A lack of demand is causing the weak economy rather than uncertainty over taxes, regulation and economic policies, according to Alan Krueger, the chairman of President Barack Obama’s Council of Economic Advisers.
via White House’s Krueger: Lack of Demand Holding Back Economy – Real Time Economics – WSJ.
The debt binge since 1975, fueled by an easy-money policy from the Fed, has landed the US economy in serious difficulties. Wall Street no doubt lobbied hard for debt expansion, because of the boost to interest margins, with little thought as to their own vulnerability. There can be no justification for debt to expand at a faster rate than GDP — a rising Debt to GDP ratio — as this feeds through into the money supply, causing asset (real estate and stocks) and/or consumer prices to balloon. What we see here is clear evidence of financial mismanagement of the US economy over several decades: the graph of debt to GDP should be a flat line.
The difference between domestic and private (non-financial) debt is public debt, comprising federal, state and municipal borrowings. When we look at aggregate debt below, domestic (non-financial) debt is still rising, albeit at a slower pace than the 8.2 percent average of the previous 5 years (2004 to 2008). Public debt is ballooning in an attempt to mitigate the deflationary effect of a private debt contraction. Clearly this is an unsustainable path.
The economy has grown addicted to debt and any attempt to go “cold turkey” — cutting off further debt expansion — will cause pain. But there are steps that can be taken to alleviate this.
If private debt contracts, you need to expand public debt — by running a deficit — in order to counteract the deflationary effect of the contraction. The present path expands public debt rapidly in an attempt to not only offset the shrinkage in private debt levels but also to continue the expansion of overall (domestic non-financial) debt levels. This is short-sighted. You can’t borrow your way out of trouble. And encouraging the private sector to take on more debt would be asking for a repeat of the GFC. The private sector needs to deleverage but how can this be done without causing a total economic collapse? The answer lies in government spending.
Treasury cannot afford to borrow more money if this is used to meet normal government expenditure. Public debt as a percentage of GDP would sky-rocket, further destabilizing the economy. If the proceeds are invested in infrastructure projects, however, that earn a market-related return on investment — whether they be high-speed rail, toll roads or bridges, automated port facilities, airport upgrades, national broadband networks or oil pipelines — there are at least four benefits. First is the boost to employment during the construction phase, not only on the project itself but in related industries that supply equipment and materials. Second is the saving in unemployment benefits as employment is lifted. Third, the fiscal balance sheet is strengthened by addition of saleable, income-producing assets, reducing the net public debt. Lastly, and most importantly, GDP is boosted by revenues from the completed project — lowering the public debt to GDP ratio.
Public debt would still rise, and bond market funding in the current climate may not be reliable. But this is the one time that Treasury purchases (QE) by the Fed would not cause inflation. Simply because the inflationary effect of asset purchases are offset by the deflationary effect of private debt contraction. Overall (domestic non-financial) debt levels do not rise, so there is no upward pressure on prices.
Infrastructure investment should not be seen as the silver bullet, that will solve all our problems. Over-investment in infrastructure can produce diminishing marginal returns — as in bridges to nowhere — and government projects are prone to political interference, cost overruns, and mismanagement. But these negatives can be minimized through partnership with the private sector.
Projects should also not be viewed as a short-term, band-aid solution. The private sector has to increase hiring and make substantial capital investment in order to support them. All the good work would be undone if the spigot is shut off prematurely. What is needed is a 10 to 20 year program to revamp the national infrastructure, restore competitiveness and lay the foundation for future growth.
There are no quick fixes. But what the public needs is a clear path to recovery, rather than the current climate of indecision.
The S&P 500 index is headed for medium-term support at 1160. 21-Day Twiggs Money Flow warns of (medium-term) selling pressure. If support at 1160 fails, primary support at 1075/1100 is unlikely to hold — offering a target of 900*. Reversal below the rising trendline on 63-day Twiggs Momentum would indicate continuation of the primary down-trend.
* Target calculation: 1100 – ( 1300 – 1100 ) = 900
Dow Jones Europe index is also headed for primary support, at 205. Failure is likely and would offer a target of 160*. Reversal of 13-week Twiggs Money Flow below zero would warn of rising selling pressure.
* Target calculation: 210 – ( 260 – 210 ) = 160
FedEx expects continued moderate economic growth, with trade flows staying volatile, executives told analysts in a conference call after the company reported results on Thursday.
FedEx, driven by online holiday orders, delivered about 17 million packages on Dec. 12 — twice the average daily shipments — in what was its busiest day in its 40-year history.
Today, American aggregate non-financial debt is at levels similar to those last seen in the midst of the Great Depression. At 250 per cent of GDP, that debt burden is equivalent to almost US$120,000 for every American (Chart 1).
…..backsliding on financial reform is not a solution to current problems. The challenge for the crisis economies is the paucity of credit demand rather than the scarcity of its supply. Relaxing prudential regulations would run the risk of maintaining dangerously high leverage – the situation that got us into this mess in the first place.
As a result of deleveraging, the global economy risks entering a prolonged period of deficient demand. If mishandled, it could lead to debt deflation and disorderly defaults, potentially triggering large transfers of wealth and social unrest.
Managing the deleveraging process
Austerity is a necessary condition for rebalancing, but it is seldom sufficient. There are really only three options to reduce debt: restructuring, inflation and growth. Whether we like it or not, debt restructuring may happen. If it is to be done, it is best done quickly. Policy-makers need to be careful about delaying the inevitable and merely funding the private exit.
……Some have suggested that higher inflation may be a way out from the burden of excessive debt. This is a siren call. Moving opportunistically to a higher inflation target would risk unmooring inflation expectations and destroying the hard-won gains of price stability.
…..With no easy way out, the basic challenge for central banks is to maintain price stability in order to help sustain nominal aggregate demand during the period of real adjustment. In the Bank’s view, that is best accomplished through a flexible inflation-targeting framework, applied symmetrically, to guard against both higher inflation and the possibility of deflation.
The most palatable strategy to reduce debt is to increase growth. In today’s reality, the hurdles are significant. Once leverage is high in one sector or region, it is very hard to reduce it without at least temporarily increasing it elsewhere.
In recent years, large fiscal expansions in the crisis economies have helped to sustain aggregate demand in the face of private deleveraging. However, the window for such Augustinian policy is rapidly closing. Few except the United States, by dint of its reserve currency status, can maintain it for much longer.
…..The route to restoring competitiveness [in the euro-zone] is through fiscal and structural reforms. These real adjustments are the responsibility of citizens, firms and governments within the affected countries, not central banks. A sustained process of relative wage adjustment will be necessary, implying large declines in living standards for a period in up to one-third of the euro area.
…..With deleveraging economies under pressure, global growth will require global rebalancing. Creditor nations, mainly emerging markets that have benefited from the debt-fuelled demand boom in advanced economies, must now pick up the baton. This will be hard to accomplish without co-operation. Major advanced economies with deficient demand cannot consolidate their fiscal positions and boost household savings without support from increased foreign demand. Meanwhile, emerging markets, seeing their growth decelerate because of sagging demand in advanced countries, are reluctant to abandon a strategy that has served them so well in the past, and are refusing to let their exchange rates materially adjust. Both sides are doubling down on losing strategies. As the Bank has outlined before, relative to a co-operative solution embodied in the G-20’s Action Plan, the foregone output could be enormous: lower world GDP by more than US$7 trillion within five years. Canada has a big stake in avoiding this outcome.
Mark Carney: Growth in the age of deleveraging.
Comment: ~ One of the most important papers I have read this year. Mark Carney, Governor of the Bank of Canada and Chairman of the Financial Stability Board — established by the G-20 in 2009 to further global economic governance — maps out the hard road to recovery from the current financial crisis.
The outlook for the global economy in 2012 is clear, but it isn’t pretty: recession in Europe, anemic growth at best in the United States, and a sharp slowdown in China and in most emerging-market economies.
……Adjustment of relative prices via currency movements is stalled, because surplus countries are resisting exchange-rate appreciation in favor of imposing recessionary deflation on deficit countries. The ensuing currency battles are being fought on several fronts: foreign-exchange intervention, quantitative easing, and capital controls on inflows. And, with global growth weakening further in 2012, those battles could escalate into trade wars.
via Fragile and Unbalanced in 2012 – Nouriel Roubini – Project Syndicate.
The euro broke through primary support at $1.32, warning of another primary decline with a target of $1.22*. Declining 63-day Twiggs Momentum indicates a strong primary down-trend.
* Target calculation: 1.32 – ( 1.42 – 1.32 ) = 1.22
Pound Sterling is testing primary support at $1.54, while 63-day Twiggs Momentum is below zero. Failure of support would signal a primary decline to $1.46.
* Target calculation: 1.54 – ( 1.62 – 1.54 ) = 1.46
The Aussie Dollar retreated below parity, indicating another test of medium term support at $0.97. Failure would test primary support at $0.94/$0.95. Respect of the zero line by 63-day Twiggs Momentum indicates a continuing primary down-trend. Weakening commodity prices, especially coal and iron ore, should strengthen the down-trend.
* Target calculation: 0.97 – ( 1.03 – 0.97 ) = 0.91
The Canadian Loonie is headed for a test of primary support at $0.94/$0.95. 63-Day Twiggs Momentum holding below zero suggests a continuing primary down-trend.
* Target calculation: 0.95 – ( 1.00 – 0.95 ) = 0.90
A monthly chart of the Greenback against the Yen shows strong bullish divergence on 63-day Twiggs Momentum, suggesting reversal of the primary down-trend. Breakout above ¥80 and the descending trendline would confirm the signal.
The US Dollar continues in a strong up-trend against both the South African Rand and Brazilian Real, helped by falling commodity prices. Breakout above R8.60 would signal a further advance to R9.20.
* Target calculation: 8.60 + ( 8.60 – 8.00 ) = 9.20
The cause of current anemic GDP growth is evident from the recently-released Z1 Flow of Funds report. GDP recovery from 2008/2009 is accompanied by only a modest rise in Domestic (Non-Financial) Debt — which is now constraining further growth.
Domestic (Non-Financial) Debt is made up of Government Debt and Private (Non-Financial) Debt — which can be further broken down into Household and Corporate debt. The Financial sector is excluded as it mainly acts as a conduit, channeling debt to other sectors of the economy. We can see below that Private (Non-Financial) Debt contraction was far greater than overall Domestic (Non-Financial) Debt. What saved the economy was a sharp spike in Government Debt in 2009, offsetting the fall. The massive fiscal deficit may have left a public debt hangover, but failure to offset the contraction in private borrowing would have had more serious consequences: a GDP collapse similar to the 1930s.
Resumption of corporate borrowing has dragged Private (Non-Financial) Debt growth into positive territory but growth remains anemic and households continue to de-leverage. Cessation of government borrowing would cause a fall in overall Domestic (Non-Financial) Debt growth to near zero and a sharp fall in GDP. The economy needs to be gradually weaned off stimulus spending in order to minimize disruption to growth. And not before Private sector borrowing recovers. We need a clear deficit-reduction plan, over 5 to 10 years, in order to restore corporate sector confidence and encourage new capital investment.
The only alternative is further quantitative easing (QE3), where continuous deficits are funded by borrowing from the Fed. But that poses a whole new set of problems — and could lead us back to square #1.
Dow Jones Industrial Average reversed below short-term support at 12000. Bearish divergence on 21-day Twiggs Money Flow warns of medium-term selling pressure — and a correction to test primary support at 10600. Reversal (of TMF) below zero and follow-through (of DJIA) below 11900 would strengthen the signal.
Respect of the descending trendline on Canada’s TSX 60 weekly chart indicates another test of primary support at 645. Failure would signal a primary decline to 575*. Breach of the zero line by 63-day Twiggs Money Flow would warn of rising selling pressure. Breakout above resistance at 715 is unlikely but would flag that the primary down-trend has ended.
* Target calculation: 645 – ( 715 – 645 ) = 575
