From Grantham Mayo Van Otterloo:
Mar 2017
GMO
White Paper
James Montier
Philip Pilkington
In a companion paper, “Six Impossible Things Before Breakfast,” we present evidence that asset
markets are generally priced for “secular stagnation,” and argue that this requires a number of
extreme assumptions on the part of investors. However, we didn’t really explore the root causes and
consequences of secular stagnation in that paper. We remedy that with this paper, which is a deep
dive into the murky world of secular stagnation, its sources, and its impact.
The rise of populism has been one of the broad themes to emerge over the last few years. This has left
many within the establishment scratching their heads as to the cause of their fall from grace. From
our perspective, the rise of populism has its roots in the same sources that have given rise to so-
called “secular stagnation.” That is, a broken system of economic governance. This system – which
we will hereafter refer to as “neoliberalism” – arose in the mid-1970s and was characterised by four
significant economic policies: the abandonment of full employment as a desirable policy goal and its
replacement with inflation targeting; an increase in the globalisation of the flows of people, capital,
and trade; a focus at a firm level on shareholder value maximisation rather than reinvestment and
growth; and the pursuit of flexible labour markets and the disruption of trade unions and workers’
organisation.
The orthodox view on secular stagnation seems to adopt one of two perspectives: either that secular
stagnation is caused by a situation where the real interest rate has to be negative in order to generate a
return to growth (a demand-side explanation), or that something has gone very wrong with the nature
of productivity in the economy (a supply-side explanation).
We have been outspoken critics of this framework1
of thinking. Rather than being the result of some
unobservable figment of economists’ imaginations (as we believe the natural rate of interest to be), or
some strange exogenous productivity event,2
we argue that it is the policies that have been pursued
that have led to the observed “stylized facts” of secular stagnation (Exhibit 2). The neoliberal regime
has given rise to: lower inflation; lower growth rates; lower investment rates; lower productivity
growth; increasing income and wealth inequality; diminished job security; and a serious deflationary
bias in the world economy that was only temporarily “plugged” by dangerously high levels of private
sector debt accumulation. These are long-term trends that have been visible for decades, but they were
severely exacerbated by the collapse of the global debt bubble in 2008-09.
As the citizens of various countries around the world gradually woke up to the fact that the quick-fix
solutions put in place after the crisis merely kept a lopsided and increasingly dysfunctional system
ticking over, they rebelled. It was then that they started to cast votes for various populist political
candidates in an apparent effort to shake up the system. Without such a splash of cold water to the face,
there is every chance that the system would march on regardless of its dysfunction until it decayed
to such an extent that it simply collapsed – not unlike what happened in the non-democratic Soviet
Union. If we are to prevent our own sickly Brezhnev era from slipping into a terminal state, we must
understand clearly the causes of our current morass.
1See, for example, “The Idolatry of Interest Rates, Part I: Chasing Will-’o-the-Wisp,” May 2015. This white paper is
available with registration at www.gmo.com.
2We argue that the slowdown in productivity largely reflects the slowdown in growth, rather than causing it. This
hypothesis is explored in the appendix to this paper.
The Four Pillars of Neoliberalism
Inflation targeting and the NAIRU
The first of the four key pillars of neoliberalism is the abandonment of full employment policy and
its replacement with inflation targeting. After the Second World War governments around the world
realised that they could easily generate full employment through spending and taxation policies. This
realisation came because of the economic experiments undertaken during the war – experiments that
were necessitated by the war but that were consciously structured in line with the economic approach
outlined in Keynes’ 1936 book
The General Theory of Employment, Money and Interest
. As Nicholas
Kaldor wrote, “The formal obligation to maintain high and stable levels of employment... emerged as
a joint impact of the Keynesian revolution in economic thought and the Second World War.”3
These policies were remarkably effective, and the decades after the war are generally known today as
capitalism’s Golden Age. The Golden Age was characterised by high rates of employment, economic
growth, and an equitable distribution of income and wealth. In the mid-1970s, however, these policies
were abandoned because they were thought to be causing inflation. This was an incorrect assessment,
as the inflation was actually generated by oil shocks imposed by the OPEC cartel in response to
US foreign policy in the Middle East combined with poor labour relations in the English-speaking
countries that led to class conflict and strikes over who should bear the brunt of these higher oil prices.
But the economics profession at the time did not realise this. Their theories told them that it was the
full employment policies that were generating the inflation, and so they encouraged policymakers to
abandon these policies and instead have the central bank attempt to control inflation through the use
of monetary policy. The impact of these policies in the US could not be clearer, as shown in Exhibit 3.
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MUCH MORE (22 page PDF)
