Category Archives: Economics

IMF selling snake oil advice…in places…

I had little choice but to hot-foot over to the IMF webpage once I spied the alert in my inbox today: UK’s Economic Outlook in Six Charts. Really, in just six charts? Awesome. Show me the money. Well it turns out a bit of a fiddle. Yes there are six charts and some of them are really interesting. Some however are pushing a political agenda.

Chart 1: UK GDP 2011-2018 compared to G7.

Yes, in the last couple of years the recorded GDP growth of the UK has fallen from being in the top set of G7 counties to the bottom. How much of that is due to Brexit or natural economic cycles or other causes?

Chart 2; Brexit will be costly to the UK.

Ok so now my spider-senses are tuned in. Have you read The Economics of Brexit – a cost-benefit Analysis of the UKs economic relationship with the EU, by Philip Wyman and Alina Petrescu? I would recommend it. Page by page, chapter by chapter, these two researchers explore the small print of the analysis completed by the IMF, OECD, the Bank of England and others, that all point to (or pointed to) the economic decline of the UK assuming Brexit takes place. The small print of every analysis that concluded and concludes depression, resection, decline, all point to assumptions about how the UK policies will change (or not) and how other countries responses will change (or not). Quite frankly the conclusion is embossing.

Virtually every analysis that falls back on WTO or other frameworks assumes something that is just not practical or likely. Won’t the UK adjust interest rates if prices increase? Won’t the UK devalue sterling if wages exceed global competitive rates? Won’t the UK’s innovation seek higher rents and drive new innovation? Won’t tax policy favor growth? These are all ignored in one or other analysis. Thus every analysis is misleading. The IMF is just as bad as everyone else. In fact I conclude that there is no fair or practical economic analysis of what will happen with Brexit. Few economists can prove what net change in GDP came ab-out from joining the EU; how can they estimate the losses when you leave?

I will let you look at the other charts. They are interesting and somewhat informative, if you take the time to understand the assumptions and try to think of the argument the author wants to message. Either way, I recommend the book.

Advertisements

Where the Skeletons, economically speaking, are laying down

Not yet buried, not even dead, firms are taking on more leveraged debt. In last week’s US print edition of the Economist, two articles make for chill reading.

The first article that heads the Finance and Economics section is titled, What Goes Up – The American economy. After emailing the current economic growth and the causes of it, the article suggests that things are likely to change. And this was written before last week’s midterms.

The theory is that the impact of the recent tax cuts will start to fade. Yes, this must be the case though there will surely be some residual net-increase in spending and change in behavior as a result. Tariffs are brought up as drag on demand; again this is likely true though there will also likely be some positives as local businesses, shielded from foreign imports, may seek new money to build up local services and supplies leading to some organic growth.

For me, the real risk is investment. Apparently that is falling again, after an uptick (due to tax breaks?). Investment, from primary R&D by central government through to capital investment by firms for plant and equipment, is really important. It is a key part of what will drive the next wave in productivity. We need to keep a watchful eye on all aspects of investment.

Finally the consumer is held up as the trump card, if growth is not to decline in the next year or so. Consumer spending is by far the largest component of US GDP. If spending here keeps up, business may yet increase again investment in response to growing demand.

With Congress split, the likelihood is that broad policy changes will not change- either the House won’t pass the Presidents policies or the President will veto, or the senate will not pass, anything significant the House desires. So my feeling is that growth may yet continue but slow down slightly, which would still be a good thing.

The second article is titled, Load Bearing. It reports that, “Authorities from the IMF to the Fed’s ex-boss are worrying about a booming corporate-credit market”. The credit being analyses here are leveraged loans. These loans are being chopped up into smaller trenches and sold to buyers with different risk appetites. Sound familiar?

The more important news is that we are talking of about $1.2 trillion dollars. Yes, that’s a big number and apparently it is twice as much as six years ago. Some of these loans are refinancing debt (about a 1/3, according to the article) and more is used to finance M&A.

These leveraged loans are attractive to some investors as they have offered good returns at a time when interest rates are low. This is a good example of unexpected and unintended consequences (and economic behavior) that has come about due to excessive periods of low or near-zero interest rates. Such rates mess with your funding approaches. Couple this with the principle, put up long ago, that lowering interest rates drives investment: not many IT or business transformation (i.e. large) projects I know about were conceived of simply because the Fed dropped rates.

The article explains how demand for these loans has led to lowering of standards, and a likely rise in defaults. Again, sound familiar?

The Assault on Capitalism is Complete

A few data points, brought together in an Financial Times article this last weekend (see At a record high, the US market is still shrinking), suggests our political and economic leaders are looking in the wrong direction for the real challenges undermining our economy. Let me summarize them for you:

  • The US stock market is at an all-time high
  • The US stock market is experiencing its longest bull run
  • The tally of listed companies in the US stock market has halved since 1996, from 8,090 to 4,336 last year
  • M&A, funded more by cheap money (via Quantitate Easing) rather than underplaying competitive weakness, has been rampant
  • Industry concentration is widely up leading to mega-firms more able to snap up smaller firms sooner in their life cycle
  • IPOs are happening at half their average rate compared to 1980 and 1990
  • The number of start-ups overall continues to be running at near historic lows

In essence, creative destruction, that natural process whereby death is the catalyst or preparatory step leading to new birth, has been put in hold and worse, twisted into an abomination. What is the cause? How did we get to a place where natural, independent, entrepreneurial spirit has near extinguished? A range of disconnected public policies and actions have conflated to nudge us to this place.

  • Increased regulation, followed up by yet more regulation, ever driven by powerful lobbies and ever more splintered interest groups
  • Reduced public funding of primary R&D
  • Poor alignment of vocational and educational services
  • Social policies that promoted the false idea that everyone should go to university (everyone should have the opportunity) and the resulting demise of things like professional apprenticeships

More insidiously is that money, more specifically the capital markets, are now so distorted that the behavior that acted as the foundations of creative destruction are not holding it back. With the volume of cheap money that flooded the market in recent years, so much money has been chasing ever more riskier bets. The M&A mentioned above was one result. Another is the funding models for how capital investment is prioritized. This has led to a huge growth in private equity and so many more private companies. Thus the cycle of creative destruction has been undermined from several fronts over a long period of time.

The current situation is that the economy is being managed by fewer and fewer public giants and larger and larger private investment and sovereign investment funds. What is left to the retail market, once thought of as a natural part of the cycle, is being shrunk and may soon count for little. The economic cycle firms used to follow, that operated naturally and yielded up profits and growth, is now a managed system by politicians and a small number of the very rich.

What do we do? The FT article suggests yet more regulation to try to rebalance some of the results. No one of note is willing to suggest we roll back the policies and actions that caused the problems in the first place. Shame.

Economic Bullies Are Fattening Up: Where are the Monitors?

When at middle school, some few years ago now, monitors would troll the break-rooms, corridors and playgrounds. If a bully or bully-like behavior was observed, a faithful monitor (sometimes of a more diminutive size) would wade in to neutralize the issue. In industry, economic bullies are getting larger and more powerful and the monitors are missing in action.

What we knew was happening in America is now clearly happening in the UK. In this week’s Economist there is an article titled, “More money, more problems” in the business section. The article reports on new research that suggests industry concentration is well established and getting more pronounced; large, dominant firms are getting larger and more dominant. As a result, a greater proportion of economic profits are being hovered up by the bullies and the rest of each industry is sucking on less and less.

If the market was operating efficiently and freely, the opportunity for start-ups to innovate and create the ‘next big thing’ would help foster creative destruction. But public policy has played a key part in (over?) regulating how business start and operate; and lobbying is running rampant such that, more clearly in America, firms with deeper chests can invest in lobbyists to ensure their masters’ interests are protected; putting more pressure in the smaller guys. The monitors have become the employees of the bullies.

There are implications a-many, some reported in the Economist article, touching innovation and its diffusion (or lack thereof), wage rates, productivity and employment. Larger firms tend to achieve higher degrees of economy of scale; this is a large playground where automation can help drive productivity thus helping the bullies get stronger. Other data from the OECD and other sources suggest that diffusion of knowledge and ideas, needed to help firms share in productivity-inducing work, is slowing down between innovators and followers; in other words between those who already have, and those that already don’t. This reinforces industry concentration or the barriers around the OECD’s ‘frontier firms’.

Employment opportunities and where we collectively go to work changes; and who is able to pay a higher wage becomes self evident. So all in all the controlled environment we live in is a far cry from the free market that was operating 20 or more years ago.

It seems the pundits feel that we need more competition. Can we legislate for more competition or can we undo the constraints that put us where we are today? I think that what is needed is:

  • Less regulation overall and particularly on small and medium business, spanning financials, hiring practices, IP development, and so on
  • Increase investment in primary R&D
  • Increase vocational collaboration with education and industry
  • If you want more regulation, point it at the lobbyists: reduce their spend and power
  • Tinker with the tax code to help motivate investment in smaller firms and Tomory for it, tax larger firms more.

But these items are not even popular topics in politics today. It’s much more likely we will talk about fake news and Russians and Facebook, than economics, growth and hard work. Oh well.

Politics and Spin Over Observation

The March 30th US print edition of the Wall Street Journal carried an Opinion piece titled, “Britain’s Monetary ‘Stimulus’ Has Fed the Pension Crisis“. The article highlights the plight of many firms whose pension funds are under water and how persistently low interest rates have crippled the chances to grow the returns on a number of investment vehicles. This is due to the widening gap between the value of assets and liabilities. The article happens to highlight this plight in conjunction with true fight in Britain over a venerable old British firm, GKN, who has impressively damaging pension liability any suitor needs to accommodate.

The real point of the article however is not really about GKN. It is that the Bank of England recently published a paper that argued its loose monetary policy and massive quantitative easing were in fact good for us. The argument of the report is that things would have been much worse, therefor whatever we have must be better. This is a strange argument. Much research has been published that correlated near-zero interest rates and QE with debt and credit price distortions, record-levels of M&A, record-levels of stock buy-backs, Stu only low capital investment levels, low productivity, and to top it all off, increased inequality. To be fair, if you didn’t watch the news and all those around you, the Bank of England report might be credible. If we had had a real crash, the pain might have been worse for a while, but the economy would have recovered as fast as other recessions due to the lack of credit and debit distortions.

The article closes on a useful warning and observations. Old firms with such large pension obligations and short-falls are suffering from a double-whammy. Such firms have to divert funds to stem the pension fund blessing that might otherwise have helped source the needed growth in the future to pay for those persons. Even if central banks had not kept rates so low for so long and stuff they investor-classes pockets with cheap money, such firms might still be in trouble-or anyway.

The Debt Chickens Are Coming Home to Roost

A story it today’s Us print edition of the financial times highlights a building ‘bubble’ of disquieting proportions. The article, ‘Britain’s Pizza Chain Boom Faces Debt Reckoning’, highlights how a large number of restaurant chains have been snapped up over recent years using debt. This might be by a private equity firm or a leveraged buy-out. In either and other cases, many acquisitions were executed using cheap debt which was facilitated by central bank policies such as near-zero interest rates and quantitative easing (QE), both of which massively distorted the price of corporate bonds and debt. Add to this public policy and pressure on banks to increase loans to help drive growth, you can see signs of a perfect storm.

The UK example is specific, but the problem is wide and applicable to most developed economies. The US has just come off a long-run marathon of high and record levels of corporate acquisitions, again much funded by cheap debt. There must be many organizations hanging by a thread, just waiting for interest rates to nudge up resulting in unsustainable debt burdens and interest payments. Unless growth drives the top-line of these businesses at a faster rate, the chances are many such firms will go to the wall.

This situation was created as an unintended consequence of near-zero interest rates for such a long time and massively price-distorting quantitative easing. Though most governments have ceased buying sovereign and corporate debt, the damage is done. Massive, trillion dollar, balance sheets at central banks need to be unwound in such a way as again, not upset the market. The act of creating the balance sheet did upset the market. In reducing their balance sheets, central banks will do it again.

And the sad part about all this, as it will play out? Smart investors with lots of money and a high risk-tolerance will hedge against such business failures and reap huge rewards. The rich investor-class will get richer, and the poor will just lose their jobs or otherwise miss out. Politicians will have a field day, calling out the failure of capitalism. Of course, it’s not a failure of capitalism since central banks and their policies are not part of any capitalist model: central bank operations are closer to a socialist model where the few take decisions to ‘help’ the many, as if they know better and how to help us.

Oh well, such is life. Just buckle down and wait the storm. The debt chickens will soon be home to roost. Maybe not by this Easter but expect them home by next year.

It Pays to Save

The UK was initially criticized for its austerity measures, employed at the height of the economic crisis that has slowly subsided now around the world. But some year’s later the UK was then lauded for being prescient. At the time, its economic growth was the fastest of any advanced economy. Things of course moved on – Brexit followed and even though the cloud did not fall in, the countries economic condition has slipped from front of the class to back. But that misses the point of this blog. The UK adopted austerity since that was the right thing to do – to reign in spending and support the natural economic rebalancing of price and supply. Other countries, when faced with economic challenges such as a slow-down or recession reach for the public sector check book.

This approach is known as Keynesian demand-management. The idea is simple, if not well understood as a simple idea from the practices namesake. When there is a shortfall in demand in the economy, the public sector increases spending to help fill the gap. Public spending, like any spending, creates knock-on effects whereby a dollar spent creates more than a dollar in ongoing spending. This simple idea became common thinking and the pain of the 1970s and 1980s were required for governments to learn that this approach has issues. First, Keynes had suggested that such spending should be temporary – since private sector spending was more efficient. However, even though Keynes noted this, it was left off the memo and his name became associated with “spend”, not “spend for a short while only”. As a result, governments spending increases were rarely ever temporary.

Secondly, and as we have seen in spades since the recent period of near-zero interest rates and QE, public sector spending crowds out private sector spending. The entire bond market has been distorted due to massive government intervention and spending. The whole pricing process has been disrupted. This is the same with the economy. As demand-management kicks in it forces normal public sector behavior to change. And so the economy is knocked off kilter even further.

So it was interesting to read some new material from the IMF that demonstrates that austerity is not the bad-boy all the politicians make out. The interesting article is called, Climbing out of Debt, and was published in the March edition of the IMF’s Finance and Development magazine. The actual data shows that countries that exploited tax-based austerity, versus reduced spending austerity, suffered deeper recessions. This is a kind of “devil you know” point in that first one has to prefer austerity over increased spending. Then, once austerity is accepted, one has to make a choice between increasing taxes (keeping public spending as-is) or reduced public spending. That is the key. Well worth reading to defend against the nay-sayers.