Podcast: Francis Fukuyama on the importance of good governance [05:23].
It is time we started raising the bar for our own political system.
Why Fixed Investment is Critical to the US Recovery
The financial sector normally acts as a conduit, channeling savings from private investors to the corporate sector. When the conduit works effectively, the injection of demand from corporate Investment is sufficient to offset the ‘leakage’ from demand caused by Savings. Savings patterns alter during a financial crisis, however, with concerned households cutting back on expenditure and using any surplus to pay down debt, rather than depositing with the bank or buying stocks. Household Savings rise but corporate Investment contracts. The resulting ‘leakage’ from demand causes GDP to spiral downward.
When Investment contracts, unemployment rises. The relationship is evident on the graph below, but it could also be said that Investment rises when employment grows — businesses invest in anticipation of rising demand. Either way, it is safe to conclude that rising investment and job growth go hand-in-hand.
Fixed Investment and Corporate Profits
Rising corporate profits also lead to increased investment. The lag on the graph below — investment growth follows profit growth — clearly illustrates the causative relationship.
This is an encouraging sign, as the current surge in corporate profits is likely to be followed by rising investment — and further job growth.
Weekly Earnings and GDP
Rising weekly earnings already point to improving aggregate demand and consequent investment growth.
All that is missing is for the federal government to increase investment in productive* infrastructure to further boost job growth.
*Infrastructure investment needs to generate a sufficient return to repay debt incurred to fund the spending. Something many politicians seem to forget when preoccupied with buying votes for the next election.
RIP ZIRP | PIMCO
From Marc Seidner:
At this point, the evidence is close to overwhelming that the Federal Reserve will embark on a tightening cycle this year. The base case for markets should be a move in September. While the pace of tightening should be very shallow and the ultimate destination for interest rates considerably lower than historical experience, investors should not underestimate the potential volatility emanating from the first interest rate increase in nine years and the first move off of the zero bound in six years….
Read more at RIP ZIRP | PIMCO Blog.
How much longer can the global trading system last? | Michael Pettis
Michael Pettis quotes a Brazilian economist on the dilemna facing the US:
….As the US becomes a declining share of the globalized world, the costs of imposing stability (and I have no illusions that this is done for charity) rise, and its share of the benefits decline. It is only a matter of arithmetic that at some point the costs will exceed the benefits.
Pettis describes how other countries have gamed the system – notably Germany and France in the 1960s, Japan in the 1980s, and China in the 2000s – and argues that the costs to the US already outweigh the benefits.
….Many economists may disagree with me that the costs of the current role the US plays in the global trade regime exceeds the benefits, but the point of this essay is to show that even if I am wrong, as long as the world grows faster than the US, more of the world is incorporated into the global trading system, and more countries design growth models that suppress domestic consumption in order to subsidize domestic growth, there must of necessity be a point at which it makes sense for the US to opt out of its role as shock absorber, and – by raising tariffs, intervening actively in the currency, restricting foreign purchases of US assets and especially US government bonds, or otherwise reducing capital inflows – become simply one more member of a system with no automatic adjustment process.
The current system, in other words, is inherently unstable and will sooner or later force the US economy into a position of choosing either to take on excessive risk or to abdicate its role as shock absorber….
Sustained current and capital account imbalances are unhealthy except for the few rare instances where capital-rich economies invest or loan money to a capital-poor recipient. In most cases capital is used to purchase secure Treasury investments in the US in order to offset a domestic current account surplus. This has a destabilizing effect not only on the US economy, which has shed millions of manufacturing jobs and created a housing bubble of epic proportions, but on the global economy as a whole, destroying any benefit to the perpetrator.
Read more at How much longer can the global trading system last? | Michael Pettis' CHINA FINANCIAL MARKETS.
Gold breaks $1180 support
Core CPI continues to track close to the Fed target of 2.0 percent (CPI All Items is distorted by falling oil prices).
Long-term interest rates are in a primary up-trend, with 10-year Treasury note yields breakout above resistance at 2.25% offering a target of 3.0 percent. Rising 13-week Twiggs Momentum above zero strengthens the signal.
The Dollar Index continues to test support at 95. Breach would warn of a test of the primary level (and rising trendline) at 93. A sharp decline on 13-Week Twiggs Momentum indicates this is likely.
Gold
A weakening dollar would boost demand for gold, but rising interest rates counter this. Spot gold broke medium-term support at $1180/ounce, warning of a test of the primary level at $1140. 13-Week Twiggs Momentum peaks below zero suggest continuation of the primary down-trend. Failure of $1140 would offer a long-term target of $1000*.
* Target calculation: 1200 – ( 1400 – 1200 ) = 1000
Australian exports hammered
This chart from Westpac highlights Australia’s export misery:
Iron ore prices are falling faster than shipments are rising. Andrew Hanlan sums up the the problem facing the Australian economy:
A jump in imports coincided with a sharp fall in export earnings. Critically, the rest of the world is paying us considerably less for our key exports, iron ore and coal. This negative shock is squeezing incomes for businesses, households and government alike.
Inflation steady while Gold tests support
CPI continues below zero, but core CPI (excluding food and energy) came in at 1.81% for April 2015, indicating long-term inflationary pressures are constant.
Low inflation relieves upward pressure on bond yields. The yield on 10-year Treasury notes encountered resistance at 2.25%, with tall shadows on the last 3 weekly candles. Expect another retracement to test support at 1.85%. Reversal of 13-week Twiggs Momentum below zero would strengthen the signal.
* Target calculation: 2.25 + ( 2.25 – 1.85 ) = 2.65
The Dollar Index broke resistance at 96 despite falling bond yields, indicating the correction is over and another test of 100 likely. 13-Week Twiggs Momentum is declining, but recovery above the descending trendline would support the (bull) signal. Reversal below 96 is unlikely, but would test support at 93.
Gold
The inflation-adjusted price of gold (gold/CPI) suggests that gold has further to fall. Unusually high levels of intervention by central banks in financial markets may, however, be fueling support at current prices — suggesting a gradual decline rather than a sharp adjustment.
Spot gold is headed for another test of medium-term support at $1180/ounce after respecting resistance at $1220. Breach of support would test the primary level at $1140. 13-Week Twiggs Momentum peaks below zero suggest a primary down-trend. Failure of $1140 would test the long-term target of $1000*.
* Target calculation: 1200 – ( 1400 – 1200 ) = 1000
Liquidity Mismatch Helps Predict Bank Failure and Distress
Liquidity mismatch compares the saleability (liquidity) of a bank’s assets to the stability of its funding. Assets such as cash and Treasury bonds are highly saleable and one can expect a ready market even in times of crisis. Residential mortgages are less liquid, but still saleable at a discount, while development and construction loans may prove unsaleable at any price when the market is under stress.
In terms of funding, long-term deposits offer stability but are far more expensive than short-term wholesale sources and call deposits. The latter, however, are highly unstable and were instrumental in the collapse of Northern Rock (UK) and Washington Mutual (US) during the global financial crisis (GFC).
The challenge facing bank regulators is to monitor liquidity mismatch to ensure bank health. The more illiquid and speculative the assets are, the more stable (illiquid) the bank’s funding sources must be to avoid a liquidity crisis during a market down-turn.
Liquidity mismatch =
(Liquidity-weighted liabilities – Liquidity-weighted assets) / Total assets
This paper by J.B. Cooke, Christoffer Koch and Anthony Murphy at the Dallas Fed (Liquidity Mismatch Helps Predict Bank Failure and Distress) suggests that large banks suffer from higher levels of liquidity mismatch and that liquidity mismatch is as important as capital ratios in determining bank health:
Precrisis Rise in Mismatch
Liquidity mismatch rose significantly between 2002 and 2007. The median level of mismatch climbed about 6 percentage points. Most of this rise was driven by changes in liquidity-weighted assets rather than liquidity-weighted liabilities. Banks pursued higher returns on riskier, less-liquid assets. To a lesser extent, banks relied less on stable core deposits and more on “unstable” wholesale funding. The rise in liquidity mismatch before the financial crisis is noteworthy because equity capital (as a percentage of assets)—the ultimate buffer against losses—changed little. The rise in mismatch was faster and more persistent at the largest banks, representing the top 25 percent of institutions (Chart 2). Among those banks, the median mismatch rose about 8.5 percentage points between 2002 and 2007, while at the 25 percent representing the smallest banks, the increase was only 3 percentage points.Early-Warning Sign?
Bank regulators look for early-warning signs of distress. Is liquidity mismatch one? Comparing the fourth quarter 2007 mismatch levels of commercial banks that failed or became distressed in 2008 or 2009 with those that did not may provide an indication. The average levels of liquidity mismatch for the two groups were significantly different. Failed or distressed banks generally had much higher levels of liquidity mismatch, as shown by the final entry in the liquidity mismatch row of Table 1.
While the timing of the changes in liquidity mismatch (as seen in Chart 2) and the difference in levels of mismatch at any one time (as seen in Table 1) suggest that liquidity mismatch is important, they do not necessarily imply that a rise in liquidity mismatch helps predict future bank failure or distress. Higher levels of liquidity mismatch may be correlated with lower levels of equity capital and higher proportions of brokered deposits and construction and land development loans as well as with nonperforming assets or lower returns on assets—all well-known predictors of failure or distress.
Modeling Failure and Distress
Statistical models were used to disentangle the effects of changes in liquidity mismatch from the effects of changes in equity capital and the other predictors of bank failure and distress between 2006 and 2011.9 This period was chosen because it followed a time when there were very few failures or cases of distress, the early 2000s. Failure or distress up to two years ahead was considered. For example, fourth quarter 2007 data were used to predict failure or distress any time in 2008.10 The results suggest that recent failure and distress rates are explained or predicted by many of the same factors as in 1985–92, when large numbers of commercial banks and savings and loans failed. These factors include too little equity capital, a high ratio of nonperforming assets and a high share of construction and land development lending……Liquidity Mismatch Matters
Liquidity mismatch rose significantly before the financial crisis, especially at large banks, our research shows. The rise in mismatch contributed to the rise in bank failures and cases of distress. Liquidity mismatch helps predict bank failure or distress one year ahead, even accounting for equity capital and the other indicators at which regulators look.
Cooke is an economic analyst, Koch is a research economist and Murphy is an economic policy advisor and senior economist in the Research Department of the Federal Reserve Bank of Dallas.
Hat tip to Barry Ritholz.
China: Cement Production
Whoops. Try again. Chinese cement production. (From Capital Economics this AM) pic.twitter.com/k5W7pdRR2c
— A Evans-Pritchard (@AmbroseEP) May 13, 2015
Lowest cement production in more than 10 years reflects the decline in infrastructure investment. Not good news for Australian resources stocks. Where cement production goes, iron ore and coal are likely to follow.
US GDP: Where is it headed?
I originally got this from Matt Busigin (I think). Average Hourly Earnings multiplied by Average Weekly Hours (Total Private: Nonfarm) gives a pretty good indication of where GDP is headed, well ahead of the BEA accounts.
Remember this is nominal GDP, so the latest (April 2015) figure of 4.38% would need to be adjusted for inflation. Inflation is somewhere between 0.5% and 1.75% depending on how you measure it. The GDP deflator looks like it will come in below 1.0% which would leave us with real GDP of at least 3.38% p.a.
