“Macro” Musings II

[frommi]

Aren`t these comparisons with the past a bit misleading, given that we had population growth back then?

Growth in real terms can only come from new consumers or more debt or not?

 

[yadayada]

productivity going up, that was an important reason for the economic boom of the 90's . More output per worker, so goods and services become cheaper to produce. Which means more disposable income.

[treasurehunt]

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.

 

I don't think this is Shilling's original idea; many others have suggested it. Here's a paper that discusses the issue in detail: http://qz.com/88781/after-crunching-reinhart-and-rogoffs-data-weve-concluded-that-high-debt-does-not-cause-low-growth/. The paper contains the following sentence in bold: But the two of us could not find even a shred of evidence in the Reinhart and Rogoff data for a negative effect of government debt on growth.

 

You may also be interested in the paper by Herndon et al that first pointed out some major problems with the analysis done by Reinhardt and Rogoff: http://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_301-350/WP322.pdf

[petec]

Thanks, treasurehunt.

 

Eric, re Schilling, I actually agree totally with his premise that once private deleveraging is done the private sector will power a recovery that will make government debt look much better.  My issue is with the 4 year figure, both in the sense that a lot can happen in that time and because after 4 years of deleveraging at this pace the consumer won't be at particularly low debt levels.

 

That said, I'm not under the delusion that I can predict the economic future.  I just want to protect myself from possible adverse outcomes when I'm stockpicking, because history doesn't suggest that this debt-level starting point is auspicious.

[giofranchi]

The paper contains the following sentence in bold: But the two of us could not find even a shred of evidence in the Reinhart and Rogoff data for a negative effect of government debt on growth.

 

No evidence? I am sure they know the following equation: GDP = M * V. If you put the chart of money velocity over the chart of total debt in the US since 1900, you can clearly see that both times total debt exceeded 250%-275% GDP, V started falling significantly, and didn’t recover until the debt overhang problem had been solved. Maybe 2 instances are not evidence enough. But surely there is at least some evidence!

 

Gio

 

[JEast]

Sending non-inflationary pressures somewhere else (e.g. mini currency wars).

http://www.bloomberg.com/video/bloom-says-dollar-to-gain-as-deflation-exported-dELZI7bjThmm~edqvpDCRw.html

 

Maybe inflation is on its way when the talking heads start discussing deflation.

[frommi]

productivity going up, that was an important reason for the economic boom of the 90's . More output per worker, so goods and services become cheaper to produce. Which means more disposable income.

 

I would argue the other way round, because we had the baby boomer generation there was lots of consumption growth and with rising debt you got more to spend at that time. (of course you borrowed consumption from the future).

In your scenario when you produce more but don`t need it, jobs or prices get cut. The theory says these workers can now produce something else and therefore GDP rises, but does this happen in reality? And now the baby boomers go into retirement where they don`t help the GDP anymore, this should be a headwind for GDP going forward. (Visible in the workforce participation rate?)

 

From 1980->1990 there were the baby boomers, from 1990->2000 there was debt balloning in the US, 2003->2007 we had a huge debt ballooning in europe, from 2008->2014 it was china. Now what comes next that lets the world economy grow?

[yadayada]

you don't produce more and don't need it. Increased productivity means that goods and services become cheaper. For example 40% of population worked in farming early 1900. The fewer people have to spend time on something to get the same output, the higher productivity is, the cheaper those things will be, and there is more room to spend on other things. So there is more disposable income.

 

Early 1900 most people could not afford much more then food and housing.

 

If babyboomers go in retirement they will still spend, so GDP wills till be helped. And if they run out of money, they will start working again if they can.

 

This shows the nice correlatioon between productivity growth and GDP growth

http://www.financialsense.com/sites/default/files/users/u673/images/2012/0727/world-average-annual-growth-rates-gdp-and-population.jpg

 

Note how before industrial revolution GDP trailed population growth, and after that it started to outpace it.

 

I think what helps to understand this is to relate value created to the time it cost to create that. And just ignore money for a second. money is used to exchange that value, and has no value in itself. Improved productivity allows to create the same amount of value as 100 years ago in a lot less time.

 

And money keeps track of how much value is created. That is why GDP goes up. For example if now 4% of population is in farming to provide the same amount of food, that means 36% of the population now has to spend very little time to get food and have more time to create additional value. Because fewer people need to be compensated for their time, food is now 'cheaper'.

 

That is why third world countries that provide basicly no value to the world and have low productivity in everything have poverty and hunger, even though there is no shortage in food. 

[frommi]

Oh you are right, stupid little me should have looked up the definition of GDP earlier. Thanks for your enlightment. :)

[yadayada]

http://www.economicprinciples.org/

 

The podcast of little over an hour is interesting, he goes a bit more in debt.

 

He makes some interesting observations on velocity.

[frommi]

Thanks for posting.

In the last year there where lots of companies buying back stock with debt, so is this good debt? :D

From my view this is bad debt, because you have to repay it later and therefore earnings/fcf is lower in the future just like debt used for consumption. But on the other hand you buy an asset with income, so whats your view?

 

What really makes me thinking is what Mr. Grant said in a presentation i watched last week, that the swiss central bank buys US equities with printed money because they have pegged their currency to the €. So they create assets out of thin air. Really strange thing to think about. The BoJ does it, too. And since they buy ETFs its probably not even stupid to just buy index funds yourself when all the liquidity goes into them.

[JEast]

Is the commodity cycle turning over?  We surely have seen Iron Ore collapse, so what is next?  Via Zerohedge, maybe it is copper as the China property cycle is (or) has at least slowed down somewhat.

 

http://i60.tinypic.com/2ed5fyv.jpg

 

http://www.zerohedge.com/news/2014-10-25/coming-collapse-copper

[yadayada]

Thanks for posting.

In the last year there where lots of companies buying back stock with debt, so is this good debt? :D

From my view this is bad debt, because you have to repay it later and therefore earnings/fcf is lower in the future just like debt used for consumption. But on the other hand you buy an asset with income, so whats your view?

 

What really makes me thinking is what Mr. Grant said in a presentation i watched last week, that the swiss central bank buys US equities with printed money because they have pegged their currency to the €. So they create assets out of thin air. Really strange thing to think about. The BoJ does it, too. And since they buy ETFs its probably not even stupid to just buy index funds yourself when all the liquidity goes into them.

look in the Coinstar thread on buybacks. If current market cap is lower then future cash flows added up of say next 10-15 years, then a buyback is good for shareholders. It is bad if the stock is overvalued. So my guess is, some buybacks with borrowed money are good, and some are bad. If you think the stocks on average doing those buybacks are overvalued, then they are destroying value. But that is an average. Some are creating v alue, but some are destroying more value then the others create, so on average value would be destroyed if you think there are more overvalued companies buying back stock.

 

The thing I see Dalio not really mentioning is productivity. You cannot discuss debt markets without discussing productivity too.

 

http://bwater.com/Uploads/FileManager/research/how-the-economic-machine-works/ray_dalio__how_the_economic_machine_works__leveragings_and_deleveragings.pdf#page=2

 

Reading this now :) .

 

Also don't understand how inflation would happen. Inflation happen when prices are going up. This can be because of

1. Demand goes up, and supply is not elastic enough

2. costs of making goods and services demanded go up

 

Now if the traditional goods like food, gadgets transportation etc (excluding housing for a second) would become more expensive. It would mean:

-more money is bidding on these things.

-supply cannot keep up (either because of too much demand at once, or because we are running out of the low cost commodities).

 

So for more money to be bidding on these thigns, wages would have to rise? If the FED injects money in the economy, that means they give it to financial institutions. But to get it in the economy and cause inflation, it would still have to end up in people's bank accounts somehow and be spent so the above things can happen.

 

In the housing bubble this happened in the form of very easy credit bidding up a limited number of houses. But in order for the other things in the CPI to become more expensive you would have to have factories with costs going up either due to rising commodity prices, or due to having to pay their workers more (because unemployment is low, meaning more negotiating leverage for workers).

 

If demand of things like food and other things in the CPI (except housing) would go up, it seems supply can easily meet up. They can just add another factory and there is no shortage of food or arable land. Productivity in these area's is only going up, and dependance on commodities will go down over the next 10 years probably.

 

monetary inflation

 

It seems hyperinflation is what you get if the government injects money directly in the economy by basicly giving people money? How did this happen in germany and Zimbabwe? How did money go from the financial system to the general public? Because you would have to see more money bidding on the same goods and services. This can not come from that much increased debt.

 

Edit: Hmm it seems those financial institutions that now have increased (non debt) money supply, they can invest that money in things like commodities pushing up prices. If Banks would gamble on things like grain, it would push up the price of food for consumers, so you would see inflation on the CPI.

[frommi]

look in the Coinstar thread on buybacks. If current market cap is lower then future cash flows added up of say next 10-15 years, then a buyback is good for shareholders. It is bad if the stock is overvalued. So my guess is, some buybacks with borrowed money are good, and some are bad. If you think the stocks on average doing those buybacks are overvalued, then they are destroying value. But that is an average. Some are creating v alue, but some are destroying more value then the others create, so on average value would be destroyed if you think there are more overvalued companies buying back stock.

 

The thing I see Dalio not really mentioning is productivity. You cannot discuss debt markets without discussing productivity too.

 

He said that it matters most in the long run. What i am missing is how in the world all the different ecnomies work together. At the moment we have a beautiful deleveragin in the US, but a deflation with austerity in europe and a debt bubble in china. Now is the US importing deflation through the currency and killing the beauty?

 

 

[yadayada]

Deflation in Europe would be less spending there, so less imports, hence less exports by the US to Europe. Importing from Europe will become cheaper though. So im not sure how much influence that really has on consumption in the US. Probably somewhat negative.

 

This quote is interesting from his paper:

Most of what economists call the velocity of money is not the velocity of money of money at all – it is

credit creation. Velocity is a misleading term created to explain how the amount of spending in a year

(GDP) could be paid for by a smaller amount of money. To explain this relationship, people divided the

amount of GDP by the amount of money to convey the picture that money is going around at a speed of

so many times per year, which is the called the velocity. The economy doesn’t work that way. Instead,

much of spending comes from credit creation, and credit creation doesn’t need money to go around in

order to occur. Understanding this has big implications for understanding how the economy and

markets will work. For example, whereas one who has the traditional perspective might think that a

large increase in the amount of money will be inflationary, one using a transactions based approach will

understand that it is the amount of spending that changes prices, so that if the increase in the amount of

money is offsetting a decrease in the amount of credit, it won’t make a difference; in fact, if the amount

of credit is contracting and the amount of money is not increased, the amount of spending will decline

and prices will fall.

[yadayada]

So large inflation usually happens when the central bank starts funding teh government with free money. That is how they push money in the system.

 

It seems current QE is just buying worthless assets from banks balance sheet? But once you pour free money directly in the government, then you will see inflation on CPI level.

[Packer16]

Inflation only happens in a reserve currency when there is a shortage.  As can be seen by the current Fed and in Victorian England that the money supply can skyrocket and result in little to no inflation if there are supply surpluses and labor surpluses.  It is only when you mix shortages and loose monetary policy do reserve currencies inflate.

 

Packer

[yadayada]

yeah see it that way too. I think to see the government free money QE you would have to see the US gov in serious problems with their debt. and that seems unlikely for now.

 

What I take from this is that they lower rates, so government can borrow cheaply to stimulate the economy so there is no deflation. This happens while the public sector (so corporations and private) deleverages. Once the everyone but the government is finished deleveraging, the budget deficit is closed, government can start of paying debts with increased tax income vs stagnant gv budgets,  from rise of GDP.

 

So for people saying FED stimulus did not help because money got stuck in financial system and only helped the rich, I don't think that is technically true. With higher interest rates government spending would have been lower.

 

This probably means that lower interest enviroment will persist for some time untill the government has some more breathing room. They cannot really afford higher interest rates? What is interesting is that budget surpluses have been very rare in the past decades. And there either has to be a surplus or GDP has to grow a lot over the next decade on a stagnant budget to get debt/gdp of government to more normal levels.

 

What is interesting in all this is canadian private sector. House prices vs median income is 9x vs 7x in the US height. And their conumer debt/GDP is much higher then the US .

 

This visualizes nicely what is going on in Japan and what could go wrong in the US if they do not watch out. I guess this is what Gio said will happen if the US debt problem gets out of control. The problem is you also need a heavily leveraged private sector and a not so healthy resulting economy for this to happen (like in japan, and not in the US). I guess gov debt grows, consumer+corporate debt shrinks. Then the process reverses. And it all ends badly when both are inflated. If both are inflated, you get hyperinflation or a very long period of deflation. Which could then easily result in hyper inflation.

 

[JEast]

So large inflation usually happens when the central bank starts funding teh government with free money. That is how they push money in the system.

 

In text books, that is what happens.  However, central banks only have the logistics of "pushing" money into the system via the help of others (e.g. profit seeking banks).  Currently in the US, those banks are are not pushing much into the system.

 

The former FED Chairman was nicknamed "Helicopter Ben" - and from a logistics point of view, I have always thought that the FED should have rented about 100 chinooks and literally dumped money over the largest 20 metropolitan areas.  That would have spurred inflation much quicker!!  Alas, the electronic currency is still sitting quietly on a server somewhere with nowhere to go.

 

[ERICOPOLY]

I looked all the way back to when I graduated university and entered the workforce -- June 1997.

 

The S&P500 has gained a bit less than 5% annualized since then. 

 

The market P/E today is largely the same as in January 1997:

http://www.multpl.com/table

 

Go all the way back to Jan 1993 and it has been a 7% annual index increase.

 

 

 

[lessthaniv]

Any thoughts or opinions on the current level of net profit margins? Do you see current aggregate net margins (on the S&P 500) as being sustainable?

 

 

 

 

[frommi]

Any thoughts or opinions on the current level of net profit margins? Do you see current aggregate net margins (on the S&P 500) as being sustainable?

 

I think common wisdom is that profit margins mean revert, so no. When sometime in the future interest rates and wages go up they will mean revert. Otherwise we get so much wealth transfer from the poor/middle class to the rich that we get revolutions. (And at that point they will mean revert :D)

[JEast]

Sweden's central bank cut interest rates to zero to ward off prolonged deflation risk.

 

http://www.reuters.com/article/2014/10/28/sweden-cenbank-idUSL5N0SN1OB20141028

[ERICOPOLY]

More Eurozone Banks Said They Eased Credit Standards for Second Consecutive Survey

 

http://online.wsj.com/articles/ecb-says-banks-continue-easing-loan-standards-1414584031?mod=WSJ_hp_LEFTWhatsNewsCollection

[petec]

Any thoughts or opinions on the current level of net profit margins? Do you see current aggregate net margins (on the S&P 500) as being sustainable?

 

In the long term I very much doubt it.  I like Frommi's line of logic and I also think about it in Dupont terms.  For the margin to stay high either roe has to be high or assets turns or leverage have to be low (compared to history).  I'm not sure why any of those things would happen in the long run.

 

P