Again I must apologize for my inactivity lately – my education has taken most of the time and my job search has taken the rest of it. If you’ve been following the mainstream media news, you know the score: It’s morning again in America. The deficit is falling fast, growth is returning, hundreds of thousands of jobs are added every month, and the stock market is reaching all time highs every other day. In this post, I am going to explain first why these signs of recovery are misinterpreted, and second why a “traditional” economic boom – the way we know it – could be decades away. Let’s get started with why the recent economic revival is just an illusion:

1) The stock market is very disconnected from the real economy. To understand how stocks can rally even as the real economy doesn’t, we have to take a (very, very basic) crash course in stock market pricing: Basically, the price of  a stock is based on the dividend and volatility of the stock. If a company does well, it tends to increase its dividend and (other factors held constant) its stock price. But, as long as the company is in fact making a profit, a dividend will be paid out, and dividends (and therefore stock price) can in fact increase even if profits are falling – it just requires a higher share of the profits to be paid out as dividends rather than reinvested in the company. This of course is an extremely simplified version of stock pricing, but it captures the gist of things: Stocks can go up even if the economy is going down. Not forever, but for a long time. However, since most people are unaware (or ignore) this, a stock market boom can have a positive effect on the real economy: It can raise consumer confidence, leading people to spend more money and buy more expensive stuff like houses and cars (sadly that wasn’t enough to save Detroit). This can then result in growth in the real economy. There is really only one problem…

2) Consumer confidence means nothing when the fundamentals are bad. Keynesian theory would have you believe that it’s all about expectations – if consumers believe the economy will get better, it gets better. If they believe it will get worse, it gets worst. But, unfortunately, fundamentals actually beat mind power 10/10 times. Let’s look at the fundamentals in 2007 and compare them to the fundamentals today:

– Divided government? Check. It’s actually even worse.

– Stock market inflated by low interest rates? Check.

– A banking system where if one bank falls, the rest of them falls as well? Check. The situation is even worse now that there are fewer banks (Lehman and Merrill disappearing in September 2008).

– Interest rates at unsustainably low levels? Check.

Not too different in other words. But how come things seem so bright, if you listen to the pundits? Why don’t we here about these fundamentals? Well, first, because fundamentals are kind of boring. Fundamentals are like mathematics – they’re important, but you’ll never see a headline that reads “The derivative of x raised to the power of 2 is 2x”. The media is focused on news, and the news right now is that the stock market is reaching all time highs, unemployment is falling, and the deficit is shrinking. Fundamentals don’t make the headlines unless they create news. However, it won’t be long before the fundamentals remind us of their existance.

3) The deficit is set to rise again. As we all know, the deficit is falling – apparently that’s what happens when you cut government spending as was done under the terms of the sequester. Who would have thought? However, while the sequester was a great first step, it won’t be nearly enough to balance the budget. Obamacare, once it takes effect (and no, I don’t think Republicans will be able to repeal it anytime soon), will immediately increase the deficit (whatever humanitarian case can be made for universal health care, it sure is expensive). Add medicare and social security and the ballooning costs associated with those programs, and it’s pretty clear that the deficit will soon be back with a vengeance.

Anyway, so the tough times are not quite over yet. But, this is still just a business cycle, yes? Booms follow busts, busts follow booms and so on, and so as we’ve had a bust, we’re going to get a boom again soon, right? No, not really. Here’s why:

1) China is crumbling. If there is one thing that almost every economist agrees on, it’s this: China is in trouble. There is no consensus on how much trouble or to what extent it will affect the rest of the world, but to me, it’s quite obvious that if even a totalitarian state like China admits that they are having some trouble, they probably have a lot of trouble. America is used to thinking about itself as the master of its own destiny, but in the age of globalization, no country really is. China’s problems can be divided into short- and long-term. In the short term, China’s problem consists of a population (+ businesses) who have borrowed more than they can afford at (at the time) low interest rates, and all this borrowing is part of the reason why China has a property bubble that is bursting as I write this.

In the long term, China’s problem are even worse: First of all, their “business model” of creating growth by moving workers from farming to manufacturing just isn’t working any more. Why? Well, you can only move so many farmers before you run out of farmers. The lack of new workers that can be put to work in the factories have led to higher salaries, making it less profitable for companies to outsource to China. This of course doesn’t mean they won’t outsource (there are still plenty of other developing countries with low salaries), only that China won’t be getting their business. Secondly, China’s one-child policy has created a demographic time bomb. The US does have an upcoming social securities crisis, but it fades compared to what China’s got coming. With only one child per two adults, taxes are bound to increase and pensions to decrease. Old workers will refuse to retire, knowing that poverty awaits them if they do, creating social unrest as younger workers become unable to find jobs. Those who are sceptical towards this demographic time bomb scenario point out that that the one child policy really isn’t enforced strictly outside the big cities. Unfortunately, from an economic point of view, this doesn’t really change anything: There may be more kids on the countryside, but they are typically poor and lacking education. Not exactly the type of youngsters you need to keep your country’s growth engine going. This is just a very brief summary of (some of) the problems facing the Chinese economy. This article by George Friedman goes into much greater detail.

What might happen to China if there were to be a true economic collapse? Or anything even remotely close to a true economic collapse? Well, for starters, the chinese people may stop tolerating their government and its frequent infringes on human rights. That sounds like a good thing – until you realize what it would actually look like: A popular revolution would be struck down with full military force. The number of dead could easily reach into the hundreds of thousands (millions?), depending on how long the uprising lasts. And, of course, the kind of material devastation that follows every war would follow this war as well, with thousands of factories destroyed and/or production being halted. This scenario however is quite unlikely – a military coup seems more likely than a popular revolution. And what would China look like after a military coup? Well, it most certainly would not be a democracy, and probably not a capitalist economy at all. It’s not like there aren’t any maoist-style communists left in China.

2) Technological growth is (likely) slowing down. In the interest of full disclosure, it is quite hard to measure technological growth. However, it does appear to be slowing down: From an economic point of view, the iPhones we are inventing today just doesn’t measure up to the cars and nuclear power plants that we were inventing yesterday. While yesterday’s technological innovations made us healthier and more productive, that cannot be said about most innovations of today. We still invent, but the innovations are more “convenience” rather than “increased production” (not that those have to be mutually exclusive) – the various innovations in social media have provided us with a convenient way of sharing information with our friends, and have certainly entertained us. Nothing wrong with that – but I doubt anyone could seriously claim that Facebook has increased productivity (in fact, the opposite is likelier). We are travelling at roughly the same speed as we did in the 1970’s. We are using very much the same housing appliances as we did in the 1970’s. Life expectancy, which increased fast during the first half of the 20th century, is now increasing at a much lower rate (all these examples were taken from this article).

Why is this important? In the long run, technological growth is the sole determinant of growth in GDP/capita. But, even in the short run, technological growth is a vital component of our overall growth. Deduct the technological component from our total growth, and we would have had many more recessions in the past 40 years than we’ve had. So with lower technological growth, it follows that recessions will become more common (all other things held constant).

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3) Culture. Everybody knows that the Western world has a culture of overconsumption. In the beginning of the crisis, I actually had my hopes up that this might change – that we might finally become a little bit more frugal and just think a bit more about the long term in general. Look around: Have people changed? I mean, more than we’ve been forced to? To me, it seems like people are just waiting for the crisis to be over so that they can go back to partying. We’ve all seemingly decided that the blame for the financial crisis falls fairly and squarly on the bankers. While the bankers are not by any means innocent, there is a bigger story that is being ignored: The story of a country who’s population is caring more and more about today, and less and less about tomorrow.

Those who grew up during the Great Depression generally became very thrifty as adults – not surprising. Are those who are growing up today going to be thriftier than the preceeding generation? I don’t know of any empirical studies into this, but I don’t think so. The emotional impact of growing up during the financial crisis just hasn’t been as big as the emotional impact of growing up during the great depression. Sure, us who are young today struggle with getting a mortgage, finding scholarships, getting approved for a credit card etc – but that’s not really comparable to struggling to avoid starvation (a very real threat for many families during the Great Depression). Also, mass media wasn’t around in the early 1930’s the way it is today – which meant that there were no-one to tell all the youngsters of the 30’s that they should keep shopping like nothing happen, that it was all the bankers fault and that politicians were going to fix all of our problems.

As long as we have a culture of irresponsibility and overconsumption, we’ll continue to have financial crises every once in awhile – and a lot more often than we have in the past.

There are many more reasons why the future will be very different from the past, and I may return to this topic in future posts. But, this article is already long enough so I’ll stop here. Thank you for reading.

Photo credit: TRiver via Flickr (attribution 2.0 generic)

3 comments
  1. “As we all know, the deficit is falling …”

    Actually, ‘WE ALL’ here don’t appear to know that the deficit is falling. In fact, many still think it’s rising. I hear Senators and Representatives still claiming that we’ve got runaway deficits. Go figure: So many of those who truly need know seem to be the least informed. I bet there is a strong correlation with those officials who think the Earth is young and other such reality-challenged nonsense.

    I agree that health care is not cheap but I’m not convinced it’s less expensive to provide basic care via emergency rooms and have people forgo preventative and early treatment. Having everyone in the insurance pool is probably a net benefit for society, both from fiscal and humanitarian standpoints.

    As for austerity programs… Yes, there are many times when this is appropriate but certainly not always. I wonder how well that’s worked out in many other countries, like the UK, for instance. The sequester has helped the debt but has also helped to slow employment growth and reduced the economic recovery. And certainly one can keep spending well after the crisis is over, as we saw with the Bush tax cuts during the early part of his Presidency, which certainly drove us into the red later on and left the US with much less capacity to respond to the current recession.

    On a related note, what does having a government that repeatedly threatens to shut down and not pay for funds already spent do to that nation’s economy? I notice that this blog has been particular quiet on this recently.

  2. Very short-sighted article. So many of the points only include a portion of the reality involved in the topic.
    1 and 2 contradict each other. The deficit is falling because the economy is improving, in addition to reductions in spending. 5% growth in China instead of 15% growth does not mean China is crumbling. Tech growth slowing down, really? No, bankers did cause the financial crisis. There were many other factors involved, like the housing bubble and supply side economics harming most of the country, but bankers were the primary instigator.
    No, we’re stuck to repeat the past, at least for now. As long as conservatives are allowed to have any influence on policy, we’ll keep making the same mistakes. A theory only fails in reality, so until the right can accept reality instead of turning theories into principles, nothing will change.

  3. Interesting perspective on the comments to the article. An attempt is made to suggest progress is being made when the annual deficit is only $800B instead of $1T. Progress, but the current administration will rack up more debt in it’s 8 year tenure than the prior 43 presidents accrued combined. Is that really progress?
    Seeing Obamacare as a solution as compared to getting healthcare in ER’s is a bit disconnected. It totally disregards the fact that many people who had healthcare will lose it because they can’t afford it going forward because of the projected increases in premiums. It disregards the suppression to employment as employers shed employees or defer hiring to avoid having to provide healthcare. It disregards the number of employees suppressing hours to keep employees at part time vs. full time to avoid having to provide health care in order to stay in business. It also disregards the fact that that the bill was passed by flauting Senate/House rules and avoiding a true debate on a 10,000 page bill that was sold to the public at an estimated cost with no tax increases to the public, but instead was a bill that is now estimated to cost in excess of $1.2T and climbing with a myriad of tax increases that are particularly punitive to the lower and middle classes, who can least afford to pay those taxes.
    Austerity doesn’t work? So, instead of cutting costs that will suppress the economy, you contine to create more and more government debt that can never be repaid unless you tax your citizens to the point that businesses fail and economic growth is smothered, requiring even more layoffs? A government accruing debt that it can never repay in lieu of austerity is akin to condemning one medicine in favor of a poison.

    The Bush tax cuts didn’t crash the economy. It was the out of control spending by Congress over the last 100 years, all agreed to by POTUS’ of both parties that got us to where we are. And the only way to fix it is to spend the next 100 years unwinding that mess by scaling back government spending and reducing excessive regulations where appropriate.

    If the Dems are unwilling to negotiate in good faith to cut spending across the board and begin fixing our fiscal problems, what choice does the GOP have unless they use some form of leverage? Currently that’s the CR with the debt limit coming up next. Had the Senate proposed and negotiated a budget in good faith at some point during the Obama adminstration, maybe we wouldn’t be discussing the need for the GOP to use extreme measures.

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