13/7/19: A New Era of Entrepreneurship? Not in Data so Far...

We are living in the Great New Era of Entrepreneurship that started in 2013 (according to someone at Forbes) and the academia is pumping high entrepreneurship training and education (the Golden Era, according to some don from Stanford). Living in all of this 'game changing' stuff around you can be daunting, inducing FOMO and other behavioural nudges toward dropping everything and launching that new unicorn doing something disruptive and raking in the miracle dollars that everyone around you seems to be minting out of thin air. Right?

Well, not so fast. Here's the data from the U.S. - that 'super-charged engine of enterprising folks':

Hmm... anyone can spot the 'New Era' in entrepreneurship out there, other than the one with historically low rates of business creation?

10/7/19: Financialising Stagnant Growth: From Japanified Economy to Christine Lagarde

Monetary policy since the GFC of 2008 has been characterised by the near-zero (and even negative) policy rates, negative bank rates, negative Government debt yields and rampant asset price inflation. The result has been zombification of the advanced economies.

Here is the latest advanced estimate of the Eurozone real GDP growth based on the CEPR/Banca d'Italia Eurocoin indicator:

Current forecast for 2Q 2019 growth in the Eurozone, based on Eurocoin indicator is for 0.17% q/q expansion. June Eurocoin sits at 0.14%, the lowest since September 2013. The growth rate forecast has now been sub-0.25% (below 1% annual) in five months (through June 2019) and counting. Meanwhile, the link between growth and inflation has been weakening, as shown in the chart below:

Both, from the point of view of view of the current data relative to 1Q 2019 and to 2Q 2018 and to Q1 2018, growth rates are shrinking, per above. The ECB, however, remains stuck in the proverbial hard corner (chart next):

 Five years into zero policy rates, inflation is gradually creeping up (chart above), but growth is nowhere to be seen (chart next):

Worse, tangible fundamentals (captured by the models, like Eurocoin) of economic growth are becoming less and less consistent with actual growth outruns - a feature of the economy that is becoming dependent on things other than real investment and real demand for generating expansion in GDP. Both, the chart above and the chart below, highlight this troubling fact.

All of this suggests that we are in the period in economic development that is fully consistent with the secular stagnation thesis: traditional tools of monetary and fiscal policies are no longer sufficient in generating real economic growth. Instead, these tools help sustain economies overloaded with debt. It is an extend-and-pretend model of economic development: as long as corporates and households can be supported in carrying existent debt loads through monetary accommodation, the economy remains afloat (no recession, nor crisis blowout), but the levels of debt are so prohibitively high that no new debt can be accumulated to generate economic expansion.

The markets know as much. Investors know that zombie loans (loans with no capacity of servicing them should interest rates rise) mean zombie banks. Zombie banks mean zombie new borrowing markets. Zombie new borrowing markets mean zombie real investment by households and companies. Zombie investment means zombie demand. Zombie demand means deflationary supply. Rinse and repeat.

This knowledge in the markets is tangible. It takes a change in investors expectations (as in recent changes in outlook toward the reversal of the monetary tightening in the U.S. and Europe) to reprice assets. No actual value added growth enters the equation. Assets are no longer being priced on their productive capacity. And the markets are now fully finacialised. Which is to say, they are now fully monetary policy-driven.

Enter Christine Lagarde, the new head of the ECB. Lagarde's appointment is hardly an accident or a politically correct nod to women in leadership. It is the only logical choice of the financialised zombie economics of the monetary policy. To re-start borrowing or debt cycle, the EU is hoping for mutualisation of the sovereign debt markets. In other words, it is hoping to leverage the only unencumbered asset the EU still has: surplus countries' bonds. Lagarde's job at the ECB will be to run the creation of the eurobonds, bonds that will proportionally link euro area members' bonds into a single product to be monetised by the ECB as a support for market pricing. There is probably EUR 2-3 trillion worth of the international and monetary demand for these, opening up the room for more borrowing and more fiscal spending.

12/6/19: Japanifying the World

Heard on the sidelines of the QE: "Honey, we've Japanified the World..."

Chart via Wells Fargo Research team.

27/5/19: Which part of the Federal spending poses a greater fiscal threat?

An interesting chart via Cato on the number of Federal state aid programs in the U.S.

The grand total of these programs in terms of annual spending is roughly US$697 billion. The issue here is that these programs are continuing to increase in scale and scope despite the so-called 'strongest economy, ever' (excluding the recent changes under the Trump Administration that propose significant cuts to some of these programs on the social welfare, public health and education sides for Budget 2020) .

Here is the summary of the main program headlines and outlays:

Source for both charts: https://object.cato.org/sites/cato.org/files/pubs/pdf/pa868.pdf

Nonetheless, whether or not the state supports and welfare entitlement programs can be afforded into the future (yes, demographics of ageing are driving up the demand for many of these programs, while also making them more politically feasible with older voters, yet reducing the capacity of the economy to carry these increases), the major issue that is left un-addressed by the American analysts is the overall composition of the U.S. Federal spending.

As discussed in this article: https://bit.ly/2VU39Hj, current 2020 budgetary outlook envisions a massive increases in military spending, offset by the reductions in assistance to the low income families, education and public health. Here is the summary slide on this from my new course slides on the subject of the Twin Secular Stagnations:

The key quote from the above: "In fact, the proposed FY2020 military and war budget makes up $989 billion of the Federal Government’s $1,426 billion Discretionary Budget. This represents a staggering 69 percent of the total Federal Discretionary Budget for FY2020!"

No matter how concerned we might be with the sustainability of the Federal fiscal policies, transfers to the States from Washington are, de facto, a form of local monetization of the Fed monetary policies, some of which is being cycled into state-level investments in public infrastructure and education, as well as public health. Pentagon's spending, in contrast, carries virtually no investment-like benefit for the rest of the society, and much of the 'securing our nation' argument in favor of spending almost a trillion dollars on weaponry and military personnel is bogus as well (unless you still, for some unfathomable reason, believe that demolishing Libya or Syria are of some benefit to the actual American society or that the likes of Iraq and Iran pose a truly existential threat to America).

6/4/19: Industrial Production and Global Trade are Tanking

The great convergence of simultaneously declining global trade flows and industrial production:

Via topdowncharts.com

The trend is also evident from the global manufacturing and composite PMIs (see https://trueeconomics.blogspot.com/2019/04/4419-bric-manufacturing-pmis-for-1q.html and https://trueeconomics.blogspot.com/2019/04/6419-bric-services-lead-manufacturing.html).

Note the range bounds for two periods (pr-GFC and post-GFC) in the first chart above.

24/2/19: Buybacks vs Capex

U.S. corporates spending or 'investing' over the last 10 years:

• CapEx ($6.4T), including often non-productive M&As
• Buybacks ($4.9T) and 
• Dividends ($3.4T) 

via @mbarna6

Just another reminder why productivity growth is not being aided by cheap credit.

15/11/18: The 'New Normal' is a Road to another Tech Sector Bust

The VC land of wonders and waste is awash with cash, thanks to a decade-long loose liquidity pumping across the markets by the Central Banks. Just as in the prior iterations of the same (the Dot.Com Bubble and the pre-GFC assets binge), the outrun will be the same as it was before: a crash.

TechCrunch reports that (https://techcrunch.com/2018/11/11/age-of-the-unicorn/):

• Over the last 5 years, the number of 'unicorns' - startups with valuations in excess of USD1 billion - has grown from 39 to 376 - almost a ten-fold increase
• The rate of 'unicorns' emergence is accelerating: in 11 months through November 1, 2018, we've added 81 new 'unicorns' to the roster, which means there is now a new 'unicorn' company launched every four days
• Mega-deals for start ups - funding rounds in excess of USD100 million - are also on the rise, with their frequency up ten-fold on five years ago. "Back in 2013, there were only about four mega rounds a month, but now there are forty mega rounds a month based..." Thus, "starting from 2015, public market IPO has for the first time no longer been the major funding source for unicorn size companies."

As the chart above shows, there has been a power-law acceleration in the trend since mid-2017 and it is now clearly topping the asymptote.

Two countries dominate the 'unicorns' league: China (with 149 count) and the U.S. (with 146 count). Which implies two things: 

• Given the close links between the PBOC policies, Chinese Government investment strategies and supports, and China's counts of 'unicorns', majority of these start ups are heavily dependent on debt, and political good will. They are sitting ducks for ESG risks and are extremely exposed to political and policy uncertainty.
• The U.S. 'unicorns' are completely dependent on the markets ability to cycle cash from corporate and financial sectors debt and private equity into start ups funding, and M&As. There is zero rational valuation happening in this sub-sector.

A dramatic shift in risks from tangible tangible technologies (including strongly patentable innovation or defensible market shares) of the likes of Apple and Google toward less tangible, highly price and income elastic SaaS types of product offers is reflecting the massive buildup in valuations risks. This too is reflected in the article, albeit the authors fail to spot the implications. TechCrunch conclusion is perhaps even more alarming that the stats they present. "Mega rounds are the new normal; staying private longer is the new normal; and the global composition of the unicorn club is the new normal." We've heard exactly the same arguments at the tail end of the Dot.Com boom about the absurdly over-valued early internet age companies. We've heard exactly the same arguments about the real estate sector prior to 2008. We've heard exactly the same arguments about tulip bulbs in Amsterdam some centuries ago too. 

'The new normal' is the old road to a bust.

19/10/18: IMF's Woeful Record in Forecasting: Denying Secular Stagnation Hypothesis

A recent MarketWatch post by Ashoka Mody, @AshokaMody, detailing the absurdities of the IMF growth forecasts is a great read (see https://www.marketwatch.com/story/the-imf-is-still-too-optimistic-about-global-growth-and-thats-bad-news-for-investors-2018-10-15?mod=mw_share_twitter).  Mody's explanation for the IMF forecasters' failures is also spot on, linking these errors to the Fund's staunch desire not to see the declining productivity growth rates (aka, supply side secular stagnation).

So, to add to Mody's analysis, here are two charts showing the IMF's persistent forecasting errors over the last four years (first chart), set against the trend and the cumulative over-estimate of global economic activity by the Fund since mid-2008 (second chart):

While the first chart simply plots IMF forecasting errors, the second chart paints the picture fully consistent with Mody's analysis: the IMF forecasts have missed global economic activity by a whooping cumulative USD10 trillion or full 1/8th of the size of the global economy, between 2008 and 2018. These errors did not occur because of the Global Financial Crisis and the high degree of uncertainty associated with it. Firstly, the forecasting errors relating to the GFC have occurred during the period when the crisis extent was becoming more visible. Secondly, post GFC, the hit rates of IMF forecasts have deteriorated even more than during the GFC. As Mody correctly points out, Fund's forecasts got progressively more and more detached from reality.

At this stage, looking at April and October 2018 forecasts from the Fund's WEO updates implies virtually zero credibility in the core IMF's thesis of a 'soft landing' for the global economy over 2019-2021 time horizon.

11/9/18: Slow Recoveries & Unemployment Traps: Hysteresis and/or Secular Stagnation

The twin secular stagnations hypothesis (TSSH, first postulated on this blog) that combines supply-side (technological cyclicality) and demand-side (demographic cyclicality) arguments for why the world economy may have settled on a lower growth trajectory than the one prevailing before 2007 has been a recurrent feature of a number of my posts on this blog, and has entered several of my policy and academic research papers. Throughout my usual discourse on the subject, I have persistently argued that the TSSH accommodates the view that the Global Financial Crisis and the associated Great Recession and the Euro Area Sovereign Crisis of 2007-2014 have significantly accelerated the onset of the TSSH. In other words, TSSH is not a displacement of the arguments that attribute current economic dynamics (slow productivity growth, slower growth in the real economy, reallocation of returns from labour and human capital to technological capital and, more significantly, the financial capital) to the aftermath of the structural crises we experienced in the recent past. The two sets of arguments are, in my view, somewhat complementary.

From this later point of view, a research paper, "Slow Recoveries & Unemployment Traps: Monetary Policy in a Time of Hysteresis" by Sushant Acharya, Julien Bengui, Keshav Dogra, and Shu Lin Wee (August 2018 https://sushantacharya.github.io/sushantacharya.github.io/pdfs/hysteresis.pdf) offers an interesting read.

The paper starts with the - relatively common in the literature - superficial (in my opinion) dichotomy between the secular stagnation hypothesis and the "alternative explanation" of the slowdown in the economy, namely "that large, temporary downturns can themselves permanently damage an economy’s productive capacity." The latter is the so-called 'hysteresis hypothesis', "according to which changes in current aggregate demand can have a significant effect on future aggregate supply" which dates back to the 1980s. The superficiality of this dichotomy relates to the causal chains involved, and to the impact of the two hypotheses.

However, as the authors note, correctly: "While the two sets of explanations may be observationally similar, they have very different normative implications. If exogenous structural factors drive slow growth, countercyclical policy may be unable to resist or reverse this trend. In contrast, if temporary downturns themselves lead to persistently or permanently slower growth, then countercyclical policy, by limiting the severity of downturns, may have a role to play to avert such adverse developments."

The authors develop a model in which countercyclical monetary policy can "moderate" the impact of the sudden, but temporary large downturns, i.e. in the presence of hysteresis. How does this work?

The authors first describe the source of the deep adverse shock capable of shifting the economy toward long-term lower growth rates: "in our model, hysteresis can arise because workers lose human capital whilst unemployed and unskilled workers are costly to retrain". This is not new and goes back to the 1990s work on hysteresis. The problem is explaining why exactly such deep depreciation takes place. Long unemployment spells do reduce human capital stock for workers, but long unemployment spells are feature of less skilled workforce, so there is less human capital to depreciate there in the first place. Retraining low skilled workers is not more expensive than retraining higher skilled workers. In fact, low skilled workers seek low skilled jobs and these require only basic training. It is quite possible that low skilled workers losing their jobs today are of certain demographic (e.g. older workers) that reduces the effectiveness of retraining programs, but that is the TSSH domain, not the hysteresis domain.

One thing that does help this paper's hypothesis is the historical trend of growing duration of unemployment, e.g. discussed here: http://trueeconomics.blogspot.com/2017/07/27717-us-labor-markets-are-not-in-rude.html and the associated trend of low labour force participation rates, e.g. discussed here: http://trueeconomics.blogspot.com/2018/06/8618-human-capital-twin-secular.html. I do agree that unskilled workers are costly to retrain, especially in the presence of demographic constraints (which are consistent with the secular stagnation on the demand side).

But, back to the authors: "... large adverse fundamental shocks can cause recessions whose legacy is persistent or permanent unemployment... Accommodative policy early in a recession can prevent hysteresis from taking root and enable swift a recovery. In contrast, delayed monetary policy interventions may be powerless to bring the economy back to full employment."

"As in Pissarides (1992), these features [of long unemployment-induced loss of human capital, sticky wages that prevent wages from falling significantly during the downturns, costly search for new jobs, and costly retraining of workers] generate multiple steady states. One steady state is a high pressure economy: job finding rates are high, unemployment is low and job-seekers are highly skilled. While tight labor markets - by improving workers’ outside options - cause wages to be high, firms still find job creation attractive, as higher wages are offset by low average training costs when job-seekers are mostly highly skilled." Note: the same holds when highly skilled workers labour productivity rises to outpace sticky wages, so one needs to also account for the reasons why labour productivity slacks or does not keep up with wages growth during the downturn, especially when the downturn results in selective layoffs of workers who are less productive ahead of those more productive. Hysteresis hypothesis alone is not enough to do that. We need fundamental reasons for structural changes in labour productivity that go beyond simple depreciation of human capital (or, put differently, we need something similar to the TSSH).

"The economy, however, can also be trapped in a low pressure steady state. In this steady state, job finding rates are low, unemployment is high, and many job-seekers are unskilled as long unemployment spells have eroded their human capital. Slack labor markets lower the outside options of workers and drive wages down, but hiring is still limited as firms find it costly to retrain these workers." Once again, I am not entirely convinced we are facing higher costs of retraining low skilled workers (as argued above), and I am not entirely convinced we are seeing the problem arising amongst the low skilled workers to begin with. Post-2008 recovery has been associated with more jobs creation in lower skilled categories of jobs, e.g. hospitality sector, restaurants, bars, other basic services. These are low skilled jobs which require minimal training. And, yet, we are seeing continued trend toward lower labour force participation rates. Something is missing in the argument that hysteresis is triggered by cost of retraining workers.

Back to the paper: "Importantly, the transition to an unemployment trap following a large severe shock can be avoided. If monetary policy commits to temporarily higher inflation after the liquidity trap has ended, it can mitigate both the initial rise in unemployment, and its persistent (or permanent)
negative consequences. Monetary policy, however, is only effective if it is implemented early in the downturn, before the recession has left substantial scars... [otherwise] ...fiscal policy, in the form of hiring or training subsidies, is necessary to engineer a swift recovery."

The paper tests the model in the empirical setting. And the results seem to be plausible: "allowing for a realistic degree of skill depreciation and training costs... is sufficient to generate multiple steady states.... this multiplicity is essential in explaining why the unemployment rate in the U.S. took 7 years to return to its pre-crisis level. In contrast, the standard search model without skill depreciation and/or training costs predicts that the U.S. economy should have fully recovered by 2011. ...the model indicates that had monetary policy been less accommodative or timely during the crisis, leading to a peak unemployment rate higher than 11 percent, the economy might have been permanently scarred and stuck in an unemployment trap. Furthermore, our model suggests that the persistently high proportion of long-term unemployed in the European periphery countries may reflect a lack of timely monetary accommodation by the European Central Bank."

Fraction of Long-term unemployed (>27 weeks) in select countries. 

The figure plots five quarter moving averages of quarterly data. 

The dashed-line indicates the timing of Draghi’s “whatever it takes” speech. 

Source: Eurostat and FRED.

This seems quite plausible, even though it does not explain why eventual 'retraining' of low skilled workers is still not triggering substantial increases in labour productivity growth rates in Europe and the U.S.

One interesting extension presented in the paper is that of segmented labour markets, or the markets where "employers might be able to discern whether a worker requires training or not based on observable characteristics - in particular, their duration of unemployment... [so that, if] skilled and unskilled workers searched in separate markets, the economy would still be characterized by hysteresis, but it would take a different form. There are two possibilities to consider. [If] ... the firm’s share of the surplus from hiring an unskilled worker, net of training costs, is large enough to compensate firms for posting vacancies in the unskilled labor market, ...after a temporary recession which increases the fraction of unskilled job-seekers, it can take a long time for these workers to be reabsorbed into employment. Firms prefer to post vacancies in the market for skilled job-seekers rather than the market for unskilled job-seekers in order to avoid paying a training cost. With fewer vacancies posted for them, unskilled job-seekers face a lower job-finding rate and thus, the outflow from the pool of unskilled job-seekers is low. In contrast, the skilled unemployment rate recovers rapidly - in fact, faster than in the baseline model with a single labor market... [Alternatively], the segmented labor markets economy could experience permanent stagnation, rather than a slow recovery, [if] unskilled workers are unemployable, since firms are unwilling to pay the cost of hiring and training these workers. Thus unskilled workers effectively drop out of the labor force."

We do observe some of the elements of both such regimes in the advanced economies today, with simultaneous increasing jobs creation drift toward lower-skilled, slack in supply of skills as younger, educated workers are forced to compete for lower skilled jobs, and a dropout rate acceleration for labour force participation. Which suggests that demographics (the TSSH component, not hysteresis component) is at play at least in part in the equation.


In summary, a very interesting paper that, in my opinion, adds to the TSSH arguments a new dimensions: deterioration in skills due to severity of a demand shock and productivity shock. It does not, however, contradict the TSSH and does not invalidate the key arguments of the TSSH. As per effectiveness of monetary or monetary-fiscal policies in combatting the long-term nature of the adverse economic equilibrium, the book remains open in my opinion, even under the hysteresis hypothesis: if hysteresis is accompanied by a permanent loss of skills twinned with a loss of productivity (e.g. due to technological progress), adverse demographics (older age cohorts of workers losing their jobs) will not be resolved by a training push. You simply cannot attain a catch up for the displaced workers using training schemes in the presence of younger generation of workers competing for the scarce jobs in a hysteresis environment.

And the Zero-Lower Bound on monetary policy still matters: the duration of the hysteresis shock will undoubtedly create large scale mismatch between the sovereign capacity to fund future liabilities (deficits) and the longer-run inflationary dynamics implied by the extremely aggressive and prolonged monetary intervention. In other words, large enough hysteresis shock will require Japanification of the economy, and as we have seen in the case of Japan, such a scenario does not lead to the economy escaping the TSSH or hysteresis (or both) trap even after two decades of aggressive monetary and fiscal stimuli.

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.

18/8/18: Monopolization trends in Advanced Economies: my column for CFR

My column for the Cayman Financial Review on the topic of structural monopolization of the global economy and the declining competitiveness. https://www.caymanfinancialreview.com/2018/08/14/breaking-the-medici-vicious-circle-monopolization-trends-in-advanced-economies/.

2/8/18: M&A Activity: More Concentration Risk Signals

In recent media analysis of the markets, less attention that the rise in shares buybacks has been given to the M&A markets. And there are some interesting observations to be made from the most recent data on these.

Top level (see https://insight.factset.com/mega-deals-dominate-even-as-the-u.s.-ma-market-remains-in-a-slump for details) analysis is that the overall M&A markets activity is remaining at cyclical lows:

As the chart above shows both values and volumes of M&A activities are shrinking. But the numbers of mega deals are rising:

Per chart above, overall transactions in excess of $1 billion are at an all-time historical high. Per FactSet: "the first half of 2018 has reported the second-highest level of deals valued over $1 billion with 200 deals; the highest level was attained in the first half of 2007 with 210 deals. It is also worth noting that the streak of billion-dollar deals started in 2013, and since then there have been over 100 billion-dollar deals in each half-year. Even in the run-up to the financial crisis the streak was only three years (2005 to 2007). And to help complete the pattern, the dot-com boom had a similar three-year streak of 100 billion-dollar deals in each half-year from 1998 to 2000."

In other words, markets reward concentration risk taking. Mega deals generally add value through increased valuation of the acquiring firm, and through synergies on costs side. But they do not generally add value in terms of future growth capacity. Smaller deals usually add the latter value. Divergence between overall M&A activity and the mega-deals activity is consistent with the secular stagnation theses.

2/8/18: Shares Buybacks: the Evil Symptoms of an Ever More Evil Disease

Yesterday, I have posted a quite unusual (for my normal arguments) defense of the shares buybacks. Normally, as the readers of this blog know, I see buybacks as a net negative to organic investment. However, that view needs to be anchored to the economic conditions prevailing on the ground. In other words, buybacks are net negative for investment and organic economic growth, unless buybacks are companies' rational responses to specific economic and policy conditions.

With this in mind, here are my thoughts on the subject of buybacks that have accelerated in recent years:

The proposition that shares buybacks are ‘starving’ (aka slowing) the economy is false. And it is false for a number of reasons, listed below:

Reason 1: Stock buybacks can ONLY slow down economic growth in the conditions when new investment by firms can generate higher economic value added than other uses of funds in the economy (e.g. investment by other agents, than the firm, or increasing aggregate demand by investors recycling gains from buybacks into general consumption, etc). Currently, this does not appear to be the case. In fact, firms are hesitant to invest in the economy even when we control for buybacks. Thus, buybacks are similar to dividends: payouts of dividends and higher buybacks rates may signal lack of profitable investment opportunities for the firms.

Reason 2: Stock buybacks can slow down economic growth if they increase cost of capital for the firms. With equity capital (shares) being made superficially more expensive than debt (QE, tax preferences, demographic shifts in clientele reasons, etc), this is not the case. equity capital is currently more expensive than debt as a funding source for new investment for listed companies. While this situation may reverse in time (which it did only on very rare occasions in the past), companies today can borrow cheaply to retire expensive equity. This might not make sense from the economy point of view (rising degree of financial leverage, increasing risk of destabilising increases in debt carry costs, etc), it might make sense from the company and management point of view.

Reason 3: Stock buybacks can harm economic growth if they reduce returns on productivity (theory of labour productivity being unrewarded via slow wages growth). This too is not the case, because labour productivity and TFP have been collapsing since prior to the increases in shares buybacks. I wrote enough about this on this blog before in the context of the twin secular stagnations theses.

So what does the story of skyrocketing shares buybacks really tell us? The reality, consistent with Reasons 1-3 above, is that stock buybacks are a SYMPTOM of the disease, not the disease itself. Shares buybacks are driven by secular stagnation: more specifically, primarily by supply-side secular stagnation (S-SSS), and are second-order related to demand-side secular stagnation (D-SSS). How?

S-SSS implies lack of profitable investment opportunities for short and medium-term investments by the firms. With falling TFP & labour productivity, and with demographically-induced slowdown in demand, this is patently so. S-SSS also implies the need for protracted QE and other distortions in capital funding costs that disincentivise equity capital relative to debt funding channels.

D-SSS implies that with demographic, structural shifts in economic activity across generations, etc, aggregate demand side of the economy is getting pressured. Which means, again, 2nd order effects, adverse pressure on supply side.

So shares buybacks are NOT a disaster, nor a disease. The disease is the structure of the economy, with
- Technological & human capital productivity and innovation stalling,
- Adverse demographics undermining future economic capacity,
- Infrastructure investments yielding lower potential growth uplifts,
- Policies (monetary & fiscal) stuck in the 20th century extremes,
- Increasing concentration, monopolisation & oligopolization of the economy and the markets resulting in reduced entrepreneurial activity.

Shares buybacks & resulting wealth inequality or concentration are not orthogonal sets to the political & policy mismanagement that marks the last 25 years of our (Western) history. They are DIRECT outcome of these.

So, go ahead, political punks. Make the markets day. Shut down shares buybacks, so you can keep gerrymandering the economy, manipulating the markets, & bend the society to your desired ends. The longer you do this, the more you do this, the tighter is the lid on the pressure cooker. The more spectacular the blowout to follow.

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:

8/6/18: Human Capital, Twin Secular Stagnations and Education Investments

I have written a lot about the twin secular stagnations hypothesis that I defined few years ago as a combination of two separate secular stagnation propositions. According to my running definition:

“The Twin Secular Stagnations Hypothesis combines two sources of the statistically significant reduction in the potential growth in the economy as:

1. Supply-side Secular Stagnation: a proposition that future growth is likely to be slower amongst the advanced economies due to the decline in returns to innovation and lower growth rate in the labour force; and
2. Demand-side Secular Stagnation: a proposition that future growth is being pushed down by the adverse demographics (ageing population) and the legacy of the Global Financial Crisis, the Great Recession and the Euro Area Sovereign Debt Crisis, which result in lower potential investment, slower growth in demand, and the rising cost of social services, pensions and healthcare provisions.”

An interesting piece of evidence, supporting the ‘productivity-labour force’ nexus of the Twin Secular Stagnations Hypothesis has been recently presented by Mary Daly, the executive vice president and Director of Research in the Economic Research Department of the Federal Reserve Bank of San Francisco (full article here: https://www.frbsf.org/economic-research/publications/economic-letter/2018/april/raising-speed-limit-on-future-growth/).

First, on evidence of secular stagnation: "Average GDP growth over the 60 years preceding the Great Recession, was just under 3.5%. But if we look ahead, economists forecast numbers closer to 2%." In other words, we are looking at long term growth rate or potential growth rate that is almost 43 percent below the empirical rates of growth experienced over the last 60 years.

Next: the evidence of nexus. Per Daly, to "account for the dramatic change in prospects" for future growth in the U.S. "To explain that, we need to look at the fundamental drivers of economic growth: growth in productivity and the labor force."

Figure 1 shows the extent to which the labor force-productivity nexus drove growth over the last 7 decades, and is expected/forecast to do so in 2017-2025 period:

Daly notes that "productivity growth has varied over time, but since the 1980s has contributed on average about 1.5% to growth and is forecast to do the same going forward." This is, at best, incomplete. In reality, as the chart shows, productivity growth penciled in for 2017-2025 is slower than in the 1980s, 1990s, and 2000-2007. In fact, labour productivity growth in 2017-2025 is forecast to run roughly at an average rate of the 1970s, 1980s and 2008-2016. This is set against the technological revolution we are allegedly experiencing which should, all thing equal, be driving up labour productivity growth in 2017-2025 over and above the 1980s-1990s period. But, in fact, labour productivity growth contribution to GDP growth has shrunk in 2000-2007, and then again in 2008-2016 (the Great Recovery) and now set to be below the 1990s over the period 2017-2025. So all is NOT well with productivity growth.

The second point, well-argued by Daly is that labour force contribution to GDP growth is shrinking and shrinking catastrophically. That is clear from the Figure above.

On the latter point, Daly shows that labour force participation rates (also a subject of frequent coverage on this blog), have fallen off the cliff in recent years: "We’ve also seen a drop in the level of labor force participation among workers in their prime employment years, a pattern that does look quite a bit different from other countries. Labor force participation in the United States for prime-age workers reached a peak in the late 1990s and then took a steep dive in the 2001 recession. In the 2007 recession, it took an even steeper tumble, reaching a low point in 2015... While we have seen improvements since, they have been modest. So today, the share of men and women in their prime working years who are employed or actively searching for a job is far lower than it was in the 1990s."

So, Daly asks a very important question: "Why aren’t American workers working?" And proceeds to give an interesting explanation: "research by a colleague from the San Francisco Fed and others suggests that some of the drop owes to wealthier families choosing to have only one person engaging in the paid labor market (Hall and Petrosky-Nadeau 2016)."

Why is it interesting? Because those who can afford single-earner households today are a vast minority. The original research from the Fed cited by Daly is here: https://www.frbsf.org/economic-research/publications/economic-letter/2016/february/labor-force-participation-and-household-income/. And here is the chart that shows the key findings from the research:

 Note: Numbers to right of lines show percentage point changes to total and quartile contributions, 2004–13

Observe that the deepest reduction in labour force participation is for the 3rd quartile of income earners. How much do these families earn? "In 2013, households in the lowest 25% of the income distribution, or the first quartile, had an average monthly income of less than $1,770. The median total household monthly income was $3,430. At the top of the distribution, the lower bound for being in the highest 25% of households, or the fourth quartile, was a monthly income of $5,993." Now, can you imagine in these modern days a household earning less that $5,993 per month in pre-tax income being able to afford not to engage the second partner in work? Personally, I can't. Unless these households benefit from huge transfers via inheritance or within-family housing subsidies, etc. But... per same paper, "On average in 2013, the upper-level households derived about 96% of their monthly income from working. For households in the poorest quartile, earnings made up about 62% of monthly income, while another 23% came from unemployment compensation, social security, supplemental social security, and food stamps." Which means that these very same households that, apparently, voluntarily withdrawing labour force participation, are not gaining much from non-labour income transfers.

So, these volunatry exits from the labour force are, apparently, impacting households more dependent on labour income AND not the highest income quartile households. Something is fishy.

Second piece of evidence from the paper cited by Daly is age cohorts of 'leavers':

This too shows that something is fishy in the data. Households in 55+ age group are more likely to have higher incomes. They are increasing labour force participation despite the fact that it is harder for them to gain quality jobs due to age effects. Households in 25-54 age bracket are exiting the workforce, just at the time when their earnings from work should be rising and just in time when they need to service student loans, mortgages, schooling for kids, pensions etc.

Again, the evidence presented simply contradicts the arguments made: both age cohorts and income cohorts analysis does not appear to support the proposition that families are voluntarily exiting the labour force, reducing their labour income to single source provision.

I am not buying this. The fact that the 3rd quartile of families are exiting the workforce is not a sign of preferences for leisure or household employment. It is, rather, a sign that the jobs market is no longer promising for the upper-middle classes, especially for the younger workers. It is a sign that families are increasingly reliant on familial transfers for housing and contingent workforce employment, both under-reported to the official stats gatherers.

Daly hints at this in her reference to the 'second factor' driving decline in labour force participation: the disappearance of the mid-level skills jobs, including the decline due to automation: "A growing body of research finds that these pressures on middle-skilled jobs leave a big swath of workers on the sidelines, wanting work but not having the skills to keep pace with the ever-changing economy". Now, that hits the target far better than the argument that people are just exiting workforce to have good times and home-school their kids.

And worse, Daly is also on the money when she points out that the U.S. system is woefully inadequate when it comes to provisions for investing in human capital: "Like in most advanced economies, job creation in the United States is being tilted toward jobs that require a college degree (OECD 2017). Even if high school-educated workers can find jobs today, their future job security is in jeopardy. Indeed by 2020, for the first time in our history, more jobs will require a bachelor’s degree than a high school diploma (Carnevale, Smith, and Strohl 2013)." Yet, "although the share of young people with four-year college degrees is rising, in 2016 only 37% of 25- to 29-year-olds had a college diploma (Snyder, de Brey, and Dillow 2018). This falls short of the progress in many of our international competitors (OECD 2018), but also means that many of our young people are underprepared for the jobs in our economy."

There are added dimensions / nuances to this. Some of the U.S. college education is of questionable quality, compared to more evenly-distributed quality of college education in Europe, Japan and Australia. Top Universities deliver top tier output. But for-profit colleges and some lower-end school deliver nothing worth talking about. A 4-year system of undergraduate education is effectively a correction on already poor quality high schools output, requiring the first year of college to be a remediation year to compensate for the lack of proper standards in secondary education. Two-year masters programs are, then, designed to take the first year to correct for the shortfalls in education quality in undergraduate levels. And so on. In effect, the U.S. higher education system is designed to inflict maximum financial damage (via costs and debt of year 1 education in undergraduate and post-graduate systems), while taking a cut of two years from the graduates careers. This is similar to what Italian system delivers, except in the case of Italians, it delivers also higher quality content in secondary and undergraduate education, taking longer time to learn more.

And so on. In simple terms, as Daly tacitly acknowledges, the U.S. economy is racing toward higher degree of automation and greater skills intensity, while running low on human capital investments. The solution to this historical problem has been to import younger, smarter foreigners via a range of schemes - from graduate schools admissions to H1Bs. But this solution is not sufficient to correct for the rate of acceleration in skills intensity. And it is not functioning in redressing training and skills gaps that already exist in the economy.

Daly notes that one important aspect of change must touch upon the need to "equalize educational attainment across students of different races and ethnicities." This, undoubtedly, is one key factor in attempting to address the human capital investment gaps. The problem, of course, is how does one achieve this? Historically, the U.S. States have gone about the problem by lowering standards and quality of secondary education curriculum for all students. They also increased quotas-based admissions for minorities. The former does nothing for actually stimulating investment in human capital. The latter creates a zero-sum game out of education system, unless new investments go into college education provision. Which is not happening, despite rampant price inflation in higher education.

Daly makes a strong case for more investment in college education. But she does not make the equally important case that such investment must start at pre-primary level and work through a combination of increased resources and higher standards across all grades and for all students. She correctly states that "In the parlance of economics, education is incentive compatible, good for everyone involved", when it comes to students, taxpayers and the economy.

But she does not recognise that better education is not incentive-compatible for one key set of participants in the market: teachers and schools administartors. In fact, in primary and secondary education systems, in the U.S., incentives for teachers are aligned toward delivering more standardised, less rigorous, less-transparent in quality, outcomes, such as rota learning and teaching-to-test. Daly says nothing as to how this problem can be addressed, despite the fact that all past reforms of the U.S. education system were led by teachers and their Unions, not by parents or other economic agents.

Finally, there is a problem of generational cohorts. Any investment in education system today will hold promise of altering the status quo of human capital investments for the cohorts of those under the age 30 (given the levels of debt accumulated by the recent graduates, probably for those under the age of 25). Which leaves the rest of the households - the vast majority of them, in fact - just where we have them today: under-skilled, facing the risk of their existent human capital depreciation to automation, etc. Formal education cannot address these problems systemically. Take an argument ad absurdum as an illustration. Suppose we invest enough funding into the current higher education system to provide 100% college graduation for those current under 25 years of age. Suppose we even fix the quality vs quantity problem in the U.S. education system. This will improve the productivity and jobs prospects for the very young. But it will make the older generations of workers (older = 25 years of and above) even less competitive, leading to further reductions in their incomes, career prospects and labor force participation rates.

Have we fixed anything when it comes to the Twin Secular Stagnations Hypothesis? Not really. Have we addressed the polarisation gap between life-cycle earnings of the lower earners and higher earners (the dropping-out of the U.S. middle class)? Not really. Have we done anything to alleviate political disillusionment amongst the U.S. voters with the economic system that reduces their social and economic mobility? Not really. So even in ad absurdum case of Daly-proposed solution success, we have fixed little if nothing at all. We, in fact, might have made the disease more deadly.

In sum, we do need more investment in education. But we also need smarter education systems reforms. And we need a parallel investment in increasing human capital investments for those already in the labour force, and those of older age cohorts who have been dropping out of it. We need a systemic approach to addressing skills depreciation arising from automaton. And we need a systemic approach to tackling economic value-added displacement away from labour, toward pure profits and technological capital. The longer we delay these major, pivotal reforms, the bigger the problem of the secular stagnation gets.

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.

24/3/18: Secular Stagnations Visit Morgan Stanley

Morgan Stanley jumps onto the secular stagnations thesis band wagon: http://www.morganstanley.com/ideas/ruchir-sharma-trends-2018 and adds an obvious cross-driver to the equation: monetary policy heading for the end of the Great Liquidity Wash.

20/3/18: Market Power and 5 Macroeconomic Puzzles: Rotten State of the ‘Competitive Markets’

Washington Centre for Equitable Growth has recently published a new modified version of the neoclassical model attempting to explain a number of empirical facts. A paper by Gauti Eggertsson, Jacob A. Robbins, Ella Getz Wold, titled “Kaldor and Piketty’s Facts: The Rise of Monopoly Power in the United States” (February 2018: http://equitablegrowth.org/working-papers/kaldor-piketty-monopoly-power/) departs from the empirical observation that the empirical facts of the real economy can be reconciled with in contrast to the traditional neoclassical models. Specifically, per authors:

• “(P1) An increase in the financial wealth-to-income ratio despite low savings rates, with a stagnating capital-to-income ratio.”
• “(P2) An increase in Tobin’s Q to a level permanently above 1.” So that stock market value of assets exceeds productive value of assets.
• “(P3) A decrease in the real rate of interest, while the measured average return on capital is relatively constant.” So profit margins on investment rise.
• “(P4) An increase in the pure profit share, with a decrease in the capital and labor share.” So shareholders get to carry away more in returns, while capital suppliers and workers get less.
• “(P5) A decrease in investment-to-output, even given historically low borrowing costs and a high value of empirical Tobin’s Q.” In  other words, low investment, even as the interest rates (cost of investment) fall.

Table 1: Factor shares. 5-year moving averages

The paper then modifies the standard neoclassical model. The authors introduce a market concentration distortion: “an increase in monopoly profits, [coupled] with a decrease in the natural rate of interest”.

To justify this, they, first, “depart from perfect competition, and posit that market power allows firms to make pure profits”. Second, authors assert that “there are barriers to entry, which prevent competition from driving these profits to zero.” This is consistent with the proposition that we are witnessing increased pressure of monopolistic and oligopolistic competition in the U.S. economy, as covered by me in a range of previous posts and articles.

“Third, claims to the (nonzero) pure profits of firms are traded and priced, and the ratio of the market
value of firms (which includes the rights to pure profits) to the replacement value of the productive capital stock is permanently above one; this ratio is commonly known as “empirical Tobin’s Q”.” Note that the tradability of pure profits of the firm (as opposed to rents on capital) is a distinct part of the model. Traditionally, we think of stock markets valuations as reflective of economic rents, not pure profits. That is so, because we assume that over the longer run, pure profits are driven down to zero. However, if/when pure profits are non-zero, stock market valuations are reflective of both: capital rents (low, due to extremely low cost of credit), plus pure profit (high, due to the transfers from interest rate subsidy from labor and technology logical capital to financial capital via pure profit monetisation, plus, dare I say it, the monetary policies excesses of the recent past).

CHART 1

Now, the authors confine their explanation for market power perpetuation to the following: “Because of the barriers to entry, the assets which hold the rights to the pure profits are non-reproducible: unlike productive capital, individuals cannot recreate these assets through investment, they must instead purchase them from others.” Personally, I would agree that barriers to entry - formal ones, e.g. via licensing and regulation - are one part of the problem. But there is a more direct problem arising in the American economy as well: concentration driven by pure monopolistic differentiation (see buy post on this here: http://trueeconomics.blogspot.com/2018/03/28218-san-francisco-fed-research.html, and here: http://trueeconomics.blogspot.com/2018/02/7218-american-wages-corporotocracy-why.html, and here: http://trueeconomics.blogspot.com/2018/02/9218-angus-deaton-on-monopolization-and.html.

The authors simply ignore this consideration as if it represents an uncomfortable truth about the state of the modern American society and economy. Instead, they create a marginal wrap-around argument to explain these dynamics: “This produces an interesting result: returns to assets that receive the rights to pure profits are significantly riskier than the returns to productive capital.” Why would returns to pure profit assets be riskier? Because the authors want to explain the differential between the returns to pure profit (higher) and the returns to productive capital (lower) by something ‘organic’, related to traditional financial theory. In other words, they need to show that pure profits returns bear additional risk and are paid additional risk premium over and above the returns to productive capital.

Here’s the authors’ argument: “The reason for this result is closely connected to the non-reproducibility of the assets which hold the rights to pure profits. When the economy is shocked, the price of these assets show large fluctuations, because their supply is fixed. In comparison, there is less fluctuation in the price of productive capital, since the supply is not fixed and it can be produced through new investment; the variance of the price of productive capital is determined in our model by the level of capital adjustment costs. As the economy transforms from one in which the majority of assets by market value are productive capital into one dominated by pure economic rents, this generates an endogenous increase in risk premium.”

CHART 2: Average return on capital

I do not buy this argument AT ALL. Let me explain. Non-reproducibility of these assets is a pure, unadulterated nonsense. We used to have Microsoft (a monopoly) and then we got Google (another monopoly), then we got FAANGS (more monopolies), and so on. If anything, rising concentration of the S&P 500 at the hands of larger, monopolistic issuers strongly suggests not only that the monopolistic assets ARE reproducible, but the our financial markets are solely preoccupied with reproducing them. Behold the ‘unicorns’.

The real driver for the abnormal (pure profit-linked) returns is the very existence of that pure profit, driven by: (a) regulatory barriers to entry (think banks), (b) state subsidies (think Tesla), (c) market macrostructure (think Google and Facebook), (d) rampant rent-seeking (think all), (e) outdated anti-trust regulations (think the U.S. system dominated by only one consideration, that of the material harm to consumers, that ignores the fact that modern ICT services are NOT your typical transactions, and involve a barter-type set of transactions between consumers and, say, Google). Majority of these drivers are reinforced by the selectively ultra-low cost of funding for the monopolistic competitors, available courtesy of the rounds and rounds of global risk-mispricing, aka, QE.

Despite the above shortcomings, the paper is an important one. Its conclusions are succinct and far-reaching. “There are a number of reasons why we argue for this hypothesis (i) there is a wide variety of confirmatory evidence that concentration, profits, and markups have increased over the time period, while the natural rate of interest has decreased (ii) it is parsimonious, in the sense that we use two data series (markups and interest rates) to explain the movements of 5 separate trends (iii) our model does not generate counterfactual implications.”

“In this paper, we argue that these trends can be explained by an increase in market power and pure profits in the US economy, i.e., the emergence of a non-zero-rent economy, along with forces that have led to a persistent long term decline in real interest rates.” Whatever your views on the causal factors might be, the dangers inherent in this systemic dismantling of the competitive, open, entrepreneurial model of the American economy of the past is a major source of future risks, uncertainties and social risks.

19/3/18: Drivers of the low labor force participation rate: U.S. data since 2001

Why doesn't U.S. economic expansion 'feel' like an economy is at full employment? Because of the low participation rate that has effectively reduced unemployment to superficially low levels without creating sufficient amount of quality jobs to offset the rise in working age population since the end of the Great Recession.

Here is a chart, via @ernietyedeschi, showing that the U.S. economic expansion has only recently started reducing the sticky non-participation drivers that remain in play since 2001:

The above is a fundamental problem for a range of advanced economies, not just the U.S. as I have noted in a number of previous posts, as well as a factor related to the secular stagnation thesis on both, demographic side (demand side secular stagnation) and technology / wages side (supply side secular stagnation).

13/3/18: Another Brick in the Secular Stagnation Wall

Another brick in the Secular Stagnation Wall: global productivity growth has now collapsed in all major groups of economies:

And the short-lived blip to the upside over the late 2014 in the advanced economies is now... well, short-lived.