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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US employment data..some important charts..secular stagnation?

I have been through the last US employment report and a few charts stood out from the rest:image

The above shows that the long term growth in total private sector employment in the US has fallen off the edge of a cliff since the late 1990s.  The trend was already set in the post 2001 recovery and has continued to date.   Employment growth is particularly important for economic growth.   The above chart is astonishing in this respect.  I have summed rolling 5 year growth in employment and divided it by the employment level 5 years previously…the one adjustment I have made is to set 5 year previous employment figure as a high water mark input.

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China may have a perfect deflationary frame!

Just a quick post!

In an October 29 blog post I talked about risks posed by outsized debt financed gross fixed capital investment binges and high savings rates.   I wanted to refer to this with respect to deflationary risks in East Asian economies, per a rather good piece by Ambrose Evans Pritchard in the Telegraph.

Strictly speaking:

Price x quantity = output, and output more or less = national income.

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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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High savings can mask complex debt spirals: brief addendum to differences between debt and saving..

In a recent blog I touched on issues of definition with respect to savings, debt and money supply.   A recent blog by Michael Pettis also touched on excess savings in high growth, debt driven, over extended gross fixed capital investment led cycles…phew.   Today Jesse Colombo @thebubblebubble tweeted that “bubbles can form with 100% down payments.  Credit is not necessary to form a bubble”.

It is an interesting point.  You can get a localised bubble without credit/debt expansion and this is where consumption demand and/or asset focussed demand plonks itself overly on one particular sector of economic activity or asset class.   This would draw resources/demand away from other asset classes or other economic sectors.  But it would show up in relative demand for other asset classes and other areas of demand.  In other words some areas would deflate and others would expand.  The damage as the bubble burst would be due to misallocation of resources, if this impacted capital and human investment allocations, or merely a revaluation of asset classes.

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Some people are confusing bank deposit creation (loan growth) as saving..this misses the point

Some people seem to think bank loans and savings are one and the same thing..in other words if a bank lends someone $10,000, some believe that this instantly becomes savings in someone’s hands.  I do not believe it does.  They seem to think that excess savings is synonymous with too much debt…I find this incredible…

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An addendum to “Sword of Damocles”

Money supply and monetary transmission are important entities and functions within our system.    Usually, even broad money supply is well defined, but I was getting to thinking about shadow banking assets and the identities they may have in the minds of those who supply the funds.   Shadow banks are not deposit takers so they do not actually hold “money”, but they do hold assets that their investors may consider to be money like, i.e high yielding cash substitutes, within their portfolios.

Now if perceived money supply is actually higher and we have an asset price shock, we also have a monetary shock by default.  Now this is just a quick “throw the thought out in the air”, but if the shadow banking system is also messing with identities and virtual money supply, things may well be more complex than we think they are as things start to unravel.

Just 30 second blog….

With monetary transmission impaired we may be in a perpetual “Sword of Damocles” moment

It may be that the monetary transmission mechanism is impaired through the structural imbalances that have developed within global economies over the last 20 years (+/-). If the transmission mechanism is impaired then we are in a perpetual “Sword of Damocles moment.”

The recent IMF blog, “The New Global Imbalance: Too Much Financial Risk-Taking, Not Enough Economic-Risk Taking” introduces a well known pre existing dynamic as “a new global imbalance”:

Policymakers are facing a new global imbalance: not enough economic risk-taking in support of growth, but increasing excesses in financial risk-taking posing stability challenges

We have been in a declining capital and human investment scenario for some time (discussed in many a recent blog), in many key developed economies, and we have been in a paradigm of increased financial leverage/asset focussed money supply growth.  This is not new and is the primary reason why we are pinned to the economic floor with the proverbial boot pressed to our throats.  I discussed this also in a recent blog…  

The IMF rightly points to the risks posed by the shadow banking financial system:

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The Geneva report and my points on the debt/asset value/IR chokehold

Many of the points I made in my choke point blog are also reflected in the latest Geneva report, Deleveraging? What Deleveraging?

One thing I would like to touch on before I highlight excerpts from that text is that high levels of debt and misallocations of capital may well be a feature of many a boom, but what makes the current situation much different is the fact that interest rates lie on a lower bound, almost incapacitated by a higher bound debt level, itself tied to highly valued asset markets.   High debt levels and weak growth dynamics are dangerous, irrespective of whether you are undecided as to whether high debt led to growth or low growth to high levels of debt, although I tend to believe that the reality is that weakening developed economy growth dynamics accompanied the debt build up prior to the onset of the crisis.  Beyond that point in time, high debt levels I would say are clearly impacting growth.

Whereas all significant debt misallocations have an impact on subsequent bank lending and new credit growth (the stock of broad MS is tied to these low or non performing loans), not all such instances have occurred at such low interest rate levels.  I think this is key, critical and as the Geneva report suggests “poisonous” intersect, although the report itself strays from emphasising what I consider to be the greater risk of high debt levels at low IRs..

Another point that I have laboured is the present value of future output growth or national income relative to debt is out of balance and this is the first time I have seen explicit reference to this in any other document I have read.

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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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Share buybacks..quantitative easing, secular stagnation and the risks of Myopic Share Virus..

The point about share buybacks is that they sit uncomfortably in a widening narrative of increasing inequality, weak income growth (worse at lower income levels), falling economic growth rates and disturbing trends in both human and capital investment. The backdrop to the narrative and one that threatens to envelop it as one are the burgeoning asset and debt markets, whose rise is at odds with the weakening fundamental growth prospects of many developed economies. Asset markets and hence debt are being supported, yet the fundamental underpinning to their longer term valuation, investment and growth in real incomes is being weakened. At some point the two, economic reality and asset market capitalisation will need to meet.

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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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Re Neil Irwin’s Archive “You Can’t Feed a Family With G.D.P.”…but the family has been eating GDP???

In a recent Washington Post article Neil Irwin quipped  that you cannot feed a family with GDP and illustrated this comment with a graph of GDP relative to income growth.  The graph showed the rate of growth of GDP and median income moving in opposite directions from circa 1998 onwards.  

My point is that the family has been feeding its family with GDP, to a large extent, via debt and falling savings and that it was the combination of high debt levels and weak income growth that played a major role in the crisis and weak economic growth thereafter. 

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We can see that personal consumption expenditures grew at roughly the same rate as GDP up to the early 1980s, started to grow at a moderately higher rate between early 1980s and 1997, and then spiked higher…

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Comments on Bank of England’s Quarterly Bulletin on Household Debt and Spending

The Bank of England report “Household debt and spending” stated that “it is difficult to evaluate whether debt has had any impact on UK household spending using aggregate data alone. Indeed, UK consumption grew at roughly the same rate between 1999 and 2007, when debt was rising rapidly, as it did between 1992 and 1998, when debt did not increase relative to income. This, together with the fact that increases in household debt were largely matched by a build-up in assets, is consistent with the suggestion that increases in debt did not provide significant support to consumption.”

First of all household expenditure did not grow at roughly the same rates over this period:

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I have used the start point for the analysis as the peak of the previous economic cycle given that part of the growth in the early 1990s would have been due the rebound in consumption from this earlier recession.  In fact, we can see that growth initially accelerated to Q4 1994, but then set off again on a second substantial leg that peaked between Q1 2000 and Q4 2001.

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Between boom and bust – US Economic context + data charts bonanza

The US economy lies somewhere between boom and bust as shown by the following graphical representation of real GDP growth.  Nevertheless, there are aspects of US economic growth that have boom type characteristics/risks; these are found primarily in the significant increases in auto focussed consumer credit and automotive production/capacityimage

Short term data has varied wildly of late; such can often obscure the underlying trend: what if we adjust for inventories and changes in consumer credit?   Well we see less noise for one, but we also see a slower underlying growth profile – yes, credit creation is part and parcel of growing expenditure but I still feel we are in a high debt/deleveraging and weak income growth dynamic that needs to be especially sensitive to growth in credit/debt.

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Weak wage growth, declining CAPEX and increasing share buybacks

I just wanted to extend the line of thought I was developing in my previous blog post: that is of the synchronisation of weak growth/capex and the increasing amount of corporate capital being allocated to share buybacks.

To a certain extent they all have one common thread, and that is a depreciation of corporate assets both current human and capital, and, with respect to the future, lower future rates of productivity growth that reduced human/capex investment imply.  I also thought it worthwhile noting the decline in shareholder capital on the balance sheet of corporations like IBM and the increase in liabilities.   Companies are becoming more highly leveraged at a time when economic growth and its important driver, income growth, is on a distinctly weakening trend.  

So when the cycle turns, what should we expect to see happen first?  An uptick in wages followed by capex and new issuance, or would buybacks slack off first, followed then by wage growth and finally capital expenditure.  Or should we first look earlier in the chain to the composition of employment?  

If we are in a strong stagnation dynamic I would expect that the economy would move through several iterations before a new wage growth cycle gains its own momentum.  And there are many stagnation dynamics overlaying the economic structure….

There is of course another interpretation of falling wages…a decline in the investment in human capital.. a part of secular stagnation

More and more people are talking about declining real and nominal wage growth and more and more people are asking when is wage growth going to pick up. 

It is a very good point.  But I think we need to look at the dynamics of wage growth from another perspective.   This perspective is that of human capital investment: wages are an investment in human capital and you pay more when you want to invest/upgrade/increase productivity etc.  If you expect to grow and you expect to depend on investment in human capital to grow, you will invest more, and one indicator of this investment is wages.

Now, we know that capital investment as a % of GDP has been declining for some time and we also know that corporations have been buying back shares and borrowing money to do so.  But these three (wages, capex, buybacks) all look to me to be pretty synchronised.

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It looks pretty much as if corporations are adjusting to lower long term economic growth either as a consequence of lower wage growth, less investment or some other natural dynamic —productivity/TFP or demographic dynamic.  Of those who discuss the issue of secular stagnation many point to the 1980s as the starting point and the trends noted above would fit into this timeframe….

Some other asset focussed and hence QE relevant charts…

Scratching my head?  How far does this asset thing need to be pushed before mission accomplished?

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The blue line shows household and NPO asset per capita relative to annual growth in income per capita (over rolling 10 year periods).   The red line shows the annualised increase in disposable personal income per capita over 10 year rolling periods.

Now clearly assets are growing relative to income at a time when income growth is declining.   QE is filling the income growth gap.

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Thoughts re a simple QE model of asset price bubbles…assorted recent tweets

I was thinking along similar lines..but if debt amplifies interest rate increases, what on earth is a neutral IR policy?

Why is raising interest rates currently a greater risk than usual?  Not just highly priced asset markets but significant levels of debt and an increasing amount of new debt issuance in lower credit quality assets.   In proportion to GDP growth, debt and asset levels are at historically high levels.  A given amount of economic return is spread much more thinly over a much wider range and supply of assets and hence the impact of interest rate increases are much more highly leveraged.  Understandably we needed to support asset prices during the abyss that opened up late 2008 to early 2009, but I am much less sanguine about monetary support 2011 onwards.

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Thoughts re a simple QE model of asset price bubbles…Will this bubble burst or will it collapse under its own weight..?

In a recent tweet I made the following comment:

“Bursting implies force>than constraint, collapse implies constraint>than its force”

In a recent blog post I discussed the large build up of money supply in the US (this is pretty much replicated across the globe) and the fact that money supply in excess of nominal GDP growth is likely asset focussed.  My point in this tweet was that a bubble either bursts, or deflates, or collapses under its own weight. 

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