This week the mandarins and thought leaders of our leading economies and policy wonks are meeting in Davos. They do this every year at the World Economic Forum. In anticipation of this the IMF publishes before hand an update to its World Economic Outlook, and the Wall Street Journal publishes it’s, “Outlook” piece. The IMF came out yesterday and reported more trouble ahead, worsening conditions, and slight reduction in global growth. The Wall Street Journal piece is very good too – and is well worth reading. It highlights several challenges we face. However, it also exposes in my mind what ought to be thought of as leading indicators that tell us our global economy might be turning a corner. Even if these analytics turn positive, there is ample room for our politicians, bent by political dogma, to make the wrong fiscal and regulatory decisions. At this time in our economic history, we need to expunge socialist, modernist, post-capitalistic ideas about furthering social policy and equality through re-distribution. Any and all such attempts, for the next two years, will actually make things worse for the poor and middle-class since such policy energy will detract from the energy needed to grow the same pie that such wonks need to share.
So what are the three main metrics that express why we are in the mess we are?
– Chinese debt
– Business Investment
– New Business Start-ups
Martin Wolf’s Comment in today’s US print edition of the Financial Times (see China’s great economic shift needs to begin) explored China’s debt challenges. Andrew Browne, of the Wall Street Journal, did the same in his article (see China’s Debt Binge Isn’t Over Yet, and That’s the Problem) in its Outlook 2016, did the same. First is the scale of the problem. Mr. Wolf reports that China’s debt to GDP was 157% at the end of 2007, 250% at the end of 2013, and 29% at the end of the second quarter in 2015. Mr Browne calls out that it was due to the launch of China’s debt binge in 2008 and 2009 that helped the global economy stave off depression, after the collapse of Lehman Brothers. The problem is that this debt mountain has been the main driver of growth in China, and China has become the second largest economy in the world and, with anemic growth in the US, the biggest single driver of global growth. Now that debt-driven demand cannot be maintained for ever and with no natural consumer demand to replace it, over capacity is driving down commodity prices around the globe. This continues to weaken growth further, and contributes to deflation. So the cycle is complete and we need to break it. We need to watch Chinese debt and debt to GDP and look for a change in behavior.
In Greg Ip’s piece in Outlook 2016 (see Dear Business Leaders: Invest in Optimism, Not Buybacks), the challenge related to the lack of business investment in productivity improving efforts are exposed. He reports that since 2009, US businesses has boosted capital investment by 43%, dividends by 67%, and stock Buybacks by 194%. Record levels of Mergers and Acquisitions are being made year over year. Record levels of debt are being taken out to fund these acquisitions, and Buybacks. And the phenomena is global, according to Mr. Ip. The press (as reported by Mr. Ip) tells us that increased government regulation and persisting trauma from the financial crisis are behind this behavior. The Fed has used this lack of investment and spending as reason to justify its entire QE program (the world over, too) and the unprecedented expansion of the Fed’s balance sheet. But if you ask business treasury leaders, you get a very different perspective. Business do not, on the whole, change investment strategies based on interest rates. They base their main investment strategies based on business goals, opportunities and strategies. It seems the M&A spurt is about the only aspect of this that has reacted to policy changes, specifically interest rates at historic low levels. The challenge remains – irrespective of the trauma, regulation, or indifference to interest rates, firms are not investing for productivity growth. Until they do, we cannot magic such growth out of the air and we cannot mandate such growth through political edict.
In the same article by Grep Ip there is a related data point: “Since 2009, annual new businesses started have run 18% below the prior eight years, while business closures haven’t changed, according to the US Census data”. Mr. Ip has been talking of this issue for some time. I blogged on an article from him on the same topic in July 2015. More telling is this quote from today’s article: “For all the hoopla surrounding social media and smart phones, US business investment in high-technology equipment remains well below its pre-recession level as a share of gross domestic product. BUsiness and individuals are taking longer to replace their computers and smart phones, since each upgrade adds fewer compelling features then the last.” R&D is this not paying off as it used too and so money is finding new ways to generate a return, and that does not include productivity-inducing IT. I have blogged on this issue too.
So I think these would be useful leading indicators. Alone, neither will lead to growth but combined, they could signal a change in our furtunes. If we could just get the politicians out of the way, we could take rational, economic decisions to help improve our chances. As it stands, this is not going to happen so economic malaise is assured. In fact it will get worse, before it gets better. Since our leaders cannot bring themselves to agree global collaboration and alignment of goals and policy, the market may force their hand. Ray Dallio, founder of Bridgwater Associates, agrees with my thoughts of the other day. Today, on CNBC, while on site at Davos, he said that the Fed’s next move would be toward quantitative easing, not towards (quantitative) tightening. This suggests that US interest rates may fall again. So even as the US determines it is strong enough to ignore the world, it will be brought back to earth with a bang.