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The US employment situation still indicates a lackluster recovery

8 Mar 2014 by Jim Fickett.

Employment data, the most fundamental of all economic data, indicate a continuing US recovery. However they also indicate one of the slowest growth rates of any recovery on record, and no sign of accelerating growth.

The number of jobs (non-farm payrolls) was up 1.6% year-over-year in February – measurably above the neutral rate of 1.0%, where job growth is keeping up with population growth. However it is discouraging that the year-over-year change remains (1) very low by the standards of most historical recoveries, and (2) still below the seven-year high of 1.9% in February of 2012.

The year-over-year change in initial unemployment claims, which typically leads changes in non-farm payrolls by about 5 months, does not suggest any improvement in job growth.

The unemployment rate has steadily improved since the crisis, but still remains above the peak level of the previous economic cycle.

Deflation is not the problem

2 Mar 2014 by Jim Fickett.

It is widely believed that Japan's slow growth is due to deflation, and that this proves deflation to be extremely dangerous. The facts show otherwise. In two recent blog posts, Andrew Smithers shows that deflation in Japan is correlated with higher spending and higher growth.

Most economists believe deflation to be extremely dangerous, because it seems to them that spending should decrease under conditions of deflation. Japan is often given as an example. For example, a 2011 publication from the Federal Reserve Bank of St. Louis says,

Inflation that is ‘too low’ can be problematic, as the Japanese experience has shown. …

Deflation discourages spending and investment because consumers, expecting prices to fall further, delay purchases, preferring instead to save and wait for even lower prices. Decreased spending, in turn, lowers company sales and profits, which eventually increases unemployment. At the same time, borrowing by businesses for investment or by households for big-ticket items (i.e., cars and homes) becomes equally unattractive.

So the theory is that when prices are falling, people delay spending and increase saving. But in a recent blog post at the Financial Times, Andrew Smithers shows that, to the contrary, since 1980 in Japan, the savings rate correlates very strongly with the inflation rate, exactly the opposite of what is usually claimed. The same is true for the last six decades in the United States.

If one googles this topic, one will find the theoretical reasoning repeated in many places but, for some reason, no one seems to check this theory against reality.

Still, it is true, is it not, that Japanese growth has been slow? Yes and no. Overall GDP growth has been low. However, as I have pointed out before, Japan's slow growth needs no explanation beyond demographics. And, indeed, in a separate blog post, Smithers shows that, in almost all recent years, GDP per person of working age has grown faster in Japan than in the US. Further, Japanese GDP growth has been better in periods of falling prices than in periods of rising prices.

If deflation were really the scourge it is made out to be, one might expect the Japanese themselves to feel quite negative about it. But according to a 2010 survey, the opposite is true:

Last year, the Bank of Japan surveyed its population about attitudes towards deflation. You might have thought this would paint a picture of pain, if not panic. After all, during most of the past decade, as Japanese prices gently drifted down, Western economists and policymakers have recoiled in horror; “deflation” has been a dirty word.

But Japanese consumers apparently feel rather differently. In last year’s survey, 44 per cent of Japanese said deflation was “favourable”, while a further 35 per cent felt neutral about the phenomenon – and just 20.7 per cent described it as “unfavourable”.

It might or might not be true that deflation would cause problems if it were to occur in the US. But the case of Japan, often cited as evidence, does not support that conclusion. Japan's problems are demographics and high debt, not deflation.

US natural gas breaks $5

25 Jan 2014 by Jim Fickett.

US natural gas on the Nymex exchange recent broke above $5 per million BTU, a price not seen for several years. This was certainly due in part to the very cold weather seen recently on the east coast. From the Financial Times:

Nymex February natural gas climbed as much as 6 per cent to a high of $5.026 per m Btu as a wave of cold weather from the Arctic hit the US east coast and Midwest for the second time this month. The benchmark is up more than 15 per cent on the week and is now up almost 20 per cent this year.

A combination of high demand amid the cold weather and frozen wells that have disrupted supplies, has sucked up gas from storage: a record 287bn cu ft was withdrawn in the week to January 10, and a net 1.4tn cu ft has been drawn since early November.

This article, and the news in general, still regards this as a temporary blip, with the cold weather bucking the long-term oversupply. However there is, in fact, at recent prices, no oversupply.

And the medium-term trend is still one of uneconomic drilling slowly being curtailed.

Since [2012] US production has plateaued, as producers favoured drilling for more expensive oil. According to Baker Hughes, almost 80 per cent of the rigs active in the US currently are drilling for oil – at the start of 2011, the majority were drilling for gas.

Government debt in China is worse than the headline numbers suggest

23 Jan 2014 by Jim Fickett.

One often reads that the Chinese government, despite rapidly rising debt, still has plenty of room to maneuver. Here is a typical passage, from Forbes, giving a standard argument that even the combination of local and central government debt is low compared to many advanced economies:

Because the central government is ultimately responsible for all local-level debts in China, local debt must be added to central government debt to come up with a total government debt/GDP ratio. Andy Rothman, China Macro Strategist for CLSA, puts this ratio at 53.5 percent for 2012 – up from 43.5 percent in 2010, 44.1 percent in 2009, and 32.9 percent in 2005. Compared to the United States and most developed European countries where government debt levels are near 100 percent of GDP, China’s government debt/GDP ratio is not exceptionally high. For this reason, as well as the fact that China’s economic growth rate, while slowing, remains significantly faster than most of the rest of the world, Andy concludes that China’s total government debt is high but manageable in the near term.

But in China not only the local governments, but also many of the largest financial institutions and companies are really arms of the government. And if one includes the debt of these so-called state-owned enterprises, total debt begins to look much more worrisome. From a recent article in the Financial Times written by David Pilling, a very insightful expert on China:

Much attention has been paid to local government debt, much of it off balance sheet. But corporate borrowing may turn out to be a bigger problem. According to the Chinese Academy of Social Sciences, if state-owned enterprise borrowing is included, total government obligations rise to 151 per cent of GDP

It is a general rule of the investing world that whenever you see high growth, most investors will attribute the growth to solid, long-term trends, while, in reality, it is very often driven by a rapid increase in debt.

US state and local government debt continues to build

5 Jan 2014 by Jim Fickett.

The Census Bureau collects comprehensive accounts of state and local government finances. In particular, Census is the only source for an overall total figure for state and local government debt. Because there are many municipalities, these data are issued with a long delay, and the latest data current available are for 2011. Through 2011, total debt, both as an absolute dollar amount, and as a multiple of total revenue, continued to build:

Strained local government finances, with occasional bankruptcies, struggles to readjust pension funds, and cutbacks in services, will be a standard feature of life in the US for a long time.

[See the Reference page State and local government debt for sources, background, and commentary on a number of related issues.]

US corporate debt bubble building

1 Jan 2014 by Jim Fickett.

The Financial Times had a good summary, from a recent conference, giving evidence of considerable froth in US corporate debt markets:

To the sceptics, the market is experiencing the kind of frothiness seen before the 2008 financial crisis. This, too, will end in tears, they warn.

Perhaps the foremost of these “credit Cassandras” is Jeremy Stein, the US Federal Reserve governor who warned in February that markets may be overheating. “A prolonged period of low interest rates, of the sort we are experiencing today, can create incentives for agents to take on greater duration or credit risks, or to employ additional financial leverage, in an effort to ‘reach for yield’,” he said, flicking through slides of warning signals. Since then, those warning signals have flashed ever brighter.

Issuance of syndicated leveraged loans – those made to companies that already carry high debt loads – reached $535.2bn in 2013. That is just shy of the $604.2bn sold in 2007, at the height of the last credit bubble. Meanwhile, loans that come with fewer protections for lenders, known as “covenant-lite”, accounted for almost 60 per cent of loans sold in 2013, compared with a 25 per cent share in 2007.

Sales of “payment-in-kind” notes, which give borrowers an option to repay lenders with more debt reached $11.5bn in 2012 – a post-crisis high.

“There are no bargains in fixed income. We have seen a return to a lot of the practices that made people nervous in 2007 such as PIKs and cov-lite,” says Russ Koesterich, chief investment strategist at BlackRock.

Sales of “junk”, or high-yield, bonds surged to a record in 2013 as companies rushed to refinance and investors snapped up the resulting assets. Issuance of junk bonds rated “triple C” – the lowest designation – jumped to $15.3bn, surpassing the pre-crisis peak.

[See graph below, adapted from the FT, with data from S&P Capital IQ.]

“There are early warning signs of excess in the high-yield bond market with the heavy issuance of triple C rated debt,” says Edward Marrinan, of RBS Securities.

Others cite reasons for optimism. They note that credit “spreads”, or the additional returns investors demand to hold riskier credit assets, are not yet near the historic lows experienced in the run-up to the 2008 crisis. That suggests investors are differentiating between riskier assets and relatively safe securities, such as US government debt.

[This is a stupid argument. Spreads are high because the Fed has forced Treasury yields to unnatural lows. What matters is whether the total yield compensates for the risk. It does not.]

In contrast to 2007, the current average junk bond yield of 5.6 per cent is far higher than the yield on offer from the five-year Treasury note, at a difference of about 423 basis points. In June 2007, this spread had narrowed to a record low of 238 bps.

The argument against a bubble forming in the market at the moment is that overall credit remains abundant, enabling companies to roll over their funding, notes Mr Koesterich. “Companies can still raise money, so there is no financing risk.”

[Just like there was no refinancing risk for mortgages that could not be repaid. For a long time. And then suddenly the money dried up, as it will here.]

US nuclear power generation has been nearly constant for over a decade

29 Dec 2013 by Jim Fickett.

Despite much pessimism concerning the future of nuclear power, nuclear generation has remained nearly constant for over a decade, and there is no evidence that this is about to change.

There has been much talk of cheap gas, subsidized wind farms, and delayed coal regulation spelling the death of nuclear power. In fact, the main competition has been between coal and gas, with gas the clear gainer. Nuclear power generation has been essentially constant for over a decade.

The graph that the DOE EIA supplies is a bit hard to read, with seasonal fluctuations obscuring the long term trends:

A 12-month moving average better shows the fundamentals of the market:

As an aside, note that over the last twelve months or so coal has gained again and gas has lost. It is hard to tell how long this will continue but, for now at least, this adds to the evidence that the artificially overdone gas market is normalizing.

In the medium term, that is, within the lifetime of most existing power plants, the economic fundamentals support continued stability in nuclear generation. An EIA analysis concludes that the total operating expenses of nuclear generation (including operation, maintenence and fuel, but probably not capital costs) have been less than those of fossil-fuel/steam generation every year from 2002 to 2012. So, although cheap gas has made it difficult for nuclear power to do well recently, once the price of gas fully reflects the costs of production it is likely that nuclear power will continue to be economically favored.

Long-term, the biggest challenge to nuclear power is negative public sentiment, resulting in very high permitting and construction costs. However the public will have to be realistic at some point. It will still be a long time before renewables can take a large share of the electricity market, and new construction for coal, too, is becoming much more expensive due to environmental concerns. As old power plants go offline, either electricity will get much more expensive, or some compromises will be made on nuclear and coal. Money usually wins the argument, and I suspect the public will vote for cheap energy over ideals.

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