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

Global forces at work

A good jobs report on Friday (non-farm payrolls increased by 209,000 in July) corroborated the previous week’s second quarter GDP growth estimate (2.6% annualized) to paint a picture of solid growth in the US. Data from Europe has tended to be on par with the US, while Japan’s growth rate is lower than both but positive. So the developed world continues to expand modestly but below the growth rate of the global economy as a whole, meaning the developing or emerging economies are growing faster.

This development has led, over time, to a “Safe Assets Shortage Conundrum,” which is the title of a recent article in the Journal of Economic Perspectives (JEP). High savings rates in places like China (due in part to a lack of government safety nets) and other Asian economies (a product of the Asian crisis of the late 1990s), have led to an on-going demand for “safe assets.” These assets are typically simple debt instruments like Treasury bills, which are expected to preserve their values during adverse systemic events. Safe assets tend to be located in the developed world, particularly the United States. So the growth rates of the advanced economies that produce safe assets have been lower than the growth rates of the high-savings emerging economies that demand them. Over time this has led to the aforementioned safe assets conundrum. This was alluded to by Ben Bernanke’s description of a “savings” glut back in 2005, and it is partly the reason for the creation of “private label” (JEP) safe assets, like AAA-rated securitized instruments. It also facilitated the excess issuance of debt by governments perceived to be safe havens at the time, like Greece and Italy. Most of these “pseudo safe haven assets” have crashed and burned, while the more enduring substitutes, and one could put US real estate in this category, remain in high demand.

Somewhat related to this is the ongoing transformation of private sector investments, particularly in the developed world, from tangible, collateralizable investments (i.e. plant and equipment) to more intangible and difficult to collateralize (i.e. borrow against) investments, like research and development (R&D). Intangible investment is hard for lenders to monitor and hence hard to finance with debt­­­. That’s one reason why technology firms tend have lower leverage or debt burdens than other firms. Former Reserve Bank of India Governor Raghuram Rajan described this 10 years ago as a “dearth” (lack) of collateralizable assets. This is really part of the safe assets conundrum, and it is one of the reasons why real interest rates are so low, particularly in the US. That is, the demand for safe haven assets (e.g. government debt, real estate, well-collateralized debt) have bid up their prices and lowered their yields. It also helps to explain the several dollar “spikes” we have seen since the Great Recession, since the majority of these safe

assets reside in the US. This, then, is a key reason for the low interest rates experienced since the Great Recession, with Central Bank policies partially reflecting this low rate environment and partially adding to it [this is an on-going debate in the profession, i.e., “does the Fed drive the market or follow it?”]. The growth and urbanization of the emerging economies (and the majority of the world’s population) should start to lead to a gradual reversal of this trend, with those high savings in emerging economies being channeled into the demands there for conventional (roads, ports, rails) and technology infrastructure spending.

Other quick points from last week’s news flow

John Williams, President of the Federal Reserve Bank of San Francisco, described the process of reducing the size of the Fed’s $4.5 trillion balance sheet (by cutting back on the amount of maturing securities reinvested each month) as follows: “we’ll start nice and easy, letting our holdings of Treasury securities decline by $6 billion a month, and those of Mortgage Backed Securities (MBS) by $4 billion per month. Thereafter, we’ll increase these caps by $6 billion and $4 billion respectively, every three months, until they reach $30 billion per month for Treasuries and $20 billion per month for MBS…it should take about four years to get the balance sheet down to a reasonable size.” Williams stated that he hopes this process will start in the fall, and he expects it to remain in the background to the Fed’s primary policy tool, which is raising or lowering the federal funds rate.

 Strategist Greg Valliere mentioned today in his “morning bullets” that it is unclear whether or not President Trump has the skills to deal with a looming debt crisis and other complicated budget issues this fall. Valliere feels that, while tax reform is a key issue for Republicans, it would be very easy for budget issues to eat up all of the month of September. He argued that Trump’s pluses include a solid economy and a loyal base, while the negatives include ongoing leaks and a Republican party that could easily go from support to undermining.