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.
In 1979 Margeret Thatcher came to power in the UK and one of her first decisions as prime minister was to scrap capital controls. It was the beginning of a new era and not just for Britain. So says Wolfgang Munchau, in yesterday’s US print edition of the Financial Times in his Comment piece, Free Capital Flows can put Economies in a Bind. He is totally correct of course. Capital flows are one of the impossible trinity – the other two being exchange rates and sovereign monetary policy. The theory has it that you can manage two at best, the third being a dynamic you can monitor and manage toward but not control directly. More specifically, it is impossible to have all three at the same time:
Stable exchange rate
Free capital movement
An independent monetary policy
Thatcher wanted to control her country’s monetary policy and in time thus improve the exchange rate, so she had to get rid of capital controls put in place to defend sterling. Now free capital movement is the stick that threatens to beat us all as the global market moves capital around the globe every day in response to policy changes in each sovereign nation. With small changes here and there, an odd point change in interest rate etc, trillions of dollars move quietly and seamlessly around the world. Thus small changes everywhere are amplified and the impact of such policy changes are hard to predict behind the obvious target of the policy. This creates a very unstable global market for capital and it is capital that makes all things possible.
Very recently we have seen the US embark on its much publicized interest rate journey with the first rise in several years. This is leading to a great sucking sound from emerging markets as investment is now diverted from lower yielding regimes to the US. Chinese economic data triggered global turmoil in the markets last week and this. The ability for the market as a whole to understand the global situation is very misleading – it simply reacts to what it sees. Politicians will soon conclude that the market has too much power that is seemingly out of any one’s control, and it is very likely that before the current economic malaise is passed, capital controls will be reinstated. This again is the conclusion of Mr. Muchau’s piece. I agree 100%.
In today’s US print edition of the Financial Times there is an article in Markets and Investing by George Magnus, titled Credit Binge is the real concern as crisis shows little sign of abating. Mr. Magnus reports the troubling situation that shows how non financial credit is ballooning in China and showing now signs of slowing down. It seems that much credit growth has gone to fuel the already highly leveraged real-estate sector, and not private sector growth. So with manufacturing slowing down it seems that the ability to use credit to soften the landing will just result in an even bigger bubble. The point being that the Chinese authorities may have money to burn (such as vast exchange reserves) but their options to control, or contain, the changing and complex economic situation are few and getting less flexible. The market will of course react quickly and sizably to any sign of weakness or policy change it does not understand. This will continue to add oil to the fire and the soon-to-emerging call for capital controls. Just as soon as China percieves its reserves are a finite resource…