Summary: Growth slows in the developed nations due to several factors, as debt levels rise. Have we entered the “coffin corner” where we cannot growth sufficiently fast to service our debt? This is the follow-up to The dilemma of the US economy: can’t take off & too close to the brink.
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In the absence of effective and comprehensible economic theory, economists often rely on analogies. Such as comparisons with aerodynamics. Flying complex vehicles at high speed under variable conditions, often with inadequate or old information — the role of pilot has similarities with that of central banker.
A common mistake of bankers is raising rates to curb inflation while the economy is in fact on the brink of recession. That’s similar to a “graveyard spiral“, in the past a frequent cause of crashes. From Wikipedia, slightly edited:
Graveyard spirals occur in nighttime or poor weather conditions with no horizon visible to provide visual correction for misleading inner-ear cues. … The pilot mistakenly believes the wings to be level, but with a descent indicated on the instruments, so the pilot attempts to climb. In a banking turn, however, the plane is at an angle and flying in a large circle. This tightens that circle, causing the plane to fall at an increasing rate.
This flying by “the seat of the pants” and failing to recognize instrument readings is the most common source of “controlled flight into terrain”.
Today the US economy might have flown into conditions similar to another perilous aerodynamic situation — the coffin corner. From the Sky-brary (slightly edited):
The coffin corner (aka Q Corner) is the altitude near which a fast aircraft’s stall speed equals its critical Mach number. As an aircraft climbs towards the altitude that defines its coffin corner, the margin between stall speed and critical Mach number becomes smaller and smaller until the Flight Envelope boundaries intersect. At this point any change in speed creates serious problems. Turning the aircraft could result in exceeding both limits simultaneously, as the inside wing slows down and the outside wing increases speed. Encountering turbulence can push the aircraft outside its flight envelope.
Is the US economy at the “coffin corner”?
From “In a debt ‘coffin corner”“, Andrea Cicione, Lombard Street Research, May 2014Â — LSR is a top-quality macroeconomic forecasting consultancy.
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Aviation metaphors are a familiar staple of the financial and economic commentary: growth reaches stall speed; economies experience hard landings; markets encounter severe turbulence; corporate earnings reach escape velocity; and so on. Everyone understands these.
… Airplanes can fly safely only as long as their airspeed remains within certain limits. If speed falls below the so-called stall speed, the wings aren’t able to generate enough lift and the aircraft falls out of the sky. Similarly, if an aircraft (at least one not designed for supersonic flight) gets too close to the speed of sound, flow separation occurs, leading to loss of lift or even structural failure. At “normal” altitudes the difference between stall speed and overspeed is large, allowing planes to fly safely at a broad range of speeds.
However, things get more dangerous as altitude increases: stall speed goes up, as the air gets thinner and thus less able to support the weight of the airplane; and the overspeed limit goes down, as the speed of sound decreases with lower air temperature. As a result, at high altitudes the range of speeds at which an aircraft can function becomes so narrow that even the best pilots become unable to keep the plane on level flight.
Why does this matter? Well, replace “airspeed” with “GDP growth”, and “altitude” with “debt-to-GDP”, and you can probably start to see where we’re heading with this. According to the OECD, the government debt-to-GDP ratio for 10 large economies (Australia, Canada, France, Germany, Italy, Japan, Korea, Spain, the UK and the US) has surpassed the previous peak recorded at the end of WWII. … the overall debt burden for the 34 OECD member countries will continue to climb in coming years. While there has been selective deleveraging in certain sectors of the global economy (e.g. US households and DM banks), debt, rather than having been reduced, has mostly been transferred from the private to the public sector.
The question is whether advanced economies, in an effort of trying to limit the damage caused by the Global Financial Crisis, have put themselves into a debt coffin corner. With debt-to-GDP (altitude) as high as it is, they can’t allow growth (airspeed) to slow too much, or debt risks becoming unsustainable. At the same time, high debt levels are likely to be a material drag, making growth hit an insurmountable economic “sound barrier” much earlier. This is because without the boost provided by credit growth, it is difficult to achieve the kind of GDP growth that was possible when debt-to-GDP was lower.
But there’s more. High levels of debt-to-GDP ratios make it difficult for governments and central banks to steer the economy – just as excessively high altitude makes it difficult for a pilot to keep control of the aircraft. Central banks have successfully employed Zero interest rates policy (ZIRP) to keep debt sustainable but, as the economy continues to recover, they may now find themselves cornered: keeping rates as low as they are may lead to overheating (or even bubbles) in certain sectors of the economy; but raising them may stall others by making the existing debt impossible to service.
Now for a bad scenario
What if the economy’s long-term growth rate continues to decline? What if our aggregate debt continues to increase so that the economy’s “stall speed” increases (i.e., a higher minimum speed is needed to keep the economy aloft)? What if the two lines cross?
Who knows what the future holds? There is relatively little research on these matters, and little agreement among economists.
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Also see the research cited in part one.
About America’s growth potential:
- Has America grown old, and can no longer grow? Or are wonders like the singularity in our future?, 28 August 2012
- Is America on the road to zero growth?, 29 November 2012
- Why America’s growth is slowing, and a solution, 28 January 2013
- Will 21st Century USA have a surprise boom, as did the 19th Century UK?, 23 October 2013
- Looking at America’s future: economic stagnation, or will computers take our jobs?, 7 January 2014
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For the moment (and I need to emphasize the moment) I’m not particularly concerned about the debt to GDP ratio. Krugman, Shiller, and Steiglitz all say that debt essentially looses its meaning in our current grey twilight of an economy. But none of them have published any research on what happens if we manage to break out of the ZIRP zone.
Krugman has said the most on the subject of debt to GDP ratios and he seems to feel that it won’t be a problem even after we leave the ZIRP zone. I’m not sure if that is because of his research or if that is because he is so anxious to avoid more austerity from the Republican party.
My own (extremely amateur) research indicates that we are in okay shape this year with little chance of slowing down below stall speed before the end of the year. But the odds of having anything resembling a real recovery are only slightly higher than the odds of a slow down. My best guess is that the economy will once again clock in with annual growth between 2-2.25% for 2014.
Next year is a bit trickier because the current years growth is partly funded by high expectations and renewed willingness to use credit in a number of areas like auto and student loans.
Pluto,
“For the moment (and I need to emphasize the moment) I’m not particularly concerned about the debt to GDP ratio.”
The direct effects of the debt to gdp ratio are irrelevant here; it’s not a question of solvency. This concerns the indirect effects, as more debt increases the stall speed (and, perhaps, slows GDP growth).
“My own (extremely amateur) research indicates that we are in okay shape this year with little chance of slowing down ”
It’s not a subject where amateur analysis has any value. Even experts, with the most sophisticated models, find it difficult to forecast GDP more than a few quarters ahead in normal conditions — and find even that difficult under current conditions. In December the consensus for Q1 US real GDP was ~3.0%. At the end of Q1 it was 1.5%. The latest est of actual is -2.9% — almost a 450 bps miss from the end of quarter estimate.
FM: “It’s not a subject where amateur analysis has any value.”
In principle I completely agree with your statement. But I have observed that my predictions for the last five years, based in large part on the works of Krugman, Shiller, Stieglitz, and others, have been consistently more accurate than the predictions of experts with sophisticated models. I find this to be a cause for considerable concern and seek to understand why this is so.
Part of the answer is that, because I cannot guess quarter by quarter numbers with any hope of accuracy, I only worry about year over year, which smooths out the effects of bad weather and other transient events.
But I am beginning to suspect that the bigger problem comes from inherent biases in their models. Krugman uses the IS-LM model which is simple and imperfect (as all models must be when trying to predict something as big as the US economy), but has long history of reasonably accurate predictions.
Call me old-fashioned or liberal, but the models based on the Freshwater school of economics (which is nearly all of them) just don’t seem to be accurate these days. I think the smart boys at the University of Chicago took a wrong turn when they started throwing around the concept of “confidence” in macro-economic discussions.
While it is a reasonable concept and seems to work fine in micro economic discussions, it just doesn’t seem to work in today’s macro economy. Aggregate demand, originated by Keynes, seems to be a much better tool (but is still very imperfect) on which to base predictions of economic activity.
Aggregate demand suggests that the overall US economy is going to stay stuck in the current grey zone (barring other shocks) for a considerable period of time. Which, as Thomas Moore notes, would suit the 1% just fine.
In this instance I have to agree with Pluto. Usually FM is spot-on, but in this case, his discussion here is simply silly. The 1% who are running the American economy quite naturally love the current economic situation, and thus have worked hard to create and maintain it. America now languishes in a state of seemingly perpetual extremely sluggish GDP growth combined with ultra-low inflation plus enormous hysteresis in the labor market. This means that the “reverse army of the unemployed” is now enormous, while near-zero inflation provides an ideal environment for wealthy investors with expensive assets. In a near-zero inflation environment, the value of expensive assets is not threatened by inflation; meanwhile, workers are so terrified by the high unemployment that they will accept brutal wage cuts and massive benefit reductions merely in order to keep their jobs.
As FM has pointed out in previous posts, the 1% who rule America do so with skill and foresight, if not to the liking of the bottom 99%. Under their guiding hands, the U.S. economy may well continue in this near-zero-growth limbo for decades, without ever slipping into recession. And yet, if the U.S. economy ever does reach the tipping point into an actual recession, it’s easy to deduce that many trillions of dollars will instantly flood into our economy to prop it back up, just as happened in 2007-2008. Where will these untold trillions of dollars come from? Obviously — from cutting back temporarily on America’s endless unwinnable foreign wars, and worthless counterproductive “national security” busywork involving domestic spying on citizens’ emails, etc.
America currently burns through at least a trillion dollars per year (one estimate runs to 1.3 trillion, other estimates put it at 1.2 trillion per year) on “national security” broadly defined. This is a highly fungible number. Clearly it can be made to rise or fall arbitrarily by the rulers of the U.S. economy merely by ginning up new bogus “threats” (more yellowcake uranium, new speeches about how “we don’t the first warning to be a mushroom cloud)) or by dialing back the threat levels. Since the entire so-called “war on terror” is a bogus sham, the 1% who run America will find it easy to temporarily suspend America’s endless wars and lay off a few of the millions of DHS and TSA goons whose jobs amount to nothing but white-collar welfare. Once the economy gets stabilized by the massive influx of cash temporarily taken from America’s national security apparatus, it will be back to business as usual with more endless unwinnable foreign wars and more spying on and imprisonment of our own population (as recently promised by presumptive presidential candidate Hillary Clinton — “a more assertive stance toward foreign threats” is code for “more endless unwinnable foreign wars”), in a process aptly described by George Orwell:
Current concerns about the deficits and America’s supposed inability to finance its national debt are fanciful fictions confected by the spin merchants hired by Pete Petersen, the Koch brothers, and the other billionaire overlords who yearn to dismantle America’s social safety net. It’s a pity that FM has fallen for their propagand…but then again, it’s very skillful propaganda, full of tales told most convincingly by armies of PhD economists eager to whore themselves out for brown bags of billionaires’ cash.
It troubles me that nearly all discussions about ZIRP, secular stagnation, etc. focus on the difficulty central banks have in setting a policy that will restore growth and so-called full employment. Why the assumption that central banks are the only place to look for a solution?
What if we can restore growth, but central bank policy isn’t the thing we need to change?
What if we cannot restore growth, for reasons that have little to do with economic policy and cannot reasonably be overcome? (E.g., we’re not going to force people to have more children to create another baby boom.)
Are there any proven means by which a nominally free-market capitalist economy can adapt to function well under persistent conditions of little or no growth? Has any country ever done so? Has anyone ever tried (that is, to tune an economy to function well with minimal growth, rather than just trying to resume unbounded growth)?
I’m not a big fan of the phrase “thinking outside the box”… but it seems as if we’ve built a special, very small box, crawled inside it, and are now declaring, with sighs and regrets, that there may be no solutions to our problems.
This is equivalent to saying we can’t raise rates and we can’t leave rates at zero. Fixed income investors like insurers know quite accurately what their cash disbursement will be. To meet these obligations they layer duration of the bonds they buy ie they hold some say ten years bonds with one year left on their duration, some with two and so on up to ten years. If the Fed goes berserk and drops rates to zero for one year it’s no big Woop to these guys due to the flywheel effect of this layering. But now it’s going on five years. No one knows the true breaking point but somewhere along here fixed income investors will fail to meet their obligations. That would be bad.
On the other hand raising rates will hit borrowers like a ton of bricks. The previous strategy of rolling over debt at perpetually lower rates or st least treading water at zero rate will end. Debt must now be rolled over at a higher rate. Many will default when this happens. As you say, damned if you speed up (lower rates) and damned if you slow down (raise them). A coffin corner indeed.
Peterblogdanovich remarks on the difficulties facing fixed income investors. As we all know, by far the biggest fixed income investors are the pension plans, particularly those run by the large states, like California.
But once again, this concern is silly. Pensions have already been gutted in the private sector: no promise of a pension will ever come true if you work for a private employer nowadays, and every worker knows it. The 1% who rule our society have now set their sights on dismantling pensions for public employees. This is simply the method they’ll use to do that. After umpty-ump years of near-zero (or possibly negative) real returns on bond investments, the states will have a perfect excuse to throw up their hands, sigh, “Oh, gosh! The economy being what it is, we just can’t afford to pay that pension we promised!” To claim that a pension with public employees is a contract raises a smile on the face of the knowing observer, for today we live in a justice system with two forms of laws — high justice for the rich, who can do anything they want merely by bribing enough high-paid lawyers and paying to lobby through enough coercive legislation…and low justice, where the laws that mean nothing to the rich crush the rest of us.
It’s obvious that public employee pensions will simply be done away with, just as private pensions have already been effectively eliminated. What peterblogdanovich and FM see as a “bug” in our economic system looks like a wonderful feature to the 1% billionaires who rule America’s economy. A perfect excuse to zero out public employees’ pensions, and no one to blame — “After all, it’s the economy that’s forcing us to do this, it’s not something we want to do.” Naomi Klein’s “disaster capitalism” in its purest form. (Create an economic crisis, then use it as an excuse to gut the safety net, roll back the New Deal, etc., etc., etc.)
As Voltaire remarked, “Laws are as evanescent spiderwebs to the rich, and binding cables of steel to the poor.”
Incidentally, the Supreme Court this session is taking up the question of whether public employees unions can legally exist at all. So the effort to roll back the New Deal has accelerated to a new frenzy. Look forward to lots more of that in the near future.
when I said “That would be bad”. I was referring to Irving Fischer’s observation that a debt deflation gets started when forced liquidations by big fish like insurers and pension funds cause asset prices to fall. Once this pump gets primed so to speak there is no end to it. Forced asset sales cause rates to climb but equities to fall even more. We don’t appreciate how preprogrammed the players are to start a self destruct sequence. The Fed fear of deflation and debt deflation in particular is well founded. Insurers have to meet their cash obligations. Pension funds must meet theirs too. They are like happy robots. If cash flows from bond purchases dry up
They will sell assets. Asset prices will fall. They will sell more assets. Asset prices will fall more. Kaboom
And then depression. And then War.
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I was actually thinking of writing an article that asks if World Banks have put themselves in the “coffin corner” with their interest rate policies and QE, but I stumbled upon this article, so it looks like you beat me to the punch.
Sebastian,
You’ve caught a mistake — and are the first one to notice this! In the first part of this series – The dilemma of the US economy: can’t take off & too close to the brink – I said that the theory of a “stall speed” to the economy “is a controversial theory; now we’re testing it.” But I forgot to mention that in the second chapter of the series, which of course some people read as a stand-alone.
That was July 2014. Two years later, the results were in: there is no “stall speed” to an economy (or it is very low). In June 2016 I wrote about this in The mystery of the US economy at stall speed. From the summary: