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Posts Tagged ‘Economy’

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View from the Bottom #23

In Uncategorized on October 20, 2011 at 3:17 am 

(image credit:  labourlist.org)

I am sorry I didn’t write.  I haven’t been able to use my right hand for the last month.  The truth is the worst possible answer, carpal tunnel.  A hunting accident would at least provoke feminine pity and the hope to bridle something untamed.  Instead, it looks like I am fast with my figures, but slow on my feet.

Which brings me to Europe.  The Eurozone has been pushing out press releases at a desperate pace.  Week in, week out, we get rumors of the ECB buying Italian bonds.  The Chinese buying Italian bonds.  Germany and France buying something with 3 trillion dollars.  Hope, perhaps.  But this is like playing defense in your kid soccer league- watch the torso not the feet.  The torso is economic growth; everything else is the feet.  Without economic growth, Europe can’t meet its debt obligations and interest rates will stay high and smother hope.  The arguments for economic growth in an environment with declining wages are stretched.  So I don’t want to spend much time on Europe.  We covered it; we know what is going to happen for the next 6-12 months.  The only hard part is not getting distracted from the truth.

What is really interesting is China, and I wish I could have written more about it earlier.  Yes, the stock market is down over there, but there is more to come.  Let’s look at what has happened in China to understand what will happen.  China’s economy has been rapidly growing, particularly after executing the largest stimulus in the world in 2009 on a not quite so large economy.  In order to pull back the reins, China has tried to curtail loan growth at the banks.  Unlike other economies, China controls how many loans are made by banks.  It is actually the best way to control monetary policy.  Except, that if banks can’t lend, then other entities in the economy will meet demand and start lending.  So what has happened in the last three years is that thousands of large and small enterprises have started to lend money out for projects that official banks could not lend to.  In other words, the least qualified lenders have been lending to the most marginal borrowers.  How much have they lent over the last two years?  One or two trillion dollars.  Between us, that is a lot of money.  For a five trillion dollar economy, that is a lot of money.

But no one knows for sure how much money has been lent out through informal channels, which is what makes it so interesting.  For all the attention that the subprime crisis got, it wasn’t that interesting.  You could go on Bloomberg, see all the securitizations and the underlying collateral mortgage-by-mortgage, know what was going to happen to home prices, then know what the impact of falling home prices would be on consumption and then know the impact of consumption on GDP.  In China, we just have no idea.  Analysts are publishing many numbers about the informal lending sector, but there are no official figures.  We simply do not know how big the problem is and China is also lacking dozens of econometric studies exploring the effects of leverage on real estate prices, real estate prices on consumption, consumption on GDP, and on and on.  They’ve had private property for 10 years, total.

However, there are a few things we can know about China.  First, it is highly likely that informal lending is at least 10% of Chinese GDP, which would make it double subprime at the peak.  Unlike subprime mortgages, the informal loans are working capital or property development loans, which means they are short duration, highly cyclical  and need to be constantly refinanced.  This means that, if we have a problem, we’ll experience it quickly.  Like, over the next 12 months, not 3 years as was the case in the subprime crisis.  We also know that the collateral (inventories and incomplete construction projects) is worse than that of the subprime mortgage market.  We also know that the Chinese government is taking steps to prevent informal lenders from foreclosing on projects, which is good in the short-term, but it means that fewer new informal loans will be made.  This is bad because if a whole portion of the economy exists because informal loans can be refinanced, then a meaningful portion of the economy will be stripped of its oxygen supply, shortly.

So what we can conclude is: that the up-and-to-the-right-line that China’s growth has tracked has had some support from an exponential growth in lending.  The trips to Macau, the handbags and empty condominiums were made possible by artificial growth in leverage.  So the correct growth trajectory for China is not 8%, but some number of degrees lower.  If M2 (money), doesn’t grow at 30% anymore, but instead grows at 10%, does the Chinese economy continue to grow at 7-8%?  Maybe, anything can happen.  But not ever before has a sharp downward change in M2 been accompanied with constant economic growth.  Nevertheless, for the moment, China and its strategists are sticking to the 7-8%, with the caveat that all bets are off if the US and Europe go into recession.  Great, so we know all bets are off.

The implications of a low-growth Chinese economy with a negative interest rate environment over the coming decade will have to wait until next time.  Sorry to hold you in suspense.

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View from the Bottom #22

In Uncategorized on September 17, 2011 at 11:01 pm

The supply chain grinds slower.  Certain areas disrupted in the Japanese earthquake are doing better than a few months ago, but the leading indicators do not look good.  Consumer confidence is hitting all-time lows, which will wreak havoc on the supply chain.  To make matters worse, recall that the economy and GDP figures have benefitted greatly from inventory restocking since 2009.  Now we get the reverse – inventory destocking – which happens when businesses get conservative and stop buying new stuff, which is what the August and September economic data is all about.  Where do we go from here?  I’m going to run through Jobs and Europe in a flash, so stay with me.

Jobs.  It’s not about jobs; it’s about productivity growth.  Productivity growth is the key to understanding where this nation is headed over the next decade.  Right now, I know we aren’t headed in the right direction because the focus is on jobs.  This isn’t an indictment against President Obama, but rather both Democrats and Republicans are wrong for focusing on the wrong thing and it will cost us another decade unless policy changes fast.

Let’s reverse the “jobs debate” to see why it doesn’t make sense.  Do Americans want jobs?  No, not really.  Step back for a moment – Americans don’t want jobs, they want money, a home, a good-looking wife and maybe a nice pair of shoes every now and then.  How do Americans get money?  Well, by borrowing, but the only way to make money sustainably is to get a dollar out of your customer’s pocket for less than a dollar of costs – even non-profits have to do this too.  Humans are competitive, so to make money over time you have to be harder working, more efficient, or think of ways to make money that others haven’t thought of yet.  That is productivity.  Have we used the words “jobs” yet?  No.  We shouldn’t confuse jobs with making money; they are two very different things.  People making money make jobs.  People making jobs that don’t make money makes Michigan.  So until the debate and economic policies shift to productivity, all roads lead to Lansing.

That’s why Democrats are wrong for trying to create jobs with job creation tax cuts and construction programs.  Those programs will certainly create some jobs temporarily, but that is not the point.  We shouldn’t borrow from our children to boost quarterly job numbers.  We need more people working because there is a profit to be made from pulling a dollar out of a customer’s pocket without government subsidies.

Republicans are also wrong for blaming Obama for creating an unfriendly business environment and stifling job growth.  Do moneymakers wake up in the morning and say to themselves – my marginal tax rate may be 3% higher in 3 years, let me not try to make money, buy a home, get a good-looking wife or buy a nice pair of shoes every now and then?  Let’s be honest, with the money in your pocket, a postage stamp and a printer, you too can start a company in America.  But before you hire anyone, you need something and someone to sell things to, and without a long-term rise in aggregate demand due to productivity growth there is no other way that is going to happen.  With or without Obamacare.

Europe.  Imagine if the Canadians controlled the Federal Reserve and every state legislature had to vote unanimously for TARP and any other spending measure.  Would 2008 have gone down differently?  Yes.  So that’s one of two problems that can’t be solved in Europe – Europe has high coordination costs at a time when decisive action to restore confidence is necessary.  Case in point today, Germany was supposed to vote on Europe’s “TARP”, but they are pushing the vote back to next year.  That’s just one of seventeen countries.  Meanwhile, back at the ranch, Rome burns.

The other unresolvable problem is growth.  European TARP may get done, the European Central Bank may print money and the stock market could go up 20% as a result.  That may all happen in the near-term, but come next year, all sentiment will be determined by Spanish and Italian economic growth figures.  Why?  So far, everyone is assuming that these Eurozone countries will grow.  That is why austerity programs are getting pushed off to 2013/2014 – to allow for some growth before austerity reduces growth.  But if these economies start to shrink in the face of growing liabilities BEFORE austerity measures kick in, it doesn’t matter what any central bank does, there is no sustainable solution.

So will Spain and Italy grow?  That is the $1 trillion question.  Well, Spain’s plan for growth is to become more competitive.  In English, this means reducing wages (now) to boost exports (over the next 10 years).  What happens when you cut wages on a levered consumer?  They stop spending, which leads to negative GDP growth in the intermediate term.  Italy’s consumer is not levered, so the impact won’t be as dramatic there, but negative in the interim nevertheless.  If that isn’t convincing, let’s step back from the economics for a moment and just answer this question- when is the next time you’ll buy a Spanish or Italian export?

We’re going to need to buy a lot more than a nice pair of shoes every now and then.

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View from the Bottom #21

In Uncategorized on July 30, 2011 at 8:22 pm

Downgrade or default.  Let’s start there.  A US sovereign downgrade won’t hurt the markets.  Rating agencies are a few years late to the party and market participants have already devalued US$-denominated assets by 80% over the last 5 years.  In English, an 80% decline in value is well within the meaning of the word “downgrade”.  So a change in rating or outlook by the agencies is a friendly  reminder and not a change in facts.

Default – not getting a debt limit deal done – is a different story all together.  The US Treasury not paying its debts may mean your wealth changes by an order of magnitude and your ATM card stops working this week.  You can see the first signs of this happening in the funding markets last week.  To make sense of the funding markets – a quick explanation of the way these markets work in 50 words:  there are trillions of dollars of assets at banks, mutual funds and companies – rather than moving these assets around constantly to do transactions or borrow money, which would be cumbersome, these institutions leave the assets alone and instead pledge the assets as collateral in exchange for cash to do whatever needs to be done day-to-day.  Sort of like if you had a house, and needed to pay a $1,000 bill before payday – you wouldn’t sell the house to pay the bill, you’d just borrow $1,000 against the house until you got your pay check.  This is called a “repurchase obligation” or “repo”.  If there is no debt limit deal by Monday morning, the “repo markets” will be the news, here’s why.

This past week was an important time for the repo markets because non-bank financial institutions that usually borrow for 30 days had to do their borrowings by month end (Friday).  30 days from now means August 31st, so after the August 2nd debt ceiling deadline.  This crunch at the end of every month usually pushes prices to borrow for 30 days up by .03%, but at the end of last week it moved out by .30%.  This change in pricing was worse than during the financial crisis.  Despite this shock, all was calm elsewhere in the markets on Friday because the big boys of the funding markets – banks – primarily borrow “overnight”, so their repo borrowings on Friday were mostly for August 1st, before the deadline.  It’s not really clear what will happen on August 1st in the afternoon, when the world financial system tries to borrow trillions for August 2nd, pledging as collateral securities that may be in default the next day.  These repo markets is what did in Lehman Brothers, Goldman Sachs, Citigroup and others during the financial crisis.  If counterparties don’t really believe/like the collateral you are pledging, the game is up the next morning.

There is talk that the US can prioritize payments and pay its debts for a short while, but it’s hard to imagine this will be acceptable to the markets.  Fixed income investors are often faulted for their lack of imagination, but they aren’t stupid.  This is an old trick that every company in the deadzone – including Lehman – has tried.  It’s not a slippery slope for a company that briefly stops paying its employees, it’s a cliff.

What will actually happen without a deal on Monday morning?  The value of assets will probably decline throughout the day.  A bit more cash will be found to push out the August 2nd deadline and a deal will get done because constituents’ savings will decline in value rapidly.  With TARP in 2008, an intransigent House of Representatives voted it down – the stock market fell ~10% – and TARP was passed a week later.  I’d expect replay.

Distant from the debt ceiling headlines, the economy is plodding along, but still at a stalling speed that is below expectations and certainly below projections that justify the current market P/E multiple.  Technology companies are seeing orders moderate and valuation multiples are contracting.  Industrial demand is ebbing across the board.  And financial services firms continue to shrink in a low interest rate environment.  There is no escaping the economic math that financial services and real estate are the largest contributors to US GDP by a wide margin  - the 80/20 of the US economy.  So it’s hard for other sectors to perform for an extended period of time without a recovery in the core of what our economy has become over the past 40 years.  Of more than passing interest, the stock market remains at cyclical highs.  Sigh.

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View from the Bottom #20

In Uncategorized on July 4, 2011 at 3:34 pm

For all the frightening headlines, the US economy is muddling along.  The sky is neither falling nor is the outlook improving.

We know the sky is not falling because we can see home prices behaving in the normal seasonal pattern of the last 50 years – rising into April, May and the summer on a month-over-month basis.  That doesn’t mean they are going up over time; it just means we don’t have a repeat of 2010 or 2008 where housing prices fell (month-over-month) throughout the summer and the government had to step in to save asset prices and bank balance sheets.

You read that the auto-related supply chain is shaky, which is true, but demand for non-auto related durable goods is just fine.  And let’s not forget that autos had earthquake disruptions and a fantastic run in demand last year.  Fantastic runs are often forgotten and incorporated into forecasts.  So considering that autos saw demand in 2010 ahead of other durable goods and 2011 is a normalizing year, autos are doing just fine.

Employment was another sore spot in May and June, but I don’t see it as much to get worked up about.  Employment data is very volatile and the 3-6 month forward indicators of employment that I put together all seem to be just fine.

The hysteria over three bad data points in one month – housing, autos and employment belies a different problem.  There is no growth outlook that holds water.  When I say the outlook is “fine” do I mean +0% or +5% like the good old days?  I mean closer to +0%.  So we find ourselves in limbo – the sky is in tact, but there is also scant hope for double-digit earnings growth without further operating margin expansion or commodity price inflation.  The markets seem to be trying to figure out if long-term earnings growth will be low single-digits or high single-digits and whether it is still appropriate to pay a double-digit P/E multiple for this kind of outlook (n.b. for all of the sticklers in the audience, I mean S&P 500 earnings growth excluding financial provisioning reversals).  Market multiples and media rhetoric are just expanding and contracting month-to-month depending on which camp is winning out.  This makes large cap beta investing hard (where most equity funds are allocated) because unless you trade these swings aggressively or know whether the S&P is going to grow earnings 3% or 8%, it is difficult to generate returns that stand out.  I don’t know how to do either, so let’s move on.

We’ll wrap it up with technology.  I get questions about the tech bubble all the time.  Is it a bubble?  Let me ask you this – how hard do people think it is to make a $1 million in tech these days?  Making $1 million should be hard.  Unless you have exceptional talents at getting money from customers or your parents have a billion dollars that they plan to give you, making a million should take about a lifetime or longer.  Are people pouring into Silicon Valley because they are planning to grind out a professional education and career making communications/entertainment products for customers over 3 to 4 decades.  That isn’t the impression that I get.  It’s not kind of like when people who barely graduated from college were answering phones on fixed income desks in 2005 for $1 million a year; it’s exactly the same.  What is puzzling about the tech bubble is that folks get so worked up about the fact that it is a bubble.  Whether a sector is in a bubble or in the 7th circle of hell (read:  financial services), there is the same rate of opportunities to learn and invest.  Despite what you read about valuations, there are very smart technology investors out there doing their best.  If there is an investor in technology companies that has a lot to teach us, it is Paul Graham.  I wanted to take the conclusion of this View from the Bottom to highlight a series of interviews he gives with technology companies in a video that can be found through this link.

Good investors are good at asking questions.  This is their craft – pushing, listening, pushing, listening until they arrive at the nugget of truth in an opportunity.  While many of the questions Graham asks are obvious, you can see how skilled he is at leaving everything in without leaving anything out.

I’d summarize his line of questioning with each entrepreneur as follows:

1)  What is this?

2)  What does it do and who uses it?

3)  What does it do and who uses it really?

4)  Let me repeat back to you what this is and what it does to make sure I clearly understand it, is that correct?

5)  What is the hardest part of getting this off the ground?

6)  Is there nothing else that is hard(er) about getting this off the ground?

7)  What is the easiest way to do the hardest part?

8)  How do you get users to discover and engage with the site over and over again.

In my view, more than half the magic comes from questions #1-#4, which most of us are too bashful to ask because we don’t want to seem ignorant.  Instead we jump in around #5 and try to show how great we are at problem solving.  When was the last time you walked through #1-#4 in a management meeting?

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View from the Bottom #19

In Uncategorized on May 10, 2011 at 2:12 am

There have been a number of incoming questions recently regarding money and monetary policy, which unfortunately are cumbersome to answer without writing an economic textbook.  So I was thinking I would mix it up a bit and post a video explaining a common question – how can printing money create jobs?  If you find it helpful – “like” the video – and I can add these as a supplement in the future:

The usual post will be up at the end of the month.

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