Why Global Growth Is Grinding Lower

Over the last few weeks, both NDD and I have taken a pretty exhaustive look at the world’s economies.  It started with my look at the Beige Book (see here for conclusion with links to various sub-parts) and NDDs look at the 2012 situation.  I also looked at Asia and the EU.   All of these reports had the same conclusion: growth was grinding slower.  There is no sign of immediate or imminent collapse, but there is also no sign of any period of rapid growth.  In short, we’re stuck in the mud with no apparent way out.  However, the question to ask is this: how did we get here, why is it happening and how do we get out?

It’s first important to understand that we’re in the middle of a post credit bubble expansion.  That means we’re dealing with a very different set of economic variables than a fed induced recession and recovery.  In the latter, the Fed raises rates to squash inflation, and then lowers rates to stimulate growth.  This is part and parcel of basic central bank theory and has been occurring for the better part of the our post WWII economic history.  However, now we’re dealing with a credit deflation recovery, which is characterised by far slower growth.  The reason for this is actually pretty simple: consumers (who account for about 70% of US economic activity) are trying to pay down debt in addition to spending for various items.  As such, consumer growth is lower, creating a demand vacuum.  Until the total debt level reaches lower levels, lower consumer spending will be the norm, leading to slower growth.  This fact-pattern was outlined in the Debt Deflation Theory of the Great Depression.

But there are two other contributing set of facts.  The first is Europe.  More has been written on this than I care to link to, but the basic problem is one of economic union without fiscal union.  Put another way, goods and services now move in a far freer manner throughout the region, but each geographical unit still has tremendous fiscal control over its own affairs.  It is this latter situation creating the problems as some countries (Greece) have been very reckless, while others have simply been in the wrong place at the wrong time (Spain).  However, each country has just enough autonomy to make resolution incredibly difficult.  Moreover, in order to realistically solve the problem, countries in general are going to have to give up a certain degree of fiscal sovereignty — not exactly the kind of platform any politician wants to run on.  But the easiest way to solve the problem (breaking up the union) is also not really in the cards as union has already come too far to stop now.  And just to make the situation that much more convoluted, the politicians who should be solving the problem don’t really seem to have any desire to step up to the plate and, well, solve the problems (see this commentary from Tim Duy as an example).  I think the best analogy I can think of is to the US under the Articles of Confederation. 

The second problem is that the BRIC method of expansion is running out of steam.  It used to be that the BRIC’s used their cheap labour (China and India) and abundant raw materials (Russia and Brazil) to rapidly grow, expanding the middle class and raising the respective country out of third world status.  However, this model is running out of power, largely because of its overall success.  China’s labour costs are rising to the level where they are no longer as competitive on the world stage.  India and Russia have political problems of the highest order.  India’s central bank has refused to lower rates despite slower growth partially because of inflation, but more so because of the government’s overall intractable inability to solve big problems.  Russia is still deeply corrupt to such a degree as to make expansion into the market a very dicey affair.  And Brazil is slowing because its raw materials are needed to a lower degree than before because of slower growth.  In short, the BRICs need to find a new model of expansion, and no one seems to be forthcoming with the next big thing.

To sum up, all major economic regions are now dealing with incredibly difficult and nuanced problems, none of which offer easy solutions.  The US consumer still has to pay down his debt; Europe needs to politically integrate further (meaning each country has to give up a certain degree of sovereignty) and the BRIC countries need to find a new model of growth.  None of this situations will be resolved quickly, leaving us where we started: stuck in the mud.   

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