A World In Disarray

Air Date: Mar 16, 2017 Length: 30:27
About this Video Richard Haass, president of the Council on Foreign Relations, joins The Agenda to discuss his latest book, "A World in Disarray: American Foreign Policy and the Crisis of the Old World Order." Haass explains how the rules and institutions that have guided international relations since the Second World War are becoming obsolete. He argues for a new global system that meets today's challenges.

Rani Mullen and Cody Poplin on the Battle for Access and Influence in the Indo-Pacific

Good piece in Foreign Affairs titled The New Great Game - A Battle for Access and Influence in the Indo-Pacific by Rani D. Mullen (Associate Professor in the Government Department at the College of William and Mary, Virginia and Director of the Indian Development Cooperation Research (IDCR) at the Centre for Policy Research, New Delhi, India) and Cody Poplin (Research Assistant at the Brookings Institution in Washington, D.C. and an Associated Editor of Lawfare).

 

Excerpt:

Huge stakes are involved. Trade, energy, and geostrategic imperatives are driving both Chinese and Indian ambitions. Between the Indian and Pacific Oceans lies the main choke point of world commerce, the Malacca Strait. Today, more than half of the world’s container traffic and one-third of all maritime traffic crosses the Indian Ocean and passes through this point and into the South China Sea. To understand the scale, consider that roughly two-thirds of South Korea’s energy supplies, nearly 60 percent of Japan’s energy supplies, and 80 percent of China’s crude oil imports arrive over this maritime route. Meanwhile, 75 percent of India’s energy supplies cross the Indian Ocean.

 

China has long felt trapped by what national strategists have termed the “Malacca Dilemma”—that China’s access to the greater Indo-Pacific is limited to one main pass and that, to reach that pass, its ships have to travel over the South China Sea, which is a mess of overlapping territorial claims from countries in the region. And so over the last decade, China has sought to secure its access to the critical sea lanes, including by creating artificial islands with airfields in the South China Sea [6] and declaring an expansive and novel Exclusive Economic Zone—one that is far larger and includes far more prerogatives than permitted under The United Nations Convention on the Law of the Sea—over the area. From this perspective, Chinese Vice Admiral Yuan Yubai’s recent, and rather incendiary, declaration that the South China Sea “belongs to China” makes strategic sense: It is after all their path to the greater Indo-Pacific.

 

Plenty of ink has been spilled over the South China Sea, and appropriately so. But the South China Sea is just an example of a larger game that is already underway.

 

Along with creating routes to and around Malacca, China has provided soft loans to Bangladesh, Pakistan, Myanmar (also called Burma), and Sri Lanka for everything from highways, to power plants, to seaports. All of this has been part of China’s Maritime Silk Road strategy, which is meant to bind countries in the Bay of Bengal and the Indian Ocean closer to the Chinese economy as well as to build trade routes from China through their territory to the Indian Ocean, which would allow China to avoid the Malacca bottleneck. Yet this approach has been hurt by China’s more muscular activities in the South China Sea, which have scared the country’s smaller neighbors into closer alliances with India, Japan, and the United States.

 

As China has become more assertive, India has focused on its own rapidly growing need for access to critical sea lines and opportunities for trade and investment. In 2011, maritime trade constituted close to 41 percent of India’s overall GDP; the figure reached 45 percent in 2015. India now imports about three-fourths of its oil through the Indian Ocean. India fears that China, relying on its alliance with Pakistan, might encircle India on land and at sea. For Indian strategists, it doesn’t seem far-fetched that China would use its increased maritime capability to create a zone of naval exclusion that stretches from the South China Sea to the Persian Gulf.

 

To counter such encroachment, India, which was the largest recipient of global foreign aid until the early 1990s, has started to dole money out. The country now has more than $12 billion in open lines of credit and dozens of major development projects in foreign countries. Although Indian aid equals just a fraction of Chinese aid in the region, India hopes to use its funding, increased trade focus, military diplomacy, and cultural ties—its so-called Act East policy—to maintain and expand its leverage over the Indian Ocean Rim states to preclude a more permanent Chinese presence in those waters.

 

This, in a nutshell, is the New Great Game [7].

 



 

My personal view is that Sri Lanka will favour China's influence as the resentment in Colombo towards New Delhi is palpable, the United States will tilt towards India for balance of power reasons in reaction to the Asian hegemon and the fact that it is angry over relentless Chinese cyber-attacks and bluster and India will lever a more assertive and muscular Japan since the Abe government  has renounced the pacifism that it embraced post World War II. Any Indian attempt to increase its profile be it through soft or hard power will be dependent upon who is in power in New Delhi. It is not a coincidence that the Indian state has hit beneath its weight for much of its existence thanks to those who have governed it at the national level.

 

 

Mark Blyth gives a no holds barred Google Talk on Austerity

HT to Stephen Kinsella for putting the video on his site.
The only disclaimer here is that Blyth does not hold back and doesn't suffer fools so the language is a colorful --as it unarguably should be-- retort against the notion of expansionary austerity (which I have written about here).

It is unfortunate that there were not more smart people from Google in attendance.

Too little, too late, EU remains on the wrong track

In its annual verdict on national budgets of all 27 EU members France, 

Spain and the Netherlands will be given a waiver on the annual 3 per cent deficit limit. Brussels will also free Italy from intensive fiscal monitoring despite its new prime minister’s decision to reverse a series of tax increases imposed by his predecessor. EU eases hard line on austerity.

(Spiegel, 2103)

This is fine but ultimately theatrics. Europe's policy makers have enabled an initial recession --that was triggered by the irresponsibility of the continent's banking sector-- to turn into a depression all for the ostensible purpose of adherence to a sound finance regime that was consistent with the Maastricht Treaty. We see the result in the massive unemployment numbers, particularly amongst youth in the periphery.

This is what a depression looks like:

Europe's Record Youth Unemployment: The Scariest Graph in the World Just Got Scarier

Four Different Views of Europe's Record Youth Unemployment

Policy prescriptions that wish to mimic the austerity experience of Canada in the 1990s would do well to remember the following:

Is there a flexible exchange rate to help with adjustments?

See how the Canadian dollar fared with the US dollar during the period 1990-2003.

Is your main trading partner growing?

After the downturn at the end of the G.H.W. Bush era the United States experienced strong growth during the Clinton terms, enabled in no small part by the flood of capital to replenish the nation's fixed capital stock during what would be called the tech boom.

How is your main trading partner's labour market?

Robust in the case of the United States during Canada's austerity drive (see the line representing Clinton).

How is your main trading partner's fiscal house?

National debt as a percentage of GDP improved during the two Clinton terms.

Austerity is tough medicine but for a small open economy like Canada's it was made possible thanks to external factors. The biggest factor being that its main trading partner, the United States, was in a healthy situation and the destination for its exports and Canada was able to depreciate its way to growth with the CADUSD exchange rate hitting 0.63 in 2003. Concurrently, the following happened below:

Canada's Balance of Trade (1990-2003)

Canadian GDP growth rate --note that it improved but is markedly lower than that of the United States (above)

Government Debt to GDP peaked in the mid 1990s to come down once growth was re-established.

Federal Budgetary Balance: Government had its fiscal house 'in order' so to speak by the turn of the century.

None of this will happen in the Eurozone. The peripheral nations have been sent to purgatory with little hope of emancipation; those wishing for structural reform as a result of the troika's edicts fail to recognize that such reform is an issue of political economy that the sovereign nation's body politic must come to grips with --it isn't something that will be solved by narrowly restrictive policy tools.

I will use Rob Parenteau's words to sum up as he was one of the original analysts who warned of the dire consequences of austerian policies (the full deck can be downloaded from this page).

The Eurozone Predicament: 3 Policy Strait jackets and Market Fundamentalism

• Common currency means varying nominal exchange rate is not available to any one nation
• Fiscal policy is subject to 3% fiscal deficit floor with fines
• Monetary policy is subject to one size fits all committee
• Burden of adjustment is largely shifted onto relative prices, private income deflation, and product innovation
• Because markets are presumed to gravitate to full employment, utility maximizing equilibrium best on their own, undistorted by "artificial" policy interventions
• If you rapidly reduce fiscal deficits in eurozone, you will also reduce private sector net saving
• More difficult for private sector to service and reduce debt
• Quest for fiscal sustainability in eurozone implies bank risk higher than government risk as private loans sour
• Unless maxi-depreciation can produce large increase in trade balance for region as a whole, otherwise:
• Peripheral eurozone trade balance swing tips up German , Dutch exporters unless new markets found

Parenteau's Key Takeaways:

• If the current account is in deficit, and exchange rate policy is constrained, the private sector is more likely to be placed on a route to financial fragility and instability
• The domestic private and government sectors cannot deleverage at the same time without a large, sustained increase in the trade (or current account) balance
• Since European banks are more highly leveraged, the pursuit of fiscal sustainability may prove unsustainable if it lead to more private debt distress and bank losses.

References:

Spiegel, Peter. "EU eases hard line on austerity." Financial Times, Online edition, sec. Europe, May 28, 2013. http://www.ft.com/intl/cms/s/0/22348284-c7a6-11e2-be27-00144feab7de.html
Thompson, . "Europe's Record Youth Unemployment: The Scariest Graph in the World Just Got Scarier." The Atlantic, May 05, 2013. http://m.theatlantic.com/business/archive/2013/05/europes-record-youth-unemployment-the-scariest-graph-in-the-world-just-got-scarier/276423/ (accessed June 3, 2013).

Parenteau, Rob. "Minsky & the Eurozone Predicament: Transcending the Dismal Science." April 14-16, 2010. http://www.levyinstitute.org/conferences/minsky2010/

Debt: How Much Is Too Much?

Neither a borrower nor a lender be;

For loan oft loses both itself and friend,

And borrowing dulls the edge of husbandry.

~Lord Polonius from William Shakespeare's The Tragedy of Hamlet, Prince of Denmark (Act 1, Scene 3)

But apart from this contemporary mood, the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.  (Keynes 1936) [ emphasis added]

Whether one admires, abhors or is agnostic towards Keynes' ideas, and regardless of one's political and philosophical leanings, there remains an enduring truth to the quotation above, gleaned from the concluding remarks of the General Theory. The Bard of Avon, in contrast, remains as timely and timeless as ever; the truism of being neither a borrower nor lender holds true for all that have suffered from the exuberance of asset bubbles: think of the the desolation of popped assets that are buried among the rubble of balance sheets that need to be repaired and reconstructed around the world.

Four years on from the Great Recession, the lay person is perplexed in coming to terms with understanding the seemingly inexorable forces of globalization: concentrated corporate power, a bottomless global reserve pool of labor and technology enabling job redundancy and off shoring -- all ingredients behind the constant change, instability and fragility that is manifested in the increasingly precarious nature of work and living. Exacerbating the discomfort is waning faith in the political class --something that admittedly ebbs and flows even during the so-called "good times" -- that is arguably at a post World War II low in much of the developed as well as in pockets of the developing world.

Turning to traditional media and, by and large, witnessing the debates within the narrow bounded confines of possible prescriptions sold as solutions is nothing but Conventional Wisdom (in John Kenneth Galbraith's pejorative sense of the phrase).

Otto von Bismarck said that "Politics is the art of the possible" (Die Politik ist die Lehre vom Möglichen) but the misbehavior of Congress over the so-called "fiscal cliff" proves that the love of farce is not isolated to Old Europe and Classical Antiquity but has a captive audience in Washington D.C., home of the imperium. As Kevin Kallaugher's  (better know as Kal in The Economist newspaper) energetic cartoons illustrate, U.S. President elect Obama's coming term is likely to be as bumpy as his previous one, particularly given his penchant for negotiating from a position of weakness and love of appeasement (via dismantling of the social contract) in order to deliver a `grand bargain`.

Meet The New Boss

...Same as The Old Boss

The United States is not peripheral Europe: it is the hegemonic power; it remains unrivaled militarily; it is issuer of the world's reserve currency in a fiat based currency world; it has far greater flexibility to enact a forward looking vision and craft policy for a new international financial architecture.

But will it do so? Not bloody likely.

This blog believes that Obama will wilt under the light of convention that has taken us from the farce of the "fiscal cliff" to the melodrama of another "debt ceiling"? Can he untangle himself from an already muscular foreign policy stance that, as an old post argued would put the country in a fiscal straitjacket. In divining the art of the possible, it is necessary to discern the wasteful from the productive. Endless foreign incursions and skirmishes are wasteful --but America is addicted to war-- while public investment by way of government spending need not be. The traditional narrative around the American debt situation revolves around the sustainability (or lack thereof) of the American fiscal picture. This has been further muddied by oft repeated (Reinhart and Rogoff 2011) citation:  

In our study “Growth in a Time of Debt,” we found relatively little association between public liabilities and growth for debt levels of less than 90 percent of GDP. But burdens above 90 percent are associated with 1 percent lower median growth.

Yet there is an untold truth that no talking head is willing to acknowledge: no one knows how much debt is too much.

The story so far, that is familiar to all: the American economy is meandering along at a rate that is far below 'potential.' The obvious counter-factual here is what happens to the purported trend rate of growth if the easy liquidity and household debt expansion from 1990 - 2007 is decreased during said period below?

Despite the pedal of monetary policy being pressed to the metal of central bank intervention during and after the Great Recession there remains a large amount of 'slack' in the economy. Forays into 'fiscal stimulus' have spooked the markets and set forth the narrative in the United States that even after conquering the 'fiscal cliff' and navigating the up coming 'debt ceiling' the US government will (surely?) hit a 'debt wall' and, as a result, businesses are unwilling to invest because the ghost of uncertainty keeps visiting from the past, present and future. The supply side story makes sense if one believes in fairy tales as the gospel truth rather than as metaphor. Just as there are two sides to a trillion dollar coin, there are two sides to the economic story. The importance of the supply side is given space in the corporate media as it holds muster through the filters of ownership and advertising and is consonant with the news shapers and news makers but the demand side story must not be neglected even if it given short shrift.

Debt: How Much Is Too Much?: The curious case of Japan
In light of Japanese Prime Minister Shinzo Abe`s recent declaration of a 10.3 trillion yen (USD 117 billion) stimulus package, ostensibly to kick start the moribund economy, Peterson Institute President Adam Posen observed:

Japan demonstrates a different reality about the problems of excessive debt – one that Shinzo Abe, its new prime minister, should keep in mind as he launches a fiscal stimulus package. Japanese public debt has ballooned for 20 years, rising from 60 per cent to 220 per cent of gross domestic product (though the true figure net of government holdings may be 130 per cent). During that time Japan has been in recession, recovery and back in recession, but interest rates on Japanese government bonds have remained below 2 per cent for the past 13 years. While the debt accumulated, the yen appreciated from Y130 to Y78 to the dollar, before reversing to Y89 over the past few months.

Japan was able to get away with such unremittingly high deficits without an overt crisis for four reasons. First, Japan’s banks were induced to buy huge amounts of government bonds on a recurrent basis. Second, Japan’s households accepted the persistently low returns on their savings caused by such bank purchases. Third, market pressures were limited by the combination of few foreign holders of JGBs (less than 8 per cent of the total) and the threat that the Bank of Japan could purchase unwanted bonds. Fourth, the share of taxation and government spending in total Japanese income was low. (Posen 2013) [ emphasis added] 

FT columnist Gillian Tett, whose analyses uses an anthropological framework, stated

One striking feature of the Japanese government bond markets in recent years is that domestic investors (who own 95 per cent of outstanding JGB stock) have continued to buy bonds, even amid ratings downgrades in the JGB market, with an extraordinary sense of quasi-patriotism. That is bad in some respects, since it removes pressure for change; but it may also make it less likely that Japan will rip itself apart. (Tett 2010) [ emphasis added]

Moreover, in a recent IMF working, the composition of Japan`s sovereign debt portfolio shows that the country has an advantage as a currency issuer in a fiat money world, and this advantage is shared by a number of countries in the same situation but is contrasted by those countries that are not.

(Arslanalp and Tsuda 2012, p. 12)

According to the authors` methodology, Japanese sovereign debt had a lower investor base risk than that of Canada (which no doubt would be met with howls of protest along Bay St. and in the corridors of Ottawa).

(Arslanalp and Tsuda 2012, p. 42)

The country`s `Supply-side Risk`indicators remain high and `Demand-side Risk`indicators are low...

(Arslanalp and Tsuda 2012, p. 43)

...and as such Japan is neighbors with the United States, United Kingdom, and the Teutonic powerhouse, Germany, rather then the peripheral eurozone.

(Arslanalp and Tsuda 2012, p. 44)

  The level of sovereign debt in a nation in a global economy where the value money is by fiat is constrained not by how much debt is owed but by how much control the sovereign has over its affairs: (i) is it a currency issuer; (ii) how much of the debt is in the hands of foreign entities; (iii) how important is social cohesion in the country; (iv) what role  does government play in the role of keeping the glue of a social contract: will it play the role of Hobbes` Leviathan or will it sell off public goods in favor of privatizing and feeding the great vampire squid wrapped around the face of humanity or will it be something in between?

Capitalism is necessarily messy and subject to fluctuations but the notion of government always and everywhere crowding private investment is a necessary fiction upholding the myth that free enterprise simply happens in a vacuum. Investments today in a productive capacity can lead to something that we cannot foresee tomorrow. The role of financial capital should be to aid and abet entrepreneurial activity rather than exist for itself as a rent seeking activity. We will get through the current crisis --just like those in the past (below)-- but to do so without a serious consideration of government's role would be naïve.

(Source: Presentation by William H. Janeway to the Fields Institute, November 8, 2012)

The key takeaway here is that government debt must be taken on a case by case basis; equating it to a household is often fallacious but it is the debt of households proper that should be of greatest concern.

Readers here are familiar with Keen`s hypothesis that the housing bubbles have been generated by the willingness of the financial sector to extend credit. In aggregate, one person`s debt may be another person`s asset logically...

(Keen 2012)

but practically, debts and assets do not simply even out: there is a heterogeneity in debt levels among different classes of households --those who need the most financing are hurt the most-- and where they live becomes a factor as the amount banks are willing to lend is based on comparables.

Your Personal Debt Matters More - but your deleveraging was triggered by the boom in housing.

Mian and Sufi estimate that homeowners borrowed more than a trillion dollars from 2002 to 2006 through home equity loans, and that homeowners did not use the extracted funds to pay down other debts or purchase financial assets. This suggests that loans were used primarily for spending, which is supported by other studies indicating that households use home equity loans mainly for home improvements and other consumer items.

As the housing market started to unravel in 2006 to 2008, homeowners who had piled on debt began defaulting on their loans. In particular, the study finds that the default rate for low credit-quality borrowers in cities where house prices increased the most jumped by 12 percentage points, compared with only a 4 percentage point increase in areas that experienced little price appreciation. (Sufi 2011)

Homeowners in cities where house prices rose quickly borrowed more, but the response varied depending on the type of consumer. (Sufi 2011)

Central Banking Has Limitations

Where are we today? In the dismal world of central banking where monetary policy is supposedly the only game in town, and static partial equilibrium diagram do more to obfuscate than to explain, we are in a `Liquidity Trap`where monetary policy remains largely ineffective at the zero lower bound (ZLB in the diagram below).

Japan has shown us the way... (but the map may be pointing us in the wrong direction).

Ben Bernanke and his beard are doing what they believe to be Right

However, for monetary policy to be effective it has to be about more than just the stock of base money.

It is really about the creation in the banking system (Yamaguchi 2012):

Because at the ZLB success has been very limited to none.

More to Hyperinflation Than "Printing Money"

 (Weeks 2012)

Excess Reserves Are Potentially Dangerous in terms of inflation risks during normal times

...central banks’ quantitative easing policies have brought excess reserves in the developed economies to extremely high levels. Excess reserves now amount to 13.3x the statutory reserves required to maintain the money supply in the US, with corresponding figures of 4.9x for Japan and 5.0x for the eurozone (Koo 2012, p. 2)

That such inflation has not been observed in Japan, the US, or Europe is attributable to the fact that, in spite of zero interest rates, businesses and households are not only not borrowing money but are actually paying down debt. Reserves supplied by the central bank cannot leave the banks in the form of loans and therefore remain trapped in the banking system.Businesses and households are not borrowing even though interest rates are at zero because their balance sheets were severely damaged when the asset price bubbles burst. Put differently, quantitative easing policies have had no impact on prices or economic activity thus far because there is no private-sector demand for funds.There is no reason why unconventional monetary accommodation should work during a balance sheet recession. But nor will it do any harm because funds supplied by the central bank simply accumulate within the banking system. (Koo 2012, p. 3)

 From your scribe`s point of view, the main reason that hyperinflation will not result from excess reserves is because those reserves are not spent into the economy – some argue that the American money center banks (for one) have been rehypothecating via the repo market – but if there is excess lending – more money lent than industrial production and household consumption warrants -- then, yes there will indeed be inflation.

Bottom Line: Household debt burdens in many parts of America are still very high and employment in the economy as a whole is affected by subdued consumption; there is an asymmetry here as the small class of the population that is relatively un-levered will drive the spending but whether it can continue to do so while the shenanigans domestically (debt ceiling) and internationally (Eurozone) continue is anyone`s guess. In the meantime, households --the sector that counts-- must continue to delever.

Deleveraging: No Easy Way Out (Minack 2012)

In the long run, we have Financial Repression (Montier 2012)

And in the aftermath of crashes, financial repression lasts a long time (Hoisington and Hunt 2012)

Even with the "Evans Rule" - Be Prepared To Wait

People are right to think that interest rates must go up in the future but by how much and when is the question. In 2011, this blog made the case for a long term secular trend of low rates without rate normalization given the facts surrounding the global economy and impending demographic changes; the facts must change in order for the position to change.

The opinions reflected in this post 'Debt: How Much Is Too Much"bare those of the author and do not reflect those of the author's employer. 
References:

 John Maynard Keynes, The General Theory of Employment, Interest and Money, (Palgrave Macmillan, 1936) http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch24.htm (accessed December 20, 2012), chap. 24.

Reinhart, Carmen M., and Kenneth S. Rogoff. "Too Much Debt Means the Economy Can’t Grow: Reinhart and Rogoff." Bloomberg View, July 14, 2011. http://www.bloomberg.com/news/2011-07-14/too-much-debt-means-economy-can-t-grow-commentary-by-reinhart-and-rogoff.html  (accessed January 16, 2013).

Posen, Adam. "Japan should rethink its stimulus." Financial Times, FT.com edition, sec. Opinion, January 15, 2013. http://www.ft.com/intl/cms/s/0/15aa8934-5e72-11e2-a771-00144feab49a.html

Tett, Gillian. "Funding and the patriotism test." Financial Times, FT.com edition, sec. Columnists, January 7, 2010. http://www.ft.com/intl/cms/s/0/0306069c-fbb4-11de-9c29-00144feab49a.html

Arslanalp, Serkan, and Tsuda, Takahiro. “Tracking Global Demand for Advanced Economy Sovereign Debt.” IMF Working Paper 12/284, December 2012. http://www.imf.org/external/pubs/ft/wp/2012/wp12284.pdf

Steve Keen, “The fiscal cliff – lessons from the 1930s: Report to US Congress, 6 December 2012”, real-world economics review, issue no. 62, 15 December 2012, pp. 98 http://www.paecon.net/PAEReview/issue62/Keen62.pdf

Sufi, Amir. University of Chicago - Booth School of Business, "Capital Ideas: Painful Debt." Last modified 2011. Accessed January 17, 2013. http://www.chicagobooth.edu/capideas/dec-2011/painful-debt.aspx.

Koo, Richard. Nomura Equity Research, "Japan’s election and the dangers of unconventional monetary accommodation." Last modified December 11, 2012. Accessed January 16, 2013.

Kaoru Yamaguchi, Macroeconomic Dynamics - Accounting System Dynamics Approach. Draft Version 4 (2012). Accessed january 17, 2013. http://gmba.doshisha.ac.jp/about-us/people/kaoru-yamaguchi

John Weeks, The Irreconcilable Inconsistencies of Neoclassical Macroeconomics: A False Paradigm , (Abingdon, United Kingdom: Routledge, 2012), 273.

Gerard Minack, "De Minimis Deleveraging", Morgan Stanley - Downunder Daily, November 27, 2012

Gerard Minack, "Can't Save Your Way Out", Morgan Stanley - Downunder Daily, November 29, 2012

James Montier, "The 13th Labour of Hercules: Capital Preservation in the Age of Financial Repression", GMP White Paper, November 2012.

Hoisington, Van R., and Lacy Hunt. Hoisington Investment Management Company, "Quarterly Review and Outlook Second Quarter 2012." Last modified 2012. Accessed January 17, 2013. http://www.hoisingtonmgt.com/pdf/HIM2012Q2NP.pdf

No "rate normalization": a case for a secular trend of low rates in Canada

The opinions reflected below are those of the author.

Summary: 

The main takeaway is that there will be neither a swift nor partially delayed return to rate normalization (a rate that may be defined by the Taylor Rule or its variant) in Canada despite the highly accomodative interest rate environment that should theoretically spur strong growth after the slack in the economy is taken up by pent up demand.


The forecast is for a secular trend of "low rates" (with an upper bound of 2.50%). This long term secular forecast does not entail no growth; it entails below trend growth and the dynamics of a global austerity cycle forming a backdrop against a Canadian demographic trend that will be coincident with government policy attempting to reflate rather than burst asset prices and the related debt that Canadians have undertaken in the absence of real wage growth. 

"Low rates" are defined as 20th percentile of median BOC rates of the last 21 years --during which monetary policy became tied to the nominal anchor of core inflation at 2% (+/- 1%); a "normal" rate during this period could be represented by the median rate that has been 4.25%.  

We should see low rates as a secular trend ("long term")--with discretion trumping rules as the end of an epoch of profligacy in the developed nations opens the door to a new era of shifting challenges within the Canadian and global economy; this will make the trend growth of the past generation as elusive in Canada as it has been in Japan but it will not mean no growth just lower than trend growth of the last 30 years that has been intensified due to a favourable credit and demographic environment.

The Canadian context of a democratic small open economy with a solvent, liquid, protected and highly regulated banking system whose greatest financial risk --a crash in the housing market akin to that in the United States-- is backstopped thanks to the unknowing largess of the Canadian taxpayer does not translate easily to the rest of the developed world that is beholden to zombie banks acting as dead weights to their respective economies and serving no purpose but black holes of capital consumption.

However, the basic framework here --incorporating Development, Debt, Deleveraging, and Demographics-- suggests that demand is driven through multiple sources and the degree to which various economic agents engage in them remains as relevant for the rest of the West as it does for Canada.

Prologue

The most popular posting of this blog has remained the commentary on the importance of and access to credit to spur and maintain growth in a modern developed capitalist economy where credit as money (rather then money as a medium of exchange that is a substitute for barter) remains central to the functioning of the real economy and the means of production.

Rather than a rhetorical flourish based on polemicist dictum the idea behind the importance of credit was influenced by two works: one constructed by orthodox neoclassical means (Biggs, Mayer, and Pick); the other via a model of systems dynamics cross pollinated with economic history (Keen) influenced by sources as diverse as Joseph Schumpeter, Irving Fisher, Augusto Graziani and Hyman Minsky.

Introduction
The Importance of Credit
Concept: The Credit Impulse (by Michael Biggs, Thomas Mayer, and Andreas Pick)
Further reading:  The myth of the "Phoenix Miracle" and Credit and Economic Recovery

GDP growth is a function of both the change in the flow of credit (second derivative aka "credit impulse")  and the change in the stock of credit (first derivative aka "credit growth"). Recalling university calculus this entails that if credit change is stable then the credit impulse is zero but if the change in credit growth is volatile then the credit impulse is large. The authors stress that GDP growth should be viewed as functions of the change in new debt and they emphasize the role of private credit (as opposed to government).

Wonkish sidebar: The credit impulse is based on the first difference of flow series (normalized by GDP) from the Fed Flow of Funds (i.e., F tables). The change in credit stock is based on the level of the credit stocks (i.e., L tables) (divided by GDP deflator).

Concept: The Credit Accelerator (by Steve Keen)
Further reading: Credit Accelerator Leads and Lags; Economic growth, asset markets and the credit accelerator;  Updated Credit Accelerators and Dude! Where's My Recovery
The Credit Accelerator (CA) at any point in time is the change in the change in debt over previous year, divided by the GDP figure for that point in time.

Wonkish sidebar: There are three legs to Keen's argument:

(i) The main constraint facing capitalist economies is not supply, but demand as capitalist economies exhibit excess labour, excess productive capacity and generate a much higher rate of innovation than socialist economies.

(ii) All demand is monetary with two sources: incomes and the change in debt; AD = AS + Δ D

(iii) Aggregate Demand is expended not merely on new goods and services, but also on net sales of existing assets asserting the inaccuracy of Walras' Law and asserting Income + Δ debt = Output + Net Asset Sales

Net Asset Sales = Asset price level x fraction of asset x quantity of asset

 Rate of change of asset prices is related to the acceleration of debt

(N.B. This is not an equality) This entails a positive feedback loop between these two variables.

 A statistical analysis of Keen's CA yielded the following comment:

The key result is that there are statistically significant relationships between CA and economic variables, suggesting the importance of private credit in the real economy and the non-neutrality of money in the short to medium term (10 to 20 years). However, the causality of credit appears complex, not displaying the simple time-invariant causality of physics. As Steve's analysis suggests in a complex system where there are nonlinear feedbacks rather than linear causation one expects leads and lags to alter over time

In contrast to orthodoxy the pretext here is that money is neither neutral nor is debt-deflation entails a redistribution from debtors to creditors in the economy in aggregate; for the neoclassical view you would accept Ben Bernanke's rejoinder to the late Irving Fisher's theory as described in The Economist.

Credit in the real world

In the real world of fractional reserve banking, banks create credit out of thin air: the banking system extends credit to businesses; businesses employ labour; labour is paid and their wages ("savings") are then placed into the banking system who lend out further based on a fractional reserve system while businesses and consumer are able to borrow further and must service debt as a result . Of course, this simplified line of thinking is heretical to the orthodox view where savings are the starting point and reserves lead to deposits.  As the late Alan R. Holmes (former Executive Director and Senior V.P at the New York Federal Reserve) stated in Operational Constraints on the Stabilization of Money Supply Growth :

The idea of a regular injection of reserves-in some approaches at least-also suffers from a naive assumption that the banking system only expands loans after the System (or market factors) have put reserves in the banking system. In the real world, banks extend credit, creating deposits in the process, and look for the reserves later. The question then becomes one of whether and how the Federal Reserve will accommodate the demand for reserves. In the very short run, the Federal Reserve has little or no choice about accommodating that demand; over time, its influence can obviously be felt.

(bold emphasis added)

Credit in the Canadian context

Building upon the importance of credit we now go to the stylized representation of the Canadian economy. Some points to ponder when viewing the graphic:

1. The GDP national accounts have been included to provide readers familiarity with the standard aggregate demand relationship however the building blocks of policy --in terms of financial, government, and business sectors-- have also been included to help consider that political consideration and ideology weigh heavily upon ultimate policy. Rather than the standard national accounting identity, the intent for this stylized representation is for it to be  fitted to a stock-flow consistent model (like those of Wynne Godley) or dynamic model that is used in systems dynamics with the fundamental difference in the approaches being the use of discrete rather than continuous time treatment.
2. The role of credit provided by the banking sector has helped drive the increase in household indebtedness and driven consumption especially in light of stagnant real wage growth for all but the upper percentiles of wage earners
3. The unsustainable rise in residential property prices in Canada has been driven (in the urban areas of Vancouver and Toronto especially where condominium developments continue to mushroom) by a combination of foreign funds from the developing world (particularly China and Russia) and the access to mortgage credit that dwarfs the disposable income of the majority of Canadians. The price trajectory of single family dwellings in major Canadian cities (shown below) is proof that a picture says a thousand words.
4. The nebulous output gap remains (officially) the driver of monetary policy looking forward barring an explicit change in methodology by the BOC --see any Bank of Canada Monetary Policy Report-- while your scribe contends that the practical driver of policy remains the first and second derivative of the change in wages (i.e. "wage push inflation") culminating in the movement of core inflation.
5. While this stylized version has nothing to do with the Bank of Canada's DSGE model, TOTEM2 (an update to its original Terms of Trade Economic Model) the contention here is that going forward there will be far less volatility in the Bank of Canada overnight rate as the sensitivity of inflation to macroeconomic shocks --a mainstay of orthodox analysis-- is minimal due to the lack of pass through related to higher wages ("second round effects"); this translates to the majority of Canadian workers' wages not keeping up with the cost of living
6. The standard argument that growth in real wages are tied to growth in productivity does not hold up to the data: the median real earnings of Canadians hardly budged between 1980 and 2005 while labour productivity rose by 37.4% over the same period: Sharp, Arsenault, and Harrison state that divergence can be explained by four factors: measurement issues associated with wages, an increase in earnings inequality, a decline in labour’s terms of trade, and a decline in labour’s share of national income.
7. Monetary policy transmits more quickly to the market rates provided by the non bank financials and the shadow banking sector (in an "exogenous" manner) while meaningful credit creation to the consumer sector remains tied to the more highly regulated and scrutinized banking sector (credit is thus created "endogenously" within an economy).
8. The potential losses of any housing correction has been backstopped ex-ante by the largess of the Canadian taxpayer in the guise of the CMHC despite that government agency's well intentioned enterprise risk management framework; the profits will be privatized by the developers, those early to entry and early to exit, and those with built up equity over many years that can weather a correction with their net worth taking a minor rather then brutal hit --while the losses have already been socialized and will be socialized further in the event of a US style housing correction. Ultimately consumption falls in lock step with labour income and many years are required to make up for the loss in equity of a marginal correction.
9. The value of the Canadian dollar (from a flow of funds as opposed to pure speculation view) rests on the demand for energy based commodities and Canadian goods and services; a strong dollar remains a noose around the sustainable expansion of the Canadian economy as Canada continues to lag in terms of productivity versus the United States where capital uptake is substantially higher and firms can take advantage of economies of scale.
10. Global demand and supply dynamics vis-à-vis international trade will be driven by the developing world rather than the developed but both face their unique set of challenges: the developed world with social unrest as the social contract of a safety net unravels under the scathing sword of austerity juxtaposed against the profligacy of failed leadership; the developing world with inflation as a burgeoning middle class and greater leveraging (through credit access) making the aspirational wants of tomorrow a reality today.
11. Canada is not an island unto itself; it remains linked to and wholly dependent upon the United States where the challenges of societal inequity are only outstripped by the the self absorbed incompetence of the political class.
12. A nation's balance sheet should be thought of in terms of the businesses, various levels of government, households and banks: these balance sheets influence the aggregated demand in the economy and (when over leveraged and indebted after many years) skew growth expectations to the downside.

See the pictures and charts that follow (and click if you wish to enlarge)

        A stylized view of the Canadian economy

Why will rates remain low over the long term?

Deleveraging
At current rate of US savings --and assuming that there is no further relapse in housing or appreciation in market values of residential properties in the United States-- it will take 12 years to deleverage (see Technical Box 1 of the October MPR).

Japan vs. US in perspective

But while US consumers are deleveraging, Canadian consumers and governments have been leveraging up and taking on more debt.

Debt

Canada's Deficits and Debts - historical overview of recent political economic history

The austerity path entails sitting out a growth cycle (at a minimum) and seeing no substantive improvement in the net worth of a nation's citizens. In Canada, this path was undertaken in the mid-1990s by Jean Chretien's Liberal government (with Paul Martin as Finance Minister) after painful cuts to programs and transfers to the provinces; are the developed economies in Europe and the United States going to go along a similar path? The UK appears to be doing that at this point. 

Canada re-embarked on the path of deficit spending in the modern era under the Liberal governments of Pierre Trudeau in the 1970s (when Federal debt/GDP ratio was 22%); these deficits and the resulting debt ballooned under the Progressive Conservative governments of Brian Mulroney in the 1980s but for a small open economy (SOE) the bell tolls quickly; while Canada sleeps next to the elephant, it never will be the elephant as that beast is the global hegemon with the world's reserve currency. Growing deficits and spiralling debt were deemed unsustainable by the capital markets with Canada losing its AAA credit rating in April 1993.

The most influential policy advisers behind the scenes in Ottawa --David Dodge and Peter Nicholson-- convinced the Prime Minister and Finance Minister by 1995 that deteriorating external market opinion --WSJ characterized the Canadian dollar as the Canadian peso-- would entail one essential prescription: smaller government ("restructuring") leading to cuts on the expenditure side of the ledger than would in turn lead to a slaying of the deficit dragon (Federal debt/GDP ratio was 71% in 1995). If this route was not followed then a visit from the IMF would be forthcoming.

The political will today is for austerity and against stimulus --even if the binary nature of the decision is a false one-- and as such the risk to growth remains to the downside. Every nation intends to muddle through by following in Canada's footsteps even if they intend to do so at varying speeds.

The Chretien Liberals took a right of centre "Keynesian" (meaning counter cyclical) fiscal policy approach by enacting cuts to spending, paying down debt, increasing taxes and building up surpluses during the growth phase of the business cycle.

In retrospect, the austerity policy meant that Canada lagged in terms of: (i) growth --which deflated political allies at centre such as former TD economist Doug Peters who advocated growth before austerity;  and (ii) social programs and combating inequity--which was criticized by opponents on the left yet, ironically, was praised by opponents on the right such as the Fraser Institute.  The outcome of policy was evident as a noticeable brain drain of talent left Canada for the greener pastures of the United States and elsewhere, many never to return.

No two nations have an identical political economy; Canada's restructuring can be see as necessary medicine for a SOE that is a price taker in world markets but the future of the Canadian debt situation remains mired in the fog of policy uncertainty versus political will.

Will the lessons learnt from the 1990s be lost since the frugality of that period provided breathing room for supply and demand side stimulus which left Canada's balance sheet less worse off than its developed world peers after the Great Recession? The closing of that deficit remains on hold with an uncertain trajectory but if that closing is realized then it will be a drag on the economy; we cannot assume crowding out when a nation is not at full employment.

A reduction in the growth of government spending (G) in the 1990s coincided with reduced growth in consumption (C) and fixed capital formation (I)

Debt and asset markets: Canadian Housing

If you are of the view that lower house prices represent a wealth transfer from households that own more housing than they plan to consume to new home buyers then a housing correction isn't necessary a problem. However, the key is that consumption can be crippled after a real estate asset crash: the cases of the United States, Spain, Japan and Ireland illustrate that it can (and will) take years to make up for the bursting of an asset bubble.

In terms of financial obligations, it is understood that a mortgage is a long-term financial commitment that can takes years to work its way out of a system and off the liability side of a household's balance sheet.  South of the 49th parallel,  25% of US mortgage holders have negative equity in their homes while another 45% have less than 20% equity which constricts the confidence channel meaning;  the "poverty effect" at the micro level translates into a lack of confidence in the aggregate; the under water mortgages create a "ball and chain" tying an individual to a particular location and precluding the opportunity for job relocation.

But does the American experience hold true for Canada? Of course, the argument in defence of high and rising real estate costs in Canada is that  housing is ultimately local and the dearth of quality housing stock supply in a large city like Toronto is small and of questionable quality when compared to the outsized demand of those who wish to settle there. 

The concern is that Canada today is where the United States was circa 2005-6. At that time, Michael Hudson's highly readable and entertaining piece  The new road to serfdom: an illustrated guide to the coming real estate collapse was published in Harper's magazine:

America holds record mortgage debt in a declining housing market. Even that at first might seem okay—we can just weather the storm in our nice new houses. And in fact things will be okay for homeowners who bought long ago and have seen the price of their homes double and then double again. But for more recent homebuyers, who bought at the top and who now face decades of payments on houses that soon will be worth less than they paid for them, serious trouble is brewing. And they are not an insignificant bunch

Can Canadians maintain their current debt trajectory?

Debt capacity = f {PAssets / PDebt, cost of funding, expected income growth}; if the majority of Canadians are not seeing rises in real income then it brings into question the sustainability of the increased indebtedness while the cost of funding has kept debt servicing manageable and the asset to debt multiple has made Canadian homeowners feel richer - especially those with plenty of equity in their properties.

Household debt to personal disposable income

Historical Canadian Prime Rate

Historical Canadian Unemployment Rate

Canadians have taken on debt with financial conditions currently at a positive to neutral level.

As a counterpoint, National Bank economists, Stefan Marion and Paul-Andre Pinsonnault have argues that Canadian indebtedness is less than that of American when health care costs are take into account.

But this fails to consider the reality of the two markets; the spending power of the American remains greater than that of the Canadian as she is able to purchase cheaper goods with lower retail and income taxes. Going forward, this may not be the case as America has the ability to take care of its fiscal situation (on the income side) at the federal level through increased taxation on consumption, fewer loopholes in the tax code, and enforcement of a progressive tax regime that is currently beholden to the whims of K street lobbyist while Canada faces a silently significant challenge: demographics.

Demographics
Recommended reading:
 Fiscal Sustainability Report (September 2011) from the Parliamentary Budget Officer (Kevin Page).
Canada's Looming Fiscal Squeeze (Chris Ragan, McGill University) (powerpoint presentation).
Canada's Looming Fiscal Squeeze (published by the Macdonald-Laurier Institute, November 2011).
The Age of Aging: how demographics are changing the global economy and our world (George Magnus, January 2008)
http://www.footwork.com/ (David Foot, University of Toronto demographer and author of Boom, Bust and Echo)

The case for low secular rates via the demographic effect is  based on Statistics Canada findings where (i) there is now the dominant baby boom cohort just retiring; (ii) lower fertility rates over the past generation (baby bust and echo cohorts) are entering their working years; and (iii) longer life expectancies, the proportion of Canadians over 65 will dramatically increase over the next two decades (see Canadian population pyramid evolution).

In 1946, retirees (over 65) proportion was 7.2 %; in 2006, 13.2%; and by 2056, it will be ~25 %.

This retiree shift will reduce the proportion of the population who are productive, while increasing the proportion who are drawing upon government services and pensions (the dependency ratio). Older Canadians have a higher demand for healthcare but lower demand for other goods and services which translates to lower aggregate demand (via lower consumption). Most importantly, older Canadians hold the political power and as we all understand, fiscal policy is politically constrained, so the entitlements will flow unless the governing party in power wishes to be kicked out of power.

Declining population growth

Increasing entitlement burden and increasing health care costs

Dependency ratio will increase as working age population (and labour force participation rate) decreases

This will result in a drag in per capita GDP without a massive increase in productivity

Income support programs

Fiscal squeeze

Christopher Ragan, "Canada's Looming Fiscal Squeeze," November 2011

"The inconvenient truth that Canadians and their governments must immediately face is that the existing demographic forces and the fiscal implications that follow are so large that governments will need to respond by making fundamental adjustments to their fiscal frameworks. As is always the case, the simple arithmetic of government budgets implies that there are only two broad fiscal choices available to address the looming fiscal squeeze. Spending programs can be reduced or eliminated or taxes can be increased. There is nothing else."  

(bold emphasis added)
Development

Wonkish sidebar

The degree of development has been left for last as it ties into how inflation will funnel through in developed and developing economies. On the one hand there is the conventional wisdom that "inflation is always and everywhere a monetary phenomenon." This meme is parroted by the intelligensia and and the respect of Milton Friedman's hucksterism within the fawning media means that it is not surprising to recognize why we are in an economic quagmire.

When Friedman coined the cliché he had referred to a one commodity economy with no technical change, eliminating the possibility of differential price movements, as well as excluding income distribution effects and quality change. While these unrealistic assumptions appear absurd, they formed the basis of Friedman's case for positive as opposed to normative economics. Given that we live in the real world as opposed to the fairy tale existence where we are rational economic actors with the foresight of prophecy, we will ignore the former positivist approach.

For a nuanced view, where we have the situation of the monetary base being increased greatly, Friedman's aphorism can be true but does not necessarily have to be true. The FED's actions, and those of the Swiss National Bank attest to that: ultimately the FED's action has led to the exporting of inflation to the developing economies (despite the analysis of the San Francisco FED economists who maintain that this has not the case). The combination of a liquidity trap and balance sheet repair domestically, and the search for growth internationally through portfolio capital flows has meant no inflation in the United States but serious asset inflation elsewhere.

But if Freidman's aphorism was meant to mean that "governments printing money create inflation" then the term is undeniably false: inflation --specifically hyperinflation-- is the result of three inter-related factors: (i) increase in money supply of fiat currency combined with (ii) social and political stress often associated with post-war political instability, civil war, or adjusting to defeat as a consequence of war and (iii) weak government.

In a developed economy such as the United States, which remains a global hegemon despite being a waning empire, the ballooning of the monetary base without a concomitant increase in the velocity equates to benign domestic inflation. The United States is not Weimar Germany and hopefully will never be.

Understanding development is important because inflation reflects increases in demand and the growth of the developing world entails greater demand for commodities. Commodity price increases, particularly food,  funnel through to headline inflation that has a 15% weighting in the U.S.; a 30% weighting in China.

Canada is a net exporter of commodities related to energy and foodstuffs within the broad dynamic of the global market. The deleveraging and debt burdened developed economies on an austerity path entails slower commodity demand; the growing and leveraging developing economies on a growth path entails greater demand for commodities which in turn signals demand for the loonie. The Canadian currency, when rising, acts as a drag on the economy while improving the nation's terms of trade and lessens the requirement for hiking.

However, in either a developed or developing economy, the critical factor remains the pricing power of labour. The occurrence of real wage increases determines the persistency of inflation; diminished labour power  (since the neoliberal revolution of the late 1970s) has meant that companies have not had to build in cost of living allowances and so the real spending power of workers can only increase through career progression (which is unrealistic for many) or an increase in the value of assets owned in relation the value of debt owed. Absent real wage increases, reliance on increasing prices of real assets and selling those at a capital gain connotes a ponzi economy: this  was Spain, Ireland and the United States and is now Canada.

An economy in which income cash flows are dominant in meeting balance-sheet commitments is relatively immune to financial crises: it is financially robust. An economy in which portfolio transactions are widely used to obtain the means for making balance-sheet payments can be crisis-prone: it is at least potentially financially fragile.

Hyman P. Minsky, Stabilizing an Unstable Economy, p.227, McGraw-Hill 2008

If inflation becomes an issue in the developed world then it is a transient one. There is no need for it to persist in a developed capitalist state: the way to break the back of inflation is to break the back of "average" wage earner. This is what former FED Chairman Paul Volcker succeeded in doing in the 1980s and it is what former Bank of Canada Chairman John Crowe perfected in the early 1990s by manufacturing a harsh made in Canada recession that brought headline inflation to close to zero in 1994. (See the unemployment chart above that ensued as a result of the religious zeal for price stability).

A policy direction of that magnitude would be disastrous for Canada now and make the interest rate forecast appear bullish.

The argument here is that the Bank of Canada and Department of Finance would, through the levers of monetary tightening by subtlety and fiscal tightening by stealth, rather engineer a soft landing in residential housing sector and permit an orderly reset so that house price affordability ratios revert to a long term mean rather than deal with the ramifications of a property crash or severe correction. While asset prices are not an explicit part of the BOC mandate, they are clearly weighing heavily on decision making --residential investment was part of consumption in TOTEM while it is modeled separately in TOTEM2.

Wonkish sidebar: Renovation + new housing + transfer costs = Residential investments from National Accounts

We have seen that monetary policy has been largely ineffective at the lower bound yet it remains incredibly potent in terms of choking off economic growth due to the sensitivity of Canadians to rate hikes.

Assuming that rates along the trajectory of a business cycle go from 1% to 2.5%, we can observe how debt servicing would increase on a mortgage of an "average" City of Toronto home owner (May 2011 data). The extra 150 bp in rate increases translates to a yearly debt servicing increase of $5,376 dollars on a variable rate mortgage whose principal amount was $535,807.

Wonkish sidebar: I am not subscribing to the New Classical notion of one representative agent as I prefer the analogy of a phase transition where a mass of people do a similar thing and pursue similar options at once due to social pressure. There must be a consequence to social structure that constrians some outcomes and encourages others.


Keep in mind that in the real world, an increase in debt servicing is not isolated; increased commodity prices funnel through to the monthly grocery and fuel bill also: in aggregate, absent a real wage increase and access to further credit to supplement income, this translates to lower consumption.

Where will domestic inflation come from? 

The middle class in the developing world is seeing gains in real incomes; this drives headline inflation over there.

The middle class in the developed world is seeing stagnation in real incomes; as such. rising commodity prices have the pervasive effect of being contractionary in North America where, for example, an increase in gasoline costs must be absorbed (like a tax) by the consumer who will have to ration consumption elsewhere without resorting to the usury of credit card financing in order to make purchases of necessities possible.

The reality is that globalization and technological change (typically embraced by developed nations) has meant that many former middle class jobs will not be returning any time soon and this concern is exacerbated if the combination of globalization and technology moves up the income "food chain".

Ultimately, if the domestic middle income wage earner is gutted then the domestic middle income target market is diminished; producers will have to cater to a market for the plutocrats and a market for the rest. 

Ultimately, this again entails less labour pricing power and less expectation of inflation growth.

Key takeaways

• This is not a doomsday scenario that predicts depression for Canada; it is a scenario that argues  for low secular rates. 
• It does predict slower growth based on an (external austerity + deleveraging) dynamic in developed nations and (long term private debt management + societal aging demographic) dynamic domestically.
• It assumes benign inflationary environment due to no rise in real wages.
• It implies a disconnet between the health of corporations versus consumers as a cap on real wages and access to developing markets plus healthy corporate balance sheets act as a float to corporate profitability.
• It takes into account the downside risk of a real asset correction as opposed to a crash.
• It also implies that the policy makers in Ottawa are actively attempting to maintain asset reflation policies without having the Canadian economy go down the well trodden disastrous  path of real estate crashes seen in other developed nations. 
• The upside risk to this long term forecast is that developing world restructures much more quickly than expected so that they become consumers and not beholden to an export driven model of economic growth.
• Moreover, the upside risk assumes that China does not suffer from capital flight and India and Russia have manageable geopolitical concerns while Brazil is able to keep the inflation genie in the bottle (all possible/probable downside risks).
• Bank balance sheets matter; private balance sheets (in particular) matter; government balance sheets matter --  but no one knows the demographic tipping point for softness in housing.
• When does the demographic wave trigger no price appreciation and possible price depreciation in residential real estate?
• The rate of credit growth and the credit impulse/accelerator drives investment in a capitalist economy but if that investment is not in productive entrepreneurial activity but disproportionately funneled towards real and paper assets then there is the ponzi economy phenomenon.

The opinions reflected in this post 'No "rate normalization": a case for a secular trend of low rates in Canada' are those of the author and do not necessarily reflect those of the author's employer.