Oil price likely to go on falling

 As the world economy slows, the oil price will fall.   I expect a GFC-style recession in 2023/24 and its impact on oil will be compounded by rise of EVs, which were 0% of global car/light truck sales in 2008, but are 15% now, and 30% in China.   

World growth slows a little.

The PMI for the big eight economies, weighted by PPP GDP,  drifted a little lower in October.  (My calculation ― the PMI for each country is extreme-adjusted, weighted and then summed together.  The economies are: USA, UK, Euro zone, Russia, India, China, Brazil, Japan, and together they make up 2/3rds of the world economy.) 

But notice that this weighted average is still higher than it was in 2017/18 and also higher than the strong rebound in 2010/11 after the GFC (global financial crisis) in 2008/9.  A combination of low interest rates and massive fiscal stimulus. 

Obvious question ― how much longer will CB discount rates remain low?

The answer for the US and Europe is at least another 12 months.   But elsewhere, policy is tightening, except in China, where there is a credit crunch because of the collapse of property companies.  So, whereas there have been tailwinds driving equity markets higher, these have waned, and there are now headwinds.  And of course, renewed lockdown in countries where vaccinations haven't reached 90% of the population but case numbers are exploding, won't be well received.

Australia slides into recession

I haven't been maintaining my Australian databases apart from a couple of time series, because, well, I had enough on my plate.  They have to be maintained manually—there is no automated supplier that I can afford—so I have just let the updates slide.  However, I wanted to see the effects of the Covid Crash here as well as in the rest of the world, so I have started to update them.  So far, I'm only about one third of the way through the lists, but as an interim measure, I've produced a composite index of the series that I have updated which have more than 20 years of data.  I'll add more as I do the updates.

The index is now back at GFC levels, though not yet as low as the 1990 recession.  Also, it's been falling for a while, long before the covid crash hit.  It's not a good thing to be going into a great exogenous (=externally caused) shock when conditions are already weak.  The risks of a financial crash rise sharply.  For example, Oz's overblown property market is at serious risk, with high levels of indebtedness and a banking system dependent on mortgage lending and also on foreign borrowings to fund it. 

Make no mistake: this is just the beginning of the downturn.  In just one month, we have fallen to near record lows.  What will happen in 3 or 6 months?

US trend growth has nearly halved

The chart shows US real GDP, with two long-term trends, plotted on a log scale.  A key factor in the lower growth rate since 2009 has been the fact that the economy recovered so sluggishly after the GFC.  It did much better than Europe, though, because the Obama administration was prepared to run huge deficits to get the economy restarted.  In Europe the EU forced weaker countries to tighten policy, causing a economic "double-dip" and 10 wasted years.

But I think a second factor is the way that the income of ordinary people stopped growing in real terms.  This made it much harder for GDP to grow as it had done before.  The shift of income upwards to the 10% and the 1% reduced growth.  Enlightened millionaires and billionaires should be in favour of a whole range of progressive ideas, such as increasing the minimum wage, spending more on education to uplift workers, a better health system, and so on, because they would increase growth which means they (the wealthy) would also be better off.  Enlightened self interest.

Don't hold your breath.

And now, we are about to enter a recession, with prob'ly a long period of sluggish growth, which will reduce trend growth even further.

Leveraged loans: the big risk for the US economy

What made the GFC (Global Financial Crisis, 2007-2008) much worse was unrestrained and ill-advised lending by the banks in the years before the crisis.  Banks lent profusely to home buyers, with low buyer deposits and "liar loans", and packaged these loans into bundles (Collateralised Debt Obligations, or CDOs) which remarkably inept rating agencies rated AAA.  When the downturn came, the defaults on the mortgages and the CDOs took down the banking system and with it the world's economies.  In the years after the GFC, banking regulators increased required capital standards and tightened regulations.

Now something very similar is happening again, and the tightened standards and regulations imposed after the crisis have been loosened by the US government.  It seems no lesson is too serious to be unlearned by the Right.

[From The Washington Post]

Actions by federal regulators and Republicans in Congress over the past two years have paved the way for banks and other financial companies to issue more than $1 trillion in risky corporate loans, sparking fears that Washington and Wall Street are repeating the mistakes made before the financial crisis.

The moves undercut policies put in place by banking regulators six years ago that aimed to prevent high-risk lending from once again damaging the economy.

Now, regulators and even White House officials are struggling to comprehend the scope and potential dangers of the massive pool of credits, known as leveraged loans, they helped create.

Goldman Sachs, Wells Fargo, JP Morgan Chase, Bank of America and other financial companies have originated these loans to hundreds of cash-strapped companies, many of which could be unable to repay if the economy slows or interest rates rise.

“This means that the next downturn that we have could be more serious and longer-lasting and more difficult to deal with than it would have been if we had constrained these practices,” former Federal Reserve chair Janet L. Yellen said in an interview.

The lending boom was precipitated, in part, by the rush to water down regulations at the start of the Trump administration. That’s when newly minted regulators — many with close ties to the financial industry — sought to strip away post-crisis financial rules and find ways to juice the economy by encouraging more lending.

One of their top targets was leveraged loans. These are giant loans that banks make to heavily indebted — in financial speak, highly leveraged — companies. Bankers often have little assurance that the loans can be repaid, which can make them particularly risky. Bankers earn large fees off these products, and many banking executives say their institutions are sheltered from losses because they sell the loans to other investors such as hedge funds, mutual funds and insurance companies.

As regulators scaled back scrutiny, bankers began to binge.

Financial companies issued a total of $1.271 trillion in leveraged loans in 2017 and 2018, 40 percent more than in 2015 and 2016, according to S&P Global Market Intelligence. More than 80 percent of the loans made in 2018 were made with fewer restrictions on the borrower and fewer protections for the lender in the event the loan falls into default.

[Read more here]

It seems very likely that the US will enter a recession this year—I would say an 80% chance.  At the same time, the yield curve (the spread between short-term rates and long-term rates) has gone negative in the US, reducing bank profits. 

Source: Business Insider

There is also a pending crisis in auto loans.  Just as happened with mortgages before the GFC, when default rates on mortgages reached record highs even before the recession began, so it is with car loans now.   What will happen when unemployment starts to rise?  It's obvious, isn't it. 

As I pointed out here, PMIs for the world are sliding.  The only good news is that Chinese re-stimulation measures are having some effect.  Meanwhile, in Europe and Japan, Central Bank discount rates are already at zero, and the banking systems remain parlous.  How will the authorities counter if growths slows any further and debt defaults explode? 

If the world goes into recession, will we experience a crisis as severe as the GFC, with even fewer tools to avert the disaster?  My concerns are rising.

The end of neo-liberalism

Cartoon by Jim Morin

Back in the late 1970s when I was at varsity studying economics, the new rising orthodoxy was "rational economics".  The theory behind it was simple and logical.  Any person knows much better what their preferences are than any centralised government authority possibly can, so we should let individuals decide what they want to do.  So far, so good.  But the advocates of rational economics took the whole idea a lot further.  They argued that any collective activity was ipso facto inferior to any individual one, and that therefore government should be scaled back to as small a profile as possible.  Regulation of private enterprises was unnecessary, because “the market” would take care of it.  Privatisation, even of entities such as schools, hospitals, generators and the grid was desirable, even if these entities were monopolies or not in fact profit-seeking organisations, because privately owned and managed enterprises would be “more efficient” than collectively owned ones.  Cutting tariffs and removing quantitative import controls would, it was maintained, lead to higher growth and rising living standards.  Welfare had to be cut back so that taxes could be cut, because taxes on the rich “reduced incentives”.    Prosperity was supposed to "trickle down" from the rich to the poor.  This philosophy is called “neo-liberalism”.

There was a fundamental flaw in the whole thesis.  When markets are “perfect” and supply is “atomistic” (i.e., there are a very large number of suppliers) the self-interest of each of the individual suppliers can potentially lead to positive outcomes, because any attempt to gouge the public is prevented by competition.  For example, in any urban centre there are thousands of cafés.  For all practical purposes supply is “atomistic”.  Each café is a “price taker”, not a “price maker”.  Contrast that with, say, the electricity grid.  It would be completely impractical to build a hundred grids with connections to each house.  The grid is a monopoly.  It could, theoretically, set its own price.  There are no constraints on the self-interest of those who own monopolies except regulation and politics.  As Adam Smith, the great guru of the economic rationalists and neo-liberals said:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices

There was a second critical flaw in the whole thesis of neo-liberalism.  The assumption was that economics would happen independently of the political system and political processes, that there would be a level playing field where all players could be potentially equally successful.  But that was wrong.  Neo-liberalism led to vastly increasing inequality, and the people with more money bought the politicians.  Laws and regulations were changed to favour incumbents.  Grumpy billionaires bought control of media outlets, and started pushing far-right agendas, which—quelle surprise!—favoured deregulation, lower taxes, lower wages and free migration. 

There are other fatal flaws to the whole doctrine of neo-liberalism, but I'll talk about them in future posts.

As the years went by I began to wonder whether neo-liberalism was actually as good as its proponents believed.  But what really killed it for me was the GFC.  The neo-liberal system plunged us into deep recession.  Banks were supposed to be capable of self-regulation.  Instead they lent imprudently and foolishly, and failed spectacularly, and had to be rescued--oh, the irony!--by the state.  The result was the  deepest recession since the Great Depression of the 30s.  And since then, trend growth in the OECD has fallen from 2.9% per annum to 1.8%.  It became obvious that austerity policies to try and balance budgets just made things worse.  The major burden of readjustment was everywhere borne by the poor.  The fastest recovery from the GFC lows was in the USA, which also ran the most Keynesian stimulatory policy in developed countries (to the fury of the Republican Party) while dogmatists elsewhere forced tax increases and spending and welfare cuts (Europe being the worst offender) which contrary to the theory simply deepened the downturns, while leaving the deficits unchanged.

I think the high water point of neo-liberalism has passed.  All the interlocking doctrines are under assault.  Just as with Communism, once a political doctrine loses its intellectual authority it is doomed.  Neo-liberalism is dying.  Its supporters just don't know it.

Six years lost

In the middle of last year, my coinciding index for the US economy passed the previous peak which occurred just before the onset of the GFC.  It's taken SIX YEARS for this to occur.  Six years of lost output and lost incomes, of lost jobs, of despair and poverty.

Oh, the index fell in the latest month, but that was due mostly to the big freeze. It'll pass.

Six years.  So much for rational markets and automatically self stabilising markets and economies.

The failure of American capitalism

The charts below (via Peter Whiteford of the Australian National University in Canberra) are most interesting.  On the same scale (so comparison is facilitated) they show the average annual growth rate in real income by decile for men and for women.  So, taking Australia as an example, they show how, over the quarter century from 1980 to 2005, men in the lowest decile (i.e., the poorest 10 % of the population) had a real (i.e., after inflation) growth in their incomes of around 0.5% per annum, or roughly 13% compounded over the whole period.  During the same period, women in the lowest decile had income growth in real terms of around 1.4% per annum.  Notice how men in the top decile--the richest 10%--had annual growth of 1.5%,  or a cumulative increase of 45%, so that income inequality among men increased, between men and women decreased, and within women increased a little.  I expect much of this difference was because of the decline of blue-collar jobs in manufacturing as Ozzie industries faced a decline in protective tariffs, whereas women weren't doing blue-collar jobs, and were also entering the labour force in a big way for the first time.

Now look at little Finland's real income growth rates.  Once again, women's incomes have grown faster than men's, but the overall growth rate has been higher and much more equal than in Australia.  In fact, almost all deciles across the spectrum had real income rises of 64%.

The United States' chart is the shocker:  Over the 25 years, for men, the poorest 10% had falling real incomes, by (I'm reading this off the chart) about 0.6% per annum.  That's a 14% decline over 25 years.  The richest had real income rises of 0.8% per annum, which over the whole period equals 22%.   Once again, women did better than men as gender income inequalities were reduced.  But notice this: apart from Canada, the total growth for all deciles was lower than in any other country.  And this was before the GFC (2008 and ongoing).  All the "socialist" countries did better than the US.  These are all countries where business is privately owned, but individuals have a comprehensive welfare safety net, including such things as universal free health care, the dole, income support, progressive income tax, etc.

The argument for the extreme dog-eat-dog form of capitalism in the US with all it entails is that even though it produces greater inequality within the populace, it produces greater income growth for everybody.  Yet this is clearly not true.  And that is very interesting indeed.

text

Spain bank audit paves way for bailout

The Age article here.

We're coming to the end of the GFC-related disasters (though note how the article points out that the current Spanish crisis has been made more severe by previous austerity; maybe the same will happen again).  No convincing signs yet that Europe has bottomed.  The usual suspects among the brokers have been wheeling out the champagne ("the worst is over") at a very modest rise in the European PMI.  I hae me doots.

Meanwhile the Spanish 10 year  bond yield has drifted up a tad (Chart from Bloomberg)  Personally, I would be extremely careful not to short Spanish or Italian bonds.  You'd be on a hiding to nothing -- if yields rise any more, a rescue will be announced and the ECB will then be empowered to buy unlimited quantities of bonds.  In other words:  if things improve by themselves, bond yields will fall, and if they don't, the ECB will open its purse, and bond yields will fall.

Old vs New G7

When I started out in this business, the US was the world's largest economy by far.  It was enough to know what the US and the other G7 countries (in order of size, Japan, Germany, The UK, France, Italy and Canada) were doing to know what was happening in the overall world economy.

That was the old G7.  The new G7, the 7 largest economies now, is still headed by the US, though its weight has fallen a lot, but the membership of the club has changed a lot.  Now the other six are (in order of size) China, Japan, India, Germany, UK &  Russia.

Just look at this chart.  The new G7 fell by less than the old, and has recovered faster after the GFC.

Yes, Europe is in the doldrums (failed economic models take a bow), yes the US is struggling to grow, and yes, if you focus on things as they were, the outlook appears bleak.  But if you look at what is really happening, the world is still growing.  Despite the headlines.  And if Europe would ditch its unseemly passion for fiscal austerity, you might even see growth there too.

What would Keynes do?

John Maynard Keynes (right)
and his lover, the artist,  Duncan Grant

The first thing to be said about Maynard Keynes is that he was an astonishingly intelligent man. Bertrand Russell, his contemporary at Cambridge, described the economist as having "the sharpest and clearest intellect" he had ever known.

Having transformed the study of logic, Russell was himself one of the great minds of the early 20th Century. Yet when he argued with Keynes, Russell wrote, "I took my life in my hands, and I seldom emerged without feeling something of a fool."

Intimately familiar with the history of economic thought and widely read in many fields, producing a major treatise on the nature of probability alongside his famous General Theory of Employment, Interest and Money and a host of penetrating essays, Keynes had a depth of culture that few economists could claim today.

His brilliant intelligence wasn't exercised only in the realm of theory. Keynes was an outstandingly successful investor, who lost heavily in the 1929 crash, changed his investment methods and recouped his losses, growing the funds of his Cambridge college and leaving a substantial personal fortune. He had a deep understanding of the complex, unpredictable and at times insolubly difficult nature of human events.

But Keynes didn't start out with this understanding. As he records in his memoir, he and his friends in Cambridge and Bloomsbury believed they already knew what the good life consisted in and were sublimely confident that it could be achieved. Influenced by the Cambridge philosopher GE Moore, they thought the only things that had value in themselves were love, beauty and the pursuit of knowledge.

Some of the most bold of Moore's disciples - Keynes was one of them - ventured to suggest that pleasure might also be worth pursuing, but Moore, who was something of a puritan, would have nothing of this. Despite these disagreements, Moore's was a liberating philosophy for Keynes and his friends.

Keynes viewed his early philosophy as being entirely rational and scientific in character. Yet it was also his religion, he tells us - the faith by which he and his friends lived. And, in many ways, it was not a bad faith to live by. It armed him against idolatry of the market, which he described as "the worm that had been gnawing at the insides of modern civilisation... the over-valuation of the economic criterion". To identify the goods that can be added up in an economic calculus with the good life was for Keynes - young and old - a fundamental error. The market was made for human beings - not human beings to serve the market.

At the same time, Keynes's personal religion immunised him against the faith in central economic planning that bewitched a later generation at Cambridge. He was never tempted by the lure of collectivism, which he dismissed as "the turbid rubbish of the Red bookshop". Firmly believing that nothing had value except the experiences of individuals, he always remained a liberal.

You can read the rest of Professor John Gray's intriguing BBC article here.  John Maynard Keynes was also a very competent medieval Latinist and he could have as well made his career there as in economics.  He was gay or bisexual  as he loved both men (Duncan Grant, among others) and women and married the ballet dancer Lydia Lopokova.

For my own part I have no doubt whatever that Keynes would have advocated massive deficit spending and  the monetisation of  the government debt as a solution to the looming debt deflation in Europe.  But he would also have rebuked the European governments for allowing debt to balloon in good times and all governments for permitted the rank financial excess which led to the GFC.