By James Pethokoukis

Post-modern philosophy questions the intellectual assumptions of the past, mostly those of the Enlightenment. So one might assume that a post-modern approach to economic analysis would reject the assumptions of recent decades. And, indeed, that’s what the bank Goldman Sachs does describing the current investment cycle. From a newish GS report:

● The traditional investment cycle (pre 1980s) was generally short and volatile reflecting booms and busts and periods of high and low inflation and interest rates; investors typically required a high dividend yield to compensate for the risks in equity markets.

● The ‘Modern Cycle’, (from the early 1980s) was characterized by more stability and predictability. It benefited from sustained falls in inflation, interest rates and risk premia. Geopolitical tensions eased and supply side reforms accompanied waves of deregulation, the end of capital controls, deeper capital markets and stronger World trade growth. A new era of globalisation drove profit shares of GDP to record highs. Independent central banks and forward guidance contributed to longer and less volatile economic cycles.

● The ‘Post Modern’ cycle (post the Pandemic) is likely to be driven by a different set of macro conditions and priorities, implying different styles of investment and opportunities.

This isn’t an investment blog, but I am interested in the sort of macroeconomic conditions that might typify this “post-modern” cycle. Higher inflation and higher interest rates are two that might seem obvious. But maybe some of these less so:

● The post financial crisis was driven by a negative demand shock as the private sector de-levered; this one is driven by a negative supply shock from the pandemic and the war in Ukraine. This cycle is likely to be more inflationary.

● Since the early 1980s interest rates and inflation have trended lower; they are now trending higher (albeit from record low levels) as we transition from QE to QT. This cycle is likely to experience higher yields, both nominal and real.

● The last 20 years was characterized by cheap and plentiful energy and labor; both energy and labor supplies are becoming more scarce and more expensive.

● Since the early 1980s we have seen a combination of deregulation, smaller government, lower taxes and rising profit shares of GDP; we are entering a period of more regulation, bigger government (higher government shares of GDP), higher taxes and potentially lower profit shares of GDP.

● Since the late 1980s we have been in an era of increasing globalization triggered by technology (cheaper and more effective communication) as well as geopolitics (with the collapse of the Berlin Wall 1989, the entry of India in the WTO in 1995 and China in 2001). We are entering an era of greater regionalisation driven by technology, cheaper and less labor-intensive production making on-shoring more viable and geopolitical tensions.

● Since 2000 the share of capex to sales has trended down amid lower nominal GDP. Demands to simplify supply chains from a security and ESG perspective, coupled with increased spending on defense and de-carbonisation is likely to push capex spend higher.

To be honest, what really pops into my mind when looking at this cycle is stagflation. I certainly don’t like some of the implications here for the supply-side of the economy. And I’m hardly the only one worried at the moment about stagflation. This from Bloomberg:

Former Federal Reserve Chairman Ben Bernanke said the current Fed leaders were too slow to react to surging U.S. inflation and as a result face a period of stagflation, or a combination of stagnant growth and high inflation. “Even under the benign scenario, we should have a slowing economy,” Bernanke told the New York Times separately. “And inflation’s still too high but coming down. So there should be a period in the next year or two where growth is low, unemployment is at least up a little bit and inflation is still high,” he predicted. “So you could call that stagflation.”

What are the public policy implications of this post-modern economy? Should one party choose to accept it, there seems to be ample opportunity to make the case for more efficient and pro-investment taxation, pro-innovation regulation (in housing and energy, for instance), expanding the skilled labor force through immigration, entitlement reform, and increasing the economic ties between nations. In other words, serious economic policy. So who wants to get serious?

The post Is Washington Ready for the Post-modern US Economy? appeared first on American Enterprise Institute – AEI.