Flashman Letters

Pettis: "Abenomics Likely to Fail in Medium Term, Debt Matters"

http://globaleconomicanalysis.blogspot.com.es/2013/10/pettis-abenomics-likely-to-fail-in.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed:+MishsGlobalEconomicTrendAnalysis+ (Mish's+Global+Economic+Trend+Analysis)

Japan’s enormous debt burden was manageable as long as GDP growth rates were close to zero because this allowed both for the country to rebalance its economy and for Tokyo to make the negligible debt servicing payments even as it was effectively capitalizing part of its debt servicing cost. If Japan starts to grow, however, it can no longer do so. Unless it is willing to privatize assets and pay down the debt, or to impose very heavy taxes of the business sector, one way or the other it will either face serious debt constraints or it will begin to rebalance the economy once again away from consumption.

As this happens Japan’s saving rate will inexorably creep up, and unless investment can grow just as consistently, Japan will require ever larger current account surpluses in order to resolve the excess of its production over its domestic demand. If it has trouble running large current account surpluses, as I expect in a world struggling with too much capacity and too little demand, Abenomics is likely to fail in the medium term.

Perhaps all I am saying with this analysis is that debt matters, even if it is possible to pretend for many years that it doesn’t (and this pretense was made possible by the implicit capitalization of debt-servicing costs). Japan never really wrote down all or even most of its investment misallocation of the 1980s and simply rolled it forward in the form of rising government debt. For a long time it was able to service this growing debt burden by keeping interest rates very low as a response to very slow growth and by effectively capitalizing interest payments, but if Abenomics is “successful”, ironically, it will no longer be able to play this game. Unless Japan moves quickly to pay down debt, perhaps by privatizing government assets, Abenomics, in that case, will be derailed by its own success.

Earnings Growth to Ramp Up? Call Me a Skeptic - Click to link - Interesting throughout.

What all of this boils down to is that current consensus earnings estimates are high and they need to come down - and come down quite a bit. I don't subscribe to the view held by some stock market bears that earnings growth will turn negative. But I don't buy into the perennial growth story either.

So what's the big deal if estimates for Q4 come down in the coming days and weeks? After all, estimates have been coming down consistently for more than a year and the stock market has not only ignored the earnings downtrend, but actually scaled new heights.

A big reason for investors' disregard of negative estimate revisions has been that they always looked forward to a growth ramp up down the road. In their drive to push stocks to all-time highs in the recent past, investors have been hoping for substantial growth to eventually resume. The starting point of this expected growth ramp-up kept getting delayed quarter after quarter. The hope currently is that Q4 will be the starting point of such growth.

Guidance has overwhelmingly been negative over the last few quarters. But if current Q4 expectations have to hold, then we will need to see a change on the guidance front; we need to see more companies either guide higher or reaffirm current consensus expectations. Anything short of that will result in a replay of the by-now familiar negative estimate revisions trend that we have been seeing in recent quarters.

Will investors delay the hoped-for earnings growth recovery again this time or finally realize that the period of double-digit earnings growth is perhaps behind us for good? Hard to tell at this stage, but we will find out soon enough.

My sense is that markets can buck trends in aggregate earnings for some time, as they have been doing lately. But expecting the trend to continue indefinitely may not be realistic.

via www.mauldineconomics.com

Austin Frakt on US Healthcare Reform

http://fivebooks.com/interviews/austin-frakt-on-us-healthcare-reform

There are many reasons why US health spending is so high – and why we allow it to be high. One of the main lines of Paul Starr’s book The Social Transformation of American Medicine is that physicians have, over many decades, amassed considerable power over the policies that have been enacted, and they’ve shaped them to their benefit economically. So a lot of money flows to healthcare providers, physicians and hospitals, and also to suppliers of drugs and medical equipment. Those organisations are relatively powerful and they’ve been able to keep it going.

Also, Americans mostly don’t see the prices. Because of insurance, they don’t directly feel how expensive it is when they enter the system in any way – whether it’s a visit to a physician or a visit to a hospital. Worse than that, they mostly don’t even see the price of insurance directly. The vast majority of Americans have employer-based health insurance and much of the premium is paid by the employer. It doesn’t show up on their pay stub, and it doesn’t appear, to them, to come out of their own pocket – even though actually it does, through lower wages. When you think you’re getting something for free or pretty cheaply – whether it’s the insurance or the healthcare itself – you’re not that motivated to shake things up.

That’s for people who work. Then for retirees, almost all of them are on Medicare, so they’re getting considerable benefit through a public programme. They don’t see why that should change either. So things just keep marching along. We haven’t been able to put in place sustainable cost controls, either publicly or privately, largely because it’s politically difficult to do that.

Did tight money cause the 2006 housing bubble?

But I never actually reversed the argument.  After all, why should tight money lead to bubbles?  Wouldn’t you expect more real estate bubbles during periods when inflation is pushing house prices higher at a rapid rate?  Perhaps, but as Kevin points out it’s real house prices that matter.  Even so, perhaps real house prices might be expected to go up during periods of high inflation, as houses are a sort of inflation hedge.

But Kevin noticed a powerful force pushing the other way.  In America mortgage debt is commonly structured so that monthly payments stay constant over 30 years.  This means that during periods of high NGDP growth, when nominal interest rates are also high, monthly payments will start very high in real terms, and then fall rapidly in real terms.  But your ability to qualify for a house depends on how large the initial nominal monthly payment is, relative to your current income.

This means that average people will have much more difficult time qualifying for a mortgage when both nominal GDP growth and nominal interest rates are relatively high. As a result, real estate “bubbles” are more likely to occur during periods when nominal interest rates are relatively low and average people find it easier to qualify for mortgage loans. I initially missed this point because I focused too much on the Fisher effect and not enough on the strange practice in America of structuring mortgage payments in nominal terms.

In this blog I frequently focused on two types of money illusion, downward wage rigidity and nominal debt. Sticky wages lead to unemployment when nominal GDP falls. Nominal debt leads to debt crises when nominal GDP falls. And now we have a third, monthly mortgage payments that are stable in nominal terms lead to real estate booms when nominal interest rates are relatively low. And of course nominal interest rates are relatively low when nominal GDP is relatively low. And of course slow nominal GDP growth is an indication of tight money.

via www.themoneyillusion.com

Is a currency crisis bad for you at the ZLB?

The second direction is to focus on the short run costs of the nominal depreciation. Some of those who commented on my original post talked about a ‘downward spiral’ in sterling. Now of course the depreciation itself may raise inflation to some extent, but this is not an unstable process. At some point sterling falls to a point where the market now thinks it is OK to hold. There is no bottomless pit.

As domestic prices are sticky, the depreciation increases UK competitiveness, which increases the demand for UK goods. If the Zero Lower Bound (ZLB) is a constraint, then this increase in demand reduces or eliminates the constraint. It may also raise inflation because demand is higher, but higher demand is what monetary policy wanted but was unable to achieve. If the depreciation is so large that demand has to be reduced through increasing interest rates, that is fine: this is what monetary policy is for. In essence the ZLB is a welfare reducing constraint that the crisis relieves, and we are all better off.

If that sounds too good to be true, I think it could be. It treats the depreciation as simply a positive demand shock, that first eliminates the cost of the ZLB, and then can be offset by monetary policy. However a sterling crisis may also involve a deterioration in the output/inflation trade-off: equivalent to what macroeconomists call a cost-push shock. Take a basic Phillips curve. If agents start to believe inflation will be higher - even if these beliefs are incorrect (the crisis, and QE, is temporary) - while these mistaken expectations last this is a cost to the economy, because the central bank will have to raise interest rates to prevent these expectations fully feeding through into actual inflation. Either output will be lower, or inflation higher, or both.

Now as long as interest rates stay at zero, this is not a problem: the ZLB constraint still dominates. [1] However if the crisis was big enough, we could overshoot Brad DeLong’s sweet spot, and end up living with a cost-push shock that was more costly than the ZLB constraint. Personally I think this is stretching non-linearities rather too much. First you have to believe that austerity, which reduces debt a bit more quickly than otherwise, is just enough to prevent a crisis, and then that the crisis is so big that it more than offsets the ZLB constraint. Unlikely, but it seems to be a coherent possibility.

via mainlymacro.blogspot.com.es

How Mexico is upending the U.S. auto industry

That's one upshot of a new report on the auto industry from the Brookings Institution. The report is ostensibly a case study focused on Tennessee's automotive sector, but it also offers a glimpse of the way the entire North American auto industry has shifted over the last 20 years.

The big story here is Mexico, which has massively expanded its share of North American auto manufacturing since the North American Free Trade Agreement (NAFTA) in 1994. Automakers from GM to Nissan have been opening plants south of the border, attracted by Mexico's low wages and dense industrial clusters:

In 2012, Mexico produced more than 3 million vehicles, compared with 10.8 million in the United States. Automotive plants in Mexico assemble everything from GM Silverado pickups to Chrysler engines. Nissan, Mazda and Audi are all building plants in the country. And jobs have followed.

Since 2000, overall auto industry employment in North America has fallen from 2 million to 1.5 million — partly because more and more positions have been automated. But Mexico actually added jobs in that time, going from 554,000 to 579,000. Today, nearly 40 percent of auto jobs on the continent are in Mexico. (More detailed numbers here.)

And that trend is expected to continue. "Over the next decade, the U.S. share of auto employment is likely to drift down below 50 percent," says Mark Muro, one of the co-authors of the Brookings report.

via www.washingtonpost.com

Abenomics might eat itself, a Pettis production

http://ftalphaville.ft.com/2013/10/21/1668282/abenomics-might-eat-itself-a-pettis-production/

What matters, I think, is that in order to generate growth Tokyo is planning to implement polices aimed at raising both inflation and real GDP, and these policies are likely to force up the national savings rate relative to investment.

What is more, to the extent that these policies are successful in generating higher nominal GDP growth, they create a problem for Tokyo in how it decides to set domestic interest rates. Japan has never really resolved the overinvestment orgy of the 1980s. Instead of writing down bad debt it effectively transferred much of it to the government balance sheet, and now this huge debt burden is itself becoming, I think, a constraint on the success of policies designed by Tokyo to spur growth.

The argument for why there hasn’t been a Japanese sovereign debt crisis are pretty well known and are also a large part of why Pettis thinks Tokyo is so eager to engage in polices that force up the Japanese savings rate — as Citi put it recently “so long as the current account is in surplus, the marginal purchaser of new JGBs issued by the sovereign can always be a domestic buyer.” The Bank of Japan now aggressively included.

That’s why the problem most people foresee is that Japan’s current account turns negative. From Citi’s Buiter and Rahbari:

As Japan continues to age rapidly, its household saving rate will continue to decline. It is possible, but not likely, in our view, that the corporate saving rate will continue to rise to offset this…

At the point where Japan becomes a persistent current account deficit country, the marginal purchaser of newly issued Japanese securities is less likely to be a domestic investor. It is quite plausible that yields on Japanese securities, including but not limited to Japanese government bonds, could rise quickly and sharply once the marginal purchaser is a foreigner.

Frankly, while that only underlines scepticism about how realistic a longer-term current account surplus is, we lack the tools to balance the ongoing demographic shift with Japan’s desire to generate growth by structurally forcing up its savings — or to put it another way, growing at the expense of its trading partners who might fight back anyway — and it doesn’t seem too silly to cover one’s bases here.

(This might also be a good place to point towards Citi’s aside on the current account and the exchange rate on p38 of their note. In summary: “The notion that any sharp depreciation of the real exchange rate, regardless of what causes it, is necessarily accompanied by an increase in the trade balance surplus or current account surplus is theoretically suspect… even the data don’t speak clearly – they barely whisper.”)

That said, we should push on and note that Pettis is increasingly wary of Japan’s nominal interest rate and worries that as it rises debt servicing is going to get a lot more difficult as “the real cost of servicing the debt during each payment period consists [then] of interest plus some real principal.”

Martin Wolf on the Contained Depression - click to link for an hour and a half of gloom

http://www.nakedcapitalism.com/2013/10/martin-wolf-on-the-contained-depression.html

‘And what we had was a situation in which the emerging world as a whole became huge net creditors of the developed world. We borrowed all this money – and we threw it away. Very very simple. Colossal wastage of this capital. And now they want their money back. And the answer of course is that they will get it back, in depreciated dollars.’

41.03
‘My basic rule is when the government tells you there is nothing to worry about, the thing you do is you take your money out.’

41.50
‘The Eurozone was created and the net flows across the Eurozone just exploded. And Germany was the dominant creditor. It went actually from a small deficit to a gigantic surplus, it’s the second largest surplus country in the world, by the way. And then there are a few other surplus countries of which the most important is the Netherlands. And down below you get these absolutely enormous deficits, by far the most important was Spain. But a number of countries, Spain, Portugal, Greece are the most important were running current account deficits of 10% of GDP for roughly a decade, their net external positions went to about 110-120% of GDP and all this stuff was invested wisely and sensibly in in overpriced houses. It is not surprising that we ended up in a very very large mess.’

47.36
(of nations in Eurozone with net government debt of more than 100%) ‘And they are all going to default. We just don’t know when.’

Why Do Airlines Continue to Shrink Seats?

http://www.concurringopinions.com/archives/2013/10/why-do-airlines-continue-to-shrink-seats.html

Airlines are shrinking economy class seats again, and they’ll achieve some efficiencies by doing so. But let’s not forget another key reason why the back of the plane becomes ever more like a cattleyard as the front transmogrifies into a luxury hotel:

It is not because of the few thousand francs which would have to be spent to put a roof over the third-class carriages or to upholster the third-class seats that some company or other has open carriages with wooden benches . . . . What the company is trying to do is to prevent the passengers who can pay the second-class fare from travelling third class; it hits the poor, not because it wants to hurt them, but to frighten the rich . . . . And it is again for the same reason that the companies, having proved almost cruel to third-class passengers and mean to the second-class ones, become lavish in dealing with first-class passengers. Having refused the poor what is necessary, they give the rich what is superfluous.

Americans Have Lost VIRTUALLY ALL of Our Constitutional Rights

http://www.ritholtz.com/blog/2013/10/americans-have-lost-virtually-all-of-our-constitutional-rights/?utm_source=dlvr.it&utm_medium=twitter

This post explains the liberties guaranteed in the Bill of Rights – the first 10 amendments to the United States Constitution – and provides a scorecard on the extent of the loss of each right. (This is an updated version of an essay we wrote in February. Unfortunately, a lot of information has come out since then.)