to higher education; the impact of environmental regulations and taxes; and real economic debt overhangs across public and non-financial private sectors.

Gordon estimates that future growth in consumption per capita for the bottom 99 percent of the income distribution is likely to fall below 0.5 percent per annum over the period of some five decades.

The supply-side thesis, implying persistently falling returns to technological innovation and resulting reduced rates of productive investment in technological capital, is supported by some top thinkers in the tech sector, notably the U.S. entrepreneur and investor Peter Thiel (see http://www.ft.com/intl/cms/s/0/8adeca00-2996-11e2-a5ca-00144feabdc0.html).

A recent study from IBM, titled "Insatiable Innovation: From sporadic to systemic", attempted to debate the thesis, but ended up confirming Gordon’s assertion that incremental and atomistic innovation is the driver for today's technological progress. In other words, the third technological revolution is delivering marginal returns on investment: significant and non-negligible from the point of individual enterprises, but hardly capable of sustaining rapid rates of growth in economic value added over time.

Disruptive Change Required

The problem is that both theses of secular stagnation are finding support not only in the past historical data, but also in the more recent trends. Even the most recent World Economic Outlook update by the IMF (April 2015) shows that the ongoing economic slowdown is structural in nature and traces back to the period prior to the onset of the Great Recession.

As both, the demand and supply side theses of secular stagnation allege, the core drivers identified by the IMF as the force behind this trend are adverse demographics, decline in investment, a pronounced fall off in total factor productivity growth (the tech factor), as well as the associated decline in labour and human capital contributions to productivity. IMF evidence strongly suggests that during the pre-crisis spike in global growth, much of new economic activity was driven not by expansion on intensive margin (technological progress and labour productivity expansion), but by extensive margin (increased supply of physical capital and emergence of asset bubbles).

Like it or not, to deliver the growth momentum necessary for sustaining the quality of life and improvements in social and economic environment expected by the ageing and currently productive generations will require some serious and radical solutions. The thrust of these changes will need to focus on attempting to reverse the decline in returns to human capital investment and on generating radically higher economic value added growth from technological innovation. The former implies dramatic restructuring of modern systems of taxation and public services provision to increase incentives for human capital investments. The latter implies an equally disruptive reform of the traditional institutions of entrepreneurship and enterprise formation and development.

Absent these highly disruptive policy reforms, we will find ourselves at the tail end of technological growth frontier, with low rates of return to technology and innovation and, as the result, permanently lower growth in the advanced economies.