The Four Horsemen of the Economic Apocalypse

The title is an exaggeration--apocalypse is only a tail risk, and perhaps not a very big one. In the long run we're gonna come out all right. Though there is a big problem with that--we have to survive long enough to get to the long run, or put another way, in the long run we'll all be dead.

Anyway--here are the four big issues that I think will determine our lives for the foreseeable future.

1) Demographics

World population growth is slowing, and by 2050 it is expected to start declining. The populations of much of the industrial world--Europe, Japan, Korea--are already in freefall. For other countries the handwriting is already on the wall--China's population is aging rapidly and within a generation they will look like Japan does today. 

The US is still growing slowly, but only because of immigration from small poor countries (e.g., El Salvador) not yet afflicted by family planning. While American baby boomers (unlike their counterparts elsewhere) gave birth to the Millennials, that latter generation is not continuing the tradition--birth rates among today's 30-somethings are very low. Unless that turns around fast, the biological clock eventually ticks against us as well.

The only part of the world still experiencing significant population growth is sub-Saharan Africa--and that likely not for very much longer.

Outside the United States (because of our large millennial generation) the population of working-age adults (18-64 year olds) is in freefall. Since economic growth depends first and foremost on the skill-adjusted size of the labor force, global GDP looks likely to shrink in coming years (unless African populations can substantially improve their skill levels and access to global markets).

A shrinking labor force means a shrinking GDP, but it's worse than that. All those old people still have to be housed and fed, so GDP per capita also has to decline. Or put another way, fewer goods and services will have to be distributed among more people. We're gonna get poorer.

In the long run the baby boomers will pass on, and presumably birth rates will eventually recover, in which case things will turn around. But that long run seems really far away--and as a baby boomer myself, I won't live to see the day.

2) Artificial Intelligence

Moore's Law states that the density of transistors on a chip--and with it, computer power--will double every 18 months. It's not just computers that have gotten more powerful, but also connectivity--from phone modems to fiberoptic cable, to 5G broadband wireless. There have been massive advances in computer architecture--not too long ago parallel processing required many computers--now as many as 12 processors are built into a single PC chip.

But even more impressive than all of that is the rise of artificial intelligence (AI)--the ability of computers to solve complex problems. In 1996, chess world champion, Garry Kasparov played a computer named Deep Blue, and won. They went for a rematch in 1997, and this time Big Blue won--it was the first time an AI machine had beaten a human grandmaster. Now it's routine--AI chess is better than any human chess player. In 2016, a computer AlphaGo beat world champion Lee Sedol at Go.

AI can do more serious things. For example, Mark Cuban (paywalled) notes that Amazon and Walmart use AI to perfectly price any product--too low a price leaves money on the table, and too high discourages purchasers. The result--the optimal market price--maximizes revenue, and gets more product into the hands of more consumers. No other retail company can do as well, and certainly not Mom & Pop, who are left in the dust.

So here's the rub: new technology has always displaced human workers, e.g., the automobile put blacksmiths out of business. But it has until now happened slowly enough that people could retrain for different jobs--not always painlessly, though usually within a decade. But AI is coming on so fast and is so disruptive that it is eliminating jobs much faster than entrepreneurs can create new ones. The result is a massive dislocation in the labor force.

My former career--college professor--is in the midst of disruption. AI can potentially create narrowly tailored, individualized instruction adapted to each person's unique learning style. Gone will be the 100-person lecture hall, along with the mediocre professor at the front of the room. The number of professor jobs is already declining, and pretty soon they will all get sucked up into the Harvard-Google cloud.

Today's workers compete against the machine only because for the moment they're cheaper. For the first time in American history, real incomes for a large fraction of the population are in absolute decline.

Today this is a disaster. But in the long run, consumers will benefit from vastly cheaper and better goods and services. And entrepreneurs will eventually find ways to reemploy the nation's labor force (though that will likely take several decades).

3) Bankruptcy

We're at the top of the debt cycle. The world is deeply in debt. In the US the federal debt is now nearing 140% if GDP. State and local debt has also grown during the pandemic.

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Because of historically low interest rates, corporate debt has exploded.

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Only households have paid down debt (deleveraged) since the great recession, forced into liquidation by the financial crisis.

(Source)

The problem is not just in the US, but extends worldwide. This debt can never be repaid under current circumstances--there simply isn't enough money. There are only two ways out of the problem.

The first is inflation. If the Fed and other Central Banks can inflate their currencies, then the real value of the debt gets smaller. This is how Germany during the Weimar Republic planned to pay off war reparations--with grossly inflated banknotes when millions of Marks bought barely a loaf of bread.

Today the Fed (and other Central Banks) are desperately trying to engineer a more modest inflation rate, which will effectively make the debt cheaper. But so far they are unsuccessful, and I think, because of items 1) and 2) above, they will continue to be unsuccessful. (They could create hyperinflation very easily--but as Weimar Germany illustrates, that cure is worse than the disease.)

The second solution--and the one that's most likely--is bankruptcy, occasionally also known as a debt jubilee. A bankrupt corporation is sometimes reorganized, which just means the lenders have to accept pennies on the dollar. Occasionally it's liquidated and all assets are sold--and again, lenders net only a fraction of what they were owed.

Nobody knows what happens to a bankrupt state, but we're likely soon to find out. Illinois is closest to disaster, but Kentucky, New Jersey, Connecticut, New York, and others are not far behind. A preview of this coming attraction happened in Puerto Rico in 2019--and it wasn't pretty.

Bankruptcy is good in that it eliminates a lot of debt and people can start over. But it's really bad because it effectively reduces the money supply, leading to massive deflation. Deflation does the opposite of inflation: while the latter makes paying off debts easier, the former makes it much harder. Therefore, if one large enterprise (corporation or state) goes bankrupt, likely many more will follow, and the country will end up in a deep depression. This is not good.

A corollary is the Fed can't raise interest rates as that would force companies into bankruptcy. A second corollary is that we will need endless streams of "stimulus" and "quantitative easing" indefinitely into the future. That won't make anybody solvent, but it will at least keep us liquid enough to make next month's mortgage payment.

In the long run, whether it be by inflation or bankruptcy, the economy has to deleverage. Only then can full economic growth resume.

4) The Dollar

The dollar is the world's reserve currency. That means almost all foreign trade around the globe is denominated in US dollars. The dollar's dominance began with the Bretton Woods agreement in 1944, and became official when President Nixon dropped the gold standard in 1971. The reserve status of the dollar gives the US a great deal of soft power. And maybe not so soft power--we can unilaterally impose financial sanctions on other countries in a way impossible for anybody else.

But owning the reserve currency comes at a cost, and increasingly the cost begins to exceed the benefits.

In order to finance global trade, there must be a vast quantity of dollars held by foreigners. These dollars are deposited in dollar accounts in foreign countries--e.g., Switzerland--and are lent out by these foreign banks to finance what we now call globalization. Dollars held in foreign banks are misleadingly called Eurodollars--they have nothing to do with the Euro, and not really anything to do specifically with Europe. A US dollar deposited in a Canadian bank is just as much a Eurodollar as one deposited in Hong Kong or Switzerland.

The way other countries acquire Eurodollars is by running a trade surplus with the USA. We buy their products--toys from China or luxury cars from Germany--and we pay in dollars, which then get deposited in foreign banks and become Eurodollars. Their trade surplus is, of course, also our trade deficit.

The cost of holding the world's reserve currency is that the US must run large and permanent trade deficits with the rest of the world. This entails, among other things, gradually off-shoring all manufacturing to foreign countries so that we can import the products.

After WWII the US contributed 50% of global GDP. Today that number is below 25%. This isn't because the US is getting poorer--it's that the rest of the world is getting richer. But whatever the cause, we can no longer afford to run trade deficits big enough to finance global trade. It is impossible. The Trump administration understood this and set as a priority the reshoring of manufacturing to the United States. The Biden administration doesn't appear to get it yet, but I think they will quickly learn--reality will bite.

There is no other country in the world that is willing to finance global trade by running a huge trade deficit. China, Japan and the Euro zone all run trade surpluses, which means neither the Yuan, Yen, nor Euro can be a reserve currency. So we're screwed. Our current age of globalization is over.

This will be bad for the US--it will reduce our global dominance, and it will raise prices for American consumers. But it is a disaster for many developing countries that have pulled themselves out of poverty by selling goods into the US market. They will increasingly find that market closed to them.

It will be good for American workers--at least for a few of them. But the real winners will be American robots, who thanks to AI will be manufacturing stuff like it's going out of style.

In the long run something like bitcoin will be the world's reserve currency. But that's a couple decades away, at least.

Conclusion

We live in perilous times.

• Will a large fraction of our labor force become unemployable because of automation?
• Will the Fed work so hard to get inflation that we end up with hyperinflation?
• Will bondholders get spooked and refuse to refinance our debts, leading to a massive wave of bankruptcies and a global depression?
• Will the demise of the dollar lead to wars as countries scramble for resources that they can no longer buy because there is no reserve currency?
• Will the S&P 500 soar to the moon as a safe haven?  Or will it crash to earth as the economy disintegrates?
• Will quantum computing wipe out all cryptocurrencies, destroying our future reserve currency and new banking system in the process?
• Will some unanticipated event happen that rescues us from this whole mess?

I have no clue. It looks pretty grim from where I sit. All I can say is that in the long run we're gonna be richer than we've ever been before.

Further Reading:

• Austerity Comes to Campus
• The Revenge of the Lumpen Proletariat
• Book Review: The Decadent Society