Paul
Hello, and welcome to Macro Bytes the economics and politics podcast from abrdn. My name is Paul Diggle, and along with my co-host Stephanie Kelly, we're guiding you through the macro economic and political themes, which are driving global markets. And today we're talking about whether the global economy and markets are about to experience another Roaring 20s. As the global economy starts to recover from the COVID crisis, some economists and investors are talking about the start of another Roaring 20s, harking back to the period of strong growth in the 1920s, which was, of course, in the wake of pandemic, the Spanish flu, as well as the First World War, but which ended in the Wall Street Crash of 1929, and the Great Depression of the 1930s. So it's a fascinating comparison, both in the ways it applies, and also in the ways that the analogy falls down. And joining me in this discussion is Dominic White, Chief Economist at Absolute Strategy Research (ASR), which is a market strategy and Economic Research Group. And I've always found Dom an extremely insightful watcher of the global economy, and macroeconomic trends. And he's recently put out a note called 'Signs of a Shift out of Secular Stagnation - The Roaring 20s Won't be Repeated - but that's a Good Thing'. So I'm really looking forward to this discussion. Dom, thanks for joining the podcast.
Dom
Thanks for having me on. It's good to be here.
Paul
So let's start with a bit of scene-setting. What were the Roaring Twenties? And why might on the surface, at least, it be a good comparison to the economic juncture that we find ourselves in at the moment?
Dom
Okay, thinking about the 1920s, a lot of the pop culture accounts, often, focuses on the glitz and glamour of the decade, the cultural and social aspects of the 1920s. So, you know, a picture an image of The Great Gatsby, and you're kind of roughly there, you know, whether it's the jazz music, the Charleston, dance, the fashion, the art deco architecture, all of those kinds of things. But I guess, you know, economically speaking, there were analogous trends taking place. Some things which were, I guess, you could say, equally exciting. So, the 1920s, arguably saw the birth of consumerism, particularly in the United States, there were lots of technologies that became, you know, far more commonplace things like, the humble radio, cars, washing machines, these kind of things. And at the same time, there were socio-economic trends that were taking place in the background. So, the US, for instance, the number of people living in cities exceeded those in rural areas for the first time, you saw progress in civil rights. So, in a lot of countries, women got the right to vote for the first time. And I suppose at a simple level, headline, GDP growth was pretty strong. So about three and a half percent per year, on average, through the 1920s in the US, and actually a little bit stronger than that, in Europe as a whole. So I guess, you know, that those are the things that arguably, people talk about when they, refer to the so-called Roaring Twenties.
Paul
And very obvious ways in which the comparison applies, above and beyond is simply being the 20s, again, is, of course, that the 1920s was in the wake of the Spanish flu pandemic. I mean, that flu did involve some of the same curtailing of economic and social freedoms as the COVID crisis has, I'm not sure if this specific phrase social distancing was used in the 1920s. But certainly, some of the same measures, the closing of schools, the emptying out of offices, some of these were used in the 1920s to varying effect, and people have traced the cultural dynamism of the 1920s to the curtailing of freedoms, which occurred during the Spanish flu. Do you think that's an important part of the comparison with today?
Dom
Yeah, I think it could be, as you say, there were social restrictions that took place regardless of what they were called. And I think some analysts have linked some of the societal and cultural trends, almost to a backlash to those freedoms being curtailed. So, a lot of people just don't think that it's a coincidence that we saw bursts of creativity span several different aspects of life and art and so on during the 1920s. Now, whether you see something similar take place, and this time around is debatable. Some people believe that will be the case, others don't but, but I guess, one of the other kind of aspects of the 1920s that I mentioned was this boom in consumer spending. And I think, clearly, there is a strong parallel there that the fact that people have been prevented from spending over the last year and have accumulated all of the savings in the process. You know, a lot of people believe that we will see a very strong period of growth in consumer spending over the next few years, as economies reopen.
Paul
The technological aspects of the 1920s, that raft of new technologies that you mentioned. People who want to push this comparison between now and then will talk about the digital communication of the 2020s, the renewable energy revolution, perhaps the rollout of electric vehicles being analogous to the widespread adoption of automotive vehicles in the 1920s. People who want to push the sociological comparisons, which you're also talking about Dom, will point to the social movements of today, things like Black Lives Matter, that kind of building social change as analogous in some sense to that broadening in the right to vote of the 1920s.
Dom
Yeah, absolutely. Yeah, I mean, I think that's exactly right.
Paul
So clearly, there are some ways in which this comparison cat can be made. Both in the fact that they follow the pandemics, and there's these technological and sociological sort of comparisons and this consumer boom. But what's really clear in your note, is that this analogy fails in a lot of ways as well. And perhaps the most obvious one is that, what happened in the 1920s, may have just as much to do, if not more to do with, the fact that it followed the First World War and the enormous upheaval of the war, rather than the pandemic. Is that the really important way in which this analogy actually doesn't work?
Dom
Well, yeah. I think what's important to recognise is that the 1920s were, I mean, they were kind of Janus faced period, really. We've talked about the positive side, or the positive face. But there was another face of that decade, which was a lot less glamorous. And I guess, without slipping into cod sociology here, I guess you could kind of sum that up, as, for all of the societal change that was taking place, for everybody who embraces those changes, there was someone else who, who struggled. And I think, reading a lot of the historical accounts of the 1920s, one of the things that really comes through very strongly is this repeated theme of tension and conflict that underlay a lot of the economic trends that were going on. So, historians talk about an urban rural divide, rising nationalism, growing anti immigration sentiment, and things like that. Now, there are clear parallels with today, which is, pretty disturbing. But I think what's really important to recognise is that a lot of those had as much to do with, as you say, with, the fallout from the First World War rather than being a response to the Spanish flu pandemic.
Paul
And one of the other ways, one of these darker sides of the 1920s. In addition to those, that rural urban divide the nationalism, even the rise of fascism, all these things can be traced to the 1920s, of course, was the growth performance from that period isn't quite as remarkable as perhaps in our historical memory, we think it was. So you've done some analysis Dom of showing that these growth numbers are actually not particularly fantastic, and in any case, are largely driven by population growth rather than a big wave of productivity and innovation.
Dom
I guess it depends to some extent on what you care about. If you just care about top level aggregate growth numbers, then the 1920s, do look reasonably strong. But on a per capita basis, I mean growth during that decade was basically in line with the long run average. So, fairly unremarkable. In the US a lot of it was driven by immigration as much as population growth, which, again, you can then link back to some of these societal tensions. The US actually introduced a ban or quotas on on immigration in 1924. Which, subsequently slowed some of these growth rates. So, yes, if you care about, let's say, living standards or per capita growth, or productivity growth even, which clearly is important for investors, then the 1920s weren't really all that, I suppose.
Paul
So another big way in which the comparison doesn't apply, is the policy regime, the monetary sort of foreign exchange regime of that period was enormously different today. So back then, was the gold standard, or some countries trying to rejoin the gold standard, completely different to the system of floating exchange rates we have now. Could you sort of explain some of the background there about what was going on with the gold standard, the transition off and back on to it for a number of countries?
Dom
Right. So obviously, The Gold Standard was, well, a lot of countries left The Gold Standard during during the First World War or in the aftermath of it. The US unilaterally kind of reinstated and committed to convertibility to gold. But through the first half of the 1920s maintained a pretty tight monetary policy. So there was some flexibility around sterilising gold inflows and outflows. The Federal Reserve could expand bank credit in order to increase the money supply over and above that, that would be implied by inflows or outflows of gold. And vice versa. And what happened in the early 1920s was, you saw this burst of inflation following the First World War. The Federal Reserve responded to that with a relatively tight monetary policy. And for any country, like the UK, for instance, that was trying to reinstate its convertibility to gold, that effectively meant that they had to match that very tight monetary policy. After the UK, it was pretty disastrous. The UK had a, what you could call a depression in the first half of the 1920s, severe deflation, double digit unemployment rates. And it persisted with that until it finally managed to get back onto The Gold Standard in 1925, when a certain man called Winston Churchill was Chancellor.
Paul
So that's a radically different of course policy backdrop to what we face today. And I think an important way in which the the economics of that time aren't really comparable to the economics of today. So we've sort of done away with the comparison, or at least showing that it only really works at a surface level. That doesn't leave you pessimistic, however. So your argument is, but we're not entering another Roaring Twenties. Because, look, the comparison is only on the surface. Nonetheless, in your sort of medium term economic forecasts, you're left pretty optimistic about the outlook from here, not because there's another Roaring 20s. But because of other changes you see to the economic environment, and in particular, the end of secular stagnation. I wonder if we can start by sort of telling us what secular stagnation is what the period the decade plus period of low growth that we went through pre COVID was driven by and then we can talk about what's going to change post-pandemic to mean that potentially we break out of that low growth regime.
Dom
So how to sum up secular stagnation in a pithy way. That's not something that economists do particularly well, generally speaking. But I guess maybe, you could think of it as being a low growth, low inflation, low interest rate regime. It really comprises a combination of both demand side and supply side features of the global economy. You can talk about demographic trends, you can talk about relatively weak productivity growth. You can talk about the fact that central banks have been stuck pretty close to zero on interest rates for the last decade or so and that has implied an inability to stimulate demand through traditional tools. All of these things I think, have have combined to create, what Larry Summers has called, this secular stagnation regime. But as I say, at a very simple level, I think maybe the simplest way of thinking about it is, that for every state of the economy that had previously existed, recombination of growth and inflation and unemployment, interest rates have tended to be lower than they had been previously, historically.
Paul
Great. So another way of framing the secular stagnation related to how you explained it there, Dom is that there has been an excess of desired saving and insufficient desired investment. So the interest rate which equilibrates, those two things has to be pushed lower, and lower. So I think that's also a sort of good framework thinking that people just have wanted to save more, perhaps because they were ageing, and they needed to save for retirement, they wanted to invest less, perhaps, because the returns on investment were less attractive. And that's also sort of pushed down that interest rate over time, and therefore made it harder for central banks to stimulate the economy. But that gets us into then what could change in what ways the COVID pandemic could be a big economic watershed, which kind of changes some of those forces. And in particular, let's start with the policy regime then. Has the COVID pandemic fundamentally changed the way that monetary and fiscal policy work to stabilise the economy? On the podcast, we've talked a lot about the shifting thinking amongst politicians and fiscal policymakers in terms of how much fiscal space they've got. But why don't you talk through your view on how this marks a policy watershed?
Dom
I know you wanted to leave the 1920s behind but if I could momentarily just return to them. I mean, I think for me, this really does represent the biggest difference between the current period and that historical analogy. Because I think if you go back and look at that time, I think you can make a pretty strong argument that the mistake policymakers made, was to try and recreate the world that existed before World War One. But in a world where that wasn't sustainable anymore. So things like The Gold Standard. They impose constraints that were just unsustainable. And now, I think you can make a pretty, pretty strong argument that actually, policymakers seem fairly determined not to repeat the mistakes that they made in the decade following the global financial crisis. So we've seen this shifting of objectives among policymakers. Now, I think you can talk about that in some senses in things like, as you say, Paul, this, recognition that perhaps there's a little bit more fiscal space, then previously acknowledged. And that may provide a little bit more scope to use fiscal leavers more aggressively than perhaps they were used in 2009, 2010 and so on. But I'm quite taken by this work that there's a political economists called Peter Hall and he has attempted to define policy regimes in a systematic way. And the way that he does so is by identifying three types of policy change. So, what he calls a first order change is when an instrument of policy is adjusted. So, for instance, you get a central bank raising interest rates or, a government may cut VAT temporarily or something like that in order to stimulate the economy. A second order change takes place when policymakers adopt a new instrument. So you can think of the examples of macro Prudential policy, which okay probably isn't a new instrument, but it was revived in the decade after the global financial crisis. And similarly, industrial policy, that was a dirty word before 2008, but it's kind of made something of a comeback. A third order change is when the instruments of policy are used to target different goals. So the objectives, the very objectives that guide policy change and it's that third order change that Peter halls says defines a change in the policy regime. It requires a dramatic departure in policy goals based on a new underlying theoretical and ideological framework. And I think that's the kind of change that I believe has taken place, and has really been accelerated by the the pandemic over the last year or so.
Paul
And so the sort of things changing your thinking, then is higher inflation targets? Or is it downgrading of the importance of targeting inflation in the first place and monetary policy being increasingly coordinated with fiscal policy? Is it a much bigger role for fiscal policy? So the end of this paradigm that previously held in which monetary policy did everything in the way of macro stabilisation and fiscal policy didn't do much. Is that the regime shift you're thinking of?
Dom
Yeah. I think going back to, Peter Hall's work, I think, really the way that I would really sum that up is when you're thinking about regime change, think about objectives, not instruments. So it's really the kind of the objectives that guide fiscal and monetary policy, which are important here. And yes, I think the fact that, the Fed has adopted this new average inflation targeting framework is an element of that. And we may see other central banks do something similar over the next few years, but I get the feeling that it goes well beyond that. You've got central bank's talking about income inequality in a way that they never have done before, about racial inequality, about supporting the climate change agenda. They are more inclined to see the economy as being subject to asymmetric risks, that a slack labour market is something that they need to guard much more actively against than one which is tight. I think putting all of these things together, it feels to me as though there is more of a focus on supporting aggregate demand, nominal aggregate demand, maintaining tight labour markets, encouraging wage growth, and so on. And those are the things that I really think, for me define this new regime, and it does seem to be guided by a break in thinking about the way that the economy works. Some people have called it the end of the neoliberal rate regime. And I think that seems right to me.
Paul
And I like the harking back against the 1920s, the point that you made in your paper, which was back then, as you say, it was returned to the old regime trying to reimpose The Gold Standard at great cost. And it wasn't until the experience of the depression in the 30s, and perhaps even the Second World War, that you then got a definite break in the macroeconomic architecture and the Bretton Woods and so on that followed World War Two. So it took a much longer, even more tumultuous set of events to really change the policy regime. And you're optimistic, but actually, it looks like we're doing it "only after a shock" rather than all those other things as well.
Dom
Yeah, exactly. We can think of the last year as being pretty difficult, and it has been, but when you put it in those terms, maybe we've got off lightly.
Paul
Okay, so another one of the big structural forces, which was driving the secular stagnation regime of the previous decade was demographic change, slowing working age, population growth, weighing on trend economic growth, weighing on the returns to investment, pushing up desired saving, and all this pushing down on equilibrium interest rates. Is that about to change? I mean, aren't demographic trends very much set already? and it's a continuing move towards ageing populations? Or how can we interpret demographic trends sort of more positively?
Dom
Well, yeah, it is largely set. I mean, demographics are one of the few things that economists can actually forecast with a reasonable degree of accuracy. And, you know, as you say, a lot of those things at a high level, don't look particularly encouraging. We know that population growth has slowed, and if anything, the pandemic appears to have depressed birth rates. So maybe it's given a bit of a kick to that trend, and the world is getting older, at a faster rate. And so those two things translate negatively in to headline, GDP growth rates, but the structure of the population is also important. And it's a key element of this book that Charles Goodhart and Manoj Pradhan have written, called 'The Great Demographic Reversal'. And the thesis of that book really is that they, identify a number of trends, including demographic ones that they believe will create the reemergence of inflation. Now, I don't think you necessarily need to go quite to that length. What you know, that is quite a controversial conclusion, I think, to draw. But one of the elements to their arguments is that, the more that people move from working age into retirement age, the more that that raises consumption relative to output. So it depresses saving rates relative to desired investment rates. And that will tend to put upward pressure on the real equilibrium interest rates. And that clearly matters because, if that does occur, and because we know demographic trends don't change hugely, it looks quite likely that that will happen. And that rise in real equilibrium interest rates may give central banks a little bit more policy space in order to provide stimulus to their economies.
Paul
Yeah, really interesting book that the The Great Demographic Reversal. Most of all, because it's recasting a long term trend that economists have long thought of as being disinflationary. The ageing of the population and saying, Well, what as you move from an ageing population to an age population and old population, perhaps actually at that point, you start putting upward pressure again on inflation and interest rates precisely because now you've got more consumption relative to production. Maybe your labour market is tighter as a result. So you're definitely not uncontroversial, but very interesting, sort of different take on the implications of demographic change. But let's move on then to sort of big force number three, which you can potentially be more positive on post pandemic, which is innovation and productivity growth, and we've been through a decade or what, maybe much longer than that, of unusually low productivity growth. Is that coming to an end with the pandemic, as we see innovations like vaccine rollout or even just our new working patterns?
Dom
Yeah, I'm quite optimistic on this. But I think we probably need to start by being quite careful to differentiate between innovation and productivity growth, because I think the former is necessary for the latter, but it's not sufficient. You probably remember the famous Robert Solow quote, you can see the computer age everywhere, but in the productivity statistics, right, and that was in 1987. So it probably wasn't maybe a decade after that, that we actually started to see the IT generation really have an effect on productivity, growth numbers, and so on. So I guess you can say that the way that innovation translates through to productivity is a process that subjects a long and variable lags. And, again, to appeal to some academia here, there's a paper that was published by three economists, Erik brynjolfsson, Daniel rock, and Chad Syverson a couple of years ago, where they talk about this phenomenon they call the productivity J curve, which, I think, is quite intuitive, and, seems to bear out in the data as well. And actually, what they're positing here is that actually, in the short term, innovation can result in weaker productivity growth, at least in the sense of how we measure it. And the way that works is that effectively when you get these huge innovations that alter the way that you work, it actually requires some time and effort to make sense of how best to put those to use and that actually diverts resources away from your kind of usual everyday job. So for a period, it can depress productivity, and then you get the payoffs at some point further down the line. I think the reason why, not just myself, I think, a lot of economists are quite excited about the pandemic is that it may have just sped up that process. It's forced the adoption of these new technologies, these new innovations, and the process of kind of learning of how to make use of them, has been compressed into a much shorter period of time. So there are some surveys that have been done by the World Economic Forum, for instance. And they have really documented just how many of these things have been adopted by firms as a result of the pandemic. So I think there are good reasons to be more optimistic now about productivity growth,
Paul
And so the speed of vaccine rollout is the most totemic example, I think, as people say, well, there's an example of an incredible pace of innovation or applying pre existing knowledge innovations, but in an extraordinarily rapid way, under the pressure of the pandemic itself. And perhaps this is encouraging both because it tells us about, we still maintain this ability as societies to innovate at great speed when necessary. So people are positive for that reason, but also, because mRNA vaccines specifically, you know, I see some people talking about these as a general purpose technology with broader applications, the range of diseases that they may be useful for could be very, very large. And actually, that's a reason for optimism. But I mean, even outwith the pandemic, there are arguments that we're at an important juncture of applying innovations in ways that will become productivity, enhancing the driverless cars is the perennial example. But the falling price of renewable energy, or lab grown meat, or, you know, the increasing bandwidth of 5g, the rollout of evermore realistic VR. There's lots of sort of protec Technologies at the moment, which are breaking through into the mainstream that I think people can become very optimistic about.
Dom
Yeah, absolutely. I focused on a narrow set of technologies that the adoption of which have been accelerated by the pandemic. But the, as you pointed out, there is huge number of things that have been in the pipeline for a decade now, which, you kind of get the impression, they are at that stage where the economist would say, the network effect starts to kick in. When they become used widely enough, then the benefits of that just kind of multiply up.
Paul
Yeah, but, and all subject, of course, this important caveat that you laid out at the beginning that innovation and productivity are different things, and there can still be a lag before we see this kind of stuff showing up in the macroeconomic data. But why don't we close then by maybe talking briefly about what all this might mean, for markets? I mean, a key investor question, it seems to me is, are we in for a short burst of cyclical recovery as we recover from from the COVID pandemic, that then gives way to a renewed low growth, low interest rate, low inflation equilibrium, the secular stagnation of the previous decade? Or are we at the start of a period of stronger growth driven by these forces of regime change? technological change, demographic change? If it's the latter, and what does that mean for markets as a whole?
Dom
So as you probably gauged by now, Paul, I'm sympathetic to the idea that we are undergoing regime change. And, and I think, for markets, that's important, because the cyclical trade appears to have played out now, maybe not in its entirety. But a lot of the good news now about the global economy seems to have been discounted, reflected in prices. And I guess for a lot of the trends that we've seen related to that reopening or reflation kind of trade to continue, we will probably need to see this regime shift take place. As you say, if we go back into the secular stagnation regime, then it seems unlikely that for instance breakeven inflation rates will continue to move higher, or that we will see long term nominal interest rates revert to, well, maybe even the levels that prevailed through much of the last decade in equity markets. We've now seen value stocks outperform growth for maybe the last kind of six months or so. But we're really only at the very early stages of that. It's basically reversed the underperformance from the previous six months or so. So for these things to gain legs, I do think you need to be talking about the global economy moving into a very different environment to the one that prevailed post 2008. And, you know, personally, I think there is an increasing amount of evidence pointing in that direction.
Paul
Dom, that's brilliant. Thank you very much.
Dom
No, thanks very much for having me on.
Paul
Well, that's about all we have time for this week. Thank you for listening to Macro Bytes. Remember that we have a mailbox macrobytes@abrdn.com. If you'd like to get us there, get in touch and ask us questions or suggest topics for the podcast.
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