| Elephant in the Room Minsky Moment Posted: 28 Sep 2014 06:02 PM PDT The "elephant in the room" is debt. Try as they might, central bankers have not been able to spur credit, hiring, or much business expansion because of the elephant. Things are even worse in Europe. Via email, this is a guest post from Steen Jakobsen, chief economist of Saxo bank. Debt - The Elephant in the Room 'Interest on debt grows without rain' – Yiddish proverb
This proverb explains most of what goes on in policy circles these days. We are now watching Extend-and-Pretend, Episode VI: Promises for improvement amid ever growing debt levels.
Short put, we're still working with the same dog-eared script we were introduced to all of five years ago, when markets had stabilized in the wake of the financial crisis: maintain sufficiently low interest rates to service the debt burden. Pretend to have credible plan, but never address the structural problem and simply buy more time. But while we were able to get away with this theme for an awfully long time, the dynamic is now changing as the risk of low inflation (and even deflation) is a brick wall for the extend-and-pretend meme. Yes, interest does grow without rain, and the cost of maintaining and servicing debt grows especially fast in a deflationary regime.
Mads Koefoed, Saxo Bank's macro economist projects US growth at around 2.0% for all of 2014. That will be the sixth year with US growth near 2.0% - so despite lower unemployment, despite a record high S&P500, the economy has a hard time escaping that 2.0% level. Any talk of higher interest rates is hard to take seriously when US growth is going nowhere and world growth is considerable weaker than expected in January or as recently as July, for that matter. It seems everyone has forgotten that even the US is a part of the global economy.
The fourth quarter is always the most politically interesting time of year. Countries need to get their new budgets in order. The EU, IMF and World Bank will need to pretend they agree or accept the weaker data, which has to mean bigger deficits. It's a tiresome exercise to watch denial-in-action as EU governments and other policymakers try to make something so obviously unpalatable go down easy in their internal reporting. It's obvious that buying more time (extending) is always the number one priority, followed by projecting (pretending) the forward looking growth will reach an ever higher trajectory in order to make the budget fit within the supposed constraints. Or in France's case, the recent unilateral abandonment of meeting budget targets for the next two years is already a fait accompli.
Who's next?
Such behavior would cost you your job in the private sector, but in the economic model of 2014, which reminds us more of Soviet Union than a market based economy, its par for the course. But, many would protest, it would be even worse if we hadn't done so much to "save the system", right?
Well maybe, except for the fact that those economies where belief in State Capitalism is strongest: Russia, China and France, are all at the end of the line. Time has caught up. Negative productivity, capital flight and a system built on protecting the elite is failing. France is now moving from recession to depression. China is moving quickly from denial towards a mandate for change, Russia's future has not looked this bleak since the late 1990's. Meanwhile the US continues on sluggish 2.0% growth. Investors and pundits seem to have forgotten that we were promised 2014 would be the end of the crisis. Instead, we are speeding towards the inflection point at which debt becomes harder to service because pretend-and-extend policy making have created a depression in investment and consumption.
The public debt loads continue to inflate across Europe: Portugal's public debt has ramped to a staggering 130% of GDP – up from about 70% in 2007. Greece's public debt load, even after the restructuring of Greek debt a few years ago, has swelled to 175% of GDP. The EU now has far more systemic risk than at the beginning of the crisis. With zero growth or as our economist Mads sees it, 0.6% with the arrow pointing down, debt levels continue to rise relative to GDP. And most importantly, the current flirt with deflation will make servicing the growing debt even more expensive. The nightmare for ECB and world is deflation as it's a tax on debtors and a boon to net savers. The new reality is that we currently stand face-to-face with the very deflation risk that just about everyone denied could ever happen when Q1 outlooks were written.
Two other global threats, or time bombs, if you will, outside of the EU are risks from the growing costs of servicing debt in China and the USA. In China, the governments national and local have piled up considerable debt, but it is the overall debt service costs in all of China that are the real concern, which have only grown so large with the dangerous assumption by Chinese banks, companies and citizens that they can count on a public bailout. According to a Societe Generale analyst, total debt service costs (including maturing debt and roll overs) in China area at nearly 39% of GDP. Compare that with the closer to 25% of GDP for the USA in 2007.
In the US, interest on US government debt cost over 6% of budget outlays in 2013. This is relatively down from its worst levels when interest rates were much higher, but only because FOMC has so drastically lowered the costs for the US government to issue debt with a zero interest rate policy. And now the debt load is vastly larger than it was before the financial crisis – at 80% of GDP (net debt according to IMF) versus 45% of GDP a mere 10 years ago. So are we actually to believe that the Fed can lift the entire front-end of the curve from 0-1% (current rates out to three years) to 2-4% over the next two years without massive further stress on the deficit and only adding to the debt? Servicing 2% interest when growth is 2% means you are doing worse than standing in place if you also have a budget deficit.
Whatever the timing, the USA, China and Europe are all headed for another Minsky moment: the point in debt inflation where the cash generated by assets is insufficient to service the debt taken on to acquire the asset. The US productivity growth last year was +0.36%. The real growth per capita was about 1.5%. Anything which is not productivity is consumption of capital. So, the only way to grow an economy without productivity growth is temporarily with the use of debt – about 75% debt and 25% productivity growth in this case.
Since the 1970s, US productivity growth rates have fallen 81% - the move onto the internet has ironically made us bigger consumers and less productive. Had we remained at pre-1970s productivity, the US GDP would have been 55% higher and the outstanding debt to GDP would be easily fundable.
I just returned from Singapore on business – Singapore, to me, used to be the most rational business model around. Its founder Lee Kuan Yew was one of the greatest statesmen in history. Now, productivity is collapsing in Singapore. They are, like us, becoming the Monaco of the world, an economy based on consumption and not on productivity and growth. The developed economies are growing old in demographic terms, but we're still not wise enough to realize that our current model is a Ponzi scheme rushing toward its inevitable Minsky moment. No serious policymaker or central banker is talking about the truth told by simple maths and hoping that things turn out well. Hope is not good policy and it belongs in church, not in the real economy.
Steen Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Reflections on Catalonia, Crimea, Iraq, California, Nation Building Posted: 28 Sep 2014 11:09 AM PDT Catalonia Independence Vote to Proceed on Schedule Arthur Mas, president of Catalonia declared today that the vote for independence of that region will go as scheduled on November 9. Spain contends the vote is illegal and vows to stop it. El Economista reports Arthur Mas Calls for Vote on Independence of Catalonia. President of Catalonia, Artur Mas nationalist, officially called for a vote on the independence of this rich region of Spain for the November 9, challenging the Spanish government began the process to prevent it.
In a ceremony at the gallery Gothic Palace of the Generalitat, the seat of regional government in Barcelona, Artur Mas, supported by his executive and representatives of other nationalist parties, signed the decree of convocation of this non-binding referendum.
"This is the way democracies are expressed and political projects are born. Voting it is the responsibility of the Democrats do not circumvent it," then said in a brief speech.
"Catalonia wants to talk, want to be heard, want to vote," he said Mas, who continues to ask Madrid to allow the query as London did in Scotland, where the "no" won Sept. 18 in a referendum with broad participation. The proposal flew like a lead balloon in Madrid. Prime Minister, Mariano Rajoy Initiated a Process to Suspend the Referendum. Reflections on Catalonia, Crimea, California There is a lot of puffery in Spain given the resolution is nonbinding, unlike the vote for Scottish independence. In the US, if California wanted to cede from the union and form its own country, look on the bright side: California independence would be a huge upside for the rest of us. Such a referendum, if allowed to stand, would take a lot of socialist votes out of the US House of Representatives. That would be a good thing. Unfortunately, there will never be support in California to cede from the union. Crimea Votes Overwhelming to Join RussiaIn Crimea, citizens voted 96.77% for integration of the region into the Russian Federation. Some claim the vote was rigged. Perhaps so, but by how much? A Gallup Poll in Crimea following the referendum shows overwhelming support. - More than eight in 10 (82.8%) say the referendum reflects most Crimeans' views.
- About three-fourths of Crimeans (73.9%) say Crimea's becoming part of Russia will make life better for themselves and their families, just 5.5% disagree.
- Crimeans are overwhelmingly likely to view Russia's role in the crisis as positive (71.3%) rather than negative (8.8%).
- Outside of Crimea, responses are practically reversed (66.4% see Russia's role as negative, 15.6% positive).
- Though Ukrainians outside of Crimea are somewhat ambivalent about the United States' role in the crisis (39.0% say it has been positive, 27.7% negative, and 21.6% neutral), Crimeans are far more unified in their view that the U.S. has played a negative (76.2%) rather than a positive (2.8%) role.
Justice was served in Crimea. The people clearly got what they wanted, and they did so in a peaceful, democratic process, undoing a haphazardly pieced together nation that simply did not belong together as configured. Who am I (or anyone in Kiev) to question what an overwhelming percentage of the Crimeans want? Nonetheless, arrogant outsiders with zero legitimate interest insist "the vote must not stand" and Russia must return Crimea to the Ukraine. Instead, I propose, the US ought to consider outcomes like the Crimea vote and the Ukrainian civil war before it goes poking sticks at bears and stirring up geopolitical trouble. Reflections on Nation BuildingNation building by outsiders does not work, ever. Results are especially bad when outside forces haphazardly piece together nations to suit political whims. Iraq and Ukraine are proof enough. In Iraq, the Kurds want their own nation. The US is against the idea. But why shouldn't the Kurds have the right of self-determination? I seem to recall at least one great nation got its start that way. Anyone else remember? And isn't the voting booth preferable to war? Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
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