“Macro” Musings II

[petec]

Some slightly disjointed thoughts:

 

1. Lending comes from savers.  So pension funds etc. invest in bonds.  This is fine so long as the lending is money good, and disastrous when it's not.  Top the extent that QE forces pensioners into risker investments at bad prices it's dangerous.

 

2. Lending comes from the Fed.  If the government issues a new bond and the Fed buys it with newly printed money, a technical liability is created albeit one that will likely never be repaid.

 

3. Lending comes from fractional reserve banking.  A loan immediately creates a deposit; subtract the reserve fraction and the deposit can be re-leant; and this can be repeated again and again.  Credit can beget credit and credit can pile up hugely.  This is why in a fractional reserve banking system the Fed can't directly control money creation or velocity. 

[prevalou]

so, this massive and increasing lending comes from ?

[yadayada]

I think you guys fail to make a difference between consumer debt and government debt. And the fact that the US is still very competitive, and generates steady tax income for the government.

 

I think there is a healthy average ratio of debt. And in the 50's people were overly pessimistic. I think we are slightly over that now. But we are moving down. So in the 50's people were losing value by being underlevered, and we are slightly overlevered right now. Note that the overwhelming majority of this debt is long term and mostly replaces another cost (rent).

 

And then there is government debt, which is unsustainable. But if you look at the difference between what will tax income likely be in 5 years, and what will spending be, it looks like there is a lot of room to go down. With hyper inflation you usually saw a cratering economy and no tax income to pay off debt. But the US does not have that problem.

 

I think what you will see is a delevering economy, and a slowly levering government. But when spending turns up again when delevering has happened on the public level, there will be more tax income for the government. And if you have a sensible president for once in the next 10-20 years you will see a government delevering too.

 

Im not too optimistic about the future, and we will likely not see a economic boom. But the ingredients for hyperinflation just are not there. You would need to see a crappy economy and increasing levels of consumer debt. Lack of productivity, sky high commodity prices compared to income, etc.

 

Germany in the 30's was being squeezed by europe as a punishment of the war. Zimbabwe was basicly a complete mess. A lot of these hyperinflation scenario's you see some external element or the country had serious problems besides debt. You don't see that in most of the western world now.

[giofranchi]

thanks for this answer. I am not a macro specialist, but i think the money printed by the fed returns to the FED because banks are fearful or borrowers are fearful.  So there is no net lending there.

 

Of course, I am no macro specialist either! I usually don’t trust macro specialists much! ;)

 

What you say might be right as far as banks are concerned. In fact, the private sector in the US has deleveraged a little. Banks have been restructured and then have kept a low leverage.

The public sector, instead, has increased leverage a lot. And QE1, QE2, QE3 have been outright purchases of government bonds, right?

 

Anyway, this is not how I deal with such things. In a very complex system I don’t need to understand everything. When total debt to GDP has never been this high in the developed world + China… that’s enough to make me behave prudently!

 

Also remember this is not a phenomenon that’s been going on only for the last 5 years… It is a much older thing: in 2000 Total Debt / GDP already was almost as high as at the peak of the Great Depression.

 

Am I wrong? Probably… And I hope so!... My philosophy simply remains better safe than sorry! ;)

 

Gio

 

[prevalou]

"QE replaced $3 trillion in Treasuries and

mortgage securities held by individuals,

investors, funds and others with cash

reserves created by the Fed"

 

JPM 2013 annual letter

[giofranchi]

"QE replaced $3 trillion in Treasuries and

mortgage securities held by individuals,

investors, funds and others with cash

reserves created by the Fed"

 

JPM 2013 annual letter

 

This might be part of the equation, but surely it is not all that we are seeing… US public debt has gone up, hasn’t it? Two might be the causes: 1) the restructuring of the banking system, a one-time event in which private debt was transformed into public debt, 2009-2010; 2) the issuing of new debt, 2011-2012-2013.

 

It is a very complex system… Very difficult to know with certainty… The risk I see is we might keep saying “for every borrower there must be a lender” and overlook the need for deleveraging, until we all get to a Total Debt / GDP of 655%... Then we will all look like Japan!... After all, even in Japan for every borrower there must be a lender, right? And their debt is practically all internal debt, therefore for every Japanese borrower there must be Japanese lender…  So, there must be a lot of Japanese savers, right? Well, today Japanese personal savings rate is 0%. And the return they are able to get on their “past” savings is so low that could be accepted only in a deflationary environment… Just a little inflation would render a significant decrease in purchasing power unavoidable. Won’t you agree with me that is worrisome?

 

Gio

 

[prevalou]

the problem with japan is that all this lending by japanese goes to an improductive borrower (the government).

[petec]

so, this massive and increasing lending comes from ?

 

An increase in the money supply multiplied by fractional reserve banking, operating over 60 years.

[petec]

I think you guys fail to make a difference between consumer debt and government debt.

 

 

No, I am very aware of the importance of the distinction.  But:

1. As I've argued before, the 'mortgage replaces rent' argument is partly false: debt drives bubbles, while rent doesn't; and if you lose your job and your house value falls (two events that are usually correlated) you still have the mortgage.  Debt makes economies far more volatile than rent does (hence the term leverage!).

2. Much consumer debt - even mortgage debt - ended up in consumption and that creates a very difficult 'comp' for GDP.  Borrowing to consume is, by definition, borrowing to consume now at the expense of consumption later.  Unless you keep adding debt at an ever - accelerating pace, or you have a positive step-change in productivity, GDP *must* slow at some point after years of borrowing to consume.  I think that's as close to a mathematical certainty as you get in the dismal science.  But the Fed consistently over-projects GDP growth at the moment and presumably others do too, which might make future tax projections inaccurate.

3. The affordability of consumer debt is affected by consumer expectations of future taxes and costs.  Thus, consumer spending might slow as government debt rises and will surely slow if it turns out that the government can't afford its unfunded promises to cover healthcare, pensions, and other benefits in the future.  So the two are distinctly connected.

 

I'm also un-nerved by any bull case that relies on there being a 'sensible' President ;)  I'm only partly being facetious: why would a population that arguably hasn't elected a good President since Eisenhower (Reagan talked a good fiscal game but didn't deliver) elect a sensible one *before* a crisis that proved the need?  Fingers crossed, but I won't hold my breath.  (Edit: Clinton wasn't bad.)

 

However I do completely agree that there won't be a hyperinflation.  I only brought that up in response to a poster who (I thought) suggested that the solution to all this was the Fed printing and cancelling the bonds they bought as a result.  Eventually that will lead to a loss of confidence in the currency.  But I don't expect it to happen.  I basically agree with you: I think there will be a long period of difficult growth and de-leveraging.  I just expect that to be a very volatile period.

[petec]

On the positive side, oil and commodities in general are going to be very good for the consumer (providing the Fed doesn't over-react to 'deflation' worries and print and push them back up again).

[Vish_ram]

Some slightly disjointed thoughts:

 

1. Lending comes from savers.  So pension funds etc. invest in bonds.  This is fine so long as the lending is money good, and disastrous when it's not.  Top the extent that QE forces pensioners into risker investments at bad prices it's dangerous.

 

2. Lending comes from the Fed.  If the government issues a new bond and the Fed buys it with newly printed money, a technical liability is created albeit one that will likely never be repaid.

 

3. Lending comes from fractional reserve banking.  A loan immediately creates a deposit; subtract the reserve fraction and the deposit can be re-leant; and this can be repeated again and again.  Credit can beget credit and credit can pile up hugely.  This is why in a fractional reserve banking system the Fed can't directly control money creation or velocity.

 

Only banks can officially lend. This includes central bank and commercial banks. If Joe lends $10 to Jill, then this lending doesn't show up in official books. Lending doesn't come from savers directly. It comes through the banks.

 

#3 is partly wrong. Fed directly controls bank's lending by setting discount rate (rate at which banks can directly borrow from FED, this is generally frowned upon), controlling fed funds rate using open market ops (banks have to borrow the fed funds and use it as reserves) and Reserve requirement (% of reserves to be kept in case of loan default).

 

Velocity is determined by economic activity. Higher activity increases velocity for a given money supply. The Fed can only indirectly control it by cooling the economy.

 

Another caveat.

FED is great in reducing the lending (akin to pulling a string) and FED is poor in increasing/stimulating lending (akin to pushing a string). FED can encourage lending by setting low rates, but the banks should decide to lend freely and above all ,the consumers/corp should feel good about economy to borrow.  i.e. pulling is more effective in pushing.

 

[petec]

 

Only banks can officially lend.

 

What about bonds?

 

#3 is partly wrong. Fed directly controls bank's lending by setting discount rate (rate at which banks can directly borrow from FED, this is generally frowned upon), controlling fed funds rate using open market ops (banks have to borrow the fed funds and use it as reserves) and Reserve requirement (% of reserves to be kept in case of loan default).

 

 

No, the Fed doesn't *directly* control bank lending.  It can influence it through the mechanisms you describe, but it can't force banks to lend and therefore it can't force money and credit multiplication via the fractional reserve system.  If it could, it wouldn't have to go to such extreme lengths to get credit flowing in the economy.

[prevalou]

so, this massive and increasing lending comes from ?

 

An increase in the money supply multiplied by fractional reserve banking, operating over 60 years.

 

from 1980 to 2013, us M2%gdp went from 69.4 % to 88 % (in M2 are the deposits you are mentioning). Source Worldbank. I don't see the massive increasing lending in these figures. Maybe the increase was before in the 50s, 60s ans 70s ?

[petec]

 

from 1980 to 2013, us M2%gdp went from 69.4 % to 88 % (in M2 are the deposits you are mentioning). Source Worldbank. I don't see the massive increasing lending in these figures. Maybe the increase was before in the 50s, 60s ans 70s ?

 

Yes and no.  1952 was the trough for US total debt/gdp.  Then went up for a couple of decades, flatlined for a couple, and accelerated again in the '80's until the peak in 2009.  Now falling, but still very high.  PW has the graph in his Fairfax presentations.  NB this doesn't include the PV of future unfunded liabilities, because governments don't hold themselves accountable in GAAP terms.

 

The discrepancy is presumably in the bond market which I believe has grown much faster than GDP as banks got disintermediated.  So the lenders then are pension funds and all the other bond buyers.

 

More importantly (for me) why worry who's lending?  The data are there and aren't disputed, and the implications of brought-forward consumption on GDP comps are the same regardless.

 

 

[prevalou]

anyway, if the 1950/1970 period doesn't explain the increase in M2% GDP, it seems "lending from fractional reserves doesn't explain the massive increase in lending.

Why is it important to know who is lending: in a borowing contract there are two concerned parts: the borrower and the lender. Why is there an obsession with the borrower ? Maybe the lender has a strong hand and can withstand a a bad credit or a recession. Nobody seems to care. Is it conventional wisdom applied ?

[petec]

anyway, if the 1950/1970 period doesn't explain the increase in M2% GDP, it seems "lending from fractional reserves doesn't explain the massive increase in lending.

Why is it important to know who is lending: in a borowing contract there are two concerned parts: the borrower and the lender. Why is there an obsession with the borrower ? Maybe the lender has a strong hand and can withstand a a bad credit or a recession. Nobody seems to care. Is it conventional wisdom applied ?

 

That's a fair point if we are talking a financial crisis.  But the correlation of slow and volatile GDP growth with high debt levels is unaffected.  I'm talking about (potentially) years of sub-par growth, not a massive meltdown.

 

Interesting discussion though, thanks!

[prevalou]

I agree with that. There was a time when conventional wisdom said: "it is important to have a lot of debt in a private company because management can't rest on its laurels and has to seek growth to refund the debt".

If I Invert: "in our societies with massive lending, people are being lazy and growth will be low for years."

[yadayada]

why is a certain level of debt not sustainable? Why should it go from little debt to medium debt to little debt? And why is the 50's our prime example here.

 

It seems the only level of debt that seems much on the high side, is government debt. I think government jobs make for little over 10%. ALlthough services and goods bought by government also produces jobs probably.

 

But it seems at some point they cannot borrow more, so then is the choice, big inflation or just cut budget and delever? It seems cutting budget and delever is more likely. Allthough looking at elections, it seems to be a popularity contest between idiots now.

 

What is a normal level of debt? It seems consumer debt is probably at normal levels now. Government debt is the one that is inflated. Also corporate debt includes debt held outside of the US right? This does not add to GDP, so it might look too high?

 

I think I agree with petec here. Probably after a few years consumer debt goes up again, and then government debt would go down. But the two cancel each other out and you just see sub par growth for a longer period.

[petec]

why is a certain level of debt not sustainable? Why should it go from little debt to medium debt to little debt? And why is the 50's our prime example here.

 

It seems the only level of debt that seems much on the high side, is government debt. I think government jobs make for little over 10%. ALlthough services and goods bought by government also produces jobs probably.

 

But it seems at some point they cannot borrow more, so then is the choice, big inflation or just cut budget and delever? It seems cutting budget and delever is more likely. Allthough looking at elections, it seems to be a popularity contest between idiots now.

 

What is a normal level of debt? It seems consumer debt is probably at normal levels now. Government debt is the one that is inflated. Also corporate debt includes debt held outside of the US right? This does not add to GDP, so it might look too high?

 

I think I agree with petec here. Probably after a few years consumer debt goes up again, and then government debt would go down. But the two cancel each other out and you just see sub par growth for a longer period.

 

A level of debt is sustainable.  Another isn't.  The exact tipping point is unknown but history gives us ranges.  The '50's are only relevant in that they are part of that history.  They happen to be at the low end of the leverage range and presaged a period of gdp growth at the high end of the growth range.  My contention is that that is not a coincidence.

 

Government *debt* is high but is actually about half what it was (as a % of gdp) at the end of WW2.  It would be way off the scale though if you included unfunded liabilities.  Private debt, however, is above the entire historical range.  I'm not sure on the consumer/corporate split within private but I think it is largely consumer.  Going off Prem's charts private debt/gdp just under 300%, having peaked at 260% in 1933 and 320% in 2009, and troughed at 130% in 1945.  It's interesting to note how much bigger private debt is than government debt: roughly 4x.  Private debt at these levels is manageable only with ultra-low rates, which have scary consequences (savers get in income, yield-seeking money is forced into risky projects and ultimately lost).  There isn't an easy way out of this unless we can engineer rising wages to pay down debt.

 

Interesting point about corporate debt being outside the US.  I think it might be the other way round: US companies have much trapped cash offshore and are borrowing against that locally to fund buybacks etc.  But it might distort the picture a bit.

 

[yadayada]

I think it goes like this, 60 trillion total debt. 9 trillion corporate, 12 trillion consumer (mortgage student credit card etc). and about 20 trillion federal?

 

I think you make an interesting point about what that 20 trillion in federal debt does not include. How big are those unfunded liabilities? That is social security and health care right?

 

Im not sure where the other 20 trillion goes to though.

[ERICOPOLY]

Slow-growth forecasts are wrong:

http://www.bloombergview.com/articles/2014-07-16/slow-growth-forecasts-are-wrong

 

The Boom is Coming and Sooner Than You Think:

http://www.bloombergview.com/articles/2014-07-18/the-boom-is-coming-and-sooner-than-you-think

[yadayada]

Then there is Robert Gordon, the Northwestern University economics professor who believes all the big growth-driving technologies have been fully exploited. He sees nothing to rival the economic impact of the automobile, telephone, phonograph, motion pictures and radio, or the post-World War II developments, including television, air conditioning, jet planes and the interstate highway system.

 

Computers and the Internet are essentially fully exploited, Gordon says, so 2 percent annual output growth per capita -- which was the case from 1891 to 2007 -- is over.

 

Hmm is mr Gordon a computer scientist? No? Maybe don't talk about things yo don't know anything about then.

 

Also ironic how he basicly lists a bunch of inventions, and then states, nah no more inventions now, I can speak for all the physisicsts engineers and scientists in general. No more inventions, nothing to see here guys!

 

BTW I think debt collectors of badly performing loans are a very nice hedge on all this. Especially some of Erbey's companies. You put 10-15% of your portfolio in one of those things and you have upside either way. But a lot more if things turn sour!

[petec]

Yeah I can't say I have a lot of time for Mr. Gordon!

 

Shilling on the other hand I do have time for and I do think there is a lot happening to drive productivity.  Problem is that at least for now, productivity is boosting corporate margins not consumer demand, so companies aren't investing to create new jobs to replace the ones the productivity displaces.

 

I'm also intrigued to know whether there has been an important mix shift in government spending.  As healthcare, pensions, welfare increases, does this mean government liabilities are more inflation linked than in the past?  Because if so it's going to be harder for the government to inflate people into higher tax brackets to reduce the deficit (because spending will rise in tandem).

 

Very interested to know more about Shilling's argument that Reinhardt and Rogoff have the causality the wrong way round (debt doesn't lead to growth so much as slow growth leads to debt).  I think the logic is demonstrably false but he doesn't explain his in the article.

 

One thing that would be very helpful is a decrease in defence spending.

 

Yadayada I've seen estimates that unfunded liabilities like healthcare etc. sum to several hundred percent of GDP if you calculate a PV but I have no idea how accurate this is.

[yadayada]

I think with productivity it is a race. The first guys getting there make a boat load of money. Just look at companies like altisource. Huge margins.

 

But when others catch on, margins get squeezed and more value goes to the consumer.

 

I think there are three large area's that take most people's budget: healthcare, education and housing.

 

I don't see how cost of housing will go down, but healthcare and education have room for improvement. Increase in preventative medicine, move to online more centralized education.

[ERICOPOLY]

Shilling feels that in 4 more years, deleveraging will be complete and real GDP growth will return to 3.5% or more.

 

 

"Sure, productivity (output per hour worked) grew by only 1.5 percent from 2009 to 2012, but that’s normal after a severe recession. I expect it to return to a 2.5 percent annual growth rate -- or more -- after deleveraging is completed in another four years or so. Even in the 1930s, productivity averaged 2.4 percent a year, higher than in the Roaring '20s. In the 1930s, much of the new technology from the 1920s -- electrification and mass production -- was adopted despite the Great Depression.

 

Shilling expects that once private sector deleveraging is finished, real GDP growth will return to about 3.5% or more. He also thinks "the slow-growth-forever crowd will need to find a new theory."

http://www.businessinsider.com/gary-shilling-optimistic-on-us-economy-2014-7#ixzz3GnebzoN8