"All This Need Not End Horribly"

Ken Rogoff says if we don't hit the brakes on global growth soon, we're headed for a train wreck:

Time to put the brakes on this runaway train, by Kenneth Rogoff, Commentary, Project Syndicate: The global economy is a runaway train that is slowing, but not quickly enough. That is what the extraordinary run-up in prices for oil, metals, and food is screaming at us.

The spectacular and historic global economic boom of the past six years is about to hit a wall. Unfortunately, no one, certainly not in Asia or the US, seems willing to bite the bullet and help engineer the necessary co-ordinated retreat to sustained sub-trend growth, which is necessary so that new commodity supplies and alternatives can catch up.

Instead, governments are clawing to stretch out unsustainable booms, further pushing up commodity prices, and raising the risk of a once-in-a-lifetime economic and financial mess. All this need not end horribly, but policy makers in most regions have to start pressing hard on the brakes, not the accelerator. ...

I am puzzled that so many economic pundits seem to think that the solution is for all governments, rich and poor, to pass out even more cheques and subsidies so as to keep the boom going. Keynesian stimulus policies might help ease the pain a bit for individual countries acting in isolation. But if every country tries to stimulate consumption at the same time, it won’t work. A general rise in global demand will simply spill over into higher commodity prices, with little helpful effect on consumption. Isn’t this obvious? Yes, there is still a financial crisis in the US, but stoking inflation is an incredibly unfair and inefficient way to deal with it.

Some central bankers tell us not to worry, because they will be much more disciplined than central banks were in the 1970 s...

But this time is different. ... The historic influx of new entrants into the global workforce, each aspiring to western consumption standards, is simply pushing global growth past the safety marker on the speed dial. As a result, commodity resource constraints ... are hitting us...

Wait a second, you say... Won’t high prices cause people to conserve on consumption and seek out new sources of supply? Yes... But the process takes time...

The ... current expansion is unusual in that ... labour constraints are not the problem. On the contrary, the effective global labour force keeps swelling.

No, this time, commodity resources are the primary constraint, rather than a secondary problem, as in the past. That is why commodity prices will just keep soaring until world growth slows down long enough for new supply and new conservation options to catch up with demand.

This runaway-train global economy has all the hallmarks of a giant crisis in the making — financial, political, and economic. Will policy makers find a way to achieve the necessary international co-ordination? Getting the diagnosis right is the place to start. The world as a whole needs tighter monetary and fiscal policy. It is time to put the brakes on this runaway train before it is too late.

Let's see if I can play along with the train game, but with a different set-up. In this version of the game, if you hit the breaks too hard, passengers can get injured (workers can lose their jobs). And if the train is riding on a shaky infrastructure (meaning the financial system), perhaps it's on a long bridge you aren't too sure about (you are worried the financial system might collapse and bring the economy, or "train," down with it), then slamming on the breaks may not be the best thing to do, especially if there's a hill (recession) beyond the bridge that will slow the train down in any case, or a long straight section that will allow ample room to slow the train down gently. It depends upon how fast the train is going at the time, how likely it is that hitting the breaks while still on the bridge will cause the bridge to collapse, how many passengers will be injured from slamming on the breaks even if the bridge doesn't collapse, how good the brakes are, and what the terrain is like beyond the bridge (e.g., the magnitude of the expected slowdown).

So even with a train that's going too fast, a level speed for the moment followed by a measured level of braking once the train is on solid ground might be best.

I also think it matters whether the inflation is being driven by relative price changes due to world growth, or by excessive demand from interest rates that are too low and from stimulative fiscal policy. Implicit in the argument above, if I read it correctly, is that it's the latter - it's inflation from excessive liquidity and from stimulative fiscal policy, and if so, I agree that the inflation needs to be moderated as soon as it's safe to do so.

But if the run-up in prices that we are seeing is the result of changes in relative prices driven by underlying fundamentals, then the case for active intervention to slow world demand to "sub-trend growth" is not as clear. While there may be reasons to limit the speed of adjustment and reduce the displacement of labor and other resources to a manageable level, trying to limit price changes that are driven by fundamentals mutes the signals that encourage conservation and the development of solutions to the energy problem (there is also the issue of externalities, but that's a long discussion in and of itself).

This is something that's been on my mind lately because it's very clear that rising prices, even those driven by fundamentals, impose costs on people that they cannot avoid in the short-run, but may be able to absorb better in the long-run, so we don't want to allow the adjustment to happen too fast, or we want to find a way to limit the damage by compensating those who are hurt. Hence, the "sub-trend growth" called for above might be optimal. But it's also clear that high prices and the high profits that come with them serve as the markets equivalent of a prize for innovation - there are big profits waiting for successful innovators that are far, far greater than, say, the amounts McCain is talking about for inventing a better battery - and we don't want to stand in the way of that process. The higher the price, the bigger the prize. So the key is, I think, to allow prices to rise quickly so as to encourage the needed adjustments, but be very aggressive in helping people make it through the transition, those who become unemployed, face high gas and food costs, etc. Unfortunately, however, I don't think it's reasonable to expect that the government will provide such help, at least not enough, not in the current political environment, and that means we'll have to take it a bit slower, and look for other ways to encourage the necessary investment in solutions to the energy problem.

Comments

[hari]

@ Mark - on Rogoff's Runaway (Golabal Economic) Train -

If I understand you right, you're actually an *optimist* who sees the glass half-full rather than half-empty.

I seem to agree with you beause I just got RGEs latest survey on global political economy which concludes that some 70% of traded futures oil is actually *paper* oil - ie. not for delivery - and is being done by speculators (led by Goldman & Sachs and its forecast of $200/b). So speculators are flush with liquidity and are risking in huge Options.

Is this a consequence of Fed rate policy constraint or not?

Rogoff is trying to wear his former IMF hat and demands regression to contain inflation and commodity prices. Neither of which is likely; although I notice both China and India are trying to contain galloping inflation using both monetary and fiscal instruments - impact of which may be down the line (not immediate).

Yet they are both growing @ net +7% or more....

In context of US economy, I suspect structural adjustment policy may take a lot of political will power to enact even by next Admin. Yet, US must try and get its household economy in balance...and finally reorder its national priorities. Me thinks fiscal policy restraint, as illustrated, so far, by inaction of Congress, is the central crux of the problem. And unless there is a consensus on what that fiscal measure(s) should or not include, going forward for the US locomotive will be like climbing a very steep hill - as emerging markets share of global GDP spikes.

On the other hand, if measures already in pipeline in India and China make a dent on global commodity markets and restraint consumption...there is a chance emerging markets can set the stage for forward macro policy movements including renewable energy development.

G-8 meeting will indicate if the future is rosy or not. It's going to take a bit of time to settle this new paradigm shift in global political economy and its emerging policy constraints.

[One Salient Oversight]

So the key is, I think, to allow prices to rise quickly so as to encourage the needed adjustments, but be very aggressive in helping people make it through the transition, those who become unemployed, face high gas and food costs, etc.

This statements seems to be exceptionally "pro inflation". I'm not against price movements, just price movements that have a net inflationary effect.

Letting inflation grow in an economy may let people "adjust to high prices" in some way, but it will reduce the value of people's savings in an even greater way.

I'm with Rogoff on this one. Anyone who can call Joseph Stiglitz a "Supply Sider" is someone to be listened to.

[ddt]

Recession is not the worst possible outcome
By Wolfgang Münchau
Published: July 6 2008
FT.com (via naked capitalism)
http://www.ft.com/cms/s/0/8362b1d0-4b59-11dd-a490-000077b07658.html

[Ryberg]

I am also with Rogoff on this one. The pro-growth lobby has so dominated discussions that the tradeoffs have not been adequately addressed and needed targets are taken off the table. This may not be the optimal time to put the brakes on but we need to have an open discussion that includes a plan to put the brakes on. And for God's sake, take the foot off the gas! The common notion that stimulus helps an indiviual econonmy grow breaks down when all economies use stimulants. The stimulants are creating the bubble that is making the hill growth steeple for all. This is a variation of the Tragedy of the Commons and we should know better.

[a]

Arguing by metaphor does not seem exceptionally constructive. Our gracious hosts' answer seems to me to indicate he believes in that old black economic magic known as "finetuning", but I could be wrong.

When you leave the metaphor aside, Rogoff is right. The problem in the U.S. (and in Britain, and in many other Western countries) the problem is that it is consuming more than it produces. So it needs to get consumption down (or produce more, but that's not going to happen given the bottlenecks in commodities). The New Keynesians want stimulus to keep consumption up. Some (I think our gracious host is in this camp) would say this is only temporary, in order to prevent too sharp dislocations. I would say they are in the same camp as those who think one can be a little pregnant.

[bakho]

If a current trend is not sustainable, it will not continue.

When one method of accomplishing a goal becomes too expensive, another method must be found. Now is the time to invest in not only research into alternatives but to rethink some of our whole processes. The smart money would anticipate these problems and have alternatives in place before we hit the wall.

The chemical industry went through some of this once they were forced to deal with their waste properly. The chemical industry found ways to alter their processes to greatly reduce the amounts of toxic waste with huge system wide cost savings. The metals industry discovered recycling as a cheaper source of raw material than ore.

The computer industry generates large amounts of waste that are difficult to recycle and difficult to recover important metals. Can the process be changed to make recycling and recovery easier? Are there ways of delivering visual information and text to our brains that do not require monitors? The way we do things today is not the way we MUST do them. We do them because they were cost effective when they were developed.

[robertdfeinman]

Anyone who wishes to propose that a national economic policy can be put in place to deal with the current global challenges will have to address the record of history and explain why things will be better this time.

I can't think of a single example from the past 100 years where a nation put a coherent policy in place, especially one that cushioned the blow for those at the bottom. Some random examples:

1. Hyperinflation in Germany in 1923 and the subsequent political revolution
2. Great Depression in the US
3. The currency and inflation issues in a succession of Asian and Latin American countries in the 1970's - 1990's
4. The US stagflation of the 1970's - 1980's
5. The collapse of the Russian economy in the 1990's
6. The destruction of New Orleans

Policies in the US have favored the rich for the past 40+ years and there is little sign of this changing any time soon, so why should we expect that new policies would suddenly reverse course?

If we couldn't even do enough to prevent the levees in New Orleans from collapsing, despite a clear understanding of what needed to be done, why should we expect better for the nation as a whole?

Optimistic Americans tend not to believe that things can really just get worse and then stay that way. The one time that this happened in the US, the great depression, has faded from memory.

Lee Raymond, former chief of Exxon Mobil, says of today’s oil prices: “There is no quick-fix on this. By the time you panic, it is way too late.”

[Sort of ironic, given that he was one of the principal people standing in the way of developing solutions, but his point is correct. There is no way out of the present situation without there being a great deal of misery.]

[ken melvin]

This big picture approach is good. We need to see more of this type thinking.

[hari]

@ bakho - very interesting your thoughts on shifting gear.

You can't be a pessimist with so much at stake for mankind, and so few brains to guide it today. I don't trust leadership will come from Fed or Congress - even shld Barack get into WH - they'll find a way to check-mate BO.

My hope rests very much on mainland China and its single-minded leadership (CPC) and its demonstrated skill at finding amicable solutions for some real sticky development issues, since 1949.

India and Brazil are democracies with their built-in baggage of social/political contagion directed at constraining a bright a prosperous future (amazing how crazy mankind is when given all its basic freedom!).

[Alex Tolley]

NK: trying to limit price changes that are driven by fundamentals mutes the signals that encourage conservation and the development of solutions to the energy problem

Exactly. I recall that when the Hunt brother's tried to corner silver, not only did supply come out of the woodwork, but there was a huge shift to:

1. Recycling silver from X-ray film.
2. A major stimulus for digital image storage to facilitate recycling.

High energy prices are stimulating VC money to pour into alternative energy companies, high oil and gasoline prices are driving the demand for more fuel efficient vehicles, especially all-electric ones, which in turn is driving more R&D into energy storage.

[Alex Tolley]

Food is another issue. However, I do not see how impoverishing the global population helps the situation other than temporarily reducing meat consumption. Better to have farmers able to use more productive techniques, shift preferences to eating more vegetables (in the rich nations) and ensure that good education, incomes and access to health care will continue to reduce population growth in poorer countries.

[Related Article]

This FT article has a similar take, but more clearly spells out the guilt of the incompetents in charge.

"The worst is for economists to try out their own theories themselves. This happened to several highly respected academics who have since become central bankers or finance ministers. If, or rather when, they turn out to be wrong, they risk a double reputational blow – as policymakers and as academics. So do not count on them to change their mind when the facts change."

[Daniil]

Its seems funny to me.
Prices are going up because 'too many' people in the developing world are getting to the western consumption levels. So we (Rogoff) are trying to tell them - buckle down, don't get to our level too fast so that our consumption does not suffer. I think more sensible would be to buckle down here in US/EU and consume less.

[don]

I'm with Rogoff, too, but not for the reasons he states. I think the imbalances - huge U.S. borrowing and a debt load that looks set to become unsustainable - rather than the level of global demand or commodity prices is the problem. Greenspan tried to prevent a slowdown and may have exacerbated the problem by postponing it, aided and abetted by Asian currency policies.
For a while, the cycle looked self-fulfilling - low rates led to appreciating housing, more borrowing and increased consumer demand. But the borrowing was being led by people who would prove unable to repay.
Now, once again, the response to a potential slowdown appears to be to spur more borrowing, this time by the government. And what will happen if it proves unable to repay?

[Liberal]

Mark,

My reading of Rogoff is that he is concerned central bankers are not paying enough attention to the secondary effects that a supply shock to the economy can have on inflation rates and inflation expectations . Rogoff is of course sophisticated enough to understand the differences between a supply and a demand shock. When the issue is excess demand central bankers must push the breaks hard, stop the party kind of thing. When the issue is a supply shock central bankers must take a gentle but still firm approach to monetary policy, which is to remind party participants that if they dont reduce the noise level the party will be over soon. At this point in the juncture the Fed has to keep an eye on inflation rate & expectations and push the breaks if they cross say 4% even if the economy is operating below its potential growth rate. Something's got give here.

[LJM]

Any "spending money" I have is going to pay for theater tickets or to go to a ball game this summer. I really have enough stuff. When the Euro got to be so much higher than the dollar, I actually thought it would be really great for China to ship all their stuff to Europe. How much stuff do people here need? If people really have to go shopping, thrift stores, garage sales and such are sources for really good stuff and recycling is a good thing. Where I live, you'd be amazed by the stuff people put out at the curb for the garbage pickup. I'm always to see the scavengers come around and grabbing something from the curb at someone's house that's still good.

As for food, I'm not one to waste food. It's a surprise to me that people in America and other rich countries don't know how to buy food and use it without generating waste. The world can't afford for good food to be tossed. Restaurants really should get over the supersizing of portions. When I go out, it's to places that are ok with a half order. Everybody should try doing that and maybe they'd get the hint.

[Winslow R.]

Mark wrote: "I also think it matters whether the inflation is being driven by relative price changes due to world growth, or by excessive demand from interest rates that are too low and from stimulative fiscal policy. "

Perhaps slow growth until oil monopoly is broken but share slowdown with worldwide 2% growth target so slowdown is distributed.

No need to put brakes on all sectors of the private economy through monetary policy as price hikes are already slowing inefficient private spending.

Public spending by government is a different matter. Targeted braking/acceleration of fiscal policy can work and is needed.

Shift resources.

Brake war for oil and accelerate war for non-food based energy renewables.

[Michael McKinlay]

The "Tressel" is already broken.

That is that financial failure is already on the cards. The current economy is unsustainable as debt becomes unpayable and credit evaporates.

Further indebtedness without radical reform is money down a rat hole.

[german_reader]

Why not combine both, a Keynesian stimulus for the economy and the necessary changes towards a more sustainable economy? Handing out tax cheques to consumers for their next visit at WalMart might improve the national mood for the next election, but it's certainly no way to make the economy sustainable.

Much better would be a massive broadscale public investment program for resource and energy saving, environment friendly technologies and a better less energy consuming infrastructure. That would stimulate the economy and make it at the same time more sustainable.

And it shouldn't not only happen in the U.S. but in many industrial countries, perhaps internationally coordinated, at the time. In the short-term that would mean new costs for the public households. But in the long-term it could save every single country a lot of money and support the world economy as a whole. With the current trends we're heading towards a disaster.

[wjd123]

The higher the price, the bigger the prize. So the key is, I think, to allow prices to rise quickly so as to encourage the needed adjustments...--Mark Thoma

I would like to take a moment to cry over spilled milk.

It's good that we can recognize a need and aim right at its solution. But I hardly think we need encourage individuals with greater prizes.

What is needed is to encourage society to marshal its resources. The evidence would indicate that the latter won't be done until the crisis is upon us. Speeding up the crisis by rising prices is undoubtedly an effective way to mobilize social resources and perhaps to move back the day of reckoning. Nevertheless it's a sad commentary on motivation to actions in our democracy.

We understood our future needs for decades and failed to mobilize our social resources. What a failure of leadership.

One last pessimistic note. Because society has a need it doesn't follow that it will find a way to answer that need. The need and the solution don't follow like a horse and carriage. We haven't done much politically to increase the percentages that we will find the horses to pull our carriage.

John McCain is going to offer a prize for a better battery? Now that's leadership.

[Lafayette]

Not all speculation is the same

MT: The higher the price, the bigger the prize. So the key is, I think, to allow prices to rise quickly so as to encourage the needed adjustments, but be very aggressive in helping people make it through the transition, those who become unemployed, face high gas and food costs, etc.

But are markets a game we play? Take advantage of speculation when we can, but when it busts us, we go crying hat in hand for help? I mean that price speculation is conditional, depending upon its nature.

If speculation is so much an attraction, should we not rather take the attraction out of it? Particularly when the speculation pertains to a good that is essential to our well-being? Namely, housing.

A lot is being made presently of the notion that oil price speculation has as much impact on oil prices at the pump as bets do on the outcome of a baseball game. Given the speculation mechanism in question, one may tend to agree with that notion. Market forces should be given the chance to correct the wild pricing exaggerations in commodities.

But, does that notion apply to flipping personal residences? I think not. This condition is very different, I suggest. Not all speculation is identically the same.

Real estate is a necessary priority as regards "well-being". The epicenter of our society is the family unit and housing is essential to its cohesiveness. It should not be a target for frenzied speculation that forces people out of house and home.

How does one stop it? By tax impositions on realty capital gains (CG), which sets an imposed tax on net annual CG for given periods. As an example, I flip a condo in less than a year? I pay 85% tax on of the net CG. I flip it twelve to twenty-four months, I pay 50%.

But, what if I sell my primary residence that I have been living in for more than two years? I pay 18% on the net gain, reduced pro-rata by 6% per annum for each succeeding year during the five-year period. At the end of the period, my CG tax rate becomes 0%.

The above scheme should nip short-term speculation in the bud, but let those who have built their realty nest egg over a lifetime of paying the mortgage to reap the full benefit of their Capital Gain.

It effectively imposes a “fine” on less than two-year real estate speculation. That’s OK, isn’t it, as long as it reduces speculation that benefits no one unless they got onto the merry-go-round whilst it was gaining speed?

Methinks.

[hari]

@ Lafayette -

You can also manage to control speculative bubble by fixing upside volume of trade/day by firms/individuals. The critical point here is that oil speculation on futures market is a *paper tiger* - with no physical delivery involved - just anticipated profits/losses on their Options -while same time there is reported stagnation in supply chain from GCC and others.

Why can't regulators like CFTC get into the act and STOP the frenzy? What are they waiting for - Bush won't approve it or what?

[Lafayette]

hari: Why can't regulators like CFTC get into the act and STOP the frenzy?

How? Shut down futures trading? That would lower the price of oil?

Of course not.

[muslim]

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