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An Unwelcome Comeback

Updated: May 17, 2022

In last month’s column I wrote about the yield curve – the difference between long-term and short-term interest rates – and how its recent inversion in the US and flattening elsewhere portends weaker economic growth ahead, perhaps even a recession. Recessions, however, are cyclical. What of structural, long-term growth? For those saving for retirement, this arguably is the more important question.

"Shells that are hoarded are not being spent on fish or wheels"

In recent years, particularly those following the 2008-9 global recession, the term “secular stagnation” has been making a comeback. Secular stagnation is a reference to persistently weak economic growth that is due to a chronic shortage of spending; or, to put it another way, a glut of saving – there are only two things you can do with your income.

Economies thrive because people are kept busy and are rewarded fairly for their work. In the case of an economy of just two people, they may decide to allocate responsibilities such that one provides shelter for both, and the other food. This is the principle of division of labour and it should be clear that as long as the two cooperate, this is a more efficient system than each acting alone.

In economies with more participants it becomes necessary to keep track of who is doing what for whom, so Mr Fishmonger may give Mr Wheelmaker a piece of paper saying “I owe you two fish” for services rendered, repairing a cart, say. In due course, societies work out how to price goods and services in some common currency, shells or small pieces of shiny metal perhaps. Thus, instead of the paper IOU, Mr F gives Mr W five shells. Furthermore, Mr W does not have to use these five shells to buy two fish but can use them for anything.

Finally, Mr Bank arrives on the scene and takes responsibility for guarding people’s existing shells as well as issuing new ones. After all, there may be some who have not yet earned shells by providing a good or service but need some in the meantime. Witness the birth of credit.

The point of all this is to explain what can go wrong with economies and what the so-called stagnationists believe is currently going wrong.

Rising income and wealth inequality can cause economic growth to weaken. If some members of society are being paid large incomes, they may well not be spending all that income – shells that are hoarded are not being spent on fish or wheels.

If wealth transfer is not taxed appropriately, that can exacerbate inequality. If members of other societies – call them emerging markets – offer to work for less, that can put people out of work and reduce production. If a population is ageing, workers must focus on looking after increasing numbers of retired and elderly rather than other things such as building or making things to sell to other societies.

Then there are other factors that dampen economic activity in a subtler way. The end of defined benefit pension schemes means that responsibility for retirement saving passes to the individual. This may mean that people err on the side of caution and save too much. Less tangible still are other concerns that may change spending and saving habits. It is pure speculation on my part, but I wonder if rising climate change fears are causing people to save more and spend less.

Many of these factors were the subject of a recent paper by former US trade secretary and prominent stagnationist Lawrence Summers and the Bank of England’s Lukasz Rachel titled On Falling Neutral Real Rates, Fiscal Policy, and the Risk of Secular Stagnation. They argue that interest rates would be a lot lower were it not for fiscal policies over the last generation that have countered lower private spending.

The term secular stagnation was coined by American economist Alvin Hansen in 1938, following the miserable years of the 1930s. Had he waited a few years, he would have witnessed the start of a remarkable period of high growth in industrialised countries that spanned the best part of half a century. Here is hoping that Summers and Rachel too have to eat their words.

Published in What Investment

The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.

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