US Q1 GDP..big picture concerns conflate with shorter term weakness!

The big picture is the risk that growth may well have peaked in the current cycle:

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And personal consumption expenditure flows (population adjusted) have arced in a worrying sign of secular decline for some time:

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GDP growth less private employment growth has been negative since Q4 2010, one of the very few such periods in the post war period and the weakest to date and symptomatic of weak productivity and wage growth:

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Preliminary US GDP grew by a real $22bn in the first quarter.  Given that we are unlikely to see the weather related bounce back in growth that we saw last year, we are left wondering where growth is going to come from in the second and third quarters, especially if global trade fundamentals remain weak.

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The slowdown continues

Manufacturing is a central cog in the growth frame and declining growth rates should be a cause for concern.  Today’s Markit flash PMI’s for the US, Japan and Europe showed continued deterioration in manufacturing fundamentals:

US Manufacturing– ““US factories reported their worst month for just over six-and-a-half years in April, dashing hopes that first quarter weakness will prove temporary. “Survey measures of output and order book backlogs are down to their lowest since the height of the global financial crisis, prompting employers to cut back on their hiring. “The survey data are broadly consistent with manufacturing output falling at an annualized rate of over 2% at the start of the second quarter, and factory employment dropping at a rate of 10,000 jobs per month.”

Japan Manufacturing – Manufacturing conditions in Japan worsened at a sharper rate in April. Both production and new orders declined markedly, with total new work contracting at the fastest rate in over three years. The sharp drop in total new work was underpinned by the fastest fall in international demand since December 2012, and following the two earthquakes on the island of Kyushu (one of Japan’s key manufacturing regions), the outlook of the goods-producing sector now looks especially uncertain.

Euro Zone Composite – ““The eurozone economy remains stuck in a slow growth rut in April, with the PMI once again signalling GDP growth of just 0.3% at the start of the second quarter, broadly in line with the meagre pace of expansion seen now for a full year. “A failure of business expectations to revive following the ECB’s announcement of more aggressive stimulus in March is a major disappointment and suggests that the modest pace of growth is unlikely to accelerate in coming months. “France continues to act as a major drag on the region, with goods exports slumping to the greatest extent for over three years. Germany and the rest of the region are enjoying more robust expansions by comparison, though growth rates slowed in April. “

The US data followed on the heels of weak industrial/manufacturing production for March and a weakening Chicago Fed National Activity index.

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US manufacturing remains in a long term funk: the last time we had such weakness in the US was during the depression and the post war adjustment.

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Monthly rates of change in manufacturing show weakness on both a monthly and smoothed trend basis:

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Motor vehicle assemblies look to have peaked and supports recent weakening in retail sales;

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CPB World Trade Monitor Update

The recent CPB World Trade Monitor Update (to February): growth in world trade volumes despite a February rebound from a January decline, based on high water mark analysis, are showing significant weakness:

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World export growth based on smoothed 6 monthly data has shown significant weakening:

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Add in weak readings in the recent flash Markit Manufacturing PMIs for Japan, the US and Europe, the weak St Louis Fed GDP Now readings and slowdown in Q1 China growth, and we see little in the tea levels that would suggest any meaningful reversion in the above trend is underway.

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US retail sales…update

It is a trend I have been following for some time….global growth is slowing down at a time in the cycle when you would usually expect to see inflation and supply bottlenecks.  If it were not for the very high levels of asset focussed money supply growth over the last few decades and the build up of debt and asset values (dependent on this growth), I would not be ringing any bells.  But the divergence between what asset values need growth to be and what growth is turning out to be is the problem.

US retail sales (I am still waiting for the CPI update which will allow for a better assessment of retail volumes) took a further hit in March:

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The biggest contributor to the recent slide has been motor vehicles and parts sales.  This component has also been the biggest contributor to retail sales growth post the 2008/2009 recession and a large contributor to significant increases in consumer credit debt loads:

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The inventory picture has also darkened with the longer term inventory to sales relationship showing an unusual divergence:

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Last month’s analysis

http://blog.moneymanagedproperly.com/?p=5056

“Investing in social infrastructure as an anti-recession tool”

…is the title of a Washington Centre For Equitable Growth article.  I think that there is some logic to investing in social infrastructure in a slowing growth frame. 

WHY?

In a slowing growth frame less of a corporation’s revenue flows are likely to be reinvested and productive capital is likely to be increasingly depreciated over time, depending on the rate of decline of the frame.  At the moment this cash flow, distributed as either dividends or buybacks, is likely to go disproportionately to those with higher wealth and hence more likely to be reinvested in existing assets, driving up their prices.

In a competitive economic model cash flows would be used to finance the transition to lower growth, with flows consumed and/or used to reduce debt.  As people age the costs associated with complex medical and personal  care needs rise, but these are liabilities that are presently not that well funded.  It makes sense to optimise the allocation of flows to a) fund the economic costs of older adult communities and b) make sure that those at the younger end of the scale continue to receive the necessary education and employment skills training.   This would ensure that the expenditure flows in the economic habitat would be healthier in terms of optimising expenditure and investment.  Imbalances due to inefficient distribution of flows are likely to lead to higher asset price and financial system risks.

In a growth frame where higher levels of productive capital investment is needed it makes sense to have lower corporate tax rates, but in a slower growth frame where higher percentages are distributed it would make sense to tax these distributions at higher levels for more efficient distribution.   In a competitive efficient market place without asymmetric properties we would be less likely to have the present skewed distribution of income and wealth and associated funding pressures on key aspects of social infrastructure.

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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Helicopter Money…Japan..25 charts

Japan has been at the forefront of weakening GDP/wages/growth, deteriorating demographics, elevated sovereign debt and extreme monetary policy.   Of all the major economies, given its existing debt burden and aging population, Japan is arguably the closest to Helicopter money.

Post 2012, policy (Abenomics) aimed at stimulating demand, generating wage growth and inflation has failed with respect to the specific objectives set.  But then again, what is an optimal level of consumption in a declining demographic paradigm?  Perhaps in the modern world it is one which drives growth to the point that current debt levels become manageable, or where risky assets provide returns commensurate with the consumption liabilities expected to be provided by them.   In this context, global Central Banks have been consciously attempting to manufacture growth for at least a decade.  Helicopter Money would however break this intercession, acknowledging that only more money supply and more debt relative to growth can support the expenditure/infrastructure side of the balance sheet: it is difficult to comprehend just how the asset side of the balance sheet would evolve in such circumstances.  I suspect that there would need to be an adjustment, a reset, but even that would be only half the story.  That said, on to Japan:

Japanese real GDP growth has been sliding heavily since the bursting of its own asset  bubble starting in 1990:

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Helicopter watch..PMIs

We do not need a global recession or a financial shock to precipitate a “Helicopter Money” operation, all we need is slow to anaemic growth given a heavily indebted economic and financial system challenged by demographics, productivity growth constraints, structural imbalances and increasing inequalities.  Anaemic to weak growth will itself precipitate a crisis. 

Today’s global PMI reports suggest that manufacturing growth globally remains constrained by weak/weakening export demand and that such demand growth that there is remains dependent on domestic demand conditions.  All cycles are punctuated by dips and rebounds but the relationship between the dip and the rebound and the strength of the latter provides clues as to the ultimate strength and direction of the cycle.  Today’s rebounds are lacklustre and this is cause for concern: 

PMI reports are littered with:

US Markit: “expansion remained subdued”, “weakest quarterly upturn since Q3 2012”, “stabilization in new export orders”, “generally improving global economic conditions”, “output growth remained below its post crisis trend”, “subdued client spending”, “cautious inventory policies”, “competitive pricing”;

Euro Zone: “weakest”, “ticked”, “stagnation”, “disappointing export trends”, “marginal”, “weak domestic demand”, “reduction in selling prices in response to competition”, jobs growth issues, “intensification of deflationary pressures”, “discounting”;

UK: “weakest performances”, “doldrums”, “challenging global economic conditions”, “poor levels of new orders from home and abroad”

(Russia): “worsening downturn”;

Indonesia: “output emerged from its prolonged slump”

TAIWAN: “moderate expansion of purchasing activity”, “client demand was relatively subdued”,”cautious inventory policies”, “raised staff numbers only slightly”, “renewed pressure on operating margins”, “new export work declined for the third month in a row”, “ companies continued to discount”, “Unless global economic conditions start to improve…”

Japan: “lowest for over three years”,”New orders…contraction was the sharpest in nearly two years”, “sharp drop in international demand”, “instability in the wider Asian economy”, “client negotiations and competition driving down selling prices”;

China: “fractional deterioration”, “continued to cut their staff numbers”, “relatively cautious stock policies”, “Weak foreign demand”

South Korea: “contracted for the third consecutive month in February”,”rate of decline was only marginal overall”, “slump in demand and challenging economic conditions”, “new orders stabilised….followed two months of contraction”, “increased competition and an unstable global economy”, “international demand declined for the second successive month”, “goods producers cut back on their staffing levels”, “increased competition encouraged companies to reduce their selling prices.“

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Helicopter Money…European growth

Long term Euro Area growth has been slowing and this is best illustrated by looking at annualised growth over 5 and 10 year horizons.  Could growth in the current cycle have already peaked?

image_thumb11Loan growth remains lacklustre and broad monetary aggregates ex M1 are declining.  The most recent decline in loan growth looks to be mirroring the deceleration in economic growth experienced since Q1 2015. The ECB increased its monetary stimulus push in March in response.

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Employment and wage growth continue to rise but are hardly inspiring amidst considerable unemployment across the Euro Area.

The slowdown in global trade appears to be impacting key manufacturing new orders, in particular in Germany where the IFO Business Cycle Clock for the manufacturing sector shows a downturn.

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German foreign capital goods orders relative to trend:

This graph shows latest results on new orders in manufacturing

Export growth is sliding…has it peaked?

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Economic sentiment is in decline as is consumer confidence in the Euro Area: yet further indication that growth may have peaked.

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Shorter term data, in particular the Flash Markit Composite PMI for the Euro Zone, shows a tepid March bounce back from weakness in the first two months of the year. 

“despite the rise in March, the average PMI reading for the first quarter of 53.4 was the lowest quarterly trend for a year, signalling a slight slowing in the pace of economic growth”

Slowing growth in China, what looks to be a weak plateau in the US and a still slow recovery in Europe is raising global financial/economic stability risks.  There remains considerable slack in Europe and lower energy prices appear to have helped boost consumption, but the concern remains that at low growth rates the global economy is skirting the edges of another financial crisis.  Negative rates and quantitative easing are failing, not unexpectedly, to have the desired effect.  We may be nearing the moment where interest in heavier infrastructure spending possibly financed by “Helicopter money”, given the global sovereign debt positions, could be rearing its head.  

Watch out for any further easing in growth!

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Helicopter Money…increasingly likely if growth continues to slow….

Helicopter money is essentially central bank financed government expenditure: Central Bank issues money to buy government debt, government uses money to fund, inter alia, tax breaks and/or infrastructure spending.

China is transitioning to slower growth, Japan remains mired in slow growth/demographic decline, European growth rates remain constrained as does US growth and there are problems in other key economies, notably Brazil and Russia.  As this pattern remains in situ, the risks to the financial system rise higher and so do the chances of “helicopter money”.

US real per capital GDP growth based on high water mark analysis

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US Nominal GDP profile: rolling average quarterly change in GDP less inventories and Consumer Credit

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Annualised real GDP growth Japan over rolling 10 year periods:

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The same for Japanese household consumption:

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Euro Zone real growth rates: annualised over rolling 5 and 10 year time frames: image

And the same for household consumption:

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In the past, asset markets have typically reacted to late cycle interest rate rises as monetary policy looked to restrain growth in the face of increasing production/supply bottlenecks.  Asset markets would increase their preference for money relative to other assets, asset market leverage and consumption/production focussed loan growth would scale back; the economy would move into a “step back” or so called recession.  But, this retracement of markets and the stutter in monetary and economic growth was usually a short term phenomena: populations, technology, productive capital, and loans were in an expansionary phase.  Growth rates of populations, productivity and capital expenditure have fallen, to lesser/greater extent, across the world. 

At a point in the economic cycle when monetary policy would usually be rising, to hold off over heating economies, growth is not only slowing but reinforcing a long established slowing trend.  The recent US interest rates rise should not be considered as a counter cyclical rise but a “normalisation” of monetary policy.

A slowdown/well paced decline in growth should not in and of itself be a problem.  Capital depreciation is a natural way in which economies transition to lower growth/declining frame regimes.  There are two ways in which the current slowdown in growth is a much bigger risk to economic/financial system health:

1 – The first is that asset markets and asset focussed money supply growth have been juiced and expanded to stimulate growth on the assumption that weak growth was transitory/shock induced; these actions have raised the supply and value of assets (debt and equity) relative to economic growth; as growth slows, and the slower trend is established, expectations over future flows which give assets their value also decline.  In the absence of monetary policy aimed at asset values, asset values correct (equity) and/or default (bonds/loans).  This correction impacts present and future consumption as well as the financial system: bank deposits (broad money supply) are backed by assets; as assets devalue/default deposits/money supply are impaired further impacting economic stability. 

2- The distribution of national income has been increasingly skewed towards corporate profits and very small sections of the population.  Unequal distribution of income and capital impacts present and future consumption and capital expenditures associated with that profile.  These capital expenditures risk extending to core infrastructure/health/education spending.   Quality of life at so many levels risks being impacted.

US Capital expenditures

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Helicopter money may be needed to support the eco system in the event of an asset price and financial system shock, as growth slows further or experiences a decline, amidst dysfunctional distribution of flows (income inequality). The time for Helicopter money may be drawing near, but it should not be considered a saviour of asset markets, rather the last gate along this particular road.  How it impacts the economic/financial system is likely to be complex and especially so given that the asset price unwind and accompanying demand shock of excess financial system debt could be fast acting.

US Manufacturing orders and inventories to January 2016

A little late in reviewing this data, but here are the takeaways:

We know new order growth had slowed considerably and had been sharply negative for some time at the nominal and moderately so at the real.

The rate of decline has since halted, but real growth is pedestrian and looks to have plateaued at a time when headline employment rates suggest the economy is close to “full” employment. 

Inventories have been scaled back but remain high, and particularly so in the key motor vehicle and parts sector which has shown weakening in momentum and the notable transportation sector.

Wage growth/consumer credit relationships are strained and it is difficult to see where domestic demand growth is going to come from, especially with the global weakness we have seen elsewhere.

Manufacturing is a small but central cog in the machine: its components are used everywhere and a slowdown in one connected cog inevitably implies a changing dynamic elsewhere.

And the pictures:

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US retail sales

With the recent CPI data I have updated my retail sales graphics.  Takeaways?

  1. Sales growth is slowing but no recessionary conditions;
  2. Weak historical growth profile held up by motor vehicles and parts sales;
  3. Motor vehicle and parts sales held up by consumer credit growth;
  4. Points 2 and 3 slowing;
  5. While personal disposable income has exceeded retail sales growth of late, cumulative historic relationship remains weak;
  6. Consumer credit growth to income relationships strained;
  7. Population growth weak in historical context;
  8. Current cycle lacking in typical wage growth spike

And the graphs:

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Helicopter drops: feeding the animals in order to keep the zoo in business..

I was reading “Helicopter drops might not be far away” by Martin Wolf in the FT.  By now those interested in macro economics/monetary policy/asset markets should be well aware of the long gradual easing in interest rates, especially since the 1990s.  Lower interest rates did not just encourage people to borrow for consumption, but they also boosted the amount of borrowing for asset purchases with rising asset values also looping back into consumption for a while.   During this period, global money supply growth also became ever more asset focussed. 

For a while this helped stimulate consumption in key economies, also aiding in developing economy growth.   Developed economy consumers became ever more indebted at a time when income growth was also slowing, but given that asset markets kept rising and interest costs kept falling, everything was able “to keep on going for a while”…many felt that this period of low interest rates and rising asset markets was a “great moderation” and few seemed to notice the enveloping divergence. 

While the financial crisis was the bursting of this particular reality, it also marked the onset of a period of unprecedented financial engineering in response, itself a denial of that reality. 

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US Retail Sales, Industrial Production, Manufacturing New Orders

Nominal retail sales data is typical of a recessionary environment, but much of this is due to declining gas prices.  Manufacturing output and new order data is also typical of recessionary conditions.   Motor vehicles and parts sales/new orders/output are still strong data points albeit showing signs of weakening, especially in the auto components.  Cycle to cycle we see retail sales, orders and output all failing to establish a clear positive post crisis fundamental growth trajectory.   That said there does not appear to any abrupt collapse in the data which is not necessarily a positive.

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Correlations, volatilities and expected returns as the monetary tide reverses flow..

I note comments by El-Erian over Central Bank’s inability to suppress volatility as a bigger risk than China and I would agree although I would qualify this in terms of the immediate asset price risk.   Asset focussed money supply growth and asset price relatives (relative to GDP growth and income growth as well as its distribution) are all deeply negative for asset markets when liquidity dynamics, amongst others, change.

Recent commentary by Zero Hedge on the winding up of Nevsky Capital is also worth reading: the Nevsky Capital report suggested that a disciplined structure can no longer be counted on to realistically manage risk and return given the uncertainty of an increasingly skewed distribution of possible outcomes in an environment worryingly distanced from fundamentals/exposed to unconventional monetary policy; liquidity dynamics in the market place also impacted.  

Another interesting piece of data shows the 10 year rolling returns on commodities that I found in a tweet from @zatapatique.

I have written on the issues of excess asset focused money supply and liquidity for some time (relevant posts of mine).

Many portfolio management structures depend on expected return/correlation/standard deviation assumptions that would be very much exposed to a break in the direction of money flows towards assets.  All statistical measures of risk and co variance are drawn from the impact of monetary demand flows for assets.  In an environment where monetary policy is accentuating flows to asset classes as well as expanding the quantity of money and reducing the supply of certain asset classes the natural flow response to risk and return in the environment are muted.  As unconventional monetary policy recedes, additions to the quantity of asset focussed money and interest rate support reverses, the natural flows not only start to reassert but the prior excess flows adjust to the new environment.  We get a break out of trading ranges and covariances.

This is all incredibly risk and uncertain for those dependent on traditional statistical measures of asset price sensitivities and covariances.

“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,”

Before we step any further we need to reassess the economic engine, its habitat and condition and the conflict between the two.

Capitalism and its economics have been the subject of much debate since at least 2007.  At its heart it represents the engine of economic growth, of technological progress, of the efficient allocation of resources, the determination and distribution of return/prices (wages, interest, dividends) key to attracting risk takers and capital and of the accumulation of capital required to produce as well as the development of markets for the trading of goods, services and assets.

Capitalism’s core engine has taken us far in at least one direction.  Two of its main alternatives socialism and communism have long since foundered on the human condition and the many issues associated with their decision making structures, and while less susceptible to the same issues, capitalism is nonetheless not immune to corruption of its process, concentration of power (asymmetries etc) and impairment by its own emergent traits.   

As an ever lasting engine of growth, capitalism has been increasingly beset with  problems: it has required ever lower interest rates and monetary stimulus to keep it chugging along, at a rate of growth set by man, I must add, and not its own mechanics; it has become increasingly burdened with higher levels of debt, financial instability and as a result has become itself susceptible to natural demographic realities; indeed, the financial instability has not been wrought of its mechanics but the aims and objectives of the social and moral structure it inhabits.  It appears as if the construct we know as capitalism has been thus engineered for one trajectory and one alone, whereas outcomes of natural forces would adjust to fit the natural dynamics of the universe it inhabits.   For anyone doubtful of what I believe is an overly “consumerism” bent of capitalism I would suggest watching the BBC documentary “The Century of the Self”.

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The Golden Age of Canadian stock market and other returns may have passed for now…..

The golden age of stock market returns for Canadian investors looks to have ended sometime in 2007:

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Adjusted for inflation, the S&P/TSX has literally only provided returns for those able to take advantage of the significant dips in valuations post 2000:

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If we look at annual returns for holding periods of 10 and 15 years we can see capital gains in decline:

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For those investors unfortunate enough to be paying through the nose for closet indexing mutual fund investments, the real capital returns are likely to be lower still, and more so after tax.  The golden age looks to have peaked in and around 2007.   This is around about the same time that debt and GDP growth took their separate routes.

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If equity markets and commodity prices remain depressed they are clearly going to detract from economic momentum going forward and may well exacerbate the latent fissures in the residential property market that we already know off (i.e. high consumer debt loads and historically high valuations). 

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Wage and salary growth has also been on a slide:

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So yes the drop in market valuations is a concern given the accompanying commodity price weaknesses and other structural risks that have built up in the Canadian economy over the decade.  This will likely raise the odds of much more aggressive monetary and fiscal policy.

This is more or less a follow up from a December 2014 post:

Is Canada’s Mini Golden Age behind it? http://blog.moneymanagedproperly.com/?p=3969

And in the context of the above, this is worth a read – http://tcglobalmacro.blogspot.ca/2015/12/recession-made-in-canada-definition.html?m=1

Would the real US employment figure please stand up: the Birth/Death adjustment debate.

A number of commentators have questioned the underlying momentum in the US economy.  If we assume that today’s birth death adjustments are based on latest data as of Q4 2014, and 2014 Q4 showed the largest increase in employment since 1983, and the latter half of 2014 represented a relatively strong period of economic growth in the current cycle, then just maybe, if the cycle is turning, then there is a risk that current employment data may be increasingly wide of the mark.

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In the latest report on US employment we see private jobs growth averaging 222,000 a month over the last three months.  On the face of it, employment growth suggests that all is well with the economy despite the slowdown in manufacturing and world trade. 

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Some takeaways from third quarter Canadian GDP and other data–27 charts

Durable goods consumption expenditure rose at an annualised pace of 9.4% (autos?) in the third quarter; business gross fixed capital formation (Commodities?) has fallen for three quarters in a row following a weak Q4 in 2014; inventory accumulation slowed dramatically (?); imports of goods and services fell for the second straight quarter running off the back of two weak quarters in Q4 2014 and Q1 2015.

The change in net exports that contributed SO MUCH to GDP showed an historically large bounce, shown here as a rolling two month data piece:

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Some of the main takeaways from US Q3 GDP 2nd estimate

The growth trend is still fundamentally weak, over reliant on consumer credit and exposed to a potential inventory correction.

Post the debt fuelled 90s and 00s, growth has tailed off as shown by the annualised real growth rate over rolling 5 year time periods.  As noted in prior posts, growth between the 90s and onset of the “crisis” was very likely overly leveraged:

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Growth is still historically weak and if we take away increases in consumer credit and adjust for inventories, the trend remains so:

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Can QE be reversed?

I just read a post on the subject of reversing quantitative easing.  Just a quick few points:

For a given velocity of asset focussed money supply and a given preferred allocation of money within the “asset portfolio”, the withdrawal of liquidity will impact the demand for assets via a) increased supply of certain assets, b) the reduced amount of money and hence readjustment of preferred percentage money allocation and c) via changes in asset preferences, in particular preferences for assets that may have increased in supply as QE was taking place. 

With QE, we have the introduction of higher levels of portfolio focussed cash with a reduction in relative supply of higher quality assets and this would cause problems if this also skews the universe of demand and supply for higher risk/less liquid assets: that is the universe pushes outwards.

As QE is reversed and money is withdrawn and lower risk/more liquid assets are injected into the asset portfolio, demand for higher risk/less liquid assets may drop as these assets are displaced within the asset portfolio: that is the asset universe contracts. 

The issue here is that we risk a secondary asset impact over and above the expected price adjustment of all assets as portfolio liquidity is withdrawn.  Unconventional monetary policy is likely to have altered the asset profile of the asset portfolio and this adjusted profile is likely to be hit most at its weaker newly developed extremities . 

The risk is that certain asset classes get crushed in the rush for the exits.  The question is how much does the market for these asset classes at the outer edge of the universe get impacted and to what extent will this likewise impact consumption and future consumption expectations?  If you cannot sell an asset you bought at a certain price with an expectation over a future value with any degree of certainty, then we have a discounted present value demand shock.  If QE is substantial and the potential reverse substantial too, this shock can be quite large.

QE may not just have impacted pricing but also market structure, liquidity, and introduced larger amounts of higher risk/less liquid assets into core portfolio destinations than would have occurred without it.

This is not a complete analysis by any means but we have changed the nature and structure of asset markets and therefore the relationship with asset markets and consumption functions. 

I discussed some of these issues in another related post:

A brief “thought” on debt defaults, asset prices, MS velocity and consumption expenditure risks.

Why do economists like Paul Krugman completely ignore financial imbalances and their structural accentuators?

In a recent post Paul Krugman challenged the “rationale” for the Minneapolis Fed appointment of Neel Kashkari.

His objection lay with “the view” of the new chair (Kashkari) that growth prior to the breaking of the financial crisis was artificially fast due to the leveraging of the economy.  Krugman’s point was that just “because we had a bubble, in which some people were borrowing too much,” does not mean that the output produced from 2000 to 2007 wasn’t real and therefore the problem we have now is 100% one of insufficient demand as opposed to supply. 

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Deeply disturbing underlying trends in Canadian retail sales data

Looking at new Canadian retail sales data one would be forgiven for thinking that all is well on the retail front: yes we had a downward blip, but we have stabilised and things seem mildly resurgent in the year to August.

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But just as in the US, Auto sales appear to be driving the headline growth rate, which if you have been keeping an eye on my US data missives should give pause for thought:

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So is this not necessarily a good thing?  We know that consumer debt has been on the rise and now stands at historical levels:

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And recent independent commentary has also pointed out the large increase in auto related debt: When will Canada’s subprime car loan bubble burst?

But the clincher is the relationship between sales of motor vehicles and parts and wage growth: the following chart looks at annual rates of changer over rolling 5 year periods to average out short term ups and downs, to get a better look at the strength of the data relationships:

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As we can see, auto related spending has taken a manifold hyper leap relative to the rate of change of employee wage growth.   This is all deeply disturbing. 

Interest rates their models and interest rate policy

The natural rate of interest and its determination, especially with respect to when and how the Fed and other world central banks should raise interest rates, is a hotly debated topic.  Many suggest that the only way to get back to trend GDP growth is to push interest rates below ZERO, into negative space, and/or to raise inflationary expectations.

The trouble, as I see it, is that the models used to determine the natural rate, or what the current policy rate should be, focus almost entirely on equilibrium concepts and a restricted set of difficult to define inputs, and can therefore miss key turning points in the domestic and global economic frame.   These are after all, in most cases, simple rule of thumb models. 

From a brief consideration of the subject and given my own historical stance with regard to key developing structural imbalances, I have the following simple propositions on the natural rate/negative interest rate debate

  • Natural Interest Rate models ignore accumulated financial and structural economic imbalances, imbalances that are also likely occasioned and accentuated by transitions and policy responses to those transitions.  Importantly the build up phase (excess) can raise growth (note US consumer debt/consumption expenditure) and mask changes in trend, while the build up itself can serve to push growth lower post crystallisation.  Additionally, point in time models are insensitive to the impact of the power of compound errors: policy that miss changes in trend and accommodate divergence from trend can last as know some time.
  • At critical turning points IR policy may ignore transitions and accumulating imbalances and risks creating significant divergences between the financial and the economic that collapse back through the core financial system as we saw in 2008/2009.  In this case, a deceleration in growth may be viewed as a below trend growth phase (for whatever reason) with policy lowering rates: note the increase in debt and debt relative to income and GDP growth in recent times.   Outsize increases in debt due to lax monetary policy may also impact global structure.
  • The financial and economic shocks that arise from this insensitive IR policy feed back into GDP and key relationships with negative consequences.   Imbalances are accentuated and transition dynamics ignored.  For example a transition to lower growth due to issues of frame may end resulting in a crisis of frame.  
  • The big question is how does IR policy fit into the big picture when we have transitions and accumulating structural economic and financial imbalances not captured by models?  Which problem do we deal with, since we now have more than 1?

In a world of many transitions and imbalances there may be more than one interest rate: one to accommodate financial imbalances and preventing their adjustment in a lower growth frame; another to offset some of the many negative trends impacting growth (thereby risking further financial and structural economic imbalances); another that would better reflect the balance of factors in emergent growth dynamics of a given frame once imbalances had adjusted and transitions completed.   A lower IR is needed for the first 2, a higher for the latter.  Of course, at the moment, our tool box only affords room for one interest rate, so who are you going to throw to the dogs?  I guess the objective is to keep all rates aligned as close to each other as possible and to minimise intervention.

If we ignore imbalances and transitions and assume that deviations from a given trend growth in output are all temporary and due to excess of saving over investment and not any other argument, then we risk more of the same.   Accumulated monetary policy errors weigh on time and are not necessarily washed out by time.