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      ["title"]=>
      string(21) "When the Facts Change"
      ["alias"]=>
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      ["introtext"]=>
      string(77) "

    The coronavirus is a human tragedy, but the markets remain sanguine.

    " ["fulltext"]=> string(8474) "

    A slowing of global growth is already factored into market expectations. Further central bank easing is expected to calm any market fears. A pick-up in import price inflation has been discounted before it arrives.

    My title is the first part of JM Keynes famous remark, ‘When the facts change, I change my mind.’ This phrase has been nagging at my conscience ever since the Coronavirus epidemic began to engulf China and send shockwaves around the world. From an investment perspective, have the facts changed? Financial markets have certainly behaved in a predictable manner. Government bonds rallied and stocks declined. Then the market caught its breath and stocks recovered. There have, of course been exceptions, while the S&P 500 has made new highs, those companies and sectors most likely to be effected by the viral outbreak have been hardest hit.

    Is the impact of Covid-19 going to be seen in economic data? Absolutely. Will economic growth slow? Yes, though it will be felt most in Wuhan and the Hubei region, a region estimated to account for 4.5% in Chinese GDP and 7% of autopart manufacture. The impact will be less pronounced in other parts of the world, although Korea’s Hyundai has already ceased vehicle production at its factories due to a lack of Chinese car parts.

    Will there be a longer-term impact on the global supply chain and will this affect stock and bond prices? These are more difficult questions to answer. Global supply chains have been shortening ever since the financial crisis, the Sino-US trade war has merely added fresh impetus to the process. As for financial markets, stock prices around the world declined in January but those markets farthest from the epicentre of the outbreak have since recovered in some cases making new all-time highs. The longer-term impact remains unclear. Why? Because the performance of the stock market over the last decade has been driven almost entirely by the direction of interest rates, whilst economic growth, since the financial crisis, has been anaemic at best. As rates have fallen and central banks have purchased bonds, so bond yields have declined making stocks look relatively more attractive. Some central banks have even bought stocks to add to their cache of bonds, but I digress.

    Returning to my title, from an investment perspective, have the facts changed? Global economic growth will undoubtedly take a hit, estimates of 0.1% to 0.2% fall in 2020 already abound. In order to mitigate this downturn, central banks will cut rates - where they can – and buy progressively longer-dated and less desirable bonds as they work their way along the maturity spectrum and down the credit-structure. Eventually they will emulate the policy of the Japanese and the Swiss, by purchasing common stocks. In China, where the purse strings have been kept tight during the past year, the PBoC has already ridden to the rescue, flooding the domestic banking system with $173bln of additional liquidity; it seems, the process of saving the stock market from the dismal vicissitudes of a global economic slow-down has already begun. 

    Growth down, profits down, stocks up? It sounds absurd but that is the gerrymandered nature of the current marketplace. It is comforting to know, the central banks will not have to face the music alone, they can rely upon the usual allies, as they endeavour to keep the everything bubble aloft. Which allies? The corporate executives of publically listed companies. Faced with the dilemma of expanding capital expenditure in the teeth of an economic slowdown - which might turn into a recession – the leaders of publically listed corporations can be relied upon to do the honourable thing, pay themselves in stock options and buyback more stock.

    At some point this global Ponzi scheme will inflect, exhaust, implode, but until that moment arrives, it would be unwise to step off the gravy-train. The difficulty of staying aboard, of course, is the same one as always, the markets climb a wall of fear. If there is any good news amid the tragic Covid-19 pandemic, it is that the January correction has prompted some of the weaker hands in the stock market to fold. When markets consolidate on a high plateau, should they then turn down, the patient investor may be afforded time to exit. This price action is vastly preferable to the hyperbolic rise, followed by the sharp decline, an altogether more cathartic and less agreeable dénouement.

    Other Themes and Menes

    As those of you who have been reading my letters for a while will know, I have been bullish on the US equity market for several years. That has worked well. I have also been bullish on emerging markets in general - and Asia in particular - over a similar number of years. A less rewarding investment. With the benefit of hindsight, I should have been more tactical.

    Looking ahead, Asian economies will continue to grow, but their stock markets may disappoint due to the uncertainty of the US administrations trade agenda. The US will continue to benefit from low interest rates and technological investment, together with buy-backs, mergers and privatisations. Elsewhere, I see opportunity within Europe, as governments spend on green infrastructure and other climate conscious projects. ESG investing gains more advocates daily. Socially responsible institutions will garner assets from socially responsible investors, while socially responsible governments will award contracts to those companies whose behaviour is ethically sound. It is a virtuous circle of morally commendable, albeit not necessarily economically logical, behaviour.

    The UK lags behind Europe on environmental issues, but support for business and three years of deferred capital investment makes it an appealing destination for investment, as I explained last December in The Beginning of the End of Uncertainty for the UK.

    Conclusions

    Returning once more to my title, the facts always change but, unless the Covid-19 pandemic should escalate dramatically, the broad investment themes appear largely unchanged. Central banks still weld awesome power to drive asset prices, although this increasingly fails to feed through to the real economy. The chart below shows the diminishing power of the credit multiplier effect - Japan began their monetary experiment roughly a decade earlier than the rest of the developed world: -

    No alt text provided for this image

     

    Source: Allianz/Refinitiv

    Like an addictive drug, the more the monetary stimulus, the more the patient needs in order to achieve the same high. The direct financial effect of lower interest rates is a lowering of bond yields; lower yields spur capital flows into higher yielding credit instruments and equities. However, low rates also signal an official fear of recession, this in turn prompts a reticence to lend on the part of banking intermediaries, the real-economy remains cut off from the credit fix it needs. Asset prices keep rising, economic growth keeps stalling; the rich get richer and the poor get deeper into debt. Breaking the market addiction to cheap credit is key to unravelling this colossal misallocation of resources, a trend which has been in train since the 1980’s, if not before. The prospect of reserving course on subsidised credit is politically unpalatable, asset owners, especially indebted ones, will suffer greatly if interest rates should rise, they will vote accordingly. The alternative is more of the same profligate policy mix which has suspended reality for the past decade. From an investment perspective, the facts have not yet changed and I have yet to change my mind.  

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    When the Facts Change

    Colin lloyd
  • 2
    object(stdClass)#13405 (59) {
      ["id"]=>
      string(4) "5523"
      ["title"]=>
      string(36) "Global R&D: The Stagnant US Position"
      ["alias"]=>
      string(35) "global-r-d-the-stagnant-us-position"
      ["introtext"]=>
      string(222) "

    Research and development isn't enough by itself. New discoveries needs to be brought into the economy in the form of new companies, new products, and new jobs. But it matters.

    " ["fulltext"]=> string(8527) "

    A long-standing concern among economists is that a market-oriented economy may tend to underinvest in R&D, because even with intellectual property like patents and trade secret law, an innovator captures on average only a modest share of the social benefits from R&D. Thus, a variety of estimates suggest thatthe social return from more R&D spending is 60%, or that the US should be aiming over time to double its R&D spending

    In a global context, the US efforts to invest in R&D look stagnant. Here are some figures from a January 2020 report of the National Science Foundation and the National Science Board, called "The State of U.S. Science & Engineering 2020," 

    This figure shows total domestic spending on R&D (government, private-sector, nonprofits). The US leads the way. The purple line is China, which surpassed Japan about a decade ago and Europe about five years ago.

    If you look at the growth rate of R&D from 2000-2017, you can see that the China is the most obvious area catching up to the US, but certainly not the only one.  

    As a result of these ongoing shifts, the US used to be the preeminent region for R&D spending. But now, the the primary geographical home of most global R&D is the East and South Asia region.

    One issue is that the US spends about 2.5% of GDP on R&D in most years, give or take a few tenths of a percent. Germany, Japan, and South Korea spend more. China spends a lower share of GDP on R&D, but the share has been rising and of course China's GDP has also been growing quite rapidly in recent decades. 



    In the US, government spending on R&D has been pretty flat for the last decade or so; instead, it has been business spending on R&D leading the way. Business involvement in R&D spending is clearly a good thing, because it suggests that business are seeing ways to bring new discoveries into the day-to-day operations. However, there are also concerns that when it comes to research and development, business can be heavier on the "D" and lighter on the "R." The giant corporate laboratories of the past like AT&T's Bell Labs, Xerox's Palo Alto Research Center, IBM's Watson Labs, and DuPont's Purity Hall have diminished in scope or closed altogether. Relatively few modern companies finance research in basic science, or in long-horizon, high-risk projects that may turn out to be central to whole new industries.



    When confronted with these kinds of issues, a standard US response is to raise suspicions that the quality of R&D being done in China or across other countries of east and south Asia may not be very high. It's of course hard to measure the quality of research, but one method is to look at whether research articles are heavily cited by follow-up research. The NSF report explains: 

    The impact of an economy’s S&E [science & engineering] research can be compared through the representation of its articles among the world’s top 1% of cited articles, normalized to account for the size of each country’s pool of S&E publications. This normalized value is referred to as an index and is similar to a standardized score. For example, if a country’s global share of top articles is the same as its global share of all publication output, the index is 1.0. The U.S. index was 1.9 in 2016, meaning that its share of the top 1% of cited articles was about twice the size of its share of total S&E articles (Figure 22). Between 2000 and 2016, the EU index of highly cited articles grew from 1.0 to 1.3 while China’s index more than doubled, from 0.4 to 1.1, indicating rising impact from both areas.



    In short, this metric suggests that US research efforts are more likely to be in the top 1% of the research literature. It also suggests that the gap is closing.

    I often see proposals for the US to focus on building its transportation infrastructure, like roads, bridges, railroads, and airports. One can certainly make a reasonable case for such investments. But I also suspect that transportation spending is not going to be the main driver for leading global economies for the remaining four-fifths of the 21st century. A serious national conversation on how best to expand US R&D spending substantially is overdue. 

    A version of this article first appeared on Conversable Economist

     
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    Global R&D: The Stagnant US Position

    Timothy Taylor
  • 3
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    In thinking about the state of the economy, it could be useful to know if the number of new business start-ups is trending up or down.

    " ["fulltext"]=> string(4424) "

    Traditionally, the data on business start-ups was only available after a considerable time lag. But the Bureau of the Census is now publishing Business Formation Statistics, which gives quarterly estimates of the patterns of new business start-ups. For example, the BFS report for Fourth Quarter 2019 was published earlier this month on January 15.

    The idea here is to get data on new business formation by using data on the number of employers who request "employer identification numbers" from the US Census Bureau--which a new business needs for government reporting on taxes and for other reasons. Thus, it provides a forward-looking view of how many firms are likely to be hiring in the near future.

    John Haltiwanger, who played a prominent role in helping to launch this data series, explained ihow it works in an essay on "Synthesizing Micro and Macro Evidence on the US Economy" in the NBER Reporter (2019:3). Haltiwanger writes (footnotes omitted):

    One challenge is that the underlying micro administrative data on businesses are typically not sufficiently timely to generate economic indicators on the current health of the economy. The Business Formation Statistics (BFS) are an important exception; I helped develop them with collaborators from the research community, the Federal Reserve Board, and the Census Bureau. BFS are based on the real-time flow of applications for new employer identification numbers that the Census Bureau receives on an ongoing basis. The potential of the BFS, illustrating new applications that have a high propensity for becoming employer businesses, is shown in Figure 3. This data series, along with other new statistical measures, is now released within a couple of weeks of the end of the most recent quarter at national and state levels. More disaggregated series at sub-state and sector levels can also be constructed. Figure 3 shows that ... [h]igh-propensity applications for new businesses in 2019:2 were still 6 percent below the pre-Great Recession levels.



    As the figure illustrates, the number of applications by businesses for employer identification numbers plummeted during the Great Recession, and even after a decade without a recession has not yet bounced back to its earlier level. For some earlier posts with other evidence and discussion about this apparently decline in US entrepreneurship, two starting points are:

    A version of this article first appeared on Conversable Economist

     

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    Business Formation Statistics: Getting to Know You

    Timothy Taylor
  • 4
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      ["title"]=>
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      string(163) "

    The Gallup Poll regularly asks about what people see as America's most important problem. 

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    The share of people mentioning economic issues has been plummeting, from as high as 86% back in the Great Recession of 2009, down to 11-12% at present--the lowest level of concern over economic issues in the 21st century.

    This decline started during President Obama's second term, but has continued during the first three years of President Trump.

    Of course, the real-world economy will always have issues and problems.

    But given that the previous recession ended more than a decade ago in June 2009 and the unemployment rate has been 4% or lower since March 2018, it makes perfect sense that economic issues should not be at the top of the current worry list.

    A version of this article first appeared on Conversable Economist

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    Americans Don't See Economy as a Nation's Most Important Problem

    Timothy Taylor
  • 5
    object(stdClass)#13412 (59) {
      ["id"]=>
      string(4) "5399"
      ["title"]=>
      string(69) "Negative Rates & The Destruction Of Money: Sweden Ends Its Experiment"
      ["alias"]=>
      string(66) "negative-rates-the-destruction-of-money-sweden-ends-its-experiment"
      ["introtext"]=>
      string(473) "

    Negative rates are the destruction of money, an economic aberration based on the mistakes of many central banks and some of their economists who start from a wrong diagnosis: the idea that economic agents do not take more credit or invest more because they choose to save too much and therefore saving must be penalized to stimulate the economy. Excuse the bluntness, but it is a ludicrous idea.

    " ["fulltext"]=> string(5863) "

    Inflation and growth are not low due to excess savings, but because of excess debt, perpetuating overcapacity with low rates and high liquidity and zombifying the economy by subsidizing the low productivity and highly indebted sectors and penalizing high productivity with rising and confiscatory taxation.

    Historical evidence of negative rates shows that they do not help reduce debt, they incentivize it, they do not strengthen the credit capacity of families, because the prices of non-replicable assets (real estate, etc.) skyrocket because of monetary excess, and the lower cost of debt does not compensate for the greater risk.

    Investment and credit growth are not subdued because economic agents are ignorant or saving too much, but because they don’t have amnesia. Families and businesses are more cautious in their investment and spending decisions because they perceive, correctly, that the reality of the economy they see each day does not correspond to the cost and the quantity of money.

    It is completely incorrect to think that families and businesses are not investing or spending. They are only spending less than what central planners would want. However, that is not a mistake from the private sector side, but a typical case of central planners’ misguided estimates, that come from using 2001-2007 as “base case” of investment and credit demand instead of what those years really were: a bubble.

    The argument of the central planners is based on an inconsistency: That rates are negative because markets demand them, not because they are imposed by the central bank. If that were the case, why don’t they let rates float freely if the result was going to be the same? Because it is false.

    Think for a moment what type of investment, company or financial decision is one that is profitable with rates at -0.5% but unviable with rates at 1%. A time bomb. It is no surprise that investment in bubble-prone sectors are rising with negative rates and non-replicable and financial assets skyrocket.

    Public debt trades at artificially low yields and, instead of strengthening economies, negative rates make governments more dependent on cheap debt. Politicians abandon any reformist impulse and prefer to accumulate more debt.

    The financial repression of central banks begins with a misdiagnosis, assuming that low growth and below-target inflation is a problem of demand, not of the previous excess, and ends up perpetuating the bubbles that they sought to solve.

    The policy of negative types can only be defended by people who have never invested or created a job because no one that has worked in the real economy can believe that financial repression will lead economic agents to take much more credit and strengthen the economy.

    Negative rates are a huge transfer of wealth from savers and real wages to the government and the indebted. A tax on caution. The destruction of the perception of risk that always benefits the most reckless. The bailout of the inefficient.

    Central banks ignore the effects of demography, technology and competition on inflation and growth of consumption, credit, and investment, and with the wrong policies generate new bubbles that become more dangerous than the previous ones. The next bubble is to increase again the fiscal imbalances of the countries. Even worse. When central banks present themselves as the agent that will reverse the effect of technology and demographics, they create a greater risk and bubble.

    Sweden launched its failed negative rate plan almost five years ago and now reverses it due to the financial risks that are created. The most interesting thing is that it reverses the policy of negative rates precisely because of the risk of an economic slowdown because the evidence shows that investment and consumption decisions do not increase with financial repression.

    In Sweden, with negative rates, the real estate price index has increased 50% (from 160 points to 240), the average residential index has risen 27%, non-replicable assets have risen between 30% and 70 % (infrastructure, etc.), the stock market has risen more than 20%. In that period, household consumption and investment (gross capital formation) have increased very little and real wages have remained stagnant.

    Monetary policy has gone from being a support for structural reforms to an excuse to avoid them. Now, governments are delighted to read that “fiscal measures” must be implemented. And when a government hears “fiscal measures” it translates into “spending.” And when the eurozone governments start spending, the result is always the same: more debt and higher taxes.

    In the eurozone, the economic aberration of negative rates continues despite the evidence of the collateral risks they generate. Meanwhile, you and I are blamed for not spending and borrowing more. What can go wrong?

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Excuse the bluntness, but it is a ludicrous idea." 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    Negative Rates & The Destruction Of Money: Sweden Ends Its Experiment

    Daniel Lacalle

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