Saturday, 22 October 2016

Sorry, Even "Economic Activity" in the U.S. is Lower Today Than 47 Years Ago

Friday, 21 October 2016

Surging U.S. Monetary Inflation: The Money Supply Growth Rate Hits Four Year High

The U.S. money supply growth rate surges to 11.4% for the week ending 10 October according to figures released last night by the Federal Reserve. This was the highest y/y growth rate reported for almost four years (since December 2012). 

The spike especially in recent weeks is driven by a more than sixfold y/y increase in the Treasury's deposits with the Federal Reserve. Currently this account balance stands at $392 billion, an account that prior to the QE programs used to carry only a negligible amount. From what I know, the surge in the account balance is related to the Fed paying back to the Treasury most of the interest earned on its current balance of some $4.2 trillion in treasury-, federal agency-, and mortgage-backed securities. If we assume an average interest rate earned on these assets of 3%, the Fed will receive some $127 billion a year in interest, most of which will be paid back to the Treasury at regular intervals. 

If we exclude the Treasury's deposits from the money supply measure (as the official aggregates such as M1 and M2 do) the current y/y money supply growth rate comes in at a more modest, but still substantial, 8.5% (the upper end of the range during the last three years). However, as the Treasury tends not to sit on cash for too long, it is highly probably this measure of the money supply growth rate will soon pick up substantially as well. 

Though the Fed no longer officially targets the money supply, FOMC members are nonetheless most certainly following money supply developments closely as they probably have not forgotten that monetary inflation is the key driver of price inflation. The recent surge in the money supply could therefore exert at least some pressure in the direction of a rate hike. These monetary developments could also exert some upward pressure on the inflation component of bond yields.

Update 22 October 2016: please read the comments from Anonymous below regarding TBAC.

Thursday, 20 October 2016

A note on "Economic Activity"

An aim of government deficit spending is typically to increase economic activity, of which "maximising" employment plays an integral part. This is also supposedly the aim of monetary policies, especially during periods of slow GDP growth. [1] 

But what is actually meant by increased economic activity? [2] Is it an increase in GDP? Is it synonymous with economic growth? The distinction between the two is necessarily a blurry one, and one regularly used interchangeably (e.g. see footnote 2). But the distinction is an important one and one that ought to be defined to avoid confusion and minimise abuse. If by increased economic activity we are to understand any increase in production, employment, investment, trade or consumption, then policies promoting such developments will probably succeed. Creating any activity to keep people busy is rather easy when it can be financed with deficit spending supported by regulations facilitating the accumulation of government debt. [3] The problem of course is that such policies rarely discriminate between productive and unproductive activity. For example, the purpose of government deficit spending (besides financing wars) once was to compensate for an economic slowdown in the private sector. The running of fiscal deficits was meant as an intermediate measure to shorten a recession [4] and spur economic growth. The idea being that this “stimulus” would bring about private sector surpluses to fill the deficit gap. This promise has never been fulfilled, especially in recent years. Instead, the results have been unequivocally poor with respect to the accumulation of further debt; most western countries, and many others, have accumulated more government debt than can ever be repaid with any reasonable or remotely palatable taxation policy. [5] Going deeper into debt to reduce debt has predictably culminated in yet more debt. In the U.S., economic policies have led to not only substantial increases in debt, but have, more importantly for the point in hand, led to a decline in personal income relative to debt.

As less debt and higher personal income is clearly desirable to more debt and less income, any reasonable taxpayer and government official, given the choice, would prefer a higher personal income to government debt ratio rather than a lower one. As the chart above shows, this ratio in the U.S. is now at the lowest level ever reported for the last 50 years. Since the ratio peaked in 1981, debt has increased 1,842 percent in total (ca 6.1% p.a.) while personal income has greatly lagged and only expanded 651 percent (ca 4.1% p.a.). 

Despite the fact that it fails to spur economic growth, [6] deficit spending continues to be the norm, rather than a counter-cyclical economic policy. Why? For one because it just might help increase economic activity over the short- to medium term. But perhaps of greater significance, it is a “tool” for politicians to actually do something tangible in an attempt to alleviate the hardship that defines the recession while, at the same time, providing “proof” to the electorate that something is actually “being done” instead of idly sitting by doing nothing. [7] It would hardly come as a surprise if most politicians acknowledged the challenge of being reelected if they document that no actions were taken while in office. Such interventions don't help economic growth however, neither over the short- nor the long term. And that’s why it’s so important to distinguish between economic policies promoting any activity and those contributing specifically to economic growth; the distinction between activity and growth necessarily becomes a blurry one as the former doesn’t discriminate between productive and unproductive activity, i.e. it may refer to any economic activity and not necessarily economic growth. Economic activity can therefore be increased rather effortlessly through increased government spending financed with debt. The recipients spend (a part of) the money received, which again are spent by the next recipient and so forth. Policies promoting economic growth on the other hand appear much more difficult to implement, not least because it requires fiscal discipline. A suggestion would therefore be to limit the meaning of the word activity to refer to any economic activity other than those actually promoting economic growth. At least, that’s what we’ll do in this book from hereon. The results of economic policies, especially during the last decade, can only help to justify this distinction.

The promoters of increased economic activity fail to see, or perhaps ignore because they’re the benefactors, the general fallacy more often than not underpinning their policies, not to mention their consequences; the fallacy of overlooking secondary consequences. [8] Firstly, if the actions triggered by the policies truly helped the economy, why hadn’t individuals and companies pursued these avenues in the first place? Presumably the answer is a lack of savings, capital, profit opportunities, or regulatory burdens. For economic policies to be effective, that is, promote economic growth, they must address the fundamental problems hampering economic growth instead of attempting to fix the symptoms (e.g. “lack” of consumer demand) created by it. On the other hand, “uncertainty” (or a “lack of confidence”), a regular complaint for lackluster business conditions and low or declining financial asset prices, is only truly problematic if it’s created by government itself. [9] Uncertainty, an inherent feature of life in general and not just in the world of business and investing, is regularly viewed as a negative only. However, uncertainty acts as an effective deterrent to the (indiscriminate) wasting of resources, a quality frequently not only disregarded, but often discarded altogether. The solution to this problem should be obvious; undo the (expected) policies that create the uncertainty. Secondly, deficit spending aiming to spur economic activity, often as a means to compensate for an alleged shortfall in aggregate demand, comes at a grave cost: the consumption of resources market participants could have employed (more) profitably elsewhere (if not immediately, then at least in due course) for producing what people truly want. Simply put, government intervention focused on increased economic activity today comes at the expense of savings and investments and, as a consequence, hampers future economic growth. [10] 

The only “stimulus” increases in economic activity can ever hope to achieve is therefore an increase in consumption at the expense of a decrease in savings; the illusion of economic growth. In short, deficit spending encourages increased spending and the depletion of savings to “keep the economy going” over the short term. This outcome is the exactly opposite of that required for economic growth. In summary, increased economic activity today is achieved at the expense of lower economic growth starting the very same day.

[1] Here’s a recent excerpt from the Federal Reserve (emphasis added): “In the short run, monetary policy influences inflation and the economy-wide demand for goods and services--and, therefore, the demand for the employees who produce those goods and services--primarily through its influence on the financial conditions facing households and firms. During normal times, the Federal Reserve has primarily influenced overall financial conditions by adjusting the federal funds rate--the rate that banks charge each other for short-term loans. Movements in the federal funds rate are passed on to other short-term interest rates that influence borrowing costs for firms and households. Movements in short-term interest rates also influence long-term interest rates--such as corporate bond rates and residential mortgage rates--because those rates reflect, among other factors, the current and expected future values of short-term rates. In addition, shifts in long-term interest rates affect other asset prices, most notably equity prices and the foreign exchange value of the dollar. For example, all else being equal, lower interest rates tend to raise equity prices as investors discount the future cash flows associated with equity investments at a lower rate. In turn, these changes in financial conditions affect economic activity. For example, when short- and long-term interest rates go down, it becomes cheaper to borrow, so households are more willing to buy goods and services and firms are in a better position to purchase items to expand their businesses, such as property and equipment. Firms respond to these increases in total (household and business) spending by hiring more workers and boosting production. As a result of these factors, household wealth increases, which spurs even more spending. These linkages from monetary policy to production and employment don't show up immediately and are influenced by a range of factors, which makes it difficult to gauge precisely the effect of monetary policy on the economy.” (Board of Governors of the Federal Reserve System, 2015).

[2] According to the online Merriam-Webster dictionary, activity is defined as “the state of being active”, where active involves action or participation.

[3] Financial companies such as banks and insurance companies are required by government to hold a large proportion of their financial assets in government bonds. Financing deficits through the issuance of bonds is therefore considerably less challenging than financing deficits through an increase in taxation.

[4] Writes Keynes: “…a decline in income due to a decline in the level of employment, if it goes far, may even cause consumption to exceed income not only by some individuals and institutions using up the financial reserves which they have accumulated in better times, but also by the Government, which will be liable, willingly or unwillingly, to run into a budgetary deficit or will provide unemployment relief, for example, out of borrowed money. Thus, when employment falls to a low level, aggregate consumption will decline by a smaller amount than that by which real income has declined, by reason both of the habitual behaviour of individuals and also of the probable policy of governments; which is the explanation why a new position of equilibrium can usually be reached within a modest range of fluctuation. Otherwise a fall in employment and income, once started, might proceed to extreme lengths” (Keynes, 1935, p. 44).

[5] E.g., as of Q2 2016, total public debt as a percent of GDP was 105% in the U.S. and 92% in the euro area.

[6] A range of other interventions also contribute to this outcome, including the elasticity of money, bail-outs of banks, and increased intervention.

[7] This is arguably a key reason why what became known as Keynesian economics won over the “hands-off, do nothing” approach advocated by free market economists (e.g. Mises). – this was especially the case since the great depression and until the 1970s when stagflation proved Keynesians wrong. Following especially the U.S. banking crises starting around 2006, deficit spending is back in vogue and at levels not seen since WWII.

[8] Writes Hazlitt in his book analysing economic fallacies: “In addition to these endless pleadings of self-interest, there is a second main factor that spawns new economic fallacies every day. This is the persistent tendency of men to see only the immediate effects of a given policy, or its effects only on a special group, and to neglect to inquire what the long-run effects of that policy will be not only on that special group but on all groups. It is the fallacy of overlooking secondary consequences” (Hazlitt, 1952).

[9] Barring the threat of war by some rogue nation unprovoked by the domestic government, the possible or probable threat of a natural disaster such as a forecasted earthquake, or meteor expected to hit earth, and so forth. Either way, the uncertainty created by the fore mentioned threats is not removed by increased deficit spending and the promotion of economic activity. Such economic policies might conceal them, but at a cost which likely will only serve to create greater uncertainty in the future.

[10] Even Keynes recognized this when he wrote about one particular kind of government intervention: “Unemployment relief financed by borrowing is best regarded as negative saving” (Keynes, 1935, p. 49).

Tuesday, 18 October 2016

Today's Words of Investing Wisdom: The Basic Principle of Successful Investment

"[You] have to go against mass opinion and buy toward the end of the exaggeration phase of the bear market and at the beginning of the adaptation phase of the bull market. [You] should then follow mass opinion and hold [your] securities through most of the bull market. Toward the end of its exaggeration phase [you] should again go against mass opinion and sell. Thus it is as wrong always to oppose the prevailing tendency as it is always to follow it. In a nutshell, the. right rule is: first against the tendency, then with it, and finally against it."
- L. Albert Hahn

"Central Bankers Have Collectively Lost The Plot"

"The policies of any one central bank may well be perfectly rational.... But so is a decision by any one sheep to run with the flock when in danger. The trouble is that the whole flock might be heading for a cliff."

The quote above is from William Hague, former UK Foreign Secretary, who today is out with an article in The Telegraph critiquing quantitative easing- and low interest policies by central banks around the globe:

"In 2008 the central banks reacted to a massive crisis they had completely failed to foresee by cutting rates to record lows and embarking on “quantitative easing” – pumping trillions of dollars into their economies by buying up the assets of commercial banks. The trouble is that eight years later they are, to varying degrees, still doing it. Like doctors keeping their patients on a drip many years after an operation, they are losing credibility and producing very dangerous side effects."  

Hague correctly points out some of the "drawbacks" to these central bank policies, including: 
  • asset price inflation ("...they are blowing up a bubble of make-believe money...") benefiting the rich at the expense of the poor 
  • a reduction in company investments 
  • pension funds now generating insufficient returns
  • central banks giving preference to some companies over others through their buying of corporate bonds
  • "zombie" companies being kept artificially alive dragging down productivity 
  • a loss of public confidence in authorities
  • that the accumulating effects of loose monetary policy globally are intensely political - "...huge public and political anger is going to burst over the heads of the world’s central banks."

Excellent to see a political authority from the UK pointing out some of the grave side-effects and "unintended" consequences of monetary policies run wild around the globe. 

Thursday, 13 October 2016

The Flight To (Un)Real Assets in Oslo, Norway

This Is What Happens When Authorities Promise Inflation to Eternity and Fire Up Demand With Historic Low Interest Rates & Aggressive Loan Growth: House prices in Oslo are now 92% higher than 10 years ago. During last year alone prices surged 17.9%, a y/y increase last seen in 2007. 

As one investor tweeted a few days back: "... natural to compare with ... London and Singapore. No, Oslo is not a world centre for trade. Hello!" 

Thursday, 6 October 2016

This Is Starting to Smell Like A Possible Rate Hike

The Federal Reserve stopped targeting the money supply growth rate more than 16 years ago. 

Undoubtedly, Fed members are still aware of the effect an out of control surge in the money supply growth rate will eventually have on price inflation. 

And if there is one mandate the Fed doesn't want to default on, it's the price inflation target. That is, facing the prospects for runaway price inflation, the Fed will simply have to tighten monetary policy.

If the recent surge in the money supply growth rate continues, it just might motivate the Fed to raise rates sooner, and possibly higher, that many seem to think. 

Wednesday, 5 October 2016

Equity Investment Checklist