Category: US & Canada

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Rising debt—not a crisis, but a serious problem | Brookings

Testimony by Alice M. Rivlin, Senior Fellow – Economic Studies, Center for Health Policy, before the Joint Economic Committee of the United States Congress on September 8, 2016:

…..our national debt is high in relation to the size of our economy and will likely rise faster than the economy can grow over the next several decades if budget policies are not changed. Debt held by public is about 74 percent of GDP and likely to rise to about 87 percent in ten years and to keep rising after that.

This rising debt burden is a particularly hard problem for our political system to handle because it is not a crisis. Nothing terrible will happen if we take no action this year or next. Investors here and around the world will continue to lend us all the money we need at low interest rates with touching confidence that they are buying the safest securities money can buy. Rather, the prospect of a rising debt burden is a serious problem that demands sensible management beginning now and continuing for the foreseeable future.

What makes reducing the debt burden so challenging is that we need to tackle two aspects of the debt burden at the same time. We need policies that help grow the GDP faster and slow the growth of debt simultaneously. To grow faster we need a substantial sustained increase in public and private investment aimed at accelerating the growth of productivity and incomes in ways that benefit average workers and provide opportunities for those stuck in low wage jobs. At the same time we need to adjust our tax and entitlement programs to reverse the growth in the ratio of debt to GDP. Winning broad public understanding and support of basic elements of this agenda will require the leadership of the both parties to work together, which would be difficult even in a less polarized atmosphere. The big uncertainty is whether our deeply broken political system is still up to the challenge.

…..There are three necessary elements of a long-run debt reduction plan:

  • Putting the Social Security program on sustainable track for the long run with some combination higher revenues and reductions in benefits for higher earners.
  • Gradually adjusting Medicare and Medicaid so that federal health spending is not rising faster than the economy is growing….
  • Adjusting our complex, inefficient tax system so that we raise more revenue in a more progressive and growth-friendly way and encourage the shift from fossil fuels to sustainable energy sources…..

Source: Rising debt—not a crisis, but a serious problem to be managed | Brookings Institution

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Credit bubbles and GDP targeting

In 2010 Scott Sumner first proposed that the Fed use GDP targeting rather than targeting inflation, which is prone to measurement error. Since then support for this approach has grown, with Lars Christensen, an economist with the Danish central bank, coining the term Market Monetarism.

Sumner holds that inflation is “measured inaccurately and does not discriminate between demand versus supply shocks” and that “Inflation often changes with a lag… but nominal GDP growth falls very quickly, so it’ll give you a more timely signal….” [Bloomberg]

The ratio of US credit to GDP highlights credit bubbles in the economy. The ratio rises when credit is growing faster than GDP and falls when credit bubbles burst. The graph below compares credit growth/GDP to actual GDP growth (on the right-hand scale). The red line illustrates a proposed GDP target at 5.0% growth.

US Credit Growth & GDP Targeting

What this shows is that the Fed would have adopted tighter monetary policies through most of the 1990s in order to keep GDP growth at the 5% target. That would have avoided the credit spike ahead of the Dotcom crash. More importantly, tighter monetary policy from 2003 to 2006 would have cut the last credit bubble off at the knees — avoiding the debacle we now face, with a massive spike in credit and declining GDP growth.

While poor monetary policy may have caused the problem, correcting those policies is unlikely to rectify it. The genie has escaped from the bottle. The only viable solution now seems to be fiscal policy, with massive infrastructure investment to restore GDP growth. That may seem counter-intuitive as it means fighting fire with fire, increasing public debt in order to remedy ballooning private debt.

Rising public debt is only sustainable if invested in productive infrastructure that yields market-related returns. Not in sports stadiums and public libraries. Difficult as this may be to achieve — with politicians poor history of selecting projects based on their ability to garner votes rather than economic criteria — it is our best bet. What is required is bi-partisan selection of projects and of private partners to construct and maintain the infrastructure. And private partners with enough skin in the game to enforce market discipline. I have discussed this at length in earlier posts.

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S&P 500 looks promising

The inverted fish hook on the S&P 500 looks promising, with a strong blue candle reversing most of Friday’s losses. Completion of an inverted fish hook (normally called an inverted scallop but I find the former more descriptive) requires a breakout above 2190/2200. Completion of the pattern would offer a strong bull signal with a target of 2400, calculated from the base of the pattern at 2000*.

S&P 500 Index

* Target calculation: 2200 + ( 2200 – 2000 ) = 2400

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Gold finds support

Spot Gold found support at $1325/ounce after retracing from resistance at $1350. Short candles suggest weak selling pressure. Respect of support at $1325 would signal another test of the July high at $1375. Follow-through above $1350 would confirm. Breakout above $1375 would offer a target of $1450* but expect strong resistance if the Fed appears intent on raising interest rates. Breach of support at $1300 is unlikely but would warn of a test of primary support at $1200/ounce.

Spot Gold

* Target calculation: 1375 + ( 1375 – 1300 ) = 1450

In Australia the All Ordinaries Gold Index ($XGD) is testing support at 4500. Respect is likely and would signal a test of the recent highs around 5600. A weakening Australian Dollar/US Dollar would tend to mitigate the impact of a fed rate hike. Breach of 4500 is unlikely but would warn of trend reversal.

All Ordinaries Gold Index $XGD

* Target calculation: 5500 + ( 5500 – 4500 ) = 6500

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US weekly earnings slow

The Institute for Supply Management updated their Non-Manufacturing Index on September 6th:

In August, the NMI® registered 51.4 percent, a decrease of 4.1 percentage points when compared to July’s reading of 55.5 percent, indicating continued growth in the non-manufacturing sector for the 79th consecutive month. A reading above 50 percent indicates the non-manufacturing sector economy is generally expanding; below 50 percent indicates the non-manufacturing sector is generally contracting……

But there is weakness in Manufacturing, as the ISM reported last week :

Manufacturing contracted in August as the PMI® registered 49.4 percent, a decrease of 3.2 percentage points from the July reading of 52.6 percent, indicating contraction in manufacturing for the first time since February 2016 when the PMI registered 49.5. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting…..

A 10-year graph of Manufacturing PMI shows that whipsaws around the 50 level are fairly common and not cause for alarm. A decline below the December 2015 low of 48.0, however, would be cause for concern.

Manufacturing PMI

Source: quandl.com

Of greater concern is the declining growth of estimated weekly employee earnings which closely follows GDP. Weekly employee earnings — estimated by multiplying Total Non-farm Payrolls by Average Weekly Hours (Total Private) and Average Hourly Earnings — have held around the 4.0 percent level since early 2014 but are now tracking the decline of GDP. Further falls in Nominal GDP, below 2.43% p.a. in the second quarter, now appear likely.

Estimated Weekly Employee Earnings

Source: FRED/ US Bureau of Labor Statistics

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Gold steady as rates fall

Interest rates retreated this week, with 10-year Treasury yields falling below support at 1.60 percent.

10-year Treasury Yield

Falling interest rates reduce downward pressure on gold. Spot Gold steadied above support at $1300/ounce. Momentum above zero continues to indicate a primary up-trend. Respect of support at $1300 would confirm. Breach of support is unlikely but would signal trend weakness and a test of primary support at $1200/ounce.

Spot Gold

* Target calculation: 1300 + ( 1300 – 1050 ) = 1550

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Gold, rising interest rates and the falling Yuan

Interest rates are rising. Upward breakout from an ascending triangle formation on 10-year Treasury yields indicates an up-trend.

10-year Treasury Yield

A rate hike from the Fed would increase pressure on the Chinese Yuan, leaving the PBOC with a dilemma. Either allow the Yuan to slide, which could panic investors and borrowers into a rout, or sell off more of its $3.2 trillion foreign exchange reserves to slow Dollar appreciation against the Yuan.

USDCNY

Long tails on USDCNY indicate buying at the 6.60 support level. Breakout above 6.70 would warn of another advance (decline for the Yuan).

Rising interest rates increase downward pressure on gold but a falling Yuan would boost demand as a store of value. Spot Gold is above the rising trendline on a weekly chart but expect a test of support at $1300/ounce. Momentum holding above zero continues to indicate a healthy primary up-trend. Respect of support at $1300 would confirm. Breach of support remains unlikely but would signal trend weakness and a test of primary support at $1200.

Spot Gold

* Target calculation: 1300 + ( 1300 – 1050 ) = 1550

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How to Counter the Putin Playbook | The New York Times

Michael A. McFaul, director of the Freeman Spogli Institute and a senior fellow at the Hoover Institution, both at Stanford, served as United States ambassador to the Russian Federation from 2012 to 2014:

…We will not find security in isolationism. No missile defense shield, cybersecurity program, tariff or border wall can protect us if we disengage. Menacing autocracies, illiberal ideas, and antidemocratic and terrorist movements will not just leave us alone or wither away. The threats will grow and eventually endanger our peace, as we saw in Europe and Japan in the 1930s, and Afghanistan in the 1990s.

Conversely, the growth of democracy around the world serves American interests. Democracies do not threaten us; autocracies do. Democratic allies also vote with us at the United Nations, go to war with us, support international treaties and norms, and stand with us against tyranny.

So we must push back, in new ways. Just as the Kremlin has become more sophisticated at exporting its ideas and supporting its friends, so must we.

We should think of advancing democratic ideas abroad primarily as an educational project, almost never as a military campaign. Universities, books and websites are the best tools, not the 82nd Airborne. The United States can expand resources for learning about democracy……

I agree with the sentiment but not the execution. Win friends by promoting education and building infrastructure abroad. These have practical, tangible benefits to citizens of developing nations. Democracy can come later. In many parts of the world it is as foreign a concept as gay marriage.

Source: How to Counter the Putin Playbook – The New York Times

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Defensive PE at a dangerous high

Low interest rates and the accompanying search for yield have driven the forward Price-Earnings ratio for Defensives to a 20-year high. This is likely to reverse when (not if) rates eventually rise. Cyclicals and Growth, however, still look reasonable.

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