Category Archives: Debt

Financial Times’ Martin Wolf Finally Get’s it Right

In “Fix the Roof while the sun is shining“, on Wednesday December 6th, Martin Wolf reports on how excessive low interest rates and quantitive easing create conditions that lead to rampant and growing debt, and now this might hold our newly growing global economy back. No kidding. It is about time that Mr. Wolf caught up with the rest of us. QE and near-do rates have were useful in saving the economy, but after a very short period of time we should have pushed rates up and had the Fed (and other central banks) withdraw from QE. If we had any form of real global central bank collaboration, this could have been coordinated together and thus no single region would have been subject to any disruption. We don’t have any form of Bretton Woods 2.0 and so we were all left to figure this out alone.

Now the newly recoding and growing global economy is now dunk on debt. We have sovereign states, states, cities and the public sector that have stoked up on cheap money. Worse this cash has not been used to drive growth economy that would have spun off profits to feed the governments, such that recovery would have improved sooner. If your home is anything like mine, the State of Georgia has rebuilt roads that were perfectly good before; and not added valuable new roads or services. The private sector has been buying back shares to drive EPS to feed the bonus needs of executives; and been gorging on M&A activity that was not driven by weak firms failing but hostile acquisitions of reasonably performing assets. On top of this, in some regions of the world (see Italy as a good example), zombie banks and firms have been hogging underperforming assets in the interests of keeping employment going. Thus the Nannie state is alive and well, dressed up in a veneer of free market economics.

Much has been written since the financial crisis about how moribund the state of economics are. It seems we no longer have a core base of trusted economists guiding anyone, let alone our political leaders. The economists are almost as decided as the politicians are. Yet even in the most basic of areas, debt and credit, we have failed. How on earth unrelenting debt, massive imbalances, and market-inflicting Federal involvement in the bond market would be a good idea but for a fleeting while is beyond me. The blind were leading the blind. At least Mr. Wolf has removed his blind. Let’s hope the rest do – and soon.

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One small picture says it all

Standing about 2-3 inches tell and 1-2 inches across, a small chart in page A6 of this last weekend’s Wall Street Journal, sums up our economic predicament. The article, Japan Firms End Yearslong Price Freezes, reports that a growing number of businesses are reporting that labor shortages and increasing demand are leading to price increases. The chart shows a pleasing, gradual but clear rise in prices in Japan over the last year, now approaching 1%. This is important.

Though 1% inflation sounds measly for Japan it could be a short-term boon. The nation has been bedeviled for over 20 years with meager growth, stagnant wages, and tepid productivity growth. In fact some economist suggest that Japan’s fall from economic grace that preceded the West’s financial crisis of 2007, demonstrated early what would happen in a deflationary economy with massive quantitative easing. QE did not drive Japan’s economy to growth; it does not seem to have done so in the west, though it may have saved it from crashing and now we see how it’s persistence has led to financial and investment dislocation.

The news all around us is quite positive:

  • Most recent quarterly GDP in US was restated up to 3.3%, almost unimaginable a year ago.
  • EU economic growth rates are forecasted to grow above their recent meager levels in recent OECD reports
  • ‘Currency war’ reports appear in the press infrequently, even though global trade remains torn by the idea that the US wants a stronger negotiating position (for what is, essentially, a very small part of the US economy).

But inflation remains stubbornly low almost everywhere. If Japan soon demonstrates ongoing growth in inflation, and global commodity prices push up, the result will be a wave of input price increase around the world. Some months later the US and more clearly the EU will see producer price increase and so consumers may see pass-through increases. This will encourage central banks to continue their march toward normality.

The downside with a return to inflation: Debt servicing becomes more onerous as interest rates increase in response to inflation increases. As such, governments and businesses that stocked up on cheap debt during QE and the near-zero interest rate period will have to squirrel away more cash to pay their interest charges. This will reduce what’s available for investment, thus slowing down growth.

The cycle feeds on itself so it can sometimes stabilize or other events can kick it into maddening swings. We will just have to see what happens. It may depend on how fast inflation growth returns. But for now, that little picture on page A6 looks very nice in a chilly autumn morning.

Normalcy is Slowly Coming Back to our Economy

Love Trump or hate him, the one thing you have to say about the economy since around his election, it is starting to show signs of normality. That is, certain data suggest that firm behavior is slowly moving back toward what is more normally expected and widespread before the financial crisis.

Front page news in today’s US edition of the Wall Street Journal, “Firms cut buybacks as stocks become too expensive“, report that – as the title suggests, stock buybacks are falling again. This is a fall compared to recent record highs, so it is not that we are done with the mischievous side of Quantitative Easing. At a run rate of $500M spend by S&P 500 this year, 2017 will be fourth or fifth highest ever. The growth of which signaled that investors had noting better to do with their money then play with the earnings per share metric in order to pay out bonuses to executives. The negative to all this was the poorly performing capital investment side of the economy.

So here is where the other side of the story adds weight to the early sings of good behavior. The article continues on the inside front cover and there is a graph of capital expenditure. Running at near all time lows for a number of years, it is showing signs of increasing in 2017, This implies new plant, new equipment, new spend on IT and other productivity inducing and growth driving engines. This is what we want to see. It is not that our economy is well, really, it is just that it is a twisted monster. It is to a free market; it is a contorted, overly regulated morass of centrally guided actors. We need to get out from under QA and allow money and investment to find returns that are normal. If we were to couple this with the promised tax reform, we might unleash a new normal for 2018. Let’s see.

The Madness of Student Loans

I read an amazing article in today’s US print edition of the Wall Street Journal. The article was titled, ‘Parents are Drowning in College-Loan Debt‘. The front page article explored data that suggests new record levels of delinquency on college-loan debts associated with a government-managed program called Parent Plus. 

Apparently this program allows parents to borrow money to support educational costs over and above the maximum a child can obtain from federal aid. The article suggests that there is no limit to what can be borrowed via Parent Plus (created by Congress in 1980 when Jimmy Carter was president); and that the most information needed to qualify is a social security ID. Apparently there is no credit check or any other required qualification.

Excuse me? I had to read that part again. What idiot approved this policy? Talk about idiot. This is just the kind of lunatic policy that contributes to unsustainable price increases in secondary education that the droves demand for more subsidies, loans and debts. This is as close to nuts as the same socialist and left-leaning policies that suggested expanding home ownership for those that cannot afford it was a good thing. This is madness.

Not every child needs to go to college. But every child should have the opportunity. There is a distinction between those two points; and the result should not lead to governments controlling access by funneling loans to those that cannot afford it. Attendance should be based on merit. Thus fewer would attend and so prices would not rise as fast and so fewer loans would be needed. But socialism informs uneducated parents that they have a right to a college education and so Uncle Sam has to bend over and make crap up and print more money and screw everyone as a result. Nice.

Now we are again in another financial pickle. But I can’t stop and write about how to fix it. I am going to rush off to go apply for my free Parent Plus loan.

US Economy Not Out of the Woods – Beware the Hype that Says Otherwise

You would think that, given the press coverage, much of the US economy is making great progress.  Apparently interest rates will continue to rise in response to the Fed’s feeling that the economy is doing well; near-full employment, GDP recovery, stock market growth, bond and dollar strength and all that jazz.  But these data points mask some other troubling items that suggest any recovery will likely be lopsided and even short-term based.  You only have to look under the covers at, say, unemployment, credit, or housing.  

  • Unemployment: despite low levels of reported unemployment many economists are concerned that the participation rate is at very low levels.  In other words, there is a lot of unemployed that is not being reported in the official KPI.  Some economists suggest that real effective unemployment maybe nearer 6 or even 9 percent.  Thus the result of economic growth may not lead to wage price pressure so soon, since the participation rate may improve the so pick up some of the slack.  This is good news overall but not if the Fed believes that they need to head off wage inflation likely to appear due to pressure on a really tight labor market
  • Consumer Credit:  Student and auto loans are running ahead at full steam, and mortgage debt continues apace.  While many firms have cleared their balance sheets of bad debts, consumers – which drive a massive part of the US economy – are amassing debt easier than looking for a hot meal.  On February 27th the US print edtion of the Financial Times carried an article, More US car owners behind on loan payments than at any time since 2009.  What is realy funky here is that if you go into the market now to look for a new or used car, you will be offered a loan for repayment now past the 5 year window.  It used to be that 5 years was the maximum and this was only a few years ago.  Now you can get a loan over 6 years or longer.  So the consumer part of the market is building up a nice bad-debt situation.
  • House prices: Yes, house prices have recovered, so we are told, to near pre-crisis levels.  So that part of the market is secure, right?  Wrong.  Home ownership is a its lowest levels in years.  It turns out that the buyers that are driving up prices are investment firms and conglomerates that are snapping up property then leasing them to. So first time buyers are being squeezed out.  The housing market has not recovered in the way we would want it or need it to for effective sustainment.

So we have a very lopsided economic recovery.  It is not stable and even the strong shoots are some challenging weeds hiding just under the covers.  Even if Trump can delivery on +2% GDP growth, I am not altogether sure that woudl mask the issues that are building up today.

My Top 5 Biggest New Year Risks to the Global Economy

In order or scale, priority and impact, here are my picks for the five most critical trigger-points that may impact, negatively, a return to ‘old normal’. Currently we stand at the edifice of a new normal, the great stagflation, but the anti-establishment and populist changes taking place seem to suggest a knew-jerk reaction by nations fed up with socialist dressed-up-as-market politics that have led the West for 20 years.

  1. China’s economy stagnates or crashes. Debt levels are above EM levels and are now among the largest, approaching the incredulous Japanese levels. This dynamic is not sustainable for a nation whose currency is not a reserve currency. However the economy is the world second largest even without the development and emergence of whole swathes of other sectors such as healthcare and leisure, which may offset contracting first world growth over the next year or two. So the risk is there and there is no clear leaning one way or the other, yet. But debt is growing faster than these new sectors; exchange reserves at $3bn are limited (though huge), and currency value management is not market-bases. So greater risk is with the downside. China’s growth flags, currency sinks, counterbalancing US growth and confidence, creating a massive imbalance in the global economy. Europe watches on as global GDP sinks under its own debt weight. KPI’s to avoid/watch out for: China GDP falls to or below 4.5%; China’s debt load surpasses 300% of GDP.
  2. Trump quits after 18 months due to intractable political limitations that prevent policy changes he seeks related to healthcare, regulatory complexity, tax reform and trade. Trump’s political rhetoric is being replaced with solid business-based policy. However not all such policies have ever been tested at a national level and scale. Some efforts will fall foul to physical, social and political limitations. This may prove frustrating for Trump. As growth will return short term, such medium term frustration will lead Trump to claim, “My policies worked, see? But now the system has reached its limit and there is nothing I can do until the country agrees with me to shut down the whole government system! Since they are not ready, yet, I am ‘outa here’ until they are!” Markets crash, interest rates balloon, inflation rages all within a year. World economy sinks into the abyss. KPI’s to avoid/watch out for: US GDP 1H 2017 reaches 4.5% but Congressional conflict leads to policy deadlock ; vacancy in position at Whitehouse. 
  3. Emerging Marker currency crisis as massed capital investment is siphoned away towards a resurgent US economy and dominant dollar, as well as a stable and even growing China economy. This situation is already underway. The risk is that what is currently a reasonably ordered trend becomes a financial route. This is possible since the financial markets are starved of yield due to the collective policies of central banks to keep interest rates very low for too long and for the build up in their massive balance sheets. If the trend becomes a torrent, EM’s will have to yank up interest rates far beyond what their local economics can support and economic disaster will follow. This will ferment more political instability and drive increased destabilizing ebonies to ruin. Though the US may be growing well, compared to its peers, it’s the imbalance they tips the ship over. KPI’s to avoid/watch out for: dollar index, the weighted value against basket of currencies, surpasses 115. It is currently at 103.33, which is a 14 year high; EM interest rate differential balloons.
  4. Hard Brexit forced through by intransigent Europeans who think the EU experiment is more about political union than economic liberalism. A new trade deal, legal framework and social contract can be negotiated within a two year window. But only if politicians and civil servants want it too. Continental politicians however, under the strain from populist pressures, will equate intransigence over Brexit negotiations with an improved politicos standing with their electorates. Fool for them as this will actually create the opposite response for such behavior will simply worsen the economic climate. The lack of any sign of return to old normal will lead to political paralysis and the clock will time-out. Hard Brexit will be forced upon a supplicant Britian. Europe and UK economies will tank; currency wars will wage; global trade will collapse further. This will not sunk the global economy short term but will act as a dead weight slowing its resurgence down. KPI’s to avoid/watch out for: no agreement at end of two year period lost triggering of Article 50. 
  5. Latin or Indian debt or economic crisis. Much like with other EM’s, growing sectors of significant size around the world may blow up- India being the best example. India’s growth is different to China. It is more integrated socially and politically with the west, but it’s corruption levels are far greater than what one can see or observe in China. It is possible that local economic difficulties, hard to observe today, may trigger a collapse in confidence that leads to a destabilizing debt or currency crisis. Brazil’s economy is certainly in the dock currently; Argentina is struggling. India’s economy looks like paradise right now but the growth across the country is extremely uneven- you only have to look at public sector infrastructure investment. So should two such countries suffer local difficulties, the combination may result in significant risk to the global financial system. KPI’s to avoid/watch out for: two simultaneous financial/debt crisis afflicting EM or India.

These are my top 5 risks the global economy faces in 2017. I hope I am wide of the mark, in a positive way. I left Japan off the top 5 list yet their economy remains anathema to growth. The Japanese market invented the whole new normal cycle with a anaemic growth, massive debt, low inflation, and demographic contraction. And Japan has an amazing debt load that refuses to spook investors. Things may yet have a Japanese tinge before the year end. Does Japan, along with the US, lead the global economy back to the old normal!
What potential risks do you see?

Near or below zero interest rates do not encourage investment

Central Banks around the world have got it wrong.  During near-normal economic cycles, lowering interest rates altered (through signaling) how businesses funded planned investments.  But those investments are driven by business strategy, not market economics.  Firms are not sitting there saying, “Well, with near zero interest rates- what innovations shall we come up with today?”  Just ask business leaders!

Lowering interest rates just signals a different potential pattern of sourcing of funds, if investments are ready to be funded.  But in this high-regulatory and low-inflation economy, with cheap money funding easy stock buy-backs and a stock market rally, there is no need to innovate as much or make the big or medium size bets that such capital investments need.  Firms are achieving their EPS goals without them.  Just look at the data.
The central bank’s have got it wrong.  Just look at the data.  Capital investment is flat when, according to central bank thinking, it should be ballooning.  Has any central banker actually spoken to any number of business leaders?  Or if so, are they confusing political sycophants for real leaders?

The only way to encourage investment in capital programs for innovation is to return the market dynamics to near-normal settings.  That means that counter intuitively central banks now need to raise rates and curtail quantitative easing.  And quickly.

Why can’t central banks see the obvious?

The problem now is that central banks are looking for even more fuel for the fire.  The Bank of Japan is now reportedly looking at even more extreme measures of the same medicine.  The bond market is about to go the same way as the stock market as in massively distorted.  If we are not careful we will enter the twilight zone and no one will be able to control a thing.