As we are in the final stage of the global bubble, we realize that we often fail to ask the most obvious questions. In this case, as every central banker tells us that his policies are directed to obtain growth, the obvious question is... how do we define economic growth? What is economic growth? Yes, yes, we know that what they do is simply monetize deficits and enable the transfer of wealth between sectors and generations, but there is also an intellectual battlefield, which we should be aware of. What is the view of the central banking cartel on how to grow output? Surprisingly, not via an increase in the marginal productivity of capital, but via the so called wealth effect: As interest rates fall, asset prices increase (it doesn’t matter which assets see their prices rise) and the assets can be used as collateral to leverage a higher than previously possible consumption level. This consumption level will drive output growth, and this increase in output –they believe- will bring about full employment. The wealth effect is mistakenly attributed to Keynes, who actually argued against it. Thus, the central banking cartel has its own interpretation of economic growth and it does not fit any of the 'reality' perspectives presented below.
The Great Economic Transformation! The Chinese are suckers for adjectives to describe and give power and eminence to their attributes, actions or constructions. The Long March. The Cultural Revolution. The Great Wall, the Yellow River. A good adjective always makes it sound as if it’s true. The Chinese have taken over as the superlative attributor to everything. The tallest (soon-to-be) building in China, the Shanghai Tower, is the living proof that China plans on making itself into a byword for superlatives it’s ‘–est’ everything these days.
In yet another confirmation that the US consumer continues to get slammed, and is respectively slamming the GDP by spending less, today's April personal spending and personal income both missed expectations, printing flat and declining -0.2% from the March numbers, much as expected following the Q1 spending spree, which means that economic growth in Q2 and onward as a function of consumer spending will only "taper" going forward especially with the delayed impacts of the payroll tax negative effect on spending finally starting to trickle down. What's worse, is that since incomes did not improve in April, the savings rate remained flat at a minuscule 2.5%, or just off the lowest its has been since the start of the Second Great Fed-propped Depression.
A. Gary Shilling's discussion of how to invest during a deleveraging cycle is a very necessary antidote to the ecstacy and euphoria that surrounds the nominal surges in risk-assets around the world sponsored by central banking largesse. Shilling ties six fundamental realities together: Private Sector Deleveraging And Government Policy Responses, Rising Protectionism, the Grand Disconnect Between Markets And Economy, a Zeal For Yield, the End Of Export Driven Economies, and why Equities Are Vulnerable. The risk on trade is alive and well - but will not last forever. We are still within a secular bear market that begin in 2000 with P/E ratios still contained within a declining trend. Despite media commentary to the contrary - this time is likely not different.
With last night's China PMI disappointing expectations and eking out a just-expansionary miasma of hope for the growth enthusiasts, the very real question of global growth sustainability (while not on US equity market participants' minds) is coming to the fore. As Michael Pettis notes, Martin Wolf's recent perspective that it may be useful to think about Japan as a model for understanding the adjustment process in China since the Japanese model shows how risky it is to shift to a slow-growth model. While expectations for a 'relatively moderate' slowdown are common (at rates considered rapid for most economies); Pettis asks rhetorically, if part of the explanation for China’s spectacular growth of the past three decades has to do with the positive feedback loops that are so typical of developing countries with fragile and unsophisticated financial systems, then a moderate slowdown in growth may be an impossible target to achieve. Once growth starts to slow, the self-reinforcing impact on urbanization, on credit growth, on financial distress, and on expectations may force growth rates to drop far more sharply than any 'plausible' analysis would suggest.
The latest personal income and expenditure report for March was of particularly interesting reading. However, as opposed to the mainstream headlines that immediately reported that despite higher payroll taxes consumers were still spending, and therefore a sign of a strong economy, it was where they were spending that was most telling. In reality, The personal income and spending report does little to brighten the economic picture. The reality is that we now live in a world where "freely traded markets" are an anachronism and fundamental rules simply no longer apply. However, the problem is that such actions continually lead to asset bubbles, and eventual busts, that not only impact economic stability but destroy the financial stability of families. The consumer is clearly delivering a message about the state of the real economy. Eventually, the disconnect between the economy and the markets will merge. Unfortunately, there is no historical evidence of such reversions being a positive event.
In the past months and right after implementing Quantitative Easing Unlimited Edition, the Fed began surfacing the idea that an exit strategy is at the door. With the latest releases of weak activity data worldwide, the idea was put back in the closet. However, a few analysts have already discussed the implications of the smoothest of all exit strategies: An exit without asset sales; a buy & hold exit. We have no doubt that as soon as allowed, the idea will resurface again. Underlying all official discussions is the notion that an exit strategy is a “stock”, rather than a flow problem, that the Fed can make decisions independently of the fiscal situation of the US and that international coordination can be ignored. This is logically inconsistent as we address below...
Despite expectations that following several months of subpar income growth offset by rampaging spending and thus a plunging savings rate, March incomes would rise by 0.4%, while spending would be flat, this did not happen, and instead both spending and incomes rose by the same amount, or 0.2% in the past month. Worse, when adjusting for inflation, real disposable income rose just 1.1% compared to last March, and just barely above the 0% breakeven. On the other side, real spending was up 2.2% Y/Y just barely above the 2% recessionary threshold. And even that number is misleading as spending on Total Goods (including durable, already known as being quite abysmal, and non-durable), dropped by $32.8 billion in nominal dollars. What was the offset? Why a massive surge in consumption expenditures on services, which rose by $53.8 billion, which absent the spending aberation for September 11, 2001, which was reversed in the following month, was the biggest monthly increase on record! What drove this record services spending spree is anyone's guess.
We are a long way from really resolving the argument between the Keynesian and Austrian economic theories, despite some so-called experts proclaiming Krugman's victory this week. The discovery of the calculation error in the Reinhart/Rogoff study does little to change the overall premise that excessive debt levels impede economic growth and have, historically, led to the fall of economic empires. All one really has to do is pick up a history book and read of the Greeks, Romans, British, French, Russians and many others. Does fiscal responsibility lead to short term economic pain? Absolutely. Why would anyone ever imagine that cutting spending and reducing budgets would be pain free? However, what we do know is that the path of fiscal irresponsibility has long term negative consequences for the economy. In the meantime we can continue to ignore the long term conseqences in exchange for short term bliss.
Back in 2010, Goldman's Jan Hatzius, fresh on the heels of QE2, committed rookie Economist mistake 101, and mistook a centrally-planned market response to what then was a record liquidity infusion, for an improvement in the economy (a move we appropriately mocked at the time, as it was quite clear that the Fed's intervention meant the economy was getting worse not better). It took him about 4 months to realize the folly of his ways and realize no recovery for the US or anyone else was on the horizon. He then wised up for a couple of years until some time in December he did the very same mistake again, and once again jumped the shark, forecasting an improvement to the US economy in 2013, albeit in the second half (after all nobody want to predict an improvement in the immediate future: they will be proven wrong very soon) based on consumer strength when in reality the only "reaction function" was that of the market to the Fed's QE4 (or is it 5, and does it even matter any more?). Four months later we get this...
The lesson from the events of 2007-2008 should have been clear: Boosting GDP with loose money can only lead to short term booms followed by severe busts. A policy of artificially cheapened credit cannot but cause mispricing of risk, misallocation of capital and a deeply dislocated financial infrastructure, all of which will ultimately conspire to bring the fake boom to a screeching halt. The ‘good times’ of the cheap money expansion, largely characterized by windfall profits for the financial industry and the faux prosperity of propped-up financial assets and real estate (largely to be enjoyed by the ‘1 percent’), necessarily end in an almighty hangover. The crisis that commenced in 2007 was therefore a massive opportunity: An opportunity to allow the market to liquidate the accumulated dislocations and to bring the economy back into balance. That opportunity was not taken and is now lost – maybe until the next crisis comes along, which won’t be long. It has become clear in recent years – and even more so in recent months and weeks – that we are moving with increasing speed in the opposite direction: ever more money, cheaper credit, and manipulated markets (there is one notable exception to which I come later). Policy makers have learned nothing. The same mistakes are being repeated and the consequences are going to make 2007/8 look like a picnic.
The “Marshmallow Test” is a landmark study in child psychology which tests a toddler’s ability to delay gratification in return for the promise of a reward in the future. Those who can wait 15 minutes unattended to eat a marshmallow are rewarded with a second treat. ConvergEx's Nick Colas, however, notes that more recent work on the topic, however, shatters the notion that innate self-control defines future success. The real answer is, Colas adds, not surprisingly, trust. If the child doesn’t believe their environment to be sufficiently predictable, they will be much more likely to gobble up the first treat regardless of any promised reward for waiting. Since all investing is ultimately a game of delayed gratification, trust plays an under-appreciated role in the success of any macroeconomic policy on long term capital market and economic outcomes. What it essentially says is that you can’t keep whacking away with novel policy programs until one catches hold. Trust in the system is what keeps the population playing along. And when that trust erodes, the next iteration of confidence-boosting measures is less effective. Repeat that cycle a few times and you end up with a population that will take the first marshmallow, gobble it down, and move on.
Succinctly summarizing the positive and negative news, data, and market events of the week...