The coming AI crash

 From Owen Jones, talking to Professor Steve Keen, who correctly forecast the GFC.   He reckons the current AI boom will fizzle out within a year, to be followed by an AI bust as AI takes over more and more jobs.  He points out that a UBI will be essential, or people will starve to death, and there will be severe civil unrest, a dystopian "Hunger Games" scenario.  A new Great Depression, leading to massive economic and social change.

The small-15 PMI is falling precipitously

 It's been a long-term project of mine to look at how smaller economies respond to the cycles caused by the larger economies, what I call the big 8:  the USA, the Euro zone, China, Russia, Japan, India, Brazil and the UK.  

Since I don't have official PMI data going back much before 2012 for most of these small economies, and since I want to examine patterns over several business cycles, what I have done is to use business confidence time series to estimate what the PMIs would have been if they were available.  The correlation is usually close between business confidence and broader-based PMIs.  In some cases there are "PMI" series produced by other agencies, for example in South Africa and Australia, or there are PMI-like indicators, e.g, Sweden and Switzerland, produced by national chambers of commerce or industry.

I have not extreme-adjusted these series.  Where they are "spiky", I have smoothed them by fitting 7- or 5-month centred moving averages.

The results for the GDP-weighted average of the small-15, recently expanded to include Turkey, Mexico and Malaysia, look like this, when compared with the Big-8:

Notice how, until recently, the small-15 more or less followed the big-8, which is what you'd expect.   In fact, the small-15 had started a new upswing, parallelling the upturn that had started in the big-8, though from a lower point.   And then, starting in January, the small-15 turned down, quite steeply.

The last time the US raised tariffs sharply, during the Great Depression (the Smoot-Hawley tariffs), this worsened the global and the US recession, turning it into the Great Depression, as jumps in US tariffs were followed by increases elsewhere.  Note that it was a Republican president, House and Senate which passed the tariff legislation, leading to a massive swing to the Democrats which lasted 20 years.

The trade wars initiated by Trump are having the same effect.  The collapse is just beginning.   And every month that the tariffs and the tariff uncertainty remain worsens the situation.   Obviously, if tariffs quickly return to pre-Trump levels, the recession will likely be short.  But even then, damage has been done, and trade flows will be permanently altered.   Unfortunately, Trump shows no signs of changing course.  Even the supposed "reset" with China would still apply 30% tariffs to Chinese exports to the USA.  There is no one grown up in the Administration who will talk him down from the ledge.  No one in the Republican Party has the courage to stop him.  They fear his MAGA movement too much.  By the time Congress does act, it will be too late.

China's slump

 The last time China's inflation was so negative was during the GFC (global financial crash), and before that in 1998/99 (the Asia crisis)  And yes, inflation is negative, i.e., consumer prices are falling.  This is called deflation, and is a sign of extreme economic weakness, but is also very dangerous in an economy with as much debt as China's.  Deflation means incomes and turnover are falling, but debt doesn't fall.  The only way to cut debt is to repay it from your profits or income, and as income/sales fall, this gets progressively harder, leading to more bad debt, more defaults, and further declines in the economy.   When this happens, it's called a debt-deflation, and it was a key factor in the collapse during the Great Depression from 1929 to 1933.

In the past, China has always averted this by encouraging investment in plant and equipment and in housing.    But her population is falling, so housing stimulus is unlikely to work.  House prices are falling, and housing investment is collapsing, leading to spectacular bankruptcies by giant property developers.  Many people have bought houses "off the plan" and are now paying mortgages for flats which will never be built.  Meanwhile, erratic policy towards the private sector is discouraging foreign investment, while domestic fixed asset investment continues to slide.   And it seems that until very recently, Xi doesn't appear to have been concerned. 

China matters.  Even though the official GDP data are very rubbery, it is prolly the world's second-largest economy with ~15% of world GDP, and it is also the world's largest importer of raw materials.

Falling prices in China is a clear sign that economic growth is much less than stated, and that the economy is in a slump.   

Euro area M1 falling fastest in 50 years

 I talked before how the US's M1 is falling faster than it's done since the Great Depression in nominal terms, and the fastest since WW2 in real terms. 

I was alarmed to see that the Euro Area's M1 is now falling faster than at any time in the last 53 years.   And that's in nominal terms, i.e., before adjusting for inflation.

What does it look like in real terms?  And compared with GDP?

The chart is below.

Note:

1.  The downward spike in GDP with covid, and the upward spike caused by the year-on-year calculation because of it;
2. that there is a lag between the changes in real M1 and the changes in the economy;
3. that real money supply (adjusted for inflation) is falling faster than before previous deep recessions (1974; 1980-83; 2007-2008).

From which I conclude:

1. That Europe (which is already in recession) is going to go into at least as deep a recession as the GFC (2007-2008), and; 
2. that it will be impossible for the world to avoid a deep recession, since the US makes up ±25% of the world economy and Europe ±20%.  In fact, one reason for China's weakness (±15-20% of the world's economy) is the slowdown in her exports.

Of course, I could be wrong.  Or, which is almost as bad, too early.  All that's keeping the US economy afloat is "revenge spending" on things like holidays, air travel, restaurants, hotels and entertainment, all things which Covid severely limited.  The gap between the services and the manufacturing sector has never been bigger.  Like Wile E. Coyote, if people look down, they'll fall.  But when?

The spike in M1 in 2005 looks suspiciously like a one-off definitional change.
I'll do some research to find out if that's so.
But it doesn't change any of my conclusions---it'll just improve the fit of the two curves.

M1's decline as severe as during the Great Depression

 Here, I showed a chart of real (= inflation-adjusted) US M1.  The unadjusted version is as interesting.

As you can see, nominal (i.e., not adjusted for inflation) M1 is falling as fast as it did during the Great Depression (1929-1933).  It fell then because banks failed, and when that happened, their deposits were written off, causing money supply to fall.  It's happening now because The Fed is allowing its book of government bonds bought during the Covid Crash to run off without replacing them.   When that happens, the money it receives is extinguished (central banking is complicated to explain!) and so the money supply is reduced.  

The huge surge in money supply during Covid led to an economic boom (though fiscal stimulus exacerbated the boom) and a jump in inflation to 40-year highs.  Of course, there's never just one factor---inflation was worsened by the invasion of Ukraine, by a surge in commodity prices, and by supply chain hiccoughs.  However, there is no doubt in my mind that massive monetary stimulus in the form of zero interest rates plus quantitative easing helped overstimulate the economy and worsened inflation.   

Now the situation is reversed.  Interest rates have risen the fastest in 40 years, and money supply is falling as fast as it did in the Great Depression.  It is of course possible that neither of these two factors will lead to recession.  But, alas, it seems very unlikely.  

We must be alert to the possibility that the Fed's redefinition of money supply to include liquid interest-bearing deposits has changed its behaviour, but you would have expected the effect to be the other way, as precautionary motives and rising interest rates led to an increase in interest-bearing liquid assets.  But M2, which includes money market funds, is also falling faster than at any time in the last 60 years, though not as fast as M1.

EU oil embargo would cause deep depression in Russia

 From Markets Insider

Germany's announcement this week that it's ready to stop buying Russian oil makes a sweeping European Union oil embargo much more likely — which would have devastating consequences for Moscow.

"Russia's economy is projected to contract by more than 10% already this year. If an EU embargo happens, it would likely send the economy spiraling into a depression," Matt Smith, lead oil analyst at markets analytics firm Kpler, told Insider. 

Without European buyers, Russia would need to find somewhere to put roughly 2.5 million barrels a day. Unless Moscow can sell that supply quickly or at least find a place to stash it, there's a strong chance Russia will have to slash its oil production dramatically due to its limited storage capacity, he said. 

Russia could use its extensive network of pipelines as storage space, but that wouldn't hold all the excess supply, Smith explained, adding that unsold crude also could be loaded onto tankers and stored offshore.

But such solutions still wouldn't address the hard-to-fill hole in Russia's economy that an EU embargo would create. Oil export revenue to Europe accounted for 11% of Russia's GDP in 2021, far more than the 2.3%-2.6% that gas exports to Europe comprised, according to the Rhodium Group. 

"A dent in export revenue will ultimately result in significant deterioration in the country's economy," Smith said. "It seems the path of least resistance for Russia will be to cut production, which doesn't come without its own consequences."

Putin can't count on China or India. India is already set to import Russian crude at a rate of 600,000 barrels per day as the lure of steep discounts outweigh international pressure to cut off business ties.

In the event of an EU embargo, those purchases could increase, and China could also help absorb some of Russia's oil. Smith estimates the two countries, which largely have avoided condemning Moscow for its war on Ukraine, could take in an additional 1 million barrels per day from Russia. 

In fact, onshore oil inventories in China are 90 million barrels below their peak from late 2020, Smith noted. If Beijing pivots away from current suppliers, it could replenish its stockpile with heavily discounted Russian oil.

But even if China and India increase Russia energy imports, it remains "highly, highly unlikely" they could absorb 100% of the stranded barrels, he added. 

"India typically imports about 4.5 million barrels per day, so it would be very difficult for them to logistically pull in a huge amount of additional crude given it likely has a significant volume of its imports under long-term contracts from the Middle East," Smith said.

He cited other logistical issues, such as getting insurance for new cargoes or finding enough available vessels to accommodate an influx of oil.

Meanwhile, China's demand for energy has dropped under Beijing's zero-Covid policies, and its own oil refineries have dialed back.

It's still possible China could buy more Russian oil and is simply waiting for an EU embargo to kick in so it can take advantage of steeper oil discounts, he said. But either way, Moscow can expect to generate less oil revenue. 

"Every single dollar a country is paying for Russian oil is funding the war [in Ukraine]. By cutting off those revenues, the goal is to ultimately cut off Russia's ability to continue this war," Smith said.

Source: How reliant is the world on Russia for oil and gas?

What do they mean by deep depression? During the 1929-1933 Great Depression, industrial production fell by 46% in the USA, 41% in Germany, and ±24% in France and the UK.  Real GDP fell ±25% in the USA, peak to trough.  In my judgement, a comparable fall in Russian GDP  from the peak before the war started seems perfectly plausible if its oil exports to the developed world are embargoed.  Russia may well introduce a ban on gas sales to Europe, in retaliation.  Europe is much more dependent on Russian gas than Russian oil, and such a ban would cause a downturn in Europe.  I've seen various estimates, ranging from a 2% fall in real GDP  to a 5% decline, if Russian gas is shut off.  

Astonishingly dreadful labour force data

I've been collecting data for the Great Depression to compare what happened then with the Covid Crash.  One of these time series is the  US unemployment rate.  There are some breaks in the series, but, as with most historic series, it's the best we have.

The first chart shows the unemployment rate, from 1929 to 2020.  The Great Depression began in 1930, deepened through 1931 to 1933, before a recovery began.  Full employment only returned when war started (deficit spending, anyone?)  So.  The unemployment rate now is higher than it's been since WWII, but not as bad as in the worst year of the Great Depression.  But remember—it's not over, yet.  Unemployment will rise again in May and most prob'ly also in June. 

The 6 month change in the unemployment rate is closely correlated with the economic cycle.  Because when the economy goes down, unemployment goes up, and vice versa, I've plotted the six month change inverted.  The rise in unemployment over 6 months (shown as a fall in the chart below) is worse than anything experienced during the Great Depression.  Worse.

17% unemployment rate?

Some analysts in the US are forecasting a 17% unemployment rate soon in the USA.  If that happens (and I think it is a plausible scenario) this will equal the unemployment rate just before WW2, when the US was coming out of the Great Depression.

US life expectancy falls again

For the third year in succession, US life expectancy has fallen.

Source: The Economist
Does not include 2017 & 2018 data.

From Science Alert:

The US is the only wealthy country in the world where the life expectancy needle is moving the wrong way.

Between 1959 and 2014, the average length of time that Americans were expected to live was on the rise. Now, for the third year in a row, it's declining, according to a new study published in the Journal of the American Medical Association.

"Americans operate under a lot of misconceptions about how superior we are in many facets of our lives and this is not one of them," the study's lead author Steven Woolf told Business Insider. "We may think we have best medical care in world and highest life expectancy … but that's not the case."

This decline can't be linked to just one ethnicity, gender, or geographic area, either: It originates among an entire age group. People between the ages of 25 and 64 in the US are dying at higher rates, wracked by health problems like opioid addiction, obesity, alcoholic liver disease, and suicide.

Despite having the highest per capita health care spending in the world, Americans are "more likely to die before age 65 than people in other countries," Woolf added. "Their children, too, are less likely to live as long".

Woolf and his co-author Heidi Schoomaker's new study looked at more than 50 years' worth of data on US life expectancy from the US Mortality Database and the US Centres for Disease Control and Prevention's WONDER database.

Results showed that, in the 1970s, the country experienced a rapid and significant jump in life expectancy. But by the 1990s, that increase started to level off.  In 2011, US life expectancy plateaued, and three years later it started to drop.

"We've reached the point where we're going into a free fall," Woolf said.

Medical advances, particularly in the realms of cancer treatment and heart health, prompted an almost 10-year increase in the average American's lifespan. Between 1959 and 2013, life expectancy rose from 69.9 years to 78.9 years. Now, however, that average has dropped to 78.6 years.

The news isn't good if you compare it to other countries, either. In 1960, Americans had the highest life expectancy of any country in the world. But in the past couple of years, the US has plummeted to the bottom of the list of countries with a similar GDP and high average income, according to the Kaiser Family Foundation.

In fact, the US is currently ranked in the mid-40s globally in terms of life expectancy, squished between countries like Lebanon, Cuba, and Chile, which have GDPs that fall far short of our own.

This counterintuitive trend – of an affluent, first-world country that spends billions on privatised healthcare losing swaths of their middle-aged working class – could be traced back to one massive elephant in the room.

"It's a quandary of why this is happening when we spend so much on healthcare," Woolf said, adding: "But my betting money is on the economy."

Upticks in suicides, drug overdoses, and alcohol-related diseases "are all symptoms of people struggling in a poor economy who can't afford housing, find consistent jobs," and despair because of it, according to Woolf.

Drug overdose, alcohol abuse, and suicide – referred to by some as "deaths of despair" – appear to be the primary culprits [of the rising mortality rates].

This age group [25 -64] experienced a nearly four-fold increase in fatal drug overdoses between 1999 and 2017.

Suicide rates went up by nearly 40 percent for people between the ages of 25 and 64, and by 56 percent for people ages 55 to 64 during the same time frame. For Americans between the ages of 25 and 34, the rate of alcohol-related disease deaths spiked almost 160 percent, as well.

Obesity-related mortality rates among this age group also went up by 114 percent, and deaths linked to high blood increased by about 80 percent.

"Working-age Americans are more likely to die in the prime of their lives," Woolf said. Between 2010 and 2017, midlife US adults experienced a 6 percent total increase in mortality rate.

"We are seeing social determinants of health shaping well-being and outcomes," Howard Koh, a professor at the Harvard T.H. Chan School of public health who was not involved in the study, told Business Insider.

"Forces like income inequality and unstable employment cause psychological distress and drive conditions by which diseases and deaths occur," he added.

In countries around the world, research has shown that people with lower incomes die sooner than their wealthier counterparts.  A 2017 study linked low socioeconomic status to significant reductions in life expectancy.

But what makes the US unique, according to Woolf, is that "poor people in other countries live longer than poor people in our country".

[Read more here]


I talked about this before, in my piece Shit-Life Syndrome.  The standard American diet (SAD) is undoubtedly one factor in falling life expectancy, but that doesn't explain suicide, now at the highest rate since the Great Depression, nor rising deaths from alcoholism.  Rising inequality is killing people.  It's time for a change.

The end of neo-liberalism

Cartoon by Jim Morin

Back in the late 1970s when I was at varsity studying economics, the new rising orthodoxy was "rational economics".  The theory behind it was simple and logical.  Any person knows much better what their preferences are than any centralised government authority possibly can, so we should let individuals decide what they want to do.  So far, so good.  But the advocates of rational economics took the whole idea a lot further.  They argued that any collective activity was ipso facto inferior to any individual one, and that therefore government should be scaled back to as small a profile as possible.  Regulation of private enterprises was unnecessary, because “the market” would take care of it.  Privatisation, even of entities such as schools, hospitals, generators and the grid was desirable, even if these entities were monopolies or not in fact profit-seeking organisations, because privately owned and managed enterprises would be “more efficient” than collectively owned ones.  Cutting tariffs and removing quantitative import controls would, it was maintained, lead to higher growth and rising living standards.  Welfare had to be cut back so that taxes could be cut, because taxes on the rich “reduced incentives”.    Prosperity was supposed to "trickle down" from the rich to the poor.  This philosophy is called “neo-liberalism”.

There was a fundamental flaw in the whole thesis.  When markets are “perfect” and supply is “atomistic” (i.e., there are a very large number of suppliers) the self-interest of each of the individual suppliers can potentially lead to positive outcomes, because any attempt to gouge the public is prevented by competition.  For example, in any urban centre there are thousands of cafés.  For all practical purposes supply is “atomistic”.  Each café is a “price taker”, not a “price maker”.  Contrast that with, say, the electricity grid.  It would be completely impractical to build a hundred grids with connections to each house.  The grid is a monopoly.  It could, theoretically, set its own price.  There are no constraints on the self-interest of those who own monopolies except regulation and politics.  As Adam Smith, the great guru of the economic rationalists and neo-liberals said:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices

There was a second critical flaw in the whole thesis of neo-liberalism.  The assumption was that economics would happen independently of the political system and political processes, that there would be a level playing field where all players could be potentially equally successful.  But that was wrong.  Neo-liberalism led to vastly increasing inequality, and the people with more money bought the politicians.  Laws and regulations were changed to favour incumbents.  Grumpy billionaires bought control of media outlets, and started pushing far-right agendas, which—quelle surprise!—favoured deregulation, lower taxes, lower wages and free migration. 

There are other fatal flaws to the whole doctrine of neo-liberalism, but I'll talk about them in future posts.

As the years went by I began to wonder whether neo-liberalism was actually as good as its proponents believed.  But what really killed it for me was the GFC.  The neo-liberal system plunged us into deep recession.  Banks were supposed to be capable of self-regulation.  Instead they lent imprudently and foolishly, and failed spectacularly, and had to be rescued--oh, the irony!--by the state.  The result was the  deepest recession since the Great Depression of the 30s.  And since then, trend growth in the OECD has fallen from 2.9% per annum to 1.8%.  It became obvious that austerity policies to try and balance budgets just made things worse.  The major burden of readjustment was everywhere borne by the poor.  The fastest recovery from the GFC lows was in the USA, which also ran the most Keynesian stimulatory policy in developed countries (to the fury of the Republican Party) while dogmatists elsewhere forced tax increases and spending and welfare cuts (Europe being the worst offender) which contrary to the theory simply deepened the downturns, while leaving the deficits unchanged.

I think the high water point of neo-liberalism has passed.  All the interlocking doctrines are under assault.  Just as with Communism, once a political doctrine loses its intellectual authority it is doomed.  Neo-liberalism is dying.  Its supporters just don't know it.

Escaping liquidity traps

A "liquidity trap" is where interest rates are zero, and so cannot be reduced any further, even if that is necessary to stimulate growth.   In most developed countries, the cash (discount) rate is at or very close to zero.  Stimulating growth requires further monetary stimulus, and the current technique is called QE (quantitative easing) where the central bank buys long-dated government stock to drive down long term interest rates.  But that hasn't been very effective.

The last time we had a liquidity trap on the scale we now do was during the great depression.  In this article, Nicholas Crafts shows how the government stimulated the British economy using unconventional measures.

In mid-1932, the UK had experienced a recession of a similar magnitude to that of 2008-09, was engaged in fiscal consolidation that reduced the structural budget deficit by about 4% of GDP, had short-term interest rates that were close to zero, and was in a double-dip recession (Crafts and Fearon 2013). The years from 1933 through 1936 saw a very strong recovery with growth of over 4% in every year. The Chancellor of the Exchequer, Neville Chamberlain (in office from November 1931 to May 1937) was the architect of this recovery. 

The policy framework adopted from mid-1932 has a strong resemblance to the so-called ‘foolproof way’ of escaping from the liquidity trap (Svensson, 2003) and to ‘Abenomics’ in today’s Japan:

• After the forced exit from the gold standard in September 1931, by the middle of 1932 the Treasury had devised the so-called ‘cheap-money policy’.

Initially, short-term interest rates were cut to around 0.6% – and stayed there throughout the rest of the decade (see Table 1).

• Second, a price-level target was announced by Chamberlain in July 1932 which aimed to end price deflation and return prices to the 1929 level.
• Third, the Treasury adopted a policy of exchange-rate targets that entailed a large devaluation first pegging the pound against the dollar at 3.40 and then against the French franc at 77 (Howson 1980), intervening in the market through the Exchange Equalisation Account set up in the summer of 1932 (see Table 2).

Real interest rates fell quite dramatically and very quickly and gold reserves almost doubled within a year. By the end of 1936, the money supply had grown by 34% compared with early 1932 (Howson 1975).

The cheap-money policy followed the textbook approach for operating at the zero lower bound of seeking to reduce the real interest rate by raising inflationary expectations. A key aspect was that the Treasury under Chamberlain, rather than the Bank of England under Montagu Norman, ran monetary policy after the exit from the gold standard. The classic problem with the ‘foolproof way’, especially for central banks, is whether they can credibly commit to maintaining inflation once recovery appears to be under way. Because of its problems with fiscal sustainability, the Treasury was in a good position to persuade markets that it wanted sustained moderate inflation as part of a strategy to reduce the real interest rate below the growth rate of real GDP and to benefit from this differential in reducing the public-debt-to-GDP ratio. This reliance, based on ‘financial repression’, allowed more tolerance for lower primary budget surpluses and eased worries about ‘self-defeating austerity’ without a Keynesian approach to the public finances.

Obviously, for the cheap-money policy to work it needed to stimulate demand – a transmission mechanism into the real economy was needed. One specific aspect of this is worth exploring, namely, the impact that cheap money had on house-building. The number of houses built by the private sector rose from 133,000 in 1931/2 to 293,000 in 1934/5 and 279,000 in 1935/6 – many of these dwellings being the famous 1930s semi-detached houses which proliferated around London and more generally across southern England. The construction of these houses directly contributed an additional £55 million to economic activity by 1934 and multiplier effects from increased employment probably raised the total impact to £80 million or about a third of the increase in GDP between 1932 and 1934. House building reacted to the reduction in interest rates and also to the recognition by developers that construction costs had bottomed out; both of these stimuli resulted from the cheap-money policy (Howson 1975).

Read the rest of the article here.

Happy Days Are Here Again

 Robert S McElvaine  writes:

Eighty years ago today, the Casa Loma Orchestra recorded a song that was to become an American standard. What happened in the OKeh recording studio on Union Square in New York on October 29, 1929, however, is not nearly as well remembered as what occurred on that day about two miles to the south, on the corner of Broad and Wall Streets.

In what must rank as one of the most ironic coincidences in history, "Happy Days Are Here Again" was recorded on the day that was to be called "Black Tuesday" and become synonymous with the end of the happy days of the 1920s and the onset of the Great Depression.

The irony is perhaps best explained by the fact that the period that came to an end on this date eight decades ago, the Roaring Twenties, was in fact a time of a happy daze.

Now it has happened again. For much of the time from 1980 to 2008, most Americans were again living in a happy daze induced by the same sorts of delusions people had in the 1920s.

Here are the salient points about the two economic collapses:

• The Great Depression should have been looked on as the Holocaust is: "Never Again!" Yet, beginning around 1980, economists and policymakers systematically unlearned the lessons of that terrible October eighty years ago, in effect saying, "Let's try it again!"
• Champions of an unfettered free market in the 1920s insisted -- as they insist today -- that low marginal tax rates on the highest incomes, concentration of wealth at the top, lax regulation, and weak labor unions are the way to prosperity. On every count, history proves them to be dead wrong. When their ideals were in effect, in the 1920s and the early 2000s, they produced economic collapses. When the opposite was the case, in the middle decades of the 20th century, there was a sustained period of prosperity:

Read the rest of this Huffington Post article by Robert S McElvaine here.

Click on chart to see bigger image