The Economic Machine

The economy works like a machine. By examining Productivity, the Short Term Debt Cycle, and the Long Term Debt Cycles we can see how the machine is working around the world.  A new country featured each post. Opinions are my own. Feel free to knock them down. @economicmachine

[theeconomicmachine]

United States’ Economic Machine

Welcome back my friends, to the show that never ends….or does it?

The “show” being, of course, the perpetual growth machine that is the largest economy in the world, and our home, sweet, home, the good ol’ U - S - of - A.

But can America just keep growing and growing...forever?  Can stocks build you a little golden stairway to heaven, with a never-ending pile of profits for you to rest your little head on?  Or does a big bad bear lurk in the deep dark woods, waiting to maul us to pieces?  

Let’s take a look, shall we?

As always, I will be looking at the economy through a “transaction-based” approach, which simply means at the bottom of everything, an economy is just someone selling something, and someone buying something, multiplied a gazillion times.  That’s really it.

I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

Productivity

United States is the largest economy in the world, with personal consumption accounting for 68% of GDP (roughly 23% goods and 45% services).  To begin our analysis we first look at current GDP Growth Rate, which expanded at an annualized rate of 0.7% in the 4th quarter of 2015, which was below estimates of 0.8% growth.

 GDP Annual Growth Rate in United States seems to have been operating within a range in the last decade, with an upward bound of 5%.  But as you look back farther there are peaks and troughs clearly seen.  At our current levels I think we have some downside risk here, but how much is the key question.

Now, keep in mind, recessions/depressions don’t occur because a drop in Productivity, as traditional economy theory teaches.  I have learned, primarily from studying Ray Dalio, that they occur because of a drop in demand, and that is largely due to a drop in credit creation, which I will explain further below.  

Let’s look at the Long Term Debt cycle to clear up the picture a bit.

 The Long Term Debt Cycle

 Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts.

We look at the Long Term Debt Cycle because the availability of credit(debt) allows people/countries to essentially spend more than they make.  Why save and wait to buy that new boat or build that new infrastructure project, when you can just borrow the money and get it now, right?  One person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending more, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in United States. United States recorded a Government Debt to GDP of 102.98 percent of the country's Gross Domestic Product in 2014 (most recent available data), and looks headed for levels we haven’t seen since World War II.  This, of course, is due to QE.  And is a very important number, as explained below.

When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy, since the government is one of the largest participants in the economy.  At these levels we are obviously in an environment of relatively high debt levels.  We’re not at Japan levels of debt here, but it is worrisome to me.

Now, let’s talk about something very important, and that is deleveragings, which are the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be improved by central banks lowering the cost of money. In depressions,

       1.  Many people/countries owe more money than they have, so they can’t pay back their debts, and

       2.     monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth because interest rates are near 0% and can’t be lowered (this produces deflationary deleveragings), or because money growth is used to buy assets to hedge against inflation (investors believe that the value of any money they lend out will be eroded by inflation, so they hedge against that), and doesn’t help expand credit growth, in which case you get an inflationary deleveraging.

Central Banks typically print money to end depressions in an effort to ease the pain felt by the reduction in credit, and austerity (if that trap was sprung).

Sorry for all the details, but I like to try to explain my thinking as clearly as possible.  

Moving on!  Next we consider Interest Rates in United States, which, as everyone knows was just raised recently 25 basis points.

As may be obvious to readers, with rates at this level, Yellen has little to no ammo if a recession/depression were to occur.  Personally, I think the Fed has backed themselves into a tough spot here.  Some think this leads to more QE, or even negative rates, in our near future, and I certainly think that is a possibility.  But I think things would have to get very bad, very quickly, for that to occur.

Let’s switch to Money Supply (M0) in United States, which has been steadily rising since the 50s, but saw a dramatic increase since 2008. 

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  Which would, of course, lead to inflation.  

But there is no inflation.  Why??  Most likely due to what I like to think of as a “mini-deleveraging”. Meaning people have been paying down debts instead of spending. 

The inflation rate in United States was recorded at 0.70% in December of 2015. Personally, I think this is due to stagnate wage growth, and people using savings from cheap gas to pay down their debts, which have accumulated over the past decade or so.

Bottom line, with all the money the Fed has pumped into the system (most of which went into financial assets and propped up the wealthy, since they own the financial assets, which in turn has inadvertently caused a furthering of the economic divide in this country), and no inflation to show for it, something is wrong here.  Very worrisome to me.

I like to look at the 10 Yr Breakevens to get an expectation of inflation in a market.  This measures the gap between the 10yr treasury and TIPS.  The lower the spread, the lower trader’s inflation expectations.  Right now, the 10-year in United States has is at an astounding 1.73 % as of this writing, and the TIPS is at 1.33%, for a spread of 40 Bps. This is a narrow spread, which seems to suggest that trader’s are not pricing in any inflation risk in the future.

Note: Inflation kills bond portfolios.  Here’s how….as inflation rises so do interest rates, by and large.  And as interest rates rise, bond prices falls (remember, they move in opposite directions!). Add to that the principal you get back in, say, 10 years is worth less if inflation has risen 2% in those 10 years.

Recently, there has been a rush to safety, as the yield on the 10-yr has fallen off a cliff since the start of 2016, when it was around 2.3%. This would further suggest the market does not anticipate inflation rising any time soon.  

Now, very important point here!!!  -  debt problems typically occur because financial assets are bought at high prices with credit…then they fall and people can’t afford to service the debt they racked up.  Let’s look at the overall United States Stock market to get a general picture of where financial assets are currently.

Obviously, we had a significant pull back since January.  But look at the march up since 2008!!  Look at that bull market we’ve all been a part of, and might not have even realized, for the past 7 years.

This chart clearly shows that the stock market in United States has seen some cycles in the last couple of decades.   This is a bit worrisome as assets prices have gaped up, and it appears that we are entering the down draft of our cycle.  Just have far will we fall, though?

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices. 

As seen above, Government spending in United States has come down off the 2009-10 peak.  That was an unsustainable level, so I actually think bringing down spending is a good thing.  However, it looks to be back on the rise again.  Just something to keep an eye on.

IMPORTANT NOTE: The top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

Long Term Debt Cycle Summary:  With a slight expansion in GDP growth, interest rates at 0.25%, a large money supply with inflation practically non-existent, the main worries right now for me are the inflated Stock Market (there is still a lot of potential down side) and a high government Debt to GDP (but when didn’t America have huge debt issues ;-).

Still, the machine in America is humming along.  We’ve been battered since that start of 2016.  But consumers are still buying.  Companies are still hiring.  There is no blood in the streets...yet.

My next level of thinking though says that we might have already seen the peak in this cycle.  And part of me wonders if it was also the peak of the Long Term Debt Cycle.  We have a scary condition here with roughly 0% inflation, high asset prices, falling GDP growth, basically 0% interest rates and the 10yr falling off a cliff.

One can never be sure, and timing the cycles in the short term, is by and large, impossible.  However, the Long Term Debt Cycle has been growing for decades now.  At some point, it will reverse, and come crashing down.

Examining the Short Term Debt Cycle will hopefully give us some more insight.  Let’s see!

 The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to tamp down inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending for the last decade.

Steadily rising!  Now, take a look at consumer credit.

While Consumer Credit increased to $21.27 Billion in December, it is nowhere near the levels we saw in 2006 or 2011.  And this is part of the reason why we are not seeing any inflation, in my opinion.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tightened monetary policy, which brings about a recession.  

Let’s take a look at Capacity Utilization to get a picture of production.  In United States, levels decreased to 76.5% in the December.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.  

We can also look at Industrial Production, which slowed to -1.8% in December of 2015, the lowest level in 6 years.  A worrisome sign.

 Conclusion:

I hate to say it, but I think there is the potential for something catastrophic to happen here...the likes of which none of us have ever experienced.  I think “the Big One” is coming.  It could be 2016...or 2017...or 2019.  I’m not sure. One thing I am certain of though is that markets are cyclical.  And right now, we look to be at the peak of a very…very long cycle.

However, even considering the recent pull back we had in the markets, America is still a beautiful bald Eagle, and she is flapping her wings, soaring high over the Rockies right now.  Just keep in mind that probably won’t last forever.

Economic growth expanded marginally 0.7% in the 4th quarter.

Government debt is high at around 102%, but that not that atypical for the US, and not a real worry at this point.

Interest rates are at 0.25%, which leaves Central Banks with few options.

Money supply has been steadily growing since the 50s.

Inflation is practically non-existent.  Even with low oil prices and a steady rise in consumer spending.

The 10-yr is at 1.73%, down from 2.3% 5-6 weeks ago!  

Capacity Utilization is at 76.5%, establishing that there is probably a bit deal of slack in the economy, but not too much to make me worry.

And Industrial Production slowed to a 6 year low of -1.8%, which is worrisome.  

Bottom line, there are problems with the United States’ Economic Machine.  Now, relatively speaking, we are considered by some to be the bell at the ball right now. But that might just be due to the fact that the rest of the party (i.e. the global market) is filled with a bunch of ugly monsters.  

I believe, by and large, we are at the end stage of this short term cycle.  More worrisome to me though is whether or not we are reaching the peak of the Long Term Debt Cycle, and it looks like we might be getting there soon, say within the next year, or couple of years.

So, if you’re a value investor, the above is all great news. Keep some powder dry, value investors. Seek some safety out there.  I would look into medium to long term treasuries, and gold.  I think there will be a huge flight to safety in the next 6-12 months, pushing down treasuries and pushing gold up.  And if there is a strong pull back, start your hunting.  Look for good companies at fair prices.  You’re never going to catch the absolute bottom.  So don’t try to time it perfectly.  You’ll do just fine focusing on buying good companies, at reduced, fair prices.  And don’t be afraid to jump in when everyone around you is screaming and crying about how they lost 40% in their 401k.  That’s precisely when you want to pounce.

The bargains of a life-time are coming, my friends.  The bargains of a life-time!

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Japan’s Economic Machine

Today we are going to take a trip to Japan, because I am curious as to where the country stands at the moment.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

Productivity

Japan is the 3rd largest economy in the world, that has been struggling through a rough go lately.   To begin our analysis we first look at Japan’s current GDP Growth Rate, which contracted by 0.30% in the 2nd quarter of 2015. 

One of my pinnacle beliefs I’ve learned from studying markets is that movements in GDP growth are typically due to expansions or contractions in credit.  People use credit to buy stuff they can’t afford.  This increases spending, bolsters company profits, pushes up stock prices, and everyone is happy.  But debt service payments become too burdensome, people can’t afford to services their debts, the cycle reaches a peak and comes crashing down.  That is how we get cycles.

Thus, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as traditional economy theory teaches.  I believe that they occur because of a drop in demand, and that is largely due to a drop in credit creation.  

Let’s look at the Long Term Debt cycle to clear up the picture a bit.

The Long Term Debt Cycle

In previous posts I’ve gone into detail about the Long Term debt cycles, but here I’m going to try to just state some important notes.

It typically occur over a period of 50-75 years.

Results from debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts.

Allows people/countries to essentially spend more than they make.

One person’s spending is another person’s income. 

So, an increase in credit, increases spending, which increases income levels, which increases spending more, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Japan. Japan recorded a Government Debt to GDP of 230% of the country's Gross Domestic Product in 2014 (most recent available data).  This, of course, is very high.

When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.

Now, lets talk about something very important, and that is deleveragings, which are the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be improved by central banks lowering the cost of money. In depressions,

Many people/countries owe more money than they have, so they can’t pay back their debts, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth because interest rates are near 0% and can’t be lowered (this produces deflationary deleveragings), or because money growth is used as a hedge against inflation and doesn’t help expand credit growth, in which case you get an inflationary deleveraging.

Central Banks typically print money to end depressions to help ease the pain felt by the reduction in credit, and austerity (if that trap was sprung).

Now, one could consider Interest Rates in Japan, which, as everyone knows, is at 0%.  And has hovered around that number for the last 15 years.

With rates at this level, central bankers have no room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  

Let’s switch to Money Supply (M0) in Japan, which has been steadily rising since the 60s, but saw a dramatic increase since 2008. 

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry here is, of course, inflation.

The inflation rate in Japan was recorded at 0.20% in July of 2015.

As well, I like to look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10-year in Japan has increased to 0.33 % on Thursday.

The yield on government debt indicates expectations on inflation and debt repayment.  Inflation kills bond portfolios.  Here’s how….as inflation rises so do interest rates, by and large.  And as interest rates rise, bond prices falls (remember, they move in opposite directions!).  Add to that the principal you get back in say 10 years is worth less if inflation has risen 2% in those 10 years.

There has been a recent up tick in the yield on the 10 year, and I think what we are seeing here, overall, is that the market is exiting out of the 10-year, and might anticipate inflation rising.

Now, very important point here!!!  -  debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Japan Stock market to get a general picture of where financial assets are currently.

Obviously, we had a significant pull back in August.  This chart clearly shows that the stock market in Japan has seen some cycles in the last couple of decades, and seems to have reached a recent peak and is on the way down.   This is a bit worrisome as assets might be over-valued at these levels, and this might not be the best time to enter the market.

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing it’s spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices. 

As seen above, Government spending in Japan has been increasing since the 80s.  

IMPORTANT NOTE: The top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

Long Term Debt Cycle Summary:  With an expansion in GDP growth, interest rates at 0%, a large money supply with inflation practically non-existent, the main worries right now are the arguably over-valued Stock Market and a high government Debt to GDP.

My next level of thinking though says that we might be climbing up to a another peak, and part of me wonders if this next peak will be the peak of the Long Term Debt Cycle.  We have a scary condition here with 0% interest rates where monetary policy couldn’t spur credit growth if that is what we needed.  I would really need to see some specific data on debt service payments, and I haven’t been able to find a could source for that.

At this time, I think Japan is in OK shape (especially when compared to much of the rest of the world).  But I worry about the next 3-5 years.

Examining the Short Term Debt Cycle will hopefully give us some more insight.  Let’s see!

The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.  

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to tamp down inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been on a steady climb since the 1980s, but may have reached a peak recently.

Consumer Credit seems to have reached a trough recently, and is on the way up it appears.  This is great for economic growth.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

Let’s take a look at Capacity Utilization to get a picture of production.  In Japan, levels increased to 96.6% in the August.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.  

We can also look at Industrial Production, which slowed to 0% in July of 2015, a worrisome sign.

Conclusion:

Even considering all the worrisome news you hear about Japan, and the lost decade they have suffered through, I think we will start to see Japan regain its footing and pull itself out of the recent slump.

Economic growth contracted by 0.3% in the 2nd quarter.

Government debt is high at around 230%, which is worrisome, and needs to come down.

Interest rates are at 0%, and have been there for years, probably moving up soon, but its anyone’s guess as to when.

Money supply has been steadily growing since the 80s.

Inflation is really low

The 10-yr is at 0.33%, at the same time we have seen a RISE in the stock market.  

Consumer spending is on the RISE.

Consumer credit looks to be on the rise.

Capacity Utilization is at 96.6%, establishing that there is TIGHT levels right now.

And Industrial Production slowed to 0%, which is worrisome.  

Bottom line:  Japan has problems, but what country doesn’t?  The government is trying everything in their power to remedy the situation.  As such, I believe we are are likely nearing the end of the Recession, and will soon enter the Early Stage of the Short Term Business Cycle.  

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Russia’s Economic Machine

Today we take a trip to the mother of all countries...Russia.  A place that is rich in natural resources, vodka and a suffocating dose of corruption ;-).

I did a previous analysis back in November, where I came to the conclusion that Russia still had some rough days ahead.  Let’s revisit the country to see if the rough days are over, and how the Economic Machine is working there now.

As always, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something, and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth (2) The Long Term Debt Cycle (3) The Short Term Debt Cycle.

Let’s get started!

Productivity

Russia is the 5th largest economy in the world, and one of the largest exporters of oil and natural gas.  Services make up 58% of the economy.  To begin our analysis we first look at Russia’s current GDP Growth Rate, which contracted by -2.1% in the 2nd quarter of 2015.

GDP Annual Growth Rate in Russia averaged 0.77 percent from 1996 until 2015, reaching an all time high of 4.10 percent in the fourth quarter of 1999 and a record low of -5.40.

At current levels we appear to be well below the average, so lets see what is driving this.  Technically, we are in a recession at these levels.  When will Russia pull itself out?

Keep in mind, one of my pinnacle beliefs I’ve learned from studying markets is that movements in GDP growth are typically due to expansions or contractions in credit.  People use credit to buy stuff they can’t afford.  This increases spending, bolsters company profits, pushes up stock prices, and everyone is happy.  But debt service payments become too burdensome, people can’t afford to services their debts, the cycle reaches a peak and comes crashing down.  That is how we get cycles.

Thus, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as traditional economy theory teaches.  I believe that they occur because of a drop in demand, and that is largely due to a drop in credit creation.   Let’s look at the Long Term Debt cycle to clear up the picture a bit.

The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts.

We look at the Long Term Debt Cycle because the availability of credit(debt) allows people/countries to essentially spend more than they make.  Why save and wait to buy that new boat or build that new infrastructure projects, when you can just borrow the money and get it now, right?  One person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending more, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Russia. Russia recorded a Government Debt to GDP of 17.92 percent of the country's Gross Domestic Product in 2014 (most recent available data). Government Debt To GDP in Russia averaged 26.09 Percent from 1999 until 2014, reaching an all time high of 99 Percent in 1999 and a record low of 7.90 Percent in 2008.  So at these levels we are near the lows of the past couple of decades.  Look for this number to rise as the government takes on more debt to spend and bring the economy out of the doldrums. 

When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.  At these levels we are obviously in an environment of low debt levels.  The government shouldn’t have any problems paying their future bills with debt at these levels, and can take on more debt to spur economic growth if they wanted.  All good signs.

Now, lets talk about something very important, and that is deleveragings, which are the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization. 

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be improved by central banks lowering the cost of money. In depressions,

1. Many people/countries owe more money than they have, so they can’t pay back their debts, and

2. monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth because interest rates are near 0% and can’t be lowered (this produces deflationary deleveragings), or because money growth is used as a hedge against inflation and doesn’t help expand credit growth, in which case you get an inflationary deleveraging.

Central Banks typically print money to end depressions to help ease the pain felt by the reduction in credit, and austerity (if that trap was sprung). Sorry for all the details, but I like to try to explain my thinking as clearly as possible. 

Moving on!  One could consider Interest Rates in Russia, which was last recorded at 11%, and have been in free fall all year, from a high of around 17%.

With rates at this level, central bankers have plenty of room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  So bankers still have this tool in their tool shed, should they need it.

Let’s switch to Money Supply (M2) in Russia, which has been steadily rising since 2000.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry here is, of course, inflation.

The inflation rate in Russia was recorded at 15.80 percent in April of 2015. Inflation Rate in Russia averaged 139.59 percent from 1991 until 2015, reaching an all time high of 2333.30 percent in December of 1992 and a record low of 3.60 percent in April of 2012.

I do not think that the hyperinflation days of the 90s are likely to return to Russia, but an inflation rate of around 16% is dangerously high and worrisome.  As prices rise, people will be able to afford less and less, and may take on more credit to make necessary purchase, which will only fuel more inflation, more credit growth, and economic expansion, but a worrisome bubble. 

I would keep a watchful eye on inflation in Russia.

As well, I like to look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10-year in Russia has increased to 11.88 percent today.  Yields have seen a rise lately drop since the middle of the summer.

The yield on government debt indicates expectations on inflation and debt repayment.  Inflation kills bond portfolios.  Here’s how….as inflation rises so do interest rates, typically.  And as interest rates rise, bond prices falls (remember, they move in opposite directions!)

I think what we are seeing here, overall, is that the market is exiting out of the 10-year to safety, and might anticipate inflation becoming a problem.  Looks like the market thinks inflation is on the rise.

Now, very important point here!!!  -  debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Russia Stock market to get a general picture of where financial assets are currently.

This chart clearly shows that the stock market in Russia has seen some cycles in the last couple of decades, and seems to be edging back up to all-time highs.   This is a bit worrisome as assets might be over-valued at these levels, and this might not be the best time to enter the market.

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing it’s spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.

As seen above, Government spending in Russia seems to have peaked.  Not a good sign for economic growth in the near term.

IMPORTANT NOTE:  Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

LTDC BREAKDOWN:  With a contraction in growth, interest rates at 11%, and Debt to GDP at good levels, the government needs to spend more money and spur credit growth, and thus, overall economic growth.  As well, inflation is at worrisome levels, and with bond prices falling I think the markets are worried about inflation at the moment.  Stock prices are at high, possible over-valued levels, so there is much to be worried about here. 

Bottom line, I think Russia is in the last moments of their long term cycle.  But examining the Short Term Debt Cycle will hopefully give us some more insight.

Let’s see!

The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.  

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to tamp down inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce. 

Below is a chart showing Consumer Spending, which has been highly cyclical and seems to have fell off a cliff in the 2nd quarter.

Consumer Credit has also been growing for years, and looks to have peaked and is falling.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession. 

Let’s take a look at Capacity Utilization to get a picture of production.  In Russia, levels increased to 61% in the August.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.  These levels seems to suggest a recession is here, as is clearly evident by the GDP numbers.

We can also look at Industrial Production, which decreased 4.70% in July of 2015.  Another worrisome sign.

Conclusion:

I like to see the bright side of things.  I’m an eternal optimist.  Life is a beautiful thing, and all that blah..blah..blah.  But even for me, I’m having a hard time finding much to like here.

Economic growth contracted in the 2nd quarter, which technically puts Russia in a Recession.  

Government debt is low at 17.92%.

Interest rates are at 11%, and have been in free fall all year, from a high of around 16%.

Money supply has been steadily growing.

Inflation has shot up to around 16%.

The 10-yr has been climbing recently to 11.88%, at the same time we have seen a RISE in the stock market. 

Consumer spending is DOWN.

Consumer credit is DOWN.

Capacity Utilization is at 61%, establishing that there is probably a great deal of slack in the economy.

And Industrial Production decreased 4.7% in the July. 

Bottom line, Russia has still has some serious problems.  They are likely in the early to middle stage of this Recession.  And they will eventually pull out of it.  But longer term I think they are reach the peak of the Long Term Debt Cycle, and that is more worrisome to me. 

I would look for a continued fall in consumer credit and spending, and if that is coupled with a continued rise in inflation, we have serious problems. 

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Malaysia’s Economic Machine

With everyone bad-mouthing Emerging Markets, I thought today we would try to find a bright spot.  Let’s take a trip to the beautiful country of Malaysia, famous for the Will Ferrell, I mean Mugatu, orchestrated coup to assassinate the Prime minister….Orange Moca Frappacino, anyone???  Any who, don’t let the only thing you see regarding Malaysia be the slide of ringgit.   There are positives once we get based this route.  Recently developing from an export led economy to one with more diversified interest, Malaysia is on the rise.   Let’s visit the country to see how the Economic Machine is working.

I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

Productivity

My grandfather made shoes for a living.  They were awesome shoes that lasted forever.  Sure, I was the only kid rocking patent leather oxfords in 4th grade gym class, but so what, you gotta differentiate from the herd, right?  Plus, my grandfather smiled every time he saw me wearing his shoes.  It was a win win.  Over the years he made me like a hundred pairs of shoes.  

Countries are like my grandfather.  They need to make some stuff...lots of stuff.  And sell it quickly.  Malaysia has done that through their exports, and that has brought their economy into its next transition, one primarily based on services.  

To begin our analysis we first look at Malaysia’s current GDP Growth Rate, which expanded by 4.9% in the 2nd quarter of 2015.  

Looks like GDP Annual Growth Rate in Malaysia averaged 4.77 percent from 2000 until 2015, so we’re right on the average.  

Movements in GDP growth are typically due to expansions or contractions in credit.  

But, remember, debt can’t grow forever.  If debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower, and you get the downturn of the cycle.

Currently Government Debt to GDP in Malaysia is at 52.80%, which is hovering a little over the average of 48% for the last 25 years.  This is a sustainable number, and not worrisome.

High debt levels can create governments that can no longer afford to service their debt.  They cut back on spending, which pulls down the economy.  But not at these levels, so Malaysia looks ok here.

Interest Rates are another important indicator, as they dictate everything from the cost of your mortgage, to the cost corporations and banks pay to fund their operations.  The benchmark in Malaysia has been stuck at 3.25% for over a year, nearing the highs of the last decade (3.50%). 

With rates at this level, central bankers have plenty of room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  So bankers still have this tool in their tool shed, should they ever need it.

Lets switch to Money Supply (M2)  in Malaysia, which has been rising since the early 70s.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

The inflation rate in Malaysia was recorded at 3.30 percent in July of 2015, which is right around the average of the past 4 decades (3.68%).  Prices seem to be under control, for the moment.

And the 10-yr has been creeping up since 2013 and sits at 4.40%. 

As most know, higher inflation kills bonds by driving up yields and crushing prices.  Traders might be pricing in a rise in inflation here, so I would watch the 10-yr closely.

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Malaysia Stock market to get a general picture of where financial assets are currently.

We’re correcting, like most emerging economies.  How far this correction goes is anyone’s guess.  Could it be the peak of the Long Term Debt cycle??

Government spending is key to figuring that out.  Government spending is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.

Love this chart. Look at those cycles!!  And it appears we at a trough here.  I would look for government spending to rebound strongly from these levels, and float the economy with it.  

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

We’re not there yet in Malaysia, with strong growth, government debt under control, interest rates at 3.25% and government spending about to pick up steam.

I think Malaysia is still in the upswing of their long term cycle.

Let’s look at the Short Term Debt Cycle to better understand this economy.

The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Consumer Spending in Malaysia slowed in the 2nd Quarter, and the below charter seems to suggest we may be at a peak...worrisome!!

Bank lending rates are at a 20 yr low of 4.57%, which would suggest a rise in credit growth.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

Lets take a look at Capacity Utilization to get a picture of production.  In Malaysia, levels increased to 78% in the 2nd quarter.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.

We can also look at Industrial Production, which increased 4.30% in 2nd quarter.

Now, lets pull it all together.

Conclusion:

So, the economy in Malaysia grew 4.9% in the 2nd quarter, Government debt is at ok levels 52.80%, interest rates are at 3.25%, money supply has been steadily growing, inflation is under control, with government spending suggesting a large pick up.  Consumer spending is up, bank lending rates are at historical lows, and Capacity Utilization is at 78%, so not much slack in the economy, and Industrial Production increased 4.3% in the 2nd quarter.  

Bottom line, Malaysia looks posed for further growth after we get out of this global correction we are seeing in EM.  Remember, buy when there is blood in the streets. 

Believe it or not, but I think that Malaysia is maybe towards the end of the “Early Cycle”, which typically lasts 5-6 quarters:

typically begins with the demand for interest rate sensitive items (e.g. housing and cars) and retails sales picking up because of low interest rates and lots of available credit.

it is also supported by prior inventory liquidations stopping and inventory rebuilding starting.

this increased demand and rising production pulls workweek and employment up.

credit growth is strong

economic growth is strong ( in excess of 4%)

inflation is low

growth in consumption is strong

the rate of inventory accumulation is increasing

Stock market is likely the best investment

And inflation-hedge assets (e.g. gold, oil, natural gas) and commodities are the worst-performing assets.

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Mexico’s Economic Machine

When I started this blog, I began with the analysis of a country I love, Mexico.  Let’s revisit the country to see how the Economic Machine is working there now.

As always, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something, and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

Productivity

Mexico is the 2nd largest economy in South America, with exports making up much of the activity.  Trade is vitally important, with 90% of it under free trade agreements  To begin our analysis we first look at Mexico’s current GDP Growth Rate, which expanded at 0.70% in the 4th quarter of 2014.

On average GDP growth rate has been around 0.76% since 1996, with a high around 2.9% and a low of -6.6%.  At current levels we appear to be at the average, so I would expect levels to hold here. But that of course is reliant on further analysis below.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Mexico at 36.9% of GDP in 2013 (most recent data available), which is a moderate level, and somewhat healthy.  However, these are the highest levels see in Mexico in about 3 decades, so we might want to watch this number as we could be hitting a peak here.

When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.  At these levels we seem to be in an environment where debt levels are falling.  The government shouldn’t have any problems paying their future bills with debt at these levels, and can take on more debt to spur economic growth if they wanted.  All good signs.

Now, lets talk about something very important, and that is deleveraging, which are the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Mexico, which have been locked at 3% for the past year.

With rates at this level, central bankers have plenty of room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  So bankers still have this tool in their tool shed, should they need it.

Lets switch to Money Supply (M3)  in Mexico, which has been steadily rising since the 1980s.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Mexico is at 3.06% in April 2015, which is a healthy rate of inflation, and seems to be the lowest levels seen in decades.  

However, if we take a closer look at CPI for the last 15 years, we see the cyclical nature of inflation in Mexico, and that we are currently in a trough.  I would expect this number to rise in the next couple of quarters, due to an increase in demand from consumers and the government.

As well, one can look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10Y decreased to 5.93% in May from 5.92% in April of 2015.  Rates were recently at a high for the year, and have been pulling back ever since as investors seek safety.  

The yield on government debt indicates expectations on inflation and debt repayment.  Inflation is typically seen as the primary killer of bond portfolios, as higher inflation typically drives interest rates up, and bond prices down.  I think what we are seeing here, overall, is that the market might anticipate inflation becoming a problem in the market, as bond yields have taken a dive lately.  

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Mexico Stock market to get a general picture of where financial assets are currently.

This chart clearly shows that the stock market in Mexico has been climbing for decades.  This is extremely worrisome to me, as the turn will come at some point, and with such a run up in asset prices I would think we will see a drop sooner rather than later.  

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Mexico had been steadily increasing for 40 years, and is extremely cyclical.  We just saw an enormous spike in spending, and might be at a peak at these levels, so I would look for a pull-back here, and that may slow economic growth.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP at good levels, and interest rates at 3%, the government has tools to spur credit growth, and thus, overall economic growth.  As well, inflation is at healthy levels.  However, stock prices are high and that is a bit concerning.  And the government could potentially be slowing their spending sometime soon.

Still, I think Mexico is still in the upswing of their long term cycle.

Let’s look at the Short Term Debt Cycle to better understand this economy.

The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been steadily increasing for a decade now, is highly cyclical and might be at a peak at these levels???

Consumer Credit has also been growing for years, and looks to be plateauing a bit.  Watch for a turn downward in this number.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

Lets take a look at Capacity Utilization to get a picture of production.  In Mexico, levels increased to 79.9% in the February of 2015.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.

We can also look at Industrial Production, which decreased 1.60% in February of 2015.  Not a super fantastic number, but not terrible or worrisome.

Now, lets pull it all together.

Conclusion:

So the recent growth numbers were ok, but not great, government debt to gdp is at a good level, consumer credit is at a healthy level, and consumer and government spending are strong, so I think that Mexico is likely somewhere in the the “Mid-Cycle” - this lasts an average of 2-3 quarters:

economic growth slows substantially

inflation remains low

growth in consumption slows

rate of inventory accumulations declines

interest rates dip

the stock market rate of increase tapers off

the rate of decline in inflation-hedge assets slows.

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Mauritius' Economic Machine

Today we are headed to Mauritius, a small country in Africa, to see how the Economic Machine is working there.

As always, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something, and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

Productivity

Mauritius is one of the most successful countries in Africa, with one of the highest GDPs.  Much of this success is due to a trade led economy that exports textiles, sugar and tourism.  To begin our analysis we first look at Mauritius’s current GDP Growth Rate, which expanded at 0.20% in the 3rd quarter of 2014.

On average GDP growth rate has been around 0.93% since 2000, with a high around 6% and a low of -1.7%.  At current levels we appear to be in a bit of a trough here, and levels typically rebound after low levels.  So I would expect levels to rise in the future.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Mauritius at 58% of GDP in 2013 (most recent data available), which is a moderate level, and somewhat healthy.  When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.  At these levels we seem to be in an environment where debt levels are falling.  The government shouldn’t have any problems paying their future bills with debt at these levels, and can take on more debt to spur economic growth if they wanted.  All good signs.

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Mauritius, which are set by the ECB and are currently at 4.65%, which is as high.

With rates at this level, central bankers have plenty of room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.

With rates falling for the last decade and a half, you would expect an increase in credit and thus spending, increased incomes, increased demand, and fast economic growth.  All of which we have seen in Mauritius.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Mauritius is at 2%, which is a very healthy level.  So I do not have any price pressure concerns here.

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Mauritius Stock market to get a general picture of where financial assets are currently.

This chart clearly shows that the stock market in Mauritius is at or near a 20 year peak.  This is worrisome to me, as the turn will come at some point, and with such a run up in asset prices I would think we will see a drop sooner rather than later.  

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices. 

As seen above, Government spending in Mauritius had been steadily increasing for 20 years, helping to prop up economic growth.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP at reasonable levels, interest rates high, but falling, inflation at a healthy level, stock prices are high and the government continuing to spend, I think this economy seems to be humming along still.  But, it is definitely going to reach the top of the mountain at some point, and there will be a crash.  Just keep that in mind.

Let’s look at the Short Term Debt Cycle to better understand this economy.

The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been cyclical and steadily increasing for a decade now..  I wonder if this is a peak?

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

Lets take a look at Industrial Production, which increased 2.60% in 3rd quarter of 2014, which is good.  Not great.  But good. 

Now, lets pull it all together.

Conclusion:

So the recent growth numbers were ok, but not great, government debt to gdp is at a good level, inflation is low, and consumer and government spending are good, so I think that Mauritius is likely somewhere in the the “Mid-Cycle” - this lasts an average of 2-3 quarters:

economic growth slows substantially

inflation remains low

growth in consumption slows

rate of inventory accumulations declines

interest rates dip

the stock market rate of increase tapers off

the rate of decline in inflation-hedge assets slows.

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Finland's Economic Machine

Today we are headed to Finland, to see how the Economic Machine is working there.

As always, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something, and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

1. Productivity

Finland is a largely industrialized economy, with manufacturing making up much of the activity.  Trade is also important, with exports accounting for around ⅓ of GDP.  To begin our analysis we first look at Finland’s current GDP Growth Rate, which expanded at 0.20% in the 3rd quarter of 2014.

On average GDP growth rate has been around 0.53% since 1975, with a high around 5% and a low of -6.3%.  At current levels we appear to be in a bit of a trough here, and levels typically rebound after low levels.  So I would expect levels to rise in the future. But that of course is reliant on further analysis below.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Finland at 57% of GDP in 2013 (most recent data available), which is a moderate level, and somewhat healthy.  When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.  At these levels we seem to be in an environment where debt levels are falling.  The government shouldn’t have any problems paying their future bills with debt at these levels, and can take on more debt to spur economic growth if they wanted.  All good signs.

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Finland, which are set by the ECB and are currently at 0.05%, which is as low as they can go, except if they go negative, which has happened in some countries recently.

With rates at this level, central bankers have no room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  That is a pervading problem throughout much of the developed world these days, and will come to the forefront in the coming years.  But at the moment I wouldn’t worry about this too much.

Lets switch to Money Supply (M3)  in Finland, which has see some cyclical moves over the last decade, but overall has been steadily rising since 1980.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Finland is at 0.50%, which is low and somewhat worrisome as the rate has been falling for decades and could potentially slip into negative territory or deflation.  The problem with deflation is that if people want to buy, say, some shoes, but they think that tomorrow the shoes will be cheaper, they will hold off purchasing them today.  That thought process ripples through the entire economy, and purchasing comes to a crashing halt and the economy slows considerably.

Deflation could pose a real problem here, and in much of the world, in the coming years.  Watch this figure closely!!

As well, one can look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10Y increased to 0.40% in February from 0.35% in January of 2015.  The overall trend has been a flight to safety and a crashing of yields in Finland.

The yield on government debt indicates expectations on inflation and debt repayment.  Inflation is typically seen as the primary killer of bond portfolios, as higher inflation typically drives interest rates up, and bond prices down.  I think what we are seeing here, overall, is that the market does not anticipate inflation becoming a problem in the market, as bond yields have bottomed out.  

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Finland Stock market to get a general picture of where financial assets are currently.

This chart clearly shows that the stock market in Finland is cyclical.  We have been rising in the last couple of years, and are nearing the highs in the short term cycle I believe.  This is extremely worrisome to me, as the turn will come at some point, and with such a run up in asset prices I would think we will see a drop sooner rather than later.  

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Finland had been steadily increasing for 40 years, and just saw an enormous spike, which has finally begun to taper a bit.  So government spending is falling in Finland and that may slow economic growth.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP at good levels, interest rates low, and inflation low and could be leading to deflation, stock prices are high and the government is slowing their spending, there are some problems in Finland.  With QE right around the corner I think it would be wise to look for inexpensive opportunities in Europe.  Finland might not be one.

Let’s look at the Short Term Debt Cycle to better understand this economy.

3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been steadily increasing for a decade now, and recently saw a huge spike.  I wonder if this is a peak?

Consumer Credit has also been growing for years, and looks to be plateauing a bit.  Watch for a turn downward in this number.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

Lets take a look at Capacity Utilization to get a picture of production.  In Finland, levels increased to 78.6% in the 1st quarter of 2015.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.

We can also look at Industrial Production, which decreased 0.90% in December of 2014.  Not great for economic growth.

Now, lets pull it all together.

Conclusion:

So the recent growth numbers were ok, but not great, government debt to gdp is at a good level, consumer credit is at a healthy level, and consumer and government spending are strong, so I think that Finland is likely somewhere in the the “Mid-Cycle” - this lasts an average of 2-3 quarters:

economic growth slows substantially

inflation remains low

growth in consumption slows

rate of inventory accumulations declines

interest rates dip

the stock market rate of increase tapers off

the rate of decline in inflation-hedge assets slows.

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Denmark's Economic Machine

Today we are headed to the lovely country of Denmark, to see how the Economic Machine is working there.

As always, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something, and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

1. Productivity

Denmark was not blessed with a great supply of natural resources, so much of their economy relies on imports and foreign trade.  It has a liberal trade policy within the EU, and one of the highest living standards in the world.  To begin our analysis we first look at Denmark’s current GDP Growth Rate, which expanded at 0.40% in the 3rd quarter of 2014.

On average GDP growth rate has been around 0.36% since 1991, with a high around 3.89% and a low of -2.4%.  The chart above shows the somewhat wild nature of Danish GDP growth.  However, when it falls it always rebounds, and with the falling euro (The Danish krone is part of the ERM-II mechanism, so its exchange rate is tied to within 2.25% of the euro), and an economy reliant on foreign trade will stand to benefit handsomely.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Denmark at 44.50% of GDP in 2013 (most recent data available), which is a moderate level, and somewhat healthy.  When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.  At these levels we seem to be in an environment where debt levels are falling.  The government shouldn’t have any problems paying their future bills with debt at these levels, and can take on more debt to spur economic growth if they wanted.  All good signs.

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Denmark.  The central bank of Denmark lowered its main interest rate for the 4th time in 2.5 weeks on February 5th, 2015.  Currently, rate are NEGATIVE, at -0.75%, which means you have to pay the bank 0.75% in order to keep your money there.  Very worrisome!!!

Lets switch to Money Supply (M2)  in Denmark, which has see some cyclical moves over the last decade, but overall has been steadily rising since 1991.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Denmark is at -0.10%, which is deflation, and very bad for economic outlooks.  The problem with deflation is that if people want to buy, say, some shoes, but they think that tomorrow the shoes will be cheaper, they will hold off purchasing them today.  That thought process ripples through the entire economy, and purchasing comes to a crashing halt and the economy slows considerably.

Deflation could pose a real problem here, and in much of the world, in the coming years.  Watch this figure closely!!

As well, one can look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10Y increased to 0.08% in February from 0.37% in January of 2015.  The overall trend has been a flight to safety and a crashing of yields in Denmark.

The yield on government debt indicates expectations on inflation and debt repayment.  Inflation is typically seen as the primary killer of bond portfolios, as higher inflation typically drives interest rates up, and bond prices down.  I think what we are seeing here, overall, is that the market does not anticipate inflation becoming a problem in the market, as bond yields have bottomed out.  

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Denmark Stock market to get a general picture of where financial assets are currently.

This chart clearly shows that the stock market in Denmark is cyclical, and that we might be at all time high at these levels.  This is extremely worrisome to me, as the turn will come at some point, and with such a run up in asset prices I would think we will see a drop sooner rather than later.  

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Denmark had been steadily increasing for 25 years, and may be plateauing at these levels, but II don’t see anything to suggest this will reverse sharply any time soon.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP high, interest rates low, and inflation low, there are some problems in Denmark.  Still, I like to take a contrarian view point.  You are supposed to sell when people are happy, and buy when people are panicking.  Not that people are panicking in Denmark, but with QE right around the corner I think it would be wise to look for inexpensive opportunities in Europe.  Denmark might be one.

Let’s look at the Short Term Debt Cycle to better understand this economy.

3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has seen some cyclical turns, but has been steadily rising for the last 4 years or so, and I would expect this to continue well into 2015.

Consumer Credit has also seen some cyclical swings, but did push higher in the 4th quarter of 2014 and I expect that to continue into 2015.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

Lets take a look at Capacity Utilization to get a picture of production.  In Denmark, levels increased to 80.30% in the 1st quarter of 2015.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.  So we are tight at these levels.  Very tight!

We can also look at Industrial Production, which increased 4.75% in December of 2014.  Clear cycles are evident in this chart, in fact, the numbers seem to drastically change each quarter, and I would think that would continue.

Now, lets pull it all together.

Conclusion:

So the recent growth numbers were ok, but not great, government debt to gdp is at a good level, consumer credit is at a healthy level, and consumer and government spending are strong.  The euro is falling (Remember, the Danish Kroner virtually pegged to the Euro through the ERM-II) I think that Denmark is in the the “Mid-Cycle” - this lasts an average of 2-3 quarters:

economic growth slows substantially ( to around 2%)

inflation remains low

growth in consumption slows

rate of inventory accumulations declines

interest rates dip

the stock market rate of increase tapers off

the rate of decline in inflation-hedge assets slows.

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Germany's Economic Machine

Today, Angela Merkel is visiting the White House to scarf some strudel and pound down some good ol’ German lager with President Obama, and Germany just posted a record surplus, so I thought it only fitting to take a deeper look at the Economic Machine of Germany.

As we always do, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

   1. Productivity

Germany is the largest economy in Euro Area, and the 4th largest in the world.  Its economy is an exports based one, and with a falling euro German products are going to get more competitive throughout the world.  To begin our analysis we first look at Germany’s current GDP Growth Rate, which expanded at 0.25% in the 4th quarter of 2014.

On average GDP growth rate has been around 0.29% since 1991, with a high around 2% and a low of -3.4%.  The chart above shows the relatively tame nature of German GDP growth.  Whenever it falls it always rebounds, and with the falling euro, and a trade surplus I would expect it to do just that in the coming quarters.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Germany at 76.90% of GDP, which is a high level, and somewhat worrisome.  When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.  At these levels we seem to be in a bit of a plateau, and I wonder if levels will fall or trend back up.  I would watch these numbers closely.

ow, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Germany, which are set by the ECB and are currently at 0.05%, which is as low as they can go, except if they go negative, which has happened in some countries recently.

With rates at this level, central bankers have no room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  That is a pervading problem throughout much of the developed world these days, and will come to the forefront in the coming years.  But at the moment I wouldn’t worry about this too much.

Lets switch to Money Supply (M1)  in Germany, which has been steadily rising for the last 4 decades or so.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Germany is at -0.30%, which is defaltion, and very bad for economic outlooks.  The problem with deflation is that if people want to buy, say, some shoes, but they think that tomorrow the shoes will be cheaper, they will hold off purchasing them today.  That thought process ripples through the entire economy, and purchasing comes to a crashing halt and the economy slows considerably.

Deflation could pose a real problem here, and in much of the world, in the coming years.  Watch this figure closely!!

As well, one can look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10Y increased to 0.37% in February from 0.27% in January of 2015.  Although, the overall trend has been a flight to safety and a crashing of yields in Germany.

The yield on government debt indicates expectations on inflation and debt repayment.  Inflation is typically seen as the primary killer of bond portfolios, as higher inflation typically drives interest rates up, and bond prices down.  I think what we are seeing here, overall, is that the market does not anticipate inflation becoming a problem in the market, as bond yields have been falling.  

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Germany Stock market to get a general picture of where financial assets are currently.

This chart clearly shows that the stock market in Germany is cyclical, and that we might be a all time high at these levels.  This is extremely worrisome to me, as the turn will come at some point, and with such a run up in asset prices I would think we will see a drop sooner rather than later.  

The only thing preventing that turn from happening in the next year is QE in Europe and the falling Euro.  Both will propel Germany forward in 2015.  But beyond that I just can’t say.  Lets dig deeper.

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Germany had been steadily increasing for 25 years, and I don’t see anything to suggest this will reverse any time soon.

As well, take a look at Government Spending to GDP, and you can see that we are in a bit of a valley here.  I think Government spending could pick up nicely in 2015, and that means economic expansion.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP high, interest rates low, and inflation low, there are some problems in Germany.  Still, I like to take a contrarian view point.  You are supposed to sell when people are happy, and buy when people are panicking.  Not that people are panicking in Germany, but with QE right around the corner I think it would be wise to look for inexpensive opportunities in Europe.  Germany might be one.

Let’s look at the Short Term Debt Cycle to better understand this economy.

   3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been steadily rising for the last 10 years.  We might be coming to a peak at current levels, and I would watch these figures closely for any sign of a downturn, because it may be coming soon.

Consumer Credit is in a bottom in the short term cycle at these levels, and I would look for it to increase in 2015, pushing the economy along nicely.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

Lets take a look at Capacity Utilization to get a picture of production.  In Germany, levels increased to 84.60% in the 1st quarter of 2015.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.  So we are tight at these levels.  Very tight!

We can also look at Industrial Production, which increased 0.40% in December of 2014.  Clear cycles are evident in this chart, and I think we could see a spike in production in 2015 as we come out of this bottom.

Now, lets pull it all together.

Conclusion:

So the recent growth numbers were healthy, government debt to gdp is at a good level, consumer credit is at a healthy level, and consumer and government spending are strong.  The euro is falling and German exports are surging….as hard as it is to believe, when I look at everything above, I think that Germany is in the The Early-Cycle”  -  this typically lasts for 5-6 quarters

typically begins with the demand for interest rate sensitive items (e.g. housing and cars) and retails sales picking up because of low interest rates and lots of available credit.

it is also supported by prior inventory liquidations stopping and inventory rebuilding starting.  

this increased demand and rising production pulls workweek and employment up.

credit growth is strong

economic growth is strong ( in excess of 4%)

inflation is low

growth in consumption is strong

the rate of inventory accumulation is increasing

The stock market is likely the best investment

And inflation-hedge assets (e.g. gold, oil, natural gas) and commodities are the worst-performing assets.

Germany is at the end of this phase in the cycle, in my opinion, and will slow transition to the mid-cycle phase probably in 2015.

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Pakistan's Economic Machine

Today we are going to take a trip to one of the poorest and least developed countries in Asia, Pakistan.  Let’s take a look at their Economic Machine, and see if there are any opportunities in this beautiful but troubled country.  

As we always do, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

     1. Productivity

Pakistan has seen around 5% GDP growth for the last decade, however it is mired in political instability, weak law enforcement and corruption that has limited foreign investment. .To begin our analysis we first look at Pakistan’s current Annual GDP Growth Rate, which expanded at 4.14% in the 2013/2014 year.

On average GDP growth rate has been around 4.92% since 1952.  The chart above shows a highly cyclical nature to GDP growth in this country, and I would look for GDP to go higher from these levels.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Pakistan at 63.30% of GDP, which is a somewhat high level, but not really that worrisome.  When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy. 

At these levels we seem to be coming out of a bottom, so we could see debt levels rise here in the next couple of years.  Pakistan’s government has room to increase debt levels to spur economic growth, so for the time being I don’t see this as a major concern, just something to keep an eye on.

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Pakistan, which are currently at 8.50%, which is high, and has plenty of room to go lower.

With rates at this level, central bankers have room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  Rates appear to be heading south in Pakistan, and that is good for increased lending and increased economic growth.  Look for a bottom around 7.5% at which point rates will begin to increase.

Lets switch to Money Supply (M0)  in Pakistan, which has been steadily rising for the last 7 years.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Pakistan is at 3.88%, which is a health rate in my opinion, so prices are rising largely due to demand, which means production should rise as well, and economic growth should follow.

Keep in mind the drop in oil prices, and Pakistan is a net oil importer, so that should be good news for the consumer.  I just think it is taking some time for the extra money they consumer may now have as a result of lower oil to make its way back into the economy.  

As well, one can look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10Y increased to 9.85% in February from 9.75% in January of 2015.  While the 10Y increased recently, it has seen a crash of sorts for the last year.

The yield on government debt indicates expectations on inflation and debt repayment.  Inflation is typically seen as the primary killer of bond portfolios, as higher inflation typically drives interest rates up, and bond prices down.  I think what we are seeing here, overall, is that the market does not anticipate inflation becoming a problem in the market, as bond prices have been falling.  

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Pakistan Stock market to get a general picture of where financial assets are currently.

This chart clearly shows that the stock market in Pakistan is hyper inflated, and is currently at a 25 year high.  This is extremely worrisome to me, as the turn will come at some point, and with such a run up in asset prices I would think we will see a drop sooner rather than later.

Perhaps Fixed Income is the way to go here, as the stock market is clearly very expensive, and when those levels turn, investors will see a flight to safety, which means bond purchases, and rates are going to crash.  So I think bond purchases at these levels might be a good idea.

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Pakistan had been steadily increasing for 50 years, and I don’t see anything to suggest this will reverse any time soon.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP low, interest rates high but falling, inflation at a good level, and a very expensive stock market, and government spending at a high, there are some problems I see in Pakistan.

Let’s look at the Short Term Debt Cycle to better understand this economy.

     3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been steadily rising for the last 15 years.  We might be coming to a peak at current levels, and I would watch these figures closely for any sign of a downturn, because it may be coming soon.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

To examine production capacity we look at Industrial Production, which increased 4.44% in November of 2014 (the most recent data available).  Clear cycles are evident in this chart, and I think this spike in production should hold for a couple of quarters.  The reverse will come in the next couple of quarters, and get back closer to the average of around 2.75%.

Thus, at current levels, spending might not be growing faster than the capacity to produce, so I don’t think inflation is a major concern in the foreseeable future.

Lets pull it all together.

Conclusion:

So the recent growth numbers were healthy, government debt to gdp is at a good level, consumer credit is rising and so is consumer and government spending, and the stock market is at or near an all time high.   

When I look at everything above, I think that Pakistan is in the “Late-Cycle” - typically begins about 2.5 years into expansion, depending on how much slack existed in the economy at the last recession’s trough)

economic growth picks up to a moderate pace (around 3.5-4%)

capacity constraints emerge

but credit and demand growth are still strong

Inflation begins to trend higher

Growth in consumption rises

inventories typically pick up

interest rates rise

the stock market stages its last advance

inflation-hedge assets (3-month TBill; Oil; Gold) become the best-performing investments

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Namibia's Economic Machine

Today we are going to take a trip to Namibia.  Let’s take a look at their Economic Machine, and see if there are any opportunities in this beautiful country.  

As we always do, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

     1. Productivity

Namibia’s economy is relatively small, with services accounting for 60% of GDP, and vast mineral resources available.  To begin our analysis we first look at Namibia’s current Annual GDP Growth Rate, which expanded at 2.30% in the 3rd quarter of 2014.

On average GDP growth rate has been around 4.80% in the last 20 years.  The chart above shows a cyclical nature to GDP growth in this country, and I would look for levels to go higher from these levels as we appear to be a valley here.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

     2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Namibia at 23.90% of GDP, which is very low, and means that the government shouldn’t have any problems paying future bills, or could even expand spending to drive up economic growth in the future.  All very positive.   

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity. One could consider Interest Rates in Namibia, which were last recorded at 6%, which is somewhat high, and has plenty of room to go lower. 

With rates at this level, central bankers have room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  Within the last 20 years, central bankers have dropped rates dramatically to spur lending and economic growth and I don’t expect that trend to reverse in the foreseeable future.  

Lets switch to Money Supply (M1)  in Namibia, which has been steadily rising for the last 20 years.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Namibia is at 4.67%, which is somewhat high, but not terribly out of control, but it could suggest that there is some price pressure at the moment, which can hamper an economy of course.  At these levels I wouldn’t be too concerned at the moment.

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Namibia had been steadily increasing for 20 years, and I don’t see anything to suggest this will reverse any time soon.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP low, interest rates respectively low, and inflation low, things are looking ok in Namibia.

Let’s look at the Short Term Debt Cycle to better understand this economy.

     3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been steadily rising for the last decade.  We might be coming to a peak at current levels, and I would watch these figures closely for any sign of a downturn, because it may be coming soon.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

However, I could not find any reliable data on Industrial Production in Namibia.  So, here I will just have to take an educated guess, and from the above data I believe spending is probably growing faster than production, which is worrisome.

Lets pull it all together.

Conclusion:

So the recent growth numbers were good, but not great.  However, government debt is well under control, and I think we could see an increase in government spending in 2015, and continued growth in consumer spending.  I think Namibia is actually in a healthy position at these levels, and could see a further economic expansion in 2015.

When I look at everything above, I think that Namibia is in the “Mid-Cycle”, which lasts an average of 2-3 quarters, and is exemplified by:

economic growth slows substantially ( to around 2%)

inflation remains low

growth in consumption slows

rate of inventory accumulations declines

interest rates dip

the stock market rate of increase tapers off

the rate of decline in inflation-hedge assets slows.

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Morocco's Economic Machine

Today we are going to take a trip to the lovely Morocco.  Let’s take a look at their Economic Machine, and see if there are any opportunities in this beautiful country.  

As we always do, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

    1. Productivity

Morocco is the 5th largest economy in Africa, and the 3rd largest producer of phosphorous, with 50% of GDP coming from the Services sector, and much of its growth coming from tourism and textiles.  To begin our analysis we first look at Morocco’s current Annual GDP Growth Rate, which expanded at 2.70% in the 3rd quarter of 2014.

On average GDP growth rate has been around 4.47% in the last 15 years.  The chart above shows a highly cyclical nature to GDP growth in this country, and I would look for levels to go higher from these levels.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

     2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Morocco at 61.70% of GDP, which is a somewhat high level, and a bit worrisome.  When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.  At these levels we seem to be coming out of a bottom, and that worries me as well.  Morocco’s government could run increase debt levels to spur economic growth, so for the time being I don’t see this as a major concern, just something to keep an eye on.

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Morocco, which are currently at 2.50%, which is low, but still has some room to go lower.

With rates at this level, central bankers have room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  Within the last 20 years, central bankers have dropped rates dramatically to spur lending and economic growth and I don’t expect that trend to reverse in the foreseeable future.  

Lets switch to Money Supply (M1)  in Morocco, which has been steadily rising for the last 30 years.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Morocco is at 0.40%, which is very low, so there does not appear to be any price pressure at the moment, and I would expect the money supply to continue to grow.

Keep in mind the drop in oil prices, and Morocco is a net oil importer, so that should be good news for the consumer.  I just think it is taking some time for the extra money they consumer may now have as a result of lower oil to make its way back into the economy.  

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Morocco Stock market to get a general picture of where financial assets are currently.

This chart clearly shows that the stock market in Morocco is pulling itself out of a bottom, and looks posed to continue to grow well into 2015.   

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Morocco had been steadily increasing for 50 years, and I don’t see anything to suggest this will reverse any time soon.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP high, interest rates low, and inflation low, there are some problems in Morocco.  Still, I like to take a contrarian view point.  You are supposed to sell when people are happy, and buy when people are panicking.  Not that people are panicking in Morocco, but with QE right around the corner I think it would be wise to look for inexpensive opportunities in Europe.  Morocco might be one.

Let’s look at the Short Term Debt Cycle to better understand this economy.

3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been steadily rising for the last decade.  We might be coming to a peak at current levels, and I would watch these figures closely for any sign of a downturn, because it may be coming soon.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

To examine production capacity we look at Industrial Production, which increased 1.30% in 2nd quarter of 2014 (the most recent data available).  Clear cycles are evident in this chart, and I think this drop in production is only temporary, and these levels will reverse in the next couple of quarters, and get back closer to the average of around 3%.

Thus, at current levels, spending is obviously growing faster than the capacity to produce, so I think inflation could be a concern in the foreseeable future, which is worrisome.

Lets pull it all together.

Conclusion:

So the recent growth numbers were not great, but I think that with the drop in oil prices we are going to see a great improvement to consumer’s in Morocco.  As well, I think Industrial Production will rebound in 2015, and with government debt well under control, I think we could see an increase in government spending in 2015, and continued growth in consumer spending.  I think Morocco is actually in a very healthy position at these levels, and could see a very fruitful 2015.

When I look at everything above, I think that Morocco is in the “Mid-Cycle”, which lasts an average of 2-3 quarters, and is exemplified by:

economic growth slows substantially ( to around 2%)

inflation remains low

growth in consumption slows

rate of inventory accumulations declines

interest rates dip

the stock market rate of increase tapers off

the rate of decline in inflation-hedge assets slows.

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Czech Republic's Economic Machine

Today we are going to take a trip to the lovely Czech Republic.  Let’s take a look at their Economic Machine, and see if there are any opportunities in this beautiful country.  

As we always do, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

     1. Productivity

The Czech Republic is one of the most industrialized of the emerging markets in Europe, has a well educated population and developed infrastructure.  To begin our analysis we first look at Czech Republic’s current Annual GDP Growth Rate, which expanded at 0.40% in the 3rd quarter of 2014.

On average GDP growth rate has been around 0.57% in the last 20 years, with a high of around 2.3% or so, and an all time low of around -3.3%.  The chart above seems to suggest a bottom here, and I think we go up from these levels.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

     2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Czech Republic at 46.40% of GDP, which is a healthy level, and not worrisome at all.  When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.  But at these levels I do not have concerns that Czech Republic’s government could run into a that situation in the future, and could even expand debt levels to spur economic growth in the future.  

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Czech Republic, which are currently at 0.05%, which is almost as low as it can go.  And it seems that at this level we are at the bottom or near bottom of the long term cycle in rates.  

With rates at this level, central bankers have no room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  Within the last 20 years, central bankers have dropped rates dramatically to spur lending and economic growth.  Further below we will see if this has helped spur growth.

Lets switch to Money Supply (M0)  in Czech Republic, which has been steadily rising for the last 20 years.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Czech Republic is at 0.01%, which is pretty much deflation, and a little worrisome to me.

Keep in mind the drop in oil prices, and Czech Republic is a net oil importer, so that should be good news for the consumer.  I just think it is taking some time for the extra money they consumer may now have as a result of lower oil to make its way back into the economy.  

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Czech Republic Stock market to get a general picture of where financial assets are currently.

This chart clearly shows the boom in 2007 or so, and the subsequent crash.  And that we have had a somewhat cyclical pattern since then.  We appear to be entering a flattening here, or plateau.  This could be a valley at these levels, and I would look for levels to reverse in 2015 and the stock market to show some gains in the coming year.   

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Czech Republic had been steadily increasing, but might be at a plateaued a bit here.   Still, levels are overall high and I don’t see any signs of government spending falling drastically.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP high, interest rates low, and inflation low, there are some problems in the Czech Republic.  Still, I like to take a contrarian view point.  You are supposed to sell when people are happy, and buy when people are panicking.  Not that people are panicking in Czech Republic, but with QE right around the corner I think it would be wise to look for inexpensive opportunities in Europe.  Czech Republic might be one.

Let’s look at the Short Term Debt Cycle to better understand this economy.

     3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been cyclical in nature.  we see a clear rise around 2007, and the subsequent crash.  Consumer spending rebounded and then fell again around 2013, and looks to have rebounded as of late.  We appear to be near a peak t current levels, and I would watch these figures closely for any sign of a downturn, because it may be coming soon.

Below is one of the strangest Consumer Credit charts I’ve ever seen.  Apparently, consumer credit fell off a cliff in the last couple of months.  Something just doesn’t seem right about that.  Prior to this drop, consumer credit was growing steadily for a decade, and I would expect these numbers to be revised to show that has continued into the present. 

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

To examine production capacity we look at Industrial Production, which decreased 0.40% in November of 2014 (the most recent data available).  Clear cycles are evident in this chart, and I think this drop in production is only temporary, and these levels will reverse in the next couple of quarters.

Thus, at current levels, spending is obviously growing faster than the capacity to produce, so I think inflation could be a concern in the foreseeable future, which is worrisome.

Lets pull it all together.

Conclusion:

So the recent growth numbers were not great, but I think that with the drop in oil prices we are going to see a great improvement to consumer’s in the Czech Republic.  As well, I think Industrial Production will rebound in 2015, and with government debt well under control, I think we could see an increase in government spending in 2015, and continued growth in consumer spending.  I think the Czech Republic is actually in a very healthy position at these levels, and could see a very fruitful 2015.

When I look at everything above, I think that Czech Republic is in the “Mid-Cycle”, which lasts an average of 2-3 quarters, and is exemplified by:

economic growth slows substantially ( to around 2%)

inflation remains low

growth in consumption slows

rate of inventory accumulations declines

interest rates dip

the stock market rate of increase tapers off

the rate of decline in inflation-hedge assets slows.

But  I could be totally wrong.  What do you think?

[theeconomicmachine]

Austria's Economic Machine

Today I am going to go drink some beers in large mugs while skiing down a massive mountain, or rather, what I like to think life is like in Austria.  Let’s take a look at the Economic Machine in Austria, and see if there are any opportunities in this beautiful country.  

As we always do, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

     1. Productivity

Austria has seen steady economic growth ever since the end of World War II, with services driving much of GDP.   To begin our analysis we first look at Austria’s current Annual GDP Growth Rate, which contracted at 0.30% in the 3rd quarter of 2014.

On average GDP growth rate has been around 0.46% in the last 20 years, with a high of around 1.6% or so, and an all time low of around -1.8%.  The chart above seems to suggest that the market is searching for a bottom, and once it finds some support I think we go up from these levels.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

     2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Austria at 74.50% of GDP, which is high, and worrisome.  When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.  At these levels I have concerns that Austria’s government could run into a tough situation in the future.  

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Austria, which are set by the European central bank as Austria is part of the EU, and currently that rate is at 0.05%, which is almost as low as it can go.  And it seems that at this level we are at the bottom or near bottom of the long term cycle in rates.  

With rates at this level, central bankers have no room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  Within the last year, central bankers in the EuroZone have dropped rates to spur lending and economic growth, and as is obvious Europe is still deep in a recession.  Typically, the strength of the recovery depends somewhat on the depth of the deleveraging.  The deeper the deleveraging, the more room to bounce back, essentially.

However, Draghi just released the details of QE in the EU, and this should obviously help Austria.  The immediate effect we are seeing is a fall in the Euro, which will benefit exporting nations, of which Austria is not one, as the country is running a trade deficit (they import more than they export).

However, they export automobiles, so maybe there is a play there will Austrian auto makers?

Lets switch to Money Supply (M1)  in Austria, which has been steadily rising for the last 20 years.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Austria is at 1%, which is a healthy level.

Keep in mind the drop in oil prices, and Austria is a net oil importer, so that should be good news for the consumer.  I just think it is taking some time for the extra money they consumer may now have as a result of lower oil to make its way back into the economy.  

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Austria Stock market to get a general picture of where financial assets are currently.

This chart clearly shows the boom in 2007 or so, and the subsequent crash.  And that we have had a few cyclical patterns since then.  We appear to be entering a valley at these levels, and I would look for that to reverse in sometime in 2015.   

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Austria had been steadily increasing, but might be at a plateaued a bit here.   Still, levels are overall high and I don’t see any signs of government spending falling drastically.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP high, interest rates low, and inflation low, there are some problems in the Austria.  Still, I like to take a contrarian view point.  You are supposed to sell when people are happy, and buy when people are panicking.  Not that people are panicking in Austria, but with QE right around the corner I think it would be wise to look for inexpensive opportunities in Europe.  Austria might be one.

Let’s look at the Short Term Debt Cycle to better understand this economy.

The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been increasing for the last decade, and shows no signs of stopping.  

More spending means more income and more spending, and the cycle continues.

Consumer Credit levels have seen a spike up until 2012 or so, and they we see a bit of pull back for a year or so, and then they again grew, and now we find ourselves at a new peak or near a new peak, so I would expect to see a pullback in consumer credit.  But not a drastic one.  

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

To examine production capacity we look at Industrial Production, which decreased 2.5% in November of 2014 (the most recent data available), and seems to be hovering around the 2.2% average.

We can also look at Capacity Utilization, which was at 83.70 in 4th quarter of 2014.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.  So, these levels suggest that the economy is humming along, and if we want to increase production we would need new factors, so large expenses.  

At these levels, I don’t really think spending is growing faster than the capacity to produce, so I don’t think inflation is a concern in the foreseeable future.

Lets pull it all together.

Conclusion:

So the recent growth numbers were not great, but I think that is going to change when QE begins.  Government spending will increase and that is a huge driver of economic activity.  we have high inflation and a central bank that is raising rates to, presumably curb inflation.  Consumer spending is high, but Government spending and credit are low, and government spending is a huge driver of economic growth in any country.  

Personally, when I look at everything above, I think that Austria is in the “Mid-Cycle”, which lasts an average of 2-3 quarters, and is exemplified by:

economic growth slows substantially ( to around 2%)

inflation remains low

growth in consumption slows

rate of inventory accumulations declines

interest rates dip

the stock market rate of increase tapers off

the rate of decline in inflation-hedge assets slows.

But heck, I could be totally wrong.  What do you think?

[theeconomicmachine]

Tunisia's Economic Machine

Today I am going to take a look at the birthplace of the Arab Spring, Tunisia.  The government in Tunisia has seen remarkable change since 2011, however, the economy has developed some fairly troubling problems.  Let’s take a look at the Economic Machine in Tunisia, and see if there are any opportunities in the vibrant and developing nation.  

As we always do, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

     1. Productivity

Tunisia has one of the highest GDP per capitas in Africa, and a diversified economy agriculture, petroleum, and manufacturing making up much of the economic activity.  To begin our analysis we first look at Tunisia’s current Annual GDP Growth Rate, which contracted at 0.30% in the 3rd quarter of 2014.

On average GDP growth rate has been around 1%, with an all time high of around 4.5% or so, and an all time low of around -7.5%.  I think that GDP will continue to grow from these levels, and I would look for this number to surpass the 1% trendline before we see any pull back.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

     2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Tunisia at 44.38% of GDP, which is low, and shows that the government is conscious of its debt, has it under control, and could increase its debt levels, and thus spending, to propel the economy to grow.   This government should also not have any troubles paying its bills.  This is a promising chart in my opinion.  

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Tunisia to get an idea of the debt service payment picture, which are currently set at 4.75%, and have been rising for the past 2-3 years.  That would seem to suggest that central bankers are trying to curb lending and thus spending, and slow down the economy.

With rates at this level, central bankers have plenty of room to lower rates to increase growth in credit, which ultimately spurs growth in the overall economy.  

Lets switch to Money Supply (M1)  in Tunisia, which has been steadily rising for the last 30 years.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Tunisia is at 5%, which is high, and a problem central bankers are trying to deal with presumably by raising interest rates.

Keep in mind the drop in oil prices, and Tunisia is a net oil importer, so that should be good news for the consumer.  I just think it is taking some time for the extra money they consumer may now have as a result of lower oil to make its way back into the economy.  

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Tunisia Stock market to get a general picture of where financial assets are currently.

This chart only stretches back 5 years, but you can clearly see the Tunisian Stock Market has seen some cyclical shifts in that time frame, with peaks around 2010, 2012, and it looks like values are rising to peak levels yet again.

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Tunisia had been steadily increasing, but has plateaued a bit here.   Still, levels are overall high and I don’t see any signs of government spending falling drastically, especially with the problems already exhibited in this economy.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP very high, interest rates low, and inflation so low,there are obviously some very serious problems in the Tunisia.  Still, I like to take a contrarian view point.  You are supposed to sell when people are happy, and buy when people are panicking.  People in Tunisia are panicking.

Let’s look at the Short Term Debt Cycle to better understand this economy.

     3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been increasing for the last decade, and shows no signs of stopping.  

More spending means more income and more spending, and the cycle continues.

I would really like to see what Consumer Credit levels are, but could not find any reliable data on that.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

To examine production capacity we look at Industrial Production, which increased 1.62% in September of 2014 (the most recent data available), and seems to be hovering around the 2.2% average.

At these levels, I think spending is growing faster than the capacity to produce, which is one of the reason we are seeing higher than average inflation, and also why we are seeing tightening monetary policy (raising interest rates).

Lets pull it all together.

Conclusion:

So the recent growth numbers were not great, we have high inflation and a central bank that is raising rates to, presumably curb inflation.  Consumer spending is high, but Government spending and credit are low, and government spending is a huge driver of economic growth in any country.  

Personally, when I look at everything above, I think that Tunisia is in the “Late-Cycle”, which typically begins about 2.5 years into expansion, depending on how much slack existed in the economy at the last recession’s trough)

economic growth picks up to a moderate pace (around 3.5-4%)

capacity constraints emerge

but credit  and demand growth are still strong

Inflation begins to trend higher

Growth in consumption rises

inventories typically pick up

interest rates rise

the stock market stages its last advance

inflation-hedge assets (3-month TBill; Oil; Gold) become the best-performing investments

But,I could be totally wrong.  What do you think?

[jeremylhill-deactivated20180427]

The emperor has spoken. All hail the emperor. European Central Bank head Mario Draghi has finally announced the details of quantitative easing within the Eurozone and the details have impressed. After teasing global markets for what seemed like forever, yesterday the ECB announced that they…

[theeconomicmachine]

Italy's Economic Machine

Today I am going to take a look at the absolutely beautiful country of Italy.  And while the landscape and artwork are breath taking, the economy has has some troubles.  Will the economic machine be another Mona Lisa, or rotten bowl of day old pasta?  Let’s take a look.  Viva Italia!

As we always do, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

     1. Productivity

Italy is the 8th largest economy in the world, and the 3rd largest in the Euro Zone, with services accounting for 73% of GDP.  To begin our analysis we first look at Italy’s current Annual GDP Growth Rate, which contracted at 0.50% in the 3rd quarter of 2014.

For the past 4 years or so Italy has been stuck in a deep depression, with year after year of negative GDP growth.  On average GDP growth rate has been around 2.5%, with an all time high of around 10% or so, and an all time low of around -6.9%.  This is obviously very worrisome, and a horrible way to begin.  But the fact are the facts.  Why has GDP not grown in 4 years?

Well, one of my pinnacle belief is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

     2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Italy at 132.60% of GDP, which is very high, and has ballooned in recent years as it seems the government in Italy tried to spend their way out this recession.   

Now, a deleveraging is the process of reducing debt burdens (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Italy to get an idea of the debt service payment picture, which are set by the ECB, and currently Interest Rates are at 0.05%, which is the lowest levels seen in a long time, i.e. governments trying to spur credit growth to pick up the economy.

With rates at this level, central bankers have no room to lower rates to increase growth in credit, which ultimately spurs growth in the overall economy.  That is why all the talk is focused on QE.   Draghi just announced QE for the Euro zone of up to 1.1 trillion through 2016.  How much will go to Italy is not certain, but Italy will certainly get a good sum, and that will help.

Lets switch to Money Supply (M1)  in Italy, which has ballooned in recent years, and steadily rising for the last 30 years.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Italy is at 0%, which is a another problem central bankers are trying to deal with.  A target of 2% inflation has been stated, and they need more spending to get inflation up.  That is what they hoped to achieve with QE.  

As well, one can look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10Y remained decreased to 1.67% in January, from 2.06% in December, as investor crowded into safety.

The yield on government debt indicates expectations on inflation and debt repayment.  Inflation is typically seen as the primary killer of bond portfolios, as lower inflation typically drives interest rates down, and bond prices up, which is exactly what we see here.  

Keep in mind the drop in oil prices, and Italy is a net oil importer, so that should be good news for the consumer.  I just think it is taking some time for the extra money they consumer may now have as a result of lower oil to make its way back into the economy.  Especially now that we are seeing deflation in Italy, that will keep buyers on the sidelines even more.

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Italy Stock market to get a general picture of where financial assets are currently.

As you can clearly see, Italy Stock Market has seen some cyclical shifts in the last couple of decades, with peaks around the dotcom boom, and the 2008 crisis.  And now we are hovering around in a valley.  Definitely room to grow.  Is this the time to jump into this market?

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Italy had been steadily increasing, but has plateaued a bit here.   Still, levels are overall high and I don’t see any signs of government spending falling drastically, especially with the problems already exhibited in this economy.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP very high, interest rates low, and inflation so low,there are obviously some very serious problems in the Italy.  Still, I like to take a contrarian view point.  You are supposed to sell when people are happy, and buy when people are panicking.  People in Italy are panicking.

Let’s look at the Short Term Debt Cycle to better understand this economy.

     3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which increased in the 3rd Quarter of 2014 in Italy.  Over the last 10 years we can see a clear cyclical pattern, and that we have peaked above the previous highs of the 2008 bubble, fell off and then pushed higher into 2011.  But then in 2012 spending fell off a cliff.  We are just seeing levels pull out of the bottoms here, which is encouraging, but the consumer needs to spend more to get this economy churning again.  

This is somewhat good for prospects of economic growth, as you want to get in at a bottom, just before things take off.  However, lets take a look at credit growth to get a better picture.

Looking at this chart, Consumer Credit Growth in the Italy might have seen its peak and could be trending lower from here, which is not good news.  I would watch these number closely, and know that if growth continues to fall that will likely have negative consequences on the overall economy.

Wage growth in Italy has seen steady growth over the last decade or so, which is good for economic growth because as wages increase, so will spending, and one person’s spending is another’s income, so you see more spending, and more income growth, which pushes economic growth even higher.  As well, people will be able to service their debts.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

To examine production capacity we look at Industrial Production, which decreased 1.80% in November of 2014 (the most recent data available), I would hope that it can get into positive territory in 2015, but I’m just not sure.

Next, I like to examine Capacity Utilization, which decreased to 72.30% in Italy in the 4th quarter of 2014, down from 73.2% in the 3rd quarter.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.  So, at these levels the economy is hurting, and is obviously deep in a recession.  

Lets pull it all together.

Conclusion:

So the recent growth numbers were not good, the economy contracted.  Consumer spending seems to be plateauing, as is consumer credit.  The same can be said about Government spendind, with Government debt to GDP at dangerously high levels, there is a lot to worry about with Italy.

In comes Draghi to the rescue?

Well, I’m not so sure.  Sure, QE will help, but how much is Italy going to get?  

I think the stock market has room to grow at these levels, and QE might help push that up.  so if you want to be bold I would say you could start looking for some value stocks and snatch them up.

Personally, when I look at everything above, I think that Italy is in the “Late Part” in their Recession phase of the cycle, which is typically exemplified by:

central bank easing monetary policy

inflation concerns subside

recession concerns grow

interest rates decline

lower interest rates cause stock prices to RISE (even though the economy hasn’t yet turned up)

commodity prices and inflation-hedge assets (oil, natural gas, gold) continue to be weak.

the lower interest rates and higher stock prices set the stage for the expansion part of the cycle to begin all over again, and we go round and round.

Remember, sell when people are happy.  And buy when they are panicking.  Might be time to buy in Italy.  

But heck, I could be totally wrong.  What do you think?