Tag Archives: Debt

The Debt Chickens Are Coming Home to Roost

A story it today’s Us print edition of the financial times highlights a building ‘bubble’ of disquieting proportions. The article, ‘Britain’s Pizza Chain Boom Faces Debt Reckoning’, highlights how a large number of restaurant chains have been snapped up over recent years using debt. This might be by a private equity firm or a leveraged buy-out. In either and other cases, many acquisitions were executed using cheap debt which was facilitated by central bank policies such as near-zero interest rates and quantitative easing (QE), both of which massively distorted the price of corporate bonds and debt. Add to this public policy and pressure on banks to increase loans to help drive growth, you can see signs of a perfect storm.

The UK example is specific, but the problem is wide and applicable to most developed economies. The US has just come off a long-run marathon of high and record levels of corporate acquisitions, again much funded by cheap debt. There must be many organizations hanging by a thread, just waiting for interest rates to nudge up resulting in unsustainable debt burdens and interest payments. Unless growth drives the top-line of these businesses at a faster rate, the chances are many such firms will go to the wall.

This situation was created as an unintended consequence of near-zero interest rates for such a long time and massively price-distorting quantitative easing. Though most governments have ceased buying sovereign and corporate debt, the damage is done. Massive, trillion dollar, balance sheets at central banks need to be unwound in such a way as again, not upset the market. The act of creating the balance sheet did upset the market. In reducing their balance sheets, central banks will do it again.

And the sad part about all this, as it will play out? Smart investors with lots of money and a high risk-tolerance will hedge against such business failures and reap huge rewards. The rich investor-class will get richer, and the poor will just lose their jobs or otherwise miss out. Politicians will have a field day, calling out the failure of capitalism. Of course, it’s not a failure of capitalism since central banks and their policies are not part of any capitalist model: central bank operations are closer to a socialist model where the few take decisions to ‘help’ the many, as if they know better and how to help us.

Oh well, such is life. Just buckle down and wait the storm. The debt chickens will soon be home to roost. Maybe not by this Easter but expect them home by next year.


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.

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!

Two Long Term Concerns Stand Taller then Brexit

Two articles in this weekend’s US print editions of the Wall Street Journal and Financial Times highlight the real concerns that threaten global growth, far more so than the ministrations of (hopefully) rational politicians soon to embroil in Brexit negotiations. One concerns China and the other Italy.
In “Rising Worries Cloud China GDP“, Alex Frangis of the WSJ reports that GDP continues to show signs of weakness and more importantly, how the declining GDP is accounted for, is more troubling than its decline. It seems private investment continues to decline and public debt continues to raise.
The declining private sector investment is bad since it already represents the lions share of investment. So as that declines, overall GDP declines and the smaller sector of public debt has to step up. But this is exactly the opposite trend China needs to help transition its economy from product based to consumer based.
Housing prices show signs of cooling though by western standards the numbers are impressive. At the same time anecdotal data on unemployment shows troubling shifts too. Overall the article suggests all the wrong data points we need to suggest positive changes. If anything, China is headed towards more problems and with that, so do we.
The second article, “Exploiting the fine print to save Italy’s Banks“, Dan MccRum a and Thomas Hale of the FT, report the troubling challenges facing EU regulators that still have not closed all the leaks that sprang up post the Greek crisis. Forget the fact that Greece’s economy remains a basket case, Italy’s banks are in trouble. Italy never addressed the bed debt problem overhanging their economy; they neither farmed out all major losses to debt holders, nor give off the bad debts to a ‘bad bank’. The chickens are coming home to roost.  
The resolution will be yet another fiddle by the EU. The Italian banks will need a bail out using public funds. Italy is always over budget and should face an EU penalty for financial promiscuity. It will be waived, as it has been waived for France and Germany before. Why do we even accept such rules if they just don’t count?  
If we ignore the politics of rule setting and bypassing then, and just focus on Italy’s financing, we can determine that the fundamental issues facing Greece are not dissimilar to Italy. What differs is how such nations seek to address those challenges. Italy needs to modernize and revamp its banking and investment sector. It needs to address losses that have piled up. Until, and if, it does, the Euro will remain a troubled currency. This is what sits at the heart of a rotten Europe.

China’s Debt Binge Headed for the Rocks – and the Global Economy with it

Pictures are more powerful than words, in many cases.  The Economist this week had a graph that presented the cycle of private non-financial sector credit as a % of GDP for a number of countries.  The chart was in the article, Free Exchange: Red Ink Rising – China cannot escape the economic reckoning that a debt binge brings.  The article, and chart, highlight how for countries such as Japan, Thailand (and the Asian financial crisis of the late 1990s), US (sub-prime crisis of 2007) and Spain, all things that go up (such as debt) have to come down.  The chart worryingly shows how China’s debt binge has been in the making for a long time, and has accelerated since 2008.  The real issue is when and how to unwind the debt without unhinging the world economy and killing off growth.  Few countries have been able to do so at such high levels of debt – that’s the problem.

And as if that was not enough, last Wednesday’s US print edition of the Financial Times carried an article that again highlighted the IMF’s misplaced clarion calls for coordination.  The article, IMF calls for global action to lift demand as China exports fall, reports on the IMF’s number 2 (David Lipton) in a speech in which he called on global leaders to increase spending and investment in parts of their economies that would create growth.  This is of course a classic Keynsian drive for government spending, at a time when debt remains significant.  The IMF continues to ask the right question – we do need coordinated action.  But the IMF continues to conclude the wrong response – we don’t need more governance spending, at least overall.  We might leverage targeted spending in some Infrastructure areas.  But we need a lot more coordination in policy change and that takes time.  If the US elects an establishment favorite in its national elections this November, that country will not make the changes needed.  If Trump were to be elected, and the republicans stay in control of the House and Senate, there will be 2 or 3 years of the kind of disruption that would clear the house of cobwebs and overly complex tax and business and private regulation.  And large chunks of non-productive government spending should be cut back, leaving funds spare for real effective infrastructure spending.  

But what the IMF should be doing is helping the leading nations of the world cope with financial volatility.  It should require leading central bankers to form up and create a new currency exchange agreement to help manage the dynamics that are killing global trade and driving the beggar-the-neighbor devlations that are hiding under the rune of negative interest rates, and sometimes not hiding in terms of currency manipulation.   We don’t need fixed exchange rates – we need managed exchange rates – for a period that allows normal, private sector growth to return.  We need a new Bretton Woods agreement.  We need a new Plazza Accord.  We need the IMF to do it’s job, not shirk its responsibility and hand off that impossible task to individual governments.

Dark Economic Storm Clouds are Gathering

I am sitting here at Gartner’s IT/Symposium 2015 in Orlando and I am having fun talking with clients and organizations about how they can better leverage information in their business to improve business outcomes.  It’s what I do for a living – help organization improve and get ahead of the rest.  However, as I do this, I have noticed some harrowing signs that concern me regatding our economy.  They are worring not for their own sake but for the fact that our leaders’ response to this kind of news has been, for the  most part, innefective and down right market distorting.  We might get more bad medicine (i.e. QE) soon.  Here is a quick rundown of a couple of storm clouds:

Tuesday October 6th: Once the biggest buyer, China now dumping US government debt.  This is not good news for several reasons.  This entire act is tied to China’s efforts to push the yuan into reserve currency status.  China has been orchestrating multiple activites to push this idea.  Only yesterday I noticed that the yuan had displaced the yen, for the first time, as the fourth most used currency for cross border trade settlement.  As China and other nations sell dollar denominated debt, the ability for the US to perpetuate its excessive debt regime diminishes, which will put pressure on interest rates, even if and when the Fed does not want to increase the.  I blogged on this domino effect before.
Wednesday October 7th: Recession buzz is heating up on Wall Street.  News that the gap between realized global GDP and the potental global GDP is widening, and this suggests growing potential for a recession in 2016.  Couple to this the IMF’s re-forecasting of growth slowing down, this looks like a very dark cloud indeed.

I hope the sun comes out soon.

New IMF Working Paper: high public debt-to-GDP can limit Growth

Ever since the Reinhart–Rogoff paper in 2010, Growth in a Time of Debt, (mostly Keynesian) economists have been gunning for data to show that public spending and debt is a great way to get out of a recession and put an economy back on its feet.  It’s as if some of us have either forgotten Thatcherism or are afraid to read the history books.  With new research, published by the IMF, we have some findings that will please all on both sides of this argument.

In a new IMF working paper published yesterday, Is There a Debt-threshold Effect on Output Growth?, the authors Alexander Chudik, Kamiar Mohaddes, M. Hashem Pesaran, and Mehdi Raissi find the following:

  • No evidence for a universally applicable threshold effect in the relationship between public debt and economic growth, once we account for the impact of global factors and their spillover effects. 
  • And regardless of the threshold, there are significant negative long-run effects of public debt build-up on output growth. 
  • Provided that public debt is on a downward trajectory, a country with a high level of debt can grow just as fast as its peers in the long run.

The first finding speaks critically against the original paper in 2010, and so that paper may now be jettisoned to the history books and study may now start from here.  The authors of this paper explain that the complicating factors, from “feedback effects from GDP growth to debt, and most importantly, error cross-sectional dependencies that exist across countries, due to global factors (including world commodity prices and the stance of global financial cycle) and/or spillover effects from one country to another which tend to magnify at times of financial crises” are missing from the earlier work.  So the original conclusion was that a public debt-to-GDP ratio of over 90% could be a ceiling above which economic growth would be strongly curtailed.  So that’s the end of Reinhart–Rogoff, right?  Wrong.

While the authors state, “[w]e do not find a universally applicable threshold effect in the relationship between debt and growth, for the full sample, when we account for error cross-sectional dependencies”, they go on to say, “Nonetheless, we find a statistically significant threshold effect in the case of countries with rising debt-to-GDP ratios beyond 50-60 percent, stressing the importance of debt trajectory. Provided that debt is on a downward path, a country with a high level of debt can grow just as fast as its peers in the long run.”  So there is no absolute threshold, but there is certainly a relationship between high public debt and low growth.

The final conclusion states the following:  “…[I]f the debt level keeps rising persistently, then it will have negative effects on growth in the long run. On the other hand, if the debt-to-GDP ratio rises temporarily (for instance to help smooth out business cycle fluctuations), then there are no long-run negative effects on output growth. The key in debt financing is the reassurance, backed by commitment and action, that the increase in government debt is temporary and will not be a permanent departure from the prevailing norms.”   

I think this is logical and somewhat self evident.  The questions is, what defines ‘temporary’?  All we seem to have discovered here is that there us no absolute threshold of public debt-to-GDP level to avoid; and worse, a level of between 50-60% with the wrong trajectory can damage the opportunities for growth.

The concluding remarks strike a polically correct pose:

“These results suggest that the debt trajectory can have more important consequences for economic growth than the level of debt-to-GDP itself. Moreover, we showed that, regardless of debt thresholds, there is a significant negative long-run relationship between rising debt-to-GDP and economic growth.”  So far, so good.  This makes intuitive sense.  But the next and final sentence is:

“Our results imply that the Keynesian fiscal deficit spending to spur growth does not necessarily have negative long-run consequences for output growth, so long as it is coupled with credible fiscal policy plan backed by action that will reduce the debt burden back to sustainable levels.”  Over what time frame is this temporary spending and debt maintained?  Who defines ‘credible’ fiscal policy?  The reality, when you relate this topic to real world situations, helps.  If I am short a few dollars for a loaf of bread and a pint of milk, a short term loan from a friend might work out OK.  Taking out a multi-year loan for a degree that is if no use to anyone is quite another matter.  What such public debt is spent on is as politically charged as the level of the debt.  I guess the debates will continue.