"Kee" Points with Jim Kee, Ph.D.

Overall, I would say that there is more confidence in accelerating growth in the U.S. than there is for the rest of the world. Yesterday’s manufacturing Purchasing Managers Index (PMI) was in solid expansion territory, and it will be interesting to see if this Friday’s payroll report for May corroborates this positive signal. Expectations are for around 200,000 new jobs created. I’d say a broad consensus outlook is for growth to move up to the 3% range in the U.S., rising earnings, rising interest rates, and rising stock market values (Goldman Sachs). Globally, Latin America (e.g. Brazil) seems to be struggling the most, with Europe (European Central Bank announcement this Thursday) and Japan doing ok, and India perhaps accelerating.


Interest rates and a conceptual aside: You may not know it, but the fields of finance and economics have yet to work out a theory of a company’s “optimal capital structure,” or how it should finance itself between borrowing (debt) and selling ownership rights (issuing equity). In fact, Nobel Prizes were issued to the late Merton Miller and Franco Modigliani just for working out how to think about it systematically and conceptually.


It’s a deep topic, made complex by the interaction of taxes and management incentives. For example, more debt is riskier in downturns, a negative, but it also focuses management’s attention on the bottom line, a positive. To economists, in pure theory, it is the nature of a firm’s assets that dictates capital structure. Firms with very ‘plastic’ assets, that is, assets that can be used in a variety of ways, like research and development (R&D), are more difficult and costly to monitor for lenders than firms with ‘implastic’ assets, like utilities. Such firms tend to have lower debt ratios (i.e. they are equity financed rather than debt financed), and that characterizes much of the information or knowledge-based economy.


Back in 2006 this led the International Monetary Fund’s Director of Research Raghuram Rajan (now heading India’s central bank) to postulate that, globally, there was increasingly a dearth (e.g. lack) of collateralizable assets relative to savings. In short, Rajan argued that cash flow generation was and is increasing faster than investment, leading to a ‘global savings glut’ (Ben Bernanke’s term) that has manifested itself in a global search for yield. This is exacerbated to the extent that the global economy is more knowledge-based, leading to a relative dearth of collateralizable assets. If true, and Rajan himself talked about the difficulty of obtaining data to test his hypothesis, then it is one reason for lower global interest rates that are not going away any time soon.