The Knife Edge Revisited

As a follow up to Tuesday’s piece, “Economy on a Knife’s Edge,” we’re adding a couple more pessimistic pieces to the mosaic, one showing that real economic activity continues to fall deeper into recessionary territory, the other predicting a negative impact on GDP from fiscal retrenchment that begins now and extends through 2011.  We then try to temper them with some more sanguine observations.

First is this dour picture painted by the Consumer Metric Institute’s Daily Growth Index, which has been indicating contraction in the U.S. since Q1 of this year:

Second is this chart from a recent Goldman Sachs piece (TOH PragCap), which echoes the concerns we’ve had since the beginning of 2010, when it appeared that additional fiscal stimulus was set to taper off:

Mike Darda of MKM Partners offered a more sanguine take on things recently by pointing out that credit market indicators have returned to very benign levels, and that there are important differences between the U.S.’s experience thus far and Japan’s in the 1990s.  While those data points are reassuring, we have some concerns looking forward.  For example:

• Treasury Yield Curve – We expect the Treasury yield curve to continue flattening in the coming years, due to dovish and possibly activist Fed policy, and to falling growth and inflation expectations.  Thus, a steep yield curve will gradually come off the table.  This implies lower nominal GDP and amounts to a diminishing subsidy for the banking sector.  And flattening at low nominal levels also implies that yield curve signals might be less powerful or less reliable in the decade ahead than they were in the five or six decades just passed. 
• Credit Risk Indicators – Interest rate and credit default swap spreads have been much tamer since the Greek debt crisis settled down.  But upside (i.e., negative) movements in those indicators tend to be sudden and severe.  The ECB and IMF have been very successful in buying time for troubled European governments.  But there is still not a permanent solution in place, and it’s important to keep in mind that during the crises of 2007-2009, those same indicators were dovish until they suddenly weren’t.  To us, they’re similar to the VIX, being more useful as ’buy’ indicators when they hit their upper extremes, rather than as a ‘hold’ indicator when they’re at lullaby levels. 
• Industrial Commodity Prices - Industrial prices have been more buoyant during this crisis than they were in Yen terms during the 1990s.  However, during the 1990s, slow to negative growth and financial crises in many emerging economies, plus a “strong dollar” policy,  provided a stiff headwind to commodity prices generally.  Growth in emerging economies, plus China’s concerted stimulus measures in 2009, are providing a tailwind to commodity prices this time around.  As long as this continues, we admit that tradable goods will be more of a stagflationary force in the U.S. than a deflationary one.  But that can’t continue indefinitely, especially if U.S. demand continues to retrench. 
• Demographics – While cruder measures like fertility rates and dependency ratios support the idea that the U.S. should outperform Japan and Europe (and perhaps China) in the decades ahead, recent and current shifts in age structure in the U.S. clearly follow a pattern like Japan’s, with roughly a ten year lag.  That implies falling rates of household formation, durables purchases, and overall demand, all else equal (for more on this topic, see our recent interview with labor economist Diane Macunovich).
• Public & Private Sector Balance Sheets - A critical theme in the current environment is that households are desperate to repair damaged balance sheets.  While corporations may be levering up, money supply data still indicates falling levels of credit and money turnover.  This is a situation that no developed countries, with the exception of Japan,  have encountered since the 1930s (a period that also coincided with the type of age structure shifts mentioned above).  The Fed is considering another round of quantitative easing, but as we recently pointed out, this is a very messy approach to monetary policy.  The obvious choice under the conditions facing the developed world — aside from incurring the long term opportunity costs of letting a deflationary wash0ut follow its natural course – is for the federal government to continue engaging in fiscal expansion, until private sector credit growth recovers.***  But it seems crystal clear to us, as reflected in the Goldman chart above, that the public sector is headed in the opposite direction, and we look for PAYGO to be alive, well, and plenty harmful in 2011.

Corporate profits as a percentage of GDP continue to grind higher too, in what appears to be a secular trend.  This is good insofar as it supports overall demand and/or saving desires in the private sector.  But there are plenty of wrinkles to it, as a recent Economist article points out:

This focus on improved efficiency without investing in growth will last a while… In particular, the “bankruptcy bubble” of a year ago is only now starting to bear fruit. Compared with previous waves of restructuring, this one was more about generating operating efficiencies by cutting jobs and capacity than about restructuring balance-sheets.

There’s still a lot more juice to be squeezed from the lemon, says Hal Sirkin of Boston Consulting Group. One obvious area is procurement, where a growing number of firms are starting to “squeeze their suppliers a second time”, after realising that the first round of renegotiations following the financial crisis did not go far enough. Many of these suppliers have themselves reduced their costs in the past 18 months and have yet to pass those savings on. Mr Sirkin also expects merger activity to accelerate, which should release “another significant amount of juice”.

The great squeeze cannot go on forever, of course, but it shows no sign of slackening. And the great decoupling of profits from jobs could last for a long time. If so, successful American firms will remain uncharacteristically unpopular.

A first reaction might be that corporate management and shareholders have used productivity gains (and perhaps other factors) to garner a greater share of wealth for themselves, but we suspect, as the Economist article notes, that this dynamic has a lot to do with globalization.  One has to wonder though if the distribution of income won’t become as serious an issue in the years ahead as it was at the turn of the 20th century. 

*** The intersectoral balances approach is not an intuitive concept, as most of us are conditioned by culture and experience to think of debt as risky and originating outside of our own “economies”.  We reflexively believe that money is created in the private sector (which it was, for the most part, when money was derived from precious metals), and taken away by the public sector via taxes and transfer payments.  But in fact, the federal government (via the quasi-public Federal Reserve) is the only supplier of the money we use to save, invest, transact with each other, and pay taxes (and that it uses to service its debt and purchase goods and services from the private sector).  But very few policymakers grasp this dynamic, much less have the courage to advocate expanded deficits in an election season dominated by misguided tea partiers and other deficit phobes (though as we have acknowledged previously, the belief that higher deficits now lead to higher taxes later is completely understandable, given how the left thinks and talks about these things; until more policymakers grasp intersectoral dynamics, the deficit phobes sort of have a point).

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy. Past performance is not indicative of future results.  This material does not take into account your personal investment objectives, your personal financial situation and needs, or your personal tolerance for risk. Thus, any investment strategies or securities discussed may not be suitable for you.  You should be aware of the real risk of loss that accompanies any investment strategy or security. It is strongly recommended that you consider seeking advice from your own investment advisor(s) when considering any particular strategy or investment.  We do not guarantee any specific outcome or profit from any investment strategy or security discussed.  The opinions expressed in this article are based on information believed to be reliable, SCM does not warrant its completeness or accuracy, and it should not be relied on as such.  SCM is a participant in the Amazon.com Associates program, and earns a revenue sharing fee for qualified click through purchases from the Amazon.com website.  The firm, its principals, and its clients do not own securities issued by Amazon.com. Any mention of investable companies and/or securities is incidental and for illustrative purposes only.  A principal of the firm owns shares of Goldman Sachs common stock.

When Smart People Are Wrong: Buffett

Investment News reports that “Warren Buffett shortened the duration of bonds held by his Berkshire Hathaway Inc. after warning that deficit spending could force inflation higher.”

Despite his occasional involvement in policy discussions, Buffett is not a macro guy, and the article only speculates on the motivation for changes in the company’s fixed income holdings.  One takeaway from the piece is that Berkshire’s balance sheet is healthy enough to incur the decline in interest income that will result from this shortening (though it may have cost Berkshire shareholders some capital gains in recent weeks, given the recent slide in ten year Treasury yields).  And given Buffett’s investing style, he’s far more likely to be attracted to equities with healthy and growing cash flows and dividend yields than government debt, regardless of the macro environment.

We would just point out to the oracle that federal deficits are not always and everywhere inflationary — at least not when the private sector is desperate to save, expectations are pessimistic, and the central bank is up against the zero bound.

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. Neither the firm, its clients, or its principals own securities issued by Berkshire Hathaway.  Some clients of the firm own Treasury debt and/or TLT. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy.  Investors should consult with their personal financial advisors before engaging in any type of investment strategy. 

Heffernan: Stop Working!

Interesting article over at BNET by Margaret Heffernan, who makes a pretty well grounded argument that heroism and other misguided notions are dampening the productivity of modern workers:

…for the last 100 years, every productivity study in every industry has come to the same conclusion: after about 40 hours in a week, the quality of your work starts to degrade. You make mistakes. That’s why working 60 hours may not save you time or money: you’ll spend too much of that time fixing the mistakes you shouldn’t have made in the meantime. That’s why software companies that limit work to 35 hours a week need to employ fewer QA engineers: there isn’t as much mess to clean up.In a knowledge economy, where thinking and creativity are the raw materials from which products and profit flow, brains are assets. They need to be cherished, nurtured and protected, not abused. Leaders need to take seriously a century’s evidence that 1) overwork doesn’t make us productive, it makes us stupid, 2) looking away from a problem is often the best way to solve it, and 3) burnout is what happens when people are asked to work in ways that obliterate all other parts of their lives.

Caveats abound, of course.  For example, a professional who bills hourly or by the service may place material aspirations above other criteria.  Competitive imperatives may lead some firms to believe that there’s no good alternative to burning out entire crops of recruits and making partners of the survivors.  If an individual can tolerate those environments, and a firm can survive or thrive following those practices, so be it, as long as there’s enough room for more humane approaches to work to choose from.

Whatever your personal views and values, Heffernan’s article is compelling food for thought, especially the idea that people should be treated as assets, even though they’re not recorded on the balance sheet.

Corporate Cash, Congress, and Midterm Elections

In today’s “Mosler vs Stockman II” piece, we wrote that David Stockman correctly pointed out that corporate cash levels are not high when properly accounted for (when aggregate assets are offset by aggregate liabilities).

John Hussman made the same point earlier this week in “Corporate Cash - Cheering the Asset, Ignoring the Liability“:

Put simply, there is a lot of apparent “cash on the sidelines” because the government and many corporations have issued enormous quantities of new debt, often with short maturities, while other corporations have purchased it. It is an equilibrium. The assets that are held in the right hand represent debt that is owed by the left. You cannot call that pile of short-term marketable securities an asset without calling it a liability. The cash on the sidelines is evidence of debt incurred to fund economic activity that is already in the past. It will remain “on the sidelines” until the debt is retired. The government debt has been issued to finance deficit spending. At the same time, a great deal of corporate debt has been issued over the past year apparently as a pre-emptive measure against the possibility of the capital markets freezing up again.

Hussman quotes other analysts who’ve noted that corporate leverage is at an all time high, and that corporate liquidity is actually worse than it was before the 2008 financial crisis.

This brings the intersectoral balances approach into stark relief against the traditional nostrums of conservative, liberal, and occasional libertarian policymakers.  When there are large and persistent shortfalls in resource utilization, and stubborn or rising pessimism, the federal government becomes the critical actor at the margin.  If it raises taxes and/or cuts spending, it exacerbates the underlying problems.  If it lowers taxes and/or raises spending, it can help close those gaps, and that’s especially true when nominal interest rates are up against the zero bound.

The more conventional alternative – which has been shaped by fifty years of experience that,  given post-WW2 reconstruction and reintegration and numerous baby booms, is likely a historic anomaly — is for the central bank to ease credit conditions in the private sector.  Given that the Fed’s interest rate targeting tool is now constrained by zero, there is increasing talk of “QE2″ or another round of quantitative easing.  Compared to fiscal easing, this is a poor choice.  While it can help, especially under extreme credit market conditions, it’s hopelessly messy as a tool for policy.  First, it’s nearly impossible to quantify such an approach, and thus to measure or manage its effects.  Second, it creates havoc internationally, allowing for all kinds of carry trades and hot flows, much as the Bank of Japan’s quantitative easing did in the last decade. 

As a result of those pr0blems, the direct beneficiaries of such measures are troubled financial institutions and leveraged speculators.  That means that both the benefits and the risks of policy accomodation are distributed in a decidedly undemocratic way — banks and speculators enjoy the benefits, while societies bear (1) the opportunity costs imposed by credit disintermediation and (2) the damages that result from speculative bubbles. 

The fiscal lever presents a far more optimal approach to economic policy, whether it’s a payroll tax holiday as Warren Mosler and David Frum have each touted, or expanded federal investment in human and technical capital, as others have proposed.  Incorporating both would have the greatest chance of bipartisan success.  And despite widespread agita over inflation risks, there’s little evidence to support those fears (though as we have always noted, depending upon the state of the global economy, inflation in tradable goods like commodities is always a risk – but that risk is greater under QE than fiscal expansion, in our view).  And as we’ve pointed out before, well designed and implemented fiscal stimulus that incorporates appropriate forms of spending and tax cutting can actually give the Fed more wiggle room on interest rates.

Unfortunately, what’s been implemented of late by Congress has been extremely wimpy, with policymakers fighting for (some of) their constituents over a shrinking pie, rather than seeking ways to enlarge it.  For example, the Senate’s Schumer-Hatch proposal, a payroll tax holiday for employers, was a perfect example of favoring one constituency (employers) over another (employees) at the expense of aggregate demand.  And the latest bill providing federal funds to states was partially offset by imposing even more draconian restrictions on repatriating overseas corporate profits, and by reducing food stamp benefits.  There’s really nothing encouraging coming out of Congress or the Administration these days.  If not for the continuing expenditures under ARRA, you have to wonder if the economy would even be limping along like it is.

On a related note, Jeff Kleintop, chief market strategist for LPL, has looked at the data for midterm election years, and found that fourth quarter rallies almost always tend to follow.  As he noted during a Kudlow appearance earlier this month, “Midterm elections are the closest thing the stock market has to magic pixie dust…only two exceptions, ’78 and ’94, when the Fed was hiking rates aggressively.”  As Kleintop and other strategists have pointed out, midterm elections mean that Congress is in session for a shorter period of time (Congressional recesses are a known driver of stock market returns), and they tend to resolve some of the policy uncertainty that precedes them. 

We have one concern with this outlook though.  Invoking the grand old Swede, and echoing some arguments we’ve made previously, the Fed does not technically need to raise rates for monetary policy to tighten.  If expectations are increasingly pessimistic, and the central bank is bound by zero, then simply keeping rates steady amounts to a de facto tightening.  Keeping in mind the still fragile state of private sector balance sheets, and the vast differences in current demographic trends versus 1978 and 1994, we wonder if the Fed’s verbal dovishness is enough to avoid a de facto tightening of policy — especially if the election outcomes imply either concerted spending cuts or significant tax hikes. 

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy. Investors should consult their personal financial advisor before engaging in any investment strategy. Any mention of investable companies and/or securities is incidental and for illustrative purposes only.

Mosler vs Stockman II

Warren Mosler takes on another missive from former OMB chief David Stockman (Stockman’s quotes are italicized):

The Federal Debt Freight Train Is Coming at Mr. Market

By David Stockman

Aug 6 — Nominal GDP has been growing at only $4 billion per month, while new Federal debt has been accumulating at around $100 billion per month.

Federal deficit spending adds income and savings of dollar denominated financial assets to the economy. The fact that this is being done and excess capacity and unemployment is still high shows the economy’s desire to save is even higher, and that additional deficit spending is needed to expedite a return to full employment.

Hence, my proposed full payroll tax (FICA) holiday.

…the desire to save (reducing debt ‘counts’ as savings) grown [sic] so quickly, due to the financial sector crisis that followed the fraudulent sub prime expansion.And [Stockman] doesn’t mention anything actually wrong with larger deficits, just continuously uses negative language regarding magnitudes and direction.

…the deficit is still not large enough to offset desires to save by not spending income, and inability and lack of desire of the private sector to go into debt.

One of the beauties of MMT is that it lends itself freely to policymaking on both the “left” and the “right”.  As Mosler points out:

For a given size govt, the readily available federal response to get the private sector back to full employment is to cut taxes sufficiently so the private sector can resume sufficient spending out of income rather than via debt expansion.

Public sector expansion will also return us to full employment. It’s a political choice as to whether we want more government or not.

Mosler agrees that, without private sector credit expansion, Stockman’s pessimistic outlook for GDP is likely to prove accurate.  We would point out to Mosler that both financial and demographic data (e.g., Richard Koo and Diane Macunovich, respectively) seem to imply that private sector credit expansion will be flat for some time, perhaps up to a decade or more.  In turn, that implies that the primary drivers of economic growth and incomes in the coming decade — without which private sector saving and balance sheet repair is impossible — will be exports and the federal government.  Today’s export numbers for June put the burden even more squarely on federal government spending. 

…we have baked into the cake a rather frightening scenario: monthly federal debt growth of upwards of $125 billion, or 3x the likely nominal GDP growth of $40 billion — as far as the eye can see.

The deficit isn’t frightening, it’s the continuing output gap that’s frightening and screams for a larger deficit- tax cut or spending increase, depending on one’s politics.

The real problem is this type of fear mongering from Stockman is what prevents the prosperity that’s at hand from happening.

Fourth, the publicly held federal debt will be about $9 trillion at the September fiscal year end, and at the built-in 3x GDP growth rate will reach $12 trillion when the next president is sworn in in January 2013. Adding in state and local debt, we’d be at $15 trillion or a Greek-scale 100% of GDP before the next president picks his or her cabinet. Every reason of prudence says not to tempt the financial gods of the global bond and currency markets with this freight-train scenario: Do something big to close the deficit, and do it now.

Now he brings in the Greek fear mongering.

By acting as if we could be the next Greece, we are well on the road to being the next Japan.

Greece is not the issuer of its own currency, but is analogous to a US state like California. There is no solvency issue for governments that are the issuer of their currency, like the US, UK, and Japan.

Fifth, there’s no possibility in either this world or the next of obtaining the needed $700-$1,000 billion structural deficit reduction by spending cuts alone. We’ve had a rolling referendum since the first Reagan budget plan in 1981, and progressively over these three decades the Republican party has exempted every material component of the budget from cuts, including middle-class entitlements, defense, veterans, education, housing, farm subsidies, and even Amtrack! Like Casey, the GOP has been in the anti-spending batter’s box for 30 years, and has never stopped whiffing the ball. The final proof is that the one GOP spending cut plan with any integrity — the “roadmap” of Congressman Paul Ryan — has the grand sum of 13 co-sponsors, and I dare say half would call in sick if it ever came to a vote. Therefore, tax increases are now needed because it’s too late and too urgent for anything else.

Again, implying there is some benefit to deficit reduction when there is excess capacity and unemployment as far as the eye can see.

…reducing private sector debt (including non residents) is done by the private sector spending less than its income, which can only be accomplished if the public sector spends more than its income.

Finally, in the context of a secular debt deflation, the overwhelming priority is public-sector solvency, not conventional growth.

Notice he has not made the case that there is a solvency issue. It just ‘goes without saying’ when in fact there can be no solvency issue for a govt that issues its own currency.

We’d go even farther on that last point — Stockman’s prescription for public finances (at the federal level, anyways) under deflationary conditions makes absolutely no sense whatsoever — not under modern monetary systems, and not under gold or commodity based systems.  The last thing the public sector should do when there’s a shortage of money is to compete more intensively with the private sector for it!  His lifelong anxiety over public deficits and debt sometimes borders on religious fanaticism. 

 Stockman goes on to point out that the “corporate cash on the sidelines” meme is faulty, and he’s right.  But his solution is for all sectors of the economy to engage in concerted balance sheet repair, a/k/a “fiscal consolidation”, at once.  But as Mosler points out:

…’savings’ for the economy as a whole (not including govt) has gone up by exactly the amount of the deficit, or someone in the CBO has to stay late and find his math error.

This is a key aspect of the intersectoral balances approach.  Under today’s monetary system, money is created directly by the Treasury and Federal Reserve, not indirectly via gold mining and the U.S. Mint.  And there is nothing in the economic data — even when you account for the expansion of the Fed’s balance sheet — that indicates a surplus of dollars in the U.S. economy.  Though we arguably haven’t seen it since the 1930s, we’re in the midst of a Keynesian moment.  Pessimism abounds, the paradox of thrift is in full effect, and both tax hikes (Dems) and spending cuts (GOP) are likely to make the problem worse. 

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy. Investors should consult their personal financial advisor before engaging in any investment strategy. Any mention of investable companies and/or securities is incidental and for illustrative purposes only.

Economy on a knife’s edge

The Philly Fed’s ADS Business Index gave us the old demon drop last week.  While the index had been negative since the start of Q2, the readings were fairly dovish, until last week’s updates.  The latest print shows that conditions in June and July were two to three times worse than originally thought (also that conditions were notably less ebullient in March, April and May).  As a result, the ”progressively more negative values” of the index are offering a much stronger indication of “progressively worse-than-average conditions”:

Excluding the 2008-2009 recession, the low of -0.79 in July was last seen in mid-2005 and during the 2001 recession:

A crude first pass at the data indicates that an ADS reading of -0.79 or lower has been associated with recessionary conditions 85% of the time.  Using more conservative and statistically meaningful approaches brings the recession probability below 50%, but that’s still too high for comfort, and is likely to rise in the weeks ahead — just one more piece in a disconcerting mosaic.

Other important pieces of the mosaic include:

The budget situation faced by state and local governments, which the FT recently took Congressional Democrats to task for:

Congress should pass the state aid bill next week, but more than that it needs to get a grip. Democrats are fearful of November, as they should be; Republicans are content to watch them squirm. Government is paralysed and the economy struggles.

The right fiscal policy for the US is ease sustained for the time being, followed by tightening through higher taxes and lower spending as conditions allow. It is a sad and even alarming fact that Washington’s political dysfunction now puts this straightforward advice in the realm of fantasy. Not just the US economy but the global economy too will have to bear the consequences.

Today’s FOMC statement, which indicated that the Federal Reserve intends to keep its balance sheet at around current levels, and to reinvest income into government securities in order to keep lending rates low:

To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature. 

And a continuing grind lower in long term Treasury yields that implies falling expectations for economic growth and/or inflation, perhaps even concerns about deflation.  The downtrend of yields in recent months looks a bit like the one that unfolded in 2H07, about six months prior to the start of the last recession:

However you slice the data, the economy appears to be walking on a knife’s edge, or at the very least approaching one.  And the key ingredients of the grout holding this pessimistic mosaic together are, in our view, negative demographic shifts and household balance sheet deleveraging, neither of which argue in favor of fiscal austerity as the right approach for policymakers. 

In fact, a small but potentially very significant piece of the mosaic is anecdotal claims about rising rates of expatriation by high U.S. income earners.  As Rueven Brenner has pointed out, immigration and emigration have historically played an important part in the rise and fall of nations and economies.  It’s too soon to make any meaningful assessments, but this is a risk that policymakers (and voters!) must stay attuned to.

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy.

Mosler vs Stockman

We caught former Reagan OMB chief David Stockman on Larry Kudlow defending his recent op-ed attack on fellow Republicans. We planned to offer a critique of his arguments, but note that Warren Mosler has already ably dismantled them, e.g.:

At least [Republicans] are practical enough to add to aggregate demand when needed. Does anyone think there is an excess of demand that calls for a tax hike? Any call for a tax hike on ‘fairness’ should be ‘paid for’ with at least an offsetting tax cut somewhere…

Public sector deficits = non govt savings of those financial assets. And the unemployment rate and inflation rate are telling us federal deficits are too small to provide the savings demanded by the rest of us…

The trade deficit is an enormous benefit. For a given size govt, it allows for lower taxes/higher deficits so Americans can have enough spending power to buy both all we can produce at full employment plus whatever the rest of the world wants to sell us. In 1999/2000, unemployment fell below 3.8%, even as the trade deficit soared to $380 billion.

Here’s Stockman’s conclusion and Mosler’s rebuttal:

The day of national reckoning has arrived. We will not have a conventional business recovery now, but rather a long hangover of debt liquidation and downsizing — as suggested by last week’s news that the national economy grew at an anemic annual rate of 2.4 percent in the second quarter. Under these circumstances, it’s a pity that the modern Republican Party offers the American people an irrelevant platform of recycled Keynesianism when the old approach — balanced budgets, sound money and financial discipline — is needed more than ever.

No, we need a full payroll tax holiday, $500 per capita revenue sharing for the states, and an $8 transition job for anyone willing and able to work.

Both Stockman’s op-ed and Mosler’s responses are pretty wonkish, but the bottom line in our not-so-humble opinion is that Stockman is self-delusional in the service of idealism (though in fairness to David, his ideals are unchanged since his Reagan days, and he’s taken a strong public stand that seems very likely to work against his private interests).  For example, historically, there’s simply no evidence that balanced budgets always and everywhere have positive economic effects, while there is evidence that under some circumstances, very high levels of  public debt are rather innocuous, and can even coincide with periods of economic and political strength. 

And Mosler is absolutely correct that there is little risk of the federal government crowding out demand (or investment), and if he were to read some of the research on age structure that we’ve incorporated into our thinking over the past year or two, he might become even more certain of that.  We see very little risk of the public sector crowding out the private one, via higher borrowing costs or inflation, for at least a decade or so. In fact, the federal government is probably far more likely to “crowd in” demand and investment under conditions like those currently prevailing.

During periods of pessimism and deflation, “crowding in” can only be carried out by a sovereign government operating in a modern monetary framework. Too many macroeconomists and pundits dismiss this realization out of hand, which is especially unfortunate given how eminently non-partisan its implications are.

The only other approach is to bide time, which certainly works, but with incalculable opportunity costs. And Stockman’s calls for fiscal discipline will only make those costs greater, both to current generations and the unborn.

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy.

Thoughts on Initial Unemployment Claims

Initial claims appear to have disappointed slightly this morning, as the headline (seasonally adjusted) number spiked to a level not seen since early April. However, the non-adjusted number fell below 400,000 for the first time since early May. The slight bump to the four week moving average was not large enough to be worried about at this point. Of course, the ultimate takeaway is that layoffs are still not falling quickly enough to put a significant dent in the unemployment rate.

With that in mind, we updated some of our claims graphics.

As in late May, running a crude spreadsheet model of the four week moving average of seasonally adjusted initital claims shows that selection of the polynomial has a notable effect on the projected trend. However, at this point, the divergence looks far more benign (an outlook that is supported by some key credit market indicators):

If we smooth out a long term moving average of initial claims, we get a clearer picture of underlying trends. Here we can see that initial unemployment trended persistently higher during most of the 1970s and early 80s, then fell steadily from the mid-1980s to the end of the 1990s except for the early 90s recession. The trend has been decidedly negative since 2008. Whether we’ve broken out of the “great moderation” of the past 20+ years and entered a period more like the 1970s remains to be seen:

One aspect of initial claims where there has been a clear and definitive break with the past is in the ratio of continuing unemployment claims to claims filed by the newly unemployed:

Through the end of the last century, the median number of continuing claimants has been just under seven.  Since the turn of this century, it has been nearly eight, and at the moment it is just shy of eleven. That means that for every individual filing a new claim for unemployment benefits, there are more than ten others filing ongoing claims. On that count, the current period looks notably worse than the 1970s. However, it does require some additional analysis — specifically, has extending the duration of benefits skewed the number of continuing claims upward?

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy.

BIS on demographics and asset prices

The Bank for International Settlements has published an excellent working paper on the effects of population age structure on home prices. Here’s how the author summarizes his findings (emphasis added):

The results suggest that global asset prices are likely to face substantial demographic headwinds in the next forty years. The theory is straightforward: House prices are determined jointly with financial asset prices. Hence, if house prices face headwinds, so should financial asset prices. Using the estimated coefficients and global population forecasts, asset prices would face headwinds up to a full percentage point. This headwind is substantial, but based on historical returns would not imply real asset price declines…

Though the results do not imply absolute real price declines, they suggest that in the next forty years house prices in advanced economies will face a more difficult environment than in the past forty years.

One of the most important aspects of the study, and of most studies of age structure’s effects on economic and financial market outcomes, is the illumination of the impacts that baby boom generations have had in different countries. For example, here’s a graphic from the paper showing the impact on real housing values over the past thirty years (appreciation or depreciation in basis points per year), and as forecasted for the next thirty, in the major English speaking countries (the projections are even more pessimistic for many non-English speaking countries):

We can’t overstate how important it is for savers, investors, retirees, business leaders, and policymakers to grasp the dynamics implied by a chart like this, as it calls into question each and every assumption about future nominal asset returns based on the last thirty years of data — assumptions that are widely used and abused by the financial services industry, in our experience!

Human beings are innately backward looking when making predictions. That’s OK if we are diligent about investigating the hows and the whys of past experience, and assessing how the relevant factors are likely to behave in the future (and just as importantly, being attentive and responsive to the many factors and possible outcomes that we are as yet unaware of). But it’s rather dangerous when we just scratch the surface of historical data in order to  produce statistical claims (usually for marketing purposes in our industry) about the future. Garbage in, garbage out. Unfortunately, our industry will continue to create and peddle garbage as long as clients are willing to be over charged for it…

In the matter at hand, the essential fact is that most of our prevailing expectations about economic and market outcomes (and prudent public policy) were formed in recent decades, as baby boomers moved through their early and middle adult years. Those expectations could be turned upside down as boomer generations head into retirement and old age in many countries during the decades ahead. Any long term investment process that ignores this secular dynamic is likely to create more downside risk than intended.

A few caveats on the paper’s implications, the last three from the BIS author:

• As touched on in our recent interview with Diane Macunovich, there are many different ways to slice and dice demographic data, and different methods can produce very different results.
• Other non-demographic factors have clearly played a role in the past, sometimes much stronger than age structure effects.
• Technology and lifestyle changes — for example, higher typical retirement ages driven by technology and/or concerns about transfer payments – are hard to predict and account for.
• Predicting age structure effects forty years into the future is hazardous, and long term forecasting has a dismal track record.

That last point is also extremely relevant to debates over national deficits and debt. Apparently it’s accepted wisdom at the current BIS that future social benefits will have to be cut dramatically in advanced nations:

In the government sector ageing related entitlement spending is currently set on an unsustainable path as Cecchetti et al. (2010) shows. Hence, lowering old age government benefits seems to be inevitable. Consequently, the next old generation might have to run down their assets in old age more aggressively than previous old generations as their private and public entitlements would be much less generous. This would exacerbate the negative impact of ageing on asset prices.

That doesn’t really make sense though. If transfer payments to retirees are cut in such a way that existing financial assets have to be drawn down more aggressively, then all else equal, you’re going to see asset deflation and rising pessimism. If powerful enough to be deflationary, then spending new money into existence would be an appropriate response — which would mean (ignoring valid political arguments over how and where government spending should occur) that the transfer payments should never have been cut! 

So this passage and the paper it’s based on look like yet more hand wringing over cursory statistics by the debt phobes. But as we noted above, cursory statistics are garbage, and that’s true whether we’re talking about financial services, economics, or public policy. For a more complete fisking of the Cecchetti et al paper, see here.

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy.