There are many problems with the extremely low interest rates available in decade since the too-big-to-fail financial crisis. The interest rates seem to me to be artificially sustained by massive central bank actions for 12 years now.
Extraordinarily low rates encourage businesses to borrow money, after all how hard is it to invest in something that will return the business more than a few percent a year (that they can borrow at). Along with the continued efforts by the central banks to flood the economy with money any time there is even a slowdown in growth teaches companies to not worry about building a business that can survive bad times. Just borrow and if necessary borrow more if you are having trouble then just borrow more.
USA corporate debt has increased from a bit over $2 trillion in 2005 to over $7 trillion in 2020.
This isn’t a healthy way to build an economy. Businesses should be robust and able to sustain themselves if the economy experiences a recession and interest rates rise and the ability to borrow decreases.
Extremely low interest rates hide a huge potential cost if interest rates rise. Sure the huge debt is covered by cash flow in good times with the interest rate on your debt is 4%. What happens if interest rates rise to 6% and the economy declines? At some point investors (and banks) are going to realize that huge debt burdens on companies that are overly leveraged are not safe and deserve a premium interest rate.
I don’t think there is any risk to companies with very strong balance sheets and a business model that won’t have any trouble maintaining positive cash flow in a significant recession (Apple, Abbvie, Google, Costco, etc.). But many businesses are over-leveraged and at a significant risk of default in a bad economy.
The stock market is down quite a bit today partially due to the worry that the leveraged oil shale companies in the USA will go under if OPEC does not manage to restrict the supply of oil in order to keep oil prices high (or at least keep oil prices from collapsing).
Plenty of leveraged buyouts (where private equity firms take out cash and leave behind barely functional businesses) are barely able to survive even with extremely low interest rates. Those companies are in danger of failing when they experience even a small problems.
When 2 year US government bonds yield more than the 10 year US government bonds a recession is likely to appear soon. This chart shows why this is seen as such a reliable predictor.
The chart shows the 10 year yield minus the 2 year yield. So when the value falls below 0 that means the 2 year yield is higher. Each time that happened, since 1988, a recession has followed (the grey shaded areas in the chart).
Do note that there were very small inversions in 1998 and 2006 that did not result in a recession in the near term. Also note that in every case the yield curve was no longer inverted by the time a recession actually started.
The reason why this phenomenon is getting so much attention recently is another thing that is apparent when looking at this chart, the 2 and 10 year yields are getting close to equal. But you can also see we are no closer than 1994 and the USA economy held off a recession for 7 more years.
Since 1970 the average length of time from the inversion of the 10 to 2 year yield curve has been 12 months (with a low of 6 months in 1973 and a high of 17 months, before the great recession of 2008).
In addition to a possibly impending yield curve inversion it has been a long time since the last recession which makes many investors and economists nervous that one may be due.
Related: 30 Year Fixed Mortgage Rates are not correlated with the Fed Funds Rate – Bond Yields Stay Very Low, Treasury Yields Drop Even More (2010) – Looking for Dividend Stocks in the Current Extremely Low Interest Rate Environment (2011) – Stock Market Capitalization by Country from 2000 to 2016
Another thing to note about yield curves at this time is that the US Federal Reserve continues to hold an enormous amount of long term government debt (trillions of dollars) which it has never done before the credit crisis of 2008. This reduces the long term yield since if they sold those assets that would add a huge amount of supply. How this impacts the predictive value of this measure will have to be seen. Also, one way for the Fed to delay the inversion would be to sell some of those bonds and drive up long term rates.
Amazon announced they are opening major new offices in Arlington, Virginia and New York City. Each site will hold 25,000 new Amazon employees at an average salary above $150,000. Getting to that level with take many years, next year under 1,000 employees will be at each site.
I lived in Arlington for many years and own rental property there. The Amazon decision is likely to catalyze a much more rapid ascent of the technology sector in the DC area. The DC area has a strong foundation of internet technology to build upon, though many people are not aware of this. The Amazon move will likely help shift the perception of the DC area as government driven and the growth of internet technology activity in the area is likely to grow rapidly.
The 25,000 jobs (even with a greater than average salary of $150,000) isn’t the main impact of the announcement. The big news is the likelihood of Amazon’s highly visible efforts catalyzing more tech businesses (especially 5-7 years down the road when some of the Amazon people start creating their own startups). It isn’t that Amazon is moving into a barren tech landscape, there is already a strong base from which to launch a long term tech boost to the DC area economy.
The direct impact of Amazon’s employees renting and buying in and around Arlington is not going to be very strong for a couple years. Amazon plans to add 500 people to Arlington in 2019; 1,000 more in 2020 and 2,000 more in 2021. But investors already can plan for a strong future demand from Amazon and all the activity that Amazon’s growing presence will contribute to.
I am actually selling my house in Arlington (in this photo), with a very nice yard (explanation below).
The increase in housing prices in 2019 and 2020 will be primarily investor driven. In 2020, 2021 and going forward the impact of Amazon employees directly and all the extra activity spurred on will start to have an impact. Unlike the stock market where such a predicable strong investment future would drive prices up say 30-50% immediately, in real estate it is much more likely for the gains to be spread out over the long term.
If prices in housing increase in Arlington it is more likely they would increase say 10% in the first year and then an extra 3% (above what the increase would have been without Amazon’s move) each of the next 10 years. From a long term investors perspective this provides a great possibility for buying now (even after the news) and not having to pay a huge premium.
Rental housing prices are not likely to go up much immediately. And they will take longer to show up in the market, they will be much more closely tied to new job additions (from Amazon and others). So investors have to pay a higher price today (say 5-10% higher) and in the first 1 or 2 years probably see no higher rents than they would have otherwise. And even after 2021 those rents are likely to go up more slowly than prices of real estate.
The stories you most frequently hear about China in Africa are
- resource extraction (oil, metals, etc.)
- infrastructure loans from China (with Chinese labor and Chinese companies doing the work, often to aid resource extraction)
- farming exports to China
While those are happening an excellent report from McKinsey (Dance of the Lions and Dragons) provides an in depth look at a much more entrepreneurial state of affairs. While there are big government backed efforts (including those with Chinese state owned company participation) there are many small companies making entrepreneurial investments led by Chinese entrepreneurs seeing a opening to build successful companies.
Chinese firms’ decisiveness is indicative of the relationship between the comparative advantages of Chinese entrepreneurs and the opportunities in African markets. To some, the high returns earned by Chinese firms are symptomatic of a market failure: too little competition in African markets. But in sectors such as manufacturing, there are too few African firms with the capital, technology, and skills to invest successfully and too few Western firms with the risk appetite to do so in Africa. Thus the opportunities are reaped by Chinese entrepreneurs who have the skills, capital, and willingness to live in and put their money in unpredictable developing-country settings.
What makes the decisiveness of Chinese investors all the more impressive is that they are mostly using their own money. Two-thirds of the private firms we surveyed, and over half of all firms in our sample, reported that their investments were self-financed through retained earnings or savings, or funded through personal loans. Only 13 percent of investment funds came from financing schemes linked to the Chinese government, and less than 20 percent came from Chinese or African commercial bank loans
I believe investments in Africa will provide great investment returns in the next 20 years. There are many challenges but the opportunity is much greater than most people realize. The potential returns are quite high due to the lack of capital and interest being shown in African opportunities.
Factory in Nigeria (I think) that my family toured.
Likely huge companies, such as Google, Tencent, Facebook, Toyota and Alibaba will do very well. But there are many opportunities. That Africa is made up of 54 different countries creates challenges for investors and companies seeking to grow (but also creates variation and opportunities). It will be interesting to see how big the role Chinese entrepreneurs play in the next 20 years in Africa.
The report is an excellent detailed look at Chinese investment in Africa. It is a long and worthwhile read.
Related: Kiva Loans Give Entrepreneurs a Chance to Succeed – Drone Deliveries to Hospitals in Rwanda – Using Capitalism in Mali to Create Better Lives – Promoting Innovation in Sierra Leone
Factfulness by Hans Rosling (of TED talks and Gapminder charts fame) is an exceptionally good book. It provides great insight into how to think more effectively and how to understand the reality of the world we live in (versus the large distortions so common in most people’s vision of the world). You can take a quick quiz to see how well you understand the world
The truth of the very widespread increase in wealth around the globe has influenced my investing strategy for decades. It should be influencing yours, is it?
Data is extremely valuable in helping us make decisions and evaluating the effectiveness of policy. However it is critical to be careful. It is very easy to focus on meeting targets that seem sensible – increasing the number of hospital beds – but that lead to less effective policy.
Dollar street provides photos of people at all 4 income levels from around the globe. This illustrates Hans’ point that what determines how people live and what their circumstances look like is mostly a matter of income not the country they live in. It is simple idea but one that runs counter to much of the economic discussion focused so much on national boundaries. National boundaries do matter and the laws and economic reality of the national economy has a large impact but the issues for people at each level of income are much more tied to those in their level of income anywhere in the world than they are tied to their nation.
The book relentlessly points out the great progress that has been made globally over the last 50 years and how that progress continues today and looks to be set to continue in the future. We have plenty of areas to work on improving but we should be aware of how much progress we have been making. As he points out frequently he has continually seen huge underestimation of the economic conditions in the world today. This book does a great job of presenting the real success we have achieved and the progress we can look forward to in the future.
* In 2017
Level 1 has 0.75 billion people living on less than $2 per day.
Level 2 has 3.3 billion people living on incomes between $2 to $8 per day.
Level 3 has 2.5 billion people living on $8 to $32 per day.
Level 4 has 0.9 billion people living on more than $32 per day.
Related: GDP Growth Per Capita for Selected Countries from 1970 to 2010 (Korea, China, Singapore, Brazil) – Stock Market Capitalization by Country from 2000 to 2016 – Ignorance of Capitalism Leads us Astray – Wealthiest 1% Continue Dramatic Gains Compared to Everyone Else
The USA is currently looking to pass a tax bill. Actually the Republican party has decided to not seek bipartisan solutions so it is the Republicans that are looking to change the tax policy. They wish to call it tax reform but they are reforming nearly nothing. They are mainly moving around tax breaks to different people. The main aim seems to be to reduce taxes without reducing spending which given the huge annual deficit the USA government currently runs that means really this is a plan to shift taxes to the grandchildren of people living right now.
And within lowering taxes for some people today while placing those payments onto their grandchildren there is a bit of shifting around who will pay what now. Mostly this amounts to lowering the taxes on the rich today – along with some lowering of many people’s taxes that are in the middle class.
When you run a huge budget deficit (and have a huge amount of debt outstanding) “cutting taxes today” is just shifting taxes to the kids, grandkids and great-grandkids of those avoiding the taxes today. Truly cutting taxes (versus shifting them to a future generation) requires cutting the outstanding debt (which represents future tax increases) in addition to cutting current taxes.
The White House, Washington DC by John Hunter. See more of my photos of Washington DC.
To find reform ideas in the proposals requires using an extremely broad definition of what reform means. There are some attempts to reduce some favors in the tax code now for special interests. But these are minor compared to the goal of shifting the tax burden to grandchildren from those alive today.
One of the other goals is to reduce the corporate tax rate. This goal doesn’t look so great politically, so they are trying to minimize any focus on this. I think likely a reduction in the corporate tax rate is wise. This is mainly due, not to some principle that 25% corporate tax rate is better than a 35% rate (with all the system-wide effects that results in). Mainly a lower rate is needed when you consider the global economic system and the tax rates of other countries with an understanding of the global economy today. What must be sacrificed to reach a 20% corporate rate seems unreasonable to me, so 25% rate seems more sensible, but at this time they are trying to stretch to a 20% rate (and leave future generations to pay for the difference).
I support the effort to lower the corporate tax rate. In order to pay for that reducing some deductions is sensible. The plans have some of that and while each tax break has special interests benefiting from them I would support adding to the decreases in deductions. I would go along with a 20% rate if that was necessary, but think 25% or 22% or something would be better.
The most ludicrous part of the plan is the favors for trust fund babies. Eliminating the most capitalist friendly tax (the estate tax) and providing trust fund babies not only free inheritance without limit but stepping up the cost basis of investments is indefensible (economically indefensible, politically the Republicans obviously feel favors for trust fund babies are wise).
See my Curious Cat Tax Proposals blog post from 2016 for more of my ideas on how tax reform should be done.
The current deficit spending is made to look much less bad than it really is due to incredibly low interest rates. Given the inevitable rise in interest rates over the next 30 years the debt we pile on future generations is going to be much greater than it appears in an extremely low interest rate environment.
There are essentially 4 areas of significant federal spending.
- interest on the debt – this can’t be changed, it is set by the market
- spending on the department of defense (including spending on veterans)
- social security
- medicare and medicaid
There is no political will to reduce the costs of social security. I would raise the age at which you can begining taking payments and reduce payments to the rich. But this won’t pass, so that won’t change.
The Republicans have greatly increased spending by the department of defense so obviously this results in a tax increase (just on our descendants because they chose not to pay for the higher level of spending they voted for)
We have written about the massive changes in manufacturing globally over the last few decades. As we have shown, the data shows that the USA remained the largest manufacturer until 2010 when China finally took over as the largest.
The massive declines in manufacturing employment were global. It led many to believe jobs were moving from the USA to China but much more accurately jobs were being eliminated everywhere. China lost more manufacturing jobs than the USA during the 1990s and early 2000s.
The manufacturing job losses have been caused by productivity improvements. And those productivity improvements have provided us much cheaper access to manufacturing goods. That continued downward pressure on prices has been a big factor in the drastic decline in inflation. The threat of excessive inflation, which was so feared in the 1980s, has been replaced by the opposite problem – the threat of deflation.
One aspect of the productivity improvement has been the global supply chains that have allowed companies to increase efficiency. The requirements of managing global supply chains are extremely complex and likely would not be possible without software to aid in the complex task.
In his book, The Great Convergence, Richard Baldwin discussed how important the decline in shipping costs had in the economics of the last 50 years (we wrote about this book in: Historical Global Economic Data and Current Issues for Globalization). Those declines in prices, aided by other factors, increased the importance of supply chains.
The last few decades have also seen dramatic changes in supply chains due to the internet. The time from manufacture to consumer has been shaved by direct shipment to consumers and nearly direct shipment to consumers via companies such as Amazon. Again software plays a central role in tying the manufacturing floor to a nearly instantaneous status of incoming orders from end users. Or in the case of software and entertainment, companies like Apple and Netflix have replaced the entire supply chain of manufacturing physical goods (DVDs, CDs…) with software.
These changes in addition to increasing efficiency are again decreasing jobs by increasing the efficiency of the economy. These changes cause harm to those that are being squeezed (both employees and companies) while the economy overall gets more goods at lower prices to consumers.
The Great Convergence by Richard Baldwin makes some interesting points about “globalization.” I actually find the long term history the most interesting aspect. It is very easy for people today to forget the recently rich “West” has not always been so dominant.
That shows how quickly things changed. The industrialization of Europe and the USA was an incredibly powerful global economic force. The rapid economic gains of Japan, Korea, Singapore, China and India in the last 50 years should be understood in the context of the last 200 years not just the last 100 years.
A central point Richard advocates for in the book is realizing that the current conditions are different from the conditions in which traditional economic theory (including comparative advantage) hold. The reasoning and argument for this claim are a bit too complex to make sensibly in this post but the book does that fairly well (not convincingly in my opinion, but enough to make the argument that we can’t assume traditional economic theory for international trade is completely valid given the current conditions).
I don’t expect this blog post to convince people. I don’t even think his book will. But he makes a case that is worth listen to. And I believe he is onto something. I have for years been seeing the strains of “comparative advantage” in our current world economy. That doesn’t mean I am not mainly a fan of freer trade. I am. I don’t think complex trade deals such as TPP are the right move. And I do think more care needs to be taken to consider current economic conditions and factor that into our trade policies.
Richard Baldwin uses 3 costs and the economic consequences of those changing over time to show globalizations history, where we are today and where we are going.
It isn’t very easy to follow but the book provides lots of explanation for the dramatic consequences of these costs changing over time.
One of his themes is that mobility of labor is still fairly costly. It isn’t easy to move people from one place to another. Though he does discuss how alternatives that are similar to this (for example telepresence and remote controlled robots to allow a highly technical person to operate remotely) without actually do moving the person are going to have huge economic consequences.
The “high spillovers” are the positive externalities that spin off of a highly knowledgable workforce.
The data, from IMF, does not include China or India.
The chart shows data for net debt (gross debt reduced by certain assets: gold, currency deposits, debt securities etc.).
Viewing our post on the data in 2014 we can see that the USA improved on the expectations, managing to hold net debt to 80% instead of increasing to 88% as expected. Nearly every country managed to take on less debt than predicted (Vietnam took on more, but is very low so this is not a problem).
Taking on debt to invest in valuable resources (building roads, mass transit, internet infrastructure, education, environmental regulation and enforcement, health care, renewable energy…) that will boost long term economic performance can be very useful. The tricky part is knowing the debt levels doesn’t tell you whether the debt was taken on for investment or just to let current taxpayers send the bills for their consumption to their grandchildren.
Also government debt can become a huge burden on the economy (especially if the debt is owed outside the country). The general consensus today seems to be that 100% net debt level is the maximum safe amount and increasing beyond that gets riskier and riskier.
Even if some lobbyists and their friends in Washington DC try to distract from the long term failure of the USA health care system the data continues to pour in about how bad it is.
U.S. Health-Care System Ranks as One of the Least-Efficient
None of these rankings are perfect and neither is this one. But it is clear beyond any doubt that the USA healthcare system is extremely costly for no better health results than other rich countries (and even more expensive with again no better results than most poor countries). It is a huge drain on the economy that we continue to allow lobbyists and special interests to take advantage of the rest of us via the Democrats and Republican parties actions over the last few decades.
We have to improve. The costs imposed on everyone to support those benefiting from this decades old transfer of economic wealth to health care special interests should no longer be accepted.
The top 5 countries are: Hong Kong, Singapore, Spain, South Korea and Japan. The first four have costs about 25% of the USA. Japan costs about 40% of the USA per person cost.
Mylan’s despicable actions with Epi-pen and the direct participation of both political parties in increasing the costs foisted on the health care system by Mylan is just one in hundreds of the individual actions that continue to saddle the rest of USA economy with huge costs.
Related: Out of Pocket “Maximum”, Understanding USA Health Care Costs – Decades Later The USA Health Care System is Still a Deadly Disease for Our Economy – 2015 Health Care Price Report, Costs in the USA and Elsewhere – USA Health Care Spending 2013: $2.9 trillion $9,255 per person and 17.4% of GDP – USA Spends $7,960 Compared to Around $3,800 for Other Rich Countries on Health Care with No Better Health Results (2009 data)