"Concern about politics and the processes of international co-operation is warranted but the best one can hope for from politics in any country is that it will drive rational responses to serious problems. If there is no consensus on the causes or solutions to serious problems, it is unreasonable to ask a political system to implement forceful actions in a sustained way. Unfortunately, this is to an important extent the case with respect to current economic difficulties, especially in the industrial world.
"While there is agreement on the need for more growth and job creation in the short run and on containing the accumulation of debt in the long run, there are deep differences of opinion both within and across countries as to how this can be accomplished. What might be labelled the 'orthodox view' attributes much of our current difficulty to excess borrowing by the public and private sectors, emphasises the need to contain debt, puts a premium on credibly austere fiscal and monetary policies, and stresses the need for long-term structural measures rather than short-term demand-oriented steps to promote growth.
"The alternative 'demand support view' also recognises the need to contain debt accumulation and avoid high inflation, but it pushes for steps to increase demand in the short run as a means of jump-starting economic growth and setting off a virtuous circle in which income growth, job creation and financial strengthening are mutually reinforcing. International economic dialogue has vacillated between these two viewpoints in recent years."
– Lawrence Summers, The Financial Times, October 14, 2012
There is indeed considerable disagreement throughout the world on what policies to pursue in the face of rising deficits and economies that are barely growing or at stall speed. Both sides look at the same set of realities and yet draw drastically different conclusions. Both sides marshal arguments based on rigorous mathematical models "proving" the correctness of their favorite solution, and both sides can point to counterfactuals that show the other side to be insincere or just plain wrong.
Spain and Greece are both examples of what happens when there is too much debt and austerity is applied to deal with the problem. One side argues that the cure for too much debt is yet more debt, while the other side seemingly argues that the cure for a lack of growth is to shrink the economy. It is as if one side argues that the cure for a night of drunken revelry is a fifth of whiskey while the other side prescribes a very-low-calorie diet of fiber and veggies.
Both sides have arguments that are intellectually appealing, yet both cannot be right at the same time. What I think we need to consider is the possibility that there is something that is happening outside of traditional economic theories, which will mean that following either traditional policy solution could lead to disaster.
But is there a third alternative? If we want to find one, the first thing we need to do is to properly diagnose the problem. In today's letter we begin to explore why the models aren't working. Sometimes the best way to understand a complex subject is to draw an analogy. So with an apology to all the true mathematicians among my readers, today we will look at what I will call the Economic Singularity. And maybe we'll have a little fun on the way. Let's jump right in.
Singularity was originally a mathematical term for a point at which an equation has no solution. In physics, it was proven that a large enough collapsing star would eventually become a black hole so dense that its own gravity would cause a singularity in the fabric of spacetime, a point where many standard physics equations suddenly have no solution.
Beyond the "event horizon" of the black hole, the…