Tag Archives: GDP

The Policy of Doom

We’ve finally found the long-awaited (due to a browser refresh issue?) Hoisington Investment Management Quarterly Review and Outlook, Second Quarter 2012. As usual, Dr. Lacy Hunt has produced a 4-page newsletter based on solid economic theory but written in a manner that a layman may understand. This one is centered on Interest Rates and Over-indebtedness. He is basing his discussion on three recent papers, especially research [that] includes the first systematic evidence of the association between high public debt and real interest rates. As he states:

both low long [bond] rates and the stagnant economic growth [the current US ‘recovery’] are symptoms of the excessive indebtedness [current sovereign debt levels] and/or low quality debt usage [government spending].

Although he relates the studies to the interest rate on the long bond, an important issue for investors, especially pension funds, there are more important broader implications for Western economies in general.

Flash Point: PMI Blues

Continuing the decline globally of PMI data noted in June, PMI PMS, and continuing in July, PMI Update: Dark Clouds and Risk of Rain On Our Parade, we have reports of further declines for August in China, China Flash Manufacturing PMI at 9-Month Low, New Export Orders Plunge at Sharpest Rate Since March 2009, and the eurozone, Eurozone PMI Declines 7th Month; German Private Sector Output Falls at Faster Rate; New Business Declines 13th Month.

Of the eurozone, Markit’s flash August reading edged slightly downward. Markit commented: The August Markit Eurozone Flash PMI reinforces the prevailing view of the economy dropping back into recession during the third quarter of 2012. The direct implication is a continued decline in economic output or GDP, notably in manufacturing. The broader implication is a global economic slowdown that is moving into a recession.

Flash Point: Europe is fixed! Not!

We received this note from our friend JR that echoes what appears to be a common sentiment.

This is simple. If the ECB sets rate caps on long-term rates then the solvency crisis is essentially over. This would essentially be a pseudo guarantee of bond markets with the ECB’s backing. This would almost certainly bring private investors back to these markets and help fund the governments. So we eliminate the solvency crisis. That’s a HUGE first step. http://pragcap.com/europe-a-policy-proposal-with-teeth

We will argue that the solvency issue is not resolved but simply kicked down the road. That in turn opens up a rarefied space we haven’t seen commentary or speculation on yet.

Flash Point: QE Coming

We’ve decided to initiate an ongoing series of short notes that address a single point. We have long been of the view that QE has no longer any significant impact on the economy and therefore no central bank (CB) will embark on more. We note that QE has major (economic) impacts on markets but this translates into little impact on the economy. We have written extensively on this before. We will summarize why QE will have no impact on the economy and present our view why in fact QE will come.

The only real tool CBs have to stimulate the economy is their control of interest rates. Lower rates encourage borrowing and spending leading to economic growth. Control at the front end of the yield curve was broken when the zero bound was reached (ZIRP – do a search on this site). QEs (note that the FED definition of QE includes the requirements that interest rates be at zero) in various forms were then used to lower rates across the curve. Later ones addressed the long (30-year) bond to lower mortgage rates with an insignificant effect on the housing market.

In short, QE has reached its limit in being able to affect the real economy which is why we have argued that the Fed in particular will not engage in more of it. The reason for this we have detailed in other posts: the consumer who is responsible for 70% of GDP in the US has reached a debt ceiling. He has no capacity left for borrowing more. Moreover as we have described, this condition (high debt among all players in the economy) will lead to reduced growth and lower GDP for decades.

For support of these points see Bloomberg yesterday – Banks Use $1.77 Trillion to Double Treasury Purchases:

  • There’s all sorts of good long-term developments that are occurring on household balance sheets, but you sense the Fed would like them to be not quite as thrifty and instead put a little more money to work
  • It’s a function of inherently weak demand for loans and that relates to inherently weak demand in the economy, … Consumers, households, businesses: they’re paying down debt, they’re saving money, they’re not borrowing. They don’t have an appetite.
  • Household purchases, which account for about 70 percent of GDP, grew at the slowest pace in a year, according to the commerce department’s report on GDP.

The Europeans, however, are using monetization, of which QE is one form, to purchase the sovereign debt of peripheral countries whose yields are out of control. The latest plan by the ECB to cap interest rates is described by Ambrose Evans-Pritchard in Germany backs Draghi bond plan against Bundesbank. If Mario Draghi gets his way, this will result in massive open-ended purchases of Italian and Spanish debt initially and several more countries ultimately. This of course will require a massive printing of euros, dropping its value, possibly precipitously.

The Fed will likely have to respond in kind to maintain a currency alignment that is not destructive to US export industries. This falls into the area of currency wars that Jim Rickards has lately been pounding the table about to promote his new book on the subject (Reserve Bank of Australia Under Pressure, ABC NewsHow China Is Driving Federal Reserve Policy). His argument is the Fed will have to entertain some form of QE such as GDP targeting in some kind of an open-ended policy, in an effort to combat the Chinese yuan.

The market has largely priced in (we recently saw an 80% figure: BofA: QE3 is 80% priced into the markets) QE3. A clear signal from the Fed that there will be no QE will cause a sharp equity correction. This would not sit well with a weak economy in front of presidential elections. On the other hand, to announce QE3 would have the appearance that the Fed had abandoned its neutrality to support Obama. Look for more equivocating similar to what has come out of the last few FOMC meetings, to come out of the Jackson Hole conference this weekend.

Ultimately the fed will probably have to intervene from the currency market rather perspective rather than the job market perspective (we have shown how QE has had little or no effect on the unemployment numbers). However the latest FOMC minutes show a growing view that more may be necessary and relatively soon (Zero Hedge: FOMC Minutes Indicate No Shift In Fed’s Views, Even As Many Members See More Easing Likely Warranted):

Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.

This sentiment has been slowly but steadily growing over a number of FOMC meetings.


Momentum is moving in the direction of massive ECB bond purchases and monetization. Germany may yet block the initiative but the signals are becoming if anything, more mixed. The Finns may prove to be the source of any effective block to the strategy. They are a small player but have taken very hard positions all along and recently stated effectively ‘no more money’. We think the ECB at this point may prevail and the result will be called QE in some eurozone parlance.

Pundits keep saying Bernanke needs an economic event such as a really bad non-farm payroll number, to justify a new QE program. We think the Fed should know that they really have no leverage left over unemployment despite this being one of their mandates. However, the increasing sentiment towards some form of stimulus intervention suggests they think they still have a card or two left to play. They may try to drag it out hoping for signs of a real recovery. Eventually they will have to decide which side of the fence appears to have the greener grass (less risk or pain). The easiest route is more QE. The currency angle is a wildcard. In either case, we think they will probably announce something by year end.


Since posting this we have found support for argument on the limitations of Fed policy from Jeffrey Lacker, president of the Federal Reserve Bank of Richmond. Reported in USNews, in an interview with The Associated Press, he said that the Fed can only do so much to lower the 8.3 percent unemployment rate. There are a lot of people overestimating the extent to which monetary policy is capable of having any sustained effect on growth or labor markets.

Ontario Is Not California

A comment comparing Ontario’s fiscal situation to California’s recently hit the news (e.g. Ont. compared to cash-strapped Calif.) It was meant as a warning to Ontarians. After some debate, we’ve decided to weigh in on the issue. The issue raised above centers on a comparison of California’s fiscal situation, among the worst of all the states in the US, to Ontario’s. As we shall see, California’s situation is significantly better than Ontario’s. To make the issue clear, we reverse this statement: Ontario’s situation is significantly worse than California’s. To find out why, read on.

Garbage and the Holy Grail

A Holy Grail of economic forecasting would be to find some data series that has good predictive value of the direction of the economy, preferably a leading indicator. Barring the latter, a coincident indicator would be the next choice. Well it turns out, as the Washing Post notes in What garbage can tell us about the direction of the economy — in 1 chart, that garbage is an excellent one. Here’s the relationship:

Some Thoughts on Debt Saturation and Growth

We recently received multiple references to this chart:

This one from Joe Miller (attributed to a David P.) was accompanied by the statement:

Regardless of whether you call it debt saturation or diminishing return on new debt, the notion that taking on more debt will magically enable us to “grow our way out of debt” is not supported by data.

Although we intuitively believe the author is right, we do not think he has proven his point. We discuss the post and explore our thoughts on the topic.

Ontario, You Are In Really Deep Trouble

In December, we wrote in Ontario, You Are In Deep Trouble:

So Dwight, tear up all those projections of GDP growth, deficit reductions and balanced budget time frames and start over. If you can’t do it, Moody’s will.

Well he didn’t and they did!

Following on the heals of an S&P’s downgrade of the outlook on Ontario’s debt (see S&P ratings agency puts Ontario on credit watch; Moody’s did same last fall), Moody’s has downgraded Ontario’s credit rating from Aa1 to Aa2.

Living In a Hypothesis

In a recent speech at the National Association for Business Economics Annual Conference, Washington, D.C. March 26, 2012, Fed Chairman Ben Bernanke talked about the US job situation and monetary policy designed to rectify the problem. That Fed policy is consistent with central bank policy worldwide makes this speech worthy of study. The frightening aspects are that this policy represents untried economic theory – a “hypothesis”, the results to date are a failure, the future impact is unknown beyond some theoretical speculation, and central banks will continue to implement it magnifying future effects.

Ontario, You Are In Deep Trouble

Regarding the announcement that Moody’s has placed Ontario on a downgrade watch, CTV News reports Ontario Finance Minister Dwight Duncan as saying:

That is not a downgrade. Spin take: while not being a downgrade on debt, it is certainly a downgrade in outlook.

This does signal that they will continue to watch us carefully. No kidding.

It challenges us to continue to meet the targets that we have so far met. Spin take: we’re not sure, Dwight, how you continue to meet a target that is already met unless there is a real risk that the result of meeting the targets is at risk of being reversed. In other words, we’re in over our heads and barely treading water.

But Dwight has a solution as the Vancouver Sun reports: We are going to have to be relentless in pursuit of transformation to ensure we are focusing our resources on those pivotal areas for job growth in the future. Huh? Such as the “green” jobs the province has been promoting? We’re living in a Dilbert cartoon.
Zero Hedge has a more in-depth discussion of Moody’s assessment. They quote a Ms. Wong of Moodys:  If a credible plan to address the fiscal imbalance and stabilize the debt burden is not implemented in the next provincial budget, expected in March 2012, downward pressure on the province’s Aa1 rating would emerge.

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