Data-Dependent ... on Imaginary Data

Federal Reserve officials like to say their policy course is “data-dependent.” That sounds very cautious and intelligent, but what does it actually mean? Which data and who’s interpreting it? Let’s ask a few questions.

Photo: Federal Reserve Board of Governors
First, how could their policy choices not be data-dependent? The only alternatives would be that they made decisions randomly or that there was an a priori path already determined by previous Fed policymakers that they were forced to comply with. A predetermined path would, of course, eventually be leaked, and then everybody would know the future of Fed policy. Until they changed it.
Of course, they do depend on data, and lots of it, but are they looking at the right data? If it is the right data, theoretically speaking, is it accurate? As we will see, more often than not they are basing their decisions on data created by models that rely on potentially biased assumptions derived from past performance, etc. Often the data they look at is actually a sort of metadata, a kind of second-derivative model, with all sorts of built-in assumptions, quite removed from the actual data.
That approach is actually reasonable when you realize that the amount of data that must be managed is simply too large for any human being to process in a coherent manner. The data has to be massaged, and that means making assumptions that create the models in the programs. Those are assumptions are not made by computers, they are made by human beings who are doing the best they can – using models based on assumptions they build in to guide them as to what assumptions they should make about the data. Convoluted? Yes.
I certainly don’t know all the answers to the problems with national and global economic data and metadata management, and it’s far from clear the Fed knows those answers, either. Whatever your economic and political ideology, we can all agree that these are big problems. Today we’ll look at how big.
First, a quick update on the Strategic Investment Conference. This is especially for the many of you who wish you could attend but have conflicts. For you, we have something new: the SIC Live Stream Virtual Pass. Video coverage for all the conference sessions will be streamed live over the internet straight to your computer or mobile device! It’s not quite like being there, but it’s darned close.
The technology to do this is quite expensive, as you may imagine. We’re making the investment because this year’s message is so important. Our theme this year is “Crossroads” because that’s exactly where the world is. We are at an inflection point and have big choices to make. Right ones will speed us along. Wrong ones could slow us nearly to a halt.
We are actually approaching multiple crossroads simultaneously. You know the list: In addition to the Fed, other central banks are on the cusp of big policy shifts, too. Geopolitical challenges are cropping up everywhere, and some big emerging-market countries are on shaky ground.
We’ll be exploring those crucial issues and more at SIC with 25+ top experts. If you can’t join us in San Diego, the Live Stream Virtual Pass will bring the conference to you. You’ll see all the sessions and even be able to submit questions to the speakers.
I’m doing this because I want every reader to have every opportunity to get ready for what’s coming. The SIC Live Stream Virtual Pass will be your ticket, and at a very reasonable cost.
Invisible Derivatives
Here’s a garden-variety mainstream media market narrative right now. I made this up, but similar thoughts are voiced everywhere.
US growth is finally taking off after years of stimulus. We’re near full employment, and wages are starting to rise. Consumers are opening their wallets just as tax cuts and deregulation embolden business to expand. At the same time, we are hitting resource constraints that have the economy close to maximum output. The resulting concern about inflation is pushing interest rates higher and taking some froth out of the stock market.
There are a lot of people who agree with this narrative, especially those who talk to us via the mainstream media. The problem with that story is that they are assuming facts that aren’t necessarily proven, two in particular:
• We’re nearing full employment.
• The economy is close to maximum output, or “potential GDP.”
Are those statements correct? How do we know? How do we even define full employment and maximum output? Measuring them isn’t like sticking a thermometer in your holiday prime rib to see how it’s cooking (which, by the way, if you are serious cook, you absolutely must be doing).
I thought about this problem with definitions last week when I read a Washington Post op-ed by Jared Bernstein. He was the chief economist for Vice President Joe Biden and now works at a left-of-center Washington think tank. He’s also not someone I would normally quote, since we are on quite different policy ground politically and economically. But we also have some common ground, and I think it’s important to note that. And for the record, more and more economists of all stripes are beginning to come around to this very same view.
But Jared does a particularly good job in a brief space of framing the issues. Here’s the lead to Jared’s article.
Recent events have exposed a hole in the middle of economists’ knowledge of key economic parameters: We know neither the unemployment rate at full employment nor the potential level of gross domestic product (GDP).
That hole is particularly important right now. The combination of the deficit-financed tax cut and the new spending bill are pumping hundreds of billions into an economy that many argue is already at full employment. If so, then much of this extra spending won’t lead to new investment, jobs or higher real pay. When the economy’s human and capital resources are fully utilized (meaning actual GDP is equal to potential GDP), fiscal stimulus just generates inflation and higher interest rates. Even if the extra demand might create some wage pressure, it will be met with higher inflation, so real wages – the paycheck’s actual buying power – won’t change at all.
The problem is that those making that argument are implicitly asserting that they know that the “natural rate of unemployment” – the lowest rate consistent with stable inflation – is roughly equal to the current unemployment rate. That is, they believe we’re at full employment. But the truth is they have no way of knowing that, and one key indicator – inflation – suggests they may be wrong.
Those are three paragraphs that I could have written and defended. I think that fact is significant. Jared and I more than likely to disagree on what economic policies we should follow – but we can’t even have that argument until we can agree on what the data says and means. And we can’t at this point. We have to rely on anecdotes and hints, at best.
This state of affairs is startling once you start thinking about it. Economists are reaching conclusions and policymakers are making decisions based on derivatives of invisible derivatives.
Sound crazy? Yes, but it’s happening.
Giant Mystery
Let’s talk about these two stats, full employment and potential GDP. They have multiple layers.
“Full employment” means all the people who want to work are gainfully employed. For the record, the Fed thinks that full employment is an unemployment rate of about 4.7%, while the BLS tells us that unemployment is currently running at 4.1%. Those who aren’t working are either in between jobs or face some barrier, like a criminal record or lack of skills.
Therefore, if we are indeed close to full employment, employers who need more help must offer higher wages, which leads to inflation. At least that has been the pattern historically.
But is it really that simple? In any given month, we have only a rough approximation of how many people are unemployed and an even rougher idea of how many might become employed but are currently not even looking. The numbers come from survey data, with all the inherent limitations surveys entail. There are actually two different federal surveys, and sometimes they disagree wildly. Over time they get in line, but on a month-to-month basis?
Not so much. Beyond those surveys, what we think we know is mostly conjecture and assumptions about what we want the data to say.
For instance, simple observation and the actual surveys suggest that many Americans, while nominally employed full-time, aren’t earning as much as they once did. Nor are they as productive as they once were or as they could be. If that’s a widespread pattern, it means the economy still has “slack.” Production could rise significantly without adding any new workers. What we have is not “full employment” in any real sense.
We use survey data to infer how many people are employed, how much they are paid, and so on. In the process we observe people who aren’t employed. We try to figure out why they don’t have jobs and what circumstances might bring them back into the labor force. It’s a many faceted mystery no one has solved, yet we make important policy decisions based on our fragmentary understanding of that mystery.
Let’s look at a few different ways to measure what we mean by full employment. The Bureau of Labor  Statistics (BLS) suggests that if you haven’t been looking for a job in the last 30 days, you are not in the workforce. Thus you don’t count as unemployed.
First off, that way of defining unemployed runs contrary to all of our personal experiences. There are lots of people who have not been able to find a job and have given up looking, but if they were offered a decent-paying job they would take it.
Choosing to say that they are no longer in the labor force after just 30 days of not looking seems rather arbitrary and unrealistic to me.
Now let’s take a look at the US labor force participation rate since 1990 via the St. Louis Fed’s FRED database:
There are a lot of reasons for the participation rate to have fallen so much, and the dropoff is an extraordinarily complex and difficult thing to get your data head around. But policymakers and economists want to have simple answers and solutions, so they make assumptions and then confidently tell us that their assumptions are the correct ones: This is what the data means. And they don’t bother to attach a 50-page white paper that parses all of the different variables that go into making those assumptions about the participation rate.
Just saying…
My friend Lance Roberts (via Michael Lebowitz) adjusts the unemployment figure based upon a methodology that includes the people who have quit looking for jobs. He compares that adjusted rate to the U3 rate in the chart below.
Is Lance’s number the real employment rate? I would suggest that it’s not, because a lot of people who are not in the labor force really aren’t looking for jobs. They are students, or they are  on disability, and so forth. Lance performed the exercise to make us think about the employment numbers.
If you argue that we are at “full employment,” then it follows that you are expecting wage inflation. But that is not what we’re seeing. Eighty percent of workers are seeing very little wage growth at all. This instructive chart comes from my associate Patrick Watson’s latest Connecting the Dots letter:
For there to be demand-led inflation, consumers need to actually have some of that wage growth in order to be able to spend more money. Yet real savings as a percentage of disposable income is down to just above 2%, a long way from the long-term average of 8%. And credit card debt is still rising while disposable income is flat.
Let’s hear from my friends at 720 Global:
The first graph below shows the traditional Phillips curve as typically displayed (U-3 and recent three-month wage growth). The second is a modified Phillips curve which uses the revised U-3 from above and one-year forward wage growth.
Both graphs … demonstrate that only 28.84% of the change in wages was due to the change in the unemployment rate. Visual inspection [of the first graph] also tells you the relationship between wages and unemployment is weak. It is this graph that has many economists declaring the Phillips curve to be irrelevant. The second graph has a (warning: economic geekspeak) statistically significant R² of .7047 and a visible confirmation that the Phillips curve relationship continues to hold. Recently, Federal Reserve Bank of Chicago President Charles Evans stated, in relation to the Phillips curve, “We don’t have a great understanding of why it’s gotten to be so flat.” Mr. Evans, perhaps employment is not as strong as you and your Fed colleagues think it is.
720 Global goes on with more math before they produce this important graph:
If one believes that the laws of supply and demand continue to hold true, then the revised Phillips curve graph above argues that the unemployment rate is in reality much closer to 9% than 4.1%. To believe that the Phillips curve is useless, one must be willing to ignore a more rigorous assessment of labor market and wage data. The only reason economists and Fed officials voluntarily ignore this data is that it belies the prettier picture of the economy they wish to Paint.
Does anyone else see a problem here? Those who crunch the data see what they want to see and disregard the rest. If you want to see low unemployment, you find data that gives you low unemployment. You don’t look at contrary measures.
The Fed has taken this position in spite of the fact that most Fed economists truly believe in the Phillips curve. They just don’t believe in it enough to take it to its logical conclusion, as 720 Global did.
Then there’s “potential GDP,” or the nation’s theoretical maximum noninflationary output. What does it tell us? First, note that we barely have a grip on actual GDP, even though it is a function of (mostly) observable data. A small army of people spend their entire careers collecting GDP inputs. They do a fine job, too; but no one really knows if they are collecting the right data to support the conclusions everyone draws. Further, GDP does not measure all the things that we used to buy at significantly higher prices, which contributed to GDP but are now (for instance) available in our phones for “free.”
I have spent entire letters talking about the limitations of GDP measurement. I thoroughly understand why we must have the measure, but we need to recognize what it is and isn’t. It is not a meaningfully, accurate number delivered from Mount Olympus by the economic gods. It is, at best, a concatenation of approximations, the movement of which, based on those approximations, can give us insights into the economy – but not with any real precision. Google Maps gives you very precise directions. The GDP number is more like “We are going west; we are not going north.”
We then use this estimated GDP, this fuzzy and incomplete growth measure, to infer potential GDP, or how high this nebulous number could go if some of its inputs changed.
Then we wonder how close we are to this vague derivative of an incomplete measure of a hypothetical construct, so that we can modify fiscal and monetary policies. It’s important to understand that if we have in fact now begun to exceed our potential GDP, then economic theory suggests that inflation – and perhaps not even mild inflation –  is right around the corner. I am not a doctorate-holding economist, but to me this seems an unwise assumption to make.
Others think so, too. Here’s Jared Bernstein again:
It’s true that influential institutions such as the Federal Reserve and the Congressional Budget Office (CBO) believe that the “natural” unemployment rate is above the current one, meaning our labor force is beyond fully employed. Their estimates are 4.6 percent and 4.7 percent, respectively, while the actual rate is 4.1 percent. The CBO also asserts that our current level of GDP – $19.7 trillion – represents full capacity.
But the evidence undermines much confidence in these authoritative-sounding point estimates. First, understand that neither of these measures – the natural rate or potential GDP – can be observed. They must be estimated based on the movements of other variables. For example, the key relationship underlying the natural rate is the one between unemployment and inflation, with the basic insight being that once economic capacity is exhausted, any more demand just shows up as more inflation (note the link between the debate over fiscal spending right now).
This is a key point. No one can directly observe the natural unemployment rate or potential GDP. “They must be estimated based on the movements of other variables,” Bernstein says. Much of our economic data is similarly inferred.
Astronomers can look into the heavens and infer that planets they cannot see are revolving around stars they can see. They can do this because they understand with some precision how gravity works. Moreover, gravity doesn’t sometimes work differently because people wish it would. Wile E. Coyote kept learning this the hard way. Economics enjoys few such certainties, even though many economists think it does, or at least wish it did.
Zero Confidence
This brings us to the present market conundrum. Is the economy close to overheating, or not? Perfectly sincere people look at the same data and come to radically different answers. That wouldn’t happen if economics were a hard science. We would apply the data to known laws and the correct answer would be obvious. It isn’t obvious at all, but policymakers act like it is.
I’m not saying we should go to the other extreme, doing nothing until we have 100% certainty. That’s not wise, either. The key is to recognize that we have blind spots and then work around them. For instance, physicians don’t know everything (certainly not as much as we like to believe they do) about the human body, but they make good use of what they do know. The lab tests show an infection, and they treat it; the CT scan shows a suspicious mass, and they remove it.
Would you let a doctor cut you open based on data as reliable as, say, GDP or unemployment? Of course not. That would be crazy. And your doctor would probably agree, because the Hippocratic Oath says “Do no harm.” Economists have no such oath. Maybe they should.
Airplanes are an even better example. Your pilot delivers you to your destination safely thanks to extensive, accurate data on the plane’s course, altitude, speed, and so on. Now imagine a plane in which Federal Reserve staff had filled the cockpit with instruments meeting their standards. Would you get on that plane?
Let me think for a nanosecond. No. I would not board such a plane because I would have zero confidence that it was taking me to the right city. A San Francisco flight could easily end up in Cleveland – if it arrived anywhere at all without crashing.
All this is very obvious to people who lack graduate degrees, yet for some reason the economics profession persists in thinking it knows things it simply does not.
Economists have physics envy. They want their profession to be a hard science, when it is probably one of the softer of the soft sciences.
Believing that the data they have is precisely meaningful gives people like Federal Reserve governors the mistaken impression that they have what they need to manage the economy successfully. They don’t. They have lots of data and not so much information.
Hence, to my great surprise, I find myself 100% agreeing with Jared Bernstein’s conclusión:
Our best move is thus to admit the uncertainty, toss the point estimates, and follow the data, particularly inflation. Recognize that we’re driving a car with no reliable indicators of engine overheating, so we’ve got to use our eyes and ears to gauge the heat. That doesn’t call for recklessly pumping the gas or the brakes. It does call for more humility about the limits of our knowledge.
Having “more humility about the limits of our knowledge” would be an excellent step toward more rational monetary policy. Will the Powell Fed take that step? I hope so… but I’m not holding my breath.
Think about this: 12 people sit around a table, chew the fat over masses of data and metadata, and then set the price for the most important commodity in the world: the US dollar, the world’s reserve currency. How do they know they’re right? Well, they tell us confidently, it’s all in the data.
If the market is competent to set long-term rates or LIBOR, then maybe we should trust the market to set short-term rates. That doesn’t mean there would be no role for the Fed. There are points in the economic cycle when the Fed can be quite useful, typically during a liquidity crisis that follows hard on the heels of too much irrational exuberance.
Want to have some fun? Read this at the Financial Times Alphaville site. A former Fed insider recounts the debate at the FOMC meeting when the committee was trying to implement QE3. It’s hilarious in a sort of “Oh my God, it can’t really be this bad can it?” way. Not exactly confidence-inspiring. And yes, I’ve talked with lots of people who have been “in the room,” and it can get that bad.
And yet the chairman of the Federal Reserve comes out after the meeting and confidently announces whatever the policy decision is, not mentioning the questions and disagreements and uncertainty and frustration of the members who sat around the table. By the way, these FOMC meeting minutes are not released for five years. I guess that’s because the parents don’t want to let the children hear them arguing.
And with that I will hit the send button. Technically, I should have spent a good deal of time talking about inflation and the CPI in conjunction with this question of the analysis of data, but the letter is long as it is. Next week we will spend the entire time talking about inflation and the assumptions we make about it. That’s an exploration I look forward to sharing with you.
Sonoma and the SIC in San Diego
I will be meeting with Mauldin Solutions business associates Sunday night through Monday night; then Tuesday morning I’ll fly off to San Francisco and then drive up to Sonoma to be with my friends at Peak Capital Management for their annual client conference. It will be a fun conference, as I have a lot of friends flying in. I’ve been wanting to spend some quality time with them. Peak has graciously allowed me to stay a few days, and I am going to bookend their conference.
After that conference I am home for a week to nail down my presentations at the Strategic Investment Conference in San Diego. I mentioned at the beginning that we are doing a video live stream of the conference. Some of the links we used when first sending that information out did not work. I am assured that this one does: SIC Live Stream Virtual Pass.
It’s the next best thing to being there. By the way, I didn’t mention it above, but you will be able to go online and ask questions and vote on the questions that those in the room are asking. We are doing everything to make the Virtual Pass as close to the real thing as possible.
Sidebar: It happens every year. This is our 15th conference, and for the last seven or eight in particular we have gotten a lot of people who should be on the stage signing up at the last minute. Last year and this year I kept a few sessions open, waiting to see who would show up that I should ask to join us as presenters. But no sooner had we finally “pulled the trigger” this year than we had several people sign up that I wished we had on the stage. Oh well, maybe next year. But for those who are attending, I will point them out from the podium so you can catch them at breaks and dinners.
Have a great week. Shane and I are going to try to relax for a day or so while we can, because life gets really busy for the next three weeks, without a lot of opportunity for breaks. People around me tell me it’s important to take breaks. I have not been very good at that over the years, but I’m going to get better. After I get back from the gym…
Your “data-dependent” analyst,

John Mauldin


by Egon von Greyerz

US economics is extremely predictable. It doesn’t matter who is President and what party he comes from. Because every president will spend more money than the US can afford. On average, US Federal debt has doubled every 8 years since Reagan came to power in 1981. And Trump has just fulfilled the prediction. The budget deal that has been agreed is guaranteed to produce substantial deficits in coming years. The current year’s deficit might be just under $1 trillion but thereafter it is virtually guaranteed that the US will not have a budget deficit under $1 trillion for many, many years.

US Federal Debt $40 trillion by 2025

During Obama, debt went form $10T to $ 20T. Whether Trump will manage to keep it below $28T by 2021 is questionable. What is more certain is that by 2025, whoever is president, debt will most certainly fulfil the historic trend of doubling every 8 years. That means a $40T debt in 2025.

The scenario to cause this huge debt is straightforward. Crashing bond and stock markets, high interest rates, high inflation leading to hyperinflation and defaults in the financial system. All that will result in massive money printing on a scale that has never been done in history. It would actually be a miracle if the US debt is only $40T in 2025. With hyperinflation, it could be multiples of that sum.


Bubbles are bursting

The signals that the markets have given in the last few weeks are a clear indication that the euphoric stage of the economy is coming to an end. It began with the biggest bubble in history starting to burst – Cryptocurrencies. In one month the market cap of this market more than halved from $835 billion to $395 billion.

Cryptos have been a wonderful speculation for the few that managed to cash in. But for many it has been a disastrous Ponzi scheme that will end in tears. Cryptos have nothing to do with real investments and even less to do with wealth preservation. There is nothing wrong with having a small flutter in a speculative instrument. Sadly though, many buyers of cryptos have been tempted to buy on credit and are sitting on major losses.

The fall in Cryptos is symptomatic of the end of an era. Compared to $80 trillion global stock markets, cryptos are insignificant. Stocks and cryptos have one thing in common, they both have a long way down from here. Whilst cryptos will go to zero, stocks will go down in real terms by at least 90%. I say real terms because hyperinflation can take the nominal level of stocks a lot higher. Between 1929 and 1932 the Dow fell by 90%. On any criteria, the stock bubble is so much greater today so once this market has topped, the coming fall will shock the world.

Stock market investors have had the most fantastic ride for over 100 years. $100 invested in 1913 when the Fed was created would today be worth $2.8 million. That assumes all dividends reinvested and no tax paid. This is a remarkable return and only achieved thanks to a group of bankers who decided to take control of the Western world’s financial system in 1910 on Jekyll Island.

This was one of the most remarkable financial coups in the financial history for the world. As the famous banker Mayer Amshel Rothschild said over 200 years ago: “Permit me to issue and control the money of a nation, and I care not who makes its laws”.

Since the Fed was created in 1913 for the purpose of controlling the money, Global Debt has gone from virtually nothing to $250 trillion today. Add unfunded liabilities of $250 trillion and derivatives of $1.5 quadrillion and we are looking at a total risk for the world economy of $2 quadrillion.

A mere 1% increase in rates will create a blood bath

Governments and central banks have mortgaged the future for generations to come. Nobody must believe that this money will ever be repaid or that the liabilities can be met. Thus, there will not be an orderly outcome of the greatest financial bubble in history. Central banks are now reversing their expansionary policies. The combination of tapering and interest rate hikes are guaranteed to pop the bubble. The global economy is totally dependent on their daily dose of fresh money and zero interest rates. A 1% increase in interest rates would according to the US Treasury’s Office of Financial Research (OFR) lead to a bloodbath in the US high-grade bond market. This would then spread to junk bonds, fixed rate mortgages and derivatives to further spread the crisis. A rise in rates will also affect the offshore dollar funding market which has risen 5 fold this century to $10 trillion. With over Yen 1 quadrillion in debt, Japan could not survive rates rising above zero.

The OFR Stress Index below is a daily market based snapshot of stress in global financial markets. It is constructed from 33 financial market variables such as yield spreads, valuation and interest rates.

The index is now at a similar risk level as before the 2007- 9 financial crisis.

Risk is at an extreme

As I have discussed in recent articles, risk is currently at an extreme in most sectors of the financial world. The main indicators which are now signalling a turn in markets are interest rates and inflation going up and the dollar falling. These moves will accelerate in coming months and years until we see both interest rates and inflation in the teens, at least, and the dollar finishing the 100 year move to zero.

The volatility in stock markets that we have seen in recent days is another indication of a turn in the economy. In 5 of 6 trading days last week, the Dow moved 500 to over 1,000 points per day. We are likely to see further pressure in the short term before either the market turns up again to finish the melt-up move sometime this year. Or alternatively we have now seen the top and markets move down strongly from here. Either way, stocks are now very high risk and investors should either reduce positions or get out of the market.

With stocks falling and cryptos halving in value, the precious metals are now starting to react.

As is common when stocks fall, metals also go down initially before they resume the uptrend.

Gold in dollars is now up $120 since early December. For gold to really move, it must move in all currencies.

But that has not been the case. Gold in Euros, Swiss francs and Pounds are just slightly above the early December levels. This means that it is actually not gold which has moved up since December. Instead, what we have seen is dollar weakness.

A strong gold move up in all currencies imminent

Thus dollar based gold investors have benefitted from the move since December but not investors in other currencies. For the last two years, gold in Euros has traded in a narrow range of EUR 160 between EUR 1,060 and 1,220. In the last 6 months this range has narrowed further and gold in Euros is now poised for a breakout to the upside above EUR 1,200. When that move starts, gold is likely to move up not just against the Euro but in all currencies.

Silver will lead the metals to new highs

The Gold / Silver ratio is often a good indicator of the direction of the precious metals. This ratio has now reached just above the 80 level for the fourth time this century. Every time the ratio has reached the 80 level there has been a sharp reversal. Looking at the chart, a reversal is likely within the next few weeks. That will result in silver taking the lead and moving up fast with gold following at a slower speed. So it is probable that silver will soon start the move to new highs, providing major capital appreciation combined with excellent wealth preservation.

But it must be physical silver since there are likely to be major shortages once the move starts.

Swiss refiners are reporting solid demand for gold. As usual most of the buying is coming from the East and China in particular. There is a constant demand for the 3,000+ tonnes of gold that is produced by the mines, mainly to the East. Once the paper gold market fails, which could start in 2018, the current gold price will never be seen again.

2007- 9 – Here we go again

2018 is likely to be the year when the 2007-9 crisis returns with a vengeance. But this time it will be a lot more serious. Central banks will panic and print money at a level never seen before in history leading to collapsing currencies and hyperinflation. The time when gold and silver can be bought at current low prices is soon coming to an end and at some point it will be virtually impossible to find precious metals at any Price.

Inclusive Growth or Else

Sergei Guriev , Danny Leipziger , Jonathan D. Ostry  

LONDON/WASHINGTON, DC – At this year’s World Economic Forum meeting in Davos, Switzerland, participants did not question the basic building blocks of growth in today’s global economy: free markets, good governance, and investment in human capital and infrastructure.

But they did criticize how unfairly the benefits of growth are being distributed. Rightly so: without a strong policy response aimed at building a more inclusive growth model, rising populism and economic nationalism will impair the functioning of markets and overall macroeconomic stability – potentially cutting short the current global recovery.

Virtually every economic policy has an impact on both aggregate income and its distribution.

Some reforms – such as those promoting impartiality and efficiency of legal institutions – are good for growth and equity (in this case, equality of opportunity). Incidence results for deregulation of product and labor markets are more mixed, possibly as a result of data limitations and the specific circumstances of each reform.

By contrast, when it comes to financial deregulation and the liberalization of international capital flows, there are clear equity-efficiency tradeoffs: they boost growth, but they also tend to increase inequality. The evidence points in a similar direction for some measures aimed at liberalizing current-account transactions (trade in goods and services).

These findings should not come as a surprise: it is well-known that rapid technological change and globalization have contributed immensely to the creation of a winner-take-all economy, in which those with a first-mover advantage accrue a disproportionate share of the benefits of growth.

Policymakers’ task is to ensure that the disadvantaged also have opportunities to succeed in the modern economy, by designing all reforms and other measures with an eye to their distributional effects. Otherwise, pro-growth reforms will lose political legitimacy, enabling destructive nationalist, nativist, and protectionist forces to continue to gain traction and thus to undermine medium- and longer-term growth.

The key to success will be to take preemptive action, rather than focusing solely (or even primarily) on ameliorative measures. This means designing coherent policy packages that internalize the distributional effects of supply-enhancing policies, and that aim to create a better balance of winners and losers across those policies. In our work for the World Economic Forum’s Global Future Council on Economic Progress, we have produced a list of concrete actions that would advance such an agenda.

The first critical area of focus is skills training, skills upgrading, and addressing job displacement. Globalization and the so-called Fourth Industrial Revolution have increased the pace of change in labor markets, putting a premium on adaptability. Public policies have a role to play not only in providing a cushion for workers in transition, via income support, but also in creating incentives and opportunities for skills acquisition.

To this end, governments should boost investment in life-long learning to retrain, retool, and reskill. For example, governments could use individual skill accounts to provide training grants throughout people’s working lives, conditional on stronger private-sector involvement in training and skills development. Governments should also reinforce the supply of skills by strengthening incentives for educational institutions to harness the power of digital technology and new business models.

A second critical area is taxation and social protection. While the specific policies would vary according to national social contracts, our work suggests that redistribution – unless extreme – does not bring salient efficiency losses. Moreover, the greater equity it brings serves to make economic growth more sustainable, such as by reducing systemic fragilities that can lead to sharp downturns.

When it comes to taxes, it is critical to safeguard the growth model’s political legitimacy by ensuring that the system is not skewed in favor of the wealthy. Beyond increased taxation of rents and estates, policymakers should pursue cooperative efforts to stem corporate tax avoidance, tax inversions, and the use of tax shelters. Fiscal transfers should also be better targeted, in order to protect the most vulnerable groups.

Similarly – and this is the third critical reform priority – more aggressive action is needed to regulate financial markets, especially to prevent insider trading and money laundering, and to close down illegal financial centers. Cross-border regulations and measures are also needed to ensure that risk-takers bear an appropriately high cost for recklessness. More generally, countries need to avail themselves of the tools at their disposal to manage cross-border capital flows, with the objective of mitigating the risk of financial crises and their associated fiscal costs.

The fourth and final priority is a more concerted effort to ensure fair competition and avoid crony capitalism. Guaranteeing a level national playing field and a rules-based international order requires effective competition policies and enforcement of fair-trade rules. Whether in industry, services, or the media, anti-trust actions to avoid capture of institutions or industries – by the powerful or the state – are vital to support inclusiveness.

The backlash against globalization – and, in some cases, against capitalism itself – demands economic policies that not only address problematic distributional effects, but also preempt them. This will require a fundamental change in mindset, with businesses and governments alike recognizing, at long last, that growth can be sustainable only if its benefits are broadly shared.

The decision to place inequality at the center of the discussion at Davos this year was a promising development. But actual solutions remain undeveloped. Despite expressions of anguish about widening economic disparities within many countries, policies to address them remain inadequate. This must change if the current economic recovery – the source of so much relief and hope around the globe – is to continue.

Sergei Guriev is Chief Economist at the European Bank for Reconstruction and Development.

Danny Leipziger, Professor of International Business at George Washington University and Managing Director of the Growth Dialogue, was a vice president of the World Bank and served as Vice Chair of the Spence Commission on Growth and Development.

Jonathan D. Ostry is Deputy Director of the IMF's Research Department. His most recent book is Taming the Tide of Capital Flows.

Flattening yield curve points to calm about US budget deficit

But those hoping for a great acceleration in the economy will be disappointed

Matthew C. Klein

The famed “bond vigilantes” are clearly unconcerned about the government’s ability to fund its debt issuance. The US government’s real long-term borrowing costs are lower now than they were at the beginning of 2016.

That is not what you would expect if traders were exercised by the prospect of large future budget deficits, nor is it what you would expect if traders were optimistic about the growth Outlook.

There is also useful information in the absolute difference between shorter and longer-term real yields. If 10-year yields are higher than five-year yields, for example, then that probably means traders expect some combination of faster growth and tighter monetary policy in the future relative to today.

During the worst of the crisis, the real yield curve was deeply inverted — real 10-year rates were about 1.5 percentage points lower than real 5-year rates. By early 2010, the prospect of monetary and fiscal stimulus had pushed 10-year real rates about 1 percentage point above 5-year real rates. This spread stayed around that level until the end of 2013. In the past year it has collapsed to zero.

This curve flattening does not necessarily mean recession is imminent, but it also suggests the future will not be much different from the way things are right now. Market pricing implies those hoping for a great acceleration will be disappointed. The better future promised in the past has already arrived.

BlackRock’s New Ambition Is a Sign of Froth

BlackRock sees an opening in the massive amount of money looking for a home, but that should worry investors

By Aaron Back

BlackRock hopes to stand out from the private-equity crowd by adopting a longer time horizon and by cross-selling its new investment product to its huge, existing client base that includes some of the world’s largest asset owners. Photo: Michael Nagle/Bloomberg News

The king of passive investing is making a foray into private investments. While the move by BlackRock makes some sense strategically, it also may be the latest indication of froth in financial markets.

BlackRock is an investment industry champion with a stellar track record of gathering assets, based largely on the strong trend toward passive, low-cost strategies. Last year they pulled in record net inflows of $367 billion.

So it is a bit of a head scratcher why the company now feels the need to raise an additional $10 billion on the side to buy and hold stakes in companies, as The Wall Street Journal reported Wednesday. This will put them into direct competition with the likes of KKR, former parent Blackstone Groupand indeed Berkshire Hathaway , to whom BlackRock compared its new approach. That is some distance away from BlackRock’s core competency.

BlackRock´s Assets under management


The apparent answer is that the money is out there for the taking. Total private-equity dry powder, or money sitting in funds waiting to be invested, exceeded $1 trillion at the end of last year, according to Preqin. That is up from just $560 billion five years earlier.

BlackRock Chief Executive Larry Fink may also figure that with equity and debt markets currently at very high levels globally, now is a good time to diversify into private-equity investments that face less near-term pressure to perform.

BlackRock hopes to stand out from the private-equity crowd in a couple of ways. One is by adopting a longer time horizon. The firm plans to hold investments for more than 10 years, the Journal reports. That is significantly longer than the typical private-equity fund; hence the firm’s comparison of itself to Berkshire Hathaway. A second way is by cross-selling this new investment product to its huge, existing client base that includes some of the world’s largest asset owners.

One can’t begrudge BlackRock for putting out its hand for a small slice of the money on offer. Even if the experiment somehow goes awry, it won’t make much of a dent in a company with $6.3 trillion of assets under management.

But the sheer imbalance between the supply of investable funds and suitable outlets for investment that gave rise to this move should ring some alarm bells for investors generally. At market tops when money is desperate to find a home, it often winds up in places it shouldn’t.