Memo to Larry Summers: It’s Secular Saturation (Not Stagnation) - Peter Diekmeyer (4/1/2017)

January 4, 2017

Donald Trump’s first challenge when he faces off with a new Congress later this month will be addressing what former Treasury Secretary Larry Summers calls “secular stagnation.”

Key will be finding ways of injecting life into a US economy, which continues to experience sub-par growth despite eight years of near-zero interest rates and deficit spending which, during the Obama Administration, has doubled the national debt. Solutions floated include increased government spending on defence and infrastructure and new tax cuts.

Equities markets seem convinced those initiatives will work. At the time of this writing, the DJIA, S&P 500 and S&P/TSX were all trading at near-record highs.

But individual investors need to careful. As we shall see, there is considerable evidence that what America is suffering from is not “secular stagnation,” but “secular saturation,” caused by decades of over-consumption.

That distinction may seem subtle. But it has significant implications as to how investors may want to structure their portfolios.

Alvin Hansen’s 1930’s style secular stagnation

The term “secular stagnation,” coined by economist Alvin Hansen in the 1930s, refers to a situation in which central banks have cut interest rates so low that they are no longer able to boost demand [i].

Summers, currently a professor at Harvard University, resurrected the term and to his credit, it has stuck.

Politicians, economists and academics love the “secular stagnation” idea, which they have adopted en masse, because it enables them – as the Economist Magazine recently did – to ascribe current challenges to “market failure.”

Capitalism doesn’t work, this line of thinking goes. What is needed to “cure” its faults is more enlightened policy by central planners.

Solutions floated range from those cited above, to the latest: “helicopter money” – which is government programs paid for using printed money [ii]. This enables politicians to get credit for the programs that are enacted, while kicking the inflation costs down the road.

Predatory central bank enticements

Yet while Summers’ “secular stagnation” thesis advances the interests of the “big government community,” individual investors need to consider another scenario.

There is a strong possibility that America is not suffering from a market failure, but rather from an inevitable reaction to a multi-decade binge in system-wide spending, borrowing and progressively easier money.

Predatory central banking enticements, particularly low interest rates, have led governments, businesses and individuals to hire people, buy stuff and invest in things that they don’t need or can’t afford. The economy is thus saturated, the argument goes.

If that is true, it is possible that the US economy has reached a state for which it needs a multi-year (and possibly a multi-decade) period to digest the excesses, put money aside and pay down some of the debts incurred.

Consider:

• Combined American government, business and personal debt as a percentage of GDP is now the highest it’s been in history.
• Even if they wanted to buy more stuff, most Americans who could afford it, simply don’t need it. According to IHS, there are nearly 253 million cars and trucks on the road. That amounts to nearly one per person over 18 who can pass a vision test. If you and your partner are already making payments on two cars, you are unlikely to need a third.
• While US home ownership rates are at multi-decade lows, predatory incentives dangled by the Fed, through its low interest rate policies, enticed many Americans to buy places they simply couldn’t afford. These families are now “house poor” and have little room to borrow more to finance new spending.
• US over-consumption is graphically depicted in its overweight/obesity rate, which now exceeds two thirds of the country’s population.
• On the infrastructure front, governments at all levels have been looking for good “shovel ready” projects for years. By now, whatever hasn’t been done is likely a bad deal, or there are strong interests lined up against it.

In short, for more than three decades, policymakers have been advocating solutions that, rather than create new demand, instead pulled it forward from future years. There is a strong case to be made that there isn’t much left to pull.

Implications for investors

The most important implication for investors is that if we are in an era of secular saturation (instead of secular stagnation), then the policy proposals currently being put forward in Washington will not work.

By channelling more taxpayer dollars to special interest groups that generate little or no spinoffs to the rest of the economy, politicians will merely make a bad situation worse.

Individual investors who believe in the “secular saturation” thesis will thus want to increase their savings to prepare for tough times ahead.

They will also want to be particularly careful about equities markets, which right now appear convinced that politicians are on the right track.

[i] A broader description of how Summers regards the issue can be found in the March/April 2016 issues of Foreign Affairs: https://www.foreignaffairs.com/articles/united-sta...

[ii] The process by which this money is printed is long on complicated, and would depend on how each deal is structured. But it would basically consist of the Federal Reserve buying up debt that the government issued to fund certain projects.

Looked at that way, with the Fed’s balance sheet above $4 trillion, there is a good argument to be made that the US economy is already snowed under with helicopter money.