29/6/19: Why Moody’s is wrong to keep Cyprus on junk status

Euromoney on Cypriot economy: "Why Moody’s is wrong to keep Cyprus on junk status" https://www.euromoney.com/article/b1g125jl1wvf0v/why-moodys-is-wrong-to-keep-cyprus-on-junk-status with a comment from myself.

4/4/2019: Debt Relief for Households: It Turns Out to be a Great Idea, Folks

The question of debt relief for households during the periods of financial crises has been a pressing one in the aftermath of the 2008 Global Financial Crisis. I have written a lot on the topic in topic in the past, but to sum the arguments here in a brief format:

• Argument in favour of debt relief: households carrying unsustainable debt burden during the crisis are likely to substantially reduce current and future consumption and investment, including long term investment in education, health and other activities. The resulting decline in the aggregate demand is likely to be prolonged and extensive, with a positive correlation to the crisis-triggered recession. Thus, debt relief via direct debt forgiveness and/or generous bankruptcy writedowns can help ameliorate adverse shocks to employment, demand and investment during large scale crises;
• Argument against debt relief: debt relief can lead to the emergence of moral hazard (inducing greater leveraging by households post-crises), and adversely impact balancesheets of the lending institutions.

I favour the first argument, based on my view that the economy is crucially dependent on households' financial health, and that moral hazard consideration does not apply ex post the crisis, but only ex ante, which means that policymakers can tackle adverse effects of moral hazard after debt forgiveness in the wake of the structural crises.

A new paper by Auclert, Adrien and Dobbie, Will and Goldsmith-Pinkham, Paul S., titled "Macroeconomic Effects of Debt Relief: Consumer Bankruptcy Protections in the Great Recession" (CEPR Discussion Paper No. DP13598: https://ssrn.com/abstract=3360065) tries to settle the debate.

The paper argues that "the debt forgiveness provided by the U.S. consumer bankruptcy system helped stabilize employment levels during the Great Recession." The authors "document that over this period, states with more generous bankruptcy exemptions had significantly smaller declines in non-tradable employment and larger increases in unsecured debt write-downs compared to states with less generous exemptions. We interpret these reduced form estimates as the relative effect of debt relief across states,... [showing that] the ex-post debt forgiveness provided by the consumer bankruptcy system during the Great Recession increased aggregate employment by almost two percent."

More specifically, the model of debt forgiveness effects developed by the authors "implies that ex-post debt relief had positive effects on employment in ...sectors and in ...regions. Ex-post debt relief directly increases spending and employment in both sectors [tradables and non-tradables] in the high--[debt]-exemption region, which increases tradable employment in the low-[debt]-exemption region through a demand spillover effect. The increase in tradable employment in the low-exemption
region then increases non-tradable spending and employment in that region. Calibrating the model
to the observed path of debt write-downs during the financial crisis, we find that average employment across regions in the second half of 2009 would have been almost 2 percent lower in both the
non-tradable and the tradable sector in the absence of the ex-post debt forgiveness provided by the
consumer bankruptcy system."

Furthermore, the authors "conclude by using the model to conduct three policy counterfactuals.

• First, we ask how the effect of ex-post debt relief changes in normal times when the zero lower bound does not bind. We find that even with a relatively aggressive monetary policy response, debt relief continues to have positive effects in both regions and in both sectors. 
• Second, we ask how the effect of debt relief changes with the size of the relief provided to borrowers. We find that the debt relief multiplier is initially invariant to the size of the relief provided to borrowers, but eventually falls as the size of debt relief grows large due to the concavity of borrowers’ consumption functions. [see chart]
• Finally, we ask how the effect of ex-post debt relief changes with the location of the savers that pay for the relief provided to borrowers. We find that the debt relief multiplier is invariant to the location of these savers, as savers smooth consumption in response to wealth transfers no matter where they are located."

30/11/18: Turning Europe into Greece

My latest column for the Cayman Financial Review is out, discussing how the lessons from the Global Financial Crisis, not learned by Europe, are creating new ghosts of VUCA across the European financial and economic landscapes:  https://www.caymanfinancialreview.com/2018/10/31/turning-europe-into-greece/.

17/11/18: Nine in Ten in the Red: Asset Markets YTD Returns Signal Risk Repricing

According to a recent research note from the Deutsche Bank, 89% of global macro assets are posting losses on year-to-date basis. This is the highest level of losses in more than a century.

Given the scale of financial risk mis-pricing in equities and bonds markets in the post-QE period, we are likely to witness more downward movement in the assets valuations in months to come. A gradual deleveraging that the market trends have been supporting so far remains highly incomplete and requires more pronounced re-pricing of assets to the downside.

Read more on this here: http://trueeconomics.blogspot.com/2018/11/161118-horsemen-of-financial-markets.html. 

16/11/18: The Horsemen of the Financial Markets Apocalypse

My column for the Manning Financial  is now available here: http://issuu.com/publicationire/docs/manning_financial_november_2018?e=16572344/65613030.

24/8/18: The Fed Bites the Bullet on Secular Stagnation

And just like... Federal Reserve Chair confirms the Twin Secular Stagnation Hypotheses in one paragraph of his speech:

Per Powell, "the U.S. economy faces a number of longer-term structural challenges ... For example, real wages, particularly for medium- and low-income workers, have grown quite slowly in recent decades. Economic mobility in the United States has declined and is now lower than in most other advanced economies.2 Addressing the federal budget deficit, which has long been on an unsustainable path, becomes increasingly important as a larger share of the population retires. Finally, it is difficult to say when or whether the economy will break out of its low-productivity mode of the past decade or more, as it must if incomes are to rise meaningfully over time."

For those who might want to read about an even more fundamental (and causally linked to the Powell's challenges) structural decline in the Cayman Financial Review here: http://trueeconomics.blogspot.com/2018/08/18818-monpolization-trends-in-advanced.html.

What is note worthy in Powell's passage is the words "in recent decades". Powell is correct (and I pointed this fact out on a number of occasions) that the adverse trends in the U.S. economy have been present for much longer than the post-Global Financial Crisis shocks residual effects. The economic stagnation (expressed in the abysmally low growth rates of economic prosperity for the lower 90 percent of the American population; in woefully slow expansion in productivity, compared to historical trends; in structurally less competitive nature of the economy and growing monopolization and oligopolization of the U.S. markets; in reduced physical and social mobility; in falling pensions savings provisions for the majority of the U.S. population; and so on) has pre-dated the GFC and its roots rest much deeper than the financial disruption of the 2007-2010 crisis.

15/518: Four macro charts that explain Trumpvolution

The current growth cycle has been the second longest on record:

Source: FactSet

But it has been much shallower than the previous cycles: "real GDP growth in the current expansion lags the other three expansions—by a lot. As of the first quarter of 2018, real GDP has expanded by 21% since the beginning of the current expansion; this is far lower than the 36% compound growth we saw at this point in the 1991‑2001 expansion. The chart also shows that the growth path for the longest expansions has continued to shift lower over time; the 1961‑1969 expansion saw real GDP grow by 52% by the end of its ninth year, while the economy had grown by just 38% by the end of year eight of the 1982‑1990 expansion."

Source: FactSet

And here's a summary of why loading risks of recession onto households is not such a great idea: "Real consumption has grown by 23% since the summer of 2009, compared to growth rates of 41% and 50% at the same point in the expansions of 1991‑2001 and 1961‑1969, respectively. The reluctance of consumers to spend in this expansion is not surprising when you consider how much of the brunt of the last recession was borne by this group."

Households' net worth collapse in the GFC has been more dramatic and the recovery from the crisis has been less pronounced than in the previous cycles:

Source: FactSet

Hey, you hear some say, but the recovery this time around has been 'historic' in terms of jobs creation. Right? Well, it has been historic... as in historically low:

Source: FactSet

So, despite the length of the recovery cycle, current state of the economy hardly warrants elevated levels of optimism. The recovery from the Global Financial Crisis and the Great Recession has been unimpressively sluggish, and the burden of the crises has been carried on the shoulders of ordinary households. Any wonder we have so many 'deplorables' ready to vote populist? As we noted in our recent paper (see: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3033949), the rise of populism has been a logical corollary to (1) the general trends toward secular stagnation in the economy since the mid-1990s, and (2) the impact of the twin 2008-2010 crises on households.

24/11/17: Learning from the GFC: Lessons for Investors

My article, summing up the key lessons from the Global Financial Crisis that investors should review before the next crisis hits is now available via Manning Financial newsletter: http://issuu.com/publicationire/docs/mf_winter_2017?e=16572344/55685136.

16/12/16: The Root of the 2007-2010 Crises is Back, with a Vengeance

There are several fundamental problem in the global economy, legacies of the past 20 years - from the mid 1990s on - that continue to drive the trend toward secular stagnations (see explainer here: http://trueeconomics.blogspot.com/2015/07/7615-secular-stagnation-double-threat.html).

One key structural problem is that of excessive reliance on credit (or debt) to drive growth. We have seen the devastating effects of the rapidly rising unsustainable levels of the real economic debt (debt that combines government obligations, non-financial corporate debt and household debt) in the case of 2008 crises.

And we were supposed to have learned the lesson. Supposed to have, because the entire conversation about structural reforms in banking and capital markets worldwide was framed in the context of deleveraging (reduction of debt levels). This has been the leitmotif of structural policies reforms in Europe, the U.S., in Australia and in China, and elsewhere, including at the level of the EU and the IMF. Supposed to have, because we did not that lesson. Instead of deleveraging, we got re-leveraging of economies - companies, households and governments.

Problem Case Study: U.S. Corporates

Take the U.S. corporate bonds market (that excludes direct loans through private lenders and intermediated loans through banks) - an USD8 trillion-sized elephant. Based on the latest research of the U.S. Treasury Department, non-banking institutions - plain vanilla investment funds, pension funds, mom-and-pop insurance companies, etc are now holding a full 1/4 of U.S. corporates bonds. According to the U.S. Treasury, these expanding holdings of / risk exposures to corporate debt are now "a top threat to stability" of the U.S. financial system. And the warning comes at the time when U.S. corporate debt is at an all-time high as a share of GDP, based on the figures from the Office of Financial Research.

And it gets worse. Since 2007, corporate debt pile in the U.S. rose some 75 percent to USD8.4 trillion, based on data from the Securities Industry and Financial Markets Association - which is more than USD8 trillion estimated by the Treasury. These are long-term debt instruments. Short term debt obligations - money market instruments - add another USD 2.9 trillion and factoring in the rise of the value of the dollar since the Fed meeting this week, closer to USD3 trillion. So the total U.S. corporate debt pile currently stands at around USD 11.3 trillion to USD 11.4 trillion.

Take two:

1. Debt, after the epic deleveraging of the 2008 crisis, is now at an all-time high; and
2. Debt held by systemic retail investment institutions (insurance companies, pensions funds, retail investment funds) is at all time high.

And the risks in this market are rising. Since the election of Donald Trump, global debt markets lost some USD2.3 trillion worth of value. This reaction was driven by the expectation that his economic policies, especially his promise of a large scale infrastructure investment stimulus, will trigger inflationary pressures in the U.S. economy that is already running at full growth capacity (see here: http://trueeconomics.blogspot.com/2016/12/151216-us-economic-policies-in-era-of.html). Further monetary policy tightening in the U.S. - as signalled by the Fed this week (see here: http://trueeconomics.blogspot.com/2016/12/151216-long-term-fed-path-may-force-ecb.html) will take these valuations down even further.

Some estimates (see https://www.bloomberg.com/news/articles/2016-12-16/republican-tax-reform-seen-shrinking-u-s-corporate-bond-market) suggest that the Republican party corporate tax reforms (that might remove interest rate tax deductibility for companies) can trigger a 30 percent drop in investment grade bonds valuations in the U.S. - bonds amounting to just under USD 4.9 trillion. The impact would be even more pronounced on other bonds values. Even making the estimate less dramatic and expecting a 25 percent drop across the entire debt market would wipe out some USD 2.85 trillion off the balancesheets of the bonds-holding investors.

As yields rise, and bond prices drop, the aforementioned systemic retail investment institutions will be nursing massive losses on their investment books. If the rush to sell their bond holdings, they will crash the entire market, triggering potentially a worse financial meltdown than the one witnessed in 2008. If they sit on their holdings, they will be pressed to raise capital and their redemptions will be stressed. It's either a rock or a hard place.


Problem Extrapolation: the World

The glut of U.S. corporate debt, however, is just the tip of an iceberg.

As noted in this IMF paper, published on December 15th, corporate leverage (debt) has been on a steady march upward in the emerging markets (http://www.imf.org/external/pubs/ft/wp/2016/wp16243.pdf).

And in its Fiscal Monitor for October 2016, the Fund notes that "At 225 percent of world GDP, the global debt of the nonfinancial sector—comprising the general government, households, and nonfinancial firms—is currently at an all-time high. Two-thirds, amounting to about $100 trillion, consists of liabilities of the private sector which, as documented in an extensive literature, can carry great risks when they reach excessive levels." (see http://www.imf.org/external/pubs/ft/fm/2016/02/pdf/fm1602.pdf)

Yes, global real economic debt now stands at around USD152 trillion or 225 percent of world GDP.

Excluding China and the U.S. global debt levels as percentage of GDP are close to 2009 all time peak. Much of the post-Crisis re-leveraging took place on Government's balancehseets, as illustrated below, but the most ominous side of the debt growth equation is that private sector world-wide did not sustain any deleveraging between 2008 and 2015. In fact, Advanced Economies Government debt take up fully replaced private sector debt growth rates contraction. Worse happened in the Emerging Markets:

So all the fabled deleveraging in the economies in the wake of the Global Financial Crisis has been banks-balancesheets deleveraging - Western banks dumping liabilities to be picked up by someone else (vulture funds, investors, other banks, the aforementioned systemic retail investment institutions, etc).

And as IMF analysis shows, only 12 advanced economies have posted declines in total non-financial private debt (real economic debt) as a share of GDP over 2008-2015 period.  Alas, in the majority of these, gains in private deleveraging have been more than fully offset by deterioration in government debt:

Crucially, especially for those still believing the austerity-by-cuts narrative presented in popular media, fiscal uplift in debt levels in the Advanced Economies did not take place due to banks-rescues alone. Primary fiscal deficits did most of the debt lifting:

In simple terms, across the advanced economies, there was no spending austerity. There was tax austerity. And on the effectiveness of the latter compared to the former you can read this note: http://trueeconomics.blogspot.com/2016/12/10122016-austerity-three-wrongs-meet.html. Spoiler alert: tax-based austerity is a worse disaster than spending-based austerity.

In summary, thus, years of monetarist activism spurring a massive rise in corporate debt, coupled with the utter inability of the states to cut back on public spending and the depth of the Global Financial Crisis and the Great Recession have combined to propel global debt levels past the pre-crisis peak to a new historical high.

The core root of the 2007-2010 crises is back. With a vengeance.

3/1/2015: Trade Protectionism Since the Global Financial Crisis

A year ago, ECB paper by Georgiadis, Georgios and Gräb, Johannes, titled "Growth, Real Exchange Rates and Trade Protectionism Since the Financial Crisis" (ECB Working Paper No. 1618. http://ssrn.com/abstract=2358483) looked at whether the current evidence does indeed support the thesis that "…the historically well-documented relationship between growth, real exchange rates and trade protectionism has broken down."

Looking at the evidence from 2009, the authors found that "the specter of protectionism has not been banished: Countries continue to pursue more trade-restrictive policies when they experience recessions and/or when their competitiveness deteriorates through an appreciation of the real exchange rate; and this finding holds for a wide array of contemporary trade policies, including “murky” measures. We also find differences in the recourse to trade protectionism across countries: trade policies of G20 advanced economies respond more strongly to changes in domestic growth and real exchange rates than those of G20 emerging market economies. Moreover, G20 economies’ trade policies vis-à-vis other G20 economies are less responsive to changes in real exchange rates than those pursued vis-à-vis non-G20 economies. Our results suggest that — especially in light of the sluggish recovery — the global economy continues to be exposed to the risk of a creeping return of trade protectionism."

One thing to add: the above does not deal with trade-restrictive policies relating directly to financial repression, such as outright regulatory protectionism of incumbent domestic banks and asset managers, or direct and indirect subsidies pumped into the incumbent banking system.