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

In the US, slightly better spending data, decent manufacturing and services data (purchasing managers surveys) and a mediocre jobs number (138,000) point to a US economy accelerating from the first quarter (1.2% annualized growth), but only modestly so. Federal Reserve forecasting models from Atlanta, New York, and Philadelphia, as well as Blue Chip consensus economists, are expecting 2%-3% growth for the second quarter, which will be released at the end of this month (June 29th). Looking abroad, good economic growth numbers were reported last week from Canada, Brazil, China (purchasing managers surveys), and Japan. Global equity markets continue to reflect this, with US stocks up over 7%, and international developed market stocks up over 10%. Emerging markets are up over 12% (most broad market indices are reflecting this). I think the best characterization of emerging market equities is the Asian Times’“Charlie-Brown-and-the-football” description, implying that the many short-lived emerging market rallies we’ve experienced since 2007 are inspiring little confidence with investors. In referring to Thailand, Turkey, Vietnam, Brazil (“an iron ore mine masquerading as a country”), etc., Economist David Goldman describes the space as follows:

“To oversimplify, Asian emerging markets are a play on productivity gains stemming from improved transport and communications, while Latin American emerging markets are broadly a commodity play.”

He puts Korea and Taiwan in the camp of “recently emerged markets,” with South Korea suffering the overhang of North Korea’s belligerence (and with Samsung’s struggles, which is 23% of the MSCI South Korea Index), and Taiwan suffering from its dependence upon a single industry – semiconductors, which faces increasing competition from China (Asian Times). Mexico is mentioned as being more sensitive to auto parts than oil, making the Trump-Mexico relationship the dominant theme there.

In Europe, the European Central Bank (ECB) continues to buy about $60 billion euros worth of bonds each month, but I think ECB President Mario Draghi wants to start tapering or reducing purchases soon, following the US Federal Reserve Bank. In fact, with all of the currency doom and gloom being preached on the internet, there is a bullish global outlook story to be told, and it goes something like this: Economist Robert Mundell uses the solar system as an analogy to the global monetary system. It used to be that the dollar was the center of gravity, the “sun,” if you will. The world in one way or another priced everything in terms of dollars. With the advent of the euro in 1999, you suddenly had a currency that represented a trading block (the countries adopting the euro) that was the same size as the US, kind of like creating two centers of gravity (two suns) for global trade. Thirteen nations including China have currencies tied to the dollar, while 22 nations are linked to the euro, making the dollar/euro area over two thirds of the world economy (Wall Street Journal). As economist Sean Rushton points out, the problem is that since 2007 the dollar/euro exchange rate has moved up or down by over 20% on more than eight occasions. Such instability is a huge drag on economic growth, both here and abroad, because it makes it very difficult for businesses to execute long-term plans and investments. This has been Mundell’s lament since the (2007) crisis began, and “normalizing” central bank policies in the US and Europe (i.e. reducing/ending asset purchases and low zero interest rate policies) is a step towards managing this instability. Exchange rate stability in-turn would greatly facilitate the global specialization and exchange that characterizes the modern world economy, and stronger global growth would ensue.

Debt issues: In my career, bond-market professionals have tended to have the reputation of being “perma-bears” (permanently negative or bearish), or always inclined towards a negative view of the economy and markets. Derided as perpetual boy-who-cried-wolf types, they certainly got their day in the sun with the subprime mortgage crisis and the near-collapse of the global financial system. Now, concerns about markets with possible excess debt issues get more of a hearing, and perhaps the pendulum has swung too far in the other direction. Debt-Armageddon stories seem to be everywhere – Japan (high debt-GDP ratio), China (high corporate debt), Europe (high country debt), and the US (subprime auto debt and student loan debt). Usually debt, like your outstanding mortgage, is compared with assets, like the value of your house. And debt service payments, like your mortgage payment, are compared to annual income. Most global debt stories omit the asset part and the debt service-cost part, making them incomplete (to put it charitably). Others fail to mention that while crisis and default are one outcome, so are debt restructurings and workouts, which are far more common.

With that said, one debt problem that seems widespread in the US is that of underfunded public pension plans. “The $5 Trillion Dollar Misunderstanding” is how a recent Milken Institute article put it. The article argues that public pensions are underfunded (liabilities exceed the assets) by something between 25% and 60%, depending upon who you ask. A lot of this hangs upon the assumptions used for the future rates-of-return on the assets, and upon how you value (“discount”) the future liabilities. The solutions aren’t easy. Cutting benefits ignores the fact that many of these workers chose these careers and spent decades in them partially because of the pension plans, in many cases accepting lower incomes as part of the deal. Expecting higher returns probably isn’t realistic either. The article points out that the largest unfunded liabilities (e.g. New Jersey) had employers who paid in less than actuaries suggested, and are now “hoping for a wizard investment advisor to save them” (Milken Institute). That has bad outcome written all over it. Another outcome would be for residents in the municipalities with underfunded pensions to receive less or lower-quality public services, with the money instead going to pay the pensioners (so more potholes, fewer police, etc.). To conclude, ruling out higher returns leaves taxpayers, pensioners, and residents playing some part in solving the public pension plan problem.