Macroeconomics and Scientific Laws – Part 2

The sun rises in the east and sets in the west.  Several centuries ago this was taken as evidence that the Sun revolved around the Earth – a logical and rational conclusion based on the evidence.  It was later proved wrong, but the original conclusion was not insanity. Insanity has been defined as “keeping doing what you’re doing and expecting something different”.  If you’re going to get something different, you have to do something different.  The problem with things that may be logical – based on the existing evidence – is that they can become “conventional wisdom”, or “mantras”, which aren’t allowed to be questioned.  And if they are questioned, the doubter becomes branded as an “idiot”.

One of today’s conventional wisdom’s is that low-interest rates and federal budget deficits will lead to an improved and robust economy.  We’ve had federal budget deficits for as long as some of us can remember, and the Federal Reserve has been keeping interest rates at near zero for going on 8 years – longer than any previous time in the history of the Fed.  Maybe some things have changed or maybe it’s just time to think about our basic assumptions.  So at the risk of being branded an “idiot”, I’m going to suggest that we think – with an open mind – about doing something different.

What things have changed from the last half of the 20th century that could make a difference?  For starters, there is the “baby boom” generation.  From 1965 until about 1985, the baby boomers were maturing, entering the work force, marrying, having kids, buying houses, and experiencing all the things that cause us to increase our consumptions expenditures.  They were entering the work force and so it was growing rapidly.  As they progressed through the various life stages, consumption was growing even faster.  As a result, manufacturing and marketing companies were making capital expenditures that added jobs and reduced costs.  Energy demand increased, and the price of oil and gas went up rapidly in the late 70’s, which, along with the increased demand for goods and services, probably contributed to inflation.  By the early 1980’s, it was obvious that the world had not run our of either oil or natural gas.  Energy prices dropped dramatically and the Fed began to raise interest rates.  There was a brief recession, but inflation was reduced to acceptable levels and all the credit was given to the rise in interest rates.  What followed was a long period of growth and prosperity.  The laws of macroeconomics were confirmed.  We had budgets deficits and the economy improved and we had high interest rates and the inflation rate was tamed.  But maybe that growth was not so much what the federal government did, but a result of the baby boomers increasing the size of the work force, growing demand for goods and services.  And maybe the reduction in energy prices helped reduce inflation?

Interest rate increases into double digits may have helped tame inflation, but at the time I thought that interest rate changes work much better at slowing things down than speeding them up.  I believe interest rates are kin to the reins on a horse-drawn wagon.  They can slow the horses down, but have a lot more difficulty speeding them up.  During the ’70’s and 80’s I worked a lot on justifying capital projects for manufacturing operations.  As long as interest rates were at or below “normal”, they weren’t usually a factor.  The biggest risks were in product growth and prices, both of which effected revenue.  Next was product manufacturing costs.  Interest rates were not even discussed until one got to the double-digit levels in the early 80’s.  In other businesses, such as commercial real estate where projects are highly leveraged they are more of a factor.  After the 2001 recession, I heard a real estate developer say that the lower interest rates helped him avoid bankruptcy because he was able to refinance some of his highly leveraged investments.  But that sort of thing is accomplished in the first couple of years of a recession.  The people who get hurt by lower rates are retirees – particularly lower and middle-income retirees – who have their retirement savings in fixed interest items because there is less risk and income is usually higher than in the stock market.  My father-in-law had most of his retirement savings in 2 and 3 year CD’s.  With CD’s and investment grade bonds, lower interest rates take some time before they actually are a factor for these portfolios.  After the 2001 recession, the interest rates returned to “normal” levels in two years and he was not really effected.  Not so after the 2007 debacle, he was struggling as his CD’s matured.  With the baby boomers retiring, low-interest rates are going to effect many more people with lower than anticipated income.

Today the bigger changes are no doubt that the baby boomers are retiring and the work force is shrinking.  It might well be that they were the major driving force in our economy’s growth.  Today, the federal budget deficits may be the biggest problem.  They are obviously not driving the economy to new heights, but they may be contributing a lot to people’s uncertainty.  If Robert Samuelson and the Pew study are correct that people’s confidence levels are the key to a good economy, then uncertainty is an enemy.  Most of us believe that the Fed will eventually raise interest rates, but when?  In the meantime they are sending a message that things are still bad,  But the 2007 recession was a debt crises, and  most of us think that normally, budgets should be balanced.  The federal budget has been balanced only once in the last 20 years or so.  The full employment budget idea of the 1960’s promised a balanced budget when the economy had recovered at the end of any recession.  But the budget has not been balanced in years and there is some concern that the national debt may grow to unmanageable levels.  This fear is not helped by the problems in Greece.  The Greek message is that sooner of later national debt can become a major difficulty and fixing it will be painful to all concerned including ordinary citizens.  The number of retirees are increasing rapidly now that the baby boomer’s have started to reach retirement age.  So the demands on Social Security and Medicare are expected to increase rapidly, and the deficits are expected to get worse even after the economy has fully recovered.

With the baby boomers retiring, the work force is shrinking.  Not only that, but Robert Samuelson in a column in last weeks paper reported that the Bureau Of Labor Statistics found the increase in  productivity for 2014 was 0.5% – normal since the end of WWII has been 2%.  But the 2014 number was the highest of the previous 3 years.  His opinion is that the productivity gains are the reason for increases in real income.  With smaller productivity gains and a smaller work force, tax revenue may fall.  Why productivity gains have fallen he says in unclear, but he cites a couple of books Mancur Olson (published in 1965 & 1982) as providing some insight on possible explanations.  But whatever the reason, he thinks it is likely going to provide more problems in controlling deficits, which he sees as a problem. With more retirees spending less and a smaller work force with less productivity,  it may be that we are in for a period of slower growth.  Does the Federal Government have a plan to address these uncertainties.  It doesn’t appear so.  Most of us think that the interest rates will have to rise and that the Federal Government will have to address the budget deficits, but when and how?  That uncertainty doesn’t help my confidence levels.  How about you?

In our paper there was an op-ed article written by a Blomberg view columnist – Mark Gilbert – who cites an opinion that a director of a Florida based bank, Neil Grossman, shared with him.  Mr. Grossman cited an Einstein discovered physics analogy to support his idea that the Fed should raise interest rates to “normal levels”.  And that they won’t be helping the economy until they do this.  Normal interest rates are generally thought to be in 4-6% range, or 3% plus the inflation rate.  I’m not familiar with the physics concept, but I believe that the best thing the government might do is keep things “normal”.

We may be like the people who thought that the sun rotated around the earth – we may need to learn more about how our environment – social, political, and economic – works before we have the real answers to some of these things.  But one thing seems certain, what we are doing isn’t working.  So if we aren’t insane, we should do something different.  My suggestion would be to have the government put priority on establishing a “normal” environment (normal interest rates and a balanced budget) rather than trying to fix every detail.  If that happens, “we the people” might start acting normally and taking responsibility for fixing our own problems.  We used to be able to recover from recessions fairly quickly – like the 1920’s recession and previous ones.

 

 

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About tjc13

BE - Chem Engineering, Vanderbilt Univ, MBA, University of Tulsa - Worked for an energy and chemical company for many years and then started a management consulting business working for both for-profit and not-for-profit organizations.
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One Response to Macroeconomics and Scientific Laws – Part 2

  1. Pat Cain says:

    Excellent

    Pat
    D. Patrick Cain, CFP®
    [cid:image003.jpg@01D0F5EB.857AED90]

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    Like

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