About this week’s show:
- Previous era of growth not coming back
- Global trade has peaked, can we hold the gains?
- Easy money policies, negative consequences
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin:Our guest today, David, is Dr. Marek Dabrowski. He is a fascinating central banker and he was living in a fascinating time and a fascinating place of change in Poland when they shifted from communism over to more of a capitalist system.
David:As First Deputy Minister of Finance in Poland, he worked with the team that basically transitioned the economy from a command system…
Kevin:The Cold War.
David:Under communism, to a free market system, tackling major issues at the time, which included massive inflation. And so, getting their arms around that in a very short period of time, implementing policies, and doing it very quickly. The need to implement it very quickly was absolutely paramount. I encountered Dr. Dabrowski in an article as project syndicate, and we will include the link to Project Syndicate, his article, next to the interview today, but he is, today, a professor of economics. He cofounded, and is the chairman, of CASE, which stands for the Center For Social and Economic Research. He is a fellow there and has been involved in so much in terms of policy research and policy advising: Azerbaijan, Belarus, Bosnia, Bulgaria…
David:Yes, even Moscow. Serbia, Syria, Turkmenistan. So when you look at transitional economies, when you look at emerging market economies and the challenges that you face, not having all of the advantages that you would have in a fully industrialized country, or an advanced economy like the U.S. or other European countries. He is looking and saying, “Well, what do we have to work with?” If you can imagine an economist being like a MacGyver. All we have is a little bit of chewing gum and bailing wire, perhaps a little duct tape and a Swiss army knife, how are we going to make this work?
Kevin:From reading him, what he is basically saying is, “Look guys, if you are counting on the kind of growth aspects or inputs that we’ve had over the last 20-30 years, they’re not there anymore, they’re shrinking, so we’d better find something else. And he does have, just from reading his articles, a serious concern for the sustainability of our fiscal situation. Everyone has known, over the last 5, 6, 7 years, that we are papering over the problem, but it’s not necessarily creating real sustainable growth.
David:When I encountered Dr. Dabrowski, it reminded me of our conversation going back to 2010 with Harold James. We talked about the end of globalization. We talked about the things that accompany those periods of globalization, we explored the parallels between the 1920s and 1930s, a historical analogy between 1929 and 1931, in the present context. Again, there were echoes of that conversation as I was looking through the concerns that Dr. Dabrowski has today, where, in essence, we are not addressing structural issues. Again, this is very similar to our conversation with William White. This is very similar to our conversation with many of those in the central banking community today who would say, “I understand crisis management, and I understand policies, whether it is monetary policies or fiscal policies, which on a short-term basis are necessary as sort of triage, but let’s not assume that that represents a long-term fix. Let’s not assume that those emergency measures were actually policies that were meant to be kept as the status quo.” And so, there are major structural issues which have to be addressed.
And I want to include another article. Make sure and read this. It is from his CASE Network E-Bridge, December 2013. “When will the global economy return to rapid growth?” In preview, it may not occur.
* * *
Thank you for joining us, Dr. Dabrowski. We’re on a path toward hopeful economic and political outcomes, but one must have a realistic appraisal of where you are starting from, and the challenges faced in getting to a goal, so if there are concerning issues in our conversation today, it certainly is in that context of seeking improvement. One issue that seems to be always in front of us: propping up aggregate demand. This seems to be the focus of central planners today, and the justification of very loose fiscal and monetary policy. Dr. Dabrowski, can they succeed? And at what cost? I am thinking particularly of the United States, this notion of propping up aggregate demands.
Dr. Dabrowski:Interesting use of the notion of central planners, it is another economic system, where really, policy makers are hyperactive, and actually they try to replace market forces. And truly, I think that with something like this, I would not say that I am totally against demand management. I think this is one of the accomplishments of 20th century economy policy, economic science, understanding that governments and central banks can make some kind of fine tuning, but the question is how far it should go, and what are long-term consequences of such policies. My understanding is that all of those who now call for continued monetary and fiscal stimulus assume that the world economy, and the economy of individual countries, is still below something that we can tell potential growth. And I have big doubts whether, really, this is the case. Empirically, I would say that were this the case, probably the economy would already grow at quite a fast rate after seven years of very loose monetary and fiscal policy, but it didn’t happen. So this means that probably the growth potential is much lower than is assumed as the base of this kind of monetary and fiscal activities.
David:So there are things that have certainly changed in the last several years. Perhaps the attempt to return to the growth rates that we had between 2003 and 2007 are no longer possible because of those changing variables. Demographics continue to shift, investment rates may or may not be sustainable at the rates that we have seen in recent years. We’ve already reaped the benefits, as they call it, the peace dividend. Things that certainly gave us 20-30 years of economic growth, perhaps it is difficult to predicate the next 20-30 years of growth on the same things that gave us previous areas of growth.
Dr. Dabrowski:Yes, you are absolutely right. This is also, actually, my point. Recently I wrote a few pieces on this, also including my commentary in Project Syndicate, where I tried to put the question, whether we can think about the same growth potential as we used to have in the 1990s and early 2000, when the global growth was quite rapid by historical standards, and most advanced in economies in emerging markets. But there were various factors in play which we cannot expect that there will be now, or in the next couple of years.
You mentioned demographics, and it is obvious that Europe and part of Asia is already on the path of demographic decline, and several other regions will also face, soon, the problem of declining cohorts of population and productive age, and this will limit growth potential, not only in advanced economies, but also in economies such as China, which face, in the next couple of years, dramatic reversals of previous demographic trends. It is the result of the one-child policy, and this means that one of the known classical factors of growth, labor, will be in shortage in many regions of the world. True, still, other regions will grow rapidly in terms of population, in terms of labor force. I mean Africa, the Middle East, Southern Asia, including India, Pakistan, Bangladesh, etc. Part of Latin America will continue to grow population at quite a rapid pace.
But then there is this problem of allocation of labor force. Those economies which I mentioned, they will have limits for various reasons, shortage of capital, or of flaws of the economic system, and other solutions which economically would sound rational – large scale migration from labor surplus regions to labor deficit regions. It is under question for political reasons. We know how big political tension, the problems of migration, rise in Europe, rise in countries like Japan, and probably to a lesser extent in the United States, but still these are quite politically and socially painful topics, so there are limits of moving labor force across regions.
Then of course there is some room for domestic reforms, like increasing retirement age, increasing the rate of employment of the female labor force in many countries, many regions, including some European countries. But still, it cannot compensate for this drastic reversal in trends. And then when we look for investment, here we see, actually, that there is historically very stable global investment rate, or even slightly declining over time, and it is unlikely that we can expect that this rate will start to grow again, especially in the countries which now contribute the most to this investment rate. China, India, especially China, will not be able to sustain the sort of investment in GDP of around 50% for a long time. It is impossible. The experience of other economies like, for example, Japan, demonstrates that with deficits of labor and also with increasing GDP per capita, the rate of investment is going down. So, the best case we will have the same pool of investment which we have now.
And then it is what is called by no classical growth [unclear] productivity, which is a synthetic measure of values, quality factors of growth. And you also mentioned some things like the peace dividend, which, obviously, was in play in the 1990s after the end of the Cold War, but still was can gain something more on the contrary with territorialism, and various unsolved regional conflicts keep pressure on military spending in many economies, both advanced and developing. So I don’t think that we can expect any additional gains. In terms of technical progress, ICT revolution is largely over, in terms of quality, changes in the method of production, still we have some new applications, technical applications, but they relate mostly to quality of life, to increase with a new generation of smart phones, we can live easier, or have more entertainment possibilities, but these are not the kind of changes which can bring any new revolutionary change to the methods of productions, and personally, I don’t see any such fundamental revolutionary change in the horizon over the next few years.
And then we have various kinds of policy forms which were of economic benefit in the 1990s and early 2000, both country-specific reforms, I mean great reforms in China and India and Central Eastern Europe, former Soviet Union, and Latin America, They are largely over. Other reforms are needed, including also advanced economies including Europe, United States, but they will not bring so rapid gains, efficiency gains, as those which I mentioned.
And also, things which greatly contributed to this rapid growth of the 1990s and early 2000s, like global trade liberalization or liberalization of capital movement. Also, [unclear] consumer effects and of course, there are still additional benefits from trade liberalization but we see that global trade negotiation, and actually, large [unclear] apart from this very limited [unclear] agreement last fall, but I don’t think that this is an agreement comparable, for example, with Uruguay [unclear] Marrakesh agreement 20 years ago. So there is no low-hanging fruit which can contribute to acceleration of economic growth.
David:So this brings us to a very interesting discussion. Several years ago, we had a conversation with Harold James about the end of globalization and how there have been multiple periods of globalization which have come to an end. He had a very disconcerting conclusion, which was that when periods of globalization, slow or end, political conflict, protectionism, even war, are consequences of the end of globalization. Perhaps you could speak to the challenges that we face if, in fact, this is another one of those periods of globalization coming to an end.
Dr. Dabrowski:Well, it depends how we see the process of globalization. In terms, I would say, of new impulses, you are right, we probably must realize that the rapid globalization which we have experienced over the last 30 years came to an end. But I still hope that these globalization gains will be sustained. Of course, we see various temptations observed to protectionists, but I hope that they will be successfully resisted. We now approach the 100th anniversary of the First World War, or Great War, as it is called by various nations, and of course, this is a very spectacular historical case of the end of globalization, not only in the sense of the lack of further progress, but reversal of the previous gains. Actually, it was a great catastrophe, not only for Europe, but for the entire world economy. If we look for what happened then in the 1920s, 1930s, and the Second World War, and after the war period, actually, it reversed globalization for more than 50 years. Fortunately, we can avoid this kind of catastrophe, but it is hard to see any new gains coming from further globalization because financial markets are more or less liberalized. Of course, we have countries like China or India which still are not fully integrated financially into the world economy, but even if they do some progress, it cannot provide us with so rapid changes as we experienced the last 70 years. And in trade, as I said before, there is still some room for further globalization gains, liberalization gains, but it is not easy to accomplish. There are a lot of political constraints, and now it is very popular, regional and cross-regional trade deals, but from the point of view of the global free trade they are not always beneficial. It is a big question, a rhetorical and practical question. We know that regional trade deals involve both trade creation, but also trade divergence, so it always must be balanced. It is not obvious that these great trade deals which are now negotiated on the table, like transpacific or transatlantic deals, that they will bring benefits for the entire world economy. This is unclear, at least for me. It should bring benefits for those parties which negotiate, but for the entire world economy, especially for developing countries it may have some adverse effect. But again, I agree, we don’t now have a political atmosphere which could bring us a new, rapid trade liberalization.
David:In the United States we have seen the Treasury and the Fed operate as lender of last resort through the crisis years. Now, looking at fiscal and monetary policy in the United States, we see the U.S. government as spender of last resort, and you have much experience with the inflationary consequences of expansive monetary and fiscal policy. Is there concern, in your view, about how we are approaching it in the U.S., in terms of stimulating demand via aggressive monetary and fiscal policy? And should we be concerned with an inflationary consequence, even on a lagging basis?
Dr. Dabrowski:Sure, I am very concerned, and not necessarily it must produce high inflation in the United States immediately. Fortunately, the few decades of lower inflation built some lower inflationary expectation, but this policy is devastating for various other actors, especially this is devastating for emerging market economies because we know that part of these additional liquidities is going to emerging markets, for very obvious reasons. Financial investors are looking for a higher rate of return. It is very difficult to find such a higher rate of return in the United States or other advanced economies with interest rates close to zero and slow growth. So they are going to so-called emerging markets. But of course, this has effects in terms of inflation pressure, in terms of very big fluctuations in capital flows to emerging markets, and it increases various kinds of macroeconomic risks, and I cannot exclude that everybody asks now, we had U.S. subprime mortgage crisis, we have global financial crisis 2008-2009, then we had Europe debt and financial crisis, which actually is still far from being covered, and what is the next stage? It is, of course, very difficult to guess, but my bet would be the new wave of emerging market crises, which it is hard to say whether there will be a copy of the crises which were experienced in the 1980s, meaning sovereign debt crisis in Latin America and several other emerging markets, and high inflation, hyperinflation episodes, or will there rather be episodes like the 1990s, Mexico, Asia, Russia, Brazil? It is hard to say, but it is clear, the last 12 months demonstrated there are several emerging markets which are at high risk: India, Indonesia, Argentina, Venezuela, Ukraine, Turkey. I would not exclude Russia, I would not exclude countries like Hungary, for example, having big problems. So, I don’t want to predict any large-scale global emerging market crisis, but individual countries can have big problems, and one of the sources of these problems is U.S. monetary policy. In previous years, when it was excessively loose and supply entire global economy was excess liquidity, and now it finally looks as if it will have to withdraw gradually from this excessive money supply. This will create another type of shock for emerging markets. For example, exchange rate, especially for those countries who have a floating exchange rate, they are very much dependent on U.S. monetary policies, so this is one of the dimensions which this policy already had a very negative effect and probably still [unclear] can be seen. Of course, this ultra-loose monetary policy also has negative consequences for financial market functioning, for allocation of resources, for financial risks. It helps those enterprise [unclear] sector which otherwise would have to leave the market, bankrupt, but the availability of cheap financial assistance helps them to survive. So there are various consequences and I am not sure whether we are aware of all these consequences yet, but most importantly, I don’t think any potential of this policy to really revive growth because I think the problem with growth in the United States and Europe and other advanced economies, and also part of the emerging markets, is a supply-side problem. We really need to address those barriers which we discussed before, like what to do with shrinking demography, what to do with declining total factor productivity or not increasing so rapidly as it increased in 1990s to early 2000s. Still, also, you mentioned in the beginning of our conversation, 2003-2007. Those years are untypical for other reasons, not only because the impact on the supply-side factors which we discussed before or better demography, or investment boom in the emerging markets, and in various kinds of systemic and technical innovation, but also the growth between 2003 and 2007 was very much fueled exactly by Fed monetary policy, and the Fed was followed by other major central banks, by Bank of Japan and European Central Bank, even if the European Central Bank doesn’t want to admit that it followed the Fed, but it really had to follow. So this, of course, built all these bubbles, which burst, and then we had the process of huge deleveraging, and this process is not finished. But this is rather shorter factor, I would say, but still, the financial sector is far from being reconstructed.
David:And it seems to me, and of course, I’m not a central banker and have a very limited understanding of this, but 5-7 years after the crisis, U.S. monetary policy is still focused on short-term and crisis-related issues. We’ve allowed a very valuable period of time to go by, in which we could have, perhaps, looked at structural issues, the kinds of supply-side problems that we have discussed today, and implemented major structural change. Now, of course, the structural change comes at a high political cost and no one is really interested in doing that unless it is absolutely necessary, but isn’t that the point? It has been absolutely necessary, and now, through two crises in less than ten years, the stock market crisis in 2001 in the United States, which led to Alan Greenspan’s ultra-loose monetary policies, lowering of rates and provision of liquidity to the financial markets, the subsequent boom in real estate and the sub-prime crisis that followed, and we’ve basically done the same thing all over again, a repeat of monetary policies focused on short-term crisis-related issues. What will it take for the U.S., or any policy-maker around the world, to focus on structural issues, as opposed to crisis management only?
Dr. Dabrowski:[unclear] rather pessimistic and sad, I would say, usual crisis, serious crisis, is the factor which pushes politicians to do something more serious and create some constituents in favor of reform. Actually, when we look for various episodes of great reforms, even some of them which we mentioned today, for example, China market reforms, it was, of course, a consequence of the great leap of Mao model, economic model, which brought starvation and almost the collapse of the nation. India, economic reforms of the 1990s, total stagnation and realizations of necessity to [unclear] strategic competition with China. Central Eastern Europe, former Soviet Union, collapse of previous system. Now when we look for Europe, some of the European countries are doing reforms. It is a question whether they are doing enough. I would say not, but still, are doing something. Countries like Greece, like Spain, like Portugal, Ireland, Italy, Thrace, some countries of Central Eastern Europe. But what was the factor which pushed them to start these reforms? Crisis. Sometimes very dramatic, like in the case of Greece. So basically, this is the factor. Of course, we can find some historical examples that the political system was able to pre-empt problems. One of my favorite examples is Germany, early this century. Of course, there was a realization that the cost of German unification was too high, that some of the elements of this famous social immigration models, social market economy, stopped work. That is a demographic challenge. There is too much labor market rigidity, and it pushed Germany to make reforms. Maybe not so dramatic and spectacular reforms. For example, done in Central Eastern Europe, or Latin America, for example, but large enough to help Germany survive in good shape, the recent crisis, and be now, basically the strong side of the European system.
But there are many other countries which hesitate to do reforms. France is one of the big concerns, not only of French economies, but also in Europe and I think that it should be a very big concern for the entire world. This is an economy which needs really very deep structural, fiscal reforms. And subsequent governments, either right or left, they may need some reforms. They are doing some partial reforms, they step forward, step back, or half-step back, and the situation is, if you look for public debt is approaching 90% of GDP. If you look at the level of public expenditure is well over 50% of GDP. Capital is going out of France to other destinations because the business climate is deteriorating, etc., etc. But still, the country’s political class is not ready to face problems. So I think that the United States is not unique in this respect. In the case of the United States I would say that, from my perspective, one of the most dramatic trends is this political ability to solve fiscal imbalances, because it is a very, very big question for me, when, and how quickly, it happens. It is very clear for me that the U.S. is on an unsustainable path of fiscal dynamics, the debt is growing quite rapidly, and all measures which have been adopted so far were not effective to stop this trend and also I can agree with all of the critics of sequestration. Automatic sequestration is not the best way of fiscal adjustment. It should be done in a more structural way, attacking those fields where there is the highest expected expenditure dynamic, like Social Security, and those kinds of things. And there is a question whether the political system is able, quickly, to find a solution.
David:In your research on fiscal deficits, as you notice U.S. debt is growing, we have our fiscal imbalances, and I know you’ve written on the financing of fiscal deficits in the past, and you have pointed out that the eventual inflationary effect depends on the size of the deficit being financed, it depends on the money multiplier, it depends on the demand for money, and perhaps you can comment. We remain puzzled by the very low levels of velocity here in the United States, and we do wonder if, looking at the low levels of velocity and those various inputs that would lead to inflation on the basis of financing our fiscal deficits, we wonder if we might see more inflation ahead, again, on a lagging basis.
Dr. Dabrowski:Well, the question about low deficit is really interesting puzzle and I cannot claim that I have the answer. I think that this is a combination of two factors. One is still balance sheets of banks and other financial institutions have not been repaired sufficiently, and also, the balance sheets of households and enterprises to come back to more intensive lending/borrowing activity. This is perhaps one factor which causes most money multipliers are lower than they used to be ten years ago, and as a consequence, money velocity is low. But other things, and perhaps this is also an unintended consequence of this ultra-loose monetary policy, which actually, not only supplies economies very cheap credit, but also, actually, it substitutes for normal market channels of distribution of credit. Actually, as far as I understand it, in many countries, not only the United States, central bank low interest rates leads to these partial [unclear] of interbank market. And this has negative consequences for allocation of resources, of course. But if at some point this market is rebuilt, and at some point, also, balance sheets are rebuilt, we can observe very fast increase of money velocity. And the question is whether the Fed and other central banks are well prepared to meet this challenge, because if they are not, then we will have, really, inflationary problems. This is a big question. Of course, it is very difficult to argue, we have some interesting historical cases, Japan, which is actually already more than 20 years in policy of zero interest rates and no inflationary consequences, even some deflationary consequences, rapidly growing public debt, still with very low market yields, etc., but the question is, intuitively, there are limits of such dynamics, and at some point, expectations have to change, and the question is, when, and whether this change will be slow or whether it will be rapid and dramatic. If it is to be rapid, dramatic, then this will create a huge challenge for central banks, because no longer will there be a discussion about tapering of QE and perspective whether we will come to normal [unclear] in 2 years’ time or 3 years’ time. This will require very, very rapid changes, returning to normal monetary policy or even with high interest rates. Actually, there was some kind of experience, not fully comparable because this was a period of relatively high inflation, and then attempts to stop this inflation at the end of 1970s, early 1980s. And of course, the situation was different at that time. We are not now in the stage that we have 2-digit inflation, in advanced economies, but who knows? In the 1970s it was all price shock which served as an accelerator to all these monetary processes. So one cannot rule out there may be some shock which changes market behavior, and velocity starts to rise rapidly, and then central bank will have to dramatically change their policies.
David:Well, I will encourage all of our listeners to read the brief article that you wrote for Project Syndicate, as well as your CASE network e-brief from December of 2013. If you don’t mind, we’ll make that available on our website so it is easy to find and people can view those very keen insights. Again, going back to where we began our conversation today, we are, hopefully, on a path toward economic and political growth and a positive outcome, ultimately. It is our view that you need a realistic appraisal of where you are starting from, and the challenges that you face, in order to accomplish any future goals. So we appreciate you adding your insights from across the pond, from across the Atlantic, both into our issues in the United States, but as well as the global context, emerging market concerns, currency crises concerns, and the policy changes which need to be considered very quickly in order to make sure that we are on the appropriate path toward growth.
Thank you for joining us and we look forward to keeping in touch in future conversations.
Dr. Dabrowski:Thank you very much. It was a big pleasure to speak with you.
* * *
Kevin:David, depth of experience is something you cannot replace. When you and I are talking about Europe, we are talking as visitors. We haven’t been through the changes. Dr. Dabrowski was there, and helping to manage probably one of the most prolific changes, at least on the Eastern bloc side of things, during that time.
But I want to bring something up that William White also brought up as a concern a couple of weeks ago. Both of these central bankers, right now, are not that concerned about inflation, but they look at velocity, which is how many times a dollar turns over in a year, and they are concerned that the central bankers won’t know what hit them if velocity actually does increase.
David:And will they change their policy quickly? Because that is what it is going to take. Going back to sort of the MacGyver picture, if you will, you have to be able to change course very quickly when the variables change. You can’t just hold on to previous policy commitments, assuming that it will work itself out.
Kevin:Let’s talk about that, because the change in course, that could be devastating. What we are talking about is raising interest rates and tightening monetary policy.
David:Right. And this is a problem. We really have to address the fact that we still have sort of a welfare state here in the United States, but as Dr. Dabrowski pointed out, also in places like France, where there is no willingness to reform. And I think particularly compelling in our conversation today was the notion that it is serious crisis that creates constituents who are willing to accept the painful changes necessary for structural reform. And ironic that we’ve been through two serious crises in the United States, and yet, perhaps, they’re not serious at all. Perhaps they are just foreshocks of what is to come, because we have yet to see the development of a constituency that is willing to take the pain of reform, and see sort of entrenched interests undone.
So what are the policies that we will have which represents structural reform in the next 5, 10, 15 years? We don’t know. But what will be precipitating events that open our minds to such change? I think this is what we glean was the major reforms in China after tens of millions of people died. It was the major reforms in India after socialism was completely failed. It was only after a complete catastrophe in Central Europe. It was only after the collapse in Russia. All of these things where you say, “Well, you know, a little pain and perhaps people will say, ‘I don’t like this.’” No, in fact, people don’t really change, and policy-makers don’t really make the significant, fundamental, structural changes until circumstances are very serious, and the current paradigm breaks.
Kevin:Well, you know, Dave, that is something that I think we probably ought to bring the moral to the story. We talk to these guys, but we also know our audience. Most of these people are not central bankers and they’re not policy-makers, for the most part, and so what we are basically saying is, prepare for this paradigm break. We’re not necessarily saying it’s the end of the world, but if you’re not prepared ahead of time…. I have to bring back the thought that back in 2007, 2008, Dr. Dabrowski was talking about a crisis that he was predicting and it certainly came to pass.
David:It is not without surprise when you look at the fundamental issues which need to be addressed, and they’re not changing at all, haven’t for the last 10-15 years in the United States, and we still see that same sort of intransigence in Europe. It is no surprise that the crisis continues on, and morphs, changes a bit, from here to there. What is the next iteration of crisis? As he said, perhaps it is in the emerging markets, perhaps it is a replay in Europe. Perhaps it is here in the United States.
So, in summary, do take the time to read the two articles attached, from Project Syndicate, and from the CASE network e-briefs. Those, I think, will be a good insight into what he sees as the major concerns that we still have to address before we can consider a return to growth. If these structural issues are not addressed, you had better prepare your portfolios accordingly.