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.