Where Does the Global Economy Go From Here?

[Viking]

2 hours ago, Ross812 said:

What do you advise to high school aged kids then? I am all for someone going into the trades if they are interested. Pushing those kids who want to be an electrician or plumber into college is indeed a waste. As for liberal arts degrees? My wife has a degree held by many baristas and has worked her way into a very well compensated director level position at a fortune 50 company. She has a friend with a masters in psychology who is in the c-block for a large hospital group. My wife and her friend would never have gotten a seat at the table without a college degree. You could argue the liberal arts degree probably served my wife better than a business degree with a concentration in marketing as she is a natural sales person and was never taught to conform; she was instead how to communicate her natural talent. 

I managed sales teams for years… the light bulb for me went off when i realized my ‘star’ employees (whether they were 60 with no degree or early 20’s right out of university) had in common: good/great attitude, strong work ethic, high personal standard, open to change, results oriented, problem solvers (no victim think), team focussed, able to work independently etc. These traits are much more important than type of education.

 

Now if you have these traits and you combine it with education then you will likely smoke. My advice to my kids is to do stuff you love (then you will work your ass off). Importantly, you also want to ride a ‘winning horse’ - find an industry with a long runway. You might think you love that ‘donkey’ today but the ride sure will get stale fast in a couple of years. 
 

My oldest daughter is doing a marketing degree. My advice to her is to stay away from the big multinational packaged goods companies (who will probably be downsizing their marketing departments over the next decade) and instead focus on where marketing is going… work for companies where she will build out her tool kit - don’t chase the cash (it will come flooding in as the tool kit gets filled up). Be forward looking and get the marketing skills today companies are going to be looking for over the next decade that will be in short supply. One of the challenges with universities is they tend to be a few years behind industry in terms of what they are teaching.
 

My goal with my kids is to have them pursue something they love but to also be rational about it - be creative and open minded about the passion - find the angle where it also rains down cash in the future (that ‘ride a winning horse’ thing and not a ‘donkey’.)

 

The problem for lots of parents is the specific model that worked for them likely will NOT work for their kids. The economy is dynamic. So i tell my kids they will have a great life… but they need to figure out their own way. Lots of great options. 

Edited April 6, 2022 by Viking

[Ross812]

1 hour ago, Viking said:

My oldest daughter is doing a marketing degree. My advice to her is to stay away from the big multinational packaged goods companies (who will probably be downsizing their marketing departments over the next decade) and instead focus on where marketing is going… work for companies where she will build out her tool kit - don’t chase the cash (it will come flooding in as the tool kit gets filled up). Be forward looking and get the marketing skills today companies are going to be looking for over the next decade that will be in short supply. One of the challenges with universities is they tend to be a few years behind industry in terms of what they are teaching.

As someone married to someone who worked their way up from field marketing for restaurants. My advice to your daughter would be to work for an advertising agency when you are young and have the energy. Learn to keep a client happy and hone your skills at a good agency for shit pay. When high paying in-house jobs come available, you will be head and shoulders above the competition. My wife looks for agency experience over a marketing degree or an MBA when screening applicants. 

[Viking]

14 minutes ago, Ross812 said:

As someone married to someone who worked their way up from field marketing for restaurants. My advice to your daughter would be to work for an advertising agency when you are young and have the energy. Learn to keep a client happy and hone your skills at a good agency for shit pay. When high paying in-house jobs come available, you will be head and shoulders above the competition. My wife looks for agency experience over a marketing degree or an MBA when screening applicants. 

@Ross812 will pass it on (she actually listens to advice). Thanks  

[Thrifty3000]

@Viking @wabuffo Here's a link to a WSJ article I bookmarked several weeks ago. I thought it presented an interesting framework for thinking about inflation.

 

I felt the most important statement was:

 

Healthy economies don’t have inflation “no matter what the central banks do,” while dysfunctional ones have inflation even with “heroic central bank presidents.”

 

I think it presents the inflation case that Buffett and Munger subscribe to. I think it also indirectly makes the case that the Hoisington thesis may have to wait many years to play out the way they expect (basically, until the government chooses fiscal discipline and austerity over inflation).

 

According to the author inflation and interest rates will reflect people's expectation of future government deficit spending as well as the degree in which debts will be repaid with devalued currency.

 

If investors expect $20 trillion of government debt to eventually be paid back with dollars that only have half the present purchasing power, then you will see reduced demand for treasuries (higher interest rates) and increased demand for other assets (inflation). Who is going to invest a dollar to get back fifty cents (other than a central bank)? The author suggests the price of other assets would have to double in relation to the price of treasuries to restore balance. (This was the big eye opener for me, as I've been pretty well in the Hoisington camp that the US economy will be trudging through a debt deflationary trap until the government gets a grip on deficit spending.)

 

Also, if the government continues running 5% annual deficits AND the Fed buys up a large percentage of the treasuries required to fund the deficits then the market will expect inflationary pressure. (This seems to be Buffett's strongest argument predicting inflationary pressure over time. I assume it's why he advocates for a 2% government deficit, and expresses inflationary concerns over higher amounts.)

 

(The article doesn't touch on impacts from demographic and productivity trends, etc. which also need to be factored into inflationary expectations.)

 

Here's a link if you want to give it a read...

 

https://www.wsj.com/articles/government-spending-fuels-inflation-covid-relief-pandemic-debt-federal-reserve-stimulus-powell-biden-stagflation-11645202057?st=4b0oqafdjth05v9&reflink=desktopwebshare_permalink

Edited April 6, 2022 by Thrifty3000

[SharperDingaan]

A degree is just a union card, no different to a professional designation or a trade certification

No card, no access to the magic kingdom, and no access to the prospective mates/spouse you might find within it. Competitive advantage has very little to do with it.

 

This is also 2022, not 1992 - a great many young women routinely add trade certifications to their degrees. Traveling the world, in a gig economy, while adding a RN, and looking over prospective mates - is a common thing. Good on them!

 

SD

 

 

 

 

Edited April 7, 2022 by SharperDingaan

[Gregmal]

Between Y, OXY, and now HP it doesn’t seem like big daddy Buff is too scared of this punch bowl boogeyman. 

[mattee2264]

Interesting theory. But in the real world I don't think people sell bonds and buy goods and services because they are worried holding bonds to maturity will result in a massive loss in purchasing power. More likely they will buy equities which at least are a partial inflation hedge. And that is doubly true when real interest rates on bonds are still highly negative. 

 

But agree with the general logic that if people believe governments will try to inflate away debt then inflation expectations will be higher and that will feed through into wage expectations and wage-price spirals can result and those can be difficult to break even after the underlying causes of inflation have tempered. The inflation genie is out of the bottle!

 

Also agree with the argument that fiscal policy is a major cause of the inflation we are experiencing. And that is something the government is unlikely to acknowledge and will instead put pressure on the Fed to deal with inflation while continuing to push big spending bills. And as pointed out the Fed doesn't have the nerve to push interest rates high enough to cripple the economy and bring inflation down via a deep recession. 

 

One argument floating around is the Fed might be thinking in terms of reverse wealth effects and is starting to figure that a stock market crash is the least painful way to bring down aggregate demand and therefore inflation. Of course such wealth effects are very weak and did little to stimulate the economy post GFC (but a lot to increase wealth inequality!). But it would be typical of the Fed to try to use the same failed playbook in reverse before taking necessary stronger action. 

 

 

 

 

 

 

 

[wabuffo]

Also, if the government continues running 5% annual deficits AND the Fed buys up a large percentage of the treasuries required to fund the deficits then the market will expect inflationary pressure.

 

Fed buying of Treasury securities does not fund the deficits.  US Treasury deficit spending 'pre-funds' the Treasury security issuance.  There is no "crowding out".   The US Treasury spends, then issues securities to replace the reserves/deposits its spending creates.  It's a circle of asset replacement for the private sector (reserves created by spending then being replaced with Treasury securities).  

 

Think of it this way.  A bank gives you a free $100 in your checking account.  It then comes in and replaces the $100 in your checking account with a $100 in a time deposit.  This is what US Treasury security issuance is = moving the same amount of money from a checking account to a time deposit so the private sector can earn a higher interest rate on the free $100 that started the process.  But the $100 time deposit (ie US Treasury bond) does not require new money - it was already there in the free $100 you received in your checking account.  Thus = no "crowding out".

 

Fed open-market buying of US Treasury securities serves a different and separate goal; which is to shrink the supply of US Treasury securities along the yield curve in the private sector's hands to force longer-term interest rates lower.   But this lower rate is not needed by the US Treasury (see next comment below) to issue its securities.  It issues them with or without these Fed actions at any interest rate it wants.

 

interest rates will reflect people's expectation of future government deficit spending as well as the degree in which debts will be repaid with devalued currency.

 

Treasury security interest rates are whatever the Federal government wants them to be (even without Fed buying).  That's because the US Treasury spends first, creating both deposits & reserves in the banking system, then issues securities to withdraw the reserves and replace them with interest-earning assets for the private sector.  If the US Treasury didn't issue securities, then reserves & deposits would choke the banking sector and interest rates would fall to zero (or less). 

 

Thus, US Treasury security issuance can be properly seen in this context as more of a reserve maintenance/hygiene function than "borrowing".   The "borrowing" is the initial US Treasury spending.  It's important to remember that the Federal government has three types of liabilities to the private sector (currency in circulation, reserves, Treasury securities).   Why are US Treasury securities the only one of three that we consider liabilities/debt of the Federal govt?

 

We saw this effect in 2021, when the US Treasury ran down its general account at the Federal Reserve from $1.7t to $150b in 5 months & didn't issue much in Treasury securities.

 

I shake my head at what is written in mainstream publications about how the monetary system works.

 

Bill

Edited April 7, 2022 by wabuffo

[Spekulatius]

The fact that the treasury interest rates are negative (adjusted for inflation)  doesn't say much about the expectations of the private sector. The shape of the yield curve does to some extend and that's why inversion can signal a recession.

The private sector will merit any investments not on the Fed's interest rates at the current time, they typically have expectation on ROIC that are more or less independent on actual interest rates (mostly double digit for any Capex investment).

 

This would change if interest rates go high single digits or double digits, but we are far from that.

[Thrifty3000]

1 hour ago, Gregmal said:

Between Y, OXY, and now HP it doesn’t seem like big daddy Buff is too scared of this punch bowl boogeyman. 

Sounds like he’s scared of cash

[Gregmal]

Says a lot when you rather own HP than cash LOL

[Thrifty3000]

@wabuffo as always, you're a saint. I feel like my Neanderthal brain is slowly grasping some of your concepts. Let me see if I'm getting any closer to reconciling the Buffett/WSJ article thesis with the Hoisington thesis with some oversimplified examples:

 

Scenario 1:

- a government is funded solely with newly created money. (Inflation becomes the de facto tax.)

Scenario 2:

- a government is funded solely by long term bonds
- the bonds MUST be purchased/held by the private sector.

Scenario 3:

- a government is funded solely by long term bonds
- the bonds are purchased/held to maturity by a government-owned bank that can create money.

 

Scenario 4:

- a government is funded solely by long term bonds

- during expansionary times the bonds are purchased/held by the private sector.

- during recessions the bonds are purchased by a government-owned bank that will sell them to the private sector during the next expansionary cycle.

Besides this being a gross oversimplification, all else equal, doesn't Scenario 3 have the same inflationary effect as Scenario 1?

 

And, doesn't Scenario 4 have largely the same inflationary effect as Scenario 2 (not much inflation over time, and can be deflationary if government excess stifles private sector growth)?

 

It seems to me Hoisington is banking on Scenario 4 long term, with government excess ultimately stifling private sector growth. While, Buffett and the WSJ author are assuming that although the government may reduce SOME of the treasuries held by the Fed they'll never have the discipline to offload ALL the treasuries AND reduce deficit spending, which will in fact resemble more of the inflationary Scenarios 1 and 3 than the less inflationary Scenario 4.

 

And, please, just ignore me if I'm wasting your time. I'm perfectly content sitting in my cave and banging rocks together for fun.

Edited April 7, 2022 by Thrifty3000

[wabuffo]

a government is funded solely with newly created money. (Inflation becomes the de facto tax.)

 

Close!  The sovereign (ie, federal govt) needs to spend to obtain resources, so it imposes tax liabilities on its citizens to create the private sector demand for its money.  It then mandates that its money is the only thing that the citizens can use to extinguish these sovereign tax liabilities. 

 

So it must run deficits (spending > taxes) to furnish its citizens with its money that they need.  If it spends too much vs tax receipts it can create inflation.  Keep in mind that the US, as reserve currency, must also provide its money to the foreign sector as well who also want to net export to us in order to get US dollars (trade deficit).  This is because the rest of the world wants to save a portion of its rising wealth in US dollars and US dollar assets for safety. 

 

That's why the US govt can run a much larger deficit safely versus other countries.  We have the world's reserve currency and the rest of the world wants/needs it. 

 

a government is funded solely by long term bonds

 

nope - a sovereign govt is funded by three types of liabilities - currency, reserves and treasury securities (bonds/bills). 

 

It first creates reserves via its spending and then converts most of the reserves into either currency or treasury securities based on the proportions demanded by the private sector (by far they want treasury securities for earning a risk-free interest income).

 

the bonds are purchased/held to maturity by a government-owned bank that can create money.

 

The govt-owned bank (I presume here you mean the central bank) does not create money.  Only the US Treasury does.  The central bank runs the payment system between the banks and between the banks and the US Treasury.  The central bank clears payments by using settlement balances (ie, reserves) on deposit at the central bank.  These settlement balances never leave the central bank. 

 

Lately, the central bank has tried to influence long-term rates on Treasury securities by buying these securities in the open market and paying for them with new reserves deposited to the banking sector's reserve accounts at the Fed.  Again these reserves circulate amongst the banking sector but never leave the Fed's payment system and never go into the private sector.  There is no increase in private sector "liquidity", money or anything else.  There is only a lowering of interest rates which the central bank hopes will increase economic activity.

 

It seems to me Hoisington is banking on Scenario 4 long term, with government excess ultimately stifling private sector growth

 

Monetary deflation only occurs if the sovereign govt does not provide enough growth in the supply of money to support the real economy's growing commercial activity.  In today's monetary system with no link to gold, that happens if the Federal govt tries to run a budget surplus (like it did from 1998-2001).  That unleashes monetary deflation which grinds down economic activity until tax revenues fall enough that the surplus slips back into deficit.  That's what happened in 1998-2001 -- the deflation caused the US economy to go into a long recession from 2000-2002.

 

Under the old US system, when the dollar was subordinated to gold (dollars could be exchanged to gold on demand), there were times when the average increase in the world's gold supply vs above-ground inventories of ~2% per year did not supply enough money to support fast economic growth.  The private sector would then increase its borrowing/debt to maintain consumption/investment.  The economy would then suffer a debt deflation/banking panic every decade or so.  A good example of this was the post US Civil War period when dollars were convertible to gold, US banks issued their own money (backed by their gold reserves), and there was no Fed (ie an Austrian economist paradise) to support the interbank payment system.  During that time period, the US suffered severe deflationary depressions in 1873, 1884, 1893 and 1907.  The Fed was created soon after in 1913 because despite the Austrian economists, this boom/bust system was intolerable to the US citizenry.

 

FWIW - I think this inflation will recede on its own (with or without the Fed) because the deficit is declining rapidly and supply will eventually catch up to demand.   The US economy is fundamentally strong because the household, corporate and banking sectors have not all been in this good a shape from a balance sheet perspective in a long time.  It is also benefiting from the mini-baby boom of the early 90s (millenial generation) currently populating the 25-34 year old age group, which is peak household/family formation.  This is a huge tailwind for housing and general consumption for the US economy interrupted temporarily by the pandemic's forced suppression of consumption.

 

I enjoy the questions/comments - please keep them coming as long as I'm not boring everyone.

 

Bill

Edited April 7, 2022 by wabuffo

[cubsfan]

13 minutes ago, wabuffo said:

 

I enjoy the questions/comments - please keep them coming as long as I'm not boring everyone.

 

 

Nope. Understanding these mechanisms is real tough - and personally, I'm hanging on - but it's terrific.

[Gregmal]

https://www.crexi.com/properties/798025/california-silver-oaks-plaza-chick-fil-a-san-jose-ca

 

3.8 on Chick-Fil-A not even commenced yet, located in a socialist stronghold. Bbbbut! rates rising means CRE has to do poorly!

[Spekulatius]

@wabuffo While I agree the inflation will should recede, simply because the ripples in supply and demand from the pandemic would peter out, a new stone was thrown in the pond - the Ukraine invasion.

 

My take is that we are at war already (even though it is a proxy war for us), but the Ukraine invasion alone screws already up things like some food items, energy etc as well as secondary effects on other items (automobile production etc). I think this will make this inflationary period last longer and it's not easy to foresee the duration.

 

I guess this inflationary period that is now going to last 2 years is now really stretching the transitory moniker and that's why the Fed as well as Mr Market is getting antsy.

[SharperDingaan]

All else equal, rising interest rates and a drift down in inflation over time is reasonable (rising real return). Problem is, bigger and bigger rocks keep getting tossed into the global pond, and quicker - making the resultant inflation waves bigger, and compound upon each other.

 

Most recognize that food prices around the globe are going to rise rapidly as Ukrainian crop production falters. But few recognize that global warming is also threatening the globes remaining growing areas with drought, and collapsed production. In most parts of the world, raise both food and cooking oil prices, and you get unstable regime change (Arab Spring). Compounding inflation further.

 

Even if US rates rose 250bp, net of current inflation, bond holders would still have a negative real return. Theory suggests that higher interest rates should lower demand, and that bond holders should be moving to convertibles funding new P&E. That new investment pressuring limited resources and pushing inflation still higher.

 

Our own view is that inflation is going a lot higher, and for a lot longer.

Straight FI being a very dumb place to be, unless it is very short duration.

 

SD

 

 

 

 

 

[Guest]

9 hours ago, wabuffo said:

 

 

I shake my head at what is written in mainstream publications about how the monetary system works.

 

Bill

 

Bill, what are you thoughts on the reliability of yield curve inversions and recessions?

[wabuffo]

Bill, what are you thoughts on the reliability of yield curve inversions and recessions?

 

I think they are ok as indicators - though the original thesis by Cam Harvey in his 1980s paper was based on the 3mo-10yr differential.  That's the one I watch.

 

My own thoughts were that the chatter about the brief 2yr-10yr inversion is a head-fake as the long end of the yield curve will rise a lot over the rest of the year.   That's bullish, BTW, for the US economy.  Stock market, maybe not so bullish, who knows?

 

Bill

[Guest]

7 minutes ago, wabuffo said:

Bill, what are you thoughts on the reliability of yield curve inversions and recessions?

 

I think they are ok as indicators - though the original thesis by Cam Harvey in his 1980s paper was based on the 3mo-10yr differential.  That's the one I watch.

 

My own thoughts were that the chatter about the brief 2yr-10yr inversion is a head-fake as the long end of the yield curve will rise a lot over the rest of the year.   That's bullish, BTW, for the US economy.  Stock market, maybe not so bullish, who knows?

 

Bill

 

 

Thanks, Bill. I always value your insight. 

[Viking]

23 minutes ago, wabuffo said:

Bill, what are you thoughts on the reliability of yield curve inversions and recessions?

 

I think they are ok as indicators - though the original thesis by Cam Harvey in his 1980s paper was based on the 3mo-10yr differential.  That's the one I watch.

 

My own thoughts were that the chatter about the brief 2yr-10yr inversion is a head-fake as the long end of the yield curve will rise a lot over the rest of the year.   That's bullish, BTW, for the US economy.  Stock market, maybe not so bullish, who knows?

 

Bill

The big no brainer loser from continually rising bond yields - especially further out on the curve - will be bonds. If this plays out over the year (bond yields across the curve increasing every month) i wonder when Mr Market will just panic and try and unload all bond holdings? At what point will the pain of falling values - month after month - become too great for most investors to bear?
 

What do you do after you sell bonds? Real estate? Tougher in a rising rate environment; but a good inflation hedge. So real estate could hang in there. Stocks? Probably will do ok. Especially sectors that provide some protection to high inflation. 
 

2023 is when things could REALLY get interesting. What if inflation is still high single digit. And labour markets are still super tight. And the economy is still doing OK. And the Fed KEEPS TIGHTENING. 

Edited April 7, 2022 by Viking

[wabuffo]

2023 is when things could REALLY get interesting. What if inflation is still high single digit. And labour markets are still super tight. And the economy is still doing OK. And the Fed KEEPS TIGHTENING. 

 

Very likely - that's why I bought a ton of TLT Jan 2024 LEAP put options (also Jan 2023 LEAP puts too).   We talked about this last summer in various Federal Reserve threads that long rates could rise a lot.

 

And I'm not really a macro investor.

 

Bill

Edited April 7, 2022 by wabuffo

[Viking]

2 minutes ago, wabuffo said:

2023 is when things could REALLY get interesting. What if inflation is still high single digit. And labour markets are still super tight. And the economy is still doing OK. And the Fed KEEPS TIGHTENING. 

 

Very likely - that's why I have a bought a ton of TLT Jan 2024 LEAP put options (also Jan 2023 LEAP puts too).   We talked about this last summer in various Federal Reserve threads that long rates could rise a lot.

 

And I'm not really a macro investor.

 

Bill

Smart. Like a fox.

 

Please keep posting and sharing your thoughts (i was ignoring most of those threads a year ago…)

[Thrifty3000]

On 4/7/2022 at 10:41 AM, wabuffo said:

Lately, the central bank has tried to influence long-term rates on Treasury securities by buying these securities in the open market and paying for them with new reserves deposited to the banking sector's reserve accounts at the Fed. 

 

@wabuffo when this transaction happens is it the Treasury's reserve account that gets credited, or is it the Federal Reserve's reserve account? Basically, what entity is "signing the check" that purchases the Treasuries?

[Thrifty3000]

On 4/7/2022 at 10:41 AM, wabuffo said:

It first creates reserves via its spending and then converts most of the reserves into either currency or treasury securities based on the proportions demanded by the private sector

Also, when you say it (the treasury) first creates reserves I'm assuming this is the act of manifesting money, right? Is converting reserves to currency or treasury securities part of ensuring the Treasury's account doesn't have a negative balance?

Edited April 8, 2022 by Thrifty3000