Category Archives: Productivity

Open Letter to Mario Draghi: Wake Up!

December 6, 2016 


I am in receipt of a copy of the transcript of your recent a speech, “The Productivity Challenge for Europe”. I have to report that your paper makes little sense and completely avoids the negative impact that your policies, as head of the ECB, have had in holding the EU’s economy back.

But before I identify the errors in your analysis I need to first highlight how your initial assumptions, outlined in the first part of the speech, are presented backwards. Here are several of your assumptions:

  • “Stronger potential output growth aids monetary policy by increasing the equilibrium real interest rate.”

Sir, this is self evident. However it is the interest rate policy of the ECB that has stifled risk and investment that can drive growth. It is not growth that aids policy; it is policy that should be creating opportunity for growth.  
Now the second backward facing assumption:

  • “And higher future growth helps monetary policy today. It encourages households to spend more and firms to invest, reducing the need for monetary policy to support current economic activity and bring inflation back towards 2%, and speeding up the return to more conventional monetary policy settings.”

This is similar to the first item; it is not growth that affords a monetary policy; it is monetary policy that should be assuring growth. You are clearly looking at the real world backwards. This will again become clear as we look and analyze your prescription to the problem of lack of growth.

The main body of your speech calls out correctly the cause of the stagnant euro productivity figure. You correctly call out capital investment and efficient allocation of resources (to the more productive) as the challenges facing us today. And supporting both of these is, ultimately, the diffusion of innovation across the region and non-frontier firms (I too read the OECD paper).

However sir, I see a weakness in your monetary policy. Firms are not sitting on their hands with a bunch of ‘shovel-ready-strategies’ waiting for the right interest rate level before launching one. Firms have strategies, first and foremost, independent of interest rate. Some of those strategies require funding and at that time, the firms’ treasurer or CFO will compare the range of funding options available.

You see sir, you have only to ask company treasurers and CFOs how they use interest rates to realize that perpetually low or even negative interest rates are anathema to growth. They are killing our economy.

As to resource allocation, well, since the capital markets are massively distorted is it any wonder that internal company allocation methods are screwed up too? With quantitative easing and the vast sums of money sloshing around the community, it turns out that companies were and are able to alter short-term ‘strategies’ to leverage it all. They simply launched non-natural M&A (at an all time high) and stock buy-backs that meet EPS targets more easily than riskier long term capital investments.

You do touch on several other polices that would positively impact rates of diffusion of innovation, namely:

  • Fostering more competition 
  • Well functioning capital, product and labor markets 

Alas the very polices you and your kind seek and set are preventing the realization of these polices:

  1. There is reduced competition due to excessive regulation and tax policies that favor established and larger firms over smaller and new
  2. Capital markets are being massively distorted as explained above
  3. Product markets are held hostage to, again, red tape and too much government involvement
  4. Labor markets are held back due to the same nanny-state efforts

Sir, I implore you to look at the data in front of you. Meet with twenty CFOs. Get out a little bit and talk to real people and put your books of theory away. I beseech you- before you bring the whole edifice of the EU down.

I have the pleasure of being, sir, your obedient servant.

A. White


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.

Biting the Hand that Fed Us

Mr. Kevin Warsh, a former member of the Federal Reserve board, now a distinguished visiting fellow in economics at Stanford University’s Hoover Institution, pens a damning Commentary of the Federal Reserve in today’s US print edition of the Wall Street Journal.   

In “The Federal Reserve Needs New Thinking“, he slams the Fed for “….[T]he economics guild push[ing] ill-considered dogmas into the mainstream of monetary policy. The Fed’s mantra of data-dependence causes erratic policy lurches in response to noisy data. It’s medium term policy objectives are at odds with its compulsion to keep asset prices elevated. It’s inflation objectives are are far more precise than the residual measurement error. It’s output-gap economic models are troublingly unreliable.”

If that were not enough he adds: “And it expresses grave concern about income inequality while refusing to acknowledge that its policies unfairly increased asset inequality.”

Wow- this is a damning perspective from a ex-member of the Fed. I have to say that I tend to agree with his perspective. However the Comment falls short of the title: there is little new policy offering or suggestion to warrant any ‘new thinking.’ The challenge is to query what could or should the Fed and other central banks do differently.
One odd idea I toyed with a few months ago (see The ghost of Keynes haunts our global leaders and economic conditions today) is to globally reset interest rates as if a new normal had been established. What I mean to say is that central banks around the world should all raise their interest rates at the same time by an agreed amount in order to:

  • Preserve current interest rate differential between central bank authorities
  • Establish a more natural rate in order to reestablish normal market and investment operations

If we had nearer-normal interest rates the following would happen:

  • Private capital investment decisions might once again take on a normal demand curve and pattern, thus contributing and steering toward increased productivity
  • The cost of money will rise and so private firms will stop issuing bonds or taking out cheap loans only to increase share buy-backs, thus decreasing the inequality in invest class assets
  • M&A levels would fall to more normal competitive levels
  • Consumers will start to save again
  • Pension funds will have their unfunded portion of their liability reduced

All in all that would be a good day at the office. But it only works if the Fed and central banks in UK, Canada, Europe, Japan, and China agree and collaborate closely.  Additionally the IMF probably needs to leed this effort.

The other problem is the large overhang of debt that central banks now have on their balance sheets. These acquisitions represent government (and some private) debt. These enlarged balance sheets also distort the market. The problem is that central banks have no idea how to jettison these debts without completely upsetting the market again.  

So I guess the only option might be to collaborate with other central banks and agree some kind of normalized write-off. If all central banks agreed to write-off 75% of the government debt they hold, it would free up government spending (since they can start up again, hopefully on the right things this time like education and infrastructure) and the market prices will be balanced. This is of course a silly idea. But how else can we make progress with this challenge?

Yes, new thinking is needed. And a lot more collaboration. The solution will not be found in one central bank. We are too connected. We need a new Bretton Woods 2.0 agreement.

Capital Investment Continues to Decline; Productivity Showing few Signs of Recovery. ¬†What are we to do?

Some of the more interesting CNBC and Bureau of Labor Statisics headlines of the last few days that I spent time exploring.  They tend to be more “half glass empty” than “half glass full”:

On the positive side:

Interest Rates are a spent force – and Uncreative Destruction

The US weekend print edition of the Financial Times carried an interesting Comment by Eric Lonergan, macro fund manager at M&G investments. His piece, “Interest rates are a spent economic force,” suggests that since the consumer and industry have not responded to low and now negative interest rates as expected by central banks, the relationship assumed by bankers and economists between spending and interest rates is kaput. I disagree.

I agree that consumers and private industry have not responded as they have in the past (and increased spending as they should) with low interest rates. But what Mr. Lonergan is missing in his article is the role the environment plays in this relationship. It is not that the relationship between interest rates and spending is broken, it is more likely that there are other factors that were not present in the past that suppress the relationship we thought was pure.

Worryingly though some of the behaviors have been talked about for some time and worse they are quite logical. As such one wonders about the assumptions our economists made all along. For example, lowering interest rates should encourage private industry to increase capital investment. This long-established assumption pre-supposes that firms have capital investments lined up ready to go. This is where the current economic conditions are quite different to what has gone before.

It seems CEO’s do not, as a rule, go looking for new capital acquisitions when interest rates are lowered; or even at rock bottom levels. If you think about it the reality is that CEOs and their boards develop business strategies. These are more likely based 0n the state of the business, their competitors and the clients they serve. Interest rates primarily impact the aspect of the strategy focused on sourcing of funds to pay for that strategy’ funding is not a business strategy per se. Firms have as  many effective shovel-ready capital investments than public sector agencies had with their crisis funds.

So why are not a plethora of capital investment strategies today just waiting to be funded?  It is believed that there are a range of reasons and a number of them reinforce each other.

  • Regulation: many forms, banks are a good example as they are in the business of risk management, are subject to huge increases in red tape; more and unpredictable levels are coming as some rules have been passed without the details drafted: e.g. Dodd-Frank
  • Political instability: The very real complexity that derives from unstable, extreme or radical political leadership is rife. The US, UK, Western and southern Eastern Europe, and the Middle East are all subject to huge disruptions
  • Quantitive easing: another policy gone array has pumped millions of dollars into, it turns out, into the investor class. As such inequality has worsened and a stock market bubble has formed. Flush with cash, and this is where low interest rates help, CEOs and boards are approving share buy-backs galore. This ‘improves’ earnings per share (EPS) without doing anything material to the business. This negates the need for a more risky long term investment approach to meeting EPS growth targets.  M&A is running at all time highs too – and much of this activity has little to do with natural competitive forces and more to do with cheep money.  This the effort post M&A ends up being much less productive (i.e. uncreativedestruction). 

Firms are thus leveraging logically what has been offered them. Now central banks have egg on their face while business leaders have a wry smile.

The Unintended Consequences of Low Interest Rates

Since capital investments are depressed and have been for some, the long term impact is that productivity will be hampered for years to come. The flat or even declining productivity is a sign. Is quite common in developed economies. The problem is that this is not a quick fix and the harm is being baked into our systems and practices.

Our economy is walking along as in a stupor and we can’t see forward clearly enough. We have to eliminate the over burdening red tape; we need political stability and a simple, private sector friendly and small government minded leadership. We need central banks to sell off their balance sheet assets, reduce QE, and raise interest rates in order for firms to return to making rational investment decisions.

If they do not, the hole will only get bigger and the rope needed to get out of it even longer.

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!