“Kee” Points with Jim Kee, Ph.D.

Global view: Recent North American data (housing starts, durable goods orders, hiring and spending data) point to continued expansion in the US, Canada and even Mexico. In Asia, Chinese data (latest purchasing manager’s survey) indicates a possible bottoming of the growth slowdown there; India’s GDP expanded 5.7% in the second quarter on an annualized basis while Japan’s declined by 6.8% annualized (some of which was the fall off of consumer spending following tax increases there that caused an acceleration in the first quarter). Europe is struggling to avoid recession, so recent positive export data from Germany was welcomed. Latin America is struggling, with recession in Brazil, and few positives in countries like Argentina (debt restructuring) Venezuela, and Chile. Overall expectations for global growth are for around the 2.8% (World Bank) to 3.4% (IMF) range. The latest World Economic Outlook from the IMF (International Monetary Fund), a good place to start, derives its 3.4% global growth rate for 2014 from 4.8% in emerging markets, 1.9% for the US, 1.5% for Japan, flat to -.4% in Europe, and 2.6% in Latin America.

 

Policy responses - monetary and fiscal - are important. On the monetary policy side, accommodative policies in the US, Japan, increasingly Europe, and piecemeal in China are positives. But in my view it is the fiscal side (tax, spending, regulation), which is much harder to implement and much more controversial, that poses the strongest global headwind. Europe’s fiscal situation is a mess, not just the debt burdens but the wage rigidity and regulatory morass. I don’t see an easy fix there. On the monetary side, a European “QE” (debt purchase program) is pretty much assured going forward, which is a key reason for the low bond yields there. It has also started to bring the Euro down below the $1.35 range that it has stayed at for most of the year (currently $1.31 now), and that’s a positive. But Europe’s outlook over the next twelve months also hinges on the Russia/Ukraine conflict and, really, the impact of economic sanctions (trade restrictions with Russia) on business confidence in Europe. Japan’s fiscal situation needs work as well, and I think Japan’s future hinges upon whether and to what extent Prime Minister Abe delivers on promises of corporate tax rate reductions, corporate governance reform (Japanese companies have the lowest ROIs -return on investment-in the world), and reforming or privatizing the $1.26 trillion Government Pension Investment Fund (those are part of Abe’s “third arrow”). These are longer-term initiatives. Recent headlines on China refer to a possible housing bust there. Property laws in China are pretty complex, and while this subject is much too lengthy for a Kee Points discussion, the Real Exchange Rate economics of UCLA professor Arnold Harberger come in to play here. In a nutshell, China links its currency to the US dollar. When a country does that and is growing faster than its currency partner, the currency or exchange rate tends to appreciate. When it is fixed, like China’s (more or less), the adjustment takes place through a rise in the prices of the non-tradable goods sector (think housing, wages, services) relative to the prices of the globally traded goods sectors. Slowing growth should produce the opposite, i.e. declining non-tradable goods sector prices (real estate, wages, services), and that is what we are seeing. Finally, I’d say Latin America is suffering from poor monetary and fiscal policies, and without the help of a Chinese-led commodities boom like they experienced in the 2000s.

 

Markets seem to know this. The US has been the strongest of the developed markets over the past several years, with Europe and Japan lagging and trading-off against one another depending upon the time frame. Emerging markets have lagged, with Asia (ex-Japan) outperforming Latin America. That makes sense given that over that time frame developed market growth has stabilized or accelerated while emerging market growth has slowed (but still exceeds developed world growth in absolute terms). It's changes rather than levels that tend to move markets. Markets tend to price what’s knowable, which is a different thing from having perfect foresight. The 2007-09 market decline is a great example. The extent of the subprime crisis was not known in advance, but rather was revealed over time, and markets priced this accordingly. In the depth of it all, former Fed Chairman Ben Bernanke’s recent testimony in the U.S. Court of Federal Claims states it pretty clearly, “September and October of 2008 was the worst financial crisis in global history, including the Great Depression. Of the 13 most important financial institutions in the United States, 12 were at risk of failure within a period of a week or two...AIG’s demise could have resulted in a 1930s-style global financial and economic meltdown, with catastrophic implications for production, income, and jobs.” That’s when the total stock market capitulation began, and the policy response was unknown. As the policy response became known - the unprecedented lender of last resort actions taken by the Fed - markets rebounded, that is, priced it accordingly.

 

final note on central bank policy. When I was a graduate student (well over 20 years ago) I was funded by a free-market group that held conferences in Jekyll Island Georgia. At one conference, one of the leading lights of that group (a strong gold currency advocate) said in a large group presentation that the best thing in the world would be for the US to default or capitulate on its debt, as it would then not be able to borrow and sustain such a large government sector. I was sitting in the back amidst a group of bankers from Dallas, and I overheard one of them remark something to the extent that “This guy’s an idiot, a government debt default would result in total global financial chaos.” The banker was right. Professors and internet “experts” make flippant comments like this to 18 year-old college students all of the time, almost guaranteed to win favor with them. But my takeaway, and I hope it is yours too, was to not be so quick to dismiss people with vast real world experience at high levels on a global scale in favor of those with no real practical experience at any level on any scale.