Sunday, October 12, 2014

Galbraith Warns of "End of Normal"

One of my very favorite economists and writers, James K. Galbraith, has a new book out entitled The End of Normal. Galbraith's thesis is that the post WW II expectation of broad and sustained economic growth ended in 2007, and we are now in, and will remain in, a period where economic growth will be far less than the average over the past seven decades. I guess you could call it the "new normal."

Galbraith contends there are four main reasons that growth will be limited: (1) Resource scarcity (especially energy) that becomes acute, with rapid price rises and speculation (as with oil in 2008) whenever economic activity increases. Galbraith calls this the "chokechain effect." Energy scarcity actually began in the 1970s, and has ebbed and flowed since that time. The current natural gas boom may be somewhat buffering the U.S. from this effect in the present. (2) Interconnectedness of the world economy even as regional, political and sectarian instability (with no possible military solution) increases. Military responses tend to suck resources away from economic growth. See: Iraq, U.S. (3) Technological changes, especially in information processing, that incentivise businesses to modify operations in ways that use less labor going forward. This happens especially after economic downturns, when businesses find ways to not re-hire laid off workers. (4) Widespread fraud in the financial system, as was exemplified in the run-up to the 2008 crisis. In many ways the financial system has become part of the problem, and a leech on economic activity, when it should be part of the solution by providing credit and efficiently allocating capital. It seems to not perform these essential functions very well any more, partly because of lax regulation in recent times.

Galbraith very briefly touched on these points in a July piece in Politico, a couple of months before the book's publication.

My own musing: Oil has recently broken out on the downside. Persistent $95-105 oil has dropped to $85. Some reasons are that the U.S. has increased its own production by close to a million barrels per day (with, for example, the North Dakota oil boom). And even with its political instability Libya has surprised observers by getting its own production back up to around 800,000 barrels per day.

Were those of us warning of the end of cheap oil wrong? Consider that the world economy has been incredibly weak since 2008, the last time we had record high oil prices. Even the very tepid economic output since then has been able to sustain $100 oil. The U.S. has actually been the world's ecomnomic bright spot, even as it struggles (and fails) to reach a mere sustainable 3 percent GDP growth. Europe, on the other hand, may be on the brink of descending into its third recession since the 2008 crisis. China's period of rapid growth may be ending or over. Perhaps energy will remain cheap as long as the world's economy languishes, which, if Galbraith is correct, may be a very long time. On the other hand, energy prices could rapidly soar any time economic growth threatens to pick up (Galbraith's "chokechain effect").

Finally, if you're not convinced of the prevalence of widespread financial fraud, you should read All The Devils Are Here by Bethany McClean and Joe Nocera. Heck, read it regardless. It remains the single best account of the origins and outcomes of the 2008 crisis. It is superbly written, authoritative, and comprehensive. And it's a very good read.

Update - Read Paul Krugman on Europe.

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