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Low Growth, the New Normal

What does a future of low economic growth look like?  The Congressional Budget Office (CBO) economic forecast estimates a real growth (adjusted for inflation) of less than 2% for the foreseeable future.  We have discussed before how this pattern is likely to hold through the next generation and around the world as population growth slows and new opportunities will come only through technology improvements.

The implications are vast, if for no other reason than investing and saving for retirement are going to be very different concepts than we have come to expect.  Everything changes – and a few things may even change for the better.  It’s worth thinking through, and carefully.

treasurybondWe have to start with projected rates for US Bonds, currently running 2% on the 10 year US Treasury.  That’s right at the target the Federal Reserve has for inflation, meaning that such an investment is little more than a place to park money and not gain any ground at all.  But it’s even worse than that.  Given the projections that bond rates are likely to rise to 3.2% by 2015 and 4.5% by 2016, the only thing that can happen to bonds is that they will fall in value until the fixed interest paid on them matches the market rates we can expect.  In other words, you’re better off not buying them today and simply holding onto actual cash.

Why does anyone buy these bonds then?  The simple answer is that those with money need some place to park it.  It’s not ordinary capital, it’s “idle money” and the holders of it are incredibly risk adverse.   So the bonds keep being sold as little more than a parking space.

Obviously, riskier investments that yield more return are going to be essential at some point, since investors can’t hold onto this situation forever.  Typically, the more risk an investment holds the higher the rate has to be in order to justify it.  But if there are no “safe” investments more money is either going to have to take that risk or simply go away.  That implies that the “risk premium” of additional return is likely to go down, too.

It’s not going to be a good time to be an investor.  Careful, even personal risk management is going to be as important as patience.  We can reasonably expect the opposite of the go-go world we became used to in the 80s and 90s as an environment suitable for longer term development becomes normal.  That will be a real boon for innovation and manufacturing, which should fuel higher growth through tech later on.  That’s the phase that we are entering in the economic cycles – a period much more like the 1950s in many ways.

That’s not to say we can see a paradise for workers in the near future, however.  Unemployment is not expected to fall below 6% before 2016 according to the CBO (page 44) and opportunities will be limited for the foreseeable future.  And rising bond rates mean that the debt burden of the federal government will become more expensive – and will ultimately be crushing unless it can be managed more effectively.

The problems for investors are a broader problem in a society that is geared to 401(k) investment for retirement.  Without any simple, safe investments it’s hard to imagine how anyone is going to retire in the next decade.  That not only puts pressure on Social Security, it also means that workers are likely to stay in the workforce as long as they can, reducing the supply of new jobs for young people in particular.  Most of our economy remains tied to a high-growth strategy that has to be completely re-tooled for the new regime that will be with us even after a substantial recovery.

Low economic growth seems very scary if for no other reason than it means that we are going to have to do a lot of things differently at all levels of the economy.  It could be a good time for those who need patient money to fund their good ideas, but everyone else is going to continue to hurt for quite a while to come according to the CBO.  Planning for this is going to be the talk of investing for the next few years as everyone learns how to adjust – and that’s the one thing you can really take to the bank these days.

18 thoughts on “Low Growth, the New Normal

  1. You found a positive! Hope you are right about more patient money but if the stock market keeps going up I wouldn’t worry about 401k’s. I think you are right that things will be different but there will be opportunity. We just have to adjust.

    • The rise in the stock market is a bit puzzling. I think that money is entering stocks because it has nowhere else to go – but I don’t see this going on forever. Without solid profits the PE ratios will get way out of whack and we’ll see a correction. So I didn’t want to say anything about that – it’s very hard to read, IMHO.

  2. I agree that this will be the talk of the investing world but so far it is all hand wringing. It has been accepted that a savvy investor has to work a lot harder than they used to but no one has any solid answers. Look at commercials for brokerages, that’s all most of them say anymore.
    An S&P index fund is still going to be your best bet but there will always be people who are chasing higher returns who are not satisfied with that. The rise in the stock market has kept everyone satisfied for now but if that slows down it will be interesting to see what they start touting. The appetite for risk is very low given how much was lost in 2008-2010 but if people just stayed put they would have gotten it back and more. I think that is the real lesson.

    • Excellent comment all around. Patience is rewarded these days, even when it looks like it’s time to get out of a bad investment.
      I have two problems with an S&P500 index fund. One is that I’m starting to consider Warren Buffett’s axiom that you should invest in what you can see first, which is to say that you have to manage risk close at hand. Small banks seem to be doing that lately and I don’t see how small investors can be different. The other problem is that real returns of 2% or less are going to be with us, and that’s hardly the way to build to retirement – there will be a reckoning.
      I am looking for good examples of local investment clubs that allow some diversity and give small investors a chance to do what Buffett suggested. If you have any ideas please pass them on!

  3. So many things to say to this but you are right that this is the new normal and we better get used to it. If bond rates do skyrocket we are in a lot or trouble with the federal budget and that is why it is the top priority. We are sunk without more responsibility. More growth would be nice but it can’t come from spending more money we don’t have and have to pay back at much higher rates.

    • You hit my perspective squarely on as usual – if nothing else, a curb in spending so that it’s not running away could keep TBill rates lower and really help prevent the crisis. However, I’m still to the left of you on creating real growth and we do have to find ways of making that happen. It’s a difficult balance at best. I think the middle ground would be carefully targeted spending in key areas, as I’ve said before.

  4. Could you please comment how this will affect those expecting a pension from their government work/career. In the legislative halls we will hear that we made a promise with the rebuttal a promise we can no longer afford. How will this be done equitably across age groups and classes? A lot of education money is going into funding long term health care and not into the classroom. I think MPLS has a $25 million dollar deficit for 2013-2014 and their school population is growing.

    • That is a very good question, and one I can’t answer. Pensions are traditionally funded as they go, not like Social Security. But government pensions are a bit different. This does seem like a huge problem that will show up in the next few years given that there is going to be slow growth.
      It’s worth thinking through a lot more. Growth of 2% is probably not enough to fund anyone’s retirement based on current plans.

  5. Or this do high skilled workers have a greater right to wage increases even when their industries are going down? See Strib journalists, professional classical musicians. One of the problems in this country is the huge wage gap, If you could somehow bring up the wages of those paid poorly perhaps they could afford rent or a mortgage and we would not have had the great implosion of 2008. Krugman says it is a wage problem.

    • Krugman is right, IMHO, and this is a classic Depression in that sense at least. A while ago I did a piece on an analysis of income disparity and how it appears to slow growth in all economies around the world – with China starting to experience a big problem. This is what it’s all about, IMHO.
      How do we close the gap? I’m quite tired of people saying “Education!” automatically because that’s nowhere near enough. We need opportunity. I still believe that starts with making real, physical things in manufacturing but I have yet to be able to prove it. However, those are good jobs where skills can be developed over a lifetime as well as having a lot of spinoff potential for research, etc.
      To me, it’s a question of how much value the job actually adds to society in the end. A shortage of jobs that add a lot of value puts a pinch on those that add less – like reporters and musicians. I’d hate to think that everyone has to add a lot of value, as that would be one cold society, but we need more value added per worker all around. And that means making stuff – for at least a lot of people.

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