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.
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.
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.
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.
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.
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…
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:
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.
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/capacity
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.
I just wanted to extend the line of thought I was developing in my previous blog post: that is of the synchronisation of weak growth/capex and the increasing amount of corporate capital being allocated to share buybacks.
To a certain extent they all have one common thread, and that is a depreciation of corporate assets both current human and capital, and, with respect to the future, lower future rates of productivity growth that reduced human/capex investment imply. I also thought it worthwhile noting the decline in shareholder capital on the balance sheet of corporations like IBM and the increase in liabilities. Companies are becoming more highly leveraged at a time when economic growth and its important driver, income growth, is on a distinctly weakening trend.
So when the cycle turns, what should we expect to see happen first? An uptick in wages followed by capex and new issuance, or would buybacks slack off first, followed then by wage growth and finally capital expenditure. Or should we first look earlier in the chain to the composition of employment?
If we are in a strong stagnation dynamic I would expect that the economy would move through several iterations before a new wage growth cycle gains its own momentum. And there are many stagnation dynamics overlaying the economic structure….
More and more people are talking about declining real and nominal wage growth and more and more people are asking when is wage growth going to pick up.
It is a very good point. But I think we need to look at the dynamics of wage growth from another perspective. This perspective is that of human capital investment: wages are an investment in human capital and you pay more when you want to invest/upgrade/increase productivity etc. If you expect to grow and you expect to depend on investment in human capital to grow, you will invest more, and one indicator of this investment is wages.
Now, we know that capital investment as a % of GDP has been declining for some time and we also know that corporations have been buying back shares and borrowing money to do so. But these three (wages, capex, buybacks) all look to me to be pretty synchronised.
It looks pretty much as if corporations are adjusting to lower long term economic growth either as a consequence of lower wage growth, less investment or some other natural dynamic —productivity/TFP or demographic dynamic. Of those who discuss the issue of secular stagnation many point to the 1980s as the starting point and the trends noted above would fit into this timeframe….
US retail sales if we move outside the month to month volatility and look at smoothed data (which focuses on capacity as opposed to volatility) and adjust for inflation and population growth is looking weak:
If we just look at nominal and monthly data it looks as if retail sales are recovering strongly as of the June data:
Scratching my head? How far does this asset thing need to be pushed before mission accomplished?
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.
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.
“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.
I am just parsing through a simple model of QE attempting to bring together the disparate strands and thoughts…
One point that is worth pointing out is the extremely large increases in money holdings in the US economy, especially over the last 12 years with regard to their differential with nominal GDP growth. I dealt in detail with the physics of changes in money supply and its distribution between expenditure and asset portfolios in a document I wrote in 2008.
A must read for anyone concerned with systemic risk issues to factors impacting asset class return and anyone interested in a comprehensive primer on the operation of today’s money markets. As the following two quotes surmise, the shadow banking sector has developed to the extent it has by virtue of certain structural economic imbalances and financial system checks and balances are not set up to manage the risks of this new plumbing.
one way to interpret shadow banking is as the financial economy reflection of real economy imbalances caused by excess global savings, slowing potential growth, and the rising share of corporate profits relative to wages in national income.
From a policy perspective, the fundamental problem at hand is a financial ecosystem that has outgrown the safety net that was put around it many years ago. Today we have a different class of savers (cash PMs versus retail depositors), a different class of borrowers (risk PMs to enhance investment returns via financial leverage versus ultimate borrowers to enhance their ability to spend via loans) and a different class of intermediaries (dealers who do securities financing versus banks that finance the economy directly via loans) to whom discount window access and deposit insurance do not apply.
The document also discussed the need to have better measures of “money supply” than the narrow money measures of insured deposits.
I for one am concerned over the large shadow banking cash pools and the financing mechanisms of today’s repo markets. At the top of my mind is a large question mark over the interplay between QE and today’s money/collateral/derivatives markets and the impact monetary tightening will have on the shadow banking system.
If you look at debt service ratios from 2008 to date you would be led to believe that consumer indebtedness has improved markedly. In fact you would believe that conditions are the best they have been since at least the early 1980s. But if you broaden your perspective you find that conditions today have not strayed too much from those conditions which have been in place for much of the last 14 years.
Some charts on US employment data drawn from the BLS CES and CPS surveys.
Yes employment is back to where it started the recession, but adjusted for civilian population growth not even close, and part time and self employed data points are still hanging in the reverb. Participation rates are also still way below pre recession peaks and there is a question mark over multiple job holders, which have risen significantly of late and may have contributed to some of the more impressive recent job gains.
Profits as a % of National Income remain elevated:
Many other commentators have likewise commented on high profit levels in expressing concerns over price earnings ratios. Importantly the cross reference of personal disposable income growth is also useful in the economic context:
When have we ever had a bull market with such weak income growth…? At least not since the 1960s..
I have been doing some research into aging populations, dementia and the care sector over the last 4 to 6 weeks, so I have not been commenting on a lot of economic and market issues. Needless to say the financial services industry appears in no way prepared to deal with the human issues associated with increasing rates of dementia and service structures in general remain mired in denial.
Economic concerns remain of course the same: weak growth dynamics in the US, world trade growth, China debt and slowing growth dynamics, European structural weakness and the depth of the decline post crisis, significant consumer and sovereign debt, demographics, income and wealth inequality, high market valuations and little margin for leeway in the event of a market or economic shock (interest rates and QE maxed out in most instances).
Growth risks going forward suggest a negatively skewed distribution of potential GDP growth outcomes and return distributions suggest significant risk of negative returns over fairly long time horizons. I share many of the same concerns as John Hussman, but my economic growth assumptions for risk management would be below his, indicating a potentially much worse risk outcome for global equity market returns.
It is a moot question whether the investment industry has appropriately modelled risks to return and hence income and capital withdrawal profiles on most portfolios. Leverage is also of concern, especially in markets with poor regulatory investor protection mandates (note Canada) and I suggest that the time to have reformed the financial industry from transaction to best interests has likely passed for those who have not yet passed through this loop (again Canada).
One of the reasons I feel that has driven markets forward has been due to increasing income inequality and historically high levels of profits that have pushed marginal allocation of income and profits towards investment assets. This is a dynamic that will break at some point, either threw an economic/market shock or through its own impact on growth in economic demand.
The UK economy has been receiving a number of plaudits for its economic growth. Initial estimates for growth in the first quarter came in at 0.8%, or 3.2% annualised. But there are growing concerns over debt, the housing market, real wage growth and income inequality and weakness in fixed capital investment and a tail off in export led growth.
Much of recent growth has been ascribed to an increase in consumer debt and housing market activity, and we can see that there has been a notable increase in secured lending: