US durable goods order data out yesterday suggested a strong rebound in new orders in April led principally by transportation orders. But I am not going to talk about the new data (at least until I get the full manufacturing new order data set due shortly), I want to talk about the difference between the new and the old order data:
Data to March 2016 had been revised down by some 2% for manufacturing orders and the rate of revision was similar for both durable and non durable goods.
However the wider picture shows that transportation, in particular motor vehicles and parts orders showed significant upward revisions:
On the other side of the variance we see non defence capital goods excluding aircraft, computers and electronic goods and primary metals heavily negatively revised:
The picture confirms the relative strength we have seen in auto led consumer credit growth on the one hand and weakness in exports and capital expenditure on the other.
In last week’s “Decision Making at the Federal Reserve” at the International House of New York Janet Yellen said that the US economy had made tremendous progress in recovering from the damage caused by the financial crisis, that labour markets were healing and that the economy was on a solid course. She also said the economy was not a bubble economy, and that if you were to look for evidence of financial instability brewing you would not find it in key areas: over valued asset prices, high leverage and rapid credit growth. She and the FRB did not see those imbalances and despite weak growth would not describe what we currently see in the US as a bubble economy.
Perhaps the question was the wrong one. The bubble, indeed most bubbles, are financial in nature and relate to both the flow of financing and the current stock of financing. We are always in a bubble to some extent given that one of the key facets of the monetary system is the discounting of the present value of future flows through the allocation of assets, principally of money relative to all other assets. Today’s differential between what the economy can produce over time and the value and supply of assets that represent the future expenditure flows from our economy, are I believe, in excess of the present value of those flows. Part of this is due to monetary stimulus designed to drive growth forward in the face of demographic change, increasing income inequality (which weakens the expenditure base of the economy) and important transitions in key emerging economies that have numerous structural relationships.
We are in a bubble and while the economic issue today is one of a deflating frame (i.e. not one with inflationary characteristic usually associated with economic overheating), the differential between the financial frame and the economic has arguably never been so wide. Perhaps the Federal Reserve should have defined what they believed to be a bubble or rather the moderator should have been a bit cleverer!
Some may say that excess financial leverage of households has moved back to more sensible levels: the following chart shows that consumer debt levels have moved back to early 2004 levels but that these levels were associated with much higher longer term real GDp growth rates. In this context debt has not really fully adjusted.
And, looking at shorter term real growth trends we see that real GDP growth has peaked at much lower levels relative not just to total debt to the rate of increase in consumer debt. One would be forgiven for thinking that the last 5 years included a recession in the data, but it has not:
Is investment expenditure in the US really looking strong? I picked up some tweets on this the other day which stated that it was indeed.
The above graph shows domestic investment of US private business net of capital depreciation. A couple of points should strike you immediately: one nominal expenditure peaked back in the late 1990s; two, a lot of the retracement (or the pluck as Friedman might have said) is a consequence of the unprecedented decline seen during the dark days of 2009.
It may be that the monetary transmission mechanism is impaired through the structural imbalances that have developed within global economies over the last 20 years (+/-). If the transmission mechanism is impaired then we are in a perpetual “Sword of Damocles moment.”
Policymakers are facing a new global imbalance: not enough economic risk-taking in support of growth, but increasing excesses in financial risk-taking posing stability challenges
We have been in a declining capital and human investment scenario for some time (discussed in many a recent blog), in many key developed economies, and we have been in a paradigm of increased financial leverage/asset focussed money supply growth. This is not new and is the primary reason why we are pinned to the economic floor with the proverbial boot pressed to our throats. I discussed this also in a recent blog…
The IMF rightly points to the risks posed by the shadow banking financial system:
The point about share buybacks is that they sit uncomfortably in a widening narrative of increasing inequality, weak income growth (worse at lower income levels), falling economic growth rates and disturbing trends in both human and capital investment. The backdrop to the narrative and one that threatens to envelop it as one are the burgeoning asset and debt markets, whose rise is at odds with the weakening fundamental growth prospects of many developed economies. Asset markets and hence debt are being supported, yet the fundamental underpinning to their longer term valuation, investment and growth in real incomes is being weakened. At some point the two, economic reality and asset market capitalisation will need to meet.
I just wanted to extend the line of thought I was developing in my previous blog post: that is of the synchronisation of weak growth/capex and the increasing amount of corporate capital being allocated to share buybacks.
To a certain extent they all have one common thread, and that is a depreciation of corporate assets both current human and capital, and, with respect to the future, lower future rates of productivity growth that reduced human/capex investment imply. I also thought it worthwhile noting the decline in shareholder capital on the balance sheet of corporations like IBM and the increase in liabilities. Companies are becoming more highly leveraged at a time when economic growth and its important driver, income growth, is on a distinctly weakening trend.
So when the cycle turns, what should we expect to see happen first? An uptick in wages followed by capex and new issuance, or would buybacks slack off first, followed then by wage growth and finally capital expenditure. Or should we first look earlier in the chain to the composition of employment?
If we are in a strong stagnation dynamic I would expect that the economy would move through several iterations before a new wage growth cycle gains its own momentum. And there are many stagnation dynamics overlaying the economic structure….
More and more people are talking about declining real and nominal wage growth and more and more people are asking when is wage growth going to pick up.
It is a very good point. But I think we need to look at the dynamics of wage growth from another perspective. This perspective is that of human capital investment: wages are an investment in human capital and you pay more when you want to invest/upgrade/increase productivity etc. If you expect to grow and you expect to depend on investment in human capital to grow, you will invest more, and one indicator of this investment is wages.
Now, we know that capital investment as a % of GDP has been declining for some time and we also know that corporations have been buying back shares and borrowing money to do so. But these three (wages, capex, buybacks) all look to me to be pretty synchronised.
It looks pretty much as if corporations are adjusting to lower long term economic growth either as a consequence of lower wage growth, less investment or some other natural dynamic —productivity/TFP or demographic dynamic. Of those who discuss the issue of secular stagnation many point to the 1980s as the starting point and the trends noted above would fit into this timeframe….