Friday, January 30, 2015

The Real Sarah Palin Steps Forward and Goes Off Script

Given that it looks like the 2016 Presidential race is starting to heat up, at least from the Republican perspective, I thought that a brief look at the recent musings from a 2008 GOP candidate was in order.

Let's open this posting with a quote from Ms. Palin at CPAC 2013 when her teleprompter seemed to be functioning:

While many of America's politicians are reliant on teleprompters to keep them on message, a performance by Sarah Palin at the recent Iowa Freedom Summit gives us a prime example of how badly things can go wrong when a teleprompter fails:

In case you don't really care to listen to her entire speech, Ms. Palin's "free association" really hits its stride around the 26 and 28 minute marks.  This performance begs the question "What would come out of the mouths of politicians if they weren't supplied with an ample inventory of talking points?".

Here's what Palin-fan Byron York had to say about the 2016 Presidential race and its "Palin problem" and her performance at the Freedom Summit:

"First, Palin embarked on an extended stream-of-consciousness complaint about media coverage of her decision to run in a half-marathon race in Storm Lake, Iowa in 2011. She then moved on to grumbling about coverage of a recent photo of her with a supporter who had made a sign saying "Fuc_ you Michael Moore" in reaction to the left-wing moviemaker's criticism of the film "American Sniper." Then it was on to Palin's objections about the social media ruckus over a picture of her six-year-old son Trig standing on the family's Labrador Retriever.

It was all quite petty, and yet the complaining took half of Palin's allotted time. She then proceeded to blow through her time limit with a free-association ramble on Barack Obama, Hillary Clinton, the energy industry, her daughter Bristol, Margaret Thatcher, middle-class economics — "the man can only ride ya when your back is bent" — women in politics, and much more. It would be hard to say that Palin's 35-minute talk had a theme, but she did hint that she is interested in running, although there are no indications she has taken any actual steps in that direction.

"Long and disjointed," said one social conservative activist when asked for reaction. "A weird speech," said another conservative activist. "Terrible. Didn't make any sense."

"There was a certain coarseness to her that wasn't there before," said yet another social conservative who noted that some in the crowd were uncomfortable with Palin declarations like, "Screw the left in Hollywood!" (It's not that they like the left in Hollywood — just the opposite — but the crudeness of Palin's expressions turned them off.)

...By the time Palin finished speaking, it was hard for anyone to believe she truly is "seriously interested" in running for president."

Let's hope that Mr. York is right and that we don't get a rerun of 2008.

The Long Decline in Per Capita GDP Growth

While economic growth in the United States is looking fairly robust as shown on this graph: fact, if we look at GDP corrected for inflation and on a per capita basis, it is quite clear that the economy has not really done all that well since the end of the Great Recession.

Here is a graph from FRED that shows real domestic growth per capita since 1948:

You will notice that there was a significant drop in real per capita GDP during the Great Recession, in fact, per capita real GDP dropped from a peak of $49,506 in the third quarter of 2007 to a low of $46,781 in the second quarter of 2009, a drop of 5.5 percent.  Since then, it has recovered to $50,805 in the third quarter of 2014, the latest quarter for which data is available.  This works out to an increase of 8.6 percent from the 2009 low point.

While this looks relatively healthy, there is another way to look at the data.  Since the standard measure of GDP in the United States is expressed as the compounded annual rate of change from one quarter to the next, let's look at the per capita real GDP in those terms as shown on this graph from FRED:

When we look at economic growth in these terms, the latest recovery certainly doesn't look quite as healthy as it did after previous recessions.    

Here is a table that provides the average compounded annual rate of change of per capita real GDP for each of the periods between recessions since 1961:

Here is the same data in graphic form:

It is interesting to note that after each recession since the recession of 1974, the per capita annual growth rate of real GDP has dropped, hitting a multi-decade low since the Great Recession.  This quite clearly shows us that United States economic growth rates have been slowing for decades.

While we are all aware that GDP data is one of the most heavily revised lagging indicators, a brief look at the history of GDP per capita shows us that this recovery has been far more modest than any recovery in the past five decades, no matter how often the data is revised. 

Thursday, January 29, 2015

Negative Interest Rates - A New Reality Coming Soon to a Federal Reserve Near You?

Updated September 2015

The very concept of negative interest rates seems counterintuitive.  After all, why would you pay someone to hold your money for you?  It intrinsically seems wrong (even though we're already doing it by paying banks monthly fees for various services).

The new reality of negative interest rates came home to roost when Switzerland's central bank moved to unpeg the Swiss franc from the euro.  While that move roiled the markets, the SNB's announcement that it was dropping interest rates further into negative territory on deposits to minus 0.75 percent.  On top of that, effective January 20th, Denmark's central bank announced that it was joining the negative interest rate crowd by lowering the rate on certificates of deposit to minus 0.20 percent.  The central banks of both of these countries made the move further into negative interest territory in a move to prevent their currencies from appreciating any further against the euro.  In both cases, intervention in the currency market through the purchasing of euros with both Danish kroner and Swiss francs had failed to stem the flow of euros into both nations.  Why would both Denmark and Switzerland be so concerned about the strength of their currencies, particularly against the euro?  In both nations, their major trading partner is Europe.  When their exports to Europe become too expensive because of the high value of both the kroner and the franc, their economies will suffer.  On top of that, it will be cheaper for Danes and Swiss consumers to import/buy goods from Europe since the euro is relatively cheap, again, negatively impacting the local economy. 

Now, let's look a bit more deeply at the entire concept of negative interest rates.  An interesting paper on negative interest rates was published by the Federal Reserve Bank of New York back in August 2012.  The paper entitled "If Interest Rates Go Negative....Or, Be Careful What You Wish For" by Kenneth Gorbade and Jamie McAndrews provides us with an interesting examination of what happens when interest rates go sub-zero.  Here is a summary.

To set the stage, we first have to look at banking system reserves and excess reserves that are held by the Federal Reserve.  Right now, the Federal Reserve actually pays the banking system 0.25 percent interest to keep excess reserves on deposit with the Fed.  This experimental monetary policy came to life in 2008 as part of the Emergency Economic Stabilization Act of 2008, the Act that famously bailed out the entire U.S. financial system.  The logic behind this decision is quoted here:

"The payment of interest on excess reserves will permit the Federal Reserve to expand its balance sheet as necessary to provide the liquidity necessary to support financial stability while implementing the monetary policy that is appropriate in light of the System’s macroeconomic objectives of maximum employment and price stability."

The Fed also believes that it can change the interest rate on excess reserves, an action that will provide it with an important "exit strategy tool" when it begins to remove monetary stimulus."

In the year prior to the Great Contraction (i.e. 2007), required banking system reserves averaged $43 billion while excess reserves averaged a measly $1.9 billion.  This relationship had been pretty consistent over the previous fifty years, however, in general, excess reserves were less than 10 percent of total reserve holdings because depository institutions had an incentive to minimize excess reserves since they earned no interest.  As I noted above, all of that changed in September 2008 when the Fed began to pay interest on excess reserves.  These actions by the Fed caused this to happen:

So, why did the banking system send trillions of dollars to be stored in the Fed's vaults, figuratively speaking, of course.  Because, there is NO risk to having the Fed hold your money and, as an added bonus, the banking system makes 25 basis points in income for its trouble along with avoiding lending the money to those pesky consumers who might default on their loans!    

Let's go back to negative interest rates and the paper in question.   The authors of the paper suggest that, if economic conditions required, the Fed could push interest rates in the broader economy into negative territory by charging interest on excess bank reserves.  By taking this step, which is similar to that taken by Switzerland and Denmark, other interest rates would follow in lockstep.

Now, let's look at the impact of negative impact on the economy.  The authors suggest that negative interest rates greater than 0.50 percent would have a significant impact on the financial system.  For instance, while small retail investors may prefer to hold at least some cash rather than deposit money in a bank account to avoid a negative interest rate charge, wealthy individuals, corporations and governments would find this to be logistically impossible since storing millions or billions of dollars worth of currency would be both costly and provide a significant security risk.

Here are some of the authors' projections about might occur in a negative interest rate environment:

1.) As the number of individuals who wish to hold physical cash grows, the United States Treasury Department will be forced to print more currency.  

2.) In the case of larger amounts, financial innovations would likely occur with the formation of special purpose bank accounts that offer conventional checking services for a fee by pledge to hold no assets but cash.

3.) Interest avoidance strategies would emerge.  For instance, a taxpayer could make large excess payments on their individual income tax and property tax filings.  In the case of federal taxes, taxpayers would allow the IRS to hold their money and refund the excess the following April.  As well, holders of credit cards could make a large advance payment and then run down the balance with subsequent purchases.

4.) As interest rates become more negative, consumers and businesses will have increasing incentive to make payments quickly and receive payments slowly, changes that would also likely spawn financial innovation.  This is in sharp contrast to the reality that most of us have grown up with, particularly in the late-1970s when spiralling short-term interest rates created a situation where consumers and businesses wanted to delay making payments for as long as possible and collect payments as quickly as possible. 

The existence of negative interest rates will also impact the accounting profession.  It is interesting to observe that the International Financial Reporting Standards Foundation (IFRS), a non-profit account organization that develops and promotes financial reporting standards, has already recognized that negative interest rates are having a significant impact in the "...presentation of income and expenses in the statement of comprehensive income.".  Interest resulting from a negative effective interest rate on a financial asset does not meet the definition of interest revenue because it reflects an outflow rather than an inflow of economic benefits.  It is also not an interest expense because it arises on a financial asset rather than a financial liability.  Obviously, the change to a negative interest rate environment will make a lot of accountants and tax lawyers very, very wealthy as their clients scramble to understand their new reality.

While the U.S. economy is showing some signs of strength, it is also definitely not as healthy as it could be, particularly when we look at long-term unemployed, declining workforce participation rate, growing debt levels and overly elevated real estate valuations in some markets (particularly parts of California) among others.  With interest rates at the zero bound, the Fed is running short of ammunition to stimulate the economy if should happen to slow down again, a scenario that is not all that unlikely given the slowing in both Europe and the Far East.  As well, if the United States dollar continues to appreciate as investors flee to the "currency of last resort" in growing numbers, the Fed may be forced to act to push the value of the dollar down as is the case in Denmark and Switzerland.  

As it looks now, the Fed faces the option of further bloating its already morbidly obese balance sheet or pushing interest rates into negative territory if it is backed into a policy corner.  Unfortunately, as was true in the case of both quantitative easing and interest rate twisting, the real impact of the negative interest rate experiment is unquantifiable, however, there is one thing that we can say for certain about negative interest rates; never, but never say never.

Wednesday, January 28, 2015

The Illusion of Deleveraging - A Debt Lesson Not Learned

In large part, the negative impact of the Great Recession on the world's economy was amplified by high debt levels among all levels of government and individuals.  One would think that the very painful but necessary lessons about excessive debt accumulation would have been learned, however, a study "Deleveraging: What Deleveraging?" by the International Center for Monetary and Banking Studies (ICBM) and the Centre for Economic Policy Research (CEPR) suggests otherwise.   The study looks at both private and public debt with private debt broken down into its household, non-financial corporate and financial corporate components both prior to and since the Great Recession.

Let's start with this graphic that shows the total world debt, excluding that of the financial sector, as a percentage of global GDP:

Other than a slight slowdown in growth between 2008 and 2009, the growth of debt continues unabated.

Here is a breakdown of the types of global debt in billions of U.S. dollars for developed economies by year:

Here is a breakdown of the types of global debt in billions of U.S. dollars for emerging economies by year:

Prior to 2008, developed economies led the growth in global debt accumulation.  This changed after 2008 with emerging economies, especially China, leading the debt accumulation "parade".  From 2001 to 2013, this is what growth in debt-to-GDP ratios, excluding the financial sector, looked like for the world as well as both developed and emerging economies:

The preceding graphics show us that global debt deleveraging has not taken place since the Great Recession; the global debt-to-GDP ratio has not improved, rather it has risen from 174 percent of GDP in 2008 to 212 percent of GDP in 2013, an increase of 38 percentage points or 21.8 percent.  Leverage in developed markets was 272 percent of GDP and in emerging markets, was 151 percent of GDP at the end of 2013.  If we include the financial sector in debt for developed economies, the debt-to-GDP level rises to a whopping 385 percent, a level that has been more-or-less consistent since 2010.

Here is a table showing global debt as a percentage of GDP excluding financial corporations for the end of 2013 for developed economies:

Debt levels in Japan are stunning, reaching 562 percent of GDP including the financial sector and 411 percent of GDP when the financial sector is excluded.  Total debt levels in the United States reached 362 percent of GDP including the financial sector and 264 percent of GDP when the financial sector is excluded.  Total debt levels in Canada reached 374 percent of GDP including the financial sector and 284 percent of GDP when the financial sector is excluded.

It is interesting to note which nations have the worst levels of household debt.  The Netherlands comes in first place with 126 percent of GDP, Australia comes in second with 110 percent of GDP, Ireland comes in third with 102 percent of GDP and Canada comes in fourth with 94 percent of GDP.  All four are well above the 74 percent average household debt-to-GDP for developed economies.  It is not surprising that both Australia and Canada (and, at one time, Ireland) have some of the world's most over-priced and unaffordable residential real estate, forcing consumers to take on massive debt to purchase even a modest home.

While this table repeats some of the information on the preceding table, it provides us with debt data (excluding the financial sector) from emerging economies:

China, the world's economic driver, has seen its debt level mushroom over the recent years, growing by 72 percentage points

The capacity of the economy to absorb ever-growing levels of debt is highly dependent on economic growth, inflation and real interest rates.  As we've seen since the end of the Great Recession, economic growth has been tepid and some economists feel that the 2008 crisis has created a permanent decline in both the level and growth rate of output.  Headline inflation has been very low meaning that governments can't count on inflation to reduce government debt as they did in the past.  Right now, with central banks turning on the credit taps, households, businesses and governments around the world have been able to avail themselves of an endless supply of credit at interest rates that are negligible compared to the past.  Current real interest rates are slightly above zero on ten year Treasuries, a situation that is quite likely unsustainable over the long-term.

We have to remember that we are almost six years into the latest "recovery".  History since 1945 shows that recessions occur roughly every six years on average.  From the data in this report, it certainly appears that the hard lessons regarding excessive debt that led to great hardships during and after the 2008 recession have been long forgotten and that any perception that the economy  is healthier now because it underwent significant deleveraging over the past six years is merely an illusion.