I am thinking about starting with ETF trading wondering any expert here already doing it.

I would like to hear from you that which ETFs are good for trading in terms of liquidity and volatility.

However, in the context of moving economies, especially after the financial crisis, the role of expectations deserves a re-evaluation:

But some kind of foundation is still required for macroeconomics. That is why I’m very excited by my friend Andrei Shleifer’s new book with Nicola Gennaioli, “A Crisis of Beliefs: Investor Psychology and Financial Fragility.” The book puts expectations at the center of thinking about economic fluctuations and financial crises — but these expectations are not rational. In fact, as all the evidence suggests, they are subject to systematic errors of extrapolation. The book suggests that these errors in expectations are best understood as arising out of cognitive biases to which humans are prone.

The financial crisis and the foundations for macroeconomics | Larry Summers

The work of Roger Farmer (see here, for instance) also goes this way.

The economy’s great. That doesn’t mean Trumponomics is. - The Washington Post

Trump’s own Office of Management and Budget projects that the deficit will reach nearly $900 billion this year and top $1 trillion next year. That’s not even including other new costs on the table, such as a $12 billion bailout for farmers hurt by Trump’s trade war or $90 billion in additional tax cuts the House passed this week. One last thing to keep in mind if you see high-fives at the White House on Friday: Where are the raises? Output may have swelled last quarter, but paychecks did not. Adjusted for inflation, average hourly earnings were flat in June compared with a year earlier, according to the Labor Department. If Trumponomics is indeed working, it’s still not working for workers..

The economy’s great. That doesn’t mean Trumponomics is. - The Washington Post

Three manufacturing companies in Arkansas say they need an exemption from the Commerce Department from President Trump's new tariffs on steel and aluminum imports or they will be forced to close. Arkansas Online reports that three tire-cord manufacturers, Bekaert Corp., Kiswire America and Tokusen USA, have jointly requested an exemption from Trump's tariffs, specifically on "grade 1078 and above wire rod for tire cord." The three companies argue that U.S.-based steel producers are unable to manufacture the quality their company needs.

Three Arkansas companies say they'll close if Trump doesn't give them exemption from steel tariffs | TheHill

The U.S. Trade Representative said NAFTA negotiations are making progress and negotiators will continue to engage in talks, but the three countries are not close to a deal. The Mexican peso fell 1.8 percent amid concerns about a NAFTA deal and after Mexico announced tariffs on a list of U.S. imports. The calendar is now working against talks to revamp the North American Free Trade Agreement, as Congress appears to have run out of time to approve a new deal this year and the Mexico election is July 1.

As NAFTA deal appears more elusive, Mexico's peso, Canadian dollar slump

President Donald Trump's abrupt, erratic approach to trade, even when he does not follow through on the harshest protectionist threats, is already damaging faith in the global trading system. "The Trump administration's increased willingness to argue that conventional imports are a threat to national security could have an adverse impact on the global trading system over the long term," write Nomura economists in a research note. NAFTA talks in particular are under threat from increasingly extreme requests on auto imports from the US delegation.

Trump tariffs already damaging faith in the global trading system - Business Insider

President Donald Trump told U.S. officials not to endorse the Group of Seven’s final communique and accused Canadian Prime Minister Justin Trudeau of making "false statements" at the summit’s closing press conference. “Based on Justin’s false statements at his news conference, and the fact that Canada is charging massive Tariffs to our U.S. farmers, workers and companies, I have instructed our U.S. Reps not to endorse the Communique as we look at Tariffs on automobiles flooding the U.S. Market!,” Trump said on his Twitter account on Saturday evening.

Trump Orders Officials Not to Endorse G-7's Final Statement - Bloomberg

There was nothing particularly surprising about Trudeau’s move — Canada had already threatened to issue them, and retaliation over tariffs is common in the trade world — but it seemed to rub Trump the wrong way. Ultimately, Trump’s harshly worded tweets, personally insulting one of the US’s closest allies and overturning an apparent commitment that had been made just hours earlier, made his exit from the summit even more acrimonious than most analysts expected.

Trump insulted Justin Trudeau after leaving the G7 summit - Vox

President Donald Trump suggested to the G7 leaders that the world should eliminate all tariffs, trade barriers, and subsides in order to promote free trade. The idea comes weeks after Trump imposed huge tariffs of steel and aluminum imports from the European Union, Canada, and Mexico. The suggestion took the G7 leaders aback, reports said. While Trump seemed to reverse course, the president also kept up his complaints about trade deficits.

Trump suggests dropping all tariffs, trade barriers at G7 summit - Business Insider

But another article, The New Class War by Michael Lind, offers a different, rather provocative explanation for our low productivity growth.  According to Lind, the last few decades have seen the rise of managerial elites in advanced economies which have been pursuing profits by methods other than technology-driven innovation and productivity growth.  Instead, they’ve been taking advantage of the significant reductions of trade barriers over this timeframe to pursue profits based on global labor arbitrage, as well as tax arbitrage and other forms of financial engineering.

Irving Wladawsky-Berger: Global Arbitrage and the Productivity Puzzle

Right now, the total market cap of the Wilshire 5000 index as a percentage of U.S. gross domestic product is about 120 percent, far above the 45-year average of 75 percent. To some, this indicates that stocks are priced too richly, and hence may not be a good buy at these levels.

By this measure, stocks are massively overvalued

There is no shortage of pundits, advisers, analysts, strategists or alarmists who warn that stocks are overvalued and that a sizable setback could occur at any time. Sure, something could occur at any time, or no particular time, simply because stocks are volatile and subject to the discontinuous ebb and flow of investors’ risk appetites that can change on a dime. Nonetheless, stocks aren't badly overvalued. Rather, they seem reasonably close to fair value. As for the future, many factors may emerge that can increase or decrease the attractiveness of stocks, albeit with more potential positives than negatives. So on balance, there's reason to be cautiously positive on the equity-market outlook.

Stocks Aren't Overvalued - Bloomberg

That brings me to another major indicator of the stock market– something known as the “Buffett Valuation”. The Buffett Valuation looks at the total value of the stock market relative to the country’s GDP. Warren Buffet has called this ratio “probably the best single measure of where valuations stand at any given moment.” Right now, for example, the total size of the US stock market according to Federal Reserve data is $22.6 trillion. Meanwhile the total size of the US economy is $18.8 trillion. This puts the Buffett valuation at around 1.2, meaning the stock market is about 20% larger than the entire US economy. Historically speaking, this is expensive. Stock markets start getting into trouble when the ratio surpasses 1.0. (The Buffett ratio was 1.11 before the 2008 crash&hellip

The US Stock Market Is Highly Overvalued. Here's Why... | Zero Hedge

This is the most dangerous and overvalued stock market on record — worse than 2007, worse than 2000, even worse than 1929. Or so warns Wall Street soothsayer John Hussman in his scariest jeremiad yet. “Presently, we observe the broadest market valuation extreme in history,” writes the chairman of the cautious Hussman Funds investment group, “with the steepest median valuations on record, and the most reliable capitalization-weighted measures within a few percent of their 2000 peaks.” On top of such warning signs as “extreme valuations, bullish sentiment, and consumer confidence,” he adds, “market action has deteriorated in interest-sensitive sectors... As of Friday, more than one-third of stocks are already below their 200-day moving averages.”

This is the most overvalued stock market on record — even worse than 1929 - MarketWatch

Several noted economists and distinguished investors are warning of a 50% stock market crash. Mark Faber, Dr. Doom himself, recently told CNBC that “investors are on the Titanic” and stocks are about to “endure a gut-wrenching drop that would rival the greatest crashes in stock market history.” Jim Rogers, who founded the Quantum Fund with George Soros, went apocalyptic when he said, “A $68 trillion ‘Biblical’ collapse is poised to wipe out millions of Americans.”

Are Stocks 80% Overvalued? New Evidence Shocks Wall Street - The Sovereign Investor

Connecting the Global Dots: The Shanghai Co-op | PIMCO Blog

Simon Derrick from BNY Mellon said we may be nearing a vicious circle where forced sales by emerging markets push US yields higher. This in turn strengthens the dollar, compelling these countries sell even more reserves, and on and on, until the system short-circuits. “There is the risk of an adverse feedback loop,” he said. Reserve sales have the side-effect of tightening monetary policy within China. This strains the banking system, which has become dangerously reliant on short-term funding in the wholesale capital markets - with echoes of Northern Rock and Lehman Brothers.

Surging 'Trump dollar' risks earthquake for emerging markets

1. The economy is merely “trudging along” at stall speed, so stocks are vulnerable

This misperception is forgivable, given that U.S. GDP growth came in at around 1% for the first and second quarters.

But to really understand the economy, you have to drill down on a lot more numbers than just GDP. And when you do so, the weak GDP numbers seem fishy. They just don’t jibe with many other bullish reads on the economy.

“There are a number of things that just seem odd,” says Jim Paulsen, the chief investment strategist and economist at Wells Capital Management.

Let’s start with an alternative economic yardstick, called gross domestic income(GDI). Instead of measuring production (which is the job of GDP), GDI measures national income. It does so by summing wages, rents, interest and profits. Over the long haul, GDI tends to track GDP.

But during the “weak” first quarter — the weak quarter that energized the gloom-and-doom crowd — those two measures diverged sharply. Real GDP (after inflation) was a mere 1.1%. But real GDI was a much more solid 2.9%.

Which one is right? Given the preponderance of other robust economic indicators out there, I’m betting that GDI at nearly 3% is the right one.

After all, 1% GDP growth in the first and second quarters just doesn’t line up with the following, much more bullish, reads on the economy.

* Auto sales are at record levels — 17.7 million expected this year, according to Center for Automotive Research chief economist Sean McAlinden, and 17.5 million in 2015, both records.

* Employment growth is strong — 255,000-292,000 new jobs in June-July, and 204,000 a month on average over the past 12 months.

* Loan growth is robust — 8.2%-8.6% growth in the first half of the year, following 9% growth in the fourth quarter of last year.

* Wage growth is solid.

* Consumer spending is strong — see below for details on these last two.

The upshot? “Concern over the economy’s performance is running high, but it is misplaced,” says Moody’s Analytics chief economist Mark Zandi. He predicts 3% GDP growth in the next 12 months.

Given this outlook, the economic mirage created by the weak headline GDP numbers matters “because it affects people’s confidence and their expectations and ultimately their behavior,” says Paulsen.

“Just imagine how different the world would be if the published numbers for GDP were 3%. If that were the case, would this be the most hated bull market ever?” asks Paulsen. “Would there be such vitriol to established political candidates? Would there be chronic worries about a global slowdown?”

To be sure, investors need to worry that September and October are looming. These are months that often bring trouble for stocks. But “trudging” economic growth would be the wrong reason to doubt this rally and take profits now. The economy is actually pretty strong when you look beyond the headline GDP numbers.

2. No one has gotten a raise in several decades

Donald Trump loves this one. Bernie Sanders did too, before he dropped out. This makes sense tactically since Hillary Clinton is seen as an extension of President Barack Obama, rightly or wrongly. So by attacking the current state of the economy, one attacks Clinton and the status quo. This makes change look more attractive.

But there’s just one little problem here. The “stagnant wage” claim is just not true. Wage gains in this recovery have been some of the biggest in the past 50 years.

There are many ways to gauge wage trends. Just about all of them point to robust gains.

* One of the cleanest ways to measure wage growth is to track workers in the same jobs over time. This technique is used in the ADP Workforce Vitality Report from Automatic Data Processing (ADP), a company that handles payroll processing for a huge number of U.S. companies. It shows wages rose 4.6% in the first quarter. This “same job” technique is useful, because it eliminates the downward drift in overall workforce wages that can show up in government numbers as more older employees (making lots of money) retire relative to the number of younger employees (earning far less) coming in.

* But even government numbers show decent gains. Disposable personal income increased 3.1% in the second quarter, according to the Bureau of Economic Analysis.

* An earned-income proxy tracked by Ed Yardeni at Yardeni Research (the equation: average hours times average hourly earnings) shows earnings jumped 4.3% in July to yet another record. Income gains are higher still over the past several decades, if you throw in the value of government benefits.

But if wage growth is so strong, how do Trump and Sanders get away with saying otherwise? Well, politicians lie, of course. But here they are misleading by telling a selective truth. They are citing the wrong data (deliberately or otherwise). They’re citing household-income analysis produced by the Census Bureau. These numbers do show that median household income has been virtually flat for the past 20 years. But a big problem here is that the number of households with one person has increased sharply. This puts downward pressure on household income.

The bottom line for investors here? Decent wage gains support growth. This could be a two-edged sword, if the gains spark inflation and speed up Federal Reserve interest-rate hikes. That can hurt stocks.

Theresa May, the revolutionary! 

The new British PM is causing a stir:

Sometimes it’s useful to put symbolic dates on when a different era begins. The end of Thatcherism, it could be argued, came on July 10 in the then PM-candidate speech by Theresa May. It was perhaps appropriate that another woman, a Tory Prime Minister, would be credited with the ending of Thatcherism. The key words, which immediately attracted attention (see also Philip Stevens in today’s “Financial Times”) were not those about  inequality (which has become a common place these  days) but about the changes in the internal structure of capitalism: reintroduction of workers’ and consumers’ representatives on management boards, limits on the executive pay, reduction of job insecurity for the young people and much greater access to top jobs for those coming from less privileged backgrounds.

For the first time since the late 1970s (at the top level of policy-making), we are back to the issues of reforms in the way capitalism functions rather than discussing the ways in which the external environment would be made more market friendly. In essence, this is a confession that “civilizing” capitalism cannot be done only “externally” by relying on the “harmony of private interests” but that the state has a bigger role that goes beyond ensuring the protection of property rights, taxation and redistribution.

globalinequality: The forthcoming changes in capitalism?

We think she's onto something, why?

1. The past four decades have shown wages are stagnating and greatly lagging productivity growth and most of the gains have gone to a small top (the 0.01%)
2. The reasons have less to do with trade, and more to do with the internal workings of capitalism (for instance, the sole pursuit of shareholder value), as May is now acknowledging, a pretty brave stance for a Conservative politician
3. It is important not to throw the baby with the bathwater and to engage in a dispassionate approach, looking at the facts and the results of different institutional settings around the world how capitalism can work better for more people.

We warned two weeks before the vote that markets were dangeroursly complacent, here we gather some interesting perspectives from around the web., The first, from David Beckworth

The second reason the rising dollar matters is the rapid growth of what the BIS calls the 'parallel dollar system'. This is a system of dollar loans and dollar debt securities that has emerged outside the United States. This dollar credit to and from non-U.S. residents has tripled since 2000, while non-resident Euro and Yen financing has remained relatively stable. In fact, the dollar's share of this non-resident credit growth has increased from 62% to 75% according to BIS data. This means there is a lot of dollar-denominated debt outside the United States that is very vulnerable to dollar shocks. Brexit just increased the real debt burden of these borrowers.

So between tightening monetary conditions for the  dollar bloc countries and increasing real debt burdens for all the non-resident issuers of dollar debt, the global economy has been hit with a large dollar shock. Put more crudely, the strong dollar noose that has been choking emerging economies since mid-2014 has now been complemented by the opening of  trap door on the gallows via Brexit. This makes the strangulation of global economy complete.

A second reason Brexit might be pushing the global economy into a global recession is that it hastening the the frantic race to bottom on safe yields. As I noted in a recent post, yields on safe assets around the world have been going down since the demand for safe assets remain unmet. Given global capital markets this also means there is a race to the bottom on safe yields as noted by Caballero, Fahri, and Gourinchas (2016) :

In the open economy, the scarcity of safe assets spreads from one country to the other via the capital account. Net safe asset producers export these assets to net safe asset absorbers until interest rates are equalized across countries. As the global scarcity of safe assets intensifies, interest rates drop and capital flows increase to restore equilibrium in global and local safe asset markets. Once the ZLB is reached, output becomes the adjustment variable again. 

Brexit massively intensified this race to the bottom as seen in the the 10-year yield below. Incredibly, the yield fell from 1.74 to 1.43 this evening! Brexit, in other words, just jolted the demand for safe, liquid assets in a major way.

This frantic race to the bottom of safe yields will eventually run up against the effective lower bound (ELB). When that happens something else will have to adjust. And that something is output, as noted by Caballero, Fahri, and Gourinchas (2016)

So there you have it. The world has been hit with a massive global monetary shock. And via dollar bloc countries, the parallel dollar system, and the shortage of safe asset problem this monetary shock may be what pushes an already slowing global economy into a global recession.

Will central bankers and finance ministries be ready for it? I hope so.

What Is Shadow Banking?

From Berlin to Basel: what can 1930s Germany teach us about banking regulation? | Bank Underground

Specifically, the recommendations were: “shadow banks should be subject to the same limits on risk-taking as banks,” “shadow banks should be subject to the same capital standards as banks,” and “[s]tress test liquidity positions.” These were the central ideas for me then, and they are central ideas for me now. (Given how the liquidity stress tests have become one of the central attacks against Dodd-Frank, with whisper campaigns about how the LCR is causing “bond market liquidity,” I think we were on the right track.)

Why I (Still) Think Shadow Banking is Key to Financial Reform - Roosevelt Institute

These policy tools have not been used systemically in the past, so their impact and the FPC’s reaction function remain unclear. Moreover, in contrast to monetary policy, where price stability can be judged against inflation, the objective of macroprudential policymakers – the stability of the financial system – is inherently unobservable. Thus macroprudential policymakers face a high degree of uncertainty over the impact and effectiveness of their tools and a target variable they cannot perfectly observe.

Uncertainty is no excuse for not using macroprudential tools | Bank Underground

I’ve been on record since early days saying that too-big-to-fail is not the key issue, so that the fact that big banks remain big is, um, no big deal. The real question — or so I’d argue — is leverage within the financial sector, and in particular the kind of leverage with no safety net that characterizes shadow banking. So Matt O’Brien weighs in with evidence that leverage has in fact declined substantially, and continued to decline even as the economy expanded — probably because of Dodd-Frank. This is certainly right; the same decline shows up in other measures, as in the chart above showing financial sector debt securities as a percentage of GDP.

Half a loaf, financial reform edition  - The New York Times

Bad loans are twice as big a problem for European banks as they are for banks in the US — despite lenders’ many efforts to clean up balance sheets in troubled eurozone hotspots such as Spain, Ireland to Greece. New official figures show that almost 6 per cent of European banks’ entire loan books are impaired, double the impairment rate of 3 per cent in the US. Bad loans remaining on the books of Europe’s banks are almost as big as the gross domestic product of Spain.

Bad loans at Europe banks double that of the US - FT.com

Share buybacks, the markets miss you | FT Alphaville

An increasingly messy divorce between market participants and monetary policymakers might be responsible for the market turmoil in 2016, according to Richard Koo. The "January correction was driven by realization that rate hikes could come faster than expected," he claims... He says the Federal Reserve's desire to calm markets prior to liftoff quickly gave way to rounds of commentary beating market participants over the head with the idea that the pace of tightening would be less gradual than they anticipate.

Koo: The Fed's Communication Shift is Behind January's Selloff - Bloomberg Business

Financial markets are undergoing two consequential transitions, which not only amplify the impact of even the smallest developments in China and oil, but also increase risk aversion overall and create the conditions for more unpredictable developments. The first has to do with the shift from a prolonged regime of repressed financial volatility to an environment in which such instability is higher and less predictable. The primary reason is that central banks are less willing (in the case of the Federal Reserve) or less able (in the case of the European Central Bank and the People’s Bank of China) to act as suppressors of volatility. In the short term, this transition inevitably leads to higher risk aversion, deleveraging and lower portfolio risk-taking, especially affecting risk-based models and asset allocations that use volatility as a major input. The second transition involves liquidity, and a move away from counter-cyclical balance sheets. Facing tighter regulation and sharply reduced market appetite for short-term earnings deviations, broker-dealers are a lot less willing to take on inventory when the market overshoots. Other pools of capital, including sovereign wealth funds, also face constraints in increasing their risk-taking.

The Deeper Causes of the Global Stocks Rout - Bloomberg View

Meanwhile, the price of the underlying equities in index funds is rising, though no one is sure exactly why. Research by S&P Capital IQ, as of Dec. 31, found stocks that were in the Russell 2000 were trading at a 50 percent premium to stocks that were not, up from 12 percent in 2006. The statistics are based on median price-to-book ratio.

Watch out for this $1 trillion stock bubble

The problems mostly lie in 'old China'; overleveraged, overcapacity, falling prices (really not what you want when you have excess capacity and are overleveraged) and the authorities are trying to make the transition from old to new China as smooth as possible.

What should be done is fairly easy, much of the overcapacity should be rationalized, and much of the related dubious debts should be written off. But this is a rather brute process, as it will make millions redundant, something which the authorities are reluctant to embark upon.

The chosen path, rollover of credit and keeping it cheap creates a bit of a zombie economy, we know that from Japan in the 1990s. Companies and (shadow) banks persist, but they're not really viable or embark on new activities. Basically it's more difficult to have creation with at least some destruction. Old China is weighing all of China down.

One idea that could work is to extent China's social safety net, this would kill two birds with one stone:

• It would reduce the exhorbitant household saving rate which is a drag on demand, especially now that old China needs a lot less investment
• It would make the rationalization of old China more bearable for those involved, smoothing the transition.

The Chinese safety net leaves much to be desired:

The problems in China’s social security system can be traced back to two key events: The break-up of the state-run economy, which had provided urban workers with an “iron rice bowl” (employment, housing, healthcare and pension), and the introduction of the one-child policy in the 1980s, which meant that parents could no longer rely on a large extended family to look after them in their old age. In other words, as the economy developed and liberalized in the 1990s and 2000s, both the state and social structures that had supported workers in their old age, ill-health and during times of economic hardship gradually vanished, leaving a huge vacuum to fill.

| China Labour Bulletin

Pensions:

Despite government attempts to increase pension and other social insurance coverage, the majority of workers still lack an effective welfare safety net. Official figures show that in 2013, only 242 million workers, less than one third of China’s total workforce of around 770 million, had a basic pension.

| China Labour Bulletin

Piecemeal reform culminating in the 2011 Social Insurance Law outsorced much of the safety net to the employment contract:

Both employers and employees are required to make contributions (at different rates) to a pension fund, unemployment insurance fund and medical insurance fund, as well as the Housing Provident Fund. Employers, but not employees, are also required to contribute to the work-related injury and maternity insurance funds.

| China Labour Bulletin

But there are also local funds:

The various insurance funds are managed by local governments and are pooled into provincial or municipal funds. Usually it is the local labour or human resources and social insurance departments that manage the social insurance funds, while the Housing Provident Fund is managed by the local government’s Housing Provident Fund Management Committee.

| China Labour Bulletin

However, the institutional make-up of this creates a rather fragmented system, which can work as a barrier to labor mobility:

Social insurance benefits should remain with workers when they move. However this provision has proved very difficult to implement because of the highly localized nature of the social welfare system in China. Getting different jurisdictions to share information is fraught with bureaucratic and technical difficulties, especially for workers coming from rural areas of China.

| China Labour Bulletin

How to escape from the slow-growth doldrums

More than six years after the Great Recession's end, economic growth in the U.S. remains lackluster. That's raising concerns among economists that the U.S. is entering a period known as "secular stagnation," an idea first proposed by Alvin Hansen in 1938 and recently revived by Larry Summers.

When an economy enters such a period, it's caught in an extended period of low economic growth. Summers believes the U.S. and other economies may be suffering from this ailment, though it's too soon to know for sure.

To understand the nature and cause of secular stagnation -- and solutions to it -- a simple example might help.

Imagine an economy with no imports and exports, perhaps an isolated island with no way of trading with other islands that produces $100,000 in goods and services each month. One of the most basic concepts in macroeconomics is that the total value of income equals the total value of production, so in this economy the total income of the residents would also be $100,000.

That's because when a good is produced and sold, the income the firm receives is paid out in wages, interest and rent, and whatever is left over is profit (which could be negative). Thus, the value of the good that is sold turns into income of some type.

When goods are held in inventory, things get a bit more complicated, though the result is the same. So, we'll assume no inventories to keep things simple.

Now suppose the island's residents spend $90,000 of their income on goods and services, and save $10,000. Wouldn't that create a problem? There's $100,000 worth of goods and services available in the economy, but only $90,000 in spending. How do the rest of the goods get purchased?

The answer is that $10,000 in saving gets turned into investments through financial markets. This is one of the main functions of financial markets: to find a way to turn saving into productive investments.

Let's assume in this economy, there's $5,000 in deprecation each month, so $5,000 of the $10,000 in saving is used to replace worn out capital, and the other $5,000 is used to purchase new capital that can be used to produce even more in goods and services. Again, to make it simple, assume that the $5,000 in new capital will increase output in the next period by $5,000.

Thus, in the next month, GDP for this economy would increase to $105,000 (a 5 percent growth rate), and the process would repeat. Part of the $105,000 in income will be used for consumption, and the rest will be saved. Financial markets will turn the saving into investment, which covers depreciation from the last period and new investment in the current period. The new investment allows the economy to produce even more, and so on, and so on.

But what if something goes wrong? What if financial markets fail to turn all of the saving into investment?

Let's start with the first month once again, which has $100,000 in income, $90,000 in spending and $10,000 in saving. Suppose something goes wrong so that only $5,000 is turned into investment -- just enough to cover depreciation, but not enough for any new investment -- and the other $5,000 sits idly in banks as excess reserves.

In this case, with no new capital, there would be no growth. So, in the next period, production and income would be $100,000 once again.

The failure of financial markets to turn all of the saving into investment results in zero percent growth instead of the 5 percent growth realized when all of the saving was utilized.

If less than $5,000 of the $10,000 is turned into investment, the economy can't even cover depreciation, and growth would be negative. If more than $5,000 is utilized, but less than $10,000, there would be some growth, but it would be less than 5 percent.

If this continues period after period, it becomes an instance of secular stagnation.

Classical economists did not believe this could happen. They argued that financial markets would always find a way to equate saving and investment.

The key is movement in the interest rate. Interest is the reward for saving. When interest rates rise, people tend to save more. However, interest is also the cost of borrowing the funds needed to make an investment, and when interest rates go up investment tends to fall (borrowing costs are higher, so fewer projects are expected to be profitable).

Saving and investment are equated through market forces that move the interest rate up and down. For example, if saving is less than investment, interest rates will tend to increase, causing saving to rise and investment to fall until both are equal. In the opposite case, interest rates will decrease until saving and investment are aligned.

The essence of this argument is no different than the usual supply-and-demand models. If supply is greater than demand, prices fall; if supply is less than demand, prices rise and bring the market back into equilibrium. Just think of the interest rate as the price of money.

There is no practical limit to how much interest rates can increase, but they can fall only so far. The "zero lower bound" (ZLB) constrains how low interest rates can go (if they're negative, you can borrow money, then pay back less than you borrowed -- but why would a lender want to do this?). I'm omitting some technical points: The bound isn't exactly zero, and the Fed has ways to produce negative interest rates, but it hasn't been willing to do that, so the ZLB has been an effective constraint.

The following two diagrams illustrate the secular stagnation problem. Both show how saving (S) and investment (I) change with the interest rate ®, as just described, and the intersection of the two lines is the equilibrium point. The first diagram shows normal times:

In this case, the classical argument is correct: Market forces will push the interest rate to the point where saving and investment are the same (think of this as the $10,000 in saving being turned into investment in the first example above).

But in a recession, the investment curve shifts inward as businesses foresee poor economic conditions ahead and invest less at every interest rate. In a big recession, like the one we just had, it's possible for the investment curve to shift inward by a large amount, so large that the equilibrium interest rate is negative:

In this case, the interest cannot fall enough to equate saving and investment because it's limited by the ZLB. When the interest rate falls to zero and gets stuck there, saving will be greater than investment (on our island, this is the case where saving is $10,000, but investment is less than that). So long as the economy is stuck in this trap, it will experience stagnant growth. Investment and growth would be higher if the economy could somehow reach the equilibrium point.

What's the solution to this problem? There are two ways the equilibrium could be returned to a positive interest rate. The first is to shift the saving function inward. If policy could cause this to happen -- a tax on saving perhaps -- it would work, but in this case investment would fall even further. A better solution would be to shift the investment function outward.

How can this be accomplished? Investment is the sum of private sector investment plus public sector (government) investment. Private investment could be increased by lowering the interest rate with monetary policy, but since the interest rate is as low as it can go, this won't be effective.

Another solution is to raise private investment through mechanisms such as tax incentives. But in a stagnating economy, business confidence is low, and it's unlikely this will have much of an effect. It's worth trying, but it's unlikely to be enough.

Yet another solution is to raise public investment; infrastructure spending is a frequently mentioned candidate. This is attractive for two reasons. First,investment in U.S. infrastructure has been lagging, which needs to be addressed independent of the secular stagnation problem. Second, while tax incentives amount to leading a horse to water and hoping it will drink, government investment is determined by fiscal policy. It can be whatever value Congress and the president want it to be.

This is why those who are worried about secular stagnation have repeatedly called for substantial investment in infrastructure.

To repeat, we do not yet know if the U.S. in a secular stagnation episode. But if it is, the time to act is now. The longer we wait, the harder it will be to overcome. Since the country needs infrastructure spending in any case, why not use it as insurance against this possibility?

Ed Dolan’s thorough deconstruction of ShadowStats is one of our favorite blog posts from 2015. From the way he picks his target, to his measurement of the data – his post reads like a step-by-step guide to winning a Silver Bullet. We found this excerpt particularly interesting:

“As mentioned above, Williams’ ShadowStats inflation series incorporates an additional 2.0 percentage point correction to reflect methodological changes that are not captured in the CPI-U-RS series. I would like to examine that number more carefully in a future post, but for the sake of discussion, we can let it stand. If so, it appears to me that, based entirely on Williams’ own data, methods, and assumptions, the adjustment for the ShadowStats inflation series should be about 2.45 percentage points below CPI-U, rather than the 7 percentage points he uses.

In my view, Williams alternative measure of inflation would be more convincing if he were to make this correction. It would also be less likely to feed the anti-government paranoia of some of his followers, who allege that the BLS is falsifies source data and manipulates reported indicators in the way that Argentina and some other countries appear to do.

It is worth noting that Williams himself makes no such claim. He is a fierce critic of BLS methodology, but he acknowledges that the agency follows its own published methods. He argues that the BLS has adopted methods that produce low inflation indicators, but not for motives of short-term partisan politics. Rather, he sees the choice of methodology as driven by a longstanding, bipartisan desire to reduce the cost of Social Security and other inflation-indexed transfer payments. It would be hard to deny that he is at least partly right about that motivation.”