Tag Archives: GDP

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?

Advertisements

Fed Watch: Taking a Long-term, Global View, Suggests No Interest Rate Rise for a While

The IMF’s annual fiscal monitor is as full of good and albeit hapless ideas as ever. It’s gets off to a poor start. The IMF has been calling (correctly) on large economies to increase debt and spend such money on growth generating projects. This could include infrastructure spending or perhaps tax rebates or write-offs for increased innovation or capital investment. The executive summary reports that government debt has been increasing and now approaches pre-crisis levels- yet money (debt) has not been used in the way the IMF suggested, nor has it been coordinated by regions. The money has been squandered on political issues and wasted away. Consequently growth remains lacking and yet risks are now greater and growing. IMF scores a B+ for ideas, D- for coordination. And leading nations a strait F for fail.

More alarming news in this weekends US print edition of the Financial Times is in an article titled, Chinese shadow lending evades regulation and more critically, a Comment by George Magnus, associate at Oxford University’s Chine Centre and senior economic advisor at UBS, titled China’s debt reckoning cannot be deferred indefinitely. This last article calls out the known risks: the share of total credit in the economy is approaching 260 per cent of GDP. It seems it is on track to bust past 300 per cent by 2020. Note here that the US is in a simile boat. Ignoring all the complexities in the data, its reliability and quality, it seems China has so little wiggle room to cope with any economic pressure and also little head room to sustain its credit binge.

The first article suggests that even though official credit might be at straining point, there is much more credit being created outside of the official governance. Given the reportedly growing amount of bad loans, all this boasts badly for China, and so the global economy. If China were to sneeze, we all would catch a severe cold. Everyone else that matters is already at the doctors office waiting treatment.

Finally I read John Auther’s The Long View in the US print edition of the Financial Times. It was depressing reading. He calls out the four reasons why the good times (yes, these are ‘good’ times) will not continue. Of course these ‘good times’ relate to the equity market, which has been the main beneficiary of central bankers quantitative easing experiment.
The flour reasons are:

  1. Inflation has been tamed – can it ever be tamed again?
  2. Interest rates have fallen – they have to go up soon
  3. The economy has grown – few new triggers remain and demographic drag will increase 
  4. Corporate profitability rose – it’s leaked and in its way down

The article draws from McKinsey Global Institute and new research. All told its more data suggesting we are in the second half of a natural down cycle whose rise has been flattened by central bank policy and the lack of political policy agreement. We are now headed for what should be a natural slow down with no gas in the tank and no cash in the wallet and an already overloaded credit card. Hang in folks, it’s gonna be a bumpy ride.

The Three Key Leading Indicators that will Signal Global Economic Recovery

This week the mandarins and thought leaders of our leading economies and policy wonks are meeting in Davos.  They do this every year at the World Economic Forum.  In anticipation of this the IMF publishes before hand an update to its World Economic Outlook, and the Wall Street Journal publishes it’s, “Outlook” piece.  The IMF came out yesterday and reported more trouble ahead, worsening conditions, and slight reduction in global growth.  The Wall Street Journal piece is very good too – and is well worth reading.  It highlights several challenges we face.  However, it also exposes in my mind what ought to be thought of as leading indicators that tell us our global economy might be turning a corner.  Even if these analytics turn positive, there is ample room for our politicians, bent by political dogma, to make the wrong fiscal and regulatory decisions.  At this time in our economic history, we need to expunge socialist, modernist, post-capitalistic ideas about furthering social policy and equality through re-distribution.  Any and all such attempts, for the next two years, will actually make things worse for the poor and middle-class since such policy energy will detract from the energy needed to grow the same pie that such wonks need to share.  

So what are the three main metrics that express why we are in the mess we are?

 – Chinese debt

– Business Investment

 – New Business Start-ups

Martin Wolf’s Comment in today’s US print edition of the Financial Times (see China’s great economic shift needs to begin) explored China’s debt challenges.  Andrew Browne, of the Wall Street Journal, did the same in his article (see China’s Debt Binge Isn’t Over Yet, and That’s the Problem) in its Outlook 2016, did the same.  First is the scale of the problem. Mr. Wolf reports that China’s debt to GDP was 157% at the end of 2007, 250% at the end of 2013, and 29% at the end of the second quarter in 2015. Mr Browne calls out that it was due to the launch of China’s debt binge in 2008 and 2009 that helped the global economy stave off depression, after the collapse of Lehman Brothers. The problem is that this debt mountain has been the main driver of growth in China, and China has become the second largest economy in the world and, with anemic growth in the US, the biggest single driver of global growth.  Now that debt-driven demand cannot be maintained for ever and with no natural consumer demand to replace it, over capacity is driving down commodity prices around the globe.  This continues to weaken growth further, and contributes to deflation.  So the cycle is complete and we need to break it.  We need to watch Chinese debt and debt to GDP and look for a change in behavior.

In Greg Ip’s piece in Outlook 2016 (see Dear Business Leaders: Invest in Optimism, Not Buybacks), the challenge related to the lack of business investment in productivity improving efforts are exposed.  He reports that since 2009, US businesses has boosted capital investment by 43%, dividends by 67%, and stock Buybacks by 194%.  Record levels of Mergers and Acquisitions are being made year over year.  Record levels of debt are being taken out to fund these acquisitions, and Buybacks.  And the phenomena is global, according to Mr. Ip.  The press (as reported by Mr. Ip) tells us that increased government regulation and persisting trauma from the financial crisis are behind this behavior.  The Fed has used this lack of investment and spending as reason to justify its entire QE program (the world over, too) and the unprecedented expansion of the Fed’s balance sheet.  But if you ask business treasury leaders, you get a very different perspective.  Business do not, on the whole, change investment strategies based on interest rates.  They base their main investment strategies based on business goals, opportunities and strategies.  It seems the M&A spurt is about the only aspect of this that has reacted to policy changes, specifically interest rates at historic low levels.  The challenge remains – irrespective of the trauma, regulation, or indifference to interest rates, firms are not investing for productivity growth.  Until they do, we cannot magic such growth out of the air and we cannot mandate such growth through political edict.

In the same article by Grep Ip there is a related data point: “Since 2009, annual new businesses started have run 18% below the prior eight years, while business closures haven’t changed, according to the US Census data”.  Mr. Ip has been talking of this issue for some time.  I blogged on an article from him on the same topic in July 2015.  More telling is this quote from today’s article:  “For all the hoopla surrounding social media and smart phones, US business investment in high-technology equipment remains well below its pre-recession level as a share of gross domestic product.  BUsiness and individuals are taking longer to replace their computers and smart phones, since each upgrade adds fewer compelling features then the last.”  R&D is this not paying off as it used too and so money is finding new ways to generate a return, and that does not include productivity-inducing IT.  I have blogged on this issue too.

So I think these would be useful leading indicators.  Alone, neither will lead to growth but combined, they could signal a change in our furtunes.  If we could just get the politicians out of the way, we could take rational, economic decisions to help improve our chances.  As it stands, this is not going to happen so economic malaise is assured.  In fact it will get worse, before it gets better.  Since our leaders cannot bring themselves to agree global collaboration and alignment of goals and policy, the market may force their hand.  Ray Dallio, founder of Bridgwater Associates, agrees with my thoughts of the other day.  Today, on CNBC, while on site at Davos, he said that the Fed’s next move would be toward quantitative easing, not towards (quantitative) tightening.  This suggests that US interest rates may fall again.  So even as the US determines it is strong enough to ignore the world, it will be brought back to earth with a bang.

Odds are that US Interest Rates will be back to Zero within 6 months

So it seems the tea leaves in the empty tea cups at the Fed’s recent planning meetings point to the first interest rate hike in 9 years.  The pundits are saying the Fed will raise rates at their regularly scheduled meeting Wednesday this week.  Something like 70-90% of polled economist’s seem to agree.  But hang on a tick – there are a few data points worth calling out:

  • Little has changed globally & economically since September, when the Fed decided against a raise that had been widely expeceted just a month before; Agreed, US economic data in terms of employment has improved slightly and job growth (albeit low wage) is still improving, but…
  • Inflation is stubbonly low (commodity prices globally remain depressed and showing little sign recovering).
  • Wage growth is weak, with only initial signs of a slight uptick recently.
  • The dollar is already quite strong and raising rates will only make it stronger, attracting funds from overseas, thus making US exports more expensive, and imports cheaper (worsening the trade balance).
  • The sucking in of foreign funds to dollars will draw investment from emerging markets that will suffer as a result.  This will further hamper global balancing and growth.
  • The actual business cycle in the US seems to be past its natural peak and business profits are falling in more than half of the economy with firms everywhere reporting contraction.  

On any other day and planet, given these conditions, we would not expect to raise rates.  In fact, in “Central Bankers Worry Rate Increase Will Come Undone” (see today’s US print edition of the Wall Street Journal), it seems that a majority of economists polled for the article worry that the Fed will be forced to undo the increase and return to zero:  “[M]ore than half said it was somewhat or very likely the Fed’s benchmark federal-funds rate would be back to zero within five years”.  Admitedly that’s a long time away and does not hint at panic, and probably allows for the backend of the business cycle to work its way through.  But I think, based on the global situation, the market is too sensitive and volvatile.  

My guess is that though we need to raise rates to move the economy toward normalization, the US cannot move in isolation and without coordinating similar moves in Europe or China.  Since those regions are diverging, the US move will just put more stress on what is already a very stressed system.  Some few weeks ago I was calling for a raise in US rates by the middle of 2016.  I still think that would be the right time to align with other large economic regions, assuming they show signs of recovery – and even that is not firm.  So all told, it will be a fun week.  It is hard to call if the market will rally or fall in response to Wednesday’s meeting.  Maybe the Fed hopes the holiday season will give the marrkets time to adapt and consume the increase and avoid any frantic movements.  Whatever happens I think it will still be a volatile week.  Hang on.

Easy Money is Crowding out Classical Ways to Improve Competitiveness and Productivity

The headline title of an article in today’s US print edition of the Wall Stree Journal says it all: ‘Firms Shy Away from Spending‘.  The article highlights recent data that suggests that firms in the US are reducing spending and pretty much across the board.  Business investment has grown 2.2% year on year, the one of the lowest in a 6 year period, the article says.  The narrower aspects of spending, such as on capital, are declining even more, falling 3.8% year on year.  This is most worrying since such spending is required to prepare for later returns from improvements in productivity.  This suggests that future periods in which firms will compete may be hamstrung with outdated methods and machines, which will reinforce a sluggish economic picture.

Pundits have worried about this loss of investment in productivity gaining channels for some time.  But noone seems to have any idea why buxiness spending on things like capital improvement is so low.  Interest rates have been lowered to such a level in order to encourage such business spending, in order to get the economy growing again.  But firms have not taken advantage of this.  Well, that is, not quite in the way expected by policy makers.  Firms have taken advantage of the low interest rate bearing loans, but have been on a M&A and share buyback spree.  

And this is the point: firms have figured out a way to maximize cash acquisition that happens to meet short-term shareholder goals as well as management goals.  Share buybacks improve earnings per share (EPS) and this is what leads to management bonuses and short-term support from investors.  The problem is this: The easy money paradigm was not meant for this purpose – and the lack of investment in capital development will harm the economies natural growth rate going forward.  As easy money starts to contract, firms will regret not investing according to expected desires.  Long term share holder value is being erroded as investment in the future is lacking.  And the side bar to this narrative is that the economy remains sluggish and wage growth flat.  It has become a vicisous cycle: low growth leads to more easy money leads to slower growth and so on.

The only way we are going to get the economy growing again is to remove the zero interest rates and sell off the assets the Fed as accumulated “in our name” to save the economy.  The economy has not only been saved but it has been and continues to be massively distorted.  We need normal interest rates (whatever that means – I no longer remember) such that firms can do the calcuations of old that used to force them to seek productivity imroving investments.  This would drive growth.  This seems so clear to me now – yet no senior policy maker in Washington seems willing to fess up to this one.  Shame on them.

Hot News from IMF: Save for a Rainy Day. Really…

The IMF published two important press releases yesterday. One looked at the summary and findings from its bi-annual update of its Fiscal Monitor, and the other is it’s World Economic Outlook. Here are the press releases showing the transcript of the briefings: 

I read both – and found some interesting points in both. First the Fiscal Monitor. 

It’s great that the IMF is promoting “four pillars of fiscal rectitude” to the world. They are as follows: 

  1. [government] “budget revenues should be mostly derived from broad based taxation, backed by strong compliance.”
  2. “improving the efficiency of spending, including energy subsidy reform, continues to be a priorities and can also facilitate fiscal adjustment. That is also clearly the case in core areas for sustainable and inclusive growth such as public investment, health, and education.”
  3. “it is important to put in place fiscal frameworks that help countries save during good times so they can protect spending during bad times.”
  4. “the quality of institutions is crucial. Fiscal rules and procedures are important but they need to be underpinned by a broader social and political commitment to adhering to these rules and laws.”

It is 2016 and the global economy is in a pickle, and a unique one at that. And this is what we get from the IMF. Don’t get me wrong, these are good rules or goals. But honestly, is this what we need from the IMF at this juncture? Seriously, pillar three is not unlike the following: “Hey fella, I see your house is burning down. You know what, I suggest you don’t leave lighted cigarettes around the house when you go out. OK?”

In some ways these pillars state the obvious and restate what has been stated by the IMF and others before:

  1. Spend within your means (don’t ratchet up debt you can’t afford)
  2. What you spend should add value to the growth drivers of the economy and not pander to non-value-add political or pet projects
  3. Save for a rainy day (not useful when it’s raining, though)
  4. Only borrow or lend to reputable, trustworthy, reliable folks and companies.

The advice is not much use, and it’s dated, and it’s incomplete anyway.

First, what use is this advice? Ask yourself this- for whom is the advice targeted? Central bankers? Well they don’t control government spending, politicians do. They don’t control debt limits, politicians do. Central bankers don’t regulate how businesses and people operate (actually there is a little of this I admit). 

So is the IMF advising politicians? What use is that? Politicians don’t really listen to the IMF until, and only then, if their house has virtually been destroyed. Politicians gleefully set policy on top of policy to shamelessly develop the art and science of politics. To assume that, for example, what has gone on in the USA in recent years, concerning fiscal and monetary policy and tax and regulation, is for the betterment of the economy, is wrong. Politicians get in the way of good, sound, economic policy. They have other priorities such as re-election and pets. 

Politicians do not control taxes for the betterment of the economy – they do so for the betterment of politicians. So firstly the IMF advice is not that helpful since we don’t know who it is for not who might be able to exploit, rationally, such advice. 

The advice is dated: it’s old and not new. In fact these principles are what your mom told you when you were growing up. It’s what great grandma and grandpa told them when they were kids. Anyone with an ounce of home economics gets this stuff. And if you are responsible to yourself, this advice is normal. If you are responsible to an electorate, this advice is forgotten and ignored. This advice does not make for good politics even though its good advice for economies.

This advice is also complete. The IMF has the right idea but does not go far enough. Fiscal and monetary policy, coupled with regulatory guidance, under conditions of uncertainty, need more than anything else, policy coordination. Uncertainty breeds distrust. This leads to a beggar thy neighbor behavior and can lead to any number of race-to-the-top (or bottom) for any number of polices. Currency Exchange is one current and excellent example. Quantitate easing (QE) is another. The list goes on.

The IMF should remember its roots and call for a second Bretton Woods. We need another extensive level of cooperation to guide exchange rates and interest rates around the world. We need to ensure we do not allow for the beggar thy neighbor policy setting. China needs to be at the table, as do some EM’s. Bretton Woods was a global project, and it worked for a good amount of time. It delivered on its prime motive for stabilizing the global economy so that the invisible hand could get back to pumping growth.

This is the fifth pillar: this is the most important, missing pillar.

In the World Economic Outlook summary there was a perfect quote, which is shown here:

“Mr. OBSTFELD: I described some of these in my opening remarks. I think there are a large number of areas where cooperation among countries is needed to reach solutions; for example, the global safety net, IMF quota reform, cooperation in the regulatory sphere, all of which would enhance resilience.” 

The IMF knows what needs to be done. They need to take action.

 

 

The World is Messing with the Fed

The world is messing with the Fed – so said the headline of an article in the US print edition of the Wall Street Journal over the weekend. The article explores the different weight of the impact between US domestic considerations and global economic conditions on the Fed’s rate change decision.  

As we know the Fed did not raise rates last week – I had predicted as much on August 18th.  The main reason cited by Janet Yellen, Fed chief, was that global concerns regarding the economy outweighed current US domestic considerations. This argument only works up to a point. In the 1930’s the US explicitly altered its own domestic monetary policy at just the wrong time for the global economy; the plan to return to gold was blown up by newly elected Roosevelt, even as the main trading nations were in conference and the results of this introverted act was disastrous for all. See London Economic Conference 1933.

The main cause of the current perturbation in the global economy derives from China. China’s economy had become a significant component of global growth – and so its economic slowdown is dragging everyone else down with it. More specifically its slowdown is depressing commodity prices globally and the impact can be seen in corporations and nations around the world. Headlines everyday include another business struggling to cope with a drop off in demand from China.  

Related to the slowdown in China is the shale-bonus: depressed oil prices, which acts as a double-whammy on some of those same corporations struggling with commodity deflation, while at the same time helping various domestic consumer segments with lower costs. All this acts in the same direction and leads to significant drag on prices overall and so what economists call deflation. Only today there was another article in the US print edition of the Wall Stree Journal highlight yet more downward pressure on prices in the Eurozone. See Eurozone Faces New Threat of Deflation.

The result of this complexity is that the models our leaders have are not working. They have moved the levers, sometimes to extreme positions (think of QE) and yet things are not moving as expected. The political machinery that wraps around the monetary and fiscal policy framework is in a funk at just the wrong time: the inability to get to a consensus on one direction or another (i.e. spend your way out of the hole, or cut your way out) has left the global economy adrift in the eddy of stagnation. 

It really does not matter which approach we take – we need to take one. Even if we elected to try the Keynes way, we know that it would blow-up and cause a real crash that would finally weed out all the dead wood that government debt has been nurturing to protect. Even that would be a fair price to pay to get us out of this cathartic dilly dallying loser of a race.