There might be no such thing as an oracle, but there is the bond market. And really, what's the difference? It is, after all, the closest thing there is to a clairvoyant when it comes to the economy . ..
. . . Which is bad news right now, because it's telling us that the whole world is turning Japanese.
What do we mean by that? Well, almost 30 years ago, Japan was the first major country to go through the boom, bust and stagnation cycle that the rest of the world has gotten to know and hate so much recently. The result was a "lost decade" of economic growth that eventually did end, but nonetheless left it acutely vulnerable to even the smallest of shocks going forward. That's because Japan didn't just end up with low inflation, low interest rates, and low population growth, but rather zero inflation, zero interest rates and negative population growth. All of these, you see, were both cause and effect of economic weakness. In particular, the fact that, on the one hand, Japan's workforce was shrinking, and, on the other hand, its interest rates were already zero meant that its economy was both going to slow down and wasn't going to be easy to speed back up again.
Now, to be fair, this doesn't have to be the end of the world, or even of an improving standard of living. Indeed, Japan has finally started to get enough things right in the past five or six years, and the rest of the world has gotten enough of them wrong that, if you adjust for how much its workforce has contracted, Japan hasn't actually done that much worse than its peers since its bubble burst in 1990. Still, this is something you'd rather avoid if you could. This kind of low-growth, low-interest-rate equilibrium just doesn't leave you with much margin for macroeconomic error - and tends to require a lot of fiscal stimulus just to make things barely work.
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Unfortunately, this is exactly what the bond market is telling us our future is. Consider the fact that the German government just sold some 10-year bonds at a record low interest rate of minus 0.24 per cent - yes, it's getting paid to borrow money - or that the U.S. government has now seen its 30-year bond yields fall back to where they were before Donald Trump was elected. The reason both of these things matter is that interest rates on long-term bonds show us what investors think they'll be, on average, over the life of it, plus a little extra to make up for the risk that inflation ends up being higher than expected. So when markets think that the economy is going to be strong enough that the Federal Reserve is going to have to raise rates quite a bit just to keep things from overheating, long-term rates will go up in anticipation of that.
That, at least, is what happened when Trump won. Investors, giddy at the prospect of big tax cuts for corporations, infrastructure spending for everyone else, and all the deregulation their hearts desired, pushed up the yield on 30-year U.S. Treasury bonds from around 2.6 to as much as 3.4% out of hope that all of these things would make the economy break out of its post-crisis doldrums. And for a little while it did. The economy really did start going about 3% instead of the 2% it had been, pushing unemployment down to what was almost a 50-year low in the process.
The only problem, though, is that it doesn't look like this is going to last. How is that possible when gross domestic product is still up 3.2 per cent the past year? Well, the simple story is there's a good chance that's overstating things right now. Maybe the best way to tell is that an alternative measure of the economy known as gross domestic income only shows it increasing 1.8 per cent in the same time frame. This, as former Barack Obama adviser and current Harvard professor Jason Furman points out, is the biggest gap between the two since the financial crisis. Which makes sense when you consider that there have been a string of less-than-stellar data points recently. Job growth, for one, seems to at least be slightly slowing down, while manufacturing numbers have been as well, even more than was expected.
The point isn't that the economy is on the cusp of a recession, but rather of reverting to the 2 per cent growth it'd largely been stuck in since the crisis. Part of the problem is that the Trump tax cuts seem to have only helped corporate shareholders in the short term, but not corporate investment in the long term as was promised. Another part of it is that there never was a Trump infrastructure plan, no matter how many times they said they were going to devote a week to it. And the last part is that the Trump tariffs might hurt consumers and scare businesses enough that the Fed looks like it's going to have to cut rates just to maintain a modest level of growth. Put it all together, then, and you have a recipe for Japanification: lower growth, lower interest rates, and young people who, even in what are supposed to be the good times, feel like they're in a tenuous enough situation that they're less likely to have kids than they might have been, creating a self-perpetuating cycle of demographic decline.
It's like the opposite of "A Tale of Two Cities": not the worst of times, but certainly not the best, either. Far, far from it.
- Washington Post