Thursday, September 20, 2012

Plutocratic Capital Flows: London Real Estate edition

I emphasized in a previous post that Wealth does not trickle down and much of the capital sloshing unproductively around the globe is going towards real estate purchases for the plutocrats as opposed to a sustainable growth. {For a less than charitable look at the (tongue firmly in cheek) "challenges" facing global plutocracy see Pathos of the Plutocrat (Krugman, 2012).}

It is unarguably a given that real estate affordability in places such as Manhattan and Central London is well beyond the reach of most citizens of the United States and United Kingdom respectively. But then the obvious question arises: who can afford such real estate and who is buying it? The expansion of shops such as Sotheby's International Realty is obviously a strong signal the demand exists and now research from Jones Lang LaSalle has been highlighted by John Authers in today's Financial Times. (bold emphasis mine) to show what foreign demand for purchases in Central London entails:
To be clear about what the chart shows, it covers all new developments, including two-bedroom flats or purpose-built estates, and not just new prime developments. Developers currently find that they can sell such developments “off plan” to buyers in south-east Asia who do not even need to take a look at the property first. The implications are that there is sufficient external demand to soak up a lot of extra supply, should it come on tap, and that the London property market is vulnerable to events in Asia, as well as in the Middle East and Europe. 

It should be no surprise that the majority of purchases (and by extension demand) is from Asia as the greatest increase in "ultra high net worth" individuals is from that region
Is this growth in the price of "Core prime" property sustainable? 
Capital flowing to the cosmopolitan safe haven that is "Prime Central London"

As Jones Lang Lasalle notes in their executive summary of Global capital flows Q2 2012:
London remains the world’s most coveted city, with foreign investment accounting for 75% of all transactions. Paris, New York and Tokyo also held strong appeal for global investors.

But flows of excess unproductive capital can be fleeting and prone to mass exits: it has happened before and --like the tides-- will happen again. Market appreciation at the high end of value chain has an annoying habit of making affordability difficult for the middle classes who embrace the idea of home ownership as a raison d'etre for what constitutes "a good life".

Moreover, with central banks en masse embracing easy money policies (such as QE3) in order to reflate assets, encourage mortgage borrowing via a flatter term structure and open the putative confidence channels in the hope that there will be greater consumption by an already indebted household sector, the ingredients are there for a new asset crash down the road that will (again) be international rather then local in scope with a potential bursting in Asia creating a domino effect of capital exiting save havens such as Canada and Australia. As (Chancellor, 2011) noted last year 

Spain, Ireland and to a lesser extent the US all witnessed high levels of housing construction during the past decade. These building booms left a terrible wreckage. Both Ireland and Spain ended up with more than a decade’s worth of housing oversupply. It has taken the US five years and counting to absorb excess supply of new homes.

The current property booms in China, Hong Kong and Singapore have much in common with those across southeast Asia in the mid-1990s and in the periphery of Europe in the past decade. In all cases, dollar pegs and a currency union took the control of interest rates away from the local central banks. Low rates inflated property bubbles. Institutionalised prudence did not save Spain. Asian policymakers should take note.

Key Takeaways: 

  • The global plutocracy has more capital than it collectively knows what to do with.
  • Capital flows of the plutocracy continues to create demand for high end real estate in cosmopolitan cities such as London and Manhattan and save havens (e.g. Canada and Australia) provide a venue for assets as well.
  • Central banks pursuing easy money policies are encouraging asset reflation not productive investment and make economies less not more resilient to future shocks.

Authers, J. (2012, September 20). London property iv: south-east asian edition. Financial Times. Retrieved from

Krugman, P. (2012, July 19). Pathos of the plutocrat. New York Times. Retrieved from

Vallikappen , S., & Tong, S. (2012, September 19). Asia’s millionaires increase as economic growth adds wealth. Retrieved from

Jones Lang LaSalle. (n.d.). Global capital flows q2 2012. Retrieved from

Chancellor, E. (2011, September 11). Asia: take note of other property bubbles. Financial Times. Retrieved from


Friday, September 14, 2012

Why are these dealers so optimistic...

...about upward movements in the BOC rate? Perhaps Canada's growth story is a lot stronger than I imagine or perhaps there is an underlying tendency to believe in "rate normalization" --essentially the idea that central bank rates and inflation plus a premium -- and "equilibrium rates" will return.
If the latter then how about the idea that we are in a new "bad" equilibrium, with a long term secular trend of low rates given the headwinds of household debt crimping consumption, demographics, a challenged financial system, and slower growth in credit in the developed world?
Simple expansion of central bank balance sheets will not create the rise in "core CPI" that central bankers use as a nominal anchor; there certainly is, to paraphrase Kyle Bass, "inflation in the things we need and deflation in the things we own" but not inflation via the wage spiral due to diminished bargaining power of labour. And for those concerned about hyperinflation here is an account of the German hyperinflation of the 1920s available here.

Thursday, September 13, 2012

Growth falters, and inequality grows as capital flows

The opinions reflected in the following post 'Growth falters, and inequality grows as capital flows' are those of the author. Any errors and omissions are the author's alone. 
The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years. (Ben Bernanke's Jackson Hole speech)
It is election time in America. For the lawmakers in Washington D.C., the capital of imperium, the emptiness of rousing rhetoric drowning the discomforting discord of American decline is in high season. 
But the American situation is not isolated; in a slowing world it is but merely a metaphor for what ails many nations: labour market stagnation begetting increasingly greater inequality as financial capital is judge and jury over putatively sovereign domestic fiscal policy. Growth of the sustainable variety built upon a foundation of a rising standard of living and wage growth can be a cure during normal times but it is merely a palliative for these times where growth requires the catalyst of endless easy credit: these times are anything but normal; there are greater forces at work then a mere slowdown of the business cycle.

Former Labor Secretary during the Clinton Administration, Robert Reich, framed it cleverly in an opinion piece for in dissecting the gaping policy holes of both incumbent and challenger after the Republican and Democratic conventions:
But another explanation for why neither candidate has come up with a concrete plan is profound disagreement even among experts about what’s gone wrong, and a paucity of credible ideas for righting it. Keynesians want more government spending but can’t come up with a convincing scenario for what happens after the pump is primed. The big stimulus in 2009 and 2010 had a positive impact but hardly enough to rescue the economy. Some Keynesians call for more spending, but how much more before credit markets begin to scream? Some want the Fed to keep interest rates near zero, but it’s kept them near zero for almost three years – along with two rounds of “quantitative easing” – with little to show for it.
So-called supply-siders want lower taxes and fewer regulations but can’t come up with a convincing argument for why American businesses would hire more workers under those circumstances. After all, much of their current profitability has come from cutting payrolls — either by substituting computers and software or outsourcing the jobs abroad. Why would they hire additional workers, especially when American consumers – whose spending is 70 per cent of the nation’s economic activity – are holding back? Deficit hawks, meanwhile, want to raise taxes and reduce public spending but have no idea how to do this without bringing on another recession as long as private spending remains in the doldrums. And if the economy contracts, the government debt only worsens in proportion. Markets are already spooked by next January’s “fiscal cliff”. 

There is no conventional way out of the current morass: the anodyne prescriptions of the past --from both sides of the political spectrum-- do not provide a convincing prelude to realizing making the "trend" growth of the past generation the same for the future. 
Monetary stimulus --the great hope that underpins our debates from "is QE3 coming" to "will the ECB set a negative deposit rate" has proven ineffective at the zero bound as analysts have been attempting to explain, since 2008, that better times are around the corner thanks to increasing "confidence" and rising "expectations". 
Fiscal stimulus along the lines of similia similibus curanter ("that which can cause can cure") has less potency due to the open nature of advanced economies and the globalization and technological changes (and by extension inequality of opportunity) that underpins it.  Freer markets can indeed create efficiency for many (but certainly not all) goods but it is the openness in factors of production abetted by trade agreements that drives down the size of the fiscal multiplier and drives up the amount of fiscal stimulus required to make a substantive difference; under the current arrangement the power of capital easily trumps labour and diminishing labour power since the 1970s has foreshadowed the inequality of today.

On the one hand, traditional stimulus --both fiscal and monetary-- is tellingly ineffective but on the other hand, fast tracking austerity guarantees depression and is tantamount to fiscal Seppuku. Traditional economic analyses are beholden to 'equilibrium' and, as such, we are -- referencing a (wonkish) paper by Matheus Graselli -- in a "bad equilibrium" with a situation of high debt, low employment and low labour share of wages, as described in the original Goodwin model (modified by Australian economic iconoclast, Steve Keen and) extended by Graselli and Costa Lima. (Graselli and Costa Lima, 2012)

How did it come to this? The system that we have know since the decline of the gold standard backing the U.S. dollar gave way to "dollar hegemony" as the greenback remained the reserve currency -- something that the Greek economist, Yanis Varoufakis, has colourfully framed as "The Global Minotaur":

As Varoufakis writes in his recent book, “The Global Minotaur,” the world in which we have been living until recently functioned thanks to the voracious consumption of a different kind of beast. After World War II, the U.S. built up the infrastructure of its European allies as well as its former enemies, all of whom became trading partners. The U.S., with its great industrial and financial might, became the world’s surplus nation: its profits flowed out to its allies in the form of aid and investments. By the early 1970s, however, other countries had robust economies, and the U.S. was a debtor nation. “At that moment, certain very bright men within the American financial hierarchy made a stunning realization,” Varoufakis told me. The realization was that it didn’t matter if the U.S. was the biggest surplus or biggest debtor nation. What mattered was controlling the world’s primary currency, which would allow the United States to continue to recycle the global economic surplus. The idea was not unlike the thinking behind a casino — whichever gamblers are winning or losing, the house, which sets the terms and takes its cut, always wins.
So a new system came into being, in which a huge part of the world’s capital flows went to service debt originating in the United States. American debt, and the need to feed it, would be the modern Minotaur. The Wall Street financial houses became the handmaidens of the Minotaur. “The massive flow of capital into Wall Street gave it the impetus for financialization,” Varoufakis said, referring to the creation of derivatives and other risky financial vehicles. “And so Wall Street created a great deal of private money, with which it flooded the world and created huge bubbles, in the U.S. housing market and elsewhere.” (Shorto, 2012)
"The Global Minotaur" system is sick and suffered a mortal wound in 2008: it is now acting as a cornered animal wounded to the point of rabidity where financialization now consumes in a parasitic rather than facilitates in a symbiotic fashion, and where speculation trumps productivity in the macroeconomy. Anyone who works in the world of high finance will openly admit that there is no lack of capital --those at the top of the pyramid have fantastic amounts of "surplus capital": portfolio flows globally looking for the highest return and it does so at the push of a keystroke depending on whether the markets are risk averse or risk neutral and across a range of asset classes. The unintended outcome is that laissez faire has led to the accumulation of wealth into fewer and fewer hands and, as outlined in a previous post, Wealth does not trickle down.

But why should we care about the results of a wounded Global Minotaur? Unlike Theseus leading the Athenians out of the labyrinth, the majority of people have nothing but blind folded politicians to guide them from the maze that is the global economy. We need to re-frame the argument into a long term solution that is sustainable but doing so requires looking at some uncomfortable truths: be it rising inequality, growth of non-productive sectors, or the anemic labour market.

Inequality matters
It always has; it is just that we have been too predisposed to notice its importance when it occurs and believe we are immune until it hits us.
This is not advocacy for equality of outcomes: people have different levels of drive, different talents, different motivations. (We are never going to embrace a utopia where we may be idle and spend our leisure time reading poetry and philosophizing). 
Everywhere, there are those who are indolent, but equally those who are industrious.
What nations require is a greater chance of upward mobility for all of their citizens not an increasing likelihood of indigence due to greater structural unemployment thanks to a policy framework that disregards politics and relies on abstractions based on political motivations.
This is advocacy for greater equality of access: to education, public services, healthcare, and opportunity. Without such building blocks the foundation of society withers and no amount of a Burkean "Big Society", as advocated by its adherents, will take its place.

The case against "excessive" equality
An excessively equal income distribution can be bad for economic efficiency. Take, for example, the experience of socialist countries, where deliberately low inequality (with no private profits and minimal differences in wages and salaries) deprived people of the incentives needed for their active participation in economic activities—for diligent work and vigorous entrepreneurship. Among the consequences of socialist equalization of incomes were poor discipline and low initiative among workers, poor quality and limited selection of goods and services, slow technical progress, and eventually, slower economic growth leading to more poverty. (Source: World Bank: Beyond Economic Growth An Introduction to Sustainable Development (Chapter V: Income Inequality))
The case against inequality
It may seem counterintuitive that inequality is strongly associated with less sustained growth. But too much inequality might be destructive to growth. Beyond the risk that inequality may amplify the potential for financial crisis, it may also bring political instability, which can discourage investment. Inequality may make it harder for governments to make difficult but necessary choices in the face of shocks, such as raising taxes or cutting public spending to avoid a debt crisis. Or inequality may reflect poor people’s lack of access to financial services, which gives them fewer opportunities to invest in education and entrepreneurial activity. (Berg and Ostry, 2011)

How is equality measured?


Trends of income shares to the top 1% (1970 - 2009/2010)
The charts below show the income shares (in Australia, Canada, United Kingdom and United States) accruing to the top 1% from the 1970s on and the data was made available by Atkinson, Piketty and Saez of  the Paris School of Economics. Go to their website to see these and many more data sets highlighting how  inequality is at the highest rate since the 1920s.

Canadian Wage Distribution Dynamics
The following charts are from a presentation by Paul Jacobson, "Recent Wage Dynamics - Working Paper" that shows inequality in the Canadian context.
Lorenz Curve

Source: Jacobson Consulting

Social and Economic Mobility
The following charts are from a presentation by Miles Corak, "Social and Economic Mobility in Canada"

Key Takeaways (please visit Miles Corak's website for more content related to this issue).

Source: Miles Corak

A Broken Economy: What it isn't
A stylized representation of flows in an economy is often represented by something akin to the diagram below, however, reality checks have been inserted to remind us that money matters, as does class (more on that below). Since money matters, by implication so does the debt, and advanced economy households are in a debt overhang.

It should be noted that Gennarro Zezza, a student of the late Wynne Godley --whose stock-flow consistent modeling provided an red flag to global imbalances in the early 2000s-- stated that:
in the economy – and therefore in models representing the economy - everything comes from somewhere and goes somewhere else: 'there are no black holes.' This obvious principle has relevant implications: one is that the debt of somebody is a credit for somebody else. 
But simply because the debt of somebody is a credit for somebody else does not mean that it is not a problem. The financialization of modern economies requires incorporation of rentier sectors into a financial model since much credit has been granted for speculative rather than productive activities in the so-called FIRE (finance, insurance, real estate) sector:
Debt-leveraged buyouts and commercial real estate purchases turn business cash flow (ebitda: earnings before interest, taxes, depreciation and amortization) into interest payments. Likewise, bank or bondholder financing of public debt (especially in the Eurozone, which lacks a central bank to monetize such debt) has turned a rising share of tax revenue into interest payments. As creditors recycle their receipts of interest and amortization (and capital gains) into new lending to buyers of real estate, stocks and bonds, a rising share of employee income, real estate rent, business revenue and even government tax revenue is diverted to pay debt service. By leaving less to spend on goods and services, the effect is to reduce new investment and employment. (Hudson and Bezemer, 2012)
This view is in stark counterpoint to conventional analysis by establishment shills (link courtesy of Charles Ferguson's "Inside Job"):
For instance, Mishkin (2012: pp. 1 and 24) explains that “in our economy, nonbank finance also plays an important role in channeling funds from lender-savers to borrower-spenders…

Finance companies raise funds by issuing commercial paper and stocks and bonds and use the proceeds to make loans that are particularly suited to consumer and business needs”. (Hudson and Bezemer, 2012)

A Broken Economy: What it is
Overall model of the FIRE (Finance, Insurance, Real Estate) sector: producers, consumers, government, world (Hudson and Bezemer, 2012: Fig. 4, p.9) based on the U.S. economy primarily but just as relevant to other nations such as the United Kingdom, Spain and Ireland who have suffered real estate asset crashes.

Only a portion of FIRE sector cash flow is spent on goods and services. The great bulk is recycled into the purchase of financial securities and other assets, or lent out as yet more interest-bearing debt – on easier and easier credit terms as the repertory of bankable direct investments is exhausted. So the pressing task today is     to trace how directing most credit into the asset markets affects asset prices much more than commodity prices. Loan standards deteriorate as debt/equity ratios increase and creditors ‘race to the bottom’ to find borrowers in markets further distanced from the ‘real’ economy. This increasingly unproductive character of
credit explains why wealth is being concentrated in the hands of the population’s wealthiest 10 percent. It is the dysfunctional result of economic parasitism. (Hudson and Bezemer, 2012: pp. 10-11)
Class Matters

While Arthur Laffer and Stephen Moore continue to use their pulpit at the Wall Street Journal to conclude that the issue of class should be a non issue as "wealth trickles down" in their worldview, the facts on the ground are quite different. The current situation of inequality was built after the embers of the defunct "Golden Age of Capitalism" burnt out conclusively in the 1970s.

(Source: Glyn, Capitalism Unleashed, Ch. 1-2)

At the end of the 1970s, capital rose to prominence and put an end of the power of labour. The concept of wage growth being tied to productivity has been tenuous since then and has been severed for those down the value chain as there are structural mismatches to the skills people have to the jobs available due since many of the jobs are unlikely to return. As I have outlined previously in 2011 the conventional view, articulated by Raghuram Rajan,  is that increased inequality has been the by product of technology and globalization. If we add to the mix the tripling of the global labour pool (or "reserve army of labour" in the Marxian sense) and the fact that a greater share of corporate profits go to those at the top -- despite no substantive proof that the CEOs have become more productive than their counterparts a generation back when compared to the people below -- we have the ingredients for more inequality in society and by extension greater instability in economic growth. This was successfully papered over for a generation by virtue of the credit spigot opening and access to credit increasing but exponential growth in credit reached a tipping point in 2008. But now, we see the reality of people living within their means, paying down debt, and unable to plan for the future due to a lack of job security. The traditional life-cycle hypothesis becomes less realistic in this case:

(Source: Marglin, Lessons of the Golden Age of Capitalism: p. 25)

What happens when that salaried professional referenced above "whose life prospects are reasonably certain and whose life experience reinforces the notion that he or she is "in control" gives way to a growing cohort of people whose jobs have been outsourced, who work on a contract basis, who lack security and whose career prospects are uncertain at best? We have, in the words of Professor Guy Standing, a group of people  living precariously: we have the precariat.

The global precariat is not yet a class in the Marxian sense, being internally divided and only united in fears and insecurities. But it is a class in the making, approaching a consciousness of common vulnerability. It consists not just of everybody in insecure jobs – though many are temps, part-timers, in call centres or in outsourced arrangements. The precariat consists of those who feel their lives and identities are made up of disjointed bits, in which they cannot construct a desirable narrative or build a career, combining forms of work and labour, play and leisure in a sustainable way.

Because of flexible labour markets, the precariat cannot draw on a social memory, a feeling of belonging to a community of pride, status, ethics and solidarity. Everything is fleeting. They realise that in their dealings with others there is no shadow of the future hanging over them, since they are unlikely to be dealing with those people tomorrow. The precariatised mind is one without anchors, flitting from subject to subject, in the extreme suffering from attention deficit disorder. But it is also nomadic in its dealings with other people.

Although the precariat does not consist simply of victims, since many in it challenge their parents' labouring ethic, its growth has been accelerated by the neoliberalism of globalisation, which put faith in labour market flexibility, the commodification of everything and the restructuring of social protection.(Guy Standing, "Who will be a voice for the emerging precariat?",

The elite are those few whom the masses cannot relate to but to whom the establishment fawn. Wealth has little reason to trickle down when the super rich do not know what to do with their surplus capital:
There was even a famous “yacht war” that got started in 1997 among the super-wealthy, competing with each other for the biggest. First, Leslie Wexner of Limited Brands bought a 316-foot vessel, some 110 feet longer than anything in its category. That cost about $300 million. But Russia’s Roman Abramovich outdid him, buying three super-yachts of the same kind. Then Paul Allen, cofounder of Microsoft, outdid them both, with a 413-foot yacht that boasts a basketball court, a heliport, a movie theater, and a submarine in the hold. (Jerry Mander, Rule by the Rich, New Left Project
The salariat, proficians and old working class are described by Standing below.

In terms of income, the group below the elite and other representatives of capital is the ‘salariat’, those with above average incomes, with an array of enterprise benefits and employment security. This group is shrinking, hit by the financial crisis, austerity packages and the extension of labour market flexibility, nowhere more so than in Greece.

Some of the salariat have joined the third group, ‘proficians’, those with bundles of technical and emotional skills that allow them to be self-selling entrepreneurs, living opportunistically on their wits and contacts. This group is growing but is relatively small; it tends to be socially liberal but economically conservative, since it wants low taxes and few obstacles to money making.

Below the salariat and proficians in terms of income is the old manual working class, the proletariat, which has been dissolving for decades. The democracy built in the twentieth century was designed to suit this class, as was the welfare state. Trades unions forged a labourist agenda and social democratic parties implemented it. That agenda has little legitimacy in the twenty-first century. (Guy Standing, The Precariat: why it needs deliberative democracy, 27 January 2012,
And for those who believe that higher education is a way out of precarious living, think again for it is the academic precariat that makes up the bulk of higher learning within the North American system of tertiary education: (See video: "Now That I'm Relevant, I Can't Get a Job")

To be certain, some of those who share the political spectrum with Guy Standing have a big problem with his class analysis and quip over the need to meddle with the old fashioned Marxian (bourgeois vs. proletariat) dichotomy but this does not change the data: more people live precarious lives, societies are experiencing greater inequality, household sectors in major economies are recovering from a debt overhang while governments struggle with fiscal initiatives as they worry about what will be acceptable to credit markets and central banks prove the impotence of monetary policy (at the zero lower bound) with each passing meeting as we struggle to resuscitate a dying economic system.

I have gone on record about my views about the future in previous posts; will policy makers continue to use the tools of the past to fight the problems of today or will revolutionary thinking come to the fore? They have failed to rise to the occasion except for saving the banks. But saving the banks has not saved the world; some of the banks have become zombies whilst the remainder are looking for opportunities to deploy risk capital in a world of spread compression.

Demographic headwinds (in the Canadian context summarized here but a challenge everywhere) will only add to the puzzle. The U.S. Federal Reserve's zero interest rate  and quantitative easing policies will effectively kill many defined benefit plans in the America and thus create a larger precariat over there with their diminished pension benefits.

What we need is less inequality and greater equality in access to opportunity. Looking for global trade access to the emerging world is not a panacea but a small part of the solution as the BRICS nations (amongst others)  have problems of their own to deal with. 

The problems remain but are the solutions forthcoming?
To begin, citizens need to be re-connected with the democratic process; if people spent a fraction of their time that they devote to distractions (such as what is on reality television or how will the NHLPA and NHL owners divide the billions in revenue) on political engagement then politicians will take note rather than assume that we are a disengaged citizenry willing to eat rhetorical pablum.

The opinions reflected in the post 'Growth falters, and inequality grows as capital flows' are those of the author. Any errors and omissions are the author's alone. 

Labour vs. labor: I have attempted to stick to the Canadian/British spelling of labour in the neutral context but when referring specifically to the United States, the American spelling has been used.

Bernanke, B. (08, 2012 31). Monetary policy since the onset of the crisis. Retrieved from

Hudson, M., and Bezemer, D. (2012). Incorporating the rentier sectors into a financial model. World Economic Review1(1), 1-12. Retrieved from

Reich, R. (2012, September 07). After the politics, the reality of the us labour market. Financial Times. Retrieved from

Berg, A. G., & Ostry, J. D. (2011). Equality and efficiency.FINANCE and DEVELOPMENT, 48(3), 12-15. Retrieved from

Graselli, M. R., & Costa Lima, B. (2012). An analysis of the Keen model for credit expansion, asset price bubbles and financial fragility. Mathematics and Financial Economics, doi: 10.1007/s11579-012-0071-8

Shorto, R. (2012, February 13). The way greeks live now.New York Times. Retrieved from 

Alvaredo, Facundo, Anthony B. Atkinson, Thomas Piketty and Emmanuel Saez, The World Top Incomes Database,, 10/09/2012.

Andrew Glyn, Capitalism Unleashed, esp. Chs 1-2. Retrieved from

Friday, July 27, 2012

Wealth does not trickle down...

Hat tip to David Ruccio at the RWER blog for making this graphic from The Guardian available.

Click to see from where capital flows for those at the top of the pyramid

Capitalism's enigma remains its undeniable ability to morph from one form to another.  The Hobbesian social contract of Western democracies in the period following World War II saw its "Golden Age" where labour power acted as a check to the power of corporations and the notion of a living wage was not alien. But as labour flexed its power and productivity wilted away, the commodity induced inflation courtesy of the OPEC cartel provided an in and paved the way for a newer global order of orthodoxy in the 1970s. America unwound from the gold standard --undoing Bretton Woods in the process-- and the neo-liberal policies were introduced that unleashed the power of capital globally.

Capital has effectively usurped labour over the past 40 years and the capitalist dilemma has been that in its so-called free "laissez faire" form it leads to an accumulation in fewer hands with the unintended consequence being a steady erosion of the social fabric within the state.

The result is that "trickle down" economics does not exist. The rich do not create jobs; entrepreneurs endogenous to a capitalist system with access to credit ultimately do. Stability is provided by governments, industries, labour --all of whom are stakeholders: institutions matter; they always have and always will.

The value added from business ventures --or 'surplus'-- when not dispersed in an equitable fashion amongst stakeholders does not lead the acquisitors of the surplus to enact in a manner befitting noblesse oblige. Instead, carefully crafted propaganda has left the general populace to worship at the alter of celebrity and wealth; this does not make people better off --it leaves them deluded.

Attend any investment conference and it is readily apparent that there is no lack of capital in the world but when it is an asset in the hands of the relative few it is unavoidably funneled into unproductive endeavours --think of the never ending asset bubbles we are witness to-- be it investment in luxury real estate, commodities, or the latest derivative concoction within the shadow banking sector.

When we consider the identity that within a closed global system assets and debts net out to zero, we can recognize that this capital socked away in tax havens and other exotic vehicles is mirrored by a mass of private sector household debt that must be paid down. It has been fashionable for everyone's favourite rag, The Economist, to lament the growth of Leviathan --putatively 'big' government-- in the years following the financial crisis of 2008.

Unless three inter-related things happen: (i) the credit spigot is turned on for productive purposes; (ii) the middle and lower classes share in the spoils of the surplus and (iii) the global economic order is re-worked under a new architecture whereby bad assets are written down, there is only one game in town --that is Leviathan, and it must enact pro-growth policies lest the West and the Rest suffer from Lost Decades. 

Friday, July 20, 2012

Betting against the FOMC

These two slides are from a deck by Vincent Reinhart and Harold Ford Jr. for a Morgan Stanley Conference call.

Referring to the lower chart, if there was a trade then I would take the other side of the "Target Fed Funds Rate" view for the "Longer Run" bucket; it appears (to me)  higher than the U.S. economy could sustain without significant de-leveraging of the private sector and renewed access to cheap credit to smooth consumption for the bottom quartiles of the wage pyramid. Clearly the FOMC believes --explicitly or implicitly-- in the rate normalization hypothesis rather the any manifestation of Irving Fisher's Theory of Great Depressions. Bernanke, a tried and true disciple of the Friedman and Schwartz narrative about the Great Contraction has enacted the "save the banks, save the world" form of monetary engagement but the coming 18 months will give investors, and more importantly working people, a clearer insight to the depths of the malaise. Of all the policy tools available, a form of quantitative easing for the public will not be an option. The global imbalances that have shown the circumspect nature of policy prescriptions from creditor and debtor nations alike will remain; not every nation can trade its way out of the quagmire and not every country can have a current account surplus. In time that longer run view of the target Fed Funds Rate will come down as reality hits the fantasy of Panglossian expectations.

Monday, July 16, 2012

Japanese rates look good these days...

It has come to this: negative rates testing the ineffictiveness of monetary policy.

China won't save the world

A previous post, "Is China misunderstood?" showed the opposing views of the China growth story and took the position that the sustainability of China, chief amongst the BRICS, growing at a breakneck pace should be greeted with caution at best and considered realistically sustainable only in the short term (i.e. up to 5 years). This post will attempt to flesh out a few of the reasons for the skepticism. There is no need to repeat conventional wisdom as others can state it more convincingly but here it is in essence: China is too reliant on fixed investment – be it property, manufacturing or infrastructure – and when increasing investment becomes unrealistic then the Chinese economy is vulnerable to a substantial slowing.
Moreover, as Capital Economics has shown (see chart) I/Y (Investment as a proportion of GDP) has been rising in China; this is against the edicts of the Politburo's previous 5 year plan that called for a re-balancing of the macro economy towards greater reliance on Consumption --entailing a stronger household sector-- and away from Investment and Net Exports as drivers of GDP.

The Chinese elite --be they current or past members of the Communist Party's politburo-- have been masterful in charting the growth trajectory of the state's crony capitalist structure and finely tuning its mercantilist policies; the result (in conjunction with helpful neoliberal corporate globalization policies that aid and abet the inflow of financial capital and outflow of jobs) has seen remarkable strides in material wealth, productive capacity, human capital and transfer of technology from Western to Chinese companies.

The usual reaction of criticism of China has been for uber-nationalist cyberspace lurkers to post defensive retorts on establishment sites (e.g. Financial Times, The Economist, New York Times, Foreign Policy) and the occasional less than radical blog usually with  incisive claims about China's mandarins focusing on the long-term and the inability of Western minds to comprehend the Chinese game theoretic approach which cites Go as the appropriate strategic war-gaming metaphor rather than the West's focus on Chess (which curiously has its origins in the East anyway). 

This is unfortunate: no reasonable individual questions either the ability, intent or talent of the Chinese people doing the work within the mainland or the diaspora internationally; it is the sustainability of the growth model that is rightly being called to question and this model will be under greater pressure as the imbalances between the consumptive West and the savings driven Rest continue and the household debt burdened are tackled through a steady dose of de-leveraging.

None of the concerns of shrieking Cassandras are new: in 2010 with China's Q2 GDP racing away at 10.3% Ken Rogoff warned of an impending correction in China's property market which would funnel through to its financial sector; that correction didn't happen.

At that time China's banking regulator ordered lenders to conduct stress tests where housing prices would fall up to 60%. But what point is a stress test in a country where economic policy is determined by political power? When is a stress test useful when non performing bank loans can be bailed out by the central government?

The main driver for China --as has been the case elsewhere-- has been credit: if credit is taken away then the progress from globalization is taken away as would the demand within China.

The Chinese - American relationship ("Chimerica" as framed by Niall Ferguson and Moritz Schularick) is the world's largest  vendor financing contract and is still viable for the short-term --or as long as the current account surplus remains. Fortunately for Chinese authorities, they are sitting on massive capital gains as export earnings invested in U.S. treasuries have seen rates plummet since 2008.

 China's 12th Five Year Plan reflects the goal of the Chinese government to move Consumption higher and Investment lower

In a recent Project Syndicate piece "Why China Can't Adjust" Minxin Pei argued that China's challenge is in the medium term rather than immediately. The growth model has depended upon the repression of the household sector in favour of state owned enterprises so while the financial sector is replete with npls the local governments, railway system and real estate developers are most vulnerable to serious downturns.

Is a downturn coming? Notwithstanding Li Keqiang's advice to US policymakers to follow electricity usage, rail cargo volume and bank lending as economic indicators rather then GDP, here are three leading indicator charts that presage a slowing growth outlook:

For the immediate term this should not be disastrous.

Chinese state owned enterprises exist and will be supported via fiscal stimulus and will continue to play a large role for sometime for a number of reasons: (i) they are strategic to the Politburo; (ii) they remain a self fulfilling patronage machine for the princelings, children and relatives of the CPC; and (iii) a healthy mistrust in Western style capitalists persists.

The quid pro quo from private entrepreneurs is political allegiance and no power allotted to labour unions as that would be counter to the enterprises absolute advantage in low wage labour. The price of such a Faustian pact is unclear but Pei estimates 1.1 trillion dollars paid to officials at various levels for bribes which ramps up exponentially at the age of 59 --the age where officials attempt to cash in.

Ultimately, how will China successfully rebalance from investment and net exports to consumption when the Soviet Union, Brazil and Japan failed to do so? Economic historians recount how extrapolations of Soviet growth in the 1950s and Japanese growth in the 1980s showed those nations surpassing the United States as GDP top dog; that also did not happen.

Pei's view is one of pragmatism and optimism that change will occur but not in the timeline expected by the CPC. The pessimists view, articulated by Michael Pettis, is that debt levels are rising in China and eventually the costs to service debts will outstrip the capacity to service them and that the 20 year experiment in Chinese capital misallocation  without a market pricing mechanism within the financial sector will spell trouble if growth slips below the growth in debt accumulation.

It is clear that with the outflow of financial capital from China will show in changes in the current and capital account.
Rebalancing can happen but are enterprises willing to pay households in a fairer manner or will exploitation of households in favour of subsidizing the tradeable goods sector through an undervalued currency continue?
China continues to lap many nations in terms of labour productivity a rebalancing to a consumption based model will require workers wages to grow faster than productivity unless there is a massive increase in accessible credit for the working classes.
And just as important, interest rates need to be set under a market rate mechanism so that financial repression against savers does not subsidize the borrowers in the upper classes who do not require it and are using that credit access to speculate.

High growth is intoxicating but one needs only a rudimentary understanding of compounding to understand that high single to double digit growth is either a mirage or unsustainable.

Who will take away the proverbial punch bowl and pay household fairly so that household incomes grow faster then GDP and thus make a consumption based model workable.

With the West bracing for two decades of de-leveraging thanks to private sectors repairing balance sheets, zombie banks, and a nod in favour of misguided austerity based on Ricardian equivalence policies that have no empirical justification --not even counting the demographic wall to come in this argument-- the proposal here of  expectations amongst the mainstream that the BRICS in general and China in particular will save the day is a tall tale indeed.

Wednesday, July 4, 2012

Canada will not avoid the Great Deleveraging

For a good portion of the years since the Global Financial Crisis, Bank of Canada ("BOC")  governor, Mark Carney, has attempted --through moral suasion-- to talk down the debt levels of those Canadians intent on buying homes, those renovating them, and those intent on keeping up appearances via conspicuous consumption in order to maintain a lifestyle akin to their seemingly affluent neighbours and friends. All to no avail: the BOC has known that the underlying economic strength of the macro economy --after glossing over the superficial GDP numbers that are forever subject to revision and drilling down to the real economy-- is weaker than at first blush. The path to so-called "rate normalization" touted in the investment community has not been forthcoming half way into 2012 and will not be (according to your humble scribe) as per the case that was made in a previous post and that unlike previous business cycles Canadians should brace for a new normal of low rates and lower than "trend" growth in economic activity.

One cannot overestimate the concern of household debt burden of Canadians in the context of the decisions of policy makers. Without fail, three of the BOC's periodicals: Bank of Canada Review; Financial System Review; and Monetary Policy Report have mentioned explicitly the concern surrounding household debt levels.
Canadian Household Finances and the Housing Market
The elevated level of household indebtedness continues to be the most important domestic risk to financial stability in Canada. There have been some welcome developments since the December FSR—notably, the pace of household debt accumulation has slowed and some vulnerability measures appear to be stabilizing. Nonetheless, vulnerabilities are entrenched for the most seriously at-risk households, and the Bank’s stress-test simulations continue to suggest that households are vulnerable to adverse economic shocks. Moreover, the continued high level of activity and stretched valuations in some segments of the housing market are of increasing concern. Overall, the Governing Council judges that the risks associated with high levels of household debt and a potential correction in the housing market are elevated and have not diminished since December. A reduction in this domestic risk requires a combination of deleveraging by vulnerable households and a reduction in housing market imbalances.

But at what point does the "combination of deleveraging by vulnerable households and a reduction in housing market imbalances" begin?

Where monetary policy has feared to tread at the risk of a hard landing, regulatory rules have stepped  in and stepped up in the form of tougher mortgage rules and stricter oversight of the CMHC as set out by Finance Minister Jim Flaherty.

This is a welcome move but too late. The asset bubble that is residential real estate in Canada can best be seen through the Panglossian valuations in the Vancouver and Toronto markets.
A hat tip to the excellent Irish economist and 2011 INET grant recipient Stephen Kinsella who provided the inspiration to consider real estate appreciation within the framework of traditional asset price appreciation and has framed the business cycle as being intertwined with the housing cycle.
Where do Vancouver...
....and Toronto...
fit in as per the cycle. Is it truly "location, location, location?"

An unscientific sampling of house prices (Source: Globe & Mail Real Estate Section) in Toronto neighbourhoods over various time spans. Note how the often parabolic rise in house prices is the result of mortgage financing growth; whose salaries (in a sample of median wage earners) is rising at such rates?

A rising tide lifts all boats, particularly when the great driver of housing prices in the willingness of financial institutions to lend: it is credit creation that has driven up real estate globally and the creation of credit is the purview of the commercial and shadow banking sector ("endogenous") rather than the central bank  ("exogenous").
At the risk of intolerant scepticism and pithy comments concerning "Banking Mysticism" as stated by a notable New York Times columnist earlier this year, in the real world banks are not reserve constrained (as the orthodox textbooks are wont to tell you) as they are constrained by the risk tolerance, expectation of profit and quality of capital of the said lending institution. The money multiplier, as described by radical (tongue firmly-in-cheek) economists Seth B. Carpenter and Selva Demiralp in their empirical paper "Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?" and by BIS and Bank of Thailand economist Piti Disytat in his paper "Monetary policy implementation: Misconceptions and their consequences" is at best completely misunderstood.
While being highly intuitive, the utilization of the money multiplier in expositions of monetary transmission can be misleading.... From a monetary policy implementation perspective, however, the problem is in assumption (i) {(i) being binding reserve requirements limit the issuance of bank demand deposits to the availability of reserves)}. This is premised on the notion that central banks set the level of reserves as the operational target of policy and that banks’ deposit base, and thus their supply of loanable funds, is linked directly to variations in reserves through the money multiplier mechanism. In fact, the true causal relationship actually runs in exactly the opposite direction. The banking system creates deposits as they are demanded by the private sector, and the central bank’s main liquidity management task is to ensure a sufficient supply of balances for the system as a whole to maintain reserve requirements, if any, associated with those deposits. It is the amount of deposits that the banking sector can attract that determines the level of reserves not the other way around.
[Bold emphasis mine and inserted for context; excerpts from pp. 14-15, BIS Working Paper No. 269, (Disytat, 2008)]
Richard Werner, Chair in International Banking at Southampton Management School describes the role of credit (productive vs. consumptive) in encouraging asset bubbles as opposed to the productive capacity of a nation's real economy in this presentation from the April Just Banking Conference at Edinburgh Business School.
The salient slides are shown below:

As the euphoria of the wealth effect from asset price appreciation has shown in the Canadian context, real estate prices and in turn mortgage debt issuance has far outstripped the income appreciations of the vast majority of Canadians. None of this is lost on the BOC.

But what next? Deleveraging is inevitable; the question is will it be the result of the soft landing that the Department of Finance and BOC wishes or will it be due to the hard landing or (worst case) crash that they fear? As the Citi charts show, as try as they might it is often the latter scenarios that prevail.