Keynes Is Dead, Abenomics Fizzles, US Fails to Reach Escape Velocity, Stimulus Fatigue

Economist Andy Xie has an interesting article in CaixinOnline that contains his views on 2014. I agree with nearly all his viewpoints but one.

Please consider Breaking Out Is Hard by Andie Xie.

The global economy is unlikely to accelerate in 2014. The hope that the U.S. economy is reaching escape velocity won't pan out. Abenomics is likely to fizzle out in 2014. Emerging economies will likely remain in low gear. The chances are that the global economy, weighted by nominal GDP at current exchange rates, will grow at 2 percent

Globalization, turbo-powered by information technology, has cut short the feedback loop between demand stimulus and supply response. Any growth response to demand stimulus is short-lived, as past five years has demonstrated.

Holding down costs of non-tradeables like housing, health care and education is the key to economic competitiveness and sustainable growth. Any economy that grows on inflating such non-tradeables through stimulus will pay back with low growth later.

Keynes Is Dead

I have argued for many years that this round of globalization has fundamentally changed how an economy works, even for a large one like the United States. While demand is and always has been local, the supply side has become genuinely global. Both manufacturing blue-collar jobs and most white-collar jobs have become global. Today's information technology allows a multinational company to position research, marketing, finance and managerial jobs to anywhere. Hence, when a country stimulates demand, it's met by supply from anywhere.

Abenomics Fizzles

Japan had two quarters of high growth, so many became convinced that Abenomics was the real deal. The data tailed off toward the usual Japan level of 1 percent in the third quarter and likely in the fourth quarter, too. Financial markets have become wobbly lately as growth momentum cools off. But the Nikkei is still at a lofty level. Too many have a vested interest in believing in Abenomics to jump ship now. When bad numbers continue for another two quarters, they will.

The Abe government has been asking Japanese companies to raise salaries to sustain the economic momentum. Even if the salary increase comes through, as people know it was forced and not likely sustainable, why would they spend it?

Shaky Ground

High commodity prices led to a frenzy in the sector's investment. The 2008 crisis prompted a pause. It continued in the following three years. Huge amounts of capital were poured into high-risk projects. The risk to commodity economies is the bursting of this investment bubble, not reduced income due to lower commodity prices per se.

I have been talking about the Australian economy heading down due to the bursting of its mining investment bubble. This story remains intact. The worst will pass only when the financial system is cleared of related non-performing assets.

Is global trade the driver or consequence of growth? Now it is probably the latter. In the decade before the 2008 financial crisis, trade was driving growth. Multinational companies were fanning out to diversify their production bases and markets. Their activities led to trade growing much higher than GDP. The golden decade of trade growth was probably a one-off event.

Every Man for Himself

When structural impediments are the main issue for growth, stimulus, even when effective, can provide only temporary relief. After the 2008 crisis, all big economies, mainly China and the United States, pursued serious stimulus. The global nature of the stimulus produced good growth for two years. It should have been the opportunity for serious structural reforms. Unfortunately, when the going is good, no one wants to take bitter medicine.

Stimulus fatigue is setting in around the world. China and the United States are likely to scale back stimulus some. The euro zone will not do anything significant. The European Central Bank may cut interest rate from 25 basis points to zero. It will not have any meaningful effect. Japan's new stimulus is unlikely to offset the impact of the consumption tax increase. Brazil, India, Indonesia and other major emerging economies may continue to increase interest rates against receding hot money.

Another major deal on global trade could rejuvenate the global economy. Unfortunately, the latest World Trade Organization agreement is very weak. It shows that the WTO system is stuck. It is no longer the platform for moving trade forward. The U.S.-led Trans-Pacific Partnership is also stuck. Washington's free trade negotiations with the European Union are stuck, too. It seems that no significant deal on trade is coming to rescue growth this year or beyond.

Any country that wants to prosper must do so within a poor global economy. One way is to devalue. Of course, competitive devaluation will eventually make everyone worse off. For emerging economies, devaluation is usually followed quickly by inflation. It doesn't bring benefits.

The only sustainable way out is to increase competitiveness through structural reforms. It increases growth potential through higher efficiency. Most major economies could identify a few key issues impeding economic growth: health care costs in the United States, labor market rigidity in Europe, zombie industries in Japan, insufficient infrastructure in India and overinvestment in China. Imagine that these big issues are all tackled. What could the global economy grow at? Four percent growth could return.

Of course, coordinated structural reforms are a pipe dream. Structural reforms are painful. Everyone is waiting for others to act first. When others are growing fast, one gets a free ride. Hence, the incentive is not to reform. Waiting for others to move first produces the stagnation equilibrium that we are in now.

While we always hope for the best, reality can be cruel. As long as muddling through is possible, real reform is hard to come by. After the 2008 crisis broke out, I predicted widespread government stimulus, its eventual failure and the world heading to stagflation. Unfortunately, this path is still the likeliest.

Lone Disagreement

So what is it above that I disagree with? Nothing much. His global growth forecast is arguably too high, but that's about it.

My major disagreement is with something in his article I did not quote above.

Xie believes the "Nikkei is at a lofty level" and he is "surprised by how many investors are taken in by Abenomics."

From my perspective, Xie has this backwards. Belief in Abenomics is not the issue. It surely isn't going to work.

And when it doesn't work, what is prime minister Abe likely to do?

I believe the answer is what all Keynesian fools do: embark on still more printing and competitive currency debasement, coupled with still more fiscal stimulus, in a further foolish attempt to make such policies work.

If Abe manages to force up wages, stops QE, and lets the Yen rise, then I would be worried about the Nikkei.

Instead, all indications are that Abe would double down, which in turn would further trash the Yen. That is why holding a yen-hedge on the Nikkei may be a smart thing to do.

Like Xie, I think Abenomics is a failure. Unlike Xie, I think the Nikkei has risen because of the failure of Abenomics, not because of unfounded belief in the policy.

Moreover, Japanese stocks are a relative value compared to most things, and arguably an outright value play as well, taking into consideration metrics like book value, debt levels, and PE ratios.

Other than the debate on the Nikkei, I think Xie pretty much nailed the state of the global economy.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com