|
Potential Larger Implications of
Volatile
Financial Markets, "Financial Glut" and
Real "Investment Restraint"
by
Econotech
March 5, 2007
Mar
5 (Econotech FHPN)--To keep this reasonably short, I am not going to
recap the highlights of what happened in global financial markets last
week, nor try to guess their short-term directions, there is plenty of
that of widely varying quality all over the web, so I keep my thoughts
on such subjects to my private e-mails (for a very small sample, see
my Feb 27 post link).
One and Done Re-Rating of Global Real
Estate Assets
Rather, I would like to focus on one simple but critical point. In
this 2002-07 business and financial cycle, the U.S. and global economy
probably has used up its “one-off” reprieve from the previous
recession, namely through a massive “re-rating” of global
residential real estate on the basis of a huge shift downward in
global long-term interest rates, term premium, and credit risk spreads
Whatever the trajectory of global real estate prices going forward, it
would seem likely that this unprecedented “re-rating” is one and
done, that asset class can’t get significantly re-re-rated yet
again, at least further upwards (although NYC real estate is still
going up since it is based on the huge bonuses generated by the
hyperspeculative financial, not real, economy).
This real estate asset re-rating was a one-time adjustment,
essentially based on compressing decades of suppressed economic
development of the majority of the global population into a very tiny
5-10 year window of unprecedented change, and projecting that
high-growth, low-inflation historic shift out into the future. Even
thought this rapid global development trend is likely to continue,
with ups and downs, that one-time historic step function is probably
now by-and-large over.
Good News Is That Time For Economic
Re-Adjustment Was Bought
The good news is that this bought the U.S. and global economy five
more years of prosperity, on the basis of a massive creation of paper
asset “wealth,” especially in home equity (and also thus
non-income “savings,” as incorrectly redefined from the
traditional GDP measures, by some conservative economists), especially
for the upper 20% of the population, that “trickled down” into
very robust U.S. consumer spending and import demand from, and
investment in, the rest of the global economy.
(Briefly, here is aggregate statistical data on household “wealth
creation” from the last release—the next quarter will come out
March 8—of the Fed’s “Flow of Funds Accounts,” Z.1. From Table
B.100 Balance Sheet of Households and Nonprofit Organizations, pg 102.
All percent changes are from the end of 2001 to end of third quarter
2006.
Household real estate assets (line 4), home mortgages (line 32), and
owners’ equity (line 49) grew 11.0%, 13.1%, and 9.3% CAGR over this
time frame. All other assets (lines 1 minus 4), liabilities (lines 30
minus 32), and net worth (lines 41-49) grew 5.6%, 5.5%, and 5.6% CAGR.
I.e., real estate assets, liabilities and net worth grew roughly twice
as fast as that of everything else the past five years.)
The Bad News Is That Time Has Probably
Now Been Squandered
The bad news is that those five years of breathing room now have been
squandered, and it’s probably too late to change that.
The U.S. economy continues to be structurally changed to satisfy this
booming home-equity “wealth creation” internal domestic demand,
not to satisfy the export market for the development of the rest of
the world, hence the huge U.S. current account deficits. A good
example of this has been the huge shift in focus of Silicon Valley
from corporate productivity tools to ad-based media business models,
following the huge success of Google.
With a long-term trend of stagnating real wages, should the worse come
to pass and last week turns out to be the harbinger of a decline into
a global slowdown or recession, the U.S. in particular will need to
live off its home equity, so to speak, built up over the past five
years, provided it doesn’t substantially fall. As a result, muddling
through may be the best that one can hope for if the U.S. and global
economy were to enter a recession.
What Will End the 35-Year Decline in
U.S. Real Wages?
By squandered breathing room I am not referring to the failure during
the recovery and expansion to address key looming fiscal issues
related to the impending “baby boomer” retirement demographic
shifts that are frequently focused on by establishment economists,
though that is very important.
Rather, I mean the failure to shift global real productive investment
away from the inward satisfying of the U.S. domestic consumption boom,
outward toward beginning to address the huge development needs of the
vast majority of the world’s population.
It seems very difficult for many Americans to think this way anymore,
since financing of its external deficits has seemed so easy and
painless. But businesses and people in literally every other country
in the world wake up every working day trying to figure out what to
sell the rest of the world in order to earn its keep. America by and
large no longer thinks that way, though it once did for two centuries.
This massive expansion of actually productive real investment may have
been the only thing that could have eventually slowly begun to reverse
the -15% decline in U.S. weekly real earnings since 1972.
(For data, see 2007 “Economic Report of the President,” Table
B-47, Hours and earnings in private nonagricultural industries on pg
286. In the column “Average weekly earnings, total private,” in
1982 dollars, 1972 was 331.59. Dec 2006, the last date provided, was
282.75, a -14.7% decline. The average in 2002 was 278.83 and in 2006
it was 278.66, i.e. no growth. The only even very modest growth since
1972 occurred from 1996 to 2000, when the data rose 6.2%, a 1.5% CAGR.)
Despite the very minor recent late cycle rise in real earnings, I’m
not sure why that long-term trend decline will be reversed. To
compensate for stagnant wages, household income was increased through
women increasingly entering the labor force, but that gain has long
since run its course. So, without some sort of renewed asset inflation
paper wealth creation, it is hard to see what will sustain aggregate
demand if a sharper slowdown were to occur.
Unfortunately, that critical opportunity to massively shift global
capital investment into more productive uses has been wasted in a
veritable orgy of unproductive private equity and other M&A deals
that have done virtually nothing except line the pockets of those
engaged in their return on leveraged legal looting (ROLLL, see my Dec
19 "World Needs Better "Face of American Capitalism," link).
“Overall Investment Restraint Is the
Real Macroeconomic Conundrum”--IMF's Rajan
To buttress that point, let me please try to invoke the authority of
no less than the former chief economist of the IMF, Raghuram Rajan,
who has just returned to his former home at that bastion of “free
market” capitalism, the University of Chicago (its business school,
not economics department). Of course he doesn’t exactly say what I
just did about ROLLL, no self-respecting eminent economist would put
it this way.
But Rajan does make a key point that I have tried to make far less
well several times on my web site, i.e. low interest rates are not
mainly the result of a so-called “savings glut,” a la Bernanke,
but rather also due to under-investment (I would argue massively so)
in real productive assets, in my formulation to meet the needs of most
of the world’s population, resulting in what Rajan calls a
“financing glut,” what I consistently label global
hyperspeculation.
(And, btw, the philanthropy directed at these needs by Gates, Buffett,
etc, which is incredibly worthwhile and extremely admirable, is not
enough, what I would argue is the "market failure" itself
ultimately must be directly addressed).
The following is from the Dec 1, 2006 remarks by Rajan, at the time
the Economic Counselor and Director of Research of the IMF, to the
G-30 meeting in NYC titled, “Is
There a Global Shortage of Fixed Assets?” The full text can
be found at this link.
I am reprinting extended excerpts of Rajan's remarks below, relying
upon the following usage policy from the IMF web site, “The IMF
freely authorizes downloading and/or reprinting files from its website
for any non-commercial use,” since my web site is completely
non-commercial.
Here is the customary disclaimer made by Rajan in footnote 1: “The
following reflect my views only and are not meant to represent the
views of the International Monetary Fund, its management, and its
board.”
Now, in Rajan’s own words:
"Is
There a Global Shortage of Fixed Assets?"
by Raghuram Rajan
"…The intent is to provoke discussion rather than to claim I
have all the answers …
I will argue that underlying these seeming anomalies [in the pricing
of financial assets] may be a global shortage of creditworthy hard
real assets relative to desired savings. This has resulted in a
financing glut that is particularly pronounced in debt markets. Of
course, I cannot prove this is what is going on, but it does fit the
facts reasonably well. Moreover the implications are quite important
for policy.
Let me draw on three global ingredients to build the case for my
hypothesis. The first is a widespread surge in productivity across the
world. The second is a desired savings rate that continues to be high,
particularly supported by corporations, but also by emerging market
governments. The third, and perhaps least well understood, is global
nominal investment in physical assets that has yet to return to past
levels (as a share of GDP) despite the higher productivity and
available savings …
Given strong productivity growth and an unabated desire to save, it is
therefore surprising that actual corporate physical investment has not
kept pace. After all, if productivity growth is strong as is the
desire to save, investment should be both profitable and easily
financed. Yet investment is only slowly returning to the levels
reached in the last decade, and I would conjecture, probably below the
quantities that might be warranted by the tremendous growth
experienced over the last few years.
To my mind, overall investment
restraint is the real macroeconomic conundrum (Bernanke (2005)
offered an early discussion of the phenomenon, though based on work at
the Fund, I believe the problem of the
excess of desired savings over realized investment is better described
as investment restraint rather than a savings glut). [bold
emphasis in this paragraph added by econotech] …
To summarize, I have argued the world has experienced strong
productivity growth, and desired savings that continue to remain high,
but actual investment, after plunging at the turn of the century,
despite rapid rates of growth recently, is yet to recover fully. Let
me now turn to the consequences.
The mismatch between unabated global
desired savings and lower realized investment, between the amounts
available for finance and the flow of hard assets to absorb it, has
led to a financing glut.
Let me now argue that the glut is
likely to be particularly pronounced in debt like instruments, and
this is partly responsible for low long term real interest rates the
world over lower. [bold emphasis added by econotech in the
above two paragraphs] …
There are a number of implications. First, given financial markets are
integrated, the glut has spilt over
into markets for existing real and financial assets—real estate,
high-risk credit, private equity, art, commodities, etc—pushing
prices higher. [unless where otherwise noted, this and the bold
highlights that follow were made in the original by Rajan] …
Second, while uncertainty may hamper
cross-border corporate investment, no such uncertainty hampers
domestic investment in non-traded goods such as real estate …
Third, different financial systems
have different abilities to take advantage of the global hunger for
savings instruments. The United States financial system is
particularly adept at creating instruments the market wants. For
instance, the recent phenomenon of
large leveraged buyouts may simply be the financial system catering to
a market that is desperate for debt. [bold emphasis added to
the second sentence by econotech]
Finally, given this discussion, I
would suggest that the easy financing conditions the world over are
not primarily because of the accommodative policy followed by the G-3
central banks in recent years, though clearly monetary policy can add
or subtract at the margin by affecting liquidity conditions and carry
trades.
Indeed, monetary authorities face a
particular dilemma. If they raise policy rates they could reduce
investment in sectors sensitive to short rates or liquidity,
increasing the financing glut, pushing long term interest rates even
lower, and increasing the possible mis-pricing in other asset markets.
… If on the other hand, monetary authorities allow the environment
to be excessively accommodative, they allow inflationary pressures to
build, even while the liquidity glut adds to the financing glut.
[bold emphasis added in this paragraph by econotech]
Let me conclude. Current conditions are unlikely to be permanent.
Indeed, investment does seem to be picking up steadily. My hope is
that as a better balance between desired savings and realized
investment is achieved over time—long term interest rates will move
up steadily, certain pumped up asset markets will deflate slowly,
exchange rates will adjust, and global imbalances will narrow, without
major blow-ups … We also know adjustments, either on the real or
financial side, rarely take place as smoothly as hoped for.
Appropriate caution is warranted. Thank you."
Paulson’s Latest China Trip,
Japan’s “Mr. Yen” on U.S.-China Deal
“On his trip next week, Paulson will meet with Vice Premier Wu Yi.
The secretary will hold meetings in Shanghai, China's financial
capital, with financial sector leaders and give a speech on Chinese
financial market reforms. The administration is trying to convince the
Chinese to open their financial markets to greater participation by
U.S. companies.” (UK Guardian, Mar 2)
Americans should be aware of Paulson’s agenda with China (I'm sure
China is, e.g. see my section on "Whither China" in my Oct
27 "Global Strategic Bargain," link).
Eisuke Sakakibara is Japan’s former Vice Minister of Finance for
International Affairs, where he gained visibility as “Mr. Yen”
during the Asian financial crisis of 1997-98. He is a strong proponent
of Japan’s system and interests, e.g. Japan floated the idea of an
Asian Fund during that crisis which was immediately snuffed out by the
Rubin-Summers U.S. Treasury Department. An economics Ph.D., he is now
at Waseda University.
In his remarks to Tokyo’s Foreign Correspondents’ Club of Japan on
Mar 2 (link
to the Bloomberg audio), Sakakibara says, “We really do not know the
magnitude of the carry trade” (my transciption, at 8:26 mark). Then,
deep in the Q&A period, he drops one of his outspoken comments
(often delivered with a hearty laugh):
“Well I think Mr. Paulsen [U.S. Treasury Secretary] and Governor
Zhou [head of China’s central bank] seem to have a struck a deal
that China would stick to a gradual appreciation of the renminbi. Wen
Jiabao [Premier of China’s State Council, like his predecessor in
that position, Zhu Rongii, CPC Politiburo Standing Committee member
most responsible for economic policy] has said that, in June of I
think 2006, that China would stick to the gradualism, and China would
not lose control of forex market either. And I think the deal is that
China would gradually appreciate the currency but at the same time
China would open the financial markets, particularly for U.S.
investment bankers. So I think as long as that deal is there, I would
not expect the renminbi to have a very rapid appreciation in the
coming year or so.” (my transcription at 1:00:31 mark)
Needless to say, China would not be pleased with this
characterization, rightfully so, especially when coming from a former
high Japanese official. My point in posting it is simply that
Americans should better understand what the real U.S. agenda is for
China and for American jobs.
Paulson is mainly concerned about the extraordinarily lucrative jobs
of his former colleagues at Goldman Sachs and other U.S.
hyper-speculative giants, not primarily with American manufacturing
jobs. That war was lost long ago, in the first Reagan administration.
America and China should also realize the risks of a Goldman-led U.S.
economy (e.g., almost the entire increase in S&P 500 earnings is
now coming from the financial sector). “Goldman Sachs Group Inc.,
Merrill Lynch & Co. and Morgan Stanley, which earned a record
$24.5 billion in 2006, suddenly have become so speculative that their
own traders are valuing the three biggest securities firms as barely
more creditworthy than junk bonds.” (Bloomberg, Mar 2)
Glenn Hubbard, a Harvard Ph.D. economist, was chairman of the Council
Economic Advisors in the Bush administration and was reportedly
interested in replacing Greenspan as Fed Chairman, the post Bernanke
got (a hilarious, light-hearted video spoof link
of this by the Columbia b-school follies, where Hubbard is dean, was
widely circulated on Wall Street last year).
Hubbard recently addressed the Stanford Institute for Economic Policy
Research. He tells a little story:
“I once showed a picture to President Bush of declining work in a
sector. And he said yeah, I’m sick of the manufacturing jobs we’re
losing. I said Mr. President, I just showed you agriculture, 1900 to
1940, and do you want to put all those people back on the farm?” (my
transcription, 32:30 mark)
Left unsaid was that earlier era was one of rapidly rising real wages
and productivity. This historically anomalous era is one of rapidly
rising productivity, but as I mentioned earlier, declining real wages
since 1972 (I won’t get into the distinction between compensation
and wages here, it doesn’t really change the unprecedented in
American history negative trend in real wages).
Book recommendations: Corporate
America has responded to the distorted “market signals” I think
inherent in Rajan’s above analysis by meeting U.S. domestic demand
from the home equity “wealth creation.”
There are several very well-meaning books, usually by professors at
leading b-schools, that attempt to re-orient this corporate focus
outward toward more sustainable global economic development.
All are excellent, but I think all suffer from the same limitation of
not realizing that the necessary re-ordering of corporate investment,
especially away from the wasteful paper-shuffling of assets by private
equity and other M&A deals, depends on the need to re-prioritize
the incentives coming from global capital markets, which have been
captured by the global hyper-speculator hedge and private equity funds
and investment bannks (the same thing).
Perhaps the two most well-known books of this genre are “The
Fortune at the Bottom of the Pyramid,” (2004) by C.K.
Prahalad and “Capitalism at the
Crossroads,” (2005) by Stuart L Hart, and also “The
86 Percent Solution,” (2005) by Vijay Mahajan and Kamini
Banga; “Green to Gold,”
(2006) by Daniel C. Esty and Andrew S. Winston.
A related genre looks at the lessons from increasingly world-class
firms from the emerging markets themselves, see “The
Emerging Markets Century,” (2007) by Antoine W. van Agtmael
and “Made in China,” (2005)
by Donald N. Sull.
A larger but also important genre is on the impact of China and India
(now called Chindia by Wall Street), e.g. two very enjoyable reads by
FT journalists, “China Shakes the
World,” (2006) by James Kynge, and “In
Spite of the Gods,” (2007), by Edward Luce.
While not related to these genres, yet another b-school academic, Phil
Rosenzweig, who acknowledges Sull, has just published a very healthy
and skeptical antidote to the most standard of all business genres,
what makes a company great, “The
Halo Effect” (2007). Also see “Hard
Facts, Dangerous Half-Truths” (2006) by Jeffrey Pfeffer and
Robert I. Sutton.
And speaking of b-school profs, about twenty-five years ago marketing
profs, including Theodore Levitt and Philip Kotler, began their
campaign to shift the mind of America’s business leaders outward to
markets and customers.
Unfortunately, that shift has now focused so heavily on the home
equity-based demands of the U.S. consumer, rather than those of the
global economy. A sympathetic description of the consumer's
never-ending obsession with “trading up” and “trading down” is
“Treasure Hunt” (2006) by
Michael J. Silverstein and John Butman.
For my book recommendations on the Middle East and oil, see the last
section my Feb 28 article link,
to which I would add to that list “The
J Curve” (2006) by Ian Bremmer. (more like a swoosh. The J
curve, from international economics, was also adapted by yet another
management author in “Managing the
Dynamics of Change,” (2006) by Jerald M. Jellison, one of the
better books on corporte change management.)
© 2007 Econotech
Editorial
Archive | Econotech
Blogspot
This
article is intended solely for information purposes. The opinions are
those of the author only. Please conduct further research and consult
your financial advisor before making any investment/trading decision. No
responsibility can be accepted for losses that may result as a
consequence of trading on the basis of this analysis.
CONTACT
INFORMATION
Econotech
USA
Email l Website
The
opinions of FSU contributors do not necessarily reflect those of
Financial Sense.
|
