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.

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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.

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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. 

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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).

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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. 

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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? 

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Some important dynamics from US Q4 GDP Update

A weak frame:

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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:

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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?”

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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:

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

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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:

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And nominal growth in expenditures have been declining:

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

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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.

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Services expenditure has been increasingly volatile:

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And note the importance of health care expenditure:

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

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

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

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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.

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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:

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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.  

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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:

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

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And as a % of disposable income, much higher:

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

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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:

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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:

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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

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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:

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

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And the fall in gross fixed capital expenditure is heady:

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Exports have fared better:

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

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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.

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A belated look at December US retail sales..

As world growth appears to be slowing an awful lot is riding on US retail sales, unfortunately.

Retail sales growth has weakened since the post winter bounce earlier in 2014.  Excluding motor vehicles and parts the picture is weaker still.  The only bright spot is falling inflation, but only on a shorter term view.   Retail and food sales per capita adjusted for CPI are not much higher than they were in 1999. 

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US Manufacturing orders..underlying weakness raises questions about growth going forward.

The global economy lost further momentum as 2014 came to a close, according to Markit’s worldwide PMI surveys. The JPMorgan-sponsored Global PMI fell to a 14-month low of 52.3 in December, down from 53.1 in November.”

The latest batch of Markit PMIs as noted show a 14 month low in global expansion.   This contrasts with some confidence in a number of quarters with respect to US economic momentum in the light of “strong” Q3 GDP and recent gains in employment.   I have commented on the GDP and employment frames in earlier posts which suggests that less focus should be placed on monthly data and more on structural imbalances and trends.

That said recent manufacturing order data may be suggestive of a slowdown from the elevated figures seen earlier in the summer.  While this may not signal a downturn it does raise questions over the underlying strength of growth going forward:

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A look at final Q3 GDP..was it really that strong? And what of the Frame?

One of the risks with short term data points is being fooled by their randomness.  I believe the US economic engine is slowing down and that weight of the past remains a significant head wind!

A number superlatives are cropping up re final Q3 GDP numbers:”fastest pace since Q3 2003” and others…

But what of the frame?   If we look at the average increase in real GDP over the last 4 quarters (average change in GDP over 4Qs/average GDP in prior 4 quarters) we see that real GDP growth is relatively low in an historical context and it is unclear whether the current trend is either a bounce back from earlier weakness or a position of growing strength.

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Importantly private consumption expenditure is still outsized with respect to economic growth and other important items such as machinery and equipment expenditure.  That is much of the growth in GDP to date has been due to growth in personal consumption expenditures: 

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Bank of England Stress Test

“..the stress-test results and banks’ capital plans, taken together, indicated that the banking system would have the capacity to maintain its core functions in a stress scenario. Therefore, the FPC judged that no system-wide, macro prudential actions were needed in response to the stress test.”

My main concern with the stress tests is that the explanatory document came bereft of the underlying economic scenarios!   How far did GDP fall, for how long and what was the recovery like?  Did IRs stay at an elevated 4+ plus from current levels or did they fall?  I have not got a clue as this exercise seemed to focus on fairly extreme contractions in domestic property markets, higher interest rates and some assumptions re mortgage, personal debt and CRE defaults.

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Is Canada’s Mini Golden Age behind it?

I remember back in the 1990s looking at long term Canadian stock market performance and thinking how lacklustre it had been.  Since then of course things changed: while many markets have fallen back below levels reached in the 1990s (UK, France, Japan,  Italy) Canada’s stock market, up until recently, has been ratcheting up one peak after another; its markets have behaved more like developing Asian markets (South Korea, Hong Kong etc).

Commodity price and production increases have played a large part in much of post 1990s economic performance as has a considerable debt financed house price/construction boom and other debt financed consumer expenditure.

With the recent hefty collapse in oil (other commodity prices have been falling for a while too) it is worth asking whether Canada’s mini golden age has passed.   Certainly the boost that came from a debt financed property market boom is unlikely to be repeated and the consequences of debt more likely than not to weigh on future economic growth.  Additionally, China, a key figure in the growth of world trade and demand for commodities post 1990s is slowing down. 

But what of other dynamics?  Well population growth and aging are very important and have likely been a major factor in slowing global growth.   If we look at employment growth between 2000 and the present point in time we see that Canada has significantly outperformed the US and a good part of its economic performance has likely been due to this superior metric:

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Recently a Statistics Canada report eulogised Canada’s population growth, the highest amongst G7 economies but I see more troubling trends behind the data:

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The age 65 and over population is expanding rapidly at the same time as under 20s has actually been falling.  Back in 1990 12.5% of the US population was over 65 and 28.8% was 19 and below.  In Canada the respective figures were just under 11% and 27.7%.  By 2013 US over the age of 65 had risen to 14.14% and those under 20 had only fallen to 26%.  In Canada the respective figures were 15.3% and 22.3%.  The trend is divergent: the working age cohort in Canada started at a higher level and has now shrunk to a lower level and looks set to fall further.

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We can see the growth rate of the key 20 to 54 age group has been declining steadily.

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We also note that employment growth in the 20 to 24 age group (and hence the 20 to 54) had benefited some from a recovery in growth (long since past) in the 0 to 19 age group from the mid 1980s to the late 1990s.   This has now worked its way out of the system.

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Canada has seen relatively strong employment growth from the late 1990s to around 2008, which had held up reasonably well post 2008.  But if we assume that the 0 to 19 age group is declining and that the surge in employment growth has been due to a temporary surge in growth in the younger cohorts, expect employment and economic growth to suffer.   Also expect demand for highly priced properties to abate.

Poor demographics and high levels of debt combined are highly deflationary.  Moreover high levels of debt and slow economic growth risk further weakening population growth, compounding growth and debt problems.   This to my mind is a key reason why we need to worry a lot more about debt levels.   

Japan….employment and real GDP per capita dynamics

I had prepared some Japanese charts at the time of the Q3 GDP announcement and for one reason or another failed to complete the analysis. Well here are the charts I was working on:

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In my previous post I posted a graph of key US labour market dynamics…the growth in US employment (based on high water mark analysis).   We know that there has been a slowdown in labour growth dynamics at the same time as we have had an increase in debt, increasing market volatility and a slowdown in economic growth.  But did the financial shock and the long term impact of the unwinding on debt lead to weakening labour market dynamics or did weakening labour market dynamics leverage the impact of the shock and the debt?

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US consumer debt and income dynamics are quite constrained!

Low savings rates, high levels of consumption relative to income and a heightened dependence on current transfers for income growth looks to be a poor frame for consumption growth.  Too much reliance is being placed on “auto loans” and a steady if unspectacular growth in employment.

US consumer debt has been growing at a reasonable pace, and non revolving debt particularly so.  In fact if we relate annual average growth in non revolving debt to growth in personal disposable income (using 3 year rolling averages) we find that non revolving credit growth is at historically high levels relative to income growth.

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