There are lots of Great Stagnations, all over the world.  I recently did a post on the situation in the US, and Tyler Cowen did one yesterday about Europe.  But compared to Japan, the US and Europe are enjoying Chinese style growth.  The modern world has never before seen a great stagnation quite like Japan.  Not that we haven’t seen horrible GDP numbers before, but never quite in these circumstances.  Let’s review:

1.  In the 1st 4 quarters of Abenomics (i.e. 2013), RGDP grew by 2.4%, which we now know was a flat out boom.  Inflation rose into positive territory and the unemployment rate fell from 4.3% to 3.7%.

2.  From the 4th quarter of 2013 to the 2nd quarter of 2015 the Japanese economy grew by a grand total of 0.1%.  And the unemployment rate continued to fall, from 3.7% to 3.4%.  That’s right, over the past 6 quarters the Japanese economy has been growing at above trend.  But that blistering pace can’t go on forever.  The unemployment rate is down to 3.4%, and unless I’m mistaken there is a theoretical “zero lower bound” on unemployment that is even more certain than interest rates. The Japanese economy is like a Galapagos tortoise that has just sprinted 20 meters, and needs a long rest.

Why is the unemployment rate falling when the economy is not growing?  Partly because the working age population is now falling at 1.4%/year.  But it seems to be more than that.  I don’t have the exact figures, but I believe Japanese total employment is up about 1% over the past 6 quarters, which suggests that productivity is trending downwards.  Or maybe their GDP is growing, but it’s all that free stuff on the internet that doesn’t get counted. Who knows? All I can say is that the statistical methods for measuring growth, and the rules of thumb about normal growth and business cycles, do not apply to 21st century Japan.  We are in are new world where growth no longer seems inevitable, almost effortless. Italy’s there as well.  Portugal and Greece may well be there too.  I wonder what Greece’s total growth will be from 2007 to 2027?  Maybe 0.1%?

Yes, there are still developed places like Singapore and Australia that have decent trend growth (although both are slowing), and the US still has a bit of growth left. But baring a miracle where Jeb Bush is elected and actually enacts his program . . . no that’s too far-fetched to even talk about. Nevermind.

A headline from Variety:

Study: Audiences Want Metal Detectors in Theaters, But Won’t Pay Extra

Fortunately the study shows exactly the opposite; the public doesn’t want metal detectors in movie theatres.  But it’s still rather frightening that 34% of the public does claim to hold that rather insane opinion. The “won’t pay extra” is a nice little cherry on top.  Let me guess; that same 34% wants a $15 minimum wage, but “won’t pay extra” for Big Macs.

PS.  In Switzerland a referendum for a $25 minimum wage actually got 24% of the vote.  My theory of public opinion polls is that there is almost no question so crazy that it won’t get at least 20% support.  And if it doesn’t (say legalizing hard drugs) it’s probably a good idea.

This caught my eye:

WASHINGTON (AP) — A different health care issue has emerged for Democrats, in sync with the party’s pitch to workers and middle-class voters ahead of next year’s elections.

It’s not the uninsured, but rather the problem of high out-of-pocket costs for people already covered.

Democrats call it “underinsurance.”

In 1986 Ted Kennedy voted to cut the top income tax rate to 28%.  In 1987 the NYT advocated eliminating the minimum wage.  In the 1990s Paul Krugman spoke up for sweatshops.  By 1999 he was ridiculing the idea that Japan should rely on fiscal stimulus, when monetary stimulus was the obvious choice.  In the 1990s lots of liberals favored ideas such as a progressive consumption tax, and health savings accounts. They favored free trade agreements.  I miss the 20th century.

And now even Fox News seems to find the FairTax (a flat consumption tax that rebates the estimated tax paid by the poor, making it progressive) to be too right wing for their taste.

Eight years ago the minimum wage was $5.15/hour, and people were proposing a 40% increase to $7.25/hour.  Cynics said, “if $7.25 is such a good idea, why not $15?”  The minimum wage advocates said that this sort of reductio ad absurdum argument was ridiculous, no one is advocating $15/hour.  Until now.  So I’ll ask the obvious question—if $15/hour is such a good idea, why not make it $30?

The New York Times was right in 1987, make it zero.  And Warren Buffett is right today, raise the wages of the poor with a higher EITC (but also stop EITC fraud.)

PS.  How many times do I have to pay for college?  I had to work my way through college and grad school (although I did get some loans too).  Now I’m about to have to pay for my daughter’s college education.  And now Hillary Clinton wants to raise my taxes to pay for the college education of kids I don’t even know, who will comprise the top 50% of the richest major country in the world once they graduate.  And who will enjoy a lifestyle far ahead of mine.

I recently listened to a very good interview of Tyler Cowen by Erik Torenberg. For me, it was 80 minutes of bliss. I tend to agree with the vast majority of his views (even one’s where I had no opinion until I heard his reasoning), with one notable exception—China.  Tyler seemed very pessimistic about China’s short-term prospects, and seemed to think they were headed into recession.

I’m not sure the last time China had a recession; the last time they experienced sub-5% economic growth was 1989-90, and growth was still about 4% in each of those two years.  I guess you could call that a growth recession.  But I’m fairly confident that Tyler expects something considerably worse.

My general view is that most types of recession are almost unforecastable, and that the least bad prediction is always “more of the same.”  (Here I’m thinking of ordinary demand shocks or financial crisis; a recession caused by something like the Syrian civil war can be predicted once the war begins.)  Thus people who in 2007 didn’t predict a recession for 2008 were making sensible predictions, and those who did predict it were making foolish predictions, and just got lucky.  So I’m going to predict no recession for China, this year or next.

Some might argue that there are good reasons to predict a recession, and that it’s not just a wild guess:

1.  The Chinese stock market has collapsed.

2.  The Chinese yuan has been devalued.

3.  The Chinese macro data is ugly.

I say no, those three statements are all inaccurate.  The Chinese stock market is about 20% below its recent peak, but still far higher than a year or two ago.  There is nothing in stock prices to indicate a recession.  You might respond that Chinese government intervention has made Chinese stock prices meaningless. Fine.  Then let me rephrase that; there is nothing in Chinese stock prices to indicate a recession, because they are meaningless.

It’s also not accurate to say the Chinese yuan has recently been devalued.  The value of the yuan against a basket of currencies has been trending higher for many years.  Nothing significant has changed in that regard in recent weeks.  The yuan is still higher than a year or two ago, still very strong against almost all currencies around the world.  (Indeed too strong, and if a recession does occur it will be due to tight money.)

And the macro data does not indicate a recession.  The Chinese economy has been growing at about 7% per year, and while I expect it to slow a little bit next year, I doubt the slowdown will be dramatic.

People often forget that with all its problems China still has enormous momentum. Let me just give you one example. China is building infrastructure at a very rapid pace, all over the country.  The construction of infrastructure is itself a part of GDP. But the whole point of building infrastructure is that it provides services.  Last year Beijing’s subways provided 3.41 billion rides, more than any other system in the world.  But their subway system is still very inadequate, and is often extremely crowded.  Many more lines are being built, and they’ll be busy too.  Now think about the flow of services from the subway.  In terms of Beijing prices it’s pretty low, as they price tickets at around 50 cents a ride.  But at New York prices it would be closer to $10 billion/year.  I can recall when Beijing’s entire GDP was about $10 billion.  (Yes there’s been inflation, but still . . . )

That flow of subway services is much bigger than the year before and next year it will be much bigger still.  And the same is true of 100 other examples I could cite. Despite what you read about “ghost cities”, there is still a enormous flow of people from rural shacks to modern urban apartments, yielding a massive and increasing flow of housing services—also part of China’s growing GDP.

China is still less that half as rich as Greece is at the bottom of Greece’s depression. Yes, China has lots of inefficiencies, such as state-owned enterprises, but they also have a labor market that’s dramatically more flexible than any labor market in Southern Europe, and which provides reasonably full employment and fast rising wage rates.  Here’s Ambrose Evans-Pritchard:

It is worth remembering that the authorities are no longer targeting headline growth. Their lode star these days is employment, a far more relevant gauge for the survival of the Communist regime.

On this score, there is no great drama. The economy generated 7.2m extra jobs in the first half half of 2015, well ahead of the 10m annual target.

Few dispute that China is in trouble. Credit has been stretched to the limit and beyond. The jump in debt from 120pc to 260pc of GDP in seven years is unprecedented in any major economy in modern times.

For sheer intensity of credit excess, it is twice the level of Japan’s Nikkei bubble in the late 1980s, and I doubt that it will end any better.

At least Japan was already rich when it let rip. China faces much the same demographic crisis before it crosses the development threshold.

It is in any case wrestling with an impossible contradiction: aspiring to hi-tech growth on the economic cutting edge, yet under top-down Communist party control and spreading repression.

That way lies the middle income trap, the curse of all authoritarian regimes that fail to reform in time.

Yet this is a story for the next fifteen years. The Communist Party has not yet run out of stimulus and is clearly deploying the state banking system to engineer yet another mini-cycle right now.

One day China will pull the lever and nothing will happen. We are not there yet.

I’m a bit more optimistic, as I think the reform process will continue.  They’ll avoid the middle-income trap.  But they haven’t yet even reached the trap—a lot more growth is ahead.  If you want to know when that day of reckoning will finally arrive in China, don’t come here looking for answers.  I will miss the collapse, blinded by the EMH, just as I missed every other dramatic economic shock in my entire lifetime.  My predictions are boring, and always the same:

More of the same ahead

My predictions are usually right, but they get no respect, and don’t deserve any.

PS.  I just talked to a Beijing resident who told me that people who cook and clean now make about $4/hour.  That sounds low to Americans.  But that figure’s been doubling every 5 or 10 years for many decades; 25 cents, 50 cents, $1, $2, and now $4.  One more doubling and it would exceed the US minimum wage.  Yes, I’d say within about 15 years something’s got to give in China.  I don’t know when it will be, or whether there’ll be a soft landing, but I can’t see this blistering growth going on much longer.

In the first three posts of the series I sketched out a simple model of inflation and NGDP growth.  For large persistent changes in the money supply, M dominates everything else.  But inflation reflects both money growth and changes in the real demand for money.  So real GDP growth raises real money demand, and hence is deflationary, while higher nominal interest rates reduce real money demand, and hence are inflationary.  The later point is not just NeoFisherism; higher interest rates actually cause inflation to be higher than what you’d get from money growth alone.  All my claims so far are supported by literally hundreds of money demand studies done in the 1970s and 1980s.  This stuff is not controversial for monetary economists who recall the 1970s.

Here in the final post I’ll consider the money/inflation correlation you’d expect when the money growth rate is endogenous. I’ll start with the case of Bretton Woods, which covers the first part of the period in Barro’s table.  Speaking of which, I erred in saying Barro used the monetary base; he actually used the currency stock.  But I’m quite confident that this distinction was unimportant for the period covered. (Today it would be very important.)  I also discovered that he got the data from the IMF.  Still not sure if he used differences of logs.

Under Bretton Woods, exchange rates were fixed and this tended to equalize inflation, due to Purchasing Power Parity.  But inflation rates were not completely equalized, as the real exchange rates would change over time, due to factors such as the Balassa-Samuelson effect.  There would also be gaps between money and inflation, due to differing patterns of real GDP growth and velocity growth.  And here’s the key point—there’s no logical reason to expect changes in real exchange rates to be strongly correlated with variations in money growth caused by all sorts of other factors.  This means that under Bretton Woods, the variation in inflation rates (which is identical to the variation in real exchange rates) will not be closely correlated with variations in money growth rates.

I had Patrick Horan do separate regressions for the top and bottom half of the data set, the 40 countries with the highest inflation rates and the 39 with the lowest. The top half regression had an R2 of over 98%. But here’s what he found in the bottom half:

A very low adjusted R2, below 10%.  About the best you can say is that the coefficients have the correct sign.

And the problem isn’t just Bretton Woods, the same thing happens under inflation targeting.  If everyone is targeting inflation at 2%, then any variation in inflation will simply represent central bank errors, and will likely not be strongly correlated with variation in money growth rates.

But don’t be fooled by the endogenous money correlations, or lack thereof.  Money growth is still driving inflation and NGDP; it’s just that the need to hit certain inflation/exchange rate targets is driving money growth.  If a country had decided to have 5% faster money growth, on average, then they would have had to leave Bretton Woods, and they would have had roughly 5% higher inflation and NGDP growth, on average.

Thus the entire “endogenous money” issue is often misunderstood.  It doesn’t mean that money growth is unimportant; it just means that if you are targeting something other than money, then money growth is determined by your target.  In other words, don’t say, “money growth didn’t cause X, as it’s endogenous”.  Your interest rate, or exchange rate, or inflation target caused money growth to cause X.  Money growth is still the “real thing”, even if you don’t see it in sophisticated models by Michael Woodford.

Conclusion:   A monetarist model that tries to explain NGDP growth and inflation by looking at money growth, real GDP growth and the opportunity cost of holding money does an excellent job of explaining the stylized facts of the Great Inflation, when there was enormous variation in inflation and NGDP growth.  And it does so in a way consistent with basic economic theory about how people behave, how they react to changes in the costs and benefits of holding real cash balances.  As far as I know, no other model can explain all of these stylized facts.  Indeed no other model comes close.  I’ll gladly convert to New Keynesianism or Austrianism, or Old Keynesianism, or MMTism, or Marxism, or New Classical economics, or RBC, or any other school of thought, if you can provide a coherent theoretical explanation for these stylized facts.  And if not, then please tell my why I shouldn’t keep on being a market monetarist.  I’ve got a model that works; why give it up for one that doesn’t?