15/4/19: One order of "Bull & Sh*t" for the U.S. Labor Market, please

The 'strongest economy, ever'...

Despite a decade-long experiment with record-low interest rates, despite trillions of dollars in deficit financing, and despite headline unemployment numbers staying at/near record lows, the U.S. economy is not in a rude health. In fact, by two key metrics of the labor force conditions, it is not even in a decent health.

As the chart above clearly shows, both in terms of period averages and in terms of current level readings, Employment to Population Ratio (for civilian population) has remained at abysmally low levels, comparable only to the readings attained back in 1986. Meanwhile, labor force participation rate is trending at the levels consistent with those observed in 1978.

Dire stuff.

Update: Here is a chart showing how the current recovery compares to past recoveries (hint: poorly):

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.

19/10/18: There's a Bubble for Everything

Pimco's monthly update for October 2018 published earlier this week contains a handy table, showing the markets changes in key asset classes since September 2008, mapping the recovery since the depths of the Global Financial Crisis.

The table is a revealing one:

As Pimco put it: "The combined balance sheets of the Federal Reserve, European Central Bank, Bank of Japan, and People’s Bank of China expanded from $7 trillion to nearly $20 trillion over the subsequent decade. This liquidity injection, at least in part, underpinned a 10-year rally in equities and interest rates: The S&P 500 index rose 210%, while international equities increased 70%. Meanwhile, developed market yields and credit spreads fell to multidecade, and in some cases, all-time lows."

The table points to several interesting observations about the asset markets:

1. Increases in valuations of corporate junk bonds have been leading all asset classes during the post-GFC recovery. This is consistent with the aggregate markets complacency view characterized by extreme risk and yield chasing over recent years. This, by far, is the most mispriced asset class amongst the major asset classes and is the likeliest candidate for the next global crisis.
2. Government bonds, especially in the Euro area follow high yield corporate debt in terms of risk mis-pricing. This observation implies that the Euro area recovery (as anaemic as it has been) is more directly tied to the Central Banks QE policies than the recovery in the U.S. It also implies that the Euro area recovery is more susceptible to the Central Banks' efforts to unwind their excessively large asset holdings.
3. U.S. equities have seen a massive valuations bubble developing in the years post-GFC that is unsupported by the real economy in the U.S. and worldwide. Even assuming the developed markets ex-U.S. are underpriced, the U.S. equities cumulative rise of 210 percent since September 2008 looks primed for a 20-25 percent correction. 

All of which suggests that the financial bubbles are (a) wide-spread and (b) massive in magnitude, while (c) being caused by the historically unprecedented and over-extended monetary easing. The next crisis is likely to be more painful and more pronounced than the previous one.

28/9/18: 10th Anniversary of the Irish Banking Crisis

Yahoo Finance's Edmund Heaphy on 10th Anniversary of the Irish Bank Guarantee: https://uk.finance.yahoo.com/news/destructive-goal-decade-irish-bank-guarantee-090447485.html with extensive quotes from myself.

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.

31/7/18: 65 years of profligacy and few more yet to come: U.S. Government Deficits

The history and the future of the U.S. Federal Government deficits in one chart:

Which shows, amongst other things, that

1. The post-2000 regime of deficits has shifted to a completely new trend of massively accelerating excessive spending relative to receipts;
2. The legacy of the Global Financial Crisis and the Great Recession far exceeds traditional cyclical increases in deficits;
3. The more recent vintage of the Obama Administration deficits has been more moderate compared to the peak crises years;
4. The ongoing trend in the Trump Administration deficits is dynamically exactly matching the worst years of Obama Administration deficits, despite the fact that the underlying economic conditions today are much more benign than they were during the peak crises period under the Obama Administration; and
5. Based on the most current projections, by the end of the year 2023, the U.S. is on track to increase cumulated deficit from USD 12.227 trillion at the end of 2016 to USD 20.466 trillion.  This would imply an average annual uplift of USD 1.177 trillion, which is significantly higher than the average annual increase in deficits of USD 838.3 billion recorded over the 2009-2016 period.

The good news is, fiscally responsible,  financially conservative, taxpayer interests-focused Republican Party has given full support to the Trump Administration on what in fact amounts to a restoration of the peak crises period trends in deficits accumulation.

14/7/18: Elephants. China Shop, Enters a Mouse: Global Debt Bubble

Bank for International Settlements Annual Report for 2018 has a very interesting set of charts covering the growing global debt bubble, one of the key risks to the global economy highlighted in the report.

First, levels:

• Global debt rose from 179% of GDP at the end of 2007 to 217% at the end of 2017 - adding 38 percentage points to the overall leverage carried by the global economy.
• The rise has been more dramatic for the Emerging Economies, with debt levels rising from 113% of GDP to 176% between the end of 2007 and the end of 2017, a net addition of 63 percentage points.
• Advanced economies faired somewhat better, posting an increase from 233% of GDP to 269%, a net rise of 36 percentage points.
• As it stood at the end of 2017, Global Debt was well in excess of x3 the Global GDP - a degree of leverage not seen in the modern history.

As noted by BIS: “...financial markets are overstretched, as noted above, and we have seen a continuous rise in the global stock of debt, private plus public, in relation to GDP. This has extended a trend that goes back to well before the crisis and that has coincided with a long-term decline in interest rates".

Next, impacts of monetary policy normalization:

As the Central Banks embark on gradual, well-flagged in advance and 'orderly' overall rates and asset purchases 'normalization', the global economy is likely to bifurcate, based on individual countries debt exposures. As the chart above shows, impact from a modest, 100bps hike in rates, will be relatively significant for all economies, with greater impact on highly indebted countries.

Per BIS: "Since the mid-1980s, unsustainable economic expansions appear to have manifested themselves mainly in the shape of unsustainable increases in debt and asset prices. Thus, even in the absence of any near-term market disruptions, keeping interest rates too low for too long could raise financial and macroeconomic risks further down the road. In particular, there are reasons to believe that the downward trend in real rates and the upward trend in debt over the past two decades are related and even mutually reinforcing. True, lower equilibrium interest rates may have increased the sustainable level of debt. But, by reducing the cost of credit, they also actively encourage debt accumulation. In turn, high debt levels make it harder to raise interest rates, as asset markets and the economy become more interest rate-sensitive – a kind of “debt trap”."

Thus, the impetus for rates and monetary policies normalisation is the threat of continued debt bubble inflation, but the cost of such normalisation is the deflation of the debt bubble already present. In other words, there's an elephant and here's the china shop.

"A further complication in calibrating normalisation relates to the need to build policy buffers for the next downturn. Indeed, the room for policy manoeuvre is much narrower than it was before the crisis: policy rates are substantially lower and balance sheets much larger". And here's the mouse: cyclically, we are nearing the turning point in the current expansion. And despite all the PR releases about the 'robust recovery' current up-cycle in the global economy has been associated with lower growth rates, lower productivity growth, lower real investment (as opposed to financial flows), and more debt than equity (see http://trueeconomics.blogspot.com/2018/07/14718-second-longest-recovery.html).

In other words, things are risky, but also fragile. Elephants in a china shop. Enters a mouse...

14/7/18: The Second Longest Recovery

One chart never ceased to amaze me - the one that shows just how unimpressive the current 'second longest in modern history' recovery (and only 9 months shy of it being the 'first longest') has been, and just how sticky the adverse shocks impacts can be in modern crises that can be best described by the VUCA (volatility, uncertainty, complexity and ambiguity) environment:

The fact that the current recovery cycle has been weak is only one part of the story, however, that would be less worrying if not for the second part. Namely, that almost every successive recovery cycle in the past three decades has been weaker than the previous one.

Here is a handy summary of the recovery cycles in the last four recessions based on annual data, for real GDP and real GDP PPP-adjusted:

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.

19/11/17: The Next Global Financial Crisis

My column for Cayman Financial Review on how the stage has been now set for the next Global Financial Crisis is available at http://www.caymanfinancialreview.com/2017/10/20/the-stage-has-been-set-for-the-next-global-financial-crisis/.

9/8/17: Euro Area Banks Bailouts: The Legacy Still Hangs Over Our Heads

The Financial Times has published a very neat visualisation of the global banks bailouts net impact to-date:

 Source: https://www.ft.com/content/b823371a-76e6-11e7-90c0-90a9d1bc9691

And the snapshot magnifying European states impact:

None of the Euro area states have recovered all funds deployed in bailing out the banks. And the worst performer of all states is Ireland.

Note: the chart references bailouts as a share of GDP. Of course, in the case of Ireland and Cyprus, GDP is by a mile (in the case of Ireland, by about one third) is unrepresentative of the actual national income available to sustain these.

Another note: the three worst-hit countries, Ireland, Greece and Cyprus, all remain deeply under water when it comes to recovering funds spent in the bailouts, even though the three had, on the surface, different bailout regimes applied. Specifically, Cyprus (and to a lesser extent, Greece) was supposed to be a model bailout, serving as the basis for the future bailouts across the Euro area (including structured bail-ins of private depositors).

So much for the hope of the Euro area 'reforms' working... And so much for the end of the Crisis...

9/4/17: Nama's Missed Opportunities

My Sunday Business Post article on Nama and the 'value-destruction' : https://www.businesspost.ie/opinion/nama-missed-opportunity-profits-paying-price-384584.

21/2/17: The Future of Finance

Last week I was speaking at a forum on Open Societies in Panama City. My speech covered the key threats and transformational changes in the global financial services. Here are my annotated slides:

20/2/17: The Effect of GFC on Italian Non-Performing Loans Overhang

In yesterday’s post I covered some interesting current numbers relating to NPLs in the European banking sector. And sitting, subsequently, in the tin can of an airplane on my way back to California, I remembered about this pretty decent paper from Banca d’Italia, published in September 2016.

Titled “The evolution of bad debt in Italy during the global financial crisis and the sovereign debt crisis: a counterfactual analysis” and authored by Alessandro Notarpietro and Lisa Rodano (Banca d’Italia Occasional Paper Number 350 – September 2016), the paper looked at the evolution (dynamics) of Italian banks’ NPLs since the start of the Global Financial Crisis and the twin recessions that hit Italy since 2008. Actual data is compared against “the counterfactual simulations". "A ‘no-crises scenario’ is built for the period 2008-2015. The counterfactual dynamics” generate a comparative new bad debt rate, which “depends on macroeconomic conditions and borrowing costs.”

Per authors, “the analysis suggests that, in the absence of the two recessions – and of the economic policy decisions that were taken to combat their effects – non-financial corporations’ bad debts at the end of 2015 would have reached €52 billion, instead of €143 billion."

Chart above plots the evolution of two time series of debt: actual and ex-crisis counterfactual, for non-financial corporates, showing the crisis-related debt overhang of around EUR 90 billion. More precisely: “In the absence of the two crises – and of the economic policy decisions that were taken to contrast their effects – the stock of non-financial corporations’ bad debts at the end of 2015 would have reached €52 billion, instead of €143billion. In the counterfactual scenario, the level at the end of 2015 is only 1.7 times larger than the one observed at the end of 2007; in actual data, the observed level was almost 5 times as large. As a share of total outstanding loans to non-financial corporations, bad debts rose at about 17.9 per cent at the end of 2015; had the two crises never occurred, it would have been around 5 per cent, roughly in line with the pre-crisis level.”

While the numbers may appear to be relatively small, given the size of the Italian real economic debt pile, provisioning on this bad debt overhang would amount to a serious dosh. Per the authors’ and previous estimates, roughly 13 percentage points was lost in Italian GDP (once public debt is accounted for). In other words,  through 2015, Italian economy has lost some 13.5 percent of GDP in potential output due to debt overhang. Of this, near 7 percentage points were lost due to sovereign debt-related losses and 6.5 percentage points due to corporate bad debt overhang.

7/10/15: Bubbles Troubles and IMF Spectacles

As was noted in the previous post (link here), IMF is quite rightly concerned with the extent of the global financial bubbles that have emerged in the wake of the years-long QE waves.

This chart shows the extent of over-valuation in sovereign debt markets:

But the following charts show the potential impact of partial unwinding of the bubbles. First up: bonds:

Then, equity:

Per IMF: “The scenario generates moderate to large output losses worldwide” as chart below shows changes in the output in 2017 under stress scenario compared to benign scenario:

And here’s what happens to projected Government debt by 2018:

         Toasty!

7/10/15: On the Illusion of Financial Stability

IMF’s Global Financial Stability Report for October 2015 is out, titled, predictably “Vulnerabilities, Legacies, and Policy Challenges: Risks Rotating to Emerging Markets”.

It is a hefty read, but some key points are the following.

“Th e Federal Reserve is poised to raise interest rates as the preconditions for liftoff are nearly in place. This increase should help slow the further buildup of excesses in financial risk taking.” As if this is something new… albeit any conjecture that the Fed move will somehow take out some of the risks built up over years of aggressive priming of the liquidity pump is a bit, err… absurd. The IMF is saying risk taking will slow down, not abate.

“Partly due to con fidence in the European Central Bank’s (ECB’s) policies, credit conditions are improving and credit demand is picking up. Corporate sectors are showing tentative signs of improvement that could spawn increased investment and economic risk taking, including in the United States and Japan, albeit from low levels.” So, as before, don’t expect a de-risking, expect slower upticks in risks. The bubbles won’t be popping, or even deflating… they will be inflating at a more gradual pace.

All of which should give us that warm sense of comfort.

Meanwhile, “risks continue to rotate toward emerging markets, amid greater market liquidity risks.” In other words, now’s the turn of EMs to start pumping in cash, as the Fed steps aside.

In summary, therefore, that which went on for years will continue going on. The shovel will change, the proverbial brown stuff will remain the same.

Still, at the very least, the IMF is more realistic than the La-La gang of european politicians and investors. Here are some warning signs:

1. “Legacy issues from the crisis in advanced economies. High public and private debt in advanced economies and remaining gaps in the euro area architecture need to be addressed to consolidate financial stability, and avoid political tensions and headwinds to confidence and growth. In the euro area, addressing remaining sovereign and banking vulnerabilities is still a challenge.” You wouldn’t know that much, but the idea of rising rates and rising cost of funding has that cold steely feel to it when you think of your outstanding mortgage…
2. “Weak systemic market liquidity… poses a challenge in adjusting to new equilibria in markets and the wider economy. Extraordinarily accommodative policies have contributed to a compression of risk premiums across a range of markets including sovereign bonds and corporate credit, as well as a compression of liquidity and equity risk premiums. While recent market developments have unwound some of this compression, risk premiums could still rise further.” Wait a second here. We had years of unprecedented money printing by the Central Banks around the world. And we have managed to inflate a massive bubble in bonds markets on foot of that. But liquidity is still ‘challenged’? Oh dear… but what about all this ‘credibility’ that the likes of ECB have raised over the recent programmes? Does it not count for anything when it comes to systemic liquidity?..
3. The system is far from shocks-proof, again contrary to what we heard during this Summer from European dodos populating the Eurogroup. “Without the implementation of policies to ensure successful normalization, potential adverse shocks or policy missteps could trigger an abrupt rise in market risk premiums and a rapid erosion of policy con fidence. Shocks may originate in advanced or emerging markets and, combined with unaddressed system vulnerabilities, could lead to a global asset market disruption and a sudden drying up of market liquidity in many asset classes. Under these conditions, a signifi cant—even if temporary— mispricing of assets may ensue, with negative repercussions on fi nancial stability.”

In summary, then, lots done, nothing achieved: we wasted trillions in monetary policy firepower and the system is still prone to exogenous and endogenous shocks.

“In… an adverse scenario, substantially tighter fi nancial conditions could stall the cyclical recovery and weaken confi dence in medium-term growth prospects. Low nominal growth would put pressure on debt-laden sovereign and private balance sheets, raising credit risks.

• Emerging markets would face higher global risk premiums and substantial capital out flows, putting particular pressure on economies with domestic imbalances. 
• Corporate default rates would rise, particularly in China, raising fi nancial system strains, with implications for growth.
• Th ese events would lead to a reappearance of risks on sovereign balance sheets, especially in Europe’s vulnerable economies, and the emergence of an adverse feedback loop between corporate and sovereign risks in emerging markets. 
• As a result, aggregate global output could be as much as 2.4 percent lower by 2017, relative to the baseline. This implies lower but still positive global growth.”

Note, the IMF doesn’t even mention in this adverse scenario what happens to households up to their necks in debt, e.g. those in Ireland, the Netherlands, Spain, and so on.

So let’s take a look at a handy IMF map plotting their own assessments of the financial systems stability in October 2015 report compared to April 2015 report. Do note that April 2015 report covers the period right before the ECB deployed its famed, fabled and all-so-credible (per IMF) QE.

Just take a look at the lot. Market & liquidity risks are up (not down), Risk Appetite is down. Macroeconomic risks improved, but everything else remains the same. That is a picture of no real achievement of any significant variety, regardless of what the IMF tells us. Worse, IMF analysis shows that risk appetite deteriorated across all 3 sub-metrics and as chart below shows, market & liquidity conditions have deteriorated across all 4 sub-metrics.

Meanwhile (Chart below), save for household risks, all other credit-related risks worsened too.

Meanwhile, markets are sustained by debt. That’s right: stock prices remain driven by debt-funded net equity buybacks and domestic acquisitions:

Meanwhile, Government bonds are in a massive bubble territory, especially for the little champions of the Euro:

You can see the extent of IMF’s thinking on the topic of just how bad the financial assets bubbles have grown in the following post.

The basic core of the IMF analysis is that although everything was made better, nothing is really much better. In the world of financial stability fetishists, that is like saying we have a steady state of no steady state. In the world of those of us living in the real economy, that is like saying all that cash pumped into the markets over the last seven years and across the globe has been largely wasted.