Dow hits new record of 13000, as US & world economies continue to grow

by wchurchill Sat Apr 28th, 2007 at 04:37:47 AM EST

A new high on the Dow Jones Index reminds us that economic growth continues in the US, and around the world. IMO there exists a bias amongst us here at ET, a bias leads to continuing predictions that the world economies, and in particular the US economy, is about to fall apart. My first diary at ET, October 15, 2005, Significant growth over the next 5 years was written to argue against scenarios that were being presented at ET, that argued that growth in the US and the world as a whole would be negative. I argued against that view, and argued that the world economies would in fact grow nicely.

It's likely that all economies can benefit from this growth. The US is best positioned in healthcare and technology, and should benefit significantly, and has been showing good growth the last several years. Asian growth will likely be the most explosive, due to their tremendous potential growth as a result of an underutilized population. Europe should certainly benefit, but growth numbers over the past several years place them third behind the US and Asia. European employees and industries may have to be flexible as Asia challenges entrenched European business positions. IMO, heavier percentage allocations to the US and Asia in terms of funds invested, may lead to better overall returns.

Not to pick on the ever gracious Jerome, but he did argue at that time for a no growth scenario, and even back then highlighted the housing market.

thanks for making a decent and argued case for bullishness.
I voted "no growth", but if you want a really pessismistic outlook dissinulated under savvy investment advice, have a look at:
http://www.hoisingtonmgt.com/HIM2005Q3_NP.pdf
I don't know them, but the kossack that pointed me to this doc+. wrote that they had an exceptional macro track record in the past. They are basically saying that interest rates will not increase because the recession will come before inflation makes it necessary.

So much for the kossack, as there has been no recession over the last 18 months and of course interest rates did continue to climb. However I imagine this "investment advice" column is continuing to be published and collecting fees from investors.

The Dow was 10287 when I wrote that diary on Oct 15, 2005. Almost a year later, Oct 7, 2006 I wrote a follow up diary as the Dow approached 12000, Dow Jones sets new all time high last week. Clearly the achievement of 12000 showed that the economy had not nose dived as predicted by Jerome and others. But, the economy was expected to slow from the rapid growth that it was one, as shown by the following comment:

-The American economy is slowing down this quarter, and likely next. That was necessary as inflation had been edging up, and the Fed responded with 17 straight interest rate hikes. There is some concern that they overdid it,,,,continuing with a couple of hike even after seeing data of the slowing economy. But concensus view seems to be there will be a soft landing, not a recession, and then return to strong growth. Good news for Europe and the world economy as well.

We should note that the economy has in fact slowed in the US, as predicted, in the 4th and 1rst quarter of '07--slowed, but to 1.3%, not negative, growth. We should note that the 13000 Dow shows an increase of 26.4% over the Dow of October 15, 2005-clearly different than the negative growth predictions of some. We should note that while I had projected that the major stock markets would all grow (US, Europe, and Asia-non Japan) that was in fact true, but while I predicted the order would be Asia, US, Europe,,,,the order has actually been Asia, Europe, US. We should further acknowledge that stock markets don't necessarily reflect the results of various economies around the world, but each of these economies grew nicely--with the order of growth being Asia-non-Japan, US, and Europe.

It's also worth noting that less developed economies have benefited dramatically over the last few decades, and that millions around the world are being pulled out of poverty. This was shown in a dramatic and very exciting manner by DEBUNKING MYTHS ABOUT THE THIRD WORLD-Hans Roslong in a very exciting presentation.

I certainly do not believe that one should plan one's life entirely around our financial rewards. satisfaction in fact comes from more spiritually and family grounded pursuits, imo. Yet meeting the basic economic needs of life is helpful for most of us. so I would just point out that on that economic dimension, those of us who have planned their lives around positive economic growth (as opposed to no growth) have done much better over the last several years, and acutally the last century, than those who have based their financial planning on the "no growth", "doom and gloom" scenarios that we sometimes see.

Dow hits new record of 13000, as US & world economies continue to grow | 130 comments (130 topical, 0 editorial, 0 hidden)

Thanks for making the bullish case (none / 1)

Here's another look at it, which compares the Dow to things that have real value...

Mike Maloney: The Dow is crashing

(Of course, the guy is in the business of selling gold and silver, so take that into account)

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sat Apr 28th, 2007 at 05:00:30 AM EST

Re: Thanks for making the bullish case (none / 0)

It appears to me that being:
(a) "short" of Fed Dollar "claims over Value"; and
(b) "long" of "Value" - producing assets isn't going to be a bad strategy these next few years.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Apr 28th, 2007 at 05:26:00 AM EST
[ Parent ]

Re: Thanks for making the bullish case (none / 0)

isn't it a great thing about free markets. you can make that bet, and if your insight is better than the market, you can make a fortune. good luck.

by wchurchill on Sat Apr 28th, 2007 at 05:31:41 AM EST
[ Parent ]

Re: Thanks for making the bullish case (none / 1)

Oil isn't priced in Dollars: Dollars are priced in Oil.

Heads Oil wins: Tails the Dollar loses.

Unfortunately it's the entire planet that has become the stake in the Dollar vs Liquid Fuels wager.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Apr 28th, 2007 at 06:40:25 AM EST
[ Parent ]

Re: Thanks for making the bullish case (none / 0)

Would you be willing to write a diary on the Simon-Ehrlich wager?

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Sat Apr 28th, 2007 at 05:37:29 AM EST
[ Parent ]

Re: Thanks for making the bullish case (none / 1)

and as you say

(Of course, the guy is in the business of selling gold and silver, so take that into account)

the dow in terms of computer chips has exploded.

but the dow in terms of uranium is horrible.

of course the euro in terms of uranium is horrible, and gold in terms of uranium is horrible, and crude oil in terms of uranium is horrible.

the real measure of the Dow, or the Nasdaq, or the S&P 500 is not in oil or in uranium, it's in dollars. just like the real measure of the EU exchanges is in euros.

what you say is clever but obfuscating.

by wchurchill on Sat Apr 28th, 2007 at 05:28:22 AM EST
[ Parent ]

Re: Thanks for making the bullish case (none / 1)

The Dow in euro is what will get people from Europe, it is the only relevant measure for them.

Please explain to me how can this be obfuscating on European Tribune?

I'm curious, thanks!

Over the last ten years (apr1997-apr2007), european buying in STOXX50E got slightly better euro returns than if they invested in NASDAQ (2.0x vs 1.9x). I did not try wider indexes.

by Laurent GUERBY on Sat Apr 28th, 2007 at 06:11:11 AM EST
[ Parent ]

Re: Thanks for making the bullish case (none / 0)

the obfuscation was aimed at valuing one's income and assets in gold and oil. I elaborated on this in a response to Migeru below. So I agree that just as Americans on this site should value in dollars, Europeans should value in euros. I should have made that distinction in my response to Jerome, but was caught up in the idea of valuing in gold or oil, or as Migeru's reference discusses, cans of soup and pasta.

by wchurchill on Sat Apr 28th, 2007 at 12:49:37 PM EST
[ Parent ]

Re: Thanks for making the bullish case (none / 1)

If we suppose that a US government sees its task to demonstrate strength in economy by stimulatig Dow value (in dollars), wouldn't be the easiest way to achieve that to take steps (blown up deficit spending and such) that depriciate dollar?

I think that Bush's administration did a lot (if not everything) to increase "demand" for speculative stocks and decrease demand for dollar. Oh yeah, that's what they are preaching - supply-side economy, push all the money into stocks.

by das monde on Sat Apr 28th, 2007 at 06:14:41 AM EST
[ Parent ]

"Speculative" stocks (none / 0)

The Dow [I suppose we're talking the http://en.wikipedia.org/wiki/Dow_Jones_Industrial_Average">Industrial Average here] doesn't represent "speculative stocks" but big industrial ones. Intel is the only component of the Average that's listed on NASDAQ (the more speculative of the big markets), the rest are on NYSE.

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Sat Apr 28th, 2007 at 06:54:23 AM EST
[ Parent ]

Re: "Speculative" stocks (none / 0)

correct. and actually I don't use the Dow in benchmarking my personal investments. I used broader indices such as the S&P 500, the US total market indices, the Morgan and Stanley set of international indices. I use the Dow here and in other broader discussion formats because it is a number that is more widely known, and it tracks the other broader US indices reasonably well.

by wchurchill on Sat Apr 28th, 2007 at 12:59:35 PM EST
[ Parent ]

Re: "Speculative" stocks (none / 0)

No, Microsoft is, as well. That's to be expected, given the importance and dominance of Intel and Microsoft. NASDAQ is typically associated with tech stocks, although HP, IBM and Verizon are all on the Dow and the NYSE.

The Dow is, as you say, less speculative. It's essentially the big dogs in American business. If you want to know where America is headed, though, the S&P and NASDAQ are probably the better choices, given the larger number of companies.

DJIA is where you dump your money when you want to play a conservative game, because people are always going to buy things from Wal-Mart and Johnson & Johnson. It's more stable, whereas NASDAQ is all over the place. NASDAQ companies are often engaged in fiercely competitive markets and can get tossed around like it's nobody's business. Intel and AMD come to mind.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Sun Apr 29th, 2007 at 09:22:12 PM EST
[ Parent ]

Heh (4.00 / 2)

The Financial Sense guys have a known bias (they are gold nuts, for many of them, and thus anti-inflation ultra-hawks), and I flagged this, but they do have a point that the real returns on the Dow have been pretty mediocre in this decade, even when expressed in dollars.

Expressing the Dow in euros is a lot more relevant to us here in Europe - and definitely legitimate and meaningful in terms of "value". The fact that the dollar has lost 40% of its value against the euro over the period has to mean something, right?

I mean, market cannot be that wrong?

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sat Apr 28th, 2007 at 06:15:57 AM EST
[ Parent ]

Re: Heh (none / 1)

yes I agree with your comments on the euro, and won't elaborate here, because I already have to Migeru and Laurent. In my own mind I was commenting on gold and oil from your comment, and really should have excluded the euro.

you can cherry pick dates to prove anything you want on returns on the American stock markets, since stock markets have cycles, though the long term trend is up. The Dow was 10791 at the beginning of the decade, which was Jan 2, 2001, so it is 21.6% higher today, six years later, and that is definitely lower than the longer term growth figures. If you chose January 2000 the returns would be far less. If you chose 1995 they would be far better. The long term returns from US equities are about 10% nominal and 7% real.

But the US economy is incredibly strong in recent times. There has been one very minor recession since 1991, which is an incredible period of prosperity, particularly thinking of the challenges of the tech wreck, 9/11, a poorly chosen and poorly run war in Iraq,,,,just to pick a few.

by wchurchill on Sat Apr 28th, 2007 at 01:20:07 PM EST
[ Parent ]

Re: Thanks for making the bullish case (none / 0)

You're supposed to be able to express the price of anything in terms of the price of anything else, and the "natural" value unit should be related to your assets/income and your expenses. So pricing things in oil, or in Euros, makes sense depending on who you are, where you are and what you do.

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Sat Apr 28th, 2007 at 06:51:00 AM EST
[ Parent ]

Re: Thanks for making the bullish case (none / 1)

the "natural" value unit should be related to your assets/income and your expenses. So pricing things in oil, or in Euros, makes sense depending on who you are, where you are and what you do.

I think this is very well said Migeru, with the exception of pricing in oil. IMO, an American who plans to live primarily in the US should therefore value his earnings and investments in dollars. s/he should diversify investments around the world, with a good percentage in Europe and Asia, so he can take advantage of those growing economies, as well as any dollar weakening such as we have experienced in the last six years. (though of course the worm turns, and a strengthening dollar will have the revrese effect.) but inflation is low in the US, relative purchasing power is extremely high, and your standard of living is very much tied to those aspects of the currency. and conversely a european should manage in euro's, with imho similar worldwide diversification.

but managing in oil or in gold does not make sense to me, nor does managing your affairs in cans of soup or pasta, as your referenced article points out.

by wchurchill on Sat Apr 28th, 2007 at 12:38:16 PM EST
[ Parent ]

I struggle with the idea that gold (4.00 / 3)

has real value. A week's wage for a lump of metal the size of a quarter? I know gold has some nice properties, but is it 50X more valuable than silver in "real" applications?

I've yet to meet a gold bug that wasn't a little bit cracked.

by HiD on Sat Apr 28th, 2007 at 06:28:19 AM EST
[ Parent ]

Re: I struggle with the idea that gold (4.00 / 2)

It may not have Value, but it does have Price.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Apr 28th, 2007 at 06:41:49 AM EST
[ Parent ]

no argument there (none / 1)

tulip bulbs were traded for houses too at one stage. Though I admit gold has been a bit more resilient over the ages.

by HiD on Sat Apr 28th, 2007 at 07:33:56 AM EST
[ Parent ]

Re: no argument there (none / 1)

You can have inflation with gold too, as the Spanish found when they looted Central America and flooded the market with newly minted gold money.

It's all relative.

Now, I take the view that Money is "Dynamic Value" and exists only in the transitory moment of Value Exchange by reference to a "Value Unit" (Mig's Numeraire).

Capital, on the other hand (underpinned by the "Property" relationship) is "Static Value" or "Potential Money".

IMHO "Value" is a direct analogy for "Energy" , and that Economics could be thought of as the "Physics of Value".

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Apr 28th, 2007 at 08:00:05 AM EST
[ Parent ]

Re: I struggle with the idea that gold (none / 1)

I tend to think that gold is pretty useless, too which, by the way, makes it a good base for money because people did not use to take their gold coins and go do something with the gold instead. In a sense, gold is as good for fiat money as nickel. But, how is Gold useful>

Wikipedia: Applications of Gold

Some gold salts do have anti-inflammatory properties and are used as pharmaceuticals in the treatment of arthritis and other similar conditions. However, only salts and radioisotopes of gold are of pharmacological value, as elemental (metallic) gold is inert to all chemicals it encounters inside the body.
Gold solder is used for joining the components of gold jewellery by high-temperature hard soldering or brazing.
Dentistry: ... The gold alloys' slight malleability facilitates the creation of a superior molar mating surface with other teeth and produces results that are generally more satisfactory than those produced by the creation of porcelain crowns.
In photography, Gold toners are used to shift the colour of silver bromide black and white prints towards brown or blue tones, or to increase their stability.
Gold is highly conductive to electricity, and has been used for electrical wiring in some high energy applications (silver is even more conductive per volume, but gold has the advantage of corrosion resistance). ... Though gold is attacked by free chlorine, its good conductivity and general resistance to oxidation and corrosion in other environments (including resistance to non-chlorinated acids) has led to its widespread industrial use in the electronic era as a thin layer coating electrical connectors of all kinds, thereby ensuring good connection. ... Besides sliding electrical contacts, gold is also used in electrical contacts because of its resistance to corrosion, electrical conductivity, ductility and lack of toxicity.
Colloidal gold is used in research applications in medicine, biology and materials science.
Gold, or alloys of gold and palladium, are applied as conductive coating to biological specimens and other non-conducting materials such as plastics and glass to be viewed in a scanning electron microscope.
Gold is used as the reflective layer on some high-end CDs.
The isotope gold-198, (half-life: 2.7 days) is used in some cancer treatments and for treating other diseases.

Silver has a similar list of applications. Transition metals are not readily replaceable for their specific aplications.

But, yeah, the "Gold standard" is a throwback to a time when wealth was flaunted by wearing and using gold.

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Sat Apr 28th, 2007 at 07:10:50 AM EST
[ Parent ]

throwback hell (4.00 / 2)

one of the largest demand side inputs to gold price is demand for India where jewelry is used as store of wealth.

wonder how that would turn out if a real alchemist turns up?

by HiD on Sat Apr 28th, 2007 at 07:35:39 AM EST
[ Parent ]

US economy continues to grow (none / 0)

Hey, wc:

Bloomberg: U.S. Economy: Growth Slows to Least in Four Years (By Joe Richter on April 27, 2007)

The U.S. economy grew last quarter at the slowest pace in four years because of the housing slump and a bigger trade deficit, leaving consumer spending to keep the expansion alive.

How long can consumer spending keep the economy going? It's been over 5 years since Bush's "keep shopping" after 9/11.

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Sat Apr 28th, 2007 at 05:43:16 AM EST

GDP minus debt increase? (4.00 / 2)

I've always wondered why the indicator GDP minus total debt increase was not the one that's used to measure current economy trend. There's a small part of short term future in GDP (inventories) but it's not at all the same horizon than most debt.

USA household debt is 50 GDP points higher in the USA than in France, and debt seems to be growing more than two times faster than the economy in the USA since 1990 :

http://mwhodges.home.att.net/nat-debt/debt-nat.htm

by Laurent GUERBY on Sat Apr 28th, 2007 at 06:18:51 AM EST
[ Parent ]

Re: GDP minus debt increase? (none / 0)

I've bookmarked your reference and will have to go back and review it sometime. I'm somewhat reluctant because every time I've done this in the past it has simply been an exercise in finding logic flaws or misinterpredtation of the data on the part of the author--and a waste of time for me.

For example, go here to see the International Debt Thermometer (page down once to see the 2nd graphic) and you'll see that the US debt is slightly below France and Germany is a % of GDP. As to adding to national debt, the US normally stays easily under the EU guideline of 3%. So if you want to criticize this aspect of the US debt, you need to start with Germany and France first. and I just don't think any of these three have a problem, as long as they stay within that 3% guideline going forward.

IMO the issue for those countries and others is having large unfunded pension programs and healthcare costs with an ever increasing age of the population. but no politician in any country is going to address this until it's a real crisis--and hey, why not kick the can down the road and let someone else handle it,,,,huh? To their credit, both Clinton and Bush made efforts to get this on the national agenda in the US, but those weak kneed nuts in Congress would rather impeach a president, try to run the war, hold congressional hearings to get their mugs on TV, etc. Even here at ET it's just an issue that people are bored with, or as Jerome says, we've always been able to tweak a few things and fix it in the past. Oh well. I have tried to get attention on this for years, but have failed--I'm a small drop in the ocean after all. The thing I can do is prepare my family for what's going to happen, and I'm doing that. Sorry about those that don't get prepared--but none of them can say they were not warned. Even some politicians have tried. (If you can't save the world, you can at least prepare yourself and your family to the best extent possible.)

by wchurchill on Sat Apr 28th, 2007 at 02:30:13 PM EST
[ Parent ]

GDP minus TOTAL debt increase? (not gov alone) (none / 0)

Not that's I'm not talking about government debt alone here (it's not clear from your answer that we're talking about the same thing).

I'm talking of total debt taken by all agents of the economy: governement but also households and business.

As GDP is the sum of government spending and other actor contributions, I don't think that government debt alone is pertinent when talking about GDP.

As of Q2 2006, total debt in the USA is 208% of GDP, in France it's 168%, so the total debt differential 40% of GDP, not a small number.

For sources see links here:

http://guerby.org/blog/index.php/2006/11/02/123-les-dettes

Note 1: I'm not including financial institution debt (column of the Fed Z1 flow of funds report and something similar from European central banks) because I don't know if it's meaningful to add them, I suspect yes but nobody has been able to answer my doubts yet.

Note 2: I don't think the data source I cited is that credible, but it seems to be based on Fed Z1 report (which is credible :).

by Laurent GUERBY on Sun Apr 29th, 2007 at 10:17:39 AM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

Can you explain your doubts?

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Sun Apr 29th, 2007 at 10:20:28 AM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

Well, I'd like to be sure that when a business or individual borrows X from a financial institution the X does not pop up in both columns. Banque de France does report financial institution debt and other debt in separate papers, and in particular "endettement interieur total" does not seem to include financial debt (the source of my small doubt).

If you know someone proficient in central bank reports, I'd be very happy to know the answer there.

by Laurent GUERBY on Sun Apr 29th, 2007 at 10:26:32 AM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

Which two culumns? GDP and Debt?

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Sun Apr 29th, 2007 at 10:27:40 AM EST
[ Parent ]

debt not gdp (none / 0)

No the "two" columns are "households, non financial institutions and business" debt and "financial institution debt".

I'm talking about debt accounting only here.

by Laurent GUERBY on Sun Apr 29th, 2007 at 10:29:51 AM EST
[ Parent ]

Re: debt not gdp (none / 0)

I thought abut that, but how can the debt appear on the "financial institutions" column? It's an asset, nt a liability, on their balance sheets.

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Sun Apr 29th, 2007 at 10:32:59 AM EST
[ Parent ]

Re: debt not gdp (none / 0)

Private banks can borrow money from other private banks and central banks I assume, in that aspect they're not different from regular business.

by Laurent GUERBY on Sun Apr 29th, 2007 at 10:45:31 AM EST
[ Parent ]

Re: debt not gdp (none / 1)

Now, here are two people - both of well above average intellect, and both well-versed in matters financial - who are scratching their heads in relation to the structure of national accounts ie their debits and credits.

Which just goes to show what utter and complete bollocks it all is.

Smoke and mirrors screening the totally unacceptable and unsustainable Reality of a deficit-based monetary system..

Consider UK Plc: it's the only Plc with no "Equity" on the balance sheet, and with accounts which show a debt, but not the assets they are secured against.

It's as though Mig's family accounts showed the mortgage, but not the house!

Instead, we see UK Plc's "assets" consisting largely of bank-issued claims over houses - over 70% of UK money supply.

Un-effing-believable. In every sense.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Apr 29th, 2007 at 01:14:10 PM EST
[ Parent ]

Re: debt not gdp (none / 0)

Consider UK Plc: it's the only Plc with no "Equity" on the balance sheet, and with accounts which show a debt, but not the assets they are secured against.

As the risk of government default is almost by definition [or in theory] negligible, government debt doesn't need to be secured, does it?

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Sun Apr 29th, 2007 at 05:21:27 PM EST
[ Parent ]

Re: debt not gdp (none / 1)

Governement debt is by definition secured against the whole country - that's why, with the sole exception of Gasprom, no company has a higher rating that the country it resides in.

Of course, there is then the issue of government being acually willing to reimburse its creditors, which affect the state rating.

Un roi sans divertissement est un homme plein de misères

by linca (antonin POINT lucas AROBASE gmail.com) on Sun Apr 29th, 2007 at 07:53:17 PM EST
[ Parent ]

Re: debt not gdp (none / 1)

Corporate debt is always less secure than a government's, because governments have the power to forbid companies in their country to pay their debts - both to external creditors (as the multiple debt crises and convertibility/transferability restrictions have shown) or even to internal creditors (the major innovation of the Russian moratorium in 1998.

Gazprom had a better rating than Russia when it was using its gas export contracts as collateral, because the only way it could default on that debt was to stop delivering gas, a much more violent step nowadays, diplomatically, than just defaulting on payments.

That's why we were happy to lend money to Gazprom, effectively taking Gaz de France risk while being paid margins sized on Russian risk (then - Russian risk today pays very little). Ah, good ol' times...

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Apr 30th, 2007 at 09:06:20 AM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

As of Q2 2006, total debt in the USA is 208% of GDP, in France it's 168%, so the total debt differential 40% of GDP, not a small number.

And according to your figures, the difference is essentially in household debt, which in the USA is 90% of GDP. Ouch.

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Sun Apr 29th, 2007 at 10:26:26 AM EST
[ Parent ]

USA household debt (none / 1)

Yep and household consumption is what drives USA GDP, if it's all debt increase based that's not so good.

by Laurent GUERBY on Sun Apr 29th, 2007 at 10:28:03 AM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

Most of that is in housing, though, so it's not wholly unexpected, given the traditional 3xIncome figure on buying a house. (It should be unusual right now, given house prices were 3.7xIncome in one of wchurchill's recent links.) The US has always had, and continues to have, a very high rate of home ownership, so one would expect household debt to be substantially higher. Germany's home ownership rate is about 45-50%, while the US typically comes in at 65-70%. I believe France's rate is about 50-55%.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Sun Apr 29th, 2007 at 09:35:45 PM EST
[ Parent ]

Nah (none / 0)

France, the US and the UK have similar rates of ownership, in the 65-70%; Latin countries tend to have higher rates (Spain especially)

So that's not the driving factor.

The bubble is:

(that's debt to net disposable income, in various countries: US, UK, Japan on the left, Germany, France, Italy Spain on the right. Note the different scales)

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Apr 30th, 2007 at 09:09:28 AM EST
[ Parent ]

Re: Nah (none / 0)

I've found 55% for France, 43% for Germany, 36% for Switzerland, and 56% for Austria. Australia is at 70%. Britain is at 70%, as well, according to The Times.

According to the St Louis Fed, America is at about 69%. (The figures on younger buyers -- under 35 years old -- from '95 to '04 are interesting.) Ireland, according to the same report, comes in at a whopping 80%.

I'd be interested to know how these figures stack up against household debt. Britain is dealing with much higher price-to-income ratios on housing than America, -- a bit under six vs a bit under four -- so, knowing that home ownership rates are roughly the same, the UK should be enduring higher household debt. That chart seems to support it.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Mon Apr 30th, 2007 at 11:21:55 AM EST
[ Parent ]

Re: Nah (none / 1)

The Irish have an attachment to owning their own land/house/home that's sort of scary, combined with historically very poor protection for renters both theoretically and in practice. The laws were/are weak and the enforcement was almost non-existent. Renting is something you do because you're too poor to buy anything.

As a result it's hard to find good rental properties, and most come fully furnished because there is/was a clause that reduced a tenants rights if the flat was furnished.

by Colman (colman at eurotrib.com) on Mon Apr 30th, 2007 at 11:30:11 AM EST
[ Parent ]

Re: Nah (none / 1)

Things were improved in 2004. I don't think that measures up well to the countries that have a tradition of renting though.

by Colman (colman at eurotrib.com) on Mon Apr 30th, 2007 at 11:41:21 AM EST
[ Parent ]

Re: Nah (none / 0)

There's a similar story to that among people descended from the Irish, Scots and Scots-Irish in the states. Owning land has historically been a very big deal in my region of the country, as well as in the Midwest, and -- perhaps not surprising -- home ownership rates have been, and continue to be, significantly higher in those two regions.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Mon Apr 30th, 2007 at 01:02:04 PM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 1)

I did understand that you are talking about debt more broadly, though my examples were, as you point out, focused on government debt, and therefore would leave you to believe I had missed the broader point.

I guess I've just gone down this debt path before, and it's just complicated, and as I said, each time I've done it, full of errors in analysis. As you and Migeru point out in your discussion, you need to look at offsetting debt and think about how to treat it--when bank loan to banks, or financial institutions loan to each other, one parties asset is another parties liability.

And on the business side, you need to consider what lies behind the tradeoffs of financing companies through debt or equity. Both methods are ways of investing in business--the trade off being made is one between risk and reward. Straight debt, fully secured, is the least risky, but also with the lowest return. Straight common stock is the riskiest. And there is all of those financial instruments in between--debt with warranties, a combination of debt and equity. or preferred stock, less risk.

There are levels of debt that are good. Many companies should have far more debt than they have, so they can leverage their earnings--raise ROE higher than ROA.

What's wrong with homeowners having 20% of their homes owned by the bank--why not 30%, 40%, 50%. It depends of course on the individual home owner. There is a tax benefit in the US, for the right kind of homeowner, to have a $1 million mortgage. But most people don't do that--even those with the credit rating.

so with my business and home ownership examples, I'm getting at the debt/equity issues. and they are complicated.

but I understood you point.

by wchurchill on Sun Apr 29th, 2007 at 02:28:14 PM EST
[ Parent ]

Re: GDP etc (none / 1)

I think you get a bit of a hard time on ET, wc, cos I think your heart's in the right place...

What's wrong with homeowners having 20% of their homes owned by the bank--why not 30%, 40%, 50%. It depends of course on the individual home owner. There is a tax benefit in the US, for the right kind of homeowner, to have a $1 million mortgage.

If only banks' DID own a proportion of the property and we actually rented that proportion at (say) 20% of the market rental.

But they don't - they create credit on the back of their Capital base and secure it with claims over our properties.

To actually own our properties wouldn't be a very effective use of their Capital would it, not when they can use their Capital as a base for credit creation which allows them to finance a dozen houses for every one they could actually buy by investing their equity in property.

Banks could easily reinvent themselves so that they actually bring together investors in property with investments in property. That way they wouldn't need to put a penny of Capital at risk, as they currently do in the mad world of fractional reserve banking...

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Apr 29th, 2007 at 03:00:57 PM EST
[ Parent ]

Re: GDP etc (none / 0)

Partial equity schemes which combine rent and a mortgage share are available in the UK, but not very popular, and mostly offered by the firms that build estates as a way to get people into those estates. They're certainly not a standard fixture on the bank-run mortgage circuit.

I'd have to look into how the numbers work out, but most people seem to buy with a view to owning outright some time close - or ideally before - retirement. So when income drops, outgoings drop too, and they're left with a substantial pile of equity.

You might think that younger buyers would be interested in building up a transferable deposit with a combined buy/rent scheme, but it doesn't seem to work like that. I'm not sure why, because when property prices are exploding a part-share of equity is better than no share at all through renting, and potentially a reasonable investment.

My guess is the banks don't like the scheme because effectively they're forced into property price speculation. Normally it's the mortgage owner who takes all of the risk, and - obviously - even when equity is negative the owner is still responsible for the full amount of the loan.

So if banks co-owned property, a price crash would wipe maybe 10-20% off the nominal book value of the holdings.

But - when prices crash, mortgage defaults lose a similar amount from mortgage loans anyway. So the objection doesn't really make sense. And when prices are increasing, banks are missing out on a huge potential source of income.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Apr 30th, 2007 at 05:32:55 PM EST
[ Parent ]

Re: GDP etc (none / 0)

My guess is the banks don't like the scheme because effectively they're forced into property price speculation. Normally it's the mortgage owner who takes all of the risk, and - obviously - even when equity is negative the owner is still responsible for the full amount of the loan.

My guess is that this is true,

But - when prices crash, mortgage defaults lose a similar amount from mortgage loans anyway. So the objection doesn't really make sense. And when prices are increasing, banks are missing out on a huge potential source of income.

and that this is less true. I know banks don't like defaults--they don't want to own the house. but I imagine their default ratios are easily covered in their interest rates, or there wouldn't be a lot of banks around. and they get a fair amount back on the default anyway--a 20% loan, one year later the property is down 10%, the owner loses everything if he can't weather things and has to default--but the property may be sold for 70, 80, 90%?

by wchurchill on Mon Apr 30th, 2007 at 06:48:39 PM EST
[ Parent ]

Re: GDP etc (none / 0)

thank you for the kind comment.

your idea is not a bad one at all. but I imagine the banks don't want to do it because they think they already have a good business model.

but you would think if the idea is a good one, some other entrepreneurs would have gotten into this and made a good business out of it, and they have not, that I know of. Though I note ThatBritGuy says this is an option in the UK, but it has evidently not been to popular.

one problem I could see is that a shared equity arrangement is really a true partnership. what happens if the owner partner doesn't take care of the house--let's it run down? If he is a wonderful owner and fixes it up himself, how do you pay him for his effort? it might be very complicated for a large corporation to run such a program. while with a loan, it's a pretty straightforward transaction--as compared to equity ownership.

by wchurchill on Mon Apr 30th, 2007 at 06:40:47 PM EST
[ Parent ]

Re: GDP etc (none / 0)

Chris I meant to add that this in all seriousness might be a real business opportunity. Look at the success that micro-credit has had. It's been incredible, as well as very heartwarming in parts of the world where it has helped the poor start their own businesses--but the entrepreneurs are also making money.

Banks obviously didn't move into this area, and perhaps they are just too closed minded, and set in their ways. that could be the same reason they are not moving into this idea you have.

I wonder though how receptive the home buyers would be--maybe they want all of the upside, so they'll save for a house of their own, and maybe even buy a smaller one to start.

by wchurchill on Mon Apr 30th, 2007 at 06:53:01 PM EST
[ Parent ]

Re: GDP etc (none / 0)

You are correct, wc in thinking this is a phenomenal business opportunity.

But not for property purchasers, who, as you identify would not wish to share the gains they are accustomed to see as inevitable - the fact that these gains are caused by deficit-based money does not concern them, and why should it?

However, the possibility is nevertheless there for a purchaser to acquire property using this mechanism. And note that the actual finance cost may be minimised since there is no reason why investment in the capital value of the land need not be treated as "Equity" (unlike buildings, land/location does not deteriorate).

ie while a return on capital will be paid by the occupier on the whole investment, there will be no need to repay much of the capital.

However, the real opportunity using this new form of finance arises at the other end of the telescope.

Equity Release.

The "Capital Partnership" is the best form of Equity Release there is, and wipes the floor with the existing toxic alternatives of:

(a) "reversion" (when you sell part or all of your property to an investor who gambles on how long you live); or
(b) a "roll-up mortgage" - where the interest rolls up - typically at 2% over base rate.

So Aunt Agatha sells (say) 10% of her £500k house to her pension fund, or someone else's, and simply pays 10% of the market rental of the property for as long as she uses the capital.

If she doesn't want to pay cash, she can pay in further equity shares instead.

Like all Equity release schemes, the equity will likely run out one day, but this structure gives :
(a) Aunt Agatha the best deal there is;
(b) Pension Funds a simple new REIT look-alike investment (since LLP and LLC vehicles are tax transparent or "pass through").

To see the extent of the opportunity, in the UK over £1 trillion in property is owned by over 65's free of mortgage.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Apr 30th, 2007 at 07:34:55 PM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

Thanks for your detailed comment.

As far as I understand there is no monetary creation with equity whereas there is monetary creation for "classical" household or business loan, and I believe that's the criteria for defining debt in the central bank reports we're looking at (after all money creation is what central bank are supposed to regulate :).

Monetary creation is a factor for the value of the dollar hence the value of US assets.

For home ownership, the right number is of course total equity of the "owner" of the house. Owners with little chance of paying back their loans are counted in the "owner" share of the population without ponderation otherwise. I haven't seen international data with total equity.

Also in France there is very limited borrowing against your current home value (it's legally possible but rarely used up to now at least) so the impact on GDP via consumption is lower than in the USA.

by Laurent GUERBY on Mon Apr 30th, 2007 at 06:42:16 AM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

Good comments Laurent, thanks. I am pretty sure that you are correct regarding the "classical household and business loan", as I think you are postulating the business loan as a bank loan.

For public companies in the US, most of their loans are in the form of bonds, that are traded on the public markets. the bonds are held by various types of investors. while the bonds are put on the market by investment banks, this is a different process. So if I understand this right, you do not get the multiplier effect, and the money creation impact on these types of borrowings. (I guess individual bondholders could decide to borrow on margin--though actually I'm not sure if bonds are considered marginable, like stocks--but even then, margin requirements are much tighter than bank reserve requirements.)

I'm interested in your comments. I haven't thought about this element of borrowing--margin versus bank reserve requirements--in a long time, maybe never. I'm learning. -:)

by wchurchill on Mon Apr 30th, 2007 at 11:46:51 AM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

Yes I believe issue of equity and bonds (and convertible bonds, credit default stuff, derivatives of all sort, etc...) do not imply monetary creation at all.

To be honest, I don't understand enough of the USA mortgage repackaging business to know what share of household debt ends up in the form of bonds vs classical bank loans. I even wonder if someone knows :).

by Laurent GUERBY on Mon Apr 30th, 2007 at 02:10:20 PM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

that is a great point, and a great question. I need to think about that. I think you are implying that maybe this would put this outside the multiplier effect? hmmm, more learning and thinking.

by wchurchill on Mon Apr 30th, 2007 at 02:31:11 PM EST
[ Parent ]

Mortgage packaging (none / 0)

My reasoning is:

the bank makes loans to a households and so creates money against paper promise (total quantity subject to fractional reserve requirements set by the Fed in the USA)
then the bank writes a legal document packaging loans and sells this paper to other entities for some amount of USD which it receives on its book cancelling more or less exactly the loans total amount.
in the end there is no or little money creation, the bank has just been an intermediate between household and other entities.

There has been (too for me :) detailed reports on the USA mortgage market on the following blog you might want to go through it:

http://calculatedrisk.blogspot.com/

An articles in the ubernerd serie:

http://calculatedrisk.blogspot.com/2007/04/mbs-for-ubernerds-i-gse-pass-throughs.html

Polical moves around bondholders liabilities:

http://calculatedrisk.blogspot.com/2007/04/bagholder-bondholder-liability-cant.html

by Laurent GUERBY on Mon Apr 30th, 2007 at 06:05:03 PM EST
[ Parent ]

Re: Mortgage packaging (none / 0)

The way I understand it, upon sale of the loans:

(a) the asset of the portfolio of household loans is replaced in the Bank's books by the asset of an interest-free loan from the Central Bank aka cash, to be immediately put on interest-bearing deposit (ie other banks and the Central Bank replace the householders as debtors to the Bank);

(b) the equal and opposite liability the Bank had to depositors/the banking system remains exactly as it was.

The original loans, and therefore the original Money, remain in existence, although the counterparty has changed. It is only when loans are paid off, or written off, that the original money created is cancelled or "destroyed".

I do not see how "static" money "tied up" in land and property - while it may have inflated asset prices when it came into being - can possibly cause retail price inflation.

It is not clear to a Bear of Little Economic Brain like me that monetarists have ever distinguished adequately between "asset-backed" (ie secured) credit/Money, which is for the most part "static" and unsecured credit/Money - which is free to circulate ie "dynamic" - and hence may potentially cause inflation.

As far as I know the vast bulk of Money created (>70% in the UK) is mortgage-backed and may be characterised as "static", therefore. Similarly any other secured loans, and any money invested in shares of limited companies may equally be characterised as "static" and IMHO for the most part (the exception being when Equity Release takes place upon the creation of the loan) non-inflationary.

As far as I can see, monetarism bears very little relation to Reality. ie in technical terms, it's almost complete bollocks.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Apr 30th, 2007 at 07:14:44 PM EST
[ Parent ]

Re: Mortgage packaging (none / 0)

I think you are right Laurent. I almost have a headache from grinding through this--there are very old brain cells back there somewhere, probably labeled "macroeconomics" and "money and banking". but they are very unused cells as my life moved from that macro area into day to day business operations (which includes lots of microeconomics, accounting, and all of the other stuff, marketing, etc--but very little macroeconomics), and now more into investing--which has a little more macro, but not all that much. so I feel those macroecon cells crying out in pain.

But I think all that has happened is a bank has sold a portfolio of mortgages and therefore gets some extra cash in place of the paper. But (in the perfect world of theoretical economics) that cash is drawn out of other banks. So cash reserves in the system are net zero.

The real economic consequence of the transaction is it moves the risks of the mortgage portfolio, and of course the rewards of the mortgage/interest payments, from the bank and into the hands of investors--individuals like you and I, pension funds, etc.

Thanks for discussing this. and thanks for the links, I'll peruse them as soon as my head stops hurting. -:)

by wchurchill on Mon Apr 30th, 2007 at 08:25:37 PM EST
[ Parent ]

Re: Mortgage packaging (none / 0)

As I read Laurent, what he is saying is that while the original loans may have created new Money, this is essentially then "repaid" when the Bank sells the loans on. ie no new "net" Money.

That is not the case.

I am saying (and you are agreeing) that once the loans = Money are created then while selling them on may change the counterparty of the loan, the "new" "asset-backed" Money created in the first place remains in existence.

As I said earlier, it just goes to show how obscure the system is, and how its fundamental flaws are entirely hidden from view behind smoke and mirrors..

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue May 1st, 2007 at 03:02:34 AM EST
[ Parent ]

Mortgage packaging => I was likely wrong (none / 0)

Yes, after a good night sleep I tend to agree that my analysis is wrong and that money is created even if there is repackaging.

The household got the created loan money and this amount won't go away in existence and in the bank book until repayment of the loan.

by Laurent GUERBY on Tue May 1st, 2007 at 05:25:17 AM EST
[ Parent ]

Re: Mortgage packaging (none / 0)

I now believe I was wrong, more headache :).

One thing is that the bank having repackaged might be able to do more loans because some regulatory limit is lowered by the lowered (or cancelled) risk of the bank.

by Laurent GUERBY on Tue May 1st, 2007 at 05:32:16 AM EST
[ Parent ]

Re: Mortgage packaging (none / 1)

That is of course the whole point.

The Bank frees up its regulatory capital.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue May 1st, 2007 at 06:07:47 AM EST
[ Parent ]

Re: Mortgage packaging (none / 0)

Fractional reserve multiplier, baby.

In fact, couldn't the bank just loan the money back to Metrovacesa?

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Tue May 1st, 2007 at 06:44:37 AM EST
[ Parent ]

Re: Mortgage packaging (none / 0)

Oh no! <coffee not yet percolated, great night sleep, "macroecon" brain cells stirring>
Initial thought is I still think you were right--but very much open to discussing and learning.
I follow what you and Chris are saying on the first point. The bank A, let's say, packages its loan portfolio, and sells it. So this transaction effects the asset side of its balance sheet--its bond portfolio account goes down, by let's say $1 million, and its cash account goes up by a million. (Let's assume it's a break even transaction, no gain no loss, so we can stay away from tracking through the P&L. And I agree that Bank A therefore has $1 million more cash, and that is available to the money multiplier to raise the level of the money supply.

However, that million of cash came from many sources, but (perfect world of economics thinking) wouldn't it come out of other banks in the system. Banks C, D, and E for example might have the three of us as customers, and we bought the bonds, paying for them from our bank accounts. And as we do so, banks C, D and E have a negative money multiplier that offsets the positve one of bank A.

However, that does leave us with the $1 million of bonds in our hands. But of course we are not banks. So it's a different process from here for us. For example I would likely have my $300,000 of the bonds in a brokerage account. I would have probably sold something, bonds or stocks, to pay for the bonds. So my financial assets are somewhat the same, with a slightly different mix of assets. Investors like me, us, can buy on margin, but I'm fairly risk adverse and my borrowings are normally below 5% of financial assets--never above 10%. and this new mortgage bond wouldn't change my thinking about risk levels. (and also I'm not sure that changes the money supply anyway--I'd have to brain crunch through the whole margin process to figure that impact. But let's ignore that for the moment.

Where does this original concept of Laurent's thinking break down? a $1 million positive impact at Bank A and the resulting positve multiplier effect, perfectly offset by $1million negative impact in banks C, D and E.

PS: I don't know if we want to go there, but WSJ had an interesting article that relates to the "margining" process I guess I'm suggesting that we put aside for the moment: OUTER LIMITS
As Funds Leverage Up,
Fears of Reckoning Rise
Fed and SEC Question
Wall Street on Policies;
'A Mockery' of Margin
By RANDALL SMITH and SUSAN PULLIAM
April 30, 2007;

Hedge-fund manager John Paulson made $1 billion using a complex financial instrument to pump up a bet that the subprime-mortgage market would crater. The parent company of retail giant Sears made $74 million using a similar device to boost its wager that a basket of stocks would rise in value.
Both were playing with leverage -- the magical power that allows investors to make big investments without putting big money on the table. These days, they have lots of company. Thanks to advances in financial engineering, investors have never had so many different ways to make commitments that exceed their bankrolls. And never before has leverage wormed its way into so many nooks of the financial world.
We're living on planet leverage, and regulators and market gurus are growing nervous.
How did this happen? For starters, hedge funds and leveraged-buyout funds have proliferated. They're pioneers in boosting returns using borrowed money, the most traditional form of leverage. Also, investment banks are pumping out newfangled leveraging tools such as derivatives, complex securities that allow hedge funds and other investors to add leverage without borrowing money.
Finally, mainstream America has gotten into the act. Once-conservative institutions are copying hedge-fund tactics. The Pennsylvania State Employees' Retirement System has begun dabbling in derivatives. Mutual-fund companies such as Easton Vance Corp. and Federated Investors Inc. have launched funds that rely heavily on derivatives. Garden-products maker Scotts Miracle-Gro Co. and other public companies have loaded up on debt to improve returns.
This leveraging binge has regulators and others worried. In the first place, no one knows how much leverage there is. Much of it is hidden, because investors aren't just juicing returns with borrowed money, but with derivatives, which are harder for regulators to track.
No one is sure what will happen to this complex brew in the event of a serious market downturn. When markets turn bad, leverage can create a snowball effect. Lenders and derivatives dealers demand that investors provide them with more collateral -- the stocks, cash or other assets they pledge to cover potential losses. Sometimes, investors dump stocks and bonds to raise cash. Prices drop more, losses accelerate, and more selling ensues. Some Wall Street analysts have taken to referring to a nightmare version of this scenario as "The Great Unwind."
Timothy Geithner, president of the Federal Reserve Bank of New York, said in an interview that the torrent of money flowing into hedge funds has coincided with a troubling erosion in lending practices.
The Fed, the Securities and Exchange Commission and European regulators have spent months trying to gauge the risk by gathering information from hedge funds and Wall Street firms. They've asked the brokerage firms, among other things, how much collateral they're demanding from hedge funds when they provide financing.

In my own mind, I think of the money multiplier effect of the banking system in one compartment. Then I think of the whole world of investments, swaps, and margining as a separate compartment, since different rules outside the banking system apply--and admittedly because this is a set of rules, that is this article shows, is evolving and controversial. Maybe this is my mistake, and you and Chris are including this aspect in your thinking, as one compartment?

by wchurchill on Tue May 1st, 2007 at 10:11:11 AM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

There are levels of debt that are good. Many companies should have far more debt than they have, so they can leverage their earnings--raise ROE higher than ROA.

Why is Return on Equity better than Return on Assets?

Bush is a symptom, not the disease.

by Migeru (migeru at eurotrib dot com) on Mon Apr 30th, 2007 at 07:32:52 AM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

There's nothing equitable about Company "Equity"....

And as for "gearing" and "leverage" - it is precisely this phenomenon that is the direct cause of asset price inflation.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Apr 30th, 2007 at 08:33:30 AM EST
[ Parent ]

Re: GDP minus TOTAL debt increase? (not gov alone) (none / 0)

I should have been more careful with this comment. Thanks for raising the point.

I believe the average company in the S&P 500 is earning about 15--16% return on its assets--basically total assets minus short term liabilities like accounts payable. and that calculation is after-tax. I believe such a company can borrow on the markets, issue corporate bonds, with an interest rate of roughly 7%. So the company can borrow money at 7% to finance its growth in its business, which will yield a 15% return. But there is an additional benefit because the interest on the bond is tax deductible. Assuming the 35% corporate tax rate, this means that the after tax interest cost is 4.55%. So this is very favorable for the owners of the company, the stockholders--borrowing money at 4.55% and earning a 15% return on those borrowed funds. The alternative of issuing more shares to raise the money would dilute the ownership position of current shareholders, and they would get a smaller % of the growing pie (earnings pie, I guess?).

If the company is in a reasonably stable business, I think most people would be comfortable if they borrowed up to, say, 20% of their capital structure--so the company is financed with 80% equity and 20% borrowings. Thus the Return on Equity is higher than the Return on Assets--they are earning the 15% ROA on the total capitalization, but the bondholders are happy with 7% (which is 4.55% to the company), leaving the extra 10.45% (15%-4.55%) to be spread to the shareholders, either in dividends are share price growth.

But what I left out in my comment is that there is too much of a good thing. If a company raises its debt/equity ratio to much, say to 50%, it can put itself into a very risky position (not unlike the subprime borrowers of today). Stuff happens in business, and things don't always go to plan. You're legally commited to make those bond payments. If your earnings fall perilously close to what the interest payments are, there are covenants and you may find other people coming in to run your business and restricting your efforts to safeguard the bondholders at the expense of the shareholders--as they should, btw, bond holders are assuming they have much less risk than shareholders.

so it's better if management is prudent, and successful. Generally company share prices will fall and remain under pressure if it lets its debt/equity ratio get too high--a "good' thing can become a bad thing, if misused, or some unforseen circumstance occurs.

by wchurchill on Mon Apr 30th, 2007 at 12:10:12 PM EST
[ Parent ]

Re: US economy continues to grow (none / 0)

The US economy has chugged along for hundreds of years, and taking a truely longer term view, I would say that will continue for another hundred years.

Thinking more short term, as I have commented before, I think the economy will remain very strong until 2010, driven by consumer spending which is 70% of the economy. and demographic trends will have a negative impact at about that time. (it could be a little earlier, like sometime in 2009 that the trends begin to hit.) but this will not just impact the US economy, European demographics or at least as negative in the upcoming decade. But imho, this is all the more reason that those who have believed the doom and gloom scenarios of this decade will have deep regrets--because the next decade is not going to be pretty, at least in terms of the prosperity that we have grown accustomed to.

btw, please note your Bloomberg quote is a description of something that has happened. as i noted in my diary and earlier diaries, this slowdown was seen by many in early 2006--pretty obvious really with the Fed's raising of interest rates 17 straight times, and appropriately to keep inflation in line. so most people, including the stock market btw, had this built into their numbers for a long time. note Jerome's article of the last few days on the dow breaking 13000, and his puzzlement with that in light of factors in the economy. it's not a surprise to the market, so it's already been built in.

by wchurchill on Sat Apr 28th, 2007 at 01:58:23 PM EST
[ Parent ]

thanks for this (4.00 / 3)

I've let my pessimism about Bush's driving of our country put me off investing for waaaaay too long. I actually check in on Bonddad's blog just to see just how much negative info can be extracted from positive data.

We have had a serious strain of Cassandra-itis in the left blogosphere. We don't just have "energy will be very expensive and our lives will be impacted". We get Kunstler's "we're all going to die". Oil isn't just peaking; instead we have the Oil Drum hyping every little thing as a signs of the great collapse. The dollar isn't going to $1.35/euro, it's been heading for $2.00 for about 2 years now.

by HiD on Sat Apr 28th, 2007 at 06:39:23 AM EST

See my comment (none / 1)

here.

The US economy is only 'growing' if you're in the mythical top 1%.

For everyone else in the US, the economy is a deeply sucky thing, and has been since the Clinton/Intertoobz heyday.

The growth is really based on printing lots of money, and screwing over Chinese workers by getting items made at sweatshop prices. And for most people in the US, plenty of debt.

If you're not capable of looking beyond the superficiality of the traditional indicators, everything looks rosy.

But if you're one of those increasing numbers unable to afford medical insurance, it's not such a pretty picture.

The useful illusion of growth continues because of the wilfulness blindness of the share dealing class, whose interest in those lower down the pyramid is small to non-existent.

Wall Street is more than happy to play this out for as long as it can.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sat Apr 28th, 2007 at 07:40:35 AM EST

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