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Monthly Archives: July 2010

Deeper recession, slower recovery

Friday’s GDP growth in 2Q came out as 2.4%, showing the recovery is losing momentum.

(click to enlarge; source: WSJ)

Once again confirming this is not your average-Joe recession (see chart below):

Prevent the next deflation – What’s left for the Fed?

From Bernanke’s speech in 2003:

Should the funds rate approach zero, the question will arise again about so called nontraditional monetary policy measures. I first discussed some of these measures in a speech last November. Thanks in part to a great deal of fine work by the staff, my understanding of these measures and my confidence in their success have been greatly enhanced since I gave that speech.

Without going into great detail, I see the first stages of a “nontraditional” campaign as focused on lowering longer-term interest rates.

The two principal components of that campaign would be a commitment by the FOMC to keep short-term yields at a very low level for an extended period together with a set of concrete measures to give weight to that commitment.

Such measures might include, among others, increased purchases of longer-term government bonds by the Fed, an announced program of oversupplying bank reserves, term lending through the discount window at very low rates, and the issuance of options to borrow from the Fed at low rates. I am sure that the FOMC will release more specific information if and when the need for such approaches appears to be closer on the horizon.

Deflation Threat: Is America another Japan?

Does America face Japanese-style deflation?

America’s Lost Decade, part 4

This is a post following my previous posts on the same topic, see p1, p2, p3.

When discussing the issue, most people focus on GDP growth. Yes, in terms of GDP growth, in the past decade, the US still managed to grow 18%, cumulatively – that’s roughly 1.8 percent per year on average. However, in terms of employment growth, it has been a lost decade for the US (see the chart below).

(click to enlarge)

Given the economic dynamism in the US, and compare it to Japan, I have long thought the Lost Decade would never happen in America, a land full of opportunities.

I guess I need to re-visit my presumptions — Whether a big housing bubble (in the US’ case, two big bubbles in one decade) always foretells anemic economic growth afterward,  as opposed to the common belief that Japan’s lost decade was largely due to policy mistakes.  Maybe, in the aftermath of a big bubble, America and Japan are really not that much different – an open question.

Consumer confidence in historical perspective

Compare almost four decades of Consumer Confidence Index from the Conference Board (NYC). The chart speaks of thousand words about current economic environment.

(click to enlarge; ht: dshort)

Four generations of iPhone compared

Compare speed of the four generations of Apple iPhones.

Time to upgrade my iPhone from 1G to 3G 🙂 (no 4G yet, due to its reception flaw and slow start-up).

Household debt in foreign currency drags Europe’s growth engine

Eastern Europe, like other emerging markets, had been investor's darling before the crisis hit in 2008. People bet money on its faster economic growth due to better demographics and cheap labor and resources compared to the more developed Western Europe.

Eastern European countries also liberalized their financial sector and allowed entry of mega European banks from France, Swiss, and Germany.  Since most of these countries are still not part of the Euro-zone, foreign banks only provided credit in foreign currencies, such to Euro and Swiss Francs.  Domestic households underestimated the currency risk – who would have anticipated a big unprecedented financial crisis is coming.

With currencies in these countries plunging, household debt sometimes doubled to the pre-crisis level.  What choices left?  Default and government bailout.   No matter what measures taken, the once growth engine of Europe now became the heavy drag.

Eastern Europe's problem is not unusual.  It drew parallels to the Club-Med (southern European) countries that joined European Union earlier.  Both were huge credit bubbles fueled by optimistic view that the ever integrated European continent will bring tremendous growth opportunities.  The difference in the case of Greece was that joining Euro-zone reduced their borrowing costs significantly for both government and households (compare the credit spreads before and after joining the Euro, you will see).  The much cheaper credit not available before made both people (and governments) think they are now artificially richer.  And boom, they went on spending (and speculation) spree.  A big cause for European housing bubble.

So don't blame Greek or Eastern Europeans, blame the fatally flawed idea of "Europe as ONE".

Now read this fascinating story from WSJ:

BUDAPEST—Dezso Kocs's family restaurant was booming in 2007. To build a bigger kitchen and renovate the dining room, he and his wife borrowed the equivalent of $150,000.

It's a decision they now regret. Like many Hungarians then, they took the loan in Swiss francs, since the interest rate was far lower than if they had borrowed in their local currency, the forint. But after the global financial crisis hit in 2008 and the forint plummeted, the Kocs's monthly payments nearly doubled.

Households and small businesses across Central and Eastern Europe are sinking under the weight of foreign-currency debts.

It's a sign of how the problems facing the region's financial system go beyond the borrowing by spendthrift governments that has been the main focus of investors.

The rising number of borrowers' defaults already has hit bank profits. Ratings agencies warn that the exposure to foreign-currency lending could hurt the creditworthiness of financial institutions in the region.

Hungarian households collectively have about $32 billion in outstanding foreign-currency debt, mostly in Swiss francs and euros, according to the Hungarian central bank. Aside from local players, about a half-dozen foreign banks—from Austria and elsewhere in Europe—have a significant presence in Hungary.

The larger international lenders generally are viewed as diversified enough that troubles in Hungary aren't likely to pose a serious threat. Regulators say banks operating in Hungary have shored up their finances and are in better shape to withstand further shocks than at the start of the financial crisis.


But consumers' debt woes are acting as a brake on the region's economic recovery as households use income to pay off loans instead of spending, damping domestic demand. The foreign-currency borrowings also constrain economic policy makers since swings in interest rates and currency values can drastically change the fortunes of indebted households and companies.

In Romania, one of the European Union's poorest members, more than 60% of household borrowing is in foreign currency. In Poland, the figure is 36%. In the Baltic states, the proportion ranges from 70% to more than 90%.

In Hungary, nearly 70% of the country's total household debt was borrowed in foreign currency. The sharp slide in the Hungarian forint, which since the summer of 2008 has fallen about 20% against the euro and some 30% against the Swiss franc, has meant large increases in the local-currency cost of repaying these loans.

Full text here.

China’s healthcare boom

China is in economic restructuring. Building affordable healthcare and social security system are on the top of the reform agenda (this helps drive down China's savings rate so to avoid crisis in the future fueled by global imbalance). Foreign companies will have tremendous business opportunities in China.

The world's largest CT-scanner makers, including General Electric Co., Siemens AG and Royal Philips Electronics, are zooming in on China.

That nation plans to spend $125 billion to build tens of thousands of hospitals and clinics, extending health care to nearly all of its citizens. Its ambitious three-year plan, announced last year, has created a rare feeding frenzy in the lucrative field of diagnostic-imaging machines, an area in which Western manufacturers still face little Chinese competition.


Indeed, China's total medical device and equipment market is expected to roughly double between now and 2015 to $53.7 billion, according to market-research firm Frost & Sullivan. That figure includes products ranging from patient-monitoring devices to stents, but much of the growth will likely come from MRI and CT scanners, which are highly profitable and can cost up to $2 million apiece. And the likely sales come amid a protracted slump in the U.S. market for medical equipment and devices triggered by the economic slump.

"The efforts made by the Chinese government are unprecedented" in terms of investing in health-care infrastructure and spending on higher-tech equipment, says Ronald de Jong, chief executive of Philips Healthcare's emerging markets business.

GE and Philips project double-digit increases in their health-care operations in China over the next few years, while Siemens says it aims to increase medical-imaging sales there at a faster pace than the market's projected 10% annual growth. Last year, GE says, it generated $1 billion in Chinese health-care revenue, including equipment sales, parts sales and maintenance fees. It declined to disclose its U.S. sales figures, but the overall U.S. market for medical-imaging equipment and services fell by one third last year to $9.7 billion from $14.4 billion, according to market research firm Frost & Sullivan.

GE remains the top seller of medical-imaging devices globally and in China, but both Siemens and Philips are gunning to expand their Chinese market shares. To cater to smaller and more rural hospitals, all three companies have opened more sales and service offices across China's interior. They are also expanding less costly, lower-end lines of imaging gear.

GE, which plans to increase its 4,000-employee health-care work force in China by as much as 15% this year, has expanded its line of lower-priced Brivo imaging equipment beyond X-ray machines and into CT scanners that are roughly 30% less expensive than the company's costlier models. GE says it has sold 70 Brivo scanners in China since they were introduced in March.

America’s New Growth Strategy

Michael Spence, Nobel prize winner in economics, argues that in order to compete with developing countries, such as China, which concentrates on labor-intensive manufacturing, the US must instead create new capital-intensive jobs with higher labor productivity.  The exports from the US and exports from developing countries are not necessarily substitutes. (source: FT)

America needs a growth strategy

By Michael Spence

As the International Monetary Fund warned on Thursday, America’s economy shows worrying signs of weakness. Worse, and in common with other developed countries, it also lacks a credible strategy for longer-term growth. Without such a strategy, a strong global recovery is unlikely.

The structural evolution of the US economy over the past 15 years has been driven by excess consumption, enabled by debt-fuelled asset inflation. The crisis put a stop to this, but structural deficiencies remain. America’s export sector is too small and underdeveloped. The financial sector became outsized, and is down-sizing.

A pattern of underinvestment in infrastructure has left the economy less competitive than it should be. Energy pricing issues have been ignored, causing underinvestment in urban infrastructure and transport. The education system has widespread problems with efficiency and effectiveness. Elsewhere, state budgets are in distress as a result of insufficiently conservative budget policies.

Even with a fiscal strategy that balances short-term stimulus and longer- term stability, America must still address the composition and size of expenditures, investments and revenues. To finance growth-supporting long-term investments, domestic private consumption has to shrink. This means higher taxes. In addition, existing government expenditure must be shifted away from consumption and towards investment, meaning fewer government services. Restoring fiscal balance in a way that supports longer-term growth will therefore be painful.

But even that is not enough. The real issue is employment: not just stubbornly high unemployment, but a bigger problem described recently in a thoughtful article by Andy Grove, the long-time chief executive of Intel. He argued that manufacturing is vanishing in the US, a trend that must be reversed. The question is how.

There is little doubt that America’s social contract is starting to break. It had on one side an open, flexible economy, and on the other the promise of employment and rising incomes for the motivated and diligent. It is the second part that is unravelling.

Incomes in the middle-income range for most Americans have stagnated for more than 20 years. Manufacturing jobs are moving offshore. Globally the set of goods and services that is tradable is expanding, but the US and other advanced countries are not competing successfully for an adequate share of the tradable sector.

The employment effects of these trends over the past 15 years have been masked by excess consumption and the overdevelopment of sectors such as finance and real estate. The latter are now set to shrink, as multinational companies grow where they have access to high-growth emerging markets in Asia and Latin America. Such companies will locate their operations where market and supply chain opportunities lie. In the tradable sector, in manufacturing and in a growing group of services, that means outside advanced countries.

The availability of low-cost, disciplined labour forces in developing countries reduces the incentive for these companies to invest in technologies that enhance labour productivity in the tradable sectors of the advanced economies. As a result, the evolving composition of advanced economies is increasingly weighted towards the non-tradable sector, combined with a set of high-end tradable services where both human capital and proximity matter. The rest of the tradable sector is shrinking. 

The shrinkage creates problems. Over-specialisation could threaten independence and national security. Spillovers between R&D, product development and manufacturing will be lost if manufacturers leave. Employment will stagnate. Income distribution will move adversely and the social contract will erode further.

Solutions to these problems are not easy to find. The unequal distribution of income can be dealt with through the tax system, although this does not attack the underlying problem. Protectionism could alter the pattern of out-migration of manufacturing, but only by imposing costs on domestic consumers and risking the breakdown of the open global economy model.

To avoid an outbreak of protectionism, there has to be an alternative. President Barack Obama’s new export council, announced on Wednesday, is a step in the right direction. But a bolder move is needed: a broad public-private partnership to invest in the development of technology in parts of the tradable sector where there are opportunities to make advanced countries competitive. The goal must be to create capital-intensive jobs that have labour productivity levels consistent with advanced country incomes.

Would this damage developing countries? Clearly not. The US (or even developed economies combined) does not have hundreds of millions to employ. A targeted programme would leave the vast majority of labour-intensive manufacturing right where it is now: in the developing world. With new credible growth strategies in America (and other advanced countries) developing countries may even be willing to play an important complementary role in restoring global demand through, for example, the reduction of excess savings.

We are already on a lengthy and bumpy road to a new normal. That is unavoidable. The risk is that without a new direction in American economic policy, the new normal may be as unpleasant as the journey.

The writer received the 2001 Nobel memorial prize in economics and chairs the Commission on Growth and Development

Cash rich yet subpar growth

I have been hoping that cash-rich US corporates will find new investment opportunities and help to drive the US economy into a “virtuous cycle” – positive corporate profits lead to improved employment and more labor income and more consumer confidence then more consumer demand.  But there are signs that maybe the opposite is more likely to happen.  Facing huge “unusual uncertainties” (Bernanke’s words), US firms, after completing their first inventory buildup, which has contributed to growth so far, now are unwilling to spend more on capital investment: they are looking at a prolonged unemployment scenario and consumer demand is likely to take very long time to recover.   What the US needs now is how to sell more to overseas – for that, the US needs a new export strategy (I will come back later for this topic).

Here is a piece from WSJ today discussing the uncertainties the US firms are facing:

Here’s a puzzler for investors: Although second-quarter economic growth figures look rather weak, corporate earnings are nevertheless coming in reasonably strong.

Specifically, about a third of S&P 500 companies have released their second-quarter earnings so far, and 78% of them have beaten analysts’ estimates, according to Thomson Reuters. On average, earnings per share are up 42% year-on-year, compared with the 27% growth expected.


Yet the market’s response so far has been lackluster. The S&P 500 is up only about 1.5% since the first earnings report July 12. It is hard to argue that such results were already priced in, as the market dropped by about 11% in the 10 weeks prior to earnings season. Why, then, the muted reaction?

Chalk it up to what Federal Reserve Chairman Ben Bernanke dubbed the “unusual uncertainty” over the economic outlook. For every upside surprise in corporate earnings, it seems there’s a disappointing piece of economic data.

The Commerce Department doesn’t release its tally of gross domestic product until this Friday, but it is expected to come in below the first quarter’s 2.7% annualized pace. Goldman Sachs economists last week cut their second-quarter GDP growth estimate to 2%, for example, and expect further slowing to 1.5% in the second half of this year. Moreover, they put the odds of another recession, or “double-dip,” at about one in four.

A double-dip would certainly wreak havoc on profits. But it increasingly looks as though the more likely outcome is that the U.S. economy muddles along for a while at roughly 2%, below the 3% average of the past two expansions. That doesn’t necessarily spell disaster for corporate profits.

For investors, the mixture of healthy, cash-rich corporate balance sheets but subpar growth “is not one we have a lot of experience with,” notes Credit Suisse U.S. Equity Strategist Douglas Cliggott. One likely outcome, he says, is that a higher share of total S&P 500 returns come from dividend yield as opposed to price appreciation over the next few years.

Indeed, companies like Procter & Gamble and McDonald’s may not be the most thrilling names on Wall Street. But with their above-3% dividend yields, they probably offer the best seat for investors to ride out the recovery.