Category Archives: Recession

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.

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Lacking Productivity: Why our economies don’t grow

I simply loved the Opinion piece (September 20th) in the US print edition of the Wall Street Journal, titled “The Reason Behind Obama Non-Recovery” by Mr. Barro, a professor of economics at Harvard University and a visiting scholar at the American Enterprise Institute. Mr Barro and colleague Tao Jin study macroeconomic disasters in 42 countries featuring 185 contractions of GDP. Basically they study economic contractions and how recovery pans out. The results are fascinating and won’t sit well with left leaning politicians.
In a nutshell:

  • The current recovery is anemic and not because it was so deep an economic collapse (as some suggest)
  • The cause of the slow non-recovery growth is lack of productivity improvement that tends to accompany all other past recoveries that are higher performing
  • The polices adopted by the US government at the height of the collapse was almost the exact opposite of what was needed and what has reduced long-term impacts of economic collapse in the past: the US focused on increased transfer payments, increased regulation, failed to invest in infrastructure and positive educational programs, and tax polices that combined inhibit innovation and productivity growth.
  • Finally the Federal Reserve stepped in as the US government checked out to help stave off financial ruin and resulted in hand-holding the economy to the point where now inequality, the fermenting spirit of the Left, has been accentuated.

The left will argue but the facts stand tall. We need economic freedom and a dose of real capitalism. This dose of socialism-by-other-name is not working; and has never worked.

As an example, there is another article in the same newspaper: “State Sue US Over New Pay Rule”. It seems the Labor Department is being sued by 21 states and businesses over a ruling that seeks to expand the definition of who qualifies for overtime payments. This federal overreach will simply lower productivity by increasing costs of inputs but not changing outputs. Winners in this whole debate will be lawyers and employed government workers.  

Such policies are typical of this administration and should be stopped. We should consider shitting gown half or more of the Labor Department for all the good it has done. 

A US Recession Would Require Fed to Raise, not Reduce, Interest Rates

I read with alarm this morning, as I tucked into my poached eggs and sausage at the China World Hotel, Beijing, a CNBC article where a previous Fed economist (Marvin Goodfriend) was quoted as saying the Fed would have to target negative 2 per cent interest rates if the US entered a recession.  See “Why the Fed might need to cut rates to minus 2 percent: Former Fed economist.” 

At this point there are few signs the US will hit a recession any time soon though the US economy is certainly in what might be considered the down-slope from the last growth ‘peak’. Private firms operating margins are being cut which is about the only non-maladjusted metric (as in no government intervention) we can relay on as a sign.  

But Mr Goodfriend’s point is logical: in some of the past recessions the Fed has had to push interest rates 2 per cent below long term rates. As it currently stands the 10 year interest rate is at around 1.5 per cent. So logically we should expect a record breaking negative 2 percent interest rate. But this is not going to work.

At near zero interest rates many ofthe economic and behavioral assumptions related to how the market works are distorted and are not working. If negative or near interest rates were a solution to growth and recovery, why hasn’t the US, UK, Europe or Japan bounced out of the current stagnation? With near zero or negative interest rates there are numerous distortions that suggest more of the same medicine would be, to say the least, daft and ineffective:

  • Private industry does not open up their strategy play-books due to changes in interest rates. Business strategy precedes interest rates. A change in interest rates simply signals to the CFO or Treasurer that there might be alternative funding models for those strategies that need funding. In other words, if there are no strategies for growth, lowering interest rates does not seem to create them. Thus capital investment seems impervious to interest rates at such low levels.
  • Cheap loans fund bad business habits. Where private firms have exploited near zero interest rates is to take out loans to fund both stock buy-backs and fund what I might call non-productive M&A. Stock buy-backs improve earnings per share (EPS) and thus reward executives according to their bonus scheme. But there is no change in the productivity of those firms led by those executives. As such the EPS metric is creating a drug that executives are finding hard to resist but it will rot their, and our, teeth. Second, so much M&A (which is running at record levels), is not actually tied to business strategy developed over time to drive improved performance. So much M&A is short-term or even knee-jerk planning from firms as opportunities to take out a competitor, muddy the market, or upset someone else’s strategy. Thus the companies being acquired are not necessarily sick or struggling. The cheap cash is being used ineffectively and not in accordance with creative destruction.

If you throw on top of this quantitive easing (QE) you can see that the vast majority of the free and cheap money goes to the well-off and investor class and this goes to explain the worsening inequality we see in the US.  And top this lot off with anti-business political policies designed to:

  • Slow growth of start-ups
  • Favor the hegemony of very large, atrophied private business
  • Force direct reallocation of funds to the less well-off versus policy to encourage expansion of employment of the same resources at a more productive and therefore higher paying level

One can see that the current medicine was only good insofar as it stalled the collapse of the financial system some 5 or more years ago. The medicine has gone off; it is now as much a poison to the economy.

Should the US fall into recession the Fed should urgently raise interest rates 2 percent. This will cause the following to happen:

  • Private industry will look at the data and start to behave more logically. Funding choices will start to resemble normal conditions. To grow a business normal business strategy will return to the fore. Capital investment over cheap M&A should start to look more desirous.
  • Stock buy-backs will slow thus forcing a more useful employment of the relatively cheap money. The stock market rally will peak and the economy will start to right itself. Not immediately but over a business cycle money will again flow to firms that grow through innovation and productivity, not intervention and policy.
  • Other sovereign nations will have to respond with similar interest rate increases since the dollar will appreciate rapidly and so the Fed could lead the gradual return to normality around the world.

The challenge will be with government for it will and does today, get in the way. Polices, outlined above, are actually preventing growth. If we don’t remove them, the success of the Fed path, to raise rates to head-off a recession, will be at risk. But this risk is smaller than what will happen if the Fed cuts rates as Mr. Goodfriend suggests.

China Shock: The Untold Story

Front one of the US print edition of the Wall Street Journal last Fridy: Deep, Swift China Shock Drove Trump’s Support. A fascinating article that suggest, despite its title, that the impacts of China as it joined the global trade game led to swift and irreparable damage to America’s workforce and so led to the swell of support for Trump and Saunders. It so happens that I am half way through reading China Shock, by  David Autor, David Dorn, and Gordon Hanson. The story in the paper and the WSJ article is referring to in its title.

There are are several things to note about this so called, “China Shock”. They are not all good news and hindsight helps (where doesn’t it?)

Firstly global trade is taking a bashing. This is unfortunate. It is unfortunate because economically global trade has been shown to balance out and help everyone, even if one nation is better than all others at everything. What the economists models thus far did not show, nor were they meant to, is what happens under extreme changes in the dynamics of global trade. That is the fact: China shock is not a weakness of global trade, it’s a lack of understanding of the dynamics underpinning it.

The WSJ journal and the paper demonstrate with examples where massive displacement of jobs took place, in a very quick period, over and over in related industries. The two factors that made the shock such a shock are:

  • Original employers (US, per WSJ article and including Europe per the paper) national institutions, job training, educational practices and industrial policy were focused on the wrong thing. Instead of being focused on rapid migration and support for global trade dynamics, they were more focused on slow and limited protection for targeted and said to be critical industries
  • Exporting nation (China) was exporting so much cheap Labour and products across a broad and often related swathe of markets and industries that had a multiplier effect I terms of displacement and elimination of ‘landing places’ for those initially displaced.

These two factors explain how it was that worker after worker listed in the article lost a job, gained a job, then lost it again. Then finally were not able to get a job.

Our economists did misunderstand some of the dynamics of global trade given the entrance of such a large supplier as China. But governments should have spent more time focused on policies related to growth and industrial migration, rather than pandering to selfish efforts protecting themselves.  

Now that China Shock has shocked, what do we do about it? Well, media and press are now gunning for global trade. This hype will damage global growth and crimp efforts to get past current anemic conditions. Capitalism is again under attack not due to a failure of the system but a failure of our own misunderstanding of the dynamics of the world around us.

Governments need to focus on building a resilient trade and industrial policy that responds to changing global dynamics. Industry and government need to work more closely together so that as global trade pressures alter the competing advantage of nations and firms, action can be taken to provide alternative safety nets.

Another article in the Business and Technology section of the WSJ demonstrates this: Coding Camps Attract Tech Firms. A small private educator runs 12 week courses for $15,000 that leads to no degree. But almost every attendee gets a job within 6 weeks of graduating with an average salary of over $74K. What is impressive is that the curriculum changes within weeks of any new demands from industry. Try doing this at more established educational establishments.

Governments also need to work on exchange rate policy and collaborative monetary policy. One aspect, not explored in detail here, relates to how currency value can have a big impact on comparative advantage. As such this policy effort needs to be reconciled to industrial policy.

If global trade gets bashed, and government policy targets protection of industries that are no longer competitive, we will just avoid paying the piper at the right time. The piper will be back but his tune will be louder and more deafening.

Alarm Bells Ringing: Productivity Dives and Credit Card Debt Soars in US; Private Investment in China Falls

Today’s US print edition of the Wall Street Journal was not a happy bunny. Articles on the front page (Productivity Fall Imperils Growth), inside front cover (Plastic Is Back In Style), and back cover (China’s Private Sector Withers as Growth Slows), pretty much portrayed a state of global gloom.

First, productivity. Readers of this blog will know my thoughts about productivity. Advanced economies are struggling to demonstrate productivity improvements and so our collective long-term growth prospects are falling. We can’t just adding more hours to get back to reasonable economic growth and pay off our debts- we need to become more productive.

Increasing red tape, political gridlock or uncertainty, uncompetitive tax rates, quantitive easing, low interest rates, and a regulatory framework that dissuades both business risks (in banking) and start-ups and capital investment (private sector investment) are crimping opportunities for productivity improvements.  Capitalism is being strangled.  I might even go as far to say that the technology or the IT industry is also struggling to demonstrate the value it can bring to business. Whatever the case, productivity is critical to our long-term success and few governments or leaders are even talking about it.

Second, credit card debt. From an economic cycle perspective the US economy is past the high-point of the recovery and most likely moving down toward the next down-cycle. Though you would not know this from the economic data. However, consumer debt is suggesting a bit of a problem is bubbling away.

After the financial crisis US consumer debt (and private sector debt, for that matter) took a bit of hiatus. We all took time off to unload some of our liabilities. However the report suggests that all the debt cycles are now trending up: mortgage debt ‘recovered’ first, then student loans, automobiles, and finally now we see credit card debt on the increase. What is interesting though is that this growth is mainly associated with those of us with a subprime or low credit score. In other words, that part of the consumer population that is most at risk of non-payment are stoking up on credit. The percent of the population with high credit scores has remained the same over the last ten years.  

Finally, China. The news is not good. The article clearly only refers to a few individual company interviews but does report on some economic data, for what it is worth. Private sector capital investment in things like factories and vehicles grew 2.8% in 1H 2016, compared to 30% in the last 10 years. June was the first time it actually fell since China started tracking the data in 2004.

Public sector spending has been very high recently, partly as an attempt to replace the loss of private investment and also to support of the needed investment to convert the Chinese economy from a supply-based manufacturing oriented economy to a demand-based consumer model. This will take years; all the while public sector debt is pilling up. The article also highlights a government official who suggests that falling productivity is part of the problem.

So with just one coffee out of the way, I was already not feeling good about the world. Off to go cook breakfast for the boys. I hope they have a better time back at school today!

Creative Destruction In Hold – Slows Economic Growth

A problem, already known about, has been festering and getting worse. Now it seems it is more clearly explained and worse, not just a US problem. The FT Big Read today in the US print edition of the Financial Times, Decline of Start Up Nation, explains the sad decline of the growth of new start up firms across America.

To be fair, though the absolute density of start ups per 100,000 residents has fallen from over 160 in 1978 to about 80 in 2013, there are pockets of recovery in a few places in the US. But the facts speak for themselves. The article lists a series of reasons for the loss of entrepreneurial mojo, that sits at the heart of Schumpeters’ creative destruction (1942).  Creative destruction describes the cycle of innovation, growth, maturation, decline, and recycling of resources for the next round of innovation. Creative destruction is central to capitalism and without it, all manner of anti-capitalist rigor mortis sets in.
First the causes: there are several listed:

  • Change in education and demographics of our innovators and entrepreneurs
  • Lack of access to capital
  • Increased government bureaucracy and red tape

Now the results:

  • Entrenchment of large firms and subsequent maintenance and growth of lobby-based policy reinforcement
  • Polarization of income and wealth, where the investor class accentuates gaps to middle and lower classes
  • Weaker economic growth
  • Which then leads to majority pushing for socialist re-balancing polices that accentuate the problem even further

And in the most recent exceptional economic and business cycle:

  • Finally economic failure leads to market distorting polices of central banks who act in lieu of effective public policy needed to reestablish growth

It is difficult to determine what starts this entire cycle. It is quite likely that any one trigger along the path will set in motion the others. The fact is that our US economy, and to a large extent, the western developed economies, are in a similar bind and firmly at the end of the cycle. There seems no way out. Worse, using the recent Bank of England response to Brexit jitters and a new reduction in interest rates and more quantitate easing, the establishments only has one response to all challenges and it is to administer more of the same medicine.

I am not a fan of Hillary or Donald, but we need a schism to break out of this mound. Clinton promises more of the same; the promise of Trump is different. Question is, is Trump going to lead to a refreshing new cycle of growth, or mayhem? Is the gamble worse than more of the same weakness under Clinton?