Overtaxing the rich: A cautionary tale

We need to look at increasing inequality as an unfair tax on social and economic stability.  And so, my brief thoughts on this Tim Cestnick article in the Globe & Mail;

At a very simple level the economy spends what it earns  (Output=expenditure=C+I=C+S, where S is income spent but not consumed).  In reality the picture is somewhat different in that we have monetary loan expansion that over time has served to increase the demand/expenditure for goods/services and investment expenditure.

Economic growth is the growth of expenditure whether it be consumption or investment goods.   If we start to allocate increasing amounts of income towards a very small % of the population what we end up doing is to constrain the ability of the economy to grow. 

For one lower income growth limits borrowing ability (something which had sustained GDP growth) and it may retroactively impact the ability to repay previous loans based on lower ex post income growth.

Greater allocation of income to one small segment of society also risks a higher allocation of money towards assets and away from consumption.  Increasing income inequality results in lower recycling of income into demand, and as the growth rate of demand slows so does the growth rate of investment.  

Importantly future flows determine the valuation of assets, so rising inequality amidst weaker GDP growth poses risks to assets prices.  The significance of this circularity has been lost on the very wealthy in a time when monetary policy has been outwardly in favour of asset price support in a weakening growth environment.

If we had less income inequality then tax rates would also likely be lower and we may also have a smaller state and a more outwardly capitalist economy.   The need for higher tax rates is partly due to structural imbalances like income inequality: think of two monkeys swinging through the trees, one with all its limbs and the other with only one arm.

Clearly we need incentives for people to take risks with capital, but we also need to make sure that the system has the necessary circularity of flow.  The income of the very wealthy is dependent on the expenditure of all and the valuation of their assets too.  This is something many have lost sight of: today’s high market valuations relative to historical benchmarks (note the Shiller CAPE) are assumed by some to reflect a different set of dynamics supporting valuation whereas many of the growth engines of the past are collapsing.  

At a time when there are so many negative forces impacting the stability of the economy a more efficient, though still incentivised, distribution of income would go a long way to alleviating economic and geo-politic stress.  Otherwise we risk increasing social instability and greater threat to income and wealth.  

The post World War II years are a very short space in time and certainly not long enough to assume that the having your cake and eat it too mentality is a natural economic dynamic.  In reality increasing income inequality is a de facto tax on economic and social stability in that shifting income and wealth from one set of people to another creates dangerous imbalances and inefficiencies.  The present need to raise taxes is an ex post not an ex ante action.

http://www.theglobeandmail.com/globe-investor/personal-finance/taxes/how-splitting-the-dinner-bill-relates-to-tax-cuts/article24441644/

“Marketplace lenders step out of the shadows in Canada — should we be worried?”

Brief thoughts re a recent Barbara Schechter article: Marketplace lenders step out of the shadows in Canada — should we be worried?

I tweeted on this. Some additional comments.  Peer to peer lending is different from bank lending in that it does not result in an increase in money supply growth.  It may result in an increase in velocity of money supply, something which has been dropping of late in many economies as a result of quantitative easing and a number of other dynamics.  It should also increase the efficiency of the intermediation system by offering lower interest rates and quicker access to credit to many borrowers.   There are some cons: one of which is that it will increase the liquidity risks in the system in the event of an economic downturn/ financial market crisis.  This of course depends on how many may view their loans as money like when they have been transformed and how this market place securitises the loan book.   At the present moment in time it may also increase the amount of consumer debt over and above safe levels, although this would not necessarily be an issue in less leveraged environments.  

Critical perspectives on US Market Valuations 2…includes 17 charts

Many say that lower interest rates should raise asset valuations by lowering the rate at which future income streams are discounted.  This may be fine for high quality government bonds where coupons are fixed, but is not necessarily the case for equities where we are dependent on future flows (earnings, dividends, economic growth, CAPEX). 

What is the major determinant of long term real equity returns?  Earnings growth, and long term earnings growth is dependent on real economic growth.  If we look at real growth rates they are falling, and have been falling for some time.  This is part of the reason why interest rates have been falling; that is to accommodate falls in nominal and ultimately real flows.

The following shows annualised annual growth rates over rolling 15 year time frames (in other words geometric returns) compared to the Shiller Cyclically Adjusted PE ratio:

image_thumb2[1]

Continue reading

A world in transition, but so many straws in the wind, some thoughts!

Everybody is asking and at times hoping to answer the question as to why world economic growth is slowing down, why is it so sub par, why has it not recovered post the turbulence of 2007 to 2009?   There are many straws in the wind, but which ones are cause, which ones are consequence and which are accommodation linking both?  In a world where diverging tiny margins can accumulate into significant distances it is hard to determine just what and which is the key.

Continue reading

Not a “Savings Glut” per se but a monetary excess amidst a period of complex global structural economic change!

If you stream through the data it is pretty clear that developed economy growth has been slowing for some time and that monetary policy has accommodated this adjustment with lower interest rates and a relaxed attitude towards money supply growth.  At about the same time these trends were moving ever closer to their sweet spot on the horizon (because we are not yet at peak of this particular movement) certain developing markets really got going, with the help of a fair amount of their own monetary stimulus but also by a reconfiguration of global supply chains and offshoring in key economies.  All factors combined to create a heady and dangerous global financial imbalance, a weak bridge cast across a widening economic divide.  No wonder it all came crashing down..but who was to blame?  The world’s central bankers who were blindsided into excessively lax monetary policy by a low inflationary world that had become obsessed with laying off and chopping and dicing of risk to those “who could best absorb and bear it”, or some of the finer strings in the mesh?  Well, some have chosen to blame excess savings in the emerging/developing part of the world, principally China, but this is all too pat.   The “savings glut” theory, if you can really call it “excess savings”, was merely a return of serve of part of the vast ocean of financial and monetary excess that barrelled through the early to mid 2000s.

Continue reading

Not a Savings Glut, a much more complex dynamic of global imbalance and monetary excess.

For me the “Savings Glut” Hypothesis falls down on a number of key areas:

The first and most important is that it appears to ignore significant loan/monetary growth which breaks the point in time National Income Identity on which “Savings Glut” arguments apparently rest. I say apparently because much of the discourse supporting the SG hypothesis is either couched in nuanced semantic surfing and/or bereft of argument that you can trace directly back to the source of the flows from which they derive savings. Many supporters of the SG hypothesis either ignore these monetary dynamics totally or disavow them without cause.

The second is that it ignores the foreign exchange and central bank monetary dynamics involved in much of the FX/asset purchases. Key components of the trade balance/net investment position were orchestrated by Central banks creating new money to buy dollars and thence assets.

The third is that it ignores the fact that the major mega surplus economy, China, was and remains to a very large extent driven by loan financed (new money) gross fixed capital investment. Again the basic National Income Identity model misses a myriad of inter temporal dynamics. The SG argument was that it was excess savings and not monetary and financial system excess that caused the crisis and to fully understand the imbalances you have to look at where National Income/output is derived.

The fourth is that it ignores the very important development of emerging Asia as a global production hub and the off shoring dynamics that saw significant components of US and other international manufacturers move tranches of their manufacturing base to these countries. This issue is well covered and documented.

Finally, as discussed in numerous papers, focussing only on the net investment flows ignores vast sources of excess demand for assets that were also instrumental in pushing financial markets out of synchonisation with their economic fundamentals.

I will look to explore and illustrate these arguments in coming posts. 

Some brief thoughts on US Incomes and expenditures

Inflationary dynamics have brought about a large relative increase in real incomes over the last six months or so. 

image

Yes it looks as if much of the most recent improvement has not been “spent”, but it is only 1 or 2 months into this gap which must itself be set against strained income increases over the last decade.  Longer trends and frames remain important for the sustained growth rates over time and the current frame remains a weak one.  Personal consumption expenditures as a % of disposable income remain at historically high levels and consumer credit growth may also be a notably factor weighing against leeway for growth in consumption (see end of post).

image

Continue reading

Re Andy Haldane: my brief comments on deflationary risks and interest rates

This is a quickly penned thought on Andy Haldane’s recent comments on interest rates and deflation:

In a recent speech Andy Haldane of the Bank of England suggested that interest rates may well need to fall as opposed to rise following on from recent falls in inflation.   I would agree that the secondary impacts of price declines need to be seen before we can assess whether or not these price falls could indeed trigger stronger deflationary forces.

For one, price declines may lead to lower revenues (note US retail sales) and lower revenues may impact on wage increases.

Secondly, lower revenues impact cash flows and cash flows impact asset prices, especially for high yield debt in sensitive sectors.   Global markets remain especially sensitive to asset price movements and factors which may impact asset prices.

Thirdly, we are in a complex deflationary frame where aging populations, slowing population growth and relative weakness in corporate investment (note buybacks) is already a significant drag on the global economy.  Falling prices could well trigger latent dynamics in this structure.

And finally, areas of the world which could well create the demand necessary to reinvigorate the frame, for example China where growth appears to be slowing sharply, may also be adding to tensions within the global growth frame.

So yes, interest rates could fall, in the sense of defending asset prices and attempting somehow (I do not quite know how) to reinvigorate or at least support demand, or rather maintain marginal cash flows.

But in reality we do not know because we lack at the moment a measure of the sensitivity of the frame to short term shocks of any financial or economic nature.  We know the frame is weak and has been for some time but as to its sensitivity, we know very little.

Are we in a financial bubble? Yes of course, we always are, but this one is different!

Many will be forgiven for feeling and being confused by the constant divergent chatter over market bubbles. 

Yes, we are in a bubble: I believe an extreme one in fact, but the natural state of the financial world relative to the economic is always one of a bubble; asset markets are always discounting the future, and the money supply that creates demand for assets and also goods and services has been growing for some time, as has the economy.  If a market is priced at x times historical earnings it is discounting future earnings and by doing so providing a valuable medium, or at least should be, for financing new investment and for facilitating the transfer of assets.   As the economy grows, so will assets and their prices and so will the bubble….and the bubble is the difference between now and future cash flows and the pricing of those cash flows. 

Continue reading

The Fed is slowly shaking the tree, but will it start to climb?

Over the last 20 or more years interest rates have fallen, for reasons other than falling inflation, and as interest rates have fallen so has nominal growth in a great many developed economies, and so has inflation fallen further.  On the other hand debt has risen and so have asset prices, quite remarkably so in fact.  But through this period we have also had a succession of financial and economic crisis, with the risk mostly of a financial nature, and in response to these asset price risks, interest rates were either cut or held low for, in my opinion, far too long.

The Fed would now like to raise interest rates, and so too would other seemingly “well on the way to economic recovery nations”.  The trouble is the “economy and our markets” are now more than ever sensitive to changes in interest rates.   The Fed partly knows this, is partly concerned that interest rates lie at close to zero (and unless they want to go negative, a place they probably worry they may never climb out of) would like to see them a bit higher, to allow them to cut interest rates in a subsequent crisis. 

In the last cycle the the Fed Funds rate rose to 5.25 and currently loiters around the 0.11 to 0.12 range.  I would suspect that a Federal Funds rate of 4% was too high for the last upward cycle and would also posit that rates would be hard pressed to rise above 2% in the current cycle before we saw the type of wrenching market reaction…but this all assumes everything else being equal.  Markets are too well worn around the interest rate, money supply asset price equation to lay back and wait for the interest rate cycle to hit economic growth.   The question is though how much of an asset price shock can the “economy take as interest rates rise before that asset price shocks impacts the economy?  I guess that is the question and the Fed is trying to work out just how sensitive the world is to a rise in interest rates.  It just does not know and while the risk of rising rates may be extremely high it may well have figured that “the Fed’s got to do, what the Fed has got to do…”.  

As many other commentators have pointed out, a whole panoply of other risks have started to move out of the closet (namely the many risks posed by a sharply appreciating US dollar), risks that may already constrain the Fed from acting.

Current rates on 5 year treasuries are around 1.5% and stood at some 4% in early 2007.  I would have thought that the peak rate for the Fed rate would be around this level at the current juncture, but just how to get through to it is the question? 

Continue reading

Some important dynamics from US Q4 GDP Update

A weak frame:

image

Personal consumption expenditure is the most important component of US GDP and growth in real Personal Consumption Expenditure (PCE) is tied to the productive capacity of the economy.  So why on a real per capita basis has the economy failed to produce sustained increases in consumption capacity post the early 1980s?  And note that this is despite an increase in PCE as a % of GDP over the post war period. 

And also on a nominal basis:

image

How reliant in fact has GDP been on the PCE component? Growth in PCE has eclipsed both GDP and equipment investment over the post war period, and significantly so.   The question begging to be asked is,”where is growth going to come from?”

image

In another recent blog I exposited about asset valuations relative to GDP growth.  Now the charts above show the increasing reliance of US GDP on PCE, a component which appears to have outsized importance in GDP terms.  Well the following shows even PCE growth being dwarfed by increases in household asset values:

image

In fact we can see that PCE expenditures have been less reliant on income growth post 2000s:

image

And looking at nominal GDP only, if we adjust for inventories and the impact of changes in consumer credit we find a much subdued trend in growth:

image

And nominal growth in expenditures have been declining:

image

And motor vehicles etc continue to be an important part of consumer expenditure…

image

And relative to the prior debt fuelled cycle we find that expenditure on MVPs and RV combined is a much greater…I have pointed out concerns with respect to the growth in non revolving consumer credit relative to income growth, a ratio which stands at historically high levels.

image

Services expenditure has been increasingly volatile:

image

And note the importance of health care expenditure:

image

Interestingly if we take out healthcare expenditure from PCE, PCE as a % of GDP has been more more stable..

image

And financial services expenditure has also picked up since Q1 2013:

image

Interestingly, all the domestic investment components (on a nominal basis) are turning down in a synchronised way:

image

Exports have been an important driver of growth recently, but more recently has fallen back as a nominal driver of expenditure: there are many explanations for this amongst them the recent decline in the oil price and weakening global demand growth.

image

And of course the chart raises the question, where is the growth going to come from?

Finally, a quick peek at growth in commercial bank deposits relative to nominal GDP growth:

image

Links–8th to 5th March

What is corporate Japan doing with its cash pile?” http://FT.com http://on.ft.com/1Aw9uS1

What is civic capitalism? An interview with Colin Hay

Who carries the risk? Asset-allocation challenges for defined-benefit pension schemes and their sponsors on the road to buyout.

Are falling prices a risk to pension schemes?

Understanding the Risks in Liability-Driven Investment (LDI) for Pension Funds

Corporate pension funds weigh derisking vs. re-risking

PENSION SCHEME GOVERNANCE IN A RISKFOCUSED WORLD

REPO SQUEEZE: IT’S ONLY THE BEGINNING Implications for UK LDI investors

The End of De-Risking

Buy-side increasing their use of derivatives in times of stress

Not Everyone Is Happy That RadioShack Ran on Derivatives

Premia in and outs?

(What’s Left of) Our Economy: February Snaps Manufacturing’s Short Strong Job Creation Streak

Too Big Too Fail: a graphical analysis of the US asset bubble..

I have been tweeting about the relationship between asset valuations and GDP and a number of other metrics recently. 

My point for some time has been that the relationship between asset valuation and GDP, amongst other reference points, is excessive and out of alignment with slower GDP and income growth.  As with many of my other posts the point is this: the financial economy, asset and debt valuations and the complex financial system linking them, has become much bigger and therefore much more important to keep alive.  I would go as far as saying that the financialization of the global economy has become too big too fail, an extension no less of the banking dilemma.  

Continue reading

Links–2nd March to 4th March

The Demolition of Workers’ Comp – ProPublica.org

Quantitative Easing vs Sovereign Money Creation (Infographic) (Positive Money)

Despite Changes, an Overhaul of Wall Street Falls Short (New York Times)

Bank of England urged to let rip on inflation (Telegraph)

The Myth of America’s Manufacturing Renaissance (ITIF)

Robert Parenteau: The Large Fly in Krugman’s New Keynesian Soup (Naked Capitalism)

The high costs of being poor in America: Stress, pain, and worry (Brookings)

Only mass default will end the world’s addiction to debt (Telegraph)

Why the Eurozone needs more than QE (World Econ Forum)

Pension risk transfer hits record £38B in 2014, more to come in 2015 (Artemis)

The behavior of aggregate corporate investment (Kothari, Lewellen, Warner)

End Games and End Times (ECRI)

Information Networks: Evidence from Illegal Insider Trading Tips (Harvard Law)

This is nuts, where have all the bonds gone? (FT Alphaville)

Plan to Exit Stocks Within the Next 8 Years? Exit Now (Hussman)

Household investment decisions influenced by performance report presentation (Chicago Booth)

Going to the Dogs (Janus Capital)

Calls for higher inflation targets

In a recent post,”There’s nothing left-wing about a higher inflation target”, Tony Yates called for an increase in the Bank of England’s inflation target from 2% to 4%.  Raising the inflation target for some reason would allow for higher interest rates that would provide the necessary leeway to combat economic downturns without being hemmed in by the zero lower bound.

While I do not necessarily agree with the statement I do agree with the dynamics that quite possibly underlie it.   Yes, if the inflation target had been higher central banks may not have been as aggressive keeping inflation under control and possibly inflation may not have fallen to current levels.   Interest rates may therefore not have trended down from the early 1990s to their pre crisis levels.

If interest rates had not moved downwards over this period then it is likely that we would have seen much less asset focussed debt creation and the foundations of the crisis that led to a precipitous immediate drop in growth and weaker growth post crisis would likely  have been somewhat curtailed.   The fact interest rates are hemmed in at the lower bound though has more to do with the dynamics of high levels of debt and their relationship with high asset values amidst the constraints of low economic/income growth.  In other words it is the past that has the greater weight, not the future.  So yes, clearly, without the debt accumulation and with higher interest rates we would possibly not be at this particular chokehold. 

But, interest rates did not fall solely because inflation fell, they fell because growth rates were also falling and because of a number of financial shocks to growth starting in the late 1990s.   In a sense interest rates fell to stimulate growth and anything that stimulates growth also risks stimulating inflation.   That it did not is a very moot point. 

In reality, all other things being equal, where inflation is caused by imbalances between supply and demand, the higher the inflation target you have the lower the interest rate target, and since I believe that lower interest rates have helped foster successive financial bubbles I am concerned over the integrity of higher inflation targets per se given the dynamics.   I would have preferred higher interest rate targets and less monetary stimulus even if this had meant a lower growth trajectory.   I can see little wrong with low inflation within a structurally stable economic framework.   

But let us suppose the argument is one of expectations and by raising the Bank’s own inflation targets so will the general public.  I think if this was the case the article should have clearly expressed it.  I do not personally feel that today’s deflation is led by individuals delaying expenditure in the expectation of lower prices tomorrow, although this does not mean it could not start to happen.   The question is, after all the best efforts of central banks the world over to stimulate growth over the last 20 years have led to the present moment in time of low interest rates and falling prices, how will putting an expectation of higher inflation into CB policy actually raise both inflation and interest rates?

Perhaps by raising inflation expectations we may cause consumers to spend more and save less.   But this assumes that people are spending less than they are capable of (the wealthy “1%” perhaps, but do they need to spend more?) as well as the fact that deflation is impacting the saving/spending decisions of consumers. 

Personally I would rather have seen a higher interest rate framework and reduced asset focussed money supply growth with lower potential inflation implications than the situation we are currently in.  It has less to do with inflation and more to do with structural economic integrity.   Trying to stimulate expenditure via every manner possible has led us into all sorts of problems.

The one bright spot in manufacturing new orders, motor vehicles and parts demand is a worry

Yep the employment numbers looked reasonable but we are going to have to see better wage growth going forward and much less reliance on consumer credit if we are to believe that the economy is no longer skating on thin ice: 

Motor vehicles and parts new orders have kept on rising:

image

But non revolving debt is growing at its hottest pace since 2000/2001

image

And as a % of disposable income, much higher:

image

And relative to income growth, well, historically high levels again:

image

I just do not feel comfortable with these kinds of fundamentals underpinning growth expectations.

Another way of looking at US employment data

There is an increasing amount of data pointing to a general deceleration in economic growth since the summer, yet US employment numbers keep on movin’ on.  Instead of going through the repetition of data points I thought it would be useful to look at employment data from another angle.

Typically employment numbers are meant to be a coincident indicator of economic activity, but this is an average characteristic.  There will be times when it will be a lagging (catch up) or a leading indicator (job losses).

Economic activity in the US surged post the winter weather interruptions and peaked around mid summer…I was wondering whether this peak in activity following a long period of relative weakness had influenced hiring somewhat and to what extent hiring has lagged this initial surge in activity:

image

The above shows the monthly unadjusted change in total private employment over 2012, 2013 and 2014.  We can see that the differential really opened up from mid summer onwards.

So let us look at the differential between 2014 data and 2013/2012:

image

Well we can see that pre May 2014 numbers were below 2013 and 2012 and post June were above, especially 2014 on 2013.  So let us look at unadjusted new order data and then compare it to employment data above:  image

image

New order data rose strongly to mid year relative to the prior two years then fell back relative to other years, so I wonder if employment data has fully reacted to this slowdown.  It is an interesting point…

Some interesting Euro Zone GDP charts

The cumulative change in final consumption expenditure of General Governments exceeds the change in GDP since 2007:

image

Household and non profit organisation expenditure has languished, especially once you exclude German data:

image

And the fall in gross fixed capital expenditure is heady:

image

Exports have fared better:

image

And imports with the exception of Germany reflect the overall economic weakness:

image

World trade

World trade fell 1% in November according to the CPB World Trade Monitor.  The 4 months since July represent the weakest period of growth since the earlier part of the year (Feb/March).  If we look on a monthly basis the slowdown has become more narrowly synchronised.  While world trade growth does go in cycles the pattern that is emerging is of stronger global growth till mid summer and fall back since that point.

Continue reading