Debt and wealth in a monetary system, part 2: discounted valuation issues in a declining frame with inequalities.

We are presently building up conflicts within the asset price frame:

  • Conflicts between asset values and GDP flows and their growth rates;
  • Between asset prices and return expectations;
  • Between human capital values and the distribution of those values and their impact on the overall wealth equation with respect to future consumption risks as well as asset pricing via increased asset focus of flows due to distribution dynamics;
  • Within portfolio structure and relative to the liquidity and capital security dynamics of liability streams. 

All of this tied to the relationship between frame transitions, emergent properties and structural imbalances and unconventional monetary policy focused overly on asset price support.

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US incomes…peaked or just about to surge?

If we look at real disposable personal income growth from the latest BEA data update we see what might appear to be, on the surface, a robust recovery:

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Quarterly data shows similar traction:

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But real data has benefited from falling energy prices and nominal flows are not as strong, in fact if we focus on nominal flows we are in the midst of a clear downward movement:

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US debt/asset dynamics……the bubble the Fed appears not to see

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.

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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:

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“Solving the UK Housing Crisis , the Bow Group”, so what about Canada?

“Denmark prohibits non-EU nationals from buying a home unless they have lived in the country for five years”

This is a worthwhile read.  A report on the UK housing market’s affordability crisis by a UK Right Wing think tank that recommends limiting foreign ownership of the property market.  I can definitely see some relevance to Canadian property markets here and the issues raised are very much in line with those expected by the considerable excess asset focussed money supply growth we see globally.   Unconventional monetary policy and increasing income inequality running alongside slowing economic growth have increased the asset focus of global money supply, especially towards hard real assets such as property that will not disappear in an economic/financial crisis.  

You can see this in the Canadian asset market:

The real return on the S&P/TSX composite since the market peak in September 2007 has been –23% to mid December 2015:

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Yet the value of the Canadian residential property and land has moved the other way:

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Interestingly the MLS Canadian Composite Home Price Index shows an increase of 33% since since September 2007 and the Greater Toronto component an increase of 59.2%.  

And there has been an increasing dialogue on the issue in the Canadian press:

Affordable housing crisis affects one in five renters in Canada: study” “One in five Canadian renters face an affordable housing crisis, spending more than half their income on shelter costs, a problem that appears to be even more acute in suburbs and small cities than in major urban centres.”

Moody’s, The Economist warn of high Canadian debt, housing prices” “”The risks are less around the rapid house price appreciation per se, than the fact that, relative to incomes, homes in Toronto and Vancouver are increasingly becoming unaffordable either to own or to rent,”

A Foray into the Fundamentals of Austerity in Anticipation of the Outcome.

A recent IMF report pointed out some supposed vast amounts of room available for the world’s economies to step up government borrowing to finance consumption, investment and production decisions.   Oddly the report appeared to ignore other forms of debt and material deterioration in key areas of the economic frame.  

When the crisis broke back in 2007 it was clear to me that monetary and fiscal policy would likely need to go for broke to support economic growth and employment at a time of collapsing asset values, debt defaults and a world wide retrenchment in expenditure of all kinds.   As it happened a great deal of that support went into asset prices and financial institutions.

But some years after the crisis, after a slow and drawn out recovery with interest rates locked to the floor, economies still appear to be borderline reliant on debt financed government expenditure.  Any attempt to reduce borrowing, to either raise taxes or cut expenditure to pay back debt would be considered by many to have an adversely negative impact on economic growth, especially at such low growth rates. 

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In the context of interest rate decisions you have to ask yourself just what are we waiting for?

I have seen that the IMF has asked the Fed to defer interest rate increases until we see clear signs of wage increases and inflationary pressure.

The request IMO is both scary and rationale given that so much of today’s National Income Accounting Identity (output=C+I+X-M) relies on factors that lie outside of its operation.  I speak of new bank generated loan growth given that income growth/distribution and investment growth still appear to be weak in the scheme of things..i.e. C+I the drivers. 

The last time the FRB delayed interest rate increases we had a debt financed consumption boom in the US followed by IR increases and a de facto financial collapse.   By raising rates we likely restrict one of the few modes of generating consumption growth in the US (note auto loans) and many other countries.  We also likely raise the impact of existing debt burdens on what are to date still historically low rates of income/wage growth.  

As such you have to ask yourself just what are we waiting for?  Well we need higher income growth, but not just higher income growth: we need a more equitable and fair distribution so that economic growth itself becomes less reliant on debt and low interest rates, and less exposed to the scary divergence of asset values. 

But the world is also changing in ways that question whether we can effectively outwait the inevitable: populations are aging and declining.  Areas where the frame can still expand in consumption terms, areas such as China, may be heading into their own period of slow growth and low IR debt support. 

Importantly will the status quo submit to a reconfiguration of the pie and can the world assume a less debt dependent economic raison d’etre?  

So yes, the rationale to defer interest rate rises is both scary and realistic, but it fails to answer important questions: what are we waiting for, how long can we wait, and are our hopes realistic? 

This is just a quick 3 minute post, but the issues are critical!

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/

QE and metaphysical dialogue

Once upon a time economic analysis was “relatively” straightforward…growing, slowing, boom, recession…all part of an upward cycle…even if you got it wrong, it never really mattered…most problems appeared consequences of excess growth…

Something changed some time way back and we have been edging in spurts, lunges and various headlong gallops to yet higher precipitous vantage points…the valleys along the way have also yielded some many interesting experiences….whether this change was a structural process that started some way back in the 1980s (secular stagnation and there are indications this could be the case), or the consequence of a misplaced emphasis on maintaining the stability of the business cycle in the late 1990s (LTCM, Asian Crisis..again consequences of this are clear), that saw central banks lowering interests rates to maintain the growth cycle, or the increasing levels of consumption and debt and widening wealth and income inequality that came hand in hand with lower interest rates and more “stable” and longer growth cycles and or financial deregulation, is a part of the overall complexity of the matter. 

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A debt/asset value/IR bounded endogenous monetary chokehold: Comments on “Patience is a Virtue When Normalising Policy”

The primary interest rate conflict is not between inflation and growth, but between asset prices and a potential asset price shock to growth and the financial system.  Increasing income inequality and weak wage growth keeps the US and other economies within a debt/asset value/IR bounded endogenous money supply chokehold.    A successive series of debt/asset bubbles and interest rate lows are not a succession of unrelated incidents but a tightening of an extremely dangerous grip.

In the most recent Federal reserve Bank of Chicago Missive,  Patience Is a Virtue When Normalizing Monetary Policy, much interesting information was imparted on employment trends…but  there was little comment about interest rates and their relationship with the build up of asset focussed money supply growth……this build up of broad MS was and still is reflected in highly valued asset markets and global debt accumulation.  Its magnitude can be gauged by the large surge in broad MS growth over and above nominal GDP growth.

“With the economy undershooting both our employment and inflation goals, monetary policy does not presently face a conflict in goals;

I foresee a time when a policy dilemma might emerge: Namely, we could find ourselves in a situation in which the progress or risks to one of our goals dictate a tightening of policy while the achievement of the other goal calls for maintaining strong accommodation.

So what happens when a conflict emerges?”

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The economic crisis was not a Monte Carlo event. My comments on Prof Sufi’s statement to Senate Sub Committee on Banking, Housing and Urban Affairs

I must admit I have not read the House of Debt, but I did read Professor Sufi’s statement to the Senate Subcommittee on Banking, Housing and Urban Affairs Subcommittee on Economic Policy.

While I agree with a lot of what Professor Sufi says about the impact of debt (I also share his concerns about income growth and about the worrying trend in auto loans) I disagree with the angle of a number of his statements:

How did we get into this mess? And why is it taking so long to recover? My research with Atif Mian at Princeton University suggests that the culprit is the devastation of wealth suffered by middle and lower income American households during the Great Recession.  The weak recovery is due in part to the lack of any rebound in wealth among these households since the end of the recession.

It was not the devastation of wealth per se but the accumulation of debt combined with invigorating domestic and global structural imbalances that led to the crisis.  The increase in the value of homes prior to the housing collapse was a consequence of excessive asset focussed money supply growth, lax lending standards and attendant growth in consumer debt.  To pin the blame on asset prices incorrectly ascribes blame to the natural risk and volatility of asset prices.

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US debt service ratios

If you look at debt service ratios from 2008 to date you would be led to believe that consumer indebtedness has improved markedly.  In fact you would believe that conditions are the best they have been since at least the early 1980s.  But if you broaden your perspective you find that conditions today have not strayed too much from those conditions which have been in place for much of the last 14 years. 

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US corporate profits and personal income analysis and charts

Profits as a % of National Income remain elevated:

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Many other commentators have likewise commented on high profit levels in expressing concerns over price earnings ratios.  Importantly the cross reference of personal disposable income growth is also useful in the economic context:

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When have we ever had a bull market with such weak income growth…?   At least not since the 1960s..  

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Income inequality and the asset side of the equation…some interesting charts…

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If we have income inequality we are likely to have an increasingly asset focussed capitalist system.  That is the demand for non productive assets and securitised indirect investment in productive capital should increase as demand for goods and services as a proportion of national income declines. 

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Income disparity and capitalism may be an increasingly squeezed play in a robot world

Capitalism is not about wealth, it is about capital and its continuous productive employment.  Increasing inequality combined with rising wealth in non productive assets is essentially anathema to a structurally sound capitalist framework.

A big part of the problem is that key elements of the operational economic model, that which determines revenues and that which determine costs, have become disassociated from each other – marginal costs and marginal revenues need to be related.    Additionally the model itself is also suffering from leakage as less profit is reinvested and earnings are increasingly distributed to those who will accumulate and not eventually consume, with consequences for asset prices, which themselves have a feedback loop into the economic engine.

I was reading a couple of posts on FT’s Alphaville (Robots won’t make you rich for long & The UK’s squeezed bottom, charted) and a Stiglitz piece on Project Syndicate (Stagnation by Design).  The second Alphaville post provided a link to an important document on income disparity, produced by the Resolution foundation

I disagreed with the gist of the Robots won’t make you richer (a repost to Martin Wolfe’s Enslave the robots and free the poor), largely because the post confuses the price of an asset in the stock market (GM stock) with the value of the actual capital invested to produce the goods and earn the profits, but I felt that there was a thread between the subject matter of these different views that was worth expanding on. 

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Is the balance sheet recession over? Financial sector debt…

Financial sector debt (and as noted consumer debt) has fallen significantly since the crisis:

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Yet, if we look at the financial sector assets with respect to non financial sector credit market debt, we start to see an interesting picture:

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Inequality, Capitalism in crisis, the democratic option or the way of the demagogue

“Should the US increase its minimum wage?”

In a competitive market place it is unlikely that we would see the current large disparity between incomes and wealth, although we would see disparity naturally.  There is just no way that the pool of candidates able to run the few hundred of our largest companies is as small as it appears (human beings are de facto mass clones of each other) – in a competitive market place the pool of those capable of running a company would drive the price down.

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Census Bureau–incomes are not enough!

While more of what there is may be flowing to the top 1%, there is altogether less of everything.

Real personal disposable income per capita remains at levels associated with recession, government personal transfer payments remain elevated well above pre recession levels and personal savings remains at post 2000 lows:

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As it came to pieces in my hands…

Paul Weller: “I stood as tall as a mountain; I never really thought about the drop; I trod over rocks to get there; Just so I could stand on top; Clumsy and blind I stumbled;…I didn’t stop to think about the consequences; As it came to pieces in my hands.”

The 2008 crisis told us that there was a mismatch between asset values and debt, asset values and future return, and debt and economic growth as well as some rather large structural economic imbalances.

We have tried to delay the eventuality implied by the difference in the hope that the “true” magical economic growth rate should return. Have we built up a bigger monster, and if so, how do we slay the beast?

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Growth dynamics have changed a bit and are in between times…

Historical equity returns reflect past growth dynamics, dynamics which may be either weaker or in transition, or both – indeed, dynamics in mature economies are weaker, and combined global dynamics are in transition.  Return expectations need to be cognisant of these structural drivers of return.

The main drivers of growth are well known: a) population growth and employment participation rates, b) capital investment and c) increases in total factor productivity, or rather efficiency gains from the combination of a and b. Continue reading

Income inequalities only add to the size of the hole we are in!

A recent IMF report (in fact one of many) highlights a relationship between income inequality and debt.

While these reports and the research that underpins them also attempt to address their causality and solution, it should be clear that income inequalities and high levels of debt amongst those outside of the wealthy elite is a fundamental aspect of the current financial crisis.

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