Steve Randy Waldamn has an interesting post on negative rates of return. Krugman relates it to China which brings me around to an idea that I am cooking up.

The Great Recession and likely both the Great Depression and the Long Depression were caused by globalization or international integration on a smaller scale.

I know this suggestion will seem irksome to many of my readers because the Great Recession seems like a thing that is bad and Globalization seems like a thing that is good. I can only say that things of themselves are not bad or good they just are. Our question is, what is?


So, there are two anchors on the real interest rate. One, anchor is the marginal return on capital. That is, if you give up consumption today, how much consumption can you get tomorrow.

The second anchor is the discounted ratio of marginal utility of consumption across time. That is, how much happier will you be tomorrow if you give up a dollar today.

Everything else being equal giving up a dollar today is more bad than getting a dollar tomorrow is good, because people put less value on the future. So without any sort of inducement people wouldn’t naturally save.

The inducement to save comes from the real interest rate. As long as the real interest rate is positive refraining from consuming a dollar’s worth of stuff today will give you more than a dollar’s worth in the future.

A second wrinkle is added, however, by the fact that a positive interest rate means that if society as a whole saves society as a whole will be richer tomorrow and hence an extra dollar’s worth of consumption will be worth less than it otherwise would

Fortunately there typically exists a balance between all these forces which has us saving, investing and consuming more over time. The real interest rate remains positive and society moves towards what economists call the steady-state.

That’s all fine and its standard growth theory. Here is the wrinkle.

An additional factor that has to be considered is technological change. As technology improves society will be wealthier in the future even if it doesn’t save and invest.

This is because when economists speak of technology we know-how. As our understanding of the world improves we can do more with less and so we are fundamentally wealthier, even if we don’t have more buildings or machines. – the kind of stuff with think of as investment.

Now here is where globalization fits in.

Globalization offers US firms an increase in productivity from offshoring. This increase in productivity operates in many ways like an increase in technological growth. We can now do more with less because we can trade with others who have a comparative advantage in certain areas.

Now imagine that we are on some steady state path. We are cruising along, saving, investing and becoming wealthier.

The suddenly barriers to trade collapse. The communist bloc falls. China opens up etc.  This causes a rise in the rate of the rate of technological growth.

As long as the rise isn’t to fast nothing all that special happens. The rate of savings in the US simply slows as American citizens use gains from trade rather than investment to increase living standards over time.

However, if the gains from trade are extremely large then it can shift us to a new paradigm where the model demands a negative savings rate. Our future selves are so rich in the bounty of international trade that wealth maximization requires us to borrow from them to fuel consumption now.

In industrial production this is actually not that hard to facilitate. Obsolesce comes quickly to industrial machinery. All you have to do is stop upgrading American equipment, wait until it runs out and then ship the jobs overseas.

Letting your equipment fall apart is akin to negative savings. And, the whole thing makes sense because the United States is effectively over-industrialized relative to its trading partners. Letting machines wear out here and rebuilding them there is the wealth maximizing thing to do.

The story is different when in comes to structures like houses and shopping centers. There is effectively no way to ship them overseas yet still receive the service stream from them.

What you can do, however, is extract value from them via the bond market. You take out mortgages on the structures, sell those mortgages to the Chinese and use that to fuel consumption right now. This again is the wealth maximizing thing to do, because you want to shift consumption from the future to today.

The problem is that forms is two fold.

First, this process is facilitated by a fall in the real interest rate, which allows heavy borrowing against by both raising the value of the asset and easing the financing costs. Yet, if the gains from trade are growing fast enough they will drive the real interest rate to zero, at which point land prices become undefined.

Because land does not depreciate you are taking the present discounted value of land but applying a discount factor of zero. This means every piece of land is worth an infinite amount.

Second, this creates a time inconsistency problem. It is in your interest to borrow heavily now under the conditions that you will repay the loan. However, because real interest rates are zero collateral values do not rise over time. Hence, any fluctuation in the value of collateral simply from trembling hand forces will make it worth your while to default.

If everyone is aware of the second factor then this will bind land values away from infinity because no one will be able to borrow ever greater amounts of money to purchase land. However, there is no inherent stability, guess wrong and there will be a wave of optimum defaults.

I think this type of model could explain the run-up in land prices during the 2000s. We would need to combine this with some balance sheet model of spending to then show how the collapse could force the economy into a liquidity trap.