The Rising Risk of Economic Downturn

Transcription

1 The Rising Risk of Economic Downturn by Lacy H. Hunt, Ph.D. Chief Economist, Hoisington Investment Mgt. Co. November 5, 2018 New Orleans, LA. AMERICAN COUNCIL OF LIFE INSURERS acli.com

2 Net National Saving by Sector as a % of Gross National Income annual Average (net) = 6. Private Sources: Bureau of Economic Analysis. Through Net national Government page 1

3 Diminishing Returns - Consequences of Excess Debt 1. Diminishing returns rests upon the production function: physical output is determined by the inputs or factors of production. 2. When a factor of production, such as capital, initially increases, output rises at an increasing rate. As excess use of that factor continues advancing, the rate of gains in output slow, flatten and eventually turn down, a condition referred to as negative returns. 3. The pattern of unexpected economic weakness in heavily indebted economies has been repeated frequently in Japan, Europe, China and the emerging markets. Japan, the most indebted nation, experienced three additional recessions after the recession. 4. When debt is converted into physical terms, academic studies have found that higher levels of debt are associated with progressively weaker rates of economic growth and consistent with the law of diminishing returns. 5. Checherita and Rother investigated the average effect of government debt on per capita GDP growth in twelve euro area countries over a period of about four decades beginning in A government debt to GDP ratio above the turning point of has a "deleterious" impact on long-term growth. Beyond this turning point, as the government debt rises to higher and higher levels, the adverse growth consequences accelerate. Results across all models "show a highly statistically significant non-linear relationship between the government debt ratio and per-capita GDP for the 12 pooled euro area countries included in their sample." 6. In addition to capital, output is a function of labor, natural resources and technology. Thus, one of these latter three factors must accelerate in order to offset the overuse of debt if production growth is to accelerate and thus boost the standard of living. 7. Natural resources and labor are unlikely to be of immediate benefit. New discoveries of raw materials have been occurring, but only serve to balance exhaustion of known supplies. 1 Cristina Checherita and Philipp Rother, The Impact of High and Growing Government Debt on Economic Growth, An Empirical Investigation for The Euro Area, European Central Bank working paper, Number 1237, August page 2

4 2.5% % % 0. World Population Growth (10 year avg. percent change and level) % change: left scale 2018 = 1. level: right scale -0.5% Sources: HYDE Population Estimates , UN Population Estimates , UN Medium Fertility Variant tril page 3

5 Technology and Diminishing Returns 1. Technology is another factor that must not be overlooked. While many dramatic advances are underway, the role of invention in the future trend of U.S. and global growth is more complex than is generally understood. 2. Robert J. Gordon, a distinguished Professor of Economics at Northwestern University and author of The Rise and Fall of American Growth: The U.S. Standard of Living Since the Civil War (2016), considers today's inventions to be more evolutionary than revolutionary since they do not entail the massive use of labor and natural resources of the past. Gordon looked at inventions from the great American economic growth era of 1870 to The five major inventions - electricity, modern communications, the internal combustion engine, urban sanitation, and pharmaceuticals and chemicals - greatly enhanced the demand for labor and natural resources and resulted in complete economic involvement. Information technology, while life changing in many ways, impacts a narrower economic segment. 3. Furthermore, business productivity from the late 20th century's digital revolution has stalled these past two decades due to innovation saturation. Viewed from a longer-term perspective, the differential effect of present inventions is already apparent. In his working paper, "Why Has Economic Growth Slowed When Innovation Appears to Be Accelerating?" (National Bureau of Economic Research, 2018), Gordon calculates that the decline in economic growth in the last decade is a stunning seven times lower than the average growth rate for the fifty years between 1920 and 1970, in real GDP per capita terms. 4. If Gordon's view is somewhat overstated, it nevertheless appears that some current technological inventions will tend to depress demand for two other factors of production - labor and natural resources. According to available data from the U.S. Bureau of Labor Statistics, there are approximately 3.25 million cashiers, 1.96 million driving trucks and 2 million operating machine tools and assembly lines. Using robots for these functions does not materially change the demand for natural resources but renders obsolete more than 7 million jobs. page 4

6 GDP Generating Capacity of Global Debt: All Major Economies 2007 Ratio of change in GDP to change in Debt 2017 Ratio of change in GDP to change in Debt % change 1. Euro Area United Kingdom % 3. Japan United States China % G (20) aggregate Emerging markets (aggregate) All reporting countries (aggregate) Advanced economies (aggregate) % % Source: Bank of International Settlements. page 5

7 2.5% Real Per Capita GDP Growth, Selected Periods average annual growth 5% Real Per Capita GDP decade average growth 5% 2.5% % 3% 3% 2. 1% 1% 1.5% % 1.1% % 0.5% Sources: Bureau of Economic Analysis, Congressional Budget Office, Office of Management and Budget, N.S. Balke & R.J. Gordon, C.D. Romer, Measuring Worth. Through Q page 6

8 Productivity 5 year periods, 5 year a.r. 3% % Avg. = 2.1% % % Sources: Bureau of Labor Statistics. Through page 7

9 The Monetary Base vs. Excess Reserves of U.S. Depository Institutions bil. monthly level '02 '05 '08 '11 '14 '17 Source: Federal Reserve Board. Through Oct. 10, Monetary Base: orange line Excess Reserves: red line bil % -32.1% Liquidity coverage ratio established. 01/ page 8

10 14 Money Multiplier (m or 3.6) = M2 ($14.2 tril) / the Monetary Base (MB or $3.5 tril.) quarterly Q = 10.6 Q = Avg. = Q = 4.5 The money multiplier or m is determined by the currency, time deposit, Treasury deposit and excess reserve ratios. 2 Mar-1913 Mar-1933 Mar-1953 Mar-1973 Mar-1993 Mar-13 Mar-1923 Mar-1943 Mar-1963 Mar-1983 Mar Sources: Federal Reserve, St. Louis Federal Reseve. The American Business Cycle; Robert Gordon. Through Q Money multiplier equals M2 money supply divided by the monetary base. page 9

11 M2 Money Stock annual % change 3 25% 9 7% M2 y-o-y % change, monthly 7% 3 25% 2 15% 5% % 5% 3% 3% '16 '17 ' Latest 52 week change 2 15% 5% -5% A B C D -5% - M2 decelerated prior to 17 of the last 21 recessions % -15% Source: Federal Reserve. Through December (Inset chart through Oct. 1, 2018.) -2 page 10

12 = 2.0 Velocity of Money Equation of Exchange: M*V = GDP annual V = Y/M avg to present = = 2.2 avg to 1983 = Lowest since Q = Q = Q = Q = = 1.2 GDP = MB*m*V Sources: Federal Reserve Board; Bureau of Economic Analysis; Bureau of the Census; The Amercian Business Cycle, Gordon, Balke and Romer. Through Q Q2 2018; V = GDP/M, GDP = 20.4 tril, M2 = 14.0 tril, V = page 11

13 Wicksell Differential for Banks: Growth Rate in Bank Credit less Growth Rate in GDP y-o-y % change, quarterly '06 '13 Source: Bureau of Economic Analysis, Federal Reserve. Through Q page 12

14 Yield Spread Between Long Term Treasury Bonds (10 years and over) and the 3 Month Bill % recessions 3 17 flattenings 10 inversions % Source: Federal Reserve Board. Through September page 13

15 3 25% 2 World Dollar Liquidity annual average of year over year growth rates WDL 20. MB 29.5% World dollar liquidity (WDL) = Monetary base (MB) + Foreign official assets held at federal reserve banks: Treasury securities (FH) 3 25% 2 15% FH 14.9% FH % 5% WDL 8. MB 6.3% WDL -.1% MB -. FH. 5% -5% Source: Federal Reserve. Through August % page 14

16 Euro Area: M2 year over year percent change, monthly 5% Japan: M2 year over year percent change, monthly 5% 3% 3% '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 Source: European Central Bank. Through August % '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 Source: Bank of Japan. Through September % 3 China: M2 year over year percent change, monthly M2 Velocity: Four Major Economies annual % 25% 2.0 U.S % 2 15% Euro Japan China % '09 '11 '13 '15 '17 Source: People s Bank of China. Through August % Sources: Bureau of Economic Analysis, Federal Reserve, European Central Bank, Bank of Japan, China National Bureau of Statistics, People's Bank of China, Haver Analytics. Through page 15

17 The Supply and Demand For Credit Determines Short Term Interest Rates (Liquidity Effect) Short-term Interest Rate S1 Caused by monetary base, excess reserves. S0 D0 R1 B Friedman calls this shift in the supply curve the liquidity effect. R0 A 0 Q1 Q0 Quantity of Credit Demanded/Supplied page 16

18 Fisher Equation Determines Long-term Yields Fisher Equation Treasury bond yield = r + e r = real rate e = inflationary expectations Friedman s extension of the Fisher effect: Monetary decelerations lead to lower bond yields through three effects: liquidity, income/output, price/fisher effect. Monetary accelerations lead to higher bond yields through three effects: liquidity, income/output, price/fisher effect. page 17

19 Effects of QT on Macroeconomic Conditions Price Level AS shifts right when costs are reduced. AD2 AD1 AS0 AD=GDP GDP=M2*V AD=GDP=M2*V M2=MB*m AD=MB*m*V P0 A CPI: All Items less Food, Shelter and Energy annual % change P1 B AD shifts inward when M2 and velocity decrease Y1 Y0 Real GDP page 18

20 Real Average Hourly Earnings year over year percent change, monthly U.R. = 5.7% - U.R. = 3.7% '01'03'05'07'09'11'13'15'17'19 Source: Bureau of Labor Statistics. Through September (Production and nonsupervisory workers.) - page 19

21 7% Long-Term Government Bond Yields Starting with Historic Panic Years: Japan 1989, U.S and 1929 Japan 1989 annual average U.S. panic year 1873 = year 1 U.S. panic year 1929 = year 1 Japan panic year 1989 = year 1 7% 5% U.S % 3% U.S U.S % 1% Sources: Federal Reserve Board, Homer & Sylla. Bank of Japan. (U.S. through 2017) 1% page 20

22 Appendix

23 22 mil. Vehicle Sales quarterly level, a.r. mil '03 '07 '11 '15 '19 Source: Bureau of Economic Analysis. Through Q page A-1

24 Existing Home Sales monthly level (thousands), a.r. '00 '03 '06 '09 '12 '15 '18 Source: Bureau of Census. Through August page A-2

25 Japan: Real GDP year over year % change, quarterly '07 '10 '13 '16 '19 Source: Cabinet Office of Japan. Through Q page A-3

26 Euro Area: Real GDP year over year % change, quarterly '07 '10 '13 '16 '19 Source: Statistical Office or the E.U. Through Q page A-4

27 Unit Labor Costs: Nonfarm Business year over year % change, quarterly '04 '11 '18 Source: Bureau of Labor Statistics. Through Q page A-5

28 Real PCE year over year % change, quarterly Sources: Bureau of Economic Analysis. Through Q page A-6

29 16 Tril. Marketable Treasury Securities Outstanding and 30 year Treasury Yields monthly Treasury Yields: right scale Marketable debt outstanding: left scale '01 '05 '09 '13 '17 Source: Federal Reserve, U.S. Treasury. Through September page A-7

30 Foreign Holdings of U.S. Securities Long Term Securities (col. 2) Long Term Debt (col. 4) U.S. Treasury Securities ( col. 7 plus Treasury bills ) Long-Term securities Equities Debt Corporates U.S. Agency U.S. Treasury 5 years and less 5-10 years over 10 years * ($trillions) * ($trillions) % 59% 2 5% * ($trillions) % * ($trillions) % 59% 2 31% 7 2 * may not sum due to rounding. Source: U.S Treasury Department 69% 2 11% Privately held marketable interest-bearing public debt: page A-8

31 Retail Sales & Food Services year-over-year % change, monthly 15% 15% 5% 5% -5% -5% % '07 '09 '11 '13 '15 '17 Source: Census Bureau. Through September % page A-9

32 Dollar Index monthly federal reserve nominal trade weighted dollar index wall street journal dollar index '00 '02 '04 '06 '08 '10 '12 '14 '16 '18 20 Source: Federal Reserve, Wall Street Journal. Through Oct. 5, page A-10