Monday, 23 February 2015

A Note on Natural Economic Growth and The Role of Savings

Natural economic growth, or a rise in living standards, which we might also refer to as sustainable economic growth, comes about as a result of production, saving and investment. Savings can only accumulate if less is consumed (spent) than is produced (earned). Real saving therefore cannot be generated through inflating the money supply as both assets and liabilities increase simultaneously when it does. Taking up a loan and depositing it in a savings account therefore does not qualify as real saving. 

The higher savings are in relation to consumption, which we may refer to as the consumption/saving ratio (C/S), the more resources become available for investments. As saving and investment are both necessary for real economic growth to take place and as there can be no investment without saving, the lower the C/S ratio, the higher the potential economic growth. Conversely, the higher the C/S ratio, the lower potential growth becomes. Less consumption and more saving hence bring about more output in the future. 

Increased saving available for investments also brings with it the added benefit of naturally pushing the interest rate on loanable funds lower than would otherwise be the case. This reduction in interest payments will by itself make more investments profitable than otherwise as the break-even point for businesses and projects decreases. As producer goods accumulate and become more advanced, businesses and labour become more productive, the supply of consumer goods increase and their prices decline. As a result, real wages increase, raising overall living standards with it. This process allows future consumption to increase. Better yet, it's sustainable.

It should come as little surprise that in the U.S. and many countries around the, the reverse is taking place. A fundamental message underlying Say's Law in my opinion, that we need to produce before we can consume, is instead turned upside down driven by a political doctrine hoping that growth starts and end with consumption. 

Combined with an ever expanding money supply,

such policies can only lead to to false booms and very real busts and an ever decreasing purchasing power of money for the majority. 

Ultimately, consumer spending falls as previous levels of expenditures are unsustainable because people simply can't afford it any longer. 

The standard policy solution to this problem? Start the whole cycle once again: create more money and induce consumers to spend more. Just how it is actually feasible, or even possible even in theory, to cure something with what caused it in the first place remains a bit of a puzzle....

Also see: 

Sunday, 22 February 2015

The Stock Market, Money Supply and Savings

What does the surging stock market and the record money supply to savings ratio tell us about the future of the U.S. economy?

I attempt to explain this in the latest article published on Seeking Alpha titled "The Stock Market Euphoria And Record Money Supply To Savings Ratio Signal Looming Recession".

Access the article here.

Investment Decisions and Emotions

Here's an excellent reply from Pater Tenebrarum to an assertion that "Most investors are simply not that frivolous with their money to buy investments on a whim",
On the contrary, the vast bulk of investment decisions are based on emotions. The "data" that are used to justify the decisions are merely rationalizations in most cases. This is the reason why the prices of financial assets very often get strongly out of line with what would be widely considered their "fundamental" values. It makes financial markets remarkably inefficient and creates both great buying and selling opportunities. If not for the fact that emotions are a main driver of asset prices, it would be very difficult to make money in the markets. 

Friday, 20 February 2015

What Do The Great Stock Market Peaks Have In Common?

A high price to dividend ratio is but one answer. Based on the Wilshire 4500 stock market index, U.S. stocks are now even more expensive than during the exuberant bull market back in 1999 and early 2000. 

Better hope those dividend payments meet those irrationally exuberant expectations soonish...

Also see:

The U.S. Stock Market Is At Its Most Overvalued Level In History

The U.S. Stock Market Is At Its Most Overvalued Level In History

By Pater Tenebrarum

We frequently run across assertions that the US stock market is allegedly "cheap," because the trailing P/E of the S&P 500 Index has not yet reached the dizzy heights of 1929 or 2000 (of course, quite often the "forward P/E" is cited rather than the trailing P/E. We believe this to be a worthless indicator, as it relies on overoptimistic analyst estimates that are continually revised lower as time passes).

Apart from the fact that the valuation peaks of the two biggest stock market manias in history hardly represent a useful yardstick for determining whether the market is attractively valued or not, these assertions are focused on an index that is capitalization weighted and the average P/E of which is greatly influenced by a small number of momentum stocks. In 2000, the extreme valuations accorded to technology stocks ended up producing a trailing P/E for the S&P 500 in cloud cuckoo land - however, the market as a whole was actually noticeably cheaper than it is today.

We have already mentioned a few times in the past that the market has never sported a higher valuation in terms price/sales as well as in terms of the median P/E. Dartmouth University Professor Kenneth R. French has calculated the US stock market's median P/E. We were previously unable to find a chart for it, but have now come across a chart that was published by Bloomberg a little while ago, which we reproduce below. Note that the median valuation is even higher at the moment, as the calculation is apparently only performed once a year in the summer months. So the chart depicts the situation as of July 2014.

Only companies reporting a profit are included, so it would be more precise to state that this is the median P/E of the market segment with positive earnings. For comparison purposes, the S&P's P/E ratio is shown as well. What is interesting about this is that the median P/E is currently actually higher than that of the S&P 500 on a trailing basis - something that has never happened before.

"Austrian" True Money Supply Weekly (9 Feb 2015)

The short version of the "Austrian" True Money Supply for the U.S. increased 0.31% on last week for the week ending 9 February 2015. At $10.6410 trillion, a new high, the money supply is now up $38.9 billion, or 0.37%, year to date.

The 1-year growth rate in the money supply ended the week on 7.52%, down from 7.66% the previous week and below the the long term average of 8.29%.

As for the longer term trend, the 5-year annualised growth rate continues to decline compared to the same week last year and has now dropped for 63 weeks in a row. The current growth rate of 10.04% is however substantially higher than the 7.58% longer term average. Such consistent drops in the growth rate last happened during the run-up to and in the aftermath of the 2008/9 banking crisis.


A note on the U.S. stock market:
An increased money supply helps push the stock market up as the purchasing power of money declines and as it pushes interest rates lower. Since 2014 however, the stock market has surged while the money supply growth has declined pushing the ratio between the two to record levels. The chart below clearly outlines the last two stock market bubbles and the current dislocation between the stock market and the money supply.

If history is any guide (there is little doubt in my mind that it is), the U.S. stock market is currently in a bubble of grand proportions. When the last two bubbles popped, the stock market declined 41.5% and 49.5%, respectively, from peak to trough. Considering the increased government debt in the U.S. (and around the world) and dismal level of savings since the previous bust, it would be optimistic to expect the next stock market correction to be smaller than the previous one.

Thursday, 19 February 2015

ECB 2014 Financial Statements: "Austerity" in Eurozone, Indulgence at the ECB

The ECB today published its financial accounts for year ending December 2014

While "austerity" is imposed on many eurozone members by the troika, of which the unelected and independent ECB belongs, prudence is an unknown word when it comes to the costs of running the Frankfurt ivory tower. Not only has the ECB now moved into its extravagant new head quarters which cost north of €1.4 billion

but the central bank also added another €150 million to its running costs bringing total administrative expenses to more than €677 million for the year, and increase of 28.5% compared to 2013. As costs surged in 2013 as well, total costs have now increased more than €213.5 million, or 46.0%, during the last two years alone. These are real costs which all people living in the eurozone pay for in one way or another. 

A €60.7 million increase in staff costs during 2014 partly explains the increase in overall costs. According to the ECB, 
Staff costs rose to €301 million in 2014 (2013: €241 million) as staff numbers gradually increased over the year owing to the preparations for the launch of the SSM in November 2014.
This is of course the Single Supervisory Mechanism. And I can assure you member countries certainly will not cut their domestic supervisory expenses as a result. If anything, each member country will likely have to hire more people to follow up demands from the SSM. This doubling up of costs in all areas related to regulations is a key feature of the eurozone and the EU. Again, these costs are very real and are paid for by eurozone members, some of which already are impoverished while others are well on their way to becoming poorer. Increased regulatory costs are the last thing all members needed. At the end of the year, 2,577 staff (full-time equivalent) were employed by the ECB, an increase of 787 employees, or 44%, on 2013. Such a waste of so many clever minds that could have made a difference in the real world.

Administrative expenses, which forms part of total costs, increased more than €93.5 million for the year, up 36.0% on 2013 and up more than €133.1 million, or 60.4%, since 2012. This mammoth increase is not explained other than in this paragraph in footnote 32 Administrative expenses,
These cover all other current expenses relating to the renting and maintenance of premises, goods and equipment of a non-capital nature, professional fees and other services and supplies, together with staff-related expenses including recruitment, relocation, installation, training and resettlement expenses. The preparations for the launch of the Single Supervisory Mechanism contributed to the increase in administrative expenses in 2014.
It is not only ironic, but it's also a great injustice committed by imprudent, to put it mildly, political leadership, that in today's Europe where citizens are increasingly becoming impoverished, where unemployment remains exceedingly high and budget deficits and debt to GDP ratios are way out of control, that the very central bank imposing cost cutting measures on others is doing the exact opposite with its own operations. Indulgence indeed, all paid for by the eurozone taxpayers. Something not only for the new Greek government to ponder.

Chart of The Day: Screw It, I'm All In, Baby

The Stock Market Boom, Industrial Production and Real Economic Progress

The industrial production numbers for January is just out, showing a reasonably strong y/y increase of 4.8%. 

But here's an interesting fact: since the end of December 2007 industrial production in the U.S. has increased a grand total of...wait for it.... 5.4%! During the same period, the U.S. stock market has surged a magnificent 86.4%, outpacing industrial production 16-fold. As a result, the ratio between the two has increased almost 77% during the same period, smashing the just under 57% increase during the 2000 to 2007 period.  

Industrial production does not matter anymore, some say. Well, production always did matter in the past and it will continue to do so as long as people consume and businesses attempt to satisfy consumers. Something is clearly out of whack in the U.S. economy where faulty monetary policies have done little, in addition to draining the country of voluntary savings, but fuel a gigantic stock market bubble of historical proportions. 

Stock market gains themselves do not represent gains to society just as stock market losses do not inflict losses on society. All these gains and losses do is shift the distribution of wealth and the income received through dividends. As a continuously rising stock market over longer periods can only be brought about by inflationary policies and as inflationary policies can only serve to inflict damage on economic progress, a rising stock market over extended periods is a symptom of a sick economy and not a progressing one. Therefore, though the coming collapse of the U.S. stock market, or poor future returns at best, will inflict real monetary losses on many, the real damage to the economy has in fact already been made during the bull market. 

Increased industrial production on the other hand, assuming of course stuff is ultimately made that consumers demand, produces real economic gains to society. Such a development, combined with non-inflationary monetary policies, would lead to the near mirror image of the chart above reflecting sound and sustainable economic progress. As the ratio between the stock market and industrial production has, bar a few dips, more or less continuously increased since 1984 (when the dollar was relatively strong), I would not be surprised if many Americans miss those days some 30 years ago. Back then, industrial production grew 58% faster than it does today (based on 30-year annualised percentage change) with a substantially smaller population.


Welcome to A Very Dislocated 2015

Wednesday, 18 February 2015

A World In Debt

By Sean Corrigan

In his magisterial 1936 work, ‘A World in Debt‘, Freeman Tilden treated the business of contracting a loan with a heavy serving of well-deserved irony, describing how the debtor gradually mutates from a man thankful, at the instant of receiving the funds, for having found such a wise philanthropist as is his lender to one soon becoming a little anxious that the time for renewal is fast approaching. From there, he turns to the comfort of self-justification, undertaking a little mental debt-to-equity conversion in persuading himself that his soon-to-be disappointed creditor was, after all, in the way of a partner in their joint undertaking and so consciously accepted a share of the associated risks.

Next he adopts an air of righteous indignation at the idea that he really must redeem his obligation on the due date, before rapidly giving into a growing fury in contemplation of how this wicked usurer has duped him into contracting for something he cannot hope to fulfil, as so many poor fools before him have similarly been entrapped by this veritable shark.

Likewise, our author quotes the 19th century utilitarian, Jeremy Bentham, to much the same effect.

‘Those who have the resolution to sacrifice the present to the future are natural objects of envy’ for those who have done the converse, our sage declared, like children still with a cake are for those who have already scoffed theirs. ‘While the money is hoped for… he who lends it is a friend and benefactor: by the time the money is spent and the evil hour of reckoning is come, the benefactor is found to… have put on the tyrant and the oppressor.’

Here we should realise the pointlessness of trying to decide whether the Greeks or the Germans are at fault in the present impasse and press on toward the crux of the matter. As Tilden rightly argued about the consequences of a bust:-

‘It follows that any scheme looking towards the avoidance of panics and depressions must deal with this cause [viz., debt] and any plan that does not do so is not only idle, but may be a dangerous adventure.’

Continue reading the article here.