JOHN MASON: The New Financial Economy: What Is In Store?



  • Debt loads have increased again to massive levels and this fact is getting more and more attention from the economics community, the financial community, and the financial press.
  • Whether these debt loads can be carried depends upon your assumptions about the economy, e.g., will economic policies generate faster growth and more inflation or faster growth with no rise in inflation.
  • What about a third possibility, the possibility that the Trump administration's economic policies will generate neither faster economic growth nor rising inflation?

Author: John M. Mason

Greg Ip writes in the Wall Street Journal that “the Seeds of Instability Are Germinating Again.”

In other words, “Debt Rolls On; Cross-border capital flows and debt growth haven’t let up since the crisis.” The crisis being the financial collapse that took place ten years ago and involved, first, Bear Stearns Co., and then, Lehman Brothers.

“Total U. S. debt, at around 250 percent of GDP, still stands at crisis-era peaks while debt levels in China have caught up and passed the U. S., according to the BIS. U. S. companies’ debts had reached 34 percent of assets by the end of 2016, the highest at least since 2000. Debt-servicing burdens haven’t risen commensurately thanks to low inflation and low rates, but they have begun climbing. More than $1 trillion a year still flows into emerging markets each year, according to the Institute of International Finance.”

Mr. Ip cautions that: “This tells us little about when or where a crisis will happen or what might trigger it.”

“Crisis surprise because they usually start with an assumption so sensible that everyone acts on it, planting the seeds of its own undoing.’’

Then he lists several historical examples of assumptions that turned out badly: “in 1982” people assumed “that countries like Mexico don’t default; in 1997 that Asia’s fixed exchange rates wouldn’t break; in 2007 that housing prices never declined nationwide; and, in 2011 that euro members wouldn’t default.”

I bring all this up because I believe that the U. S. economy and its financial markets are facing such a possible dilemma these days. I have written about it in two recent posts: “New Economic Experiment: Thank You Mr. Trump - Mr. Kudlow,” and “Bond Market Dilemma: Who is Right, Inflation Hawks or Inflation Doves?".

The dilemma has to do with the debate between the Inflation Hawks, the believers in demand-side macroeconomic analysis who see higher rates of economic growth and higher rates of inflation coming from the tax policies and the spending policies coming out of the Trump administration, and the Inflation Doves, the believers in supply-side macroeconomic analysis who see higher rates of economic growth with little or no increase in inflation - even a possible decrease in the inflation rate.

Both the demand-siders and the supply-siders see an increase in economic growth coming from the government’s efforts to stimulate the economy.

They differ on what might happen to inflation. However, both sides see a positive outcome with respect to the debt load that has been built up.

Those who argue from the demand-side outcomes see both the economic growth and the higher rates of inflation helping those that have increased their debt loads, even though interest will be rising due to the increased demand resulting from higher rates of economic growth and from the increase in inflationary expectations that get built into interest rates.

Those arguing from a supply-side outlook see the debt loads being carried by the higher rates of economic growth that will generate cash flows to support the high levels of debt. Furthermore, interest rates will not have to rise much because with no little or no increases in inflation, there will not be much more pressure on interest rates to rise. The debt load will not increase substantially.

OK, but there is a third case to present, something that neither the demand-side economists nor the supply-side economists foresee. What if neither economic growth nor inflation rises.

Mr. Ip cites James Bianco, founder and head of Bianco Research, LLC, as speculating, “We will never see higher inflation or higher growth.”

Mr. Bianco argues that neither the rate of economic growth nor the rate of inflation increases “the low interest rates that have raised household stock and property wealth to an all-time high relative to disposable income won’t be sustainable.” The high debt loads accumulated will not be able to be supported by the economy, so interest rates will have to rise because of an over-supplied financial market.

This, according to Mr. Bianco puts central banks in a bad spot, “which is one reason they are wary of raising interest rates too quickly—while nervous that if they raise them too slowly, the problem will get worse.”

And, why might we get a scenario in which neither economic growth nor inflation rose due to the economic policies of the Trump administration?

Well, in terms of economic growth, it might not be possible to artificially stimulate a more rapidly growing economy. Robert Gordon, in his well-received book “The Rise and Fall of American Growth,” depicts a U. S. economy that has not grown all that rapidly since 1970 and is facing headwinds that could keep the growth rate down well into the future.

Mr. Gordon gives little or no encouragement to those that would like to “goose up” the economy through short-run policies created by politicians and government bureaucrats. Economic growth is generated by the spread of information and innovation. It should also be noted that the era of the Reagan tax-cuts, the 1980s, falls within the period of slow growth mentioned above, and Mr. Gordon makes no reference to President Reagan or to supply-side policies aimed at speeding up economic growth during the eighties.

In this sense, Mr. Gordon is just as hard on demand-side policies, as he sees longer-term economic growth as more of a result of the growth in labor productivity that comes about because of technological changes and the spread of information related to innovative ideas.

But, what about the possibilities for inflation increasing?

I have argued that the demand-side and supply-side models don’t work here in terms of inflation, because of the financial engineering that now goes on in the economy. Most government stimulus now tends to go into the financial circuit of the economy, driving up asset prices, and not into the industrial circuit of the economy, where “measured” inflation can be impacted.

Morgan Stanley ran a survey soon after the Trump tax cuts were passed:

“Morgan Stanley analysts estimated that 43 percent of corporate tax savings would go to buybacks and dividends and nearly 19 percent would help pay for mergers and acquisitions. Just 17 percent would be used for capital investment, and even a smaller share, 13 percent, would go toward bonuses and raises. Other Wall Street analysts have issued similar reports. If more evidence was needed, Axios reported that just nine pharmaceutical companies have announced $50 billion in buybacks since the tax law was passed."

Actions like these do not create consumer price inflation.

Is it possible that economic growth will not speed up and inflation will not accelerate? As Greg Ip implies, however, this is certainly not “a sensible assumption” that “everyone will act on.”

NOTE: This column originally appeared on


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