February’s labour market data was strong enough to suggest that the economy will weather the coming interest rate rise, but contained no indication that the economy has really approached full employment, and no reason to believe that the labour markets are incubating an outbreak of inflation. No reason, in other words, to think that the Fed is behind the curve.
China’s ‘real GDP’ headlines tell us little, with quarterly movements sticking very closely to both trend and official expectations. Nominal GDP, however, is accelerating sharply, which suggests:
- rising inflationary pressures, denied by CPI but surfacing in PPI, but also;
- recovering return on capital, which underpins current profits growth and likely future GDP growth’; but also:
- the slowdown in growth of capital stock (down to nominal 8.4% yoy estimated in 2016) is implicated in China now losing market share of NE Asia exports.
- the credit squeeze has produced a noticeable recovery in the marginal economic efficiency of finance, but there is a very long way to go before China is weaned off credit-fired growth; and
- the improvement in overall allocation of savings is much less convincing than the improvement in bank credit allocation.
In short, the 4Q national accounts do show some progress being made in the structure of China’s growth. But the progress is painfully slow compared to the distance to be travelled, and is already developing unexpected diversions.
Can the US could break out of the ‘new normal’ patterns of sluggish acyclical growth seen since 2010? Part I showed that improving trends in return on capital and real labour productivity generate a background in which we should expect rising capital investment and rising employment. At the least, this suggests an uptick in GDP growth in the short and medium term. In addition, it looked at two potential subcyclicals that could accelerate that growth into a genuine business cycle upswing - ie, a breakout from the ‘new normal’. The dynamics for both the capital goods sector and for inventory management - both of which can act as business cycle accelerators - have been in a ‘negative adjustment’ phase over the last two years , but this has left them, ironically, increasingly sensitive to the current rise in global producer prices.
But if all these provide fuel for a potential business cycle upswing, could these nevertheless be snuffed out by a deterioration in saving/consumption decisions in the household sector and, more generally, a tightening of credit and monetary conditions?
This piece makes three points:
- The current tightening in monetary conditions are not dramatic, and pose no material threat to GDP growth in 2017/18.
- Bond yields have already risen further than is easily explained either by current supply/demand conditions in bond markets, or by what consensus expects of Fed rate rises, and the prospects for inflation and GDP over the coming five quarters. In the absence of a monetary policy ‘mistake’ bond markets alone are not about to snuff out a significant acceleration in economic growth.
- Nevertheless, household savings rates fell gently but persistently throughout 2016 and are now at historically low levels. A reversion to the mean would cut approximately 30bps off GDP growth. In a ‘new normal’ scenario, in which GDP averages 2.1% with a standard deviation of 70bps, this is a material risk.
Bloomberg’s published consensus expects no change from the ‘new normal’ as far as US growth is concerned over the coming two years. But the new political leadership has been washed into Washington precisely because the ‘new normal’ produced unacceptable results. It is therefore likely to strain every sinew to break out of it. And the current state of both returns to the strategic factors of production, and shorter-term potential cyclical accelerators mean there is a good foundation for the breakout to be made.
Since 2010, quarterly GDP yoy growth has averaged 2.1% with a standard deviation 0.7 percentage points. This expansion has been a sustained but grinding affair, never seriously threatening to develop the usual cyclical dynamics either for recession or boom. And for the next two years, the consensus expects more of the same, settling on 2.3% GDP growth, with a 15% chance of recession.
But to expect ‘the new normal’ to linger indefinitely no longer seems cautious. Radical change in political, financial and ultimately economic attitudes and choices have made it onto the US agenda. The desire to break out of the new normal is likely to frame major policy choices made this year and next. Whether that is possible or actually desirable will be discovered only in the long-term. But an attempt will be made.
Warning! This piece contains optimism about the UK economy in 2017! All public commentary to the contrary, return on capital is improving even as the expansion of capital stock quickens, the decline in labour productivity is moderating, and the terms of trade are near record highs. On top of all that, the private sector has been busy deleveraging throughout 2016 (yes really), replenishing its potential firepower. All of it points to stronger growth in 2017.
Introduction - Here’s the Problem
Bottom Line: Alibaba’s Shopping Prices Indexes look like something you’re familiar with. In fact, they are little short of revolutionary, and could change the way we understand and measure economic activity.
On the same day that China published CPI data for December, at 2.1% yoy, Alibaba also reported its own online shopping prices indexes. The two headline indexes were the Alibaba Shopping Price Index (aSPI), which showed prices up 3.9% mom and 9.3% yoy; and the Alibaba Shopping Price Index-core (aSPI-core), which showed prices up 0.9% mom and up 0.2% yoy.
That’s a huge difference in result, and in both cases a very different result from China’s official CPI. What’s going on?
Three months ago, 10yr US government bond yields were a little over 1.7%, today they are at 2.4%, with the capital risk premium (measured as 10yr nominal minus 10yr TIPS) and the Fed-calculated term premium both trend up out of zones they have occupied since mid-2015. What threat does this rise in interest rates pose to consumers and corporates, and hence to short-to-medium term GDP prospects? Last week saw the release of 3Q US flow of fund tables, which sketch the state of financial vulnerability of both household and corporate sectors.
It is natural to assume that the fall in the yen will improve the profits outlook for corporate Japan. And perhaps it does - particularly for exporters. However, the overall outlook for corporate profits, margins, investment spending and domestic demand are not good, and are unlikely to be rescued by the current fall in the yen.
These conclusions spring from looking at current corporate position described in the Ministry of Finance’s massive quarterly survey of private sector balance sheets and p&ls (up to 3Q16), the track record of corporate behaviour they suggest, and the impact a weaker yen has previously made.
For all the millions of worthless words wasted during this election, I’ve seen nothing that explains what’s going on better than a piece in Salon.com by Anis Shivani, published back in May, entitled: ‘Donald Trump is Going to Win: This is Why Hillary Clinton Can’t Defeat What Trump Represents.’
Back in 2009, someone who I respect and who works broadly in the nexus between intelligence and finance remarked: ‘You haven’t seen anything yet. Wait until they start chasing us down in the streets’.
It didn’t happen, but that didn’t mean that new political imperatives were not going to demand a radical revision of the terms of globalization.
Almost certainly this will result in the rebirth of inflation as the underlying global trend, and the reversal of a bond bull market which has been in place since the start of the 1980s, and which since 2008 has survived only in the central banks’ intensive care units.
Why? Because the political systems of the West are being forced to recognize the claims of a constituency which has been able to ignore for the last 30yrs or so: the working class. The ability of Western states to mobilize sufficient financial resources to satisfy these newly urgent claims must be doubted - who, after all, are they going to tax? Equally, the ability/willingness of businesses to invest enough to underwrite the sort of productivity gains which could be needed to sustain a rapid rise in real wages must also be doubted. In these circumstances, inflation beckons - the ultimate extension of financial repression.
Yesterday morning China slipped out the news that its respected finance minister Lou Jiwei is to be replaced by Xiao Jie. The same announcement named new ministers for state security and for civil affairs. The low-key way in which the news made its way to public view, and its unorthodox timing, raised all sorts of questions about the political manoeuvrings which may lie behind the move, as well as the policy implications.
I think the crucial point is that in the new finance minister, China has a committed taxman. China’s policymakers recognize that at the heart of China’s debt and property market problems lies the inability of local governments to finance themselves adequately by taxes. And at the heart of that problem is the stark lack of an adequate system of personal taxation. Very probably a fresh assault on this nexus of problems has forced its way to near the top of the policy agenda.
The most important important surprise in China’s August data was the recovery of M2 growth, which was far stronger than was suggested by credit growth. This shores up the foundations of a recovery in profits which is already emerging, and is likely to be a major feature of the coming year.
Although almost all of the August data China has released records gathering strength it is difficult to ignore, one of the major factors driving China’s business cycle dynamics continues to be underestimated. From the beginning of the year, it seemed likely that despite the immediately quite gloomy economic data China’s return on capital was likely to inflect upwards this year for the first time since 2007. That upturn was a predictable consequence of the economy finally managing to digest the binge-investing China undertook between 2003 and 2009/10 - an unprecedented investment-frenzy which resulted in a growth of capital stock which even an average nominal GDP growth of 16.6% pa was unable to match. As a result, asset turns and return on capital fell. The likelihood that 2016 was the year when this would finally reverse held the promise of a ‘surprise’ recovery in Chinese profitability.
Those looking for the next unexpected crisis likely to derail global markets habitually cast their eyes toward the Eurozone, and in particular speculate about the vulnerability of its banking system.
But there are several reasons to think that, in the absence of definitive political revolt from Southern Europe, now is not the time that the racks in the Eurozone’s architecture will actually bring the house down. Private sector cashflows are sharply positive, resulting in a positive flow of cash into Europe’s banks. That means those banks need not worry too immediately about deteriorating asset quality. What is more, the combination of seriously dampened leverage and a build-up of bank capital provides greatly improved protection against the impact of bad assets.
As a result, real economic factors are unlikely to topple the Eurozone’s banks any time soon.The lesson of the the 2008/09 collapse, however, is that threats to financial system stability usually comes from the sudden realization of excessive inter-bank financial leverage. But here too the signs are encouraging. Money is still flowing into Germany’s banking system in order to escape the risks of other Eurozone banking systems, but for now that flow is only moderate, and seems both stable and predictable. And in the wider global context, the recovery of volumes in derivatives markets (interest rate swaps, credit default swaps), also suggest confidence is, ever so slightly, gaining.
Just how bad was China’s July data? And what should be its impact be on policymakers as they assemble for their summer policy meeting in Beidaihe?
All main aspects of economic activity, from indicator for domestic demand, to trade and industry and financing, all posted July results worse than consensus expected. Such a swathe of disappointing data cannot be ignored: July was a weak month for China’s economy. However, it is easy both to overestimate how bad most of this data was, and also to ignore the largely-overlooked signs of life.
But policymakers should question why China’s private sector is scrambling to secure cashflow in the face of weak demand, and why they are now effectively on strike as far as investment is concerned.
For the last few months I have been preparing the Coldwater Economics Good Stats Guide, which has involved checking the methodology, provenance and track record of the hundreds of data-series which I follow in my Shocks & Surprises work. It has been a constant reminder of how much we take ‘the economic data’ for granted, trusting that these eyes and ears on the world economy are reasonably accurate accounts of what’s actually going on.
This illusion sometimes cannot survive a close examination of what is involved in producing them. Sometimes the problems are merely empirical (trouble doing the counting), but very often they are conceptually profound and possibly intractable (for example, estimating services activity, counting ‘real’ investment spending). Sometimes, the problems are simply perverse, with seemingly reasonable methods producing predictably absurd results.
Take, for example, Britain’s construction output index, which for five out of the last six months has reported outright contraction, which has resulted in yoy output falling consistently for the last four months. June’s numbers showed output falling 0.9% mom sa and falling 2.4% yoy.
It was a black day for Indonesia when in 2010 Finance Minister Sri Mulyani Indrawati was hounded out of government over her handling of the Bank Century rescue of late 2008. For she is, by some distance, one of the most impressive politicians/financial technocrats to have come from Southeast Asia in recent memory. Consequently, when on 27th July President Jokowi announced that he had lured her back from the World Bank to resume office at the Ministry of Finance, it was easy to feel renewed optimism about Indonesia.
Financial markets anticipated it, with:
the Jakarta Composite Index up 12% since the end of June, a move which has been largely attributed to the advance rumours of Sri Mulyani’s imminent return;
10yr government bond yields falling to 6.85%, the lowest since June 2013, whilst
the currency has remained stable against the dollar.
But Sri Mulyani would be the first to acknowledge that there is a limit to how much difference one person can make - no matter how clear eyed and determined they may be. What is the state of Indonesia’s economic fundamentals which greet her? At best, they are modestly encouraging, but they have not yet fulfilled their promise of breaking through to something better.
The last week has brought the first estimates of 2Q GDP from every region of the world. They are a varied bunch, with growth disappointing in some place (US, France,) but surprising in others (S Korea) whilst arriving much as expected in others (Eurozone, Spain, UK, Taiwan).
When we look at the foundations of growth, however, we discover that the shape of world growth is shifting, with challenges emerging in the anglo-saxon economies which have been leading the post-crisis grinding expansion, whilst sources of new potential growth are emerging in unexpected places such as the Eurozone and S Korea. Whether the improvement in fundamentals in such places can fully compensate for the deterioration in the current growth-leaders is unclear. This piece looks in more detail at the US GDP disappointment, and explain how it masks an underlying early upturn in profits.
Much has been written about the ‘new normal’ as the long, grinding and stubbornly acyclical expansions which have characterised the US, the UK and to an extent Europe in the aftermath of the implosion of Western financial institutions. For Asia, the acyclicality of the West’s post-crisis expansion, at a time when central banks have deployed extraordinary policies in attempts to spark a recognizable business cycle into life, has resulted only sharp volatility of capital flows. During the initial period of near-zero Western interest rates, the result was a flood of capital into Asian economies which bore no relation to underlying trade flows. But since the recovery of the dollar in mid-2014, this flood abruptly reversed, with the outflows again fundamentally divorced from any underlying trade dynamic.
The new and seemingly purposeless volatility of capital flows, unrelated to savings imbalances either in Western or Asian economies (since the private sectors were almost universally running cashflow and savings surpluses), has distracted attention from a development in trading patterns which, in time, is likely to have a lasting impact.
But since the beginning of this year, a new stage of quasi-stabilization has been emerging, both in terms of capital flows (as shown in the stabilization in Asian fx reserves), and in terms of the reversion roughly to trend growth of both G3 imports and NE Asian exports. So it is time to start thinking about the likely implications of this new stabilization.
China’s reported real 2Q GDP growth unchanged at 6.7%, but more importantly showed a modest acceleration in nominal GDP. If maintained, this acceleration will result in a stabilization or better of asset turns by the end of the year. This would imply a reversal of the long-term fall in return on assets which has been the central economic fact of the last decade. To complement this, the 12m to June saw a near-stabilization of monetary velocity (GDP/M2), suggesting that the deterioration in the allocation of China’s savings is also bottoming out. In addition, any recovery in topline growth is likely to improve profitability very sharply, since even in the subdued markets of 1H2016, China’s industrial operating margins have started to record.
The normal response to these circumstances is a quickening of investment spending. But in China’s case, all the gains in quarterly and monthly data are undercut by a slowdown in private investment spending so severe that by June there was no yoy growth at all. Whilst the central authorities have responded by sending out inspection teams to harry local governments into more investor-friendly initiatives, it is Xi Jinping’s anti-corruption which is the most likely factor currently deterring private investment. If corruption in China is endemic throughout its government system - and China ranks 83rd out of a global 167 on Transparency International’s 2016 Corruption Perception Index - any enthusiastically pursued anti-corruption campaign must generate tremendous investor uncertainty.
The impact of Brexit on the UK economy in the long term is, obviously, incalculable, and will remain so, since it is currently a world of infinite hypotheticals. But in the short term, it is possible to outline the template upon which will be printed a likely fall in consumer confidence, a hiatus in investment spending, and a c10% devaluation of sterling against the dollar. It is also possible to measure the current pressures on private sector cashflows, and the cyclical pressures being experienced by business and labour markets.
In general terms they suggest that the current UK expansion, which has been fundamentally acyclical, is finally becoming a bit ‘leggy’: cashflows are slightly strained, return on capital has peaked, and labour productivity is falling. None of these deteriorations are extreme, and within the context of an acyclical expansion this would raise the prospect of a ‘soft patch’ of slowing growth marked by slowing consumer spending, slowing investment growth and slowing employment growth. Since the cycle has not been generated, accelerated or even supported by increases in credit, one would not expect that ‘soft patch’ to degenerate into a recession.
The recent weakening of Britain's employment and retail sales data isn't a coincidence, but rather a sign of sliding productivity. With little in the way of credit expansion, the growth of payroll income has been the mainstay of the long expansion, supplemented recently by the private sector running down its savings surplus to a modest deficit. So in the absence of any other props, the long grinding expansion is entering a soft patch.
The UK and the US exited the Great Recession at about the same time, in the second half of 2009, but in both cases the recovery has been feeble compared to the recession, and has lacked in the usual cyclical accelerators. Rather, it has been a long upward grind, frequently threatening to ebb away out of inanition, rather than excess. In both cases, what has driven the expansion has been a slow and steady rise in employment, which in turn has been based on harder work - modest gains in output per worker achieved even in the absence of increases in capital per worker.