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When the future is uncertain, is the past any guide?




If you looked at the VIX volatility index for, let’s say, the likelihood of a global financial meltdown occurring in the end of 2007, you would have bought options on nothing happening for the next year. The index hit its all-time low right then, two months before the subprime crisis kicked off.

If you had then wagered that the liberal economic ideas that had governed global markets for the prior quarter century would be completely forgotten, as dusty old Keynesian textbooks were consulted on what to do in the world’s finance ministries as it all went to hell in 2008, you would have also have gotten very long odds.

And finally, when the world’s central banks began chucking trillions of dollars, euros, and yen into the global economy starting in 2010, the smart money was betting on a massive inflation being the result. Today, the world is mired in deflation instead.

Yogi Berra once said, “Prediction is hard, especially about the future”. To which one might add, “especially when that future seems to look like the opposite of our past expectations.” So how then can we make sense of it?

There is, on the one hand, a temptation, especially with the established politics of the past quarter-century giving way to a cabal of variously: American reality TV hosts, Italian comedians, Spanish lefty-academics, and uber-posh British nationalist twits – to conclude that it’s all random and there is no way predict any of it.


Rise of a ‘new fascism’?

On the other hand, there is a similar temptation, to harken back to the 1920s and 1930s – the last time recessions and depressions shook up established politics – to predict the rise of a new fascism in everything from Trump to Brexit, which surely generalises too much from an N of 1.

But maybe there is something in the current moment that can tell us how this new and uncertain environment was generated – and how that may play out: the lack of inflation almost anywhere that isn’t Venezuela.

This is not in the textbooks. If inflation is, as Milton Friedman convinced us, “always and everywhere a monetary phenomenon,” then with more and more money being pushed into the global system than ever before, the lack of inflation is a puzzle. But it’s also a clue. To see why, go back to the last time we had inflation, in the 1970s.


What’s changed since the GFC?

The so-called “great inflation” was caused by consistently super-tight labour markets, in relatively closed national markets, pushing up wages and prices at the same time as there was a massive commodity shock. The solution to this inflation was to globalise markets, which weakened labour while boosting the returns to capital through higher real interest rates. Investors everywhere ran those rates down to zero over the next 20 years, taking on leverage all the way to make money on a declining spread. The result was a massively overleveraged financial sector that was brutally exposed in 2008.

Nearly 10 years on we still live in a world where labour cannot push up wages, both public and private indebtedness is still rising, and global supply chains and technology combine to make margins razor thin, profits harder to come by, and most shocks price negative.

What if we live in a world that is not the precursor of the 1930s, but the ‘mirror universe’ (apologies to Star Trek fans) of the 1970s? Having vanquished the forces of inflation so completely have we instead built a system that generates system deflation despite the money sloshing (very unequally) around it?

That would explain persistent low growth, super low rates, central bank impotence, a global savings glut, and, to an extent, even Donald Trump. After all, those low wages and offshored jobs didn’t come from nowhere. So if this is minimally plausible, where can we invest in such a world?


Mark Blyth, Eastman Professor of Political Economy at Brown University in the USA, discussed this topic at ASI in September.