Tag Archives: GDP

Update on the Canadian Housing Bubble

When we were doing our monthly update of Tracking Canadian House Prices, we found (Teranet – National Bank House Price Index  –  Communiqués, research tab, Economic News, click for more information) a link to a monthly 2-page newsletter that Teranet publishes for the National Bank Financial Markets. It had a graph that showed the marked divergence between the Teranet house price index for Canada and the Case-Schiller house price index for the US. Through research we found a comparable graph shown in Figure 1 (multiple source attributions shown on the chart).

Figure 1. Canadian and US house price indices.

We took this graph from an April 29 newsletter from Otterwood Capital Management titled: Canadian housing crash? Not yet. Otterwood’s argument is that the strong Canadian housing market is a product of a strong economy (more or less) that is a product of a recovering American economy. One might infer the reverse from this: a US in recession would drive Canada into a recession which would pop the Canadian housing bubble.

This Is How It’s Done!

The Fed has been desperately trying to goose the US economy for years with various forms of quantitative easing, largely without success. As we have argued, there is no way of separating the effect of QE on recovery from the last recession from normal economic forces that have lead to economic recovery from every recession in history. Now, we have a new and measurable way of creating economic growth independent of QE.

Courtesy of the Commerce Department, we find that simply by revising the way GDP is calculated – cooking the numbers – we can achieve instant economic growth. The following chart from MarketWatch illustrates this achievement:

This result is even more remarkable than at first appears. Looking carefully at the two bars covering the period 1959 to 2007, we find there is essentially no revision to the growth numbers. It all occurs since 2007. Keeping in mind that the last recession started in 2007 and recessions are normally marked by negative GDP numbers, the significant difference in growth between the two methodologies for the recent period shown is actually compressed into the recession recovery since 2009.

As we said, if you can’t create economic growth by dumping tons of liquidity onto the market, simply cook the numbers to get the growth you want.

How Effective Has QE Been?

under construction

We have written a number of essays on quantitative easing (QE) as practiced by the Fed. We also have just finished our series on Understanding Money with the publication of Understanding Money: Part 5 – It’s All Money. As we were finishing we realized that a number of questions in our mind about QE might be tidied up using our ideas on money. This essay examines the monetary mechanics of QE and attempts to quantify its impact on the money supply and hence the economy.

Flash Point: Yappy Little Dogs

We have been monitoring although not writing about the tensions in the South China Sea and between Japan and China particularly. We have decided to comment.

Aside: we have observed that obnoxiousness and aggressiveness in dogs is inversely correlated with their size. In particular, we had a neighborhood pack  of three Shih Tzu mongrels that would surround you yapping and snapping at your heels.

It occurred to us that the recent rise of belligerence in Japan when compared to the rise of belligerence in China. Was an apt comparison. Japan is a comparatively small nation geographically although its population ranks 10th in the world. Still this is less than one tenth the population of China. And Japan ranks third in GDP, just behind China.

It is the demographic imbalance, however, that should muzzle Japan. China’s population in 2010, had a median age of 34.2 whereas Japan had a median age of 44.7. That’s a ten year difference. Japan cannot afford a war with China. A significant loss of young people in a war would have major economic implications down the road simply by its impact on the median age of the workforce – robots excepted. For a discussion of Japanese demographics see: Zero Hedge Guest Post: How Demography Is Changing Japan.

Flash Point: Why High Unemployment Is Structural

We have argued in the past that the current high unemployment rate in the West is structural, not cyclical (Signs of a Structural Change in the US Economy). We have also supported research that suggests that the high level of debt will depress economic growth for a decade or two (The Policy of Doom). In effect, since debt is incurred to increase current spending, while the debt is active (An Insight into the Impact of Debt on Economic Growth), future disposable income and hence future spending is depressed.

In short, debt has these effects:

  • Future income is moved into the present.
  • Future spending is moved into the present.
  • Future economic activity is moved into the present.

The part we had missed until now is this:

  • Future employment is moved into the present.

The massive credit bubble created over the last two decades created economic activity in that time frame that would have occurred in the future. The employment rate during that period would have been elevated by this elevated activity and future employment will be depressed as a result of unavailable economic activity.

On the issue of whether unemployment is cyclical or structural, the answer becomes both. In terms of the credit super-cycle, it is cyclical (discounting other events in the labour market) but in terms of the business cycle which is much shorter, it is structural.

It’s wonderfully simple!

Update: 20120127

Zero Hedge posts an article, The Stock Market Is Back To December 2007 Levels; Here Is What Isn’t, that graphically demonstrates how employment is not coming back as the policy wonks expect.

Distortions in the Global Economy

We have argued in several places that a high unemployment level in the US is structural. In today’s “Outside the Box” titled Sorting Out the Decade, John Mauldin presents two articles by Bill Gross and Charles Gave that have bearing on themes we have written on.

In the first, Bill Gross confirms our argument that high unemployment level in the US is structural (see the emphasized segment below):

Recently, Erik Brynjolfsson and Andrew McAfee at MIT have affirmed that workers are losing the race against the machine. Accountants, machinists, medical technicians, even software writers that write the software for “machines” are being displaced without upscaled replacement jobs. Retrain, rehire into higher paying and value-added jobs? That may be the political myth of the modern era. There aren’t enough of those jobs. A structurally higher unemployment rate of 7% or more is the feared “whisper” number in Fed circles. Technology may be leading to slower, not faster economic growth despite its productive benefits.

Flash Point: Twenty More Years (If We’re Lucky)

We have argued two themes in recent months:

  1. Low economic growth is structural and will persist for 20 years or more. See Signs of a Structural Change in the US Economy, The Hole in Jackson Hole.
  2. High unemployment is structural and here to stay. See The Hole in Jackson Hole, What’s the Future for Jobs?

Two new eletters contribute significantly to both points.

Flash Point: Where Does It End?

We had just finished our latest essay The Hole in Jackson Hole, when we got this article from Bloomberg: Fed Moves Toward Open-Ended Bond Purchases to Satisfy Bernanke. In our essay we presented our arguments that LSAPs (QE) have been ineffective in stimulating the economy. The Bloomberg article, however, suggests some new LSAP will be coming soon (something we agreed with as a result of our analysis of Bernanke’s speech).

LSAPs were introduced to manipulate interest rates because the traditional tool for doing this, the  Effective Federal Funds Rate (EFFR), became ineffective when it reached the zero lower bound. Since the EFFR was designed to manipulate short-term rates and these were effectively at zero, the Fed used LSAPs to affect longer dated maturities, eventually lowering rates across the entire yield curve to the 30-year bond. All have recently touched historic lows.

As we argued, there has been no observable effect of LSAPs on the employment situation. Bloomberg speculates that the Fed will soon introduce an LSAP policy that is open ended. Its goal will not be to acquire a certain class of assets in a specified quantity in a specified period of time as previous LSAPs have done, but to set an economic target for the program rather than an asset target. Jim Rickards suggested they would do this several months ago, targeting a certain level of GDP. Bloomberg suggests they may target a certain level of unemployment – say 7%.

In an economic environment where GDP and employment are in a cyclical downturn one might assume they will return to historic norms. If however, there are structural changes in the economy, this assumption is invalid. In our essay we showed a thirty year downtrend in GDP and employment growth. We argued that this is structural since it it spans four recessions or business cycles.

Bernanke’s bet is the recovery has a cyclical basis. We argue it has a structural basis*. If Bernanke is wrong and sets a policy objective for levels that are no longer relevant due to structural changes, then he will have created an open-ended ticket to money creation at the Fed bounded by a goal that is unattainable. But what is worse, he cannot realize that the failure of his policy is based on a fundamental misreading of the economy. Rather the danger is he will misread the situation as Paul Krugman has done and feel that the problem simply requires more money to be thrown at  it.

*Update: 20120914

We find today, Ambrose Evans-Pritchard arguing in The Telegraph in his essay Era of ‘jobs-targeting’ begins as Fed launches QE3, that the employment situation is due to a structural change. He quotes Bernanke’s concern as:

a grave concern, not only because of the enormous suffering and waste of human talent it entails, but also because high levels of unemployment will wreak structural damage on our economy that could last for many years

Then he quotes Minneapolis Fed chief Narayana Kocherlakota as saying that the lack of jobs skills imply less slack than assumed – known as an upward shift in the “Beveridge Curve”. The problem is “structural”.

In The Hole in Jackson Hole, Figure 4 shows that for the current ‘recovery’, the year-over-year change in GDP is at trend. This we interpret to mean the full recovery has happened and current employment numbers are the ‘new normal’. To support this notion, we note Ambrose’s statement America’s output is now well above its previous peak in late 2007, unlike Japan and most of Europe. If output has fully recovered, there is no room for any significant expansion in employment. Indeed, the larger levels of unemployed – the actual levels, not the official levels – will prove to be a drag on economic expansion as these people will require social service support while remaining unproductive.

The implication then for a QE program that targets a level of employment is that this level will be reached only when sufficient people drop out of the labour force to reduce the numbers and not by job creation. We have  a nagging feeling, not that QE will not be effective since we believe it won’t be, but that it will actually damage the economy at an accelerating rate. We’re thinking about it.


The Hole in Jackson Hole

Fed Chairman Ben S. Bernanke gave his annual address at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 31. We review the speech, Monetary Policy since the Onset of the Crisis, and suggest the Chairman has it wrong. As a consequence, the further policy intervention that he is signalling will likely not help the economy but will continue to distort markets making an inevitable market correction more severe. Call it building a Minsky moment.

Flash Point: How to Spot Hyperinflation

We maintain that hyperinflation is not just a case of large-scale price inflation but essentially, a loss of confidence in the currency causing holders of currency units to immediately convert them into hard assets. This creates a positive feedback loop that exacerbates the runaway price problem (our use of the term ‘positive feedback’ is the correct usage and counter to how most pundits use the term. See Negative Feedback, theTragedy of the Commons, and Complex Systems).

The economic measure of this is called the “velocity of money” or the number of times it changes hands in the economy. If the velocity grows sharply then we should become concerned that we may be on the edge of hyperinflation. So where does the US stand? Consider the following graph:

Figure 1. Velocity of the M2 money stock. Click to open in a new window.

For the broadest measure of the money supply, M2’s velocity has been decreasing since the late 1990s and is currently at record lows for the period the available data covers. Velocity is a calculated rather than a measured quantity and is the ratio of nominal GDP to M2. The interpretation is that the money supply has been growing faster than GDP since the late 1990s. Or in the interpretation of velocity, the rate of circulation of available money in the economy has been slowing. Should this begin to show a large sharp increase (upturn in the graph) then we would want to look for signs that hyperinflation might be emerging.

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