This week, the column will focus on global economic policy and why central banks – still the most powerful economic institutions in the world – don’t understand how disruptive technology is changing the way our world works.
What if they are stuck in a late 20th-century mindset not sufficiently clued in to the impact of new technology and therefore, as the world worries about an impending recession, they are like old generals, fighting the last war not the new one?
This week saw a flurry of activity from the world’s central bankers. From the US to New Zealand, Thailand and India, interest rates were slashed to all-time lows. Why the hyperactivity now? What they are up to?
Traditionally, interest rates are cut to stimulate inflation. When an economy is slowing down, central banks drop interest rates to encourage demand, push down unemployment and push up prices. The central banks make credit cheaper, coaxing people to borrow and spend, driving the economy upwards.
For central bankers, deflation is the big fear and when deflation is the problem, inflation is the answer. Falling prices can become ingrained, and such deflation makes existing debts much harder to pay because companies and countries have to sell more products to pay back the same amount of debt.
Since the 2009 financial crisis, global debts have risen substantially. According to the Institute of International Finance, global debt levels currently stand at a near-record high of $244 trillion.
The data from Q3 2018 reveals that this debt pile is over three times the size of the global economy, with the global debt-to-gross domestic product ratio rising to 318 per cent. Global debt has ballooned over the past decade or two. Global debt doubled from $84 trillion at the turn of the century to $173 trillion in 2008 at the height of the financial crisis.
Over the decade since, global debt levels have risen a further 40 per cent or so. This debt has found its way into every nook and cranny of the world economy; only some of it has been invested productively.
With these levels of debt, any threat of deflation must be taken very seriously. The best indicator of coming deflation is the long-term interest rate. All around the world, these rates are signalling that falling prices are coming. Long-term interest rates – the rates governments borrow at – have fallen to historic lows in recent days.
There are many countries where investors now have to pay the government for the pleasure of lending to them, not the other way around. In Germany, Japan, Switzerland and Sweden, long-term interest rates are negative.
Traditionally, such drastically low long-term interest rates are a sure signal that financial markets expect a recession in the years ahead. This is why central banks are cutting interest rates, to avoid recession, drive demand and push up prices.
But what if that way of looking at the economy – linking interest rates cuts to higher inflation – is outdated? Let’s consider that there is a new economy emerging, driven by disruptive technology.
In the 20th century, the key rule of monetary economics was that easier monetary conditions, lower interest rates and more availability of credit drove prices up. Traditionally, full employment was associated with wages going up. Therefore, when interest rates were pushed down, demand would rise, employment would take off and eventually so would wages.
But these days, we see unemployment at very low levels in the US for example, and yet wages are not rising. Interest rates are at an all-time low, yet inflation is not going up. What if, rather than causing inflation and higher prices, lower interest rates actually cause deflation and lower prices?
If this were to be true, it would have revolutionary consequences for our understanding of the global economy.
Cost of capital
Here’s my new line of thinking. Today, when interest rates are very low and credit is abundant, investors are prepared to invest in speculative new technology where the pay-off might be years and years away. Because low interest rates drive down the cost of capital, the cost of waiting for a return also falls.
Therefore, investors are prepared to wait for possible riches tomorrow rather than real income today. Investing becomes more akin to winning the lotto than accumulating steady profit.
Many of these new tech companies might not survive but some will. Technology is often about trying to cut out the middle man, making the final product cheaper for the consumer. Essentially, new technology disrupts old business models, pushing down prices. So, if there is an infinite investor appetite for new technology as Silicon Valley is awash with capital because the central banks are cutting interest rates, lower rates might cause prices to fall rather than rise.
Let’s take Uber as an example of this disruptive-technology process. Uber makes transport much cheaper. But right now, the investors of Uber are subsidising the consumer. Last year, Uber lost $3.04 billion on an operating basis on revenue of $11.3 billion, bringing total operating losses over the past three years to more than $10 billion. This $10 billion is money that investors have put into the company and it enables Uber to keep its prices low, keeping transport costs down.
Like Amazon, Uber intends to continue driving prices down until it destroys the competition. To do this, it needs investors to tolerate losses for a long time because this is the only way it will emerge as the winner. It aims to be the last one standing.
However, to do this, interest rates must be low because it is only via the mechanism of very low costs of capital that investors are prepared to wait indefinitely.
When it comes to financing disruptive technology, lower interest rates are deflationary rather than inflationary. In short, technology changes the game. This process is further aided by the emergence of huge new sources of cheap workers in places like India, Vietnam, Laos and Myanmar.
Long periods of deflation driven by technology are not unusual in economic history. For example, innovations like refrigeration and electricity drove down the cost of food and production for almost half a century from 1860 to 1910. This was a 50-year period when prices fell and remained low. We could be in a similar period now.
And if we are, central banks panicking into cutting rates as they did this week will just make prices fall further rather than rise any time soon.
One of the most essential, but least well-understood aspects of macroeconomics is that economics is counterintuitive. This is because macroeconomics, unlike accountancy, is more concerned with the collective than the individual.
The rule of thumb that dominates economics – again, as opposed to accountancy – is that what is good for the individual is not always good for the collective. When things are going really well and demand is very strong, like now, the Government should, counterintuitively, act to dampen it.
When demand is strong and people and companies are spending, the State should save and build up a surplus. Because, as night follows day, there will be a downturn, when people stop spending.read more
As the China-US trade war sends international stock markets reeling and threatens to escalate, economic history can help us make sense of it.
For example, recently in Russia, during an inevitable conversation about the UK and Brexit, some Russian friends compared the much-loved (in the West), Mikael Gorbachev to Boris Johnson.
To our ears, Gorbachev is the brave hero who brought democracy to the Soviet Union. Comparing the great Russian reformer with the buffoonish Johnson appears unfair and harsh, but many Russians dislike Gorbachev intensely. They accuse him of having – like Boris Johnson – no sense of responsibility.read more
The Berlin taxi driver was a bit groggy on Tuesday morning. The night before, Union Berlin, the East Berliner football team – used to playing second fiddle to the more celebrated West Berliner Herta Berlin – won promotion to the Bundesliga for the first time in the club’s history. Next year, Union will be lining out against giants such as Bayern Munich, Bayer Leverkusen and Borussia Dortmund. It had been a long night in the city.
After the essential few minutes on football and a quick natter about Berlin in springtime, when this tree-lined city turns green, we switched to politics. He was proud to tell me that Berliners know how many trees are in the city (430,100) but don’t know how many immigrants live in the city.
In one sentence he framed German politics on the day after the European election, when the big story was the surge for the Greens in what was West Germany and the dogged gains for the Alternative fur Deutschland (AfD) in the old East Germany.read more
When Zeus heard that the boy Apollo, his child with one of his lovers, Leto, had incensed Zeus’s wife, Hera, by killing the python Hera had sent to kill Apollo and his twin sister, Artemis, he banished the twins to Delphi for eight years.
While there, Apollo, a god of many talents and traits, one of which was that he couldn’t lie, established the Delphic Oracle. The mortals could ask the Sybil, the high priestess who looked after the oracle for Apollo, to tell their future.
The Sybil would then interpret the prediction in a ridiculously ambiguous riddle, so as to be never exactly right but never specifically wrong. Such ambiguity allowed the gods to cover their backs and left the mortals scratching their heads.read more
Last week Uber, the taxi-sharing app, floated on the New York stock exchange. As a result the company is now worth just over $65 billion.
We are entering the 11th year of a bull market, and because success tends to breed a disregard for the possibility of failure, investors expressed “disappointment” at the shares’ performance in the first few days of trading.
Does this tell us where we might be in the global economic and financial cycle? Tech insiders are said to be “disappointed” at this valuation of more than $60 billion for a taxi firm with precious few assets, that has no immediate prospect of making a profit, and burns through $2 billion of shareholders’ money a year.read more
The Irish State is going to pay the lion’s share of the upfront cost of rolling out broadband around the country and then is going to gift this infrastructure to a private investment company. Take that in.
The private company has the potential to sell off these assets at a profit – even if the State allows itself some clawback of such funds. That is what private companies tend to do.
As a result, over the next 15 years or so the average Irish citizen will end up transferring billions to a small number of people. And we still won’t own the infrastructure.read more
The corner of Middle Abbey Street and Marlboro Street in the centre of Dublin is a heroin bazaar. Every day about 10am, almost in the shadow of our national theatre, dozens of addicts line up in a reasonably orderly queue and one dealer arrives with a plastic bag of wraps of heroin and a second dealer holds another plastic bag open for the cash.
This goes on in broad daylight. Once the deals are done, the addicts head off, usually up one of the lanes off O’Connell Street or down to the Liffey boardwalk to bang up. The street dealer heads off to get more gear from a bigger dealer higher up the chain.
And the miserable cycle of dealer, addict, money, heroin, crime and destitution, rotates with life-numbing daily regularity.read more
The 2019 Sign of the Times survey by Behaviour & Attitudes provides a useful snapshot of an economy where the majority of people think things are going well, younger people still feel they will be better off than their parents, but where the housing market and childcare costs divide the generations, leaving younger adults stressed and the older generation much more chilled.
The survey reveals a society where only 14 per cent say they are struggling financially, with 37 per cent saying they are living comfortably.
As this column argued last week, although it is unfashionable to say so, the country is now a reasonably content, reasonably tolerant society, generating lots of jobs and embracing immigrants and diversity like never before.read more
David has been writing for almost 20 years and there are plenty of articles covering some of the most turbulent times in the world economy.
Head over to the archives page to view all published articles.