17/2/16: The Four Horsemen Of Economic Apocalypse Are Here

Recent media and analysts coverage of the global economy, especially that of the advanced economies has focused on the rising degree of uncertainty surrounding growth prospects for 2016 and 2017. Much of the analysis is shlock, tending to repeat like a metronome the cliches of risk of ’monetary policy errors’ (aka: central banks, read the Fed, raising rates to fast and too high), or ‘emerging markets rot’ (aka: slowing growth in China), or ‘energy sector drag’ (aka: too little new investment into oil).

However, the real four horsemen of the economic apocalypse are simply too big of the themes for the media to grasp. And, unlike ‘would be’ uncertainties that are yet to materialise, these four horsemen have arrived and are loudly banging on the castle of advanced economies gates.

The four horsemen of growth apocalypse are:

1. Supply side secular stagnation (technology-driven productivity growth and total factor productivity growth flattening out);
2. Demand side secular stagnation (demographically driven slump in global demand for ‘stuff’) (note I covered both extensively, but here is a post summing the two: http://trueeconomics.blogspot.com/2015/10/41015-secular-stagnation-and-promise-of.html)
3. Debt overhang (the legacy of boom, bust and post-bust adjustments, again covered extensively on this blog); and
4. Financial fragility (see http://trueeconomics.blogspot.com/2016/01/19116-after-crisis-is-there-light-at.html)

In this world, sub-zero interest rates don’t work, fiscal policies don’t work and neither supply, nor demand-side economics hold any serious answers. Evidence? Central bankers are now fully impotent to drive growth, despite having swallowed all monetary viagra they can handle. Meanwhile, Government are staring at debt piles so big and bond markets so touchy, any serious upward revision in yields can spell disaster for some of the largest economies in the world. More evidence? See this: http://trueeconomics.blogspot.com/2015/10/101015-imf-honey-weve-japanified-world.html.

To give you a flavour: consider the ‘stronger’ economic fortress of the U.S. where the Congressional Budget Office latest forecast is that the budget deficit will rise from 2.5 percent of GDP in 2015 to 3.7 percent by 2020. None of this deficit expansion will result in any substantive stimulus to the economy or to the U.S. capital stocks. Why? Because most of the projected budget deficit increases will be consumed by increased costs of servicing the U.S. federal debt. Debt servicing costs are expected to rise from 1.3 percent of GDP in 2015 to 2.3 percent in 2020. Key drivers to the upside: increasing debt levels (debt overhang), interest rate hikes (monetary policy), and lower remittances from the Federal Reserve to the U.S. Treasury (lower re-circulation of ‘profits and fees’). Actual discretionary spending that is approved through the U.S. Congress votes, excluding spending on the entitlement programs (Medicaid, Medicare and Social Security) will go down, from 6.5 percent of GDP in 2015 to 5.7 percent of GDP by 2020.

Boom! Debt overhang is a bitch, even if Paul Krugman thinks it is just a cuddly puppy…

Recently, one hedgie described the charade as follows: ”I like to use the analogy that the economic patient is riddled with cancer — central banks are applying a defibrillator, but there's only so much electricity the patient can take before it becomes a burnt-out corpse.” Pretty apt. (Source: http://www.businessinsider.com/36-south-four-horsemen-2016-2?r=UK&IR=T)

My favourite researcher on the matter of financial stability, Claudio Borio of BIS agrees. In a recent speech (http://www.bis.org/speeches/sp160210_slides.pdf) he summed up the “symptoms of the malaise: the “ugly three”” in his parlance:

• Debt too high
• Productivity growth too low
• Policy room for manoeuvre too limited

Source: Borio (2016)

The fabled deleveraging that apparently has achieved so much is not dramatic even in the sector where it was on-going: non-financial economy, for advanced economies, and is actually a leveraging-up in the emerging markets:

Source: Borio (2016)

And these debt dynamics are doing nothing for corporate profitability:

Source: Borio (2016)

Worse, what the above chart does not show is what the effect on corporate profitability will interest rates reversions have (remember: there are two risks sitting here - risk 1 relating to central banks raising rates, risk 2 relating to banks - currently under severe pressure - raising retail margins).

Boris supplies a handy chart of how bad things are with productivity growth too:

Source: Borio (2016)

The above are part-legacy of the Global Financial Crisis. Boris specifies: Financial Crises tend to last much longer than business cycles, and “cause major and long-lasting damage to the real economy”. Loss in output sustained in Financial Crises are not transitory, but permanent and include “long-lasting damage to productivity growth”. Now, remember the idiot squad of politicians who kept droning on about ‘negative equity’ not mattering as long as people don’t move… well, as I kept saying: it does. Asset busts are hugely painful to repair. Boris: “Historically there is only a weak link between deflation and output growth” despite everyone running like headless chickens with ‘deflation’s upon us’ meme. But, there is a “much stronger link with asset price declines (equity and esp property)”, despite the aforementioned exhortations to the contrary amongst many politicos. And worse: there are “damaging interplay of debt with property price declines”. Which is to say that debt by itself is bad enough. Debt written against dodo property values is much worse. Hello, negative equity zombies.

But the whole idea about ‘restarting the economy’ using new credit boost is bonkers:

Source: Borio (2016)

Because, as that hedgie said above, the corpse can’t take much of monetary zapping anymore.

Hence time to wake up and smell the roses. Borio puts that straight into his last bullet point of his last slide:

Source: Borio (2016)

Alas, we have nothing to rely upon to replace that debt fuelled growth model either.

Knock… knock… “Who’s there?” “The four horsemen?” “The four horsemen of what?” “Of debt apocalypse, dumbos!”

22/10/15: Ah, those repaired credit flows...

BIS data on 2Q 2015 cross border lending is ugly... on so many levels (see breakdowns here: https://www.bis.org/statistics/rppb1510.pdf). But the ugliest is the aggregate rate of change:

Yep, that's right. In the economy repaired by multiple countries surrenders to the IMF, years of massive QEs, the printing presses perpetual overheating and all other policy shenanigans, 2Q 2015 has seen the sharpest decline in cross border lending by the banks in history of the series (from 1978 on).

Borrowing is down across all intermediaries:

and all currencies save Japanese Yen:

and for every borrowing region, save EMEs (read: China):

and if you think the rot is dominated by the Emerging Markets, think again:

So when some time ago I described the state of play in the global economy as being Japanified, I wasn't kidding. The monetary policy dream of 'repairing' credit flows by making credit dirt cheap has had... well... at best an underwhelming effect. Time to think about actual, real, economic demand, maybe?..

8/5/15: BIS on Build Up of Financial Imbalances

There is a scary, fully frightening presentation out there. Titled "The international monetary and financial system: Its Achilles heel and what to do about it" and authored by Claudio Borio of the Bank for International Settlements, it was delivered at the Institute for New Economic Thinking (INET) “2015 Annual Conference: Liberté, Égalité, Fragilité” Paris, on 8-11 April 2015.

Per Borio, the Achilles heel of the global economy is the fact that international monetary and financial system (IMFS) "amplifies weakness of domestic monetary and financial regimes" via:

• "Excess (financial) elasticity”: inability to prevent the build-up of financial imbalances (FIs)
• FIs= unsustainable credit and asset price booms that overstretch balance sheets leading to serious financial crises and macroeconomic dislocations
• Failure to tame the procyclicality of the financial system
• Failure to tame the financial cycle (FC)

The manifestations of this are:

• Simultaneous build-up of FIs across countries, often financed across borders... watch out below - this is still happening... and
• Overly accommodative aggregate monetary conditions for global economy. Easing bias: expansionary in short term, contractionary longer-term. Now, what can possibly suggest that this might be the case today... other than all the massive QE programmes and unconventional 'lending' supports deployed everywhere with abandon...

So Borio's view (and I agree with him 100%) is that policymakers' "focus should be more on FIs than current account imbalances". Problem is, European policymakers and analysts have a strong penchant for ignoring the former and focusing exclusively on the latter.

Wonder why Borio is right? Because real imbalances (actual recessions) are much shallower than financial crises. And the latter are getting worse. Here's the US evidence:

Now, some think this is the proverbial Scary Chart because it shows how things got worse. But surely, the Real Scary Chart must reference the problem today and posit it into tomorrow, right? Well, hold on, for the imbalances responsible for the last blue line swing up in the chart above are not going away. In fact, the financial imbalance are getting stronger. Take a look at the following chart:

Note: Bank loans include cross-border and locally extended loans to non-banks outside the United States.

Get the point? Take 2008 crisis peak when USD swap lines were feeding all foreign banks operations in the U.S. and USD credit was around USD6 trillion. Since 'repairs' were completed across the European and other Western banking and financial systems, the pile of debt denominated in the USD has… increased. By mid-2014 it reached above USD9 trillion. That is 50% growth in under 6 years.

However, the above is USD stuff... the Really Really Scary Chart should up the ante on the one above and show the same happening broader, outside just the USD loans.

So behold the real Dracula popping his head from the darkness of the Monetary Stability graveyards:

Yep.  Now we have it: debt (already in an overhang) is rising, systemically, unhindered, as cost of debt falls. Like a drug addict faced with a flood of cheap crack on the market, the global economy continues to go back to the needle. Over and over and over again.

Anyone up for a reversal of the yields? Jump straight to the first chart… and hold onto your seats, for the next upswing in the blue line is already well underway. And this time it will be again different... to the upside...

1/1/2015: Shared Liability: Debtor and Lender

In a recent blogpost on geography of Euro area debt flows prior to the crisis, I noted the extent to which Irish (and other peripheral euro area economies') debt bubble pre-2008 has been inflated from abroad (see here: http://trueeconomics.blogspot.ie/2014/12/27122014-geography-of-euro-area-debt.html). The argument, of course, is that the funding source, just as the funding user, should co-share in the liability created by the bubble.

This argument, advanced by myself and many others over the years of the crisis, has commonly been refuted by the counter-point that no such liability is implied: borrowers willingly borrowed from the banks, banks willingly borrowed from the markets (aka other banks) and that is where liability ends.

Here is a cogent paper on the subject from the Bank for International Settlements (not some lefty-leaning think tank or a libertarian hothouse of dissent): Turner, Philip, Caveat Creditor (July 2013). BIS Working Paper No. 419: http://ssrn.com/abstract=2384445).

The paper asserts that "One area where international monetary cooperation has failed is in the role of surplus or creditor countries in limiting or in correcting external imbalances." In common parlance, that is the area of liability of one economic system that, having generated surpluses of savings, provides funding to another economy.

"The stock dimensions of such imbalances - net external positions, leverage in national balance sheets, currency/maturity mismatches, the structure of ownership of assets and liabilities and over-reliance on debt - can threaten financial stability in creditor as in debtor countries." In other words, net lender (e.g. Germany) co-creates the imbalance with the net borrower (e.g. Ireland).

And thus, "creditor countries ...have a responsibility both for avoiding "overlending" and for devising cooperative solutions to excessive or prolonged imbalances."

Unless responsibility does not imply liability (in which case me being responsible for driving safely should not translate into me being liable for any damages done to other parties from failing to do so), we have confirmation of my logic: net lending countries (I refer you to the chart in the blogpost linked above) bear shared liability with the borrowers. By extension, lending banks share liability with the borrowers. Per BIS. Not just per the unreasonable myself.

16/9/2014: More of a Risk, Less of a Bubble: Irish Property Prices in Q1 2014

An interesting BIS paper on House Prices data across a number of advanced economies (http://www.bis.org/publ/qtrpdf/r_qt1409h.htm). A key chart:

Data is through Q1 2014 and is based on the aggregate of 8 data sets for Ireland. It is worth noting that data is for Ireland overall, not Dublin.

In the nutshell, in Q1 2014 Irish property prices were still at the lower end in terms of price/rent ratio and price/income ratio.

An interesting contrast to other peripheral and advanced economies in terms of dynamics:
"Year-on-year residential property prices, deflated by CPI, rose by 9.5% in the United States and 6% in the United Kingdom. Real house prices also grew, by 7% in Canada, 7.7% in Australia and 2.2% in Switzerland, three countries that were less affected by the crisis, as well as in some countries that were severely affected by the crisis, such as Ireland (+7.2%) and Iceland (+6.4%).  Real price growth remained in negative territory in Japan (–2.6%) and was generally weak or negative in continental Europe. Prices rose in Germany (+1.2%) and the Nordic countries (+1.7% in Denmark and +4.8% in Sweden), but continued to fall in the euro area’s southern periphery (Italy, –5%; Spain, –3.8%; Portugal, –1.2%; and Greece, –6%). "

So as I noted before, two points of concern and two points of solace:

• Dynamics of prices, not levels, are signalling serious problems in the markets;
• Dublin is the core driving factor for this with the rest of the country barely showing much of an improvement;
• Levels of prices remain benign in relation to incomes and to rents, especially outside of Dublin;
• Compared to other peripherals, we are witnessing much faster recovery supported by significant past falls in prices relative to income (note similar levels of prices in Iceland, although prices recovery and dynamics are more concerning there than in Ireland).

16/9/2013: Some scary charts from BIS: Yields Blowing Up & Leverage Climbs

BIS Quarterly (http://www.bis.org/publ/qtrpdf/r_qt1309a.pdf) has some interesting analysis of the US yields:

"An examination of the rise in US bond yields between May and July reveals as a key  driver the uncertainty about the future stance of monetary policy. The sell-off mainly shifted bond yields at long maturities, while the short end of the yield curve remained anchored by the Federal Reserve’s continued low interest rate policy."

"In addition, the federal funds futures curve also shifted upwards, signalling market perceptions that a policy rate exit from the current 0–0.25% band had become quite likely to occur as early as in the second quarter of 2014."

"A model-based decomposition of the  10-year US Treasury yield, which sheds light on the various drivers of these shifts,  indicates that the recent yield spike was largely the result of a rising term premium. This is consistent with markets reacting to uncertainty about the extent to which an improving economic outlook would affect future policy rates. It is also consistent with uncertainty as regards the impact that a reduction in the Federal Reserve’s purchases of long-term Treasuries would have on these securities’ prices."

"In comparison, the bond market sell-offs in 1994 and 2003–04 were different in  nature. During those episodes, long-term nominal yields rose together with policy rates or on the back of expected increases in future real interest rates and inflation. By contrast, inflation expectations were largely unchanged in the second and third quarters of 2013."

Basically, as we all know  by now, current yields have nothing to do with inflation and are solely priced by reference to expected liquidity conditions. Or put differently, nothing but printing press matters. So much for monetary policy-real growth links...


And BIS does deliver a nicely focused warning: "Their recent spike notwithstanding, bond yields in mature markets remained low by historical standards. For one, the yields on sovereign bonds in the largest world economies had been on a downward trend since 2007. And investment grade spreads in the United States, the euro area and the United Kingdom declined respectively by 75, 110 and 190 basis points between May 2012 and early September 2013, falling past their earlier troughs in 2010 and reaching levels last seen at end-2007. The evolution of the corresponding high-yield bond indices was similar, with spreads declining by 230 to 470 basis points over the same period."

Go no further than the second chart above: reversion to the mean is going to be brutal. And this brutality will only be reinforced by the fact that quietly, unnoticed by most, leverage has returned: overall share of leveraged and highly leveraged loans in total syndicated loan signings is now at all-time high.

Starting with page 6 (above link), the quarterly is a must-read as it exposes growing problem with high risk debt accumulation by investors and that amidst the historically low rates. The system is back at end-of-2007 levels of credit underpricing. The big difference today in contrast with 2007 is that no one has any bullets left to fight the bear, should one appear on the horizon.

15/9/2013: BIS Quarterly: a tale of two banking systems

Two hugely revealing charts from the BIS Quarterly Review, September 2013 (http://www.bis.org/publ/qtrpdf/r_qt1309e.pdf) show exactly the remaining adjustments yet to be undertaken by the banking sector in Europe, compared to the US.

Here they are:

 and

 
note how European banks lag US banks in assets deleveraging, and in raising capital, and are slightly lagging in terms of changes in the ratio of risk-weighted assets. In risk-weighted capital ratios, the european banks are about 1/3rd of the way shy of the US, and in terms of capital, roughly 1/2 of the adjustment to the US levels is still required.

And per operational weaknesses of the European banking system? Next we have a table:

Although different across periods, the divergences between the European and US banks are still qualitatively the same for pre-crisis and crisis periods. In particular, US banks operate at higher cost than European ones, but generate more interest income and other income.