“Unintended Consequences provides a provocative interpretation of the causes of the global financial crisis and the policies needed to return to rapid growth. Whether you agree or not, this analysis is well worth reading.” - Nouriel Roubini, New York University; Chairman, Roubini Global Economics
What About Japan?YiLi Chien, Harold Cole and Hanno LustigFederal Reserve Bank of St. Louis
A new @stlouisfed piece contends that the Japanese government takes on both duration and currency risk as it borrows short to invest in long-duration assets including foreign equities, domestic equities, and foreign debt. @HannoLustig
We show that Japan’s government has engineered a sizeable duration mismatch on its consolidated balance sheet. The Japanese government implements a sizeable carry trade, and it earns high realized asset returns while its borrowing rates decline. Japan’s government has realized an ex-post excess return of about 2.13% per annum above its funding cost by going long in long-duration risky assets, financed with mostly short-duration funding in the form of bank reserves, T-bills, and bonds. This investment strategy has allowed the government to earn more than 3% of GDP from its risky investments.
.@FedGuy12 argues the bond bear market is likely to resume, as issuance remains at a historical high, the Fed has left the market, and private demand looks weak.
The share of bills is set to gradually rise next year, but the trajectory of the increase may not be aggressive enough to support the market. Under Treasury Borrowing Advisory Council’s recommendation, the amount of new money raised next calendar year through coupons would be around $1.8t. Assuming $2.5t in privately held borrowing for 12 calendar months, net bill issuance next year looks to be around $700b. This would take some pressure off the market by increasing the share of bills to around 22% of marketable debt outstanding. A recession and rate cuts would likely boost Treasury demand, but current U.S. economic strength suggests they are more likely to occur later next year after the market is forced to digest a significant amount of issuance. The more likely sequence may be a sharp rise in yields that then leads to both a recession and rate cuts, which together finally create strong demand for Treasuries.
$1.3T of speculative-grade corporate borrowing is facing refinancing over the next three years, at rates more than double their 2021 lows. Moody’s predicts the US default rate will peak at 5.4% in January but could soar as high as 14%.
Average funding costs for the $8.6tn market in the highest quality corporate bonds, known as investment grade, are now above 6%, according to Ice BofA data. Although that is three times their lows of below 2% in late 2020, market participants are relatively sanguine about the health of these high-quality companies. There is more concern about less creditworthy borrowers in the $1.3tn non-investment grade market, often called junk or high-yield. Coupons now average 9.4%, more than double their lows in late 2021. Moody’s predicts the US default rate will peak at 5.4% in January, but if conditions worsen it could soar as high as 14%.
A @markets analysis suggests the natural rate of interest in the US will rise to 2.7% by 2050, implying 10-year Treasury yield somewhere between 4.5-5%, though higher investment levels could leave the yield at 6%.
Our model shows a rise of about a pp from a trough of 1.7% in the mid-2010s to 2.7% by 2050. In nominal terms, that means 10-year Treasury yields could settle somewhere between 4.5% and 5%. And the risks are skewed toward even higher borrowing costs than our baseline suggests. If the government doesn’t get its finances in order, fiscal deficits will stay wide. The fight against climate change will require massive investment. BloombergNEF estimates getting the energy network in shape to achieve net-zero carbon emissions will cost $30 trillion. And leaps forward in artificial intelligence and other technologies might yet boost productivity—resulting in faster trend growth. High government borrowing, more spending to fight climate change, and faster growth would all drive the natural rate higher. According to our estimates, the combined impact would push the natural rate to 4%, translating to a nominal 10-year bond yield of about 6%.
Foreign firms repatriated at least $160B of their Chinese earnings over the past 6 quarters. Historically, foreign firms have reinvested their Chinese earnings.
Foreign firms yanked more than $160 billion in total earnings from China during six successive quarters through the end of September, according to an analysis of Chinese data, an unusually sustained run of profit outflows that shows how much the country’s appeal is waning for foreign capital. The torrent of earnings leaving China pushed overall foreign direct investment in the world’s second-largest economy into the red in the third quarter for the first time in a quarter of a century.
A @washingtonpost analysis finds 34.6% of American women 25-44 have never had a child, up 13pp from 1980. Single-child families have stayed steady at ~ 20% over that time period, while families with 4 or more children declined significantly.
Women in their early 20s embraced childlessness first, with a sharp rise beginning around 2002. That happens to be when the first millennials, born in 1981, entered that age group. For women in their later 20s, the jump in childlessness happened in 2006, just as the first millennials arrived. As you ascend the age spectrum, the millennial echo follows. When the oldest millennials hit their 40s, even 40-year-olds become more likely to go childless. Just about every source we consulted pointed to the broader economic climate. If women are able to follow through on their delayed family plans, much of the rise in childlessness could be erased, but with older millennials in their 40s, time for a reversal may be running out.
Trump is leading Biden in five of six swing states driven by a decline in Biden support among young non-white voters. @Nate_Cohn
The deterioration in Mr. Biden’s standing is broad, spanning virtually every demographic group, yet it yields an especially deep blow to his electoral support among young, Black, and Hispanic voters, with Mr. Trump obtaining previously unimaginable levels of support with them. Mr. Biden barely leads at all among nonwhite voters under 45, even though the same voters reported backing Mr. Biden by almost 40 points in the last election.
Noting strong nominal wage growth, @M_C_Klein argues that short-term interest rates may need to stay at current levels or rise to prevent borrowing and spending from accelerating.
While there has been a significant deceleration in the rate of price increases from around 6% a year to 3% a year, the growth rate of the dollar value of spending and incomes has slowed by much less (from 7% a year to 6% a year). So far, this has translated into a massive acceleration in the growth rate of Americans’ living standards. I can think of two basic reasons why the (simple-minded) benign forecast that we will stay in a world with 6% nominal and 3% real growth might not turn out to be correct: Financial constraints force nominal spending to slow. Real constraints worsen the tradeoff between total spending and inflation. The short version is that while real growth may slow, it is much less clear why nominal growth would slow.
According to @pewresearch analysis, women made up 35% of workers in the 10 highest-paying occupations in 2021, up from 13% in 1980. 47% of the US workforce is female.
Women now make up 35% of workers in the United States’ 10 highest-paying occupations – up from 13% in 1980. They have increased their presence in almost all of these occupations, which include physicians, lawyers, and pharmacists. Women remain the minority in nine of the 10 highest-paying occupations. The exception is pharmacists, 61% of whom are women. More broadly, the share of women across all 10 of these occupations (35%) remains well below their share of the overall U.S. workforce (47%). Women remain in the minority among those receiving certain bachelor’s degrees required for some high-paying occupations. Mathematics or statistics: 42% of recipients today are women, unchanged from 1980. Physics: 25% of recipients are women, versus 13% in 1980. Engineering: 23% of recipients are women, versus 9% in 1980.
.@LHSummers issues a warning that America’s fiscal trajectory is leaving it little slack for meeting contingencies, “military or non-military.”
I would suggest that substantial and accumulating deficits and debts are a substantial threat to national security and national power. A reasonable calculation would suggest that our budget prospects are vastly worse than they were at the time of the Clinton administration's successful budget actions and substantially worse than they were at the time of the Simpson-Bowles efforts. The budget deficits a decade out comfortably in double digits as a share of GDP now seem a reasonable projection with primary deficits quite likely in the 5% of GDP range. This is without the assumption of the need for vast mobilization for meeting contingencies, military or non-military. And I think it is reasonable to ask the question. How long can or will the world's greatest debtor be able to maintain its position as the world's greatest power?
US equities account for nearly 70% of the MSCI World index, and the 10 largest US equities are larger than the combined market capitalization of Japan, the UK, France, Canada, and Germany. European-based firms are looking at listing on US exchanges.
US equities account for nearly 70% of the MSCI World index; the next five largest — in Japan, UK, France, Canada, and Germany — total less than 20%. The top 10 constituent equities of the MSCI World index, which are all US companies including Apple at number one and ExxonMobil at number 10, aggregate to more than 20%. To put it bluntly, the 10 most valuable US equities are larger than the market capitalisations of Japan, UK, France, Canada, and Germany combined. In effect, the US has scaled up the largest companies in the world in its own public markets, creating a colossal pool of recyclable equity capital residing in domestic and non-US investor portfolios. This has created a virtuous cycle of new listings from US and overseas issuers attracted by the depth and liquidity of that equity pool.
.@FedGuy12 writes that Treasury liquidity is low as dealer balance sheets have not scaled up with Treasury issuance. The average daily volume of Treasuries has increased very slowly over the past decade despite a flood of issuance.
While Treasuries remain the most liquid security in the world, they are structurally becoming less liquid. The average daily cash transactions in Treasuries has not come close to scaling with the overall growth in issuance. Although average daily cash volumes have increased slightly in recent years to $700b, that increase is in part due to the activity of principal trading firms whose strategy is to profit from small intraday fluctuations in price. These firms account for 20% of cash market volumes, but they disappear when volatility picks up so their provision of liquidity is illusory. Excluding their participation, cash market activity would be progressively thinning relative to the steady growth in issuance.
.@M_C_Klein notes that the spot 5-year yield on TIPS is at levels not seen since before the financial crisis. He suggests that if term premia revert to historical levels, there would be negative implications for all asset prices.
Even if wage growth did normalize, it is not clear why interest rates would need to fall much, if at all, in a world of 2% real growth, 2% inflation, and healthy private sector balance sheets. Real yields on 5-year Treasury inflation-protected securities (TIPS) are currently about 0.5 percentage point higher than 5-year real yields starting five years from now. But from 2003 until the pandemic, spot 5-year real rates were about 1pp lower than forward rates. (This includes the flat curve years of 2006-7 and 2018-2019, when the spread was more or less zero.) If further-forward real yields were poised to revert to this longer-term average, then that would have implications for a range of asset prices.
Torsten Sløk @apolloglobal notes that since the start of the hiking cycle, American households have bought $1.5 trillion in Treasuries.
Since the Fed started hiking rates last year, US households have bought $1.5 trillion in Treasuries, and over the past six months, US pension and insurance have also emerged as a buyer. Over the same period, the Fed has been doing QT and been a net seller of Treasuries. The bottom line is that US households and real money are finding current levels of US yields attractive.
New business applications by firms that are likely to hire workers remain elevated relative to pre-pandemic; in July 2023, they were 40% higher than the mean 2019 level. @BankofAmerica
The pandemic led to a surge in new business formations. What is striking to us is that this elevated level has continued post-Covid. According to data from the Census Bureau, in July, high-propensity business applications, which include all those that are more likely to become businesses with a payroll, were 40% higher than the average level in 2019. While not all of these businesses survive (the number of business deaths also rose in 2022 according to the Bureau of Labor Statistics), the net impact still points to strong growth in business formation. Business applications each year seem to be driven by a different sector. At the start of the pandemic, retail trade saw the biggest surge, driven largely by the growing demand for e-commerce, according to commentaries from the Census Bureau.
A new paper documents weaker technological diffusion in the economy and relates that to higher concentration of patents and a rise in patent litigation, factors that benefit incumbents and harm new entrants. @ProfUfukAkcigit @UChi_Economics
Patent concentration, which can affect diffusion, has risen over the past several decades with a concurrent surge in patent litigation cases. In the post-1980 period, a parallel trend concerning patents in the U.S. has been the dramatic increase in the number of patent cases filed, which some authors have dubbed the “patent litigation explosion.” The annual number of litigation cases filed per 100 granted patents rises from about 1.2 in the early 1990s to an average of about 1.5 between 1995 and 2010, before rising again to more than 1.8 between 2010 and 2015 and only receding marginally since then.
Stabilizing US federal debt at 100% of GDP will require increased tax revenue and non-interest spending cuts of 5% of GDP going forward. @Brian_Riedl suggests that increasing tax rates on the rich could yield at most 2% of GDP and likely less.
Stabilizing the federal debt at 100% of GDP over the long term—which would far exceed the post-1960 average of 45% of GDP—would require non-interest savings beginning at 2% of GDP and ramping up to 5% of GDP over the next three decades. (The resulting interest savings from a smaller debt would provide the rest of the savings.) These figures assume the renewal of the 2017 tax cuts (as there is strong bipartisan support for extending the tax cuts for the bottom-earning 98% of earners) but do not assume any additional spending expansions, tax cuts, or economic crises—all of which would also have to be fully offset to meet this debt target. In short, the non-interest savings required to stabilize the debt will almost surely rise past 5% of GDP when accounting for additional spending and tax-cut legislation. Taxing the rich cannot close more than a small fraction of this gap.
.@Brad_Setser argues that there is little evidence that China has shifted reserves out of dollars since the start of the Russo-Ukrainian War; he writes that the dollar share of Chinese reserves has likely increased since 2014.
There is no good evidence that China has reduced its exposure to the dollar. In fact, if you account for the higher dollar share of China's hidden reserves, its USD likely has increased since 2014. I am pretty sure that over the last year China hasn't shifted its reserves out of the dollar. It has shifted from US custodied Treasuries to offshore custodians and risk assets (Agencies, equities). When China stops targeting 60% for the dollar share of its formal reserves, we will know. The interesting question is what is the dollar share of China's shadow reserves -- and I think the answer is that it is a lot higher than the dollar share of China's formal reserves.
In 2023, only 16% of Americans said they trust the government always/most of the time. Republican-leaning voters are lower trust at 8% relative to 25% of Democratic-leaning voters.
Since the 1970s, trust in government has been consistently higher among members of the party that controls the White House than among the opposition party. Republicans have often been more reactive than Democrats to changes in political leadership, with Republicans expressing much lower levels of trust during Democratic presidencies; Democrats’ attitudes have tended to be somewhat more consistent, regardless of which party controls the White House. However, the GOP and Democratic shifts in attitudes from the end of Donald Trump’s presidency to the start of Joe Biden’s were roughly the same magnitude.
The average hourly wage for auto workers has dropped 30% since 2003 and has converged with non-auto production workers. The UAW is attempting to arrest the trend, but the Big Three’s profits would be erased if they meet the UAW’s demands. @foxjust
During the past 20 years, the inflation-adjusted average hourly wage of non-management US workers, also known as production and nonsupervisory employees, has risen 13%. That’s not exactly a rip-roaring pace — 0.6% a year. Then again, real hourly wages for production and nonsupervisory employees fell in the 1970s and 1980s and rose at only a 0.3% annual pace in the 1990s. The average hourly wage for autoworkers on the production line has dropped 30% since 2003. GM, Ford and Stellantis are all profitable, with a combined net income of $42B for the 12 months ended in June and the amount coming from their US operations probably adding up to somewhat less than $30B. Bloomberg reported last month that Ford and GM’s internal estimates of the costs of the UAW’s demands peg them at $80B per company over the next four years, which would wipe out all those profits and then some.
The typical Asian-American household in the US earns just over $100,000, 3x a typical Japanese family’s earnings.
Even after a planned rise in October, the minimum wage in Tokyo will be the equivalent of just $7.65, compared with $15 in New York City. Median household income in Japan in 2021, the most recent year for which data are available, was equivalent to about $29,000 at the current exchange rate, compared with $70,784 in the U.S. that year, according to government statistics in the two countries. The typical Asian-American household brought in just over $100,000—more than triple what the typical Japanese family made.
Capital inflows into North American markets have contributed to a 3.9x Price/Book value relative to market averages of 1.9x in Europe and 1.4x in Japan according to @verdadcap_quant. He believes this offers opportunities in both Europe and Japan.
We’ve found reasons to think more highly of Europe and Japan. Notably, we find that value stocks in Europe and Japan are more profitable, with Europe being particularly impressive. Among firms that trade at a discount to book value, Europe has a Gross Profit/Assets ratio of 18.5%, which is 1.5x the profitability of North American value firms. The differences are even more stark in terms of EBITDA/Assets, with Europe’s value firms delivering a 6.4% return on assets, almost 3x higher than North America’s profitability among value firms. We believe that the combination of historically wide valuation spreads in Europe and higher levels of profitability among Europe’s value stocks bolster the case for upward mean reversion going forward. Historically, mean reversion in multiples has supported significant outperformance of value relative to growth.
Racial polarization in voting has been declining since 2012 in the US. @Nate_Cohn finds Biden underperforming relative to 2020 in current polling with non-white voters; 5% of 2020 non-white Biden voters now say they support Trump.
Mr. Biden’s weakness among nonwhite voters is broad, spanning virtually every demographic category and racial group, including a 72-11 lead among Black voters and a 47-35 lead among Hispanic registrants. The sample of Asian voters is not large enough to report, though nonwhite voters who aren’t Black or Hispanic — whether Asian, Native American, multiracial or something else — back Mr. Biden by just 40-39. In all three cases, Mr. Biden’s tallies are well beneath his standing in the last election. The survey finds evidence that a modest but important 5% of nonwhite Biden voters now support Mr. Trump, including 8% of Hispanic voters who say they backed Mr. Biden in 2020.
.@Nate_Cohn argues that current polling suggests a significant decline in black turnout in 2024 relative to 2020.
Looking back over the last few decades, there’s a clear relationship between the racial turnout gap — the difference between white and Black turnout — and the proportion of Black registered voters who back Democrats in pre-election polls since 1980. Or put differently: When Black voters don’t support Democrats, they tend not to vote. It’s possible that the Black voters who back Mr. Trump in the polls today will ultimately show up for him next November. But for now, when I see Mr. Biden’s share among Black voters slip into the 60s and 70s in the polls, I mostly see yet another decline in the Black share of the electorate, at least “if the election were held today.” If there’s any good news for Mr. Biden here, it’s that the election is still 14 months away.
.@cwcalomiris argues high American public debt levels and chronic deficits may lead toward an era of “fiscal dominance,” in which the government forces banks to hold non-interest-bearing debt.
The essence of fiscal dominance is the need for the government to fund its deficits on the margin with non-interest-bearing debts. Inflation taxation has two components: expected and unexpected inflation taxation. Both are limited in their ability to fund real government expenditures. The expected component of inflation taxation (per period) is the product of the nominal interest rate and the inflation tax base, which consists of all non-interest bearing government debt. Unexpected inflation taxation occurs when the nominal value of outstanding government debt falls unexpectedly (thereby taxing government debtholders), and this component is also limited by the ability of government to surprise markets by creating unanticipated inflation. It is quite possible that a fiscal dominance episode in the US would result in not only the end of the policy of paying interest on reserves, but also a return to requiring banks to hold a large fraction of their deposit liabilities as zero-interest reserves.
.@B_Eichengreen argues that high public debt levels are here to stay and that methods to suppress interest rates are “less feasible than in the past.” This means chronic fiscal deficits will need to be reduced even in countries that issue safe assets.
Large, persistent primary budget surpluses are not in the political cards. It is difficult to imagine more favorable interest-rate-growth-rate differentials (favorable interest-rate-growth-rate differentials reducing debt ratios in an accounting sense). Real interest rates have trended downward to very low levels. It is hard to foresee them falling still lower. Faster global growth is pleasant to imagine but difficult to engineer. Inflation is not a sustainable route to reducing high public debts. Statutory ceilings on interest rates and related measures of financial repression are less feasible than in the past. Investors opposed to the widespread application of repressive policies are a more powerful lobby. Financial liberalization, internal and external, is an economic fact of life. The genie is out of the bottle. All of which is to say that, for better or worse, high public debts are here to stay.
Since 2007, the ratio of Treasuries outstanding to primary dealer assets has increased by a factor of four. @DuffieDarrell argues that this will drive increasing illiquidity in the Treasury market.
The total amount of Treasuries outstanding will continue to grow rapidly relative to the intermediation capacity of the market because of large and persistent US fiscal deficits and the limited flexibility of dealer balance sheets, unless there are significant improvements in market structure. Broad central clearing and all-to-all trade have the potential to add importantly to market capacity and resilience. Additional improvements in intermediation capacity can likely be achieved with real-time post-trade transaction reporting and improvements in the form of capital regulation, especially the Supplementary Leverage Ratio. Backstopping the liquidity of this market with transparent official-sector purchase programs will further buttress market resilience.
Alan Auerbach @Kotlikoff argue that the global savings glut was a “myth.” The market return on capital, which would show a decline if there were a capital glut, increased in the 2000s and 2010s.
There has been no major increase in the US capital-output ratio, nor has there been a major decline in the US marginal product of capital – the economy’s real return to capital. The US capital-output ratio remains close to its postwar average and capital’s real return has remained roughly constant -- around 6%. During the 2000s the marginal product of U.S. capital (MPK) was a healthy 5.84%. In the 2010s it was even higher at 6.42%. The market return to capital would show a decline if there were a capital glut and investors expected lower rates of return, It shows no such decline. The market return to capital’s real return averaged 5.52% between 1950 and 1989. Btw 1990 and 2019 it averaged 6.95. Hence, the broadest market-based real return data shows a rise, not a fall in returns in the recent decades during which capital has allegedly been in vast oversupply. The real return to US wealth between 2010 and 2019 averaged 8.25% – the highest average return of any postwar decade.
Ideologically driven donors of $200 or less are driving political polarization in the US, as small donors hold far more extreme views than those of the mean voter. @Edsall
A 2022 paper, “Small Campaign Donors,” documents the striking increase in low-dollar ($200 or less) campaign contributions in recent years. The total number of individual donors grew from 5.2mm in 2006 to 195mm in 2020. The appeal of extreme candidates can be seen in the OpenSecrets listing of the top members of the House and Senate ranked by the percentage of contributions they have received from small donors in the 2021-22 election cycle: Bernie Sanders raised $38.3mm, of which 70%, came from small donors; Marjorie Taylor Greene raised $12.5mm, of which 68% came from small donors; and Alexandria Ocasio-Cortez raised $12.3mm, of which 68%, came from small donors. House Republicans who backed Trump and voted to reject the Electoral College count on Jan. 6 received an average of $140,000 in small contributions, while House Republicans who opposed Trump and voted to accept Biden’s victory received far less in small donations, an average of $40,000.