Posts Tagged ‘GDP’
Tuesday, August 14th, 2012
by Don Vialoux, EquityClock.com
Upcoming US Events for Today:
- Retail Sales for July will be released at 8:30am. The market expects an increase of 0.3% versus a decline of 0.5% previous. Excluding Autos, the market expects an increase of 0.4% versus a decline of 0.4% previous.
- Producer Price Index for July will be released at 8:30am. The market expects an increase of 0.2% versus an increase of 0.1% previous. Core PPI is expected to increase by 0.2%, consistent with the previous report.
- Business Inventories for June will be released at 10:00am. The market expects an increase of 0.2% versus an increase of 0.3% previous.
Upcoming International Events for Today:
- French GDP for the Second Quarter will be released at 1:30am EST. The market expects a year-over-year increase of 0.2% versus an increase of 0.3% previous.
- German GDP for the Second Quarter will be released at 2:00am EST. The market expects a year-over-year increase of 1.0% versus an increase of 1.2% previous.
- Great Britain Consumer Price Index for July will be released at 4:30am EST. The market expects a year-over-year increase of 2.3% versus 2.4$ previous.
- Euro-Zone GDP for the Second Quarter will be released at 5:00am EST. The market expect a year-over-year decline of 0.5% versus no change (0.0%) previous.
- German Economic Sentiment Survey for August will be released at 5:00am EST. The market expects –18.5 versus –19.6 previous.
Recap of Yesterday’s Economic Events:
Equity markets traded mixed on Monday during a low volume session that saw the S&P 500 trade on either side of the 1400 mark. Volume has been a significant factor in recent trade, showing some of the lowest levels in years. Monday was no different with the S&P 500 ETF (SPY) showing the lowest volume day since April 25th 2011, approximately the 2011 peak. Volume has clearly been problematic as it provides evidence of a lack of conviction to equities; investors are showing no impetus to buy or sell. Investors are clearly waiting for a catalyst, preferably in the form of central bank easing to give equities a quick boost, despite how bad economic fundamentals get. The sustainability of this is obviously questionable.
Equity markets have had a substantial run since the low set at the beginning of June. The S&P 500 has added over 140 points from the low of 1266 to the recent high of 1407. Resistance is now at hand, as presented by the March and April peaks. Reaction to this peak will be critical in determining the strength behind this market. Rejection from this level could chart a double top, which would likely follow with a significant selloff. A healthy breakout, ideally accompanied by a pickup in volume, could see the continuation of this rally into the fall, a period that is typically negative on a seasonal basis. An increase in the number of stocks breaking out to new 52-week highs is an ideal tell to hint of a breakout to come. Unfortunately, the number of stocks breaking to new 52-week highs has been declining since the start of July, a situation similar to what was realized from February through April of this year in which equity market trends remained positive, but momentum deteriorated prior to a peak. This divergence compared to recent price activity could be warning of a near-term peak in equities.
World equity benchmarks are also approaching a level of resistance presented by a declining long-term trendline. Reaction to this point of resistance is expected, potentially bringing an end to the bullish rally that has remained intact for two and a half months. Descending triangle patterns, potentially a bearish setup, can also be derived from the charts, suggesting negative things ahead for equities. June’s lows will be critical point to watch upon any pullback from the recent intermediate positive trend.
Sentiment on Monday, as gauged by the put-call ratio, ended bullish at 0.80. The ratio is back within the bounds of the falling wedge pattern.
Chart Courtesy of StockCharts.com
Chart Courtesy of StockCharts.com
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Tags: Amp, Business Inventories, Consumer Price Index, Conviction, Core Ppi, Decline, Don Vialoux, Economic Events, Economic Sentiment, ETF, ETFs, Euro Zone, GDP, German Gdp, great Britain, Impetus, Producer Price Index, Report Business, Retail Sales, Second Quarter, Thackray, Trendline, Volume Session
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Saturday, August 11th, 2012
The Economy and Bond Market Radar (August 13, 2012)
Treasury yields rose for the third week in a row. It is interesting that as we get closer to additional monetary easing in the U.S., Europe and China, the Treasury bond market has already anticipated that and is selling into the news. This would follow a similar pattern as the two quantitative easing programs in 2009 and 2010, as bond yields moved higher immediately after the announcements.
- Initial jobless claims fell to 361,000 this week, indicating a somewhat better job dynamic than a couple of months ago.
- The Labor Department reported that job openings in June were the highest since July 2008.
- The U.S. trade deficit narrowed to $42.9 billion in June, lower by more than $5 billion. Exports grew while imports contracted.
- New foreclosures rose 6 percent in July, the third monthly increase in a row.
- European economic data remains weak as Italian GDP has contracted for four quarters in a row.
- Economic news out of China was weaker than expected for July as exports grew a meager 1 percent and industrial production was weaker than expected.
- The ECB appears ready to implement some form of quantitative easing in the very near future.
- With weak economic data out of China this week, odds of additional easing measures continue to move higher.
- Interest rates are likely to remain very low for the foreseeable future.
- Europe remains a wildcard with the markets shifting focus on a weekly basis.
- China also remains somewhat of a wildcard as the economy has slowed and officials appear in no hurry to take decisive action.
Tags: Bond Yields, Decisive Action, ECB, Economic Data, Economic News, Foreclosures, GDP, Hurry, Initial Jobless Claims, Italian Gdp, Job Openings, Labor Department, Market Radar, Quantitative Easing, Quarters, Shifting Focus, Trade Deficit, Treasury Bond Market, Treasury Yields, Wildcard
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Wednesday, August 8th, 2012
It would appear that the dilemma of the world exporting more than it imports (that we initially pointed out here) is starting to come to a head in reality with a negative export trade shock. As Gluskin Sheff’s David Rosenberg notes, since the recovery began three years ago, over 70% of the real GDP growth we have seen was concentrated in export volumes and inventory investment; and recent data from the ISM (here and here) points to a dramatic slowdown in both. Compounding this weakness is the fact that the remaining growth was from Capex – which is now likely to slow given the weakening trend in corporate profits – and will more than offset any nascent turnaround in the housing sector – if that is to be believed. The consumer has all but stalled and adding up all these effects and there is a high probability of a 0% GDP growth print as early as Q4.
Macro Risks Squarely To The Downside
I think that there may be a time, before too long, when we will walk into the office to find that the US prints a negative GDP reading on the back of a negative export trade shock that does not appear to be in any forecast – let alone consensus.
Look at the pattern of ISM export orders:
- April: 59.0
- May: 53.5
- June: 47.5
- July: 46.5
That is called a pattern. And this is a level that coincided with the prior two recession. As the chart below vividly illustrates, there is a significant 81% correlation between annual growth in total US exports and the ISM new orders index (with a four month lag). So either the market has already priced this in or it is going to end up coming as a very big surprise. We are already seeing the lagged effects of the spreading and deepening European recession hit Asian trade-flows: Korean exports sagged 4.1% in July after a 3.7% slide in June and are down 9% on a YoY basis. Industrial production there edged lower by 0.4% as well last month – I like to look at Korea since it is a real global ‘play’ on the economic cycle.
There is likely going to be another surprise, which is inventory destocking. How do I know that? Because the share of ISM industries polled in July reported that customer inventories were excessively high soared to 33% in July from 11% a year ago (because this metric is not seasonally adjusted it can only be assessed year-on-year), the highest ever for any July in the historical database.
Add to that what is happening to order books – the share of the manufacturers reporting expanded orders sank to 17% in July from 50% a year ago and again – the worst July showing on record.
The food price situation is another major wild card, especially since whatever relief we enjoyed from lower gasoline prices is now behind us. At a 14% share of the consumer spending pie, only shelter is more important than food. And when you go back to the last food cost surge, in the first quarter of 2011 when the grocery bill soared at a punishing 10% annual rate, real GDP growth slowed to a 0.0% annual rate that quarter, which arguably was the big surprise of the year (up until the dent downgrade, that is).
In the final analysis, since the ‘recovery’ began three years ago, over 70% of real GDP growth we have seen was concentrated in these two areas: export volumes and inventory investment. The rest was in capex which is now likely to slow along with the weakening trend in corporate profits, more than offsetting the nascent turnaround in the housing sector. Also keep in mind that the consumer has stalled.
Tally all these effects up and you are looking at the prospects of 0% growth as early as Q4.
Tags: Asian Trade, Capex, Corporate Profits, Correlation, Dalio, David Rosenberg, Downside, Dramatic Slowdown, Export Orders, Export Trade, Export Volumes, GDP, GDP Growth, Gluskin Sheff, Growth Outlook, Inventory Investment, Ism, Korean Exports, Real Gdp, Recession, S David
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Tuesday, August 7th, 2012
August 6, 2012
The Wall Street Journal published an article on August 1 headlined: “Bill Gross: Equities are Dead.” In fairness to Gross, what he actually wrote in his August “Investment Outlook” was, “the cult of equities is dying.” We agree with most of Gross’s argument—but not with his unsupported forecast of extremely low stock returns.
Let’s take a look at Gross’s claims:
1) Gross notes that bonds have outperformed stocks for the last 10, 20 and 30 years. With long US Treasuries currently yielding 2.7%, it is unlikely that bonds will replicate the performance of decades past.
We agree. That is why stocks are attractive today relative to bonds. Bonds—having outperformed—are now unusually expensive and have low expected returns going forward. By contrast, stocks—having performed poorly—are cheaper than normal and are likely to significantly outperform bonds over the next 10 years.
2) Gross argues that US stocks can’t maintain their 6.6% average annualized real return over the last 100 years. The 6.6% real equity return was 3% higher than real GDP growth, with shareholders gaining at the expense of labor and government. Labor and government must demand some recompense for wealth creation, and GDP growth itself must slow due to deleveraging.
We agree. We are now in a lower return environment. The question is, how low? Let’s concede that stocks will grow in line with real GDP. Over the long haul, real GDP growth primarily reflects population (growing a little over 1%) and productivity (growing just above 2%). That would give us a projected real equity return of maybe 3%—less than half the historical 6.6% rate.
3) Gross asserts that stocks will have a nominal return of 4%.
This is where Gross’s math gets fuzzy. Why this sudden switch to nominal instead of real returns? Does Gross expect that US population will shrink, productivity gains will disappear, and inflation will remain quiescent forever? That is what needs to happen for long-term nominal GDP growth to be as low as 4%. The scenario is possible, but hardly likely. Just assuming that inflation runs at a relatively tame 3% with below-normal real GDP growth of another 3%, we’d have nominal equity returns of 6% or so. That looks quite attractive when you get just 2.7% for holding long bonds to maturity.
In our recently published paper “The Case for the 20,000 Dow,” we show that with reasonable assumptions we can get returns in the 6% to 7% range and that the Dow hits that target in five to 10 years. We will also lay out our argument in an upcoming blog post.
Most investors today are very concerned about equity volatility, and for good reason. But there is another risk that should concern investors: the risk that their investments will not keep up with inflation and meet their goals. As investors balance short-term market risk against the long-run risk of falling short of their objectives, we think an appropriate allocation to equities continues to improve the likelihood for success.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Seth J. Masters is Chief Investment Officer of Asset Allocation and Defined Contribution Investments at AllianceBernstein and Chief Investment Officer of Bernstein Global Wealth Management, a unit of AllianceBernstein.
Tags: Alliancebernstein, August 1, Bill Gross, Bonds, Equity Return, Fairness, GDP, GDP Growth, Government Labor, inflation, Investment Outlook, Productivity Gains, Real Gdp, Recompense, Seth, Stock Returns, Treasuries, Wall Street Journal, Wealth Creation
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Friday, August 3rd, 2012
by Wolf Richter, www.testosteronepit.com
The strongest and toughest creatures out there that no one has been able to subdue yet, the inexplicable American consumers, are digging in their heels though the entire power structure has been pushing them relentlessly to buy more and more with money they don’t have, and borrow against future income they might never make, just so that GDP can edge up for another desperate quarter.
But it’s been tough. Despite the Fed’s insistence that inflation is “contained,” or its periodic fear-mongering about deflation, consumers have been hit with rising costs. Tuition has been ballooning—up 21% in California in 2011 alone! Student loan balances exceed $1 trillion. Some parents who are still paying for their own student loans are now watching their kids piling them up too [read.... Next: Bankruptcy for a whole Generation]. Healthcare expenses have seen a meteoric rise. And so have many other items that cut deep into the average budget.
Inflation is a special tax. It’s not that horrid if it’s small, if higher yields compensate investors and savers for it, and if higher wages compensate workers for it. But that hasn’t been the case. The Fed’s Zero Interest Rate Policy has seen to it that entire classes of investors and savers get their clocks cleaned; and wages haven’t kept up with inflation since the wage peak of 2000—with the very logical but brutal goal of bringing wages in line with those in China.
But for a welcome change, disposable income adjusted for inflation, reported earlier this week, actually rose 0.3% in June from May. So spending should have gone up as well. It didn’t. The inexplicable American consumer spent less in June than in May. And April. The decline was focused on goods, the lowest since January.
And instead of buying goods with the additional money they’d earned, they saved! What temerity! It wasn’t a one-month fluke. The savings rate reached 4.4%, after a fairly consistent uptrend from the November low of 3.2%. An unusual and courageous act of rebellion in face of the punishment the Fed inflicts on savers.
There’s other evidence: while new car and truck sales weren’t great in July at a seasonally adjusted annual rate of 14.09 million units—down from June’s 14.38 million and February’s 14.50 million, the high of the year—they concealed ominous undercurrents. Honda’s sales jumped 45.3% and Toyota’s 26.1% over July 2011. After the March 11 earthquake last year, supply-chain problems created shortages, which the flood in Thailand made worse. Brand-loyal buyers who couldn’t find the right model, option package, or color, rather than switching to other makes, delayed their purchase—thus creating pent-up demand. Now, supply problems have been resolved, and buyers are swarming all over their favorite dealerships. This specialized pent-up demand obscured a huge problem: GM’s sales dropped 6.4% and Ford’s 3.8%. The two leaders taking a simultaneous turn south! This doesn’t bode well for total vehicle sales once Honda’s and Toyota’s pent-up demand has been satisfied. Another act of rebellion by the inexplicable American consumer.
But the Commerce Department, in its press release on income and spending, had a convenient answer: blame “the economic turmoil in Europe.” For everything. And then it added what was practically a campaign ad: “Therefore, it is critical that we continue to push for policies that will grow our economy and support our middle class, such as abolishing the Fed (sorry, my screw-up) the remaining proposals in President Obama’s American Jobs Act.” And it goes on to praise Obama’s tax proposal. Priceless! Expunging the last vestiges of objectivity from our government agencies, such as the Department of Commerce whose Bureau of Economic Analysis had collected the numbers.
The cellphone in your pocket is NASA-smart, write Alex Daley and Doug Hornig. Yet it costs just a couple hundred dollars. So why is it that these rising technical capabilities are leading to drastically falling prices in tech products, but not in your medical bill? The answer may surprise you. Read…. “Why Your Health Care Is so Darn Expensive.”
Tags: American Consumers, Clocks, Disposable Income, Fear Mongering, Fluke, GDP, Healthcare Expenses, inflation, Insistence, Interest Rate Policy, Many Other Items, Meteoric Rise, Power Structure, Richter, Student Loan Balances, Student Loans, Temerity, Trillion, Wages, Zero Interest
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Monday, July 23rd, 2012
I’ve been running a short EURUSD for the past six weeks. I got in at 1.2650 on June 30, and doubled up on July 8 at 1.2260. I was delighted to see the Euro get cheap in Friday’s trading, but the market action forced a decision. I wrote some things down on a pad, thought about it a bit, and said, “Screw it”, and cut the whole position. Some of my thinking:
I hate trading FX at the end of July . The markets shut down with the approaching European August vacations. The last week of the month is about cleaning up positions, not putting new ones on. August is never a time to be involved, unless you have to.
There was something odd about the EURUSD trading Monday through Thursday. Tyler Durden, at Zero Hedge, made note of this.
The red arrows that Tyler drew bother me. This stinks of “official guidance”. It’s tough to make a buck at the FX casino, it’s tougher still when the tables are rigged.
In May and June the Swiss National Bank (SNB) bought CHF 110Bn worth of Euro’s. That’s a staggering amount. I’m convinced that the intervention was heavy in July as well. Reserves are headed up another CHF50Bn. I think these numbers still understate what is happening, as the SNB has been writing calls on the Franc.
In the course of just three months ¼ Trillion Euros have crossed into the Alps. This is unsustainable. At some point it will have to result in a messy blow up. But not necessarily in the month of August.
I don’t think the SNB is going to fold its cards just because they are under attack. If the SNB were to quit intervening, the EURCHF would be nearing par in a matter of days. The cost to the SNB would be CHF40Bn (15% of GDP).
Before taking a loss of this magnitude, the SNB, (with the blessings of the government), would implement a variety of exchange controls. I think this is a something that could come sooner than the market believes.
It is my understanding that there is significant macro hedge fund positioning in the EURCHF. I don’t believe that the SNB is going to simply write a monster check to some fat cats up in Greenwich. There will be (at least) one more chapter in this story.
Should there be something that makes people blink on the CHF, it could end up causing short positions in the EURUSD to get jumpy. I’d rather not be part of a jumpy crowd.
I’m worried about what Bernanke may do on August 1st. We could see something that brings the US negative short-term interest rates. (My thoughts on this). It’s very difficult for me to be a dollar bull. I’m much more comfortable playing the dollar from the short side.
The Euro weakness on Friday was related to a big selloff in Spanish bonds. The Spanish ten-year ended up at 7.27%. This means that a Spanish bailout is not far off and Italy is next in the crosshairs.
Really? I don’t think so. It’s not going to be that easy.
The Euro technocrats are not going to fold in August. They may be going down, but I fear more battles are in the offing first. SMP purchases of sovereign debt is likely next week.
Realized gains have been elusive for me this year.
Now that I don’t have a position to worry about, I’m worried about not having a position. I will be looking for an opportunity to re-load a short Euro exposure. Hopefully it will be at higher levels than Friday. Either way, I will act before September rolls in. The Euro is still toast.
Tags: Alps, Bank Snb, Blessings, Eurchf, Eurusd, Franc, GDP, Guidance, Hedge Fund, Magnitude, Monday Through Thursday, Month Of August, Red Arrows, S Trading, Six Weeks, Swiss National Bank, Three Months, Trillion, Tyler Durden, Vacations
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Saturday, July 14th, 2012
by Russ Koesterich, Chief Investment Strategist, iShares
A few weeks ago, the Wall Street Journal reported that a European courtruled that employees are not only entitled to long vacations–or at least long by American standards–but in the event they become ill while on vacation, they also get a “do-over.”
In other words, employers need to guarantee five or six weeks of vacation, and if employees get ill while taking time off, they can simply retake the vacation when they’re feeling better. While extending vacation time may be a good thing for an employee, it raises the costs for a company or for a government struggling to repay debt.
This relatively harmless ruling, easy to dismiss as silly, illustrates a broader European problem: even when governments try to reform, restrictive labor laws and sympathetic courts can be an obstacle if they impede growth. Though Europe’s politicians have made a reasonable, albeit slow, start to reform, Europe’s existing labor laws and courts are unlikely to help today’s austerity plans and efforts to end the eurozone crisis if they impede a pickup in Europe’s secular growth rate. Thanks to the courts and laws, even when politicians want to reform, they often can’t.
Recently, there was a similar (but arguably more serious) example in Portugal. As the Wall Street Journal reported over the weekend, a Portuguese court struck down a central element of that country’s austerity program. As part of its efforts to comply with the terms of its bailout package, between 2012 and 2014 the government had planned to eliminate the traditional summer and Christmas bonuses for public sector workers. While the ruling eliminating the pay cut will not impact the 2012 budget, it will force the government to adopt additional measures to reach its 2013 target of a deficit of no more than 3% of GDP.
Italy faces similar challenges in reforming its labor market, and, in the absence of necessary labor reforms, Italy is unlikely to increase its anemic growth rate. Unfortunately, what holds for Italy and Portugal is true for the broader Europe.
Europe is not alone in having courts that act as brakes on structural reform. The United States will arguably face similar challenges in coming years (the recent Supreme Court decision on healthcare could be considered the first salvo in this battle). However, the United States still enjoys the bond market’s confidence, i.e. it still has time. The same cannot be said of Europe. Without structural reform, Europe is unlikely to solve its sovereign debt or banking problems, and bond investors are likely to continue to lose confidence.
Ultimately, I believe the path to reform will continue to be slow and uneven, especially considering that several structural issues remain unresolved. That said, I believe a worsening eurozone crisis can be avoided if European politicians aggressively address their region’s problems.
In the meantime, I continue to advocate underweighting Italy and Spain, which look cheap for a reason. I do like some countries in more economically stable northern Europe and I especially like Germany, which has stronger economic fundamentals than its eurozone counterparts.
Investors can access the northern European countries I prefer through the iShares MSCI Germany Index Fund, (NYSEARCA: EWG), the iShares MSCI Netherlands Investable Market Index Fund (NYSEARCA: EWN), and the iShares MSCI Norway Capped Investable Market Index Fund (NYSEAMEX: ENOR).
Source: Bloomberg, The Wall Street Journal
The author is long EWG and EWN
In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Securities focusing on a single country may be subject to higher volatility.
Tags: Austerity Program, Bailout Package, Central Element, Chief Investment Strategist, Christmas Bonuses, GDP, Labor Laws, Necessary Labor, Obstacle, Politicians, Portuguese Court, Public Sector Workers, Russ, Secular Growth, Six Weeks, Taking Time, Target, Time Off, Vacation Time, Wall Street Journal
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Thursday, July 12th, 2012
While the technical definition of recession commonly used is negative GDP two quarters in a row, it is actually something far less simple.
ECRI has been calling for recession for a few quarters now and with the data coming in, it is looking more accurate now – especially if you use the definition on the NBER website:
The Committee does not have a fixed definition of economic activity. It examines and compares the behavior of various measures of broad activity: real GDP measured on the product and income sides, economy-wide employment, and real income. The Committee also may consider indicators that do not cover the entire economy, such as real sales and the Federal Reserve’s index of industrial production (IP).
Lakshman Acuthan visited Bloomberg early this week for an extended interview – email readers will need to come to site to view:
Thursday, July 12th, 2012
Submitted by John Aziz of Azizonomics
The Deleveraging Trap
Hayekians and Minskians agree on one key thing: an increase in debt beyond the underlying productive economy is unsustainable.
In my view, the key figures in defining this are total debt as a percentage of GDP, and its relationship with industrial production. Debt as a percentage of GDP tracks how much debt there is relative to one measure of economic activity, GDP. Yet GDP is a very limited tool of measurement; all GDP really tracks is the circulation of money. To get a clearer sense of the true relationship with underlying productivity, it is useful to compare the ratio of debt-to-GDP with the level of industrial production.
Up ’til the ’70s, debt-to-GDP grew more slowly than industrial production. That is healthy and sustainable. While the total market debt may grow in tandem with GDP, and with industrial production — indeed, this can be the case even under a gold exchange standard (as the gold supply increases) — there is no sensible reason for the ratio of debt-to-GDP to grow faster than industrial production. Indeed, this is symptomatic of just one thing — consumption without income, enjoyment without effort, living beyond the means of productivity. This is just an unsustainable bubble.
As the ’90s turned to the ’00s and the United States gains in industrial production ceased to accumulate, while GDP and most concerningly (and hilariously) while the debt-to-GDP ratio continued to increase. This was classical bubble behaviour, and the end came very poetically; the recession and the industrial production collapse hit just as growth in the debt to GDP ratio (as indexed against 1953 levels) finally surpassed growth in industrial production. Indeed, I hypothesise that a very strong indicator of a Minsky moment — when excessive indebtedness forces systemic deleveraging, leading to price falls, leading to widespread economic contraction — is the point when long-term growth in the debt-to-GDP ratio exceeds long-term growth in industrial output.
The debt-to-GDP ratio is gradually falling, yet it is still at a far higher level than the historical average, and it is still proportionately higher than industrial output. And at the same time, consumers are re-leveraging, and government debt is soaring. And industrial production is barely above where it it was a decade ago, and far below its pre-2000 trend line. We have barely started, and already this has been a slow and grinding deleveraging; rather than the quick and brutal liquidation like that seen in 1907 where the banking system was effectively forced into bailing itself out, the stimulationist policies of low rates, quantitative easing and fiscal stimulus have kept in business zombie companies and institutions carrying absurd debt loads. Like Japan who experienced a similar debt-driven bubble in the late ’80s and early ’90s, we in the West appear to have embarked on a low-growth, high-unemployment period of deleveraging; and like Japan, we appear to be simply transferring the bulk of the debt load from the private sector to the public, without making any real impact in the total debt level, or any serious reduction in the debt-to-GDP ratio.
Cutting spending — for both the private sector and public sector — is problematic. My spending is your income; as spending falls, income falls, which leads to more consumers, producers and governments attempting to deleverage. This leads to more monetary easing, simply to keep the zombie system stable, and keep the zombie debt serviceable. More consumers and producers can take on debt, at least for a time, but the high residual debt level makes any great expansion of productivity or growth challenging, as consumers and producers remain focussed on paying down the pre-existing debt load. It is a vicious cycle.
Quantitative easing does not even tackle the main challenge: reducing the debt load. In fact, it is targeted at precisely the opposite — increasing the debt load, by encouraging lending. But lending into a society that is already heavily indebted leads to no great uptick in productivity, because consumers and producers are already over-indebted to begin with, so few can afford new debt. And banks — flush with cash — have no real incentive to lend; the less they lend, the more deflationary conditions are prone to become, increasing the purchasing power of their excess reserves (on which the central bank already pays interest). The outcome is greater economic stagnation, ’til the next round of monetary easing which leads to a brief uptick, and then further stagnation.
To break out of the deleveraging trap, the debt load needs to be drastically reduced. In my mind there are three potential pathways there, each with various drawbacks and advantages:
- Liquidation; when a debt-driven crash happens, the central bank stands back and lets it happen, as happened in 1907. Prices will drastically fall, many companies and banks and debt will be liquidated, until the point at which prices have fallen to a sustainable level. But we may have missed the boat — the crash already happened, the system has already been bailed out, and the financial system today has already become zombified. And under a system where the central bank determines the availability of money and the level of interest rates this approach has in the past led to excessive central-bank-enforced liquidation, from which the economy may struggle to recover, as happened after 1929.
- (Hyper)inflation; the central bank prints money and injects it into the economy via the banking system. Prices rise, wages rise, and the nominal debt remains the same, thus reducing the debt burden. While most economists who advocate such an approach advocate a slightly elevated level of inflation, the higher the rate of inflation, the more the residual debt load will be devalued; under a Weimar-style regime, mortgages could be repaid in a week. Unfortunately inflation is nonuniform; whoever gets the money first (i.e. banks) can buy up assets on the cheap, and pass the cost of the inflation down the chain of transactions. As Keynes himself noted: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.” Inflation discourages savings and capital formation, which are necessary for new growth. And most significantly — as the Fed’s experiment with QE shows — inflation unless it is very severe will not even necessarily have much bearing on reducing the debt-to-GDP load. The results of a severe (hyper)inflation could be very chaotic and dangerous.
- Debt Jubilee; the central bank prints money, and injects it into the economy via the citizens, with the explicit condition that they use it to clear their debts. This will have the desirable effect of directly reducing debt levels, and lifting over-indebted consumers and producers out of the deleveraging trap. Additionally, the inflation would be uniform and so not to the advantage of the banks or the financial elite. However introducing a large quantity of money to the system — even directly as a medium for debt-cancellation — does itself carry a high inflationary potential.
Certainly, the current status quo of high unemployment, low growth, sustained over-indebtedness and zombie banks and corporations surviving on government handouts is not sustainable in the long run. We shall see which route out of the deleveraging trap we take. Liquidationism seems unlikely, as central banks are afraid of the concept. Inflation (or its unintentional corollary, currency collapse) seems risky and dangerous. A debt jubilee would at least address the real problem of excessive debt, although it is in modern times uncharted territory, and would surely face much political opposition.
Copyright © Azizonomics
Tags: Circulation, Collapse, Consumption, Economic Activity, Economic Contraction, GDP, Gdp Ratio, Gold Exchange Standard, Gold Supply, Indebtedness, Measurement, Minsky Moment, Money, Productive Economy, Productivity, Recession, Sensible Reason, Tandem, True Relationship, United States
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Wednesday, June 13th, 2012
The situation in Europe goes from bad to worse. Gluskin Sheff’s David Rosenberg is back to his bearish roots as he remind us that ‘throwing more debt after bad debts ends up meaning more debt‘. As he notes, the definition of insanity is (via Bloomberg TV):
When you realize that of the potential $100 billion to spend, 22% of that has to be provided by Italy and their lending to Spain is at 3% but Italy has to borrow at 6%. They have to lend to Spain $22bn at 3% – it is just madness. Everybody is getting worried again. The solution that they seem to have come up with seems to be worse than the problem in the first place.
As we have pointed out vociferously over the past few days, even though the assistance is being earmarked for the banks, the Spanish government assumes the responsibility and so this once ‘low national debt’ sovereign is following in Ireland’s footsteps as its debt/GDP takes a 10pt jump to 89% (based on the government’s data) and much higher in reality (when guarantees and contingencies are accounted for). As Rosie explains succinctly, this is right at the Reinhart-Rogoff limit of 90% at which debt begins to erode the nation’s economic fabric.
It is probably not long before this credit – two notches away from junk and having to raise money at 6.75% when its economy is contracting at nearly a 2% annual rate – is going to require external assistance as it follows Ireland onto the sidelines.
The situation in Europe indeed goes from bad to worse.
Tags: Bad Debts, Contingencies, David Rosenberg, Definition Of Insanity, Economic Fabric, External Assistance, Few Days, Footsteps, GDP, Gluskin Sheff, Guarantees, Madness, National Debt, Notches, Roots, Rosie, S David, Sidelines, Sovereign, Spanish Government
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