Friday, December 11, 2015
Rising government debts are becoming worrisome all over the world. Over the past eight years, governments have added $60 trillion in new debt to the already enormous piles of existing debt.
As a point of reference, the entire output of the global economy in 2014 was estimated at $77.6 trillion by the International Monetary Fund (IMF).
The US has been an active player in this global debt binge.
According to the US Treasury, the national debt now stands at $18.775 trillion.
Without context, numbers can be meaningless, and even misleading. So, let me attempt to provide some context.
The IMF recommends that a developed nation’s debt not exceed 60 percent of its gross domestic product (GDP), or the entire output of its economy. A nation’s debt is the cumulative byproduct of accruing annual budget deficits.
In essence, a deficit results from a government spending more money in any given year than it collects in taxes and other revenues. The deficit adds to a nation’s debt.
The concern is that high debt-to-GDP ratios cause economic instability and hinder economic growth.
Again, the national debt is $18.775 trillion, which is bigger than our projected $18.125 trillion economy in 2015.
In other words, our debt is more than 100 percent of our economic output. That’s a whole lot bigger than the IMF’s 60 percent recommendation.
Yet, it's important to remember that the government doesn't pay its expenditures with the entire US economy; it pays for them with its revenues, which are procured through corporate and personal taxes.
The 2016 federal budget shows $3.525 trillion in revenues, which is about 20 percent of the national debt. That's a more accurate and useful reflection of the government's true debt ratio than is debt-to-GDP. It's also more worrisome.
In essence, if the government dedicated every dollar it collected this year to the national debt, it could only pay down roughly 20 percent, and there would be no money for anything else.
The trouble is that each annual deficit leads to even more debt.
For example, the federal government will run a $474 billion deficit in fiscal 2016, which amounts to 2.5 percent of GDP (by the way, the fiscal year is supposed to begin on October 1, but, due to Congressional dysfunction, the budget wasn’t handed to the president to be signed into law until November 2).
Economists have long recommended that a nation’s deficit should not exceed its annual economic growth. For example, if a country’s economy grows by 3 percent, it can sustain a deficit of 3 percent.
While the US economy used to grow by 3 percent annually, it hasn’t cracked that number since 2005. We’re now stuck with roughly 2 percent annual economic growth, which means our deficits should be smaller as well.
However, it should be noted that if the US were to follow the above deficit formula it would be perpetually indebted. A country needs to have economic growth exceeding its deficit in order to begin paying down its existing debt, rather than adding to it each year.
The current federal deficit of 2.5 percent is certainly better than it had been in recent years.
After the 2008 financial and economic crash, deficits soared as the federal government sought to fill the void left by crippled US companies and households, as can be seem below.
Deficits by Year, as a Percentage of GDP (source: Federal Reserve)
2009 - 9.8 percent
2010 - 8.6 percent
2011 - 8.4 percent
2012 - 6.7 percent
2013 - 4.1 percent
2014 - 2.8 percent
Clearly, the deficits have been moving in the right direction. But this doesn’t diminish the fact that deficits are the norm in the US, and they have been for many decades. There is never an honest attempt by Congress to balance the budget by either spending less or collecting more to avoid continual deficits.
Kiplinger’s and the Conference Board both project US economic growth of 2.5 percent this year. If that proves to be accurate, the 2.5 percent deficit would be a wash.
But here’s the concern:
As the national debt has grown continually larger, deficits that once seemed reasonable (say, 3 percent) result in rather huge dollar amounts. For example, this year's 2.5 percent deficit amounts to a whopping $474 billion.
In fiscal 2015, the US spent more on debt service (interest payments) than on housing & community, transportation, education, and food & agriculture. Debt service buys you nothing.
The debt will reach $20 trillion by 2017. By that time, a deficit of 2.5 percent would equal $500 billion — half-a-trillion dollars!
Deficits of that size were once unimaginable; they are now a matter of fact, and they will continue to be at least that large from this point forward. It's just math.
There’s no reason that the deficit will necessarily be restricted to 2.5 percent annually, but even if it is, the result would be $1 trillion in added debt every two years. Yet, as the debt continues to rise, deficits of 'just' 2.5 percent will result in ever larger dollar amounts.
It’s easy to see how this whole thing spirals out of control and eventually cripples the United States.
It’s not some far out notion. The numbers are rather clear.
Debt service crowds out other spending. It robs from critical national needs, such as science, research & development, infrastructure, education, healthcare, etc.
Our debt is on track to become so cumbersome that it will prevent the government from tending to needs that most Americans take for granted.
The national debt isn’t going away. It will continue growing dangerously larger each and every year, well into the foreseeable future.
Tuesday, November 17, 2015
The economic expansion that followed World War II — known as the post-war expansion — was unparalleled in the 20th Century.
Much of Europe, which had been destroyed by years of warfare, needed to be rebuilt. The Marshall Plan — the American initiative to aid in the rebuilding Western Europe after the war — cost approximately $130 billion in today's dollars.
The rebuilding effort put millions of men to work and utilized huge amounts of resources. Roads, bridges, dams, train stations, railways and buildings all needed to be rebuilt or constructed.
The US, absent any competition from Europe or Japan, became the world’s dominant economic superpower in the latter half of the 20th Century.
Once the rebuilding of Europe and Japan was completed, however, a huge source of economic growth came to an end. But Europe and Japan were then able to redirect their energy and resources from the war effort toward other, more useful economic pursuits.
In the process, Europe and Japan became huge sources of industrial output, manufacturing, engineering, research, development and invention. The US suddenly had some competition.
But all developed economies eventually experience a slowing of their growth rates. At some point, most of the potential growth has been ultimately realized and there is less juice to be squeezed from the fruit, so to speak.
Inevitably, the economies of the US, Japan and Europe have all slowed from the from their postwar glory years.
Enter China to pick up the slack.
China’s expansion over the past 30 years — especially the last 20 — rivals the postwar expansion in Europe, Japan and the US.
The Asian giant became the dominant consumer of many — if not most — of the world’s industrial commodities (copper, zinc, iron ore, coal, etc.), creating an economic boom that spread to other countries that are commodities exporters (Brazil, Chile, Australia, New Zealand, Indonesia, etc.).
Between 2000 and 2011, broad indices of commodity prices tripled, easily outpacing global growth, notes The Economist. That was clearly unsustainable, and we are now seeing the fallout.
China’s economy has begun to slow, and like the US, Japan and Europe, it too is overburdened by debt.
From the New York Times:
The so-called supercycle driven by China’s once insatiable appetite for raw materials has been extraordinary by any standard. Edward L. Morse, Citigroup’s global head of commodities research, likens China’s boom to the three decades after World War II when Europe was rebuilt, or the Gilded Age industrialization of the United States in the half-century after the Civil War.
“The last 20 years have been mind-boggling,” Mr. Morse said. “Between 1993 and 2013, China built 200 cities of a million people or more. This was incredibly intensive in terms of steel and copper and other commodities.”
Consider that for a moment. The US, the third most populous country in the world, has just 10 cities with a population of 1 million or more. But China built 200 of them in just 20 years. That is absolutely stunning!
The Chinese boom is tantamount to the massive buildout that occurred in Europe and Japan after WWII. In fact, it was even bigger.
Yet, that massive infrastructure buildout has finally come to an end, and with it so has the commodities super-cycle. Hence, the global crash we are now witnessing.
Commodity prices have fallen to their lowest level since the financial crisis and — by at least one measure — to the lowest this century.
The Bloomberg Commodity Index, which tracks a basket of 22 commodities, has fallen to its lowest level since 1999.
Copper is a key component in manufacturing everything from electronics to cars and other industrial goods. But copper prices are near their worst levels since 2009. Copper has sunk by about 22% so far this year.
China represents 40% of global demand, says financial blogger Wolf Richter. But China and the rest of the global economy are slowing. Absent demand, supplies have grown, so prices have fallen.
Shanghai steel futures have fallen to a record low, largely due to shrinking demand from its top consumer, China.
China is the biggest buyer of iron ore, but its demand is rapidly dwindling. Construction activity in China has fallen considerably over the last year or so.
A global glut of iron ore has sent prices to below $45 a tonne this year, less than a quarter of record highs seen in 2011.
Think about that: iron ore prices are less than a quarter of what they were just four years ago. That’s an epic crash.
Here’s how the NY Times describes it:
"The fall in prices for a variety of products, including crude oil, iron ore and agricultural crops like corn and soybeans is reminiscent of the collapse of the technology boom in 2000 or the bursting of the housing bubble nearly a decade ago. And behind the pain and anxiety are headwinds blowing from China and other emerging markets, where growth is slowing and demand for the raw materials that drive the global economy has dried up.”
Economists describe trends as either cyclical (repeating in shorter-term ups and downs, aka booms and busts) or as secular, meaning they are long term. There is every reason to believe that commodities are now in a secular down trend.
China is not about to build 200 more cities of at least 1 million people over the next 20 years.
That means the global economy is also likely on a long term downward trend. Growth will not match previous levels.
Slow growth and stagnation are likely the new normal.
The only thing growing at a great clip is global debt.
Slow growth and rapidly rising debt are a really unhealthy combination.
But, again, that’s our new normal.
No one wants to hope for an economic expansion that might follow WWIII.
Wednesday, November 04, 2015
There has been a lot of discussion over many years about the decline of the American middle class. That’s because the process has been decades in the making.
But a closer look reveals a broader economic decline, involving almost all Americans, from all classes.
The stagnation of incomes and wages isn’t merely a recent phenomena. When adjusted for inflation, both have suffered a long term decline.
A new report by the Social Security Administration has some rather stunning findings.
In 2014, 38% of all American workers made less than $20,000; 51% made less than $30,000; 63% made less than $40,000; and 72% made less than $50,000.
Put another way, if you make more than $30,000, you earn more than 51% of Americans. And if you make more than $50,000, you earn more than 72% of Americans.
That is simply breath-taking, and it doesn’t square with the notion that America is a prosperous society where anyone can get ahead with some hard work and discipline.
In fact, the U.S. dropped out of the top 10 and into 11th place in the 2015 Legatum Institute Prosperity Index, which measures economy, education, entrepreneurship & opportunity, governance, personal freedom, social capital, health and safety.
If you’re still recovering after digesting those depressing findings from the Social Security Administration, get ready to be shocked again.
In September the US Census Bureau released its report on US household income by quintile. The findings are brutal.
Every quintile (or 20% share), as well as the top 5%, has experienced a decline in real household income since their peaks.
The bottom quintile (the lowest 20 percent) has experienced a 17.1% decline in real income from the 1999 peak (from $14,092 to $11,676). The 4th quintile has had a 10.8% fall in real income since 2000 (from $34,863 to $31,087). The middle quintile has had a 6.9% decline in real income since 2000 (from $58,058 to $54,041). The 2nd quintile has had a 2.8% fall in real income since 2007 (from $90,331 to $87,834). The top quintile has had a decline in real income since 2006 of 1.7% (from $197,466 to $194,053). The top 5% has experienced a 4.8% reduction in real income since 2006 (from $349,215 to $332,347). Only the top One Percent or less (mainly the 0.1%) has experienced growth in income and wealth.
Meanwhile, the US stock markets are still flirting with their all-time highs. Quite a disconnect, huh?
Many American corporations have been actively buying up their own shares with the use of very cheap money — the result of the Fed’s zero-interest-rate policy.
However, stock buy backs are just gimmicks to improve share prices. They don’t actually improve business, and they aren’t a productive use of capital. Stock buy backs may increase earnings per share, but they don't increase earnings. Fewer outstanding shares doesn’t help the bottom line.
Likewise, a company can trim costs (such as personnel) without actually increasing revenues. Ultimately, profits may increase for a while, but there are limits to cost cutting. If revenues aren’t growing, then neither is the company.
The use of stock buybacks and similar gimmicks amount to nothing more than smoke and mirrors.
Corporations engage in such shenanigans as a means of increasing earnings per share, which pleases Wall Street. And, as we all know, what Wall Street wants, Wall Street gets.
Companies will engage in unsustainable practices just to improve their stock price and/or earnings per share in an effort to satisfy the Street.
All focus is on the short term. Live for today, and don’t worry about tomorrow. More precisely, it’s live for this quarter — don’t worry about anything that comes after. There is no concern for the long term.
Wall Street’s takeover of the economy is what is known as “financialization.”
Over the last 35 years, or so, the financial sector has become more important than the industrial and agricultural economies — the sectors that actually produce tangible things. Leverage (debt) has taken precedence over capital, or equity.
Finance is not a productive activity. It is extractive, robbing from the economy. Nothing is created, other than debt.
Joan McCullough, of Longford Associates, sums it up quite nicely in her recent piece, The Financialization of the Economy.
Financialization is characterized by the accrual of profits primarily thru financial channels (allocating or exchanging capital in anticipation of interest, divvies or capital gains) as opposed to accrual of profits thru trade and the production of goods/services.
Economic activity can be “creative” or “distributive.” The former is self- explanatory, i.e., something is produced/created. The latter pretty much simply defines money changing hands… Financialization is viewed as largely distributive.
Business (and government) does the bidding of its financial masters on Wall Street. And Wall Street’s game is pumping out debt, which hangs like a grotesquely outsized albatross around the neck of our economy.
With the Federal Reserve keeping its benchmark at near-zero for the last seven years, companies have loaded up on debt.
“They now owe more in interest than they ever have, while their ability to service what they owe, a metric called interest coverage, is at its lowest since 2009,” notes Bloomberg.
As of the second quarter, high-grade companies tracked by JPMorgan incurred $119 billion in interest expenses over the last year, the most for data going back to 2000, according to the bank’s analysts. Companies have already issued $9.3 trillion in new debt since the financial crisis.
That’s a big hinderance to economic growth.
As the IMF notes, “the marginal effect of financial depth on output growth becomes negative … when credit to the private sector reaches 80-100% of GDP …”
In other words, too much financialization restricts growth.
We’ve long since surpassed that critical threshold. As of 2014, the US ratio of private sector debt to GDP stood at 194.8.
Making money out of money creates nothing.
“By creating nothing, the economy relies on the financialization process to create growth,” writes McCullough. “But the evidence supports the notion that once overdone, financialization stymies growth.”
However, as we all know, debt is not just corporate America’s problem.
The federal government owes over $18.4 trillion in debt (not including trillions more in unfunded liabilities), and the 50 states have a collective debt of over $5 trillion.
Then there’s the debt of ordinary Americans. As of June 30, total household debt was $11.85 trillion — 6.5% below its third quarter 2008 peak of $12.68 trillion, according the the New York Fed. Despite the improvement, Americans are still heavily indebted — or, more accurately, over-indebted.
The point that I’ve made many times through the years is that Americans are tapped out. Despite their shrinking wages and incomes, Americans don’t want to take on further debt. Diminished incomes and large debts have only served to shrink demand and diminish consumption.
Without adequate demand and consumption, business slows, as does investment. In the long run, job creation will be negatively affected as well.
Now the economy just hobbles along, a shadow of its former self. The days of 3,3% annual economic growth (our historic average) are a thing of the past. In fact, the economy hasn’t surpassed 3% annual growth since 2005.
This is our reality. This is what financialization has done to us. It has squeezed and siphoned from the economy. It is leaving a ravaged carcass, as it eats all the meat from our economic bones.
Thursday, October 29, 2015
Of unicorns and interest rates...
The Federal Reserve decided to leave its benchmark interest rate unchanged on Wednesday, maintaining its zero-interest-rate policy (ZIRP) that has been in affect since December 2008.
The decision likely surprised no one. It is an open admission that the Fed doesn’t have much faith in the US economy, or its alleged recovery.
Markets (and the economy) are moved by sentiment (including fear), and this decision signals that economy still isn’t healthy in the eyes of America’s central bank.
For many months, the Fed has led us to believe that would soon raise its key rate; first in June, then in September, and then again in October. Instead, there has been no change in policy.
It's all been much ado about nothing.
The federal funds rate — the benchmark rate for all long term lending in the US — has never been this low, this long.
Inflation is nonexistent (it was literally 0% in the 12 months ending in September), negating the reason to hike. The Fed generally raises rates when it is concerned about inflation, and lowers or maintains them when it is concerned about unemployment and weak economic growth.
After eight years, zero interest rates are no longer shocking — especially in a world of negative interest rates.
Over the last two years, four central banks in Europe moved interest rates into negative territory. The negative interest rate policy (NIRP) was introduced when ZIRP wasn’t working as intended (stimulating the economy through the increased lending of cheap money).
The problem is that, even at these extraordinarily low rates, there aren’t enough borrowers.
The European Central Bank (ECB), along with the central banks of Sweden, Denmark, and Switzerland, all charge large depositors to hold cash.
That’s pretty shocking. It would be even more shocking if it were to be employed here in the US.
But what was once unimaginable in the US is suddenly quite imaginable. After all, the template has been created in Europe. The playbook has been written. There is a precedent taking place right now.
While individuals might be able to close their accounts to avoid the fees — moving to an all-cash payment system where they can — corporations are not able to do this. That would be very costly and disruptive for them.
In a normal world, banks take cash from depositors, pay them interest, and then lend the money at higher rates to borrowers. This helps fuel economic activity and growth.
But this is no longer a normal world.
US rates are significantly higher than the rest of the developed world. The 10-year U.S. Treasury bond yields around 2.0%. Meanwhile, the German 10-year pays a mere 0.5%, and Swiss 10-year bonds are yielding -0.3%.
This is attracting foreign depositors and strengthening the US dollar. That’s making our goods more expensive overseas and hurting trade. In fact, quarterly profits and revenue are set to decline together for the first time since the financial crisis.
Rather than concerning ourselves about when the Fed might finally raise interest rates, maybe we should instead be wondering when they might actually cut them to negative.
No one had ever seen ZIRP before 2008. It was a mythical notion, like a unicorn.
However, now that we’ve seen one unicorn, another may be on the horizon. We might call it NIRP.
Friday, October 16, 2015
I’ve been following the unfolding crisis in Brazil, where economic problems are leading to national misery. This is a really sad and grim time for most Brazilians.
I always try to view these economic crashes through the dimension of human suffering — the suffering of individuals and families. The situation in Brazil is just awful, and terribly painful for millions of its citizens.
And this suffering is going on all around the world right now. It's how political instability begins.
Brazil’s unemployment rate has risen to 7.6 percent from a record-low 4.3 percent at the end of 2014. That’s a 76 percent increase in less than a year, which is enormous.
Latin America’s largest economy is now in recession — already the worst since 1990 — and the situation is expected to worsen.
The spike in unemployment is particularly troubling since the country based its growth model in recent years on a credit-fueled boom in consumer spending. But now millions of Brazilians may be unable to repay their loans for houses and cars.
Over the past decade, Brazil's banks engaged in a massive credit expansion that enabled some 40 million Brazilians to rise out of poverty and into the middle class. Total loans in the banking sector climbed five-fold over that time to 3.1 trillion reais. Family household indebtedness, as a percent of annual income, jumped to 46 percent from 20 percent.
The following is summary of the country's economic malaise:
Brazil officially entered recession four months ago. Its currency, the real, has fallen more than any other major currency in the world this year; annual inflation has soared to almost 10 percent; the budget deficit has swelled to the widest in at least two decades; and the government’s credit rating was cut to junk by Standard & Poor’s.
Last week, analysts at Itau Unibanco Holding predicted the economy will shrink 3 percent this year and unemployment will top 10 percent by 2016.
This means Brazil’s economic woes are expected to worsen over the next year, and with that there will be an increase in human suffering.
Brazil is a major exporter of commodities, and the slowdown in China and the rest of the global economy means that fewer of its commodities are being bought by other nations. This has crushed exports and hurt the overall economy.
Yet, Brazil does not exist in isolation. As the largest economy in Latin America, its pain and suffering will likely be felt more broadly, throughout the Latin world. Economic crashes often have a domino affect.
As I said earlier, this isn’t just about numbers; it’s about human lives. It’s about dashed hopes and dreams. It's about the suffering of millions of people who will lose their jobs and houses, and often wonder where they will find their next meal.
That’s especially difficult for children, who have no idea why any of this is happening.
Brazil is not unique. A number of countries around the world are confronting economic recession right now, including our northern neighbor, Canada, as well as Russia, Japan, and Greece — which is actually in a full blown depression.
Recessions are not merely things that give economists and analysts something to talk about. They are crises that negatively impact the lives of millions of ordinary, everyday working people, whose standard of living usually declines while their suffering typically increases.
That’s the stuff I always keep in mind.
Tuesday, October 13, 2015
One of the primary themes I’ve written about on this page in recent years is how little bang for the buck the Federal Reserve has gotten from its massive -- and unprecedented -- monetary policies.
Near-zero interest rates, three rounds of quantitative easing (QE), Operation Twist, etc., have gotten essentially nothing in return.
Consider that the Fed increased its balance sheet from $869 billion in August, 2007 to $4.5 trillion today. That’s a 450% increase in just eight years.
Yet, the US economy remains stuck at roughly 2 percent annual economic growth -- less than two-thirds of its historic average. That's clearly not the result the Fed was anticipating.
However, the Federal Reserve hasn’t acted alone. Central banks around the world — the Bank of Japan, the Bank of England, the European Central Bank, for example — have initiated their own QE schemes (money printing) and zero-interest-rate policies (ZIRP).
The central banks took these extraordinary measures in the belief that they would stimulate their beleaguered economies in the wake of the 2008 financial and economic crash.
After seven years of easy-monetary policies in developed countries, central bank balance sheets have risen to nearly $8 trillion!
And what do they have to show for it? Roughly 1 percent annual economic growth. Simultaneously, inflation has descended toward zero. In fact, deflation has become a genuine, and growing, threat.
After so much manipulation, so many schemes, and such gargantuan efforts by central banks, investment and growth both remain below pre-crash levels.
Bloomberg described it this way:
"More and more, bond traders are drawing the same conclusion: central bankers globally are coming up short in their attempts to combat the world’s economic woes.
"Even after hundreds of interest-rate cuts and trillions of dollars in quantitative easing, the bond market’s outlook for inflation worldwide is approaching lows last seen during the financial crisis. In the U.S., Europe, U.K., and Japan, those expectations are now weaker than they were before their respective central banks began their last rounds of bond buying.”
The emperor has been revealed to have no clothes. Central bankers, who see themselves as masters of the universe, have been exposed as having little power after all.
One Fed official has even publicly admitted that QE failed.
Stephen D. Williamson, vice president of the St. Louis Fed, says that quantitative easing has, at best, a tenuous link to actual economic improvements.
"There is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed — inflation and real economic activity. Indeed, casual evidence suggests that QE has been ineffective in increasing inflation,” wrote Williamson.
Williamson also said the zero interest rate policy in place since 2008, which was designed to spark "good" inflation, has actually resulted in just the opposite.
Even as monetary policy has failed to meet its goals, government leaders around the world have (through the utilization of fiscal policy) vigorously added to their already enormous piles of debt. They seemed determined to spend their economies out of the doldrums and invigorate them with new debt. But it hasn't worked as planned.
In just eight years, they have added nearly $60 trillion in new debt to the existing mountain — while GDP grew by only $12 trillion over the same time period, notes Chris Martenson, over at Peak Prosperity.
Despite the debt binge, global nominal GDP is projected to be $68.6 trillion in 2015 — virtually unchanged from 2013.
In other words, that massive debt increase got the world very little in return, and essentially nothing over the last two years. The global economy continues to struggle and is, in fact, barely growing at all.
Taken as a whole, developed and emerging countries racked up debt at five times the rate of nominal GDP growth.
This is madness!
Massive debts are not a solution to economic woes if they aren’t accompanied by commensurate economic growth and higher tax collections. Absent those things, debt is an albatross that ultimately weighs down a nation and hinders its government from serving the public interest in areas such as education, health and infrastructure. Servicing the interest on massive debts buys you nothing.
Back in 2010, I wrote that the world’s answer to the debt crisis was to add more debt. In essence, the solution was to treat the disease with more of the same disease.
Five years later, nothing has changed. Somehow, the world still hasn’t learned that you cannot cure a debt crisis with even more debt.
The lack of economic growth presents an epic challenge for global leaders.
They all need economic growth to service their enormous debts. The trouble is, there can be no growth without debt. Growth equals debt. In order to grow, the world's economies will have to incur even more debt. But that’s like adding more disease to an already sick patient.
Central bankers keep doing more of the same, expecting different results. By the way, that’s the definition of insanity.
The IMF recently downgraded its growth outlook for the world, and warned of a rising risk of a global recession.
Meanwhile, the Organization for Economic Cooperation and Development says leading indicators on a wide variety of data show that the world’s three largest economies — the U.S., China and Japan, as well as the U.K. and Canada -- are poised for slowdown.
This has got to be stunning, and depressing, for central bankers and government planners (not to mention the rest of us).
They’ve given it their best shot — utilizing every resource at their disposal, really — yet they’ve failed to re-inflate the bubble. All they’ve done is create absurdly unstable balance sheets, while racking up absolutely massive amounts of debt.
Maybe they’ve so far prevented a global depression. We’ll never know, since you can’t prove a negative.
We’re now in uncharted waters. These are unprecedented times. The world has never seen so much debt. Nor has it seen interest rates this low, never mind for this long.
In a normal world, this should be sparking massive, out of control inflation. But that hasn’t happened. This isn’t how the playbook says things should be. Economic textbooks will have to be re-written.
At this point, the Federal Reserve and other central banks appear to be trying to hold back the tide. Obviously, such an effort is in vain. The forces of global deflation are gaining steam, and world economic growth has reached a standstill.
There is plenty of academic work showing that massive debts -- both government and private -- ultimately hold back economic growth, and we're likely seeing that right now.
Again, global debt has increased at five times the rate of nominal GDP growth over the past eight years.
Clearly, that isn’t a solution. It’s more like a recipe for disaster.
Hold on tight. Things are about to get very bumpy.
Friday, October 02, 2015
The US economy created 142,000 jobs in September, following a revised 136,000 gain in August, which was lower than previously estimated.
This raises the real concern that the economy may be slowing.
However, the glaring issue is that a record 94,610,000 Americans were not in the American labor force last month — an increase of 579,000 from August, which had been the previous record increase.
The labor force participation rate, which indicates the share of the working-age people in the labor force, decreased to 62.4 percent from 62.6 percent. That was the lowest since October 1977.
When the Great Recession officially began in December 2007, the proportion of adults who either have a job or are looking for one stood at 66 percent. This means that, eight years later, roughly 8 million fewer people are now in the workforce.
The number of Americans in the labor force has continued to fall partly because of retiring Baby Boomers, and because fewer workers are entering the workforce.
The Congressional Budget Office says about half the decline is due to the aging population. Roughly 10,000 baby boomers turn 65 every day, and many of them retire.
Again, the retirement of the Baby Boomers is only half the reason that the labor force participation rate continues to fall.
This raises a thorny issue -- a whopping number of Americans are no longer productive and helping to support the economy.
In September, there were 156,715,000 people (age 16 or older who were not in the military or an institution) participating in the labor force by either holding a job or actively seeking one, according to the Labor Department’s Bureau of Labor Statistics.
Let me put this in a clearer perspective:
There are 156,715,000 people in the labor force.
There are 94,610,000 people not in the labor force.
In essence, there are just 1.66 workers for every non-worker.
There is no good way to spin this. It’s just not healthy for our economy.
Even if you attribute the problem solely to the retiring Baby Boomers (which isn’t entirely so), that means it is a long-term, structural problem without a solution. It is something that just needs to play itself out over many years.
However, 1.9 million people were marginally attached to the labor force in September, meaning they were not in the labor force but wanted and were available for work, and had looked for a job some time in the prior 12 months.
Additionally, there were 6 million people employed part time for economic reasons (involuntary part-time workers) in September. These individuals, who would have preferred full-time employment, were working part time because their hours had been cut back or because they were unable to find a full-time job.
The economy simply cannot fire on all cylinders with nearly 8 million people out of the workforce for involuntary reasons. These folks can’t propel demand, increase consumption, or drive economic output.
Yet, those figures don’t even include the 8 million who are officially listed as unemployed (the unemployment rate remained at 5.1 percent in September).
Taken as a whole, it means that 16 million Americans are either unemployed or under-employed.
Many of these people are reliant on government assistance to get by. That robs from the economy rather than adding to it. Fewer workers result in less economic growth.
The more people who are either too young or too old to work leaves fewer working-age people to support them and contribute to the economy. This is what’s know as the “dependency ratio.” The higher the ratio, the worse it is for the economy.
This is not a political screed. It is not meant as an indictment of the president, or either political party.
These are just stubborn facts, and they point to a significant reason that our annual economic growth has remained stuck at roughly 2 percent since the Great Recession officially ended. The nation’s long-tern, historic average for annual economic growth is 3.3 percent.
So, if you hear anyone (namely a candidate for president) say this is a problem with an easy solution, and that he/she will just “get” our economy back to its historic average, or even up to 4 percent annual growth (as some have suggested), don’t believe it for a minute.
This is a long-term, structural problem with no solution other than the passage of time.
The Baby Boomers are defined as the generation born between 1946 and 1964, and they comprise nearly a quarter of the US population — or more than 75 million people.
While they were once were an unprecedented economic force, that is no longer the case.
With the Social Security retirement age now age 67 for anyone born after 1960, the last of the Baby Boomers won’t retire until 2031 — 16 years from now.
But, again, the retirement of the Baby Boomers is only half the reason for the fall in the labor force rate, according to the Congressional Budget Office.
The other half is due to an education and skills gap, and that won’t be easy to fix either.
Tuesday, September 29, 2015
Some are calling Monday's announcement by Shell Oil that it will cease drilling in the Arctic a victory for environmentalists.
In truth, it is a victory for economics. In essence, drilling in the region simply did not make financial sense.
Shell had already sunk billions of dollars into exploration, and the results were quite disappointing for the Dutch company.
Shell drilled in the Chukchi Sea this summer, but found only traces of oil and gas. The company got essentially nothing for its $7 billion exploration project.
It will result in an absolutely massive loss considering that Shell's entire net profit in the second quarter this year was $3.4 billion.
Shell’s investors must be none too happy right now. The oil giant’s share price has fallen by around a third over the past year.
When Shell got its license to explore the Chukchi Sea in 2008 and then began drilling, oil prices were more than $100 a barrel. Today, prices have tumbled to less than half that, due to excess global supplies.
The failure to find sufficient oil and gas casts doubt about the viability of future Arctic projects. That should buoy environmentalists.
But make no mistake: Shell’s decision to abandon its drilling project in the Arctic was not due to pressure from environmental groups. It was due to financial pressure.
The numbers simply didn’t add up, and economics (or good sense) prevailed.
Drilling more than a mile beneath the ocean’s surface (Shell drilled to 6,800 feet) has been compared to operating in outer space. The technology and costs involved are enormous. The process is challenging enough in the warm waters of the Gulf of Mexico. But it is another magnitude of difficulty in the frigid Arctic.
If crude prices again reach $100 per barrel, some energy companies may be emboldened to begin exploration in the area once again.
The U.S. Geological Survey estimates that American Arctic waters in the Chukchi and Beaufort seas contain 26 billion barrels or more of recoverable oil.
However, that estimate now seems highly questionable.
Additionally, an Energy Department advisory council said it would take more than a decade for oil in the Arctic to be discovered, developed and brought to market.
For example, Italian energy company Eni SpA and Norwegian producer Statoil ASA are just now moving into production on a giant oil field in the Barents Sea -- 15 years after it was discovered.
Timelines aside, it’s critical to remember that Shell didn’t decide to abandon its efforts simply because the price of oil had fallen too far for drilling to make financial sense.
Shell walked away because there simply wasn’t enough oil or gas to be found in the region, and $100 per barrel oil won’t change that.
Thursday, September 24, 2015
During the Great Recession, states across the country began running large budget deficits. This was to be expected. Tax receipts fell, while safety net expenditures (such as unemployment payments, food assistance and other help for those in need) increased.
While the Great Recession is defined as beginning in December 2007 and ending in June 2009, the state burdens never really went away.
Some governors cut their state’s taxes with the hope that it would increase economic activity, but unfortunately they were proven wrong.
More than six years after the alleged economic recovery began, numerous states are still running budget deficits, ranging from small states like Rhode Island to large states like Illinois.
Here are just a few examples:
• Illinois had a staggering $6 billion budget deficit in the 2014 fiscal year, and a $9 billion budget in the 2015 fiscal year — the largest state budget deficit in the nation.
• Pennsylvania dealt with a $2.3 billion budget deficit for 2015.
• Wisconsin faces a $2.2 billion budget deficit over the 2015 and 2016 fiscal years.
• Maryland grappled with a $750 million budget deficit in the last fiscal year.
• Kansas had a $710 million budget deficit for the 2014 fiscal year.
All but four states (Alabama, Michigan, New York and Texas) begin their fiscal year on July 1, meaning that they are now in fiscal 2016. Yet, the budget problems of recent years have continued unabated.
The New York Times reports the following state budget deficits for fiscal 2016, and this is only a partial list:
• Alaska is facing a deficit that could reach $4 billion in a budget of only about $5 billion — with years of deficits projected after that as well.
• Illinois is grappling with a $3 billion budget shortfall.
• Louisiana is struggling with a $1.6 billion shortfall.
• Alabama has a long-term $702 million shortfall.
• Kansas has a $400 million budget gap.
• Wisconsin has a budget shortfall of more than $280 million.
In short, the fiscal position of many states across the nation is awful, and the problem has been growing continually worse.
Just how bad is debt burden in all 50 states?
State and local governments have sharply increased borrowing over the past three decades. In 1980, they were carrying close to $400 billion in outstanding debt; by 2000, it was $1.2 trillion; and by 2013, it had reached $3 trillion, according to the Board of Governors of the Federal Reserve System.
Yet, according to another analysis, the cumulative state debt has grown much worse in recent years.
State governments faced a combined $5.1 trillion in debt, which amounted to $16,178 per capita in the nation, according to a January 2014 report by the nonprofit organization State Budget Solutions.
This means that state and local debt increased nearly 13-fold in just 33 years. Think about that for a moment; it amounts to a 1,300 percent debt increase in just over three decades. That’s astonishing!
While it’s true that state economies, revenues and budgets are also considerably larger today than in 1980, the massive increase in debt is still striking.
Given that reality, it’s not enough to simply look at the size of each state’s budget deficit; you have to consider the size of its economy, or gross domestic product (GDP), as well.
That's when the problem becomes more complicated: a whopping 47 states had deficits that were larger than their GDP growth in fiscal 2015.
In simple terms, if a state’s debt increases 2% but its economy also grows by 2%, it is effectively a wash.
But almost every state saw its debt increase well beyond its economic growth, which makes servicing those debts much more difficult.
So where is this all leading? Well, the outcomes will be very uncomfortable.
Whether it's public-employee pensions; the building, repair or maintenance of critical infrastructure; education; police; fire departments; or any of the other countless services that taxpayers have come to expect, something has to give.
The means simply do not exist to pay for all of it given the structural economic constraints.
In Here Comes The Next Crisis ’Nobody Saw Coming’, Charles Hugh Smith notes the following:
• Nominal GDP rose about 77% since 2000, while state and local debt rose 150% — double the rate of GDP. Again, debt has increased at double the rate of economic growth.
• State and local taxes have soared 75% since 2000, while earnings have risen just 38%, barely keeping pace with inflation. So, state and local taxes have risen at twice the rate of wages/salaries.
• State and local government expenditures have risen 82% since 2000 — faster than GDP, and twice the rate of inflation.
• Yet, wages and salaries are down 8.5% since 2000.
Taken as a whole, this is a recipe for disaster. All the problems from 2008 were simply papered over, not solved.
Debt is like the monster in every horror film; it’s hard to kill and keeps coming back.
This is a simple math problem, and the numbers do not add up. Debt has significantly outpaced economic growth, while taxes have significantly outpaced wages and salaries. Taxpayers are already squeezed and have little left to give.
As Herb Stein’s law states, “If something cannot go on forever, it will stop."
States cannot carry this much debt while their economies continue to struggle for growth.
This will not have a happy ending, and anyone paying attention knows this. The pending crisis won’t come out of nowhere.
It is already unfolding.
Thursday, September 17, 2015
Right now, there is a growing concern about deflation around the world.
The price of oil has crashed (along with most other commodities), which has pushed down transportation costs. That, in turn, has driven down the cost of virtually all goods.
The Federal Reserve has a publicly stated goal of maintaining an annual inflation rate of 2 percent.
However, the latest inflation rate for the United States is just 0.2 percent through the 12 months ended in August.
For perspective, the inflation rate in the United States averaged 3.32 percent from 1914 until 2015.
Most worrisome, perhaps, over past year wholesale prices have fallen 0.8 percent.
Recessions are by definition deflationary, and many of the world’s major economies are now in recession -- including Japan, Russia, Canada and Brazil, for example.
Even China, the world's second biggest economy (after the U.S.), is slowing.
The Asian giant is the top user of almost all commodities, including coal, iron ore and most metals. But as its economy slows, its demand for commodities is slowing too.
China overtook the United States as the world's top importer of crude oil for the first time in April.
Though it is not in recession, China's falling demand has put downward pressure on all commodities, which is having a global impact -- especially on commodities exporters, such as Australia, Russia, Brazil, Indonesia, and the big oil producers of the Middle East.
This is adding to disinflationary pressures around the globe.
Despite their best efforts, central bankers around the world have seen inflation rates fall far short of their targets in recent years, to the point that deflation is now a genuine concern.
Central banks fear deflation above all else. When it takes hold it can be very difficult to halt, and it can be crippling.
Deflation is worrisome because falling prices make it difficult for the government and companies to repay debts. Whatever you borrow money for is soon worth less than you paid.
Delation is marked by continually declining asset prices, and is often associated with a reduction in the money supply, or credit. It leads to falling wages and layoffs, and can be the prelude to a very bad recession.
Obviously, falling wages make debt repayments more difficult (or impossible) for consumers.
While deflation is characterized by falling prices, it is ultimately a continual increase in the purchasing power of money.
While that may seem wonderful, it is a particularly troubling outcome because it de-incentivizes investment. All investments simply lose value over time, even on an annual basis. The purchase of houses, cars, commercial buildings, factories and the like quickly become bad investments.
But without these investments, the economy will spiral downward in horrifying fashion. The last time the US experienced deflation was during the Great Depression.
The specter of Japan's struggle with deflation is what worries many. The Asian nation has battled slowly falling prices for the last two decades. Despite nominal interest rates of zero, Japan is still fighting deflation.
When confronting deflation (or even low inflation), central banks will typically cut interest rates.
However, with near-zero interest rates in the US for the past seven years, there is little room left to maneuver without going into negative territory.
For perspective, the Fed's benchmark rate has averaged 6 percent since 1971, and soared as high as 20 percent in 1980.
Low interest rates generally stimulate demand, which will lift the economy. Yet, historically low rates have not stimulated demand in recent years.
Consumers remain cautious, and are wary of spending and/or borrowing at pre-recession levels.
Even though the Fed has made money very cheap and readily available, it cannot force Americans to borrow. People with huge debts, low and/or falling wages, no jobs, or the fear of becoming unemployed, will not be persuaded to borrow.
And therein lies the problem: Our entire economy is predicated on borrowing and lending for economic growth to occur.
Money is created through borrowing. Without borrowing, there is less money and no growth. Absent growth, there are no jobs. And without jobs, there is a shrunken tax base and, ultimately, recession.
The Fed is now confronting the fact that three rounds of quantitative easing (QE) and seven years of its zero-interest-rate policy (ZIRP) have failed. The Vice President of the St. Louis Federal Reserve recently admitted as much.
That’s the scary part.
When you’ve given it your best shot and it still isn’t enough, then what?
Deflation is a bitch. Just ask the Japanese.
Wednesday, September 09, 2015
Call it a non-recovery.
Since the alleged economic recovery began in mid-2009, annual economic growth has hovered around 2%, well short of the nation’s historical average of 3.3%. In fact, the US economy has not surpassed 3% annual growth since 2005.
So, for a decade, the US economy has lagged its long term norm.
Yet, this slowdown is just part of a longer term decline.
From 1947 through to 2015, the United States economy grew by an average of 3.25% per year.
However, since 1973, the economy has experienced slower growth, averaging just 2.7% annually.
The best year for the US economy since 1948 came in 1950, when it expanded by 8.7%.
Here are the top five years of GDP growth since 1948:
As you can see, four of the five best years came in the 1950s, and the other occurred 31 years ago.
Though the economy had already been in long term decline for over three decades, the growth rate has slowed quite considerably in the years since the 2008 financial crisis and subsequent Great Recession.
In response to the crisis, which nearly sank the US economy, the Federal Reserve took some rather drastic actions.
First, it lowered the Federal Funds Rate (essentially an overnight lending rate for banks) to a range of 0% to 0.25%. This has allowed banks and large corporations to borrow very cheaply for the past seven years. In fact, for the Big Banks, money has been essentially free at times.
Then the Fed started its quantitative easing (QE) program, under which it printed money to buy mortgage bonds and Treasuries. In fact, the Fed ultimately unleashed three rounds of quantitative easing (QE1, QE2, QE3), plus Operation Twist.
In the process, the Fed’s balance sheet has increased rather significantly, rising from $869 billion in August, 2007 to $4.5 trillion today. That's a 450% increase in just eight years.
Yet, all of these absolutely massive Federal Reserve stimulus programs, which were intended to re-inflate the economy, have barely made a difference.
Here’s a look at the last eight years of US economic growth, according to the World Bank:
This continued weakness, coupled with stagnant wages and incomes, has lowered the standards of living for millions of Americans.
The US economy is driven by consumer spending, which accounts for roughly 70% of GDP. Yet, consumers are in no position to be the engine that brings this economy roaring back to life.
Household incomes are the same now as they were in 1995, after you adjust for inflation. That means that the typical American family isn’t any better off now than 20 years ago.
Consequently, Americans have substituted debt for income growth in recent decades.
Average household debt, though below pre-Great Recession levels, is much higher than it was three decades ago.
According to the Federal Reserve’s Survey of Consumer Finances, after adjusting for inflation, the amount of debt held by the average family nearly doubled from $47,356 in 1989 to $91,114 in 2013.
Additionally, household debt as a share of GDP has increased by roughly 20 percentage points over that same time period, from around 60 percent in 1989 to just above 80 percent in 2013.
The economy needs continually increasing demand and consumption to keep growing. When consumers can’t create enough demand to spur sufficient growth, the government typically steps in.
But, with a national debt in excess of $18 trillion, further deficit spending is no longer a reasonable option (and it wasn’t many trillions ago either).
As it stands, debt growth is outpacing economic growth. That’s a terrible, and unsustainable, situation.
The federal budget deficit for fiscal 2015 (which ends Sept. 30) is expected to drop to roughly $425 billion, according to a report released last month by the nonpartisan Congressional Budget Office (CBO).
If so, it would be a seven-year low for the government’s annual budget shortfalls.
Last year’s deficit was $483 billion, 2.1 percent of gross domestic product, the lowest level since 2008.
If this year's lower deficit sounds like good news to you, ask yourself why $425 billion in deficit-spending in a single year can be considered good news.
Yet, if it wasn’t for that $425 billion in deficit spending this year, and the nearly half-trillion in deficit spending last year, our economy would most certainly be in recession.
Our economy is entirely reliant on debt to keep functioning.
Since all money is loaned into existence, money equals debt. The economy cannot grow without an expansion of debt, meaning that debts can never be fully retired. If debt isn’t accumulating, then money isn't being created and the whole system locks up and shuts down.
And therein lies the problem: Ours is a debt-based economy, and without continually expanding debt at all levels — consumer, corporate and government — there can be no return to what was once viewed as "normal."
In short, there can be no economic growth without debt.
It’s quite likely that without all of the government’s continual deficit spending, we’d be in the midst of a long term depression.
Advanced economies are mature economies, and are therefore harder to grow. The hard reality is that the low growth rates of last eight years are likely just the beginning of a longer-term period of lower, perhaps even zero, growth.
The Federal Reserve has undertaken massive, extraordinary, and rather drastic measures to get the economy out of recession and resume vigorous growth.
Yet, their nearly seven-year efforts have largely failed, and that is a troubling reality.
We are witnessing the limits of monetary policy. This is the best that it can do.
Wednesday, September 02, 2015
In December 2008, the Federal Reserve set its benchmark interest rate close to zero as a way to bolster the economy. The rate has remained there ever since.
Leaving the rate that low, for this long, is unprecedented. In fact, the last time the Fed raised interest rates was in June 2006.
Now the Fed wants to raise its key interest rate — the federal funds rate — which has been set between 0.00% and 0.25% for nearly seven years. That has led to increased volatility and instability in the stock markets.
When interest rates are this low, even small increases make a big difference.
Very small absolute changes in interest rates are proportionately large when the primary interest rate is so low.
That’s why the market has been thrown into such turmoil in recent months over the prospect that the Fed will soon rise its key interest rate — likely by no more than a mere quarter point.
The federal funds rate is the amount banks charge each other for overnight loans. It is set by the Federal Reserve through its purchases and sales of short-term Treasuries in trades with commercial banks.
The Fed typically raises or lowers the funds rate in quarter point increments.
If the funds rate increases from 0.25% to 0.50%, the rate effectively doubles. That’s why the markets are freaking out. A quarter point is typically a small movement, but when the funds rate is as low as it is now, a quarter-point hike is relatively huge.
If, for example, the 10-year Treasury moves from 2% to 2.25%, that quarter-point increase actually represents a proportional increase of 12.5%, which is substantial.
However, when the 10-year is at 5%, a quarter-point increase isn’t nearly as impactful.
By setting the funds rate near zero, the Fed went as far as it could with its main tool for guiding the economy. Since the Fed could no longer use interest rates to stimulate the economy, it was effectively out of ammunition.
When rock bottom interest rates didn’t have the intended effect, the Fed then used a strategy known as “quantitative easing” (QE) to try to stimulate the economy.
Employing QE, the Fed created money to buy Treasuries and mortgage securities in an effort to bring down long-term rates even further. Ultimately, the Fed utilized QE three times — QE1, QE2 and QE3, as well as “Operation Twist.”
The strategy led to a stock market bubble, pumped up the housing market (perhaps another bubble), and led to lots of mortgage refinancing.
Yet, the economy continues to muddle along, with an annual growth rate of roughly 2%.
When the next financial crisis or economic downturn occurs (and we all know it’s coming), the Fed will have one less tool to employ with its benchmark rate near zero. That’s why it desperately wants to raise the funds rate as soon as possible.
The problem is that outside forces are stymying the Fed’s plans.
The global commodities crash is creating deflationary forces, which makes raising rates a bad idea (central banks generally cut rates to fight deflation).
Additionally, the global stock market rout has everyone worried right now. The entire global economy is slowing (for example, Japan, Brazil and Canada are all in recession), which will likely affect the US at some point.
When that moment arrives, the Fed wants to be ready to act by cutting interest rates again.
But it can’t do that until it raises them first.
Kind of a nutty situation, huh?
With the funds rate so remarkably low, the Fed is performing a high wire act at present, and desperately hoping to avoid global cross winds.
That's an unlikely prospect right now.
Thursday, August 27, 2015
Japan has a major demographics problem.
The country has the oldest population, and the highest proportion of age 65+ adults, in the world. In fact, the size of Japan’s senior population is unprecedented in world history.
Seniors make up a significant portion of Japan's population. According to the latest estimates from Statistics Japan, over a quarter of the population is over the age of 65 and nearly 13 percent are over 75.
By 2030, one in every three people will be 65+ years, and one in five people will be 75+ years.
Think about that for a moment. Japan is the world’s first mass-geriatric society.
In 1963, Japan had only 153 centenarians. Today, there are more than 58,000.
However, a UN projection estimates that by 2050, Japan will have around 1 million centenarians. That is a population bomb of very old people.
Yet, the overall population is shrinking.
Young Japanese couples have lost interest in having children, to the degree that it is bringing down the population. It's not a new phenomena; it's been going on for decades.
The country’s population peaked in 2004 at 128 million, and is projected to shrink to 75 percent of its peak size by 2050.
So, the population is simultaneously getting smaller and significantly older.
This is already affecting pensions, health care, and long-term care, all of which have enormous costs. That’s bad news for an economy that has been struggling for decades.
Japan has the highest life expectancy for women in the world, at 87, and falls in the top 10 for men, at 80.
With the second lowest birthrate in the world (behind Germany), how will Japan care for this tsunami of seniors?
In 2030, one person aged 65+ years will be supported by two working-age persons, compared with 11.2 persons in 1960.
Japan’s birthrate of 1.42 is far below the 2.07 deemed necessary to maintain the population — a level that has not been recorded in Japan since 1973.
Last year, the nation suffered the largest natural decline in its population as the number of newborns hit a record low and the number of deaths rose to a postwar high — a reflection of the rapid aging of the population.
Even if the fertility rate picks up, the pool of women of child-bearing age itself is shrinking so there will still be fewer babies born.
The social implications of this concurrent collapse in the birthrate, and the huge rise in the number of seniors (even centenarians), come with major economic implications.
The number of young working adults isn’t nearly large enough to support the huge number of older, non-working adults. The nation’s social security system could collapse under the weight of this.
The basic math simply does not add up. It's clear that most of Japan’s seniors will have to find a way to keep working.
The large number of deaths in Japan is having other consequences as well.
As its population dwindles, more and more residences are being abandoned and left in disrepair. There are now eight million vacant homes in Japan, the New York Times reports. That’s significant for a nation of 127 million people.
Japan’s upside-down demographic pyramid is creating enormous economic challenges.
Japan’s debt is already at about 245 percent of its annual gross domestic product, and the International Monetary Fund has warned that its debt will be three times the size of its economy by 2030, unless the government acts now to control spending.
However, the country has been battling deflation for two decades, and the government has used fiscal and monetary policy to help raise the country out of its economic doldrums. But it hasn’t done much except to raise the nation’s debt to unsustainable levels.
Japan’s economy contracted at an annualized rate of 1.6 percent in the second quarter (April-June) as exports slumped and consumers cut back on spending.
Living standards have steadily eroded and per capita incomes today are 10 percent below the level of 1990, which is likely why Japanese couples stopped having kids.
The economic decline has surely created a depressing environment for the Japanese people, particularly for younger workers who will not have the same economic freedoms as their parents.
That’s aside from the fact that China overtook Japan to become the world’s second biggest economy in 2010. Japan had held the number two spot, behind the US, since 1968, when it overtook West Germany.
That was surely a huge psychological blow to the society, which witnessed its standing in the world decline in a measurable way.
Japan’s tax base is shrinking along with its population, which makes its debt all the more cumbersome. How much longer before the country faces a full blown debt crisis is hard to tell, but it seems like just a matter of time.
The only good news for Japan is that most of its debt is owed internally, rather than externally.
No matter, debts are always expected to be repaid. That's a troubling assumption for such an indebted nation, especially one with such awful demographic problems.
Sunday, August 23, 2015
On Friday, the Dow Jones Industrial Average suffered its biggest two-day point drop since the 2008 financial crisis. The Dow plummeted over 1,000 points last week -- the worst week since 2011.
Volatile equities markets and worries about the global economic slowdown are driving investors into safe havens.
Treasury yields dropped Friday for a third straight day, with the 10-year yield posting its largest weekly decline in five months and finishing at a nearly four-month low.
The yield on the 10-year Treasury declined 3.1 basis point to 2.052% on Friday, its lowest point since April 30.
Demand for Treasuries drives down yields. The US doesn’t need to induce desperate investors to buy when fear does that all by itself.
So, how might this affect the Fed's long-held plan to raise its key interest rate, which has been stuck at or below 0.25 percent since December 2008?
If Treasury yields are falling on their own, would the Fed essentially be in the position of trying to hold back the tide with a rate hike?
Or, would the Fed feel empowered to raise the funds rate since the downward pressure on yields would give them some cover, and room to maneuver?
The combination of lower international yields and higher Treasury yields has already increased investor demand, both foreign and domestic. Higher demand pushes yields lower.
Another consideration for the Fed is the continuing strength of the dollar, which makes dollar-denominated fixed-income assets additionally attractive.
A rate hike would draw in even more foreign money from around the world. The yield sharks are everywhere. And though Treasuries may be falling, they are still higher than yields in much of Europe and Japan, the other perceived “safe” zones.
For example, the German 10-year bund was yielding just 0.565% last week.
Raising the federal funds rate would surely create a flood of hot money into the US, searching for the combination of higher yield and safety.
That would crush already suffering emerging markets, which have been experiencing an exodus of investor money.
Moreover, the strong dollar is already punishing US exporters. American-made goods are less competitive against cheaper foreign goods.
A move higher in rates would only exacerbate the problem, raising the trade deficit even further.
An interest rate hike would also add to deflationary forces. In simple terms, a stronger dollar increases the risk of deflation.
Oil, which is priced in dollars, is already falling due to excess global supplies and weaker global demand. A stronger dollar would make oil even cheaper in the US.
That would be great for American drivers, but awful for US oil companies. The US is the No. 3 crude producer in the world. A lot of jobs and tax revenue are derived from the domestic oil industry.
The Fed has been expected to raise interest rates all year, something it hasn’t done in over nine years. But a combination of deflationary forces and a stumbling economy have kept policy makers from acting.
The Fed surely wants a higher funds rate in order to confront the next financial/economic crisis. We all know it’s coming.
With rates currently just above zero, the only place to go in the event of such a crisis would be zero, or even negative.
That’s a nightmarish scenario.
So, while the Fed is desperate to raise rates, outside forces are tying its hands, and are in fact driving rates down instead.
Thursday, August 20, 2015
If this stock market seems to defy both gravity and rationality, you’re not crazy.
Corporate profits are barely growing, yet the stock market has continued its uprward march this year.
However, largely because of oil-ravaged energy companies and the strength of the dollar, second-quarter earnings from S&P 500 companies are largely flat.
About 44 percent of the revenues from S&P 500 companies come from outside the United States, and the global slump is starting to hurt US markets.
Fully one-third of the companies in the Russell 2000 stock index do not earn any profits, the highest percentage in a non-recessionary period, notes Francis Gannon, co-chief investment officer at Royce Funds. And through the second quarter, a majority of the performance in the Russell 2000 index came from companies that lost money before interest, taxes, depreciation and amortization.
Corporate buybacks are artificially raising share prices, which has created a false sense of health. But cracks are finally showing.
The S&P 500 is now down 1.1 percent this year.
Meanwhile, the Dow is down 2 percent year-to-date, while the Nasdaq is up just 6 percent.
Despite this weak performance, stocks aren’t cheap. The US equity market is trading at a richer valuation than most others.
Professor Robert Shiller’s cyclically adjusted price earnings ratio (CAPE) for the S&P 500 stands at 27.2, some 64 percent above its historic average of 16.6. On only three occasions since 1882 has it been higher – in 1929, 2000 and 2007.
Market crashes followed each time.
In a normal world, stocks would be challenged to move higher in the absence of real earnings growth.
Yet, reality may finally be setting in. We may be witnessing the beginning of a long overdue decline in this six-year bull run.
Absent profits and earnings, how long will investors continue to play this game of roulette?
Historically low interest rates have provided few alternatives for investors. Up until now, there’s been little sense in buying government bonds, or putting your money in a bank CD (which seems positively old fashioned at this point) when the stock market has continued an upward ascent.
However, those ultra-low rates have driven a lot of people into stocks who would not normally be there. That money could exit the markets quickly once rates start to normalize, or if the markets continue to tumble.
The perceived safety of Treasuries and other safe havens, such as gold, could see huge inflows of money.
Another concern is the level of borrowing to fund stock investments. The use of 'leverage' to buy stocks is very near its peak.
According to the New York Stock Exchange, margin debt stood at $505 billion in June, the most recent figure available. That’s down just a bit from the April peak of $507 billion, but up 9 percent from the same period last year.
That's a recipe for disaster.
This is the third-longest bull market in 80 years. There is bound to be a significant correction (likely an outright crash) sooner than later, and it may have already begun.
Economies around the world are slowing, from the biggest to the smallest. That’s putting downward pressure on global markets and, worst of all, creating fear.
Markets don’t like fear; it creates a mad rush to the exits.
As the Romans once implored, "caveat emptor."
Or, in today’s parlance, "buyer beware."
Saturday, August 15, 2015
The signs of a global economic slowdown are everywhere, and they are numerous.
Economies around the world -- both big and small, developed and emerging -- are hurting.
Japan’s economy contracted in the second quarter (April-June) as exports slumped and consumers cut back on spending.
The world’s third-largest economy shrank at an annualized rate of 1.6 percent in the second quarter, after expanding 3.9 percent in the first quarter.
This is despite the fact that the Bank of Japan is engaged in a massive monetary stimulus plan intended to end two decades of deflation and economic decay.
Living standards have steadily eroded and per capita incomes today are 10 percent below the level of 1990.
It is a positively nightmarish scenario for Japan if its monetary stimulus policy is failing.
Then there's China, the world's second largest economy.
Though China reported that its economy expanded at a 7 percent annualized clip in the second quarter, no one believed them. And it was for good reason.
Chinese exports fell 8.3 percent in July, its stock markets have been crashing, and it is confronting the collapse of its real estate market.
Meanwhile, China’s index of producer prices declined 5.4 percent from a year earlier in July, the most since 2009 and and the 40th straight month of price decline, raising fears of deflation.
China responded by devaluing its currency this week. It was a rather blatant sign of desperation, indicating that its economy is much worse than officials are admitting. If that’s the case, it’s a very bad omen for the global economy.
Chinese authorities don’t just look desperate; they look clueless. Free markets aren’t manipulated markets.
In the same way that Wall St. is manipulated by bankers, China's markets are manipulated by government officials.
China has a decades-long history of dictating top-down, state-planned, authoritarian policies. The leadership simply implements policy by force of will. However, markets don’t work like that.
The Asian giant is trying a first-of-its-kind attempt at a communism / capitalism hybrid. The notion of such a thing seems schizophrenic, and perhaps it is finally proving to be so.
The decline of China’s economy is bad news for Brazil’s economy, which is heavily dependent on commodities exports (as are Australia, South Africa and other emerging markets).
Brazil is already in recession, and its economy will shrink 2.3 percent by the end of the year, says Bank of America Merrill Lynch. The bank also predicts a recession in 2016.
Brazil's currency is plummeting, having fallen 34 percent against the dollar this year to its lowest point since 2003.
Russia has been driven into recession by a combination of plunging oil prices and Western sanctions. Its economy contracted 4.6 percent in the second quarter, its weakest performance since 2009.
In short, without oil and natural gas, Russia wouldn’t have an economy.
Inflation plagues Russia; the annual pace of price growth has remained above 15 percent for several months, far above the central bank’s 4 percent target.
Eurozone growth has also slowed. The 19-nation economic bloc expanded just 0.3 percent in the second quarter, which followed a meager 0.4 percent gain in the first quarter.
Analysts at Capital Economics said the eurozone would likely continue slow growth.
Even our northern neighbor, Canada, is in recession as a result of collapsing oil prices.
Around the globe, the warning signals are flashing.
Commodities prices are collapsing. Many have fallen to bear market levels last seen in 2008. We all remember what happened then.
"Eighteen of the 22 components in the Bloomberg Commodity Index have dropped at least 20 percent from recent closing highs, meeting the common definition of a bear market. That’s the same number as at the end of October 2008, when deepening financial turmoil sent global markets into a swoon."
The US has the world’s biggest, most powerful economy. Yet, it is not immune to the ailments of the rest of the world. The gravitational pull of a global recession would suck the US right into its own downward spiral.
As I’ve noted many times, the US economy is not what it used to be.
Our economy remains stuck at around 2 percent annual growth, well below our long term average of 3.3 percent annually. In fact, the US hasn’t topped the 3 percent mark in a decade — the longest such stretch in modern times.
In the minds of many Americans, things seem tenuous. Consumer confidence surveys continually show this.
Just 41 percent of Americans said the economy is good, and 57 percent said it is poor in a July AP-GfK poll.
Confidence is everything for an economy that relies so heavily on consumer spending; 70 percent of US GDP is derived from it.
When Americans hear about the economic woes, financial turmoil and outright recessions in other parts of the world, perhaps they’re asking, “What if we’re next?"
It’s a reasonable question.
Monday, August 10, 2015
Most Americans can feel it; even though the Great Recession has officially ended, things just aren’t getting better.
Household incomes are the same now as they were in 1995, after you adjust for inflation. That means that the typical American family isn’t any better off now than 20 years ago. This is likely why there’s so much interest in the minimum wage and income inequality issues right now.
Average hourly wages have been growing no faster than 2.2% a year — two-thirds as fast as usual. That’s hurting consumer demand, which drives 70% of our economy. Without adequate wages, people can’t spend enough to drive the economy to new heights.
Even falling gas prices haven’t encouraged more consumer spending, as had been predicted.
While unemployment may have fallen to 5.3%, over 6.5 million people work part-time jobs but want full-time jobs. That’s much higher than the roughly 4.5 million part-timers before the Great Recession began.
The official unemployment rate excludes 16.5 million people who are either too discouraged to look for work, or who can only find part-time jobs. The so-called U-6 unemployment rate, which does recognize these people, stands at 10.4%. That’s nearly twice the 5.3% U-3 rate the government and media typically reference.
Companies in the service sector (such as retail, health care and hospitality) account for about 80% of all US jobs. Unfortunately, most of them are low paying. That’s no way to build a thriving, middle-class economy. In fact, it’s why the middle class has been eviscerated.
Stagnant incomes have led to our economic decline.
The obliteration of the middle class has resulted in an economy that now just limps along, despite historically low interest rates and three rounds of quantitative easing by the Federal Reserve.
In other words, desperate measures don't really work anymore.
The US economy remains stuck at around 2% annual growth, well below our long term average of 3.3% annually. In fact, the US hasn’t topped the 3% mark in a decade — the longest such stretch in modern times.
America is not an export economy; we’ve long imported more than we export and have maintained a trade deficit since 1976, which is an albatross to our economy.
Instead, the US relies on domestic demand. Consumers must consume for the economy to grow at a healthy pace. But if consumers are squeezed financially (as US consumers have been for decades), consumption will weaken (as it has).
This is especially troubling for a nation with an $18 trillion national debt, that will not go away. Our debt is growing at a faster rate than the economy, meaning we cannot, and will not, grow our way out of debt.
That’s aside from the fact that economic growth is predicated on debt. No debt means no growth. It’s a nightmarish economic system.
Americans have grown quite pessimistic about our economic decline and about the future, particularly for their kids.
Most Americans say their kids will be worse off economically than they are.
The pessimism stems from high levels of student debt, the high cost of housing and the scarcity of well-paying jobs.
Sadly, social mobility has declined for the first time in generations.
In other words, the parents are right: their kids are worse off, except for the children of the wealthiest American families.
While corporate profits have reached all-time highs, wages have stagnated. This is greed of the highest magnitude, and it has only served the elite 1% who control our economy, and our politics.
There isn’t likely a happy ending to all of this until there is a very unhappy, turbulent ending to the current system.
Once there is a major crash — bigger than the last one, perhaps — then there will be an essential need to realign and begin again, with an economy that favors and builds the middle class, and one that provides ladders for the lower classes to join it.