Category Archives: Interest Rates

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.

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.

New Cracks in the Euro

News today suggests that the central European economies are beginning to surge ahead with growth while at the same time the periphery continues to struggle terribly.

In today’s US print edition of the Wall Street Journal there is news that German GDP in December continues to grow. We only just read that house prices are surging too. As Germany starts to surge ahead, it will need to push interest rates up to help control growth and prevent overheating.  

See German Economy Accelerated Last Year and Eurozone Output Data Suggests Strong Upturn.  
But Greece, Spain, and even Italy, really don’t want and may not even be able to sustain an increase in interest rates. The Greek economy has not yet recovered. It needs persistent low rates and in fact additional help (or changes in policy) to help repair the damage.

As such the pressure-cooker-politics of the Euro is about to get a dose of heat. It won’t be another six months before the pressure becomes clear to all.
 

The Home Owners/Renters Market is Upside Down

Two articles today suggest that two of the world’s largest economies are swapping roles and focus for home ownership and renting. Germany has been a nation of renters; home ownership has run at relatively low levels compared to the UK or US. The US has operated under the assumption that home ownership is central to the American Dream.

As we all now know, policies adopted by the US government in the 1980s led to a relaxation of requirements for those seeking a mortgage and low income, even zero-income families, obtained mortgages they could never afford. The result, when combined with human greed both by home buyers and the investment community, led to the financial crisis that is the cause of the situation we are in today: near zero interest rates and massive influx of quantitive easing that has filled the coffers of the investor class.

But what is happening now? It seems that the near zero interest rates in Germany are driving record levels of home ownership and low interest rates in the US is driving up demand for rental property with record low-levels of home ownership. The world is turning upside down!

In the US print edition of the Financial Times, the article, “German’s switch to home ownership fuels bubble fears“, reports that house prices are rising as demand for mortgages continues to rise. The good news is that many of these new mortgages are fixed rate plans- which protects home owners as interest rates increase.  Germany has been a relative laggard when it comes to home ownership. See Most Germans don’t buy their homes: Theey rent.  Here’s why.  

In the US print edition of the Wall Street Journal, in an article, “Millennials Fuel House Rental Boom“, we hear of the later boom afflicting the US market. It turns out that US home ownership is at record lows, yet house prices around the country are recovering and in some regions, back to pre-crisis levels. How can this be?   Turns out that firms flush with cash and low cost loans have been buying up property in the cheap and renting them. The article above goes even further and explains how firms are now increasing investing in entirely new property developments specifically for the rental market.  

This all might alarm you. The American Dream, perhaps western democracy, was assumed to be predicated on home ownership. But this is not the case. The German economy has done very well with relatively low home ownership rates. The US might have to learn from the Germans how to run such an economy; likewise the Germans need to take a leaf out of the US’ books to avoid bubble blow-out.  

But in all practical terms we should be alarmed. Germany is an export-based economy. Other counties want (or need) to buy Germany’s products. Exports from the US is vastly less of a proportion of it’s GDP than it is for Germany. So there is little room for the US to behave more like Germany. Additionally Germany cannot set its own interest rates; even now the stresses between the EU center and periphery are growing again. Greece, Spain and Italy continue to need low interest rates to help nurture their local economies to recovery. Germany, never near a recession, is showing signs of too rapid growth (and growing inflation) and may approach overheating before the periphery is even back to positive growth.  

Bottom line: zero interest rates and quantitive easing (and resulting central bank balance sheet ballooning) is changing our economic foundations. This will impact our societies in ways it is hard to predict. Hang on guys, it’s gonna be a bumpy ride!

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?

Trumponomics is About to go Global

The critics were wrong and we know this now. On election market futures tanked on the hint that Clinton would lose and Trump might win. They and their pundits assumes that mediocrity and continuation of the Obama polices would permit the investor class to get richer so Trump represented change and risk. Not five hours later the market reverses and streaks ahead.  

Today the market continues to charge ahead. Trump’s election promises of lower taxes, less regulation, less government, seems to be recognized for what it is- a growth agenda. But more importantly, Trump’s winning will result in the export of his policies abroad.

The dollar was already strong against all other currencies. The Fed has no choice but to seek to get to normality with interest rates, and soon. The more the US economy morphs towards higher GDP growth, the more US interest rates will rise. This is a good thing. We need to return to the old normal or an approximation for it.  

But as rates rise so the dollar will surge alongside GDP. As the dollar surges imbalances in exchange rates will lead to two cycles:

  1. Liquidity will center on US and emerging markets and other developed marked will contract as money seeks yield. This will starve other regions of cash. At the same time US exports will be hampered (not overly important to US national economy as a percentage) and for other nations, exports will balloon as their currency is cheaper. The result will be that the US trade deficit will itself balloon again. Inflation will get a fillip due to increased US demand (note that inflation is already showing signs of stability) and as a result, trade partners will suffer greatly under either the weight of their new economic normal (zero rates, no inflation, high relative tax rate, loose monetary policy) being inconsistent with a resurgent US or lack of capital.
  2. As a result, trading partners will need to raise their own interest rates to help stabilize currency markets. This will alleviate some of the dollar’s strength. But if this is the only policy followed, those trading partners will sink into the abyss of stagflation. They will therefore need to emulate many other of Trump’s polices in order to ‘keep up’. So deregulation, lower taxes and more devolved government (perhaps focused on education improvements and local healthcare) will follow.

Trump and his ‘buddy’ Yellen will together export Trumponomics around the world. And it will likely start by the middle of 2017 as the first increase in interest rates in Japan, Europe and/or in some emerging market is triggered.  

The real question though, the real conundrum, concerns China. China is still in a massively debt-fueled growth period and its currency continues to fall against the dollar. Trumponomics will push the Yuan down further and faster, helping Chinese exports to the US. But China will need to raise rates internally, or sell US treasuries (to buy yuan) or buy selling dollars from its massive foreign exchange reserves. Any and all of these will force the Fed to raise treasury yield and rates. Thus the entire cycle that has kept the world economy down for six years will reverse and little will stop it accelerating quickly. It could easily overheat within two years.