Archive | US

Fed lifts rate again

The US Federal Reserve decided overnight to raise its federal funds rate to a range of 1-1.25%.

The central bank dropped its target range to 0-0.25% in December 2008 and held it there for 7 years. In December 2015 it lifted the target range to 0.25-0.5%, and raised it again in December 2016 & March 2017, each time by 25 basis points.

One member of the bank’s open market committee, Federal Reserve Bank of Minneapolis president Neel Kashkari, wanted to hold the rate today. The vote to raise was 8-1.

The bank expects to start a “balance sheet normalisation programme” this year, by gradually decreasing reinvestment of principal payments to reduce its holdings of Treasury securities.

The committee said it expected economic conditions would “evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”

Attribution: Bank release.

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Fed holds funds rate

The US Federal Reserve’s open market committee stuck overnight to the 0.75-1% target range for its federal funds rate.

In its statement issued this morning, the US central bank said: “The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labour market conditions and a sustained return to 2% inflation.”

The committee said it would maintain its policy of reinvesting principal payments from its holdings of agency debt & agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, “and it anticipates doing so until normalisation of the level of the federal funds rate is well under way. This policy, by keeping the committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.”

Link to full statement: Federal Reserve issues FOMC statement

Attribution: Bank release.

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Fed approves the anticipated raise

The US Federal Reserve did what was widely expected overnight, and raised its federal funds rate target range 25 basis points to 0.75-1% “in view of realised & expected labour market conditions & inflation”.

Its previous 25-point raise was in December.

Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, wanted no change. The other 9 members of the committee supported the raise.

The central bank’s open market committee said in its summary of economic conditions this morning:

“Information received since the federal open market committee met in February indicates that the labour market has continued to strengthen and that economic activity has continued to expand at a moderate pace. Job gains remained solid and the unemployment rate was little changed in recent months. Household spending has continued to rise moderately while business fixed investment appears to have firmed somewhat. Inflation has increased in recent quarters, moving close to the committee’s 2% longer-run objective; excluding energy & food prices, inflation was little changed and continued to run somewhat below 2%. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.”

Looking ahead, the bank said: “The committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

“The committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt & agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalisation of the level of the federal funds rate is well under way. This policy, by keeping the committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.”

Attribution: Fed release.

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Fed holds funds rate, continues aiming for 2% inflation “goal”

The US Federal Reserve’s open market committee decided overnight to hold the target range for the federal funds rate at 0.5-0.75%, based on “realised & expected labour market conditions and inflation”.

The committee said: “The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labour market conditions and a return to 2% inflation.”

The committee increased its target rate by 0.25% in December.

One thing that surprises me about this pronouncement is that the Fed now calls 2% an “inflation goal”. It’s like a baseball player landing precisely on a base with both feet, whereas in economics the cycles are moving constantly – provided they’re not being manipulated, as they have been in the US since this millennium began.

The committee said it would continue to maintain its policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities, and of rolling over maturing Treasury securities at auction, “and it anticipates doing so until normalisation of the level of the federal funds rate is well under way. This policy, by keeping the committee’s holdings of longer-term securities at sizeable levels, should help maintain accommodative financial conditions.”

Link:
Federal Reserve, 2 February 2017: Federal Reserve issues FOMC statement

Attribution: Fed release.

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Whose waggling finger should NZ follow?

The US accuses, and the rest of the world must adopt its stance. True? Reasonable?

The latest version of this is new president Donald Trump’s unilateral, instant closing of borders to selected travellers. It’s his method of combatting terrorism: Keep everybody out, and terrorists will be among those unable to enter.

If the rest of the world doesn’t like that method, it must produce alternatives, and quickly.

That’s one issue. Currency is another, and it won’t be long before President Trump formalises his accusation that China is a currency manipulator.

In the sense that China has tried to adopt a fixed or pegged rate of exchange with the $US, and then a managed float, it is. It just happens that both China & the US have wanted to devalue their currencies at the same time. That obviously can’t happen.

New Zealand has been in the same boat, and the Reserve Bank has expressed concern many times that the $NZ is overvalued, to no avail. The $NZ just happens to be among the most traded currencies in the world, and there’s no way the country can defeat its use by the traders while it’s free-floating.

Jaundiced view from the divine-rule mindset

Over the weekend I read on one US website, Our Future, how currency manipulation was costing up to 5.8 million US jobs in 2014, and up to $US720 billion in gross domestic product (gdp). That website declared – and plenty of readers will have visited the site and believed it – that currency relationships are supposed to be self-correcting, and that free-floating is the only way for currencies to be valued.

The Our Future website gave the example of how a country with a trade surplus (ie China) could defeat that mechanism: “Suppose that, instead of lots of people & businesses in the trade-surplus country using the stronger currency to buy more stuff from the rest of the world, that country instead has a central authority that uses the surplus of incoming cash to buy the currency of other countries. This is called currency manipulation. It bypasses the natural market supply/demand function of the currency exchanges.”

The $NZ was pegged to the $US when New Zealand changed from pounds to dollars in 1967, and pegged at a rate closer to parity later that year.

In 1971, the US unilaterally broke the Bretton Woods system that had been put in place in 1944 and the gold standard was gone. Over those 27 years, the currencies of a handful of major western countries had been fixed in relation to gold, and thereby to each other, with a little flexibility.

Move from $US reserve currency status opens more options

The US action turned the $US into the world’s reserve currency, which put a premium on it, but that status has been declining and the use of the $US in international transactions has recently fallen below 50% as a result of bilateral agreements and the determination of some countries to trade outside the $US.

This trend will lead to more trade in the currencies of Russia & China, and also the use of the International Monetary Fund’s special drawing rights (SDRs). That, in turn, is likely to support new trade agreements, including new partnerships, and the potential for China especially, but also Russia, to be drawn into agreements such as a revised Trans Pacific Partnership.

Partners in these future agreements would need reassurance on legal standing, in particular, which means that more commercially international Russia & China are likely to gradually redraft their laws. The US manipulated its currency from a position of power, but the positions of Russia & China are a long way from achieving that kind of status.

Through all of this, New Zealand’s dollar is likely to remain a highly traded commodity.

China repositions, not just on currency

Chinese repositioning, both to move away from reliance on the $US as a determinant of the yuan’s value and to control the trading behaviour of its population, opens up numerous short-term & longer-term possibilities.

Assuming Mr Trump labels China a currency manipulator, a currency war between the US & China will spill over into other countries’ trading. Mr Trump has already raised the prospect of tariffs to suit American purposes, and retaliation would normally follow – not necessarily tit-for-tat tariffs. One alternative to the tariff reaction is to switch trade to a different bloc so, for example, New Zealand could be drawn into more Asian trade.

New Zealand might not have any intention of doing that but, again for example, a change in shipping services could turn it into a natural course to follow.

Meanwhile, the US has gigantic problems. The quantitative easing since the global financial crisis erupted in 2008 added, as far as I can see, about $US1.7 trillion to the US Federal Reserve’s balance sheet through the printing of money which was intended to spread through the wider economy and lift the country out of recession.

The money was printed, the $US exchange rate remained untouched, and the formula back to prosperity didn’t work very well. According to the US Debt Clock website, the US national debt is approaching $US20 trillion at terrifying speed. George Bush Junior began printing money and under Barack Obama the process was greatly accelerated. Donald Trump knows that can’t continue, but he’s also promised various measures to lift the US economy, particularly for the “flyover territory” voters who supported his campaign.

Who will pay?

As with the Mexican wall, he will look outside the Federal bank account to fund a lot of the expected infrastructure. What doesn’t seem to have hit home yet is that the communities of flyover territory will need to think of new ways to boost their economies.

All of this is relevant for New Zealand, even if it looks too far away to bother thinking about.

The machinations of the US economy matter. It’s New Zealand’s third biggest export market, though figures out from Statistics NZ yesterday show it declined by 8% in the last year, by $460 million to $8.265 billion. It’s also our third biggest supplier, though that also dropped in the last 12 months, by 5.7% ($352 million) to $5.83 billion.

China is already by far our biggest export market & biggest supplier – exports up 9.1% to $9.39 billion in 2016, imports from China up 0.4% to $10.3 billion.

The exchange rates matter, access matters, and international partnerships smooth the way. What the US & China do will determine trade flows, could make a big difference to flows of finance and will probably affect decisions on who invests here.

The present long list of uncertainties should encourage NZ Inc to spread both its export markets & supply sources, which has been happening, but, most importantly, to widen the value-add export range beyond the traditional commodity focus.

And that means changing many aspects of the way we live.

Links:
The Balance, 8 September 2016: What is quantitative easing? Definition & explanation – How central banks create massive amounts of money
Our Future, 22 June 2014: What is currency manipulation?
Wikipedia: Fixed exchange rate system
Wikipedia: Managed float regime
Wikipedia: Bretton Woods system
US Debt Clock

Attribution: Statistics NZ, The Balance, Our Future, Wikipedia, US Debt Clock.

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Trump rolls the dice and tells all the players what to do

Donald Trump’s visit to Auckland in August 1993 lasted just a few hours, and his visit on a blustery day to the proposed Auckland Casino Ltd site, the old central railway station, took only a few minutes – enough to greet intending partners, be greeted by a few protesters and make a quick tour of the vacated station building.

It wasn’t hard to see a man on a mission which wasn’t going to include Auckland. He was here to assess a deal to his advantage, not to see where he might fit into a relatively small & tightly regulated venture in an outpost.

But now, from New Zealand’s support of the UN Security Council resolution on 23 December declaring Israeli West Bank settlements a flagrant violation of international law, as a supporter of the Trans Pacific Partnership and as an eager signatory to the China-led Asian Infrastructure Investment Bank, New Zealand might just get marked down among the Bad People.

On that miserable August day he also visited the Casino Control Authority, which had the task of assessing intending casino owners & operators. Mr Trump’s financial position at the time was precarious and his lead development partner, the National Maori Congress, went on to present a poorly devised case.

The Maori congress’s partner in premises licence applicant Auckland Casino Ltd, New World Development Co Ltd of Hong Kong, was a major developer there and in mainland China but showed little understanding of what was required in Auckland.

Not surprisingly, in December 1993 the authority awarded the casino premises licence to Brierley Investments Ltd’s slicker Sky Tower project. The casino business has been a highly successful venture, but would have been far less of one if Harrah’s had stayed as SkyCity’s operator or Trump had won the operating licence. SkyCity has ridden the local ups & downs and come out well ahead. The American operators would have crawled into their shells in bad times back home and the outpost venture would have suffered, or been sold.

Ability to sum up a position flows through Twitter

Mr Trump was a man in a hurry then, with an evident ability to sum up his surroundings & company. He’s been in financial straits many times since then which would have knocked most serial entrepreneurs off their perch, and every time he’s come out proclaiming victory. Since he vanquished Hillary Clinton in the US presidential race on 8 November, however, he’s surpassed himself in summing up opponents, the people who are going to fill executive roles in his governance ensemble, the foreigners he wants to dominate.

His master stroke has been the use of Twitter. His relentless tweeting has been derided by many, but it’s worked. Before he’s taken office he’s espoused the policies that will be followed and his lackeys, the generals & Goldman Sachs entourage fast filling executive posts, have mostly fallen into line. They all know the words they’ll hear if they get out of line: “You’re fired!”

The result is that, before he even gets the keys to the White House on Thursday, Mr Trump has directed a total revision of the natural order.

Hardlining versus working with nuances

Socialist policy, very limited in the US anyway and resisted by a high proportion of the electorate, will be reduced to the corporate capitalist version: What’s necessary to keep the workforce working.

Mr Trump acknowledges governments as providers of services, but every service involves a deal. He wants his people to drive hard bargains, starting (via Twitter) with aircraft construction contracts, pharmaceutical contracts (via his media conference this week), the Mexican wall, trade with China and China as a currency manipulator (is there a country in the world that doesn’t at least try to manipulate its currency?), reordering trade relations with many other countries, decreeing boundaries which other nations ought not pass (as in the South China Sea).

The US was going to get a better deal than it ought to have from the Trans Pacific Partnership – for its pharmaceutical manufacturers & licence rights, for corporates & their ability to contest national positions. That partnership began as a small affair between 4 countries and expanded, ultimately including the largest Pacific trader, the US. It could continue to a signed partnership excluding the US, but it would be a much less effective agreement.

In the bluster of the Twitter outpourings, Mr Trump has made it clear he wants deals that are fair to the US. Which, as his desire to force carmakers to produce vehicles in the US rather than next door in Mexico shows, won’t be “fair” to Mexico.

It’s an example of bullying because you can, but it’s a course open to unintended consequences such as an increase in illegal migration through Mexico to the US, wall or no wall.

Always, the unintended consequences

Another unintended consequence, though, is the impact of US arrogance on other nations. I’ve always seen the 9/11 attacks on the World Trade Centre in New York and Pentagon building in Washington in 2001 as at least partly a response to that arrogance, whereas the official US view then & since has been that this was an unjustified terrorist attack – without cause.

As China builds islands in the South China Sea – undoubtedly heightening the consternation other nations bordering that sea feel – the US comes in heavy-handed: Do as we tell you.

China – through both government & private-sector companies – has been investing heavily in businesses & property around the world, including landmarks around the US. It has also been lifting the international importance of its currency for bilateral trade, particularly with Russia, and has been forging new trade partnerships – BRICS (Brazil, Russia, India, China & South Africa), the New Silk Road across Asia to Europe, the maritime Silk Road, the Asian Infrastructure Investment Bank and, perhaps most important of all, having renminbi added on 1 October 2016 to the basket of currencies used to value International Monetary Fund special drawing rights, joining the $US, euro, yen & pound.

The Silk Road trade routes, to Europe across continental Asia, and to Africa on a maritime course.

According to currency website The Balance, over 85% of forex trading involves the $US and 39% of the world’s debt is in $US. When the global financial crisis hit in 2008, non-US banks had $US27 trillion of international liabilities denominated in foreign currencies, and $US18 trillion of that was in $US.

The rouble & renminbi aren’t going to take over, but it will suit Russia & China to have a strong alternative, and IMF special drawing rights can achieve that for international trade, if not for consumer transactions. They were calling for such a move before the global financial crisis.

China in, US heading out?

China’s president, Xi Jinping, will deliver the opening address at this year’s World Economic Forum gathering in Davos, Switzerland, on Tuesday, and he’ll be accompanied by the largest Chinese delegation since the Davos meetings began in 1979. As the US erects barriers and its almost-president tweets decrees, China is opening itself to wider relationships, including drawing closer to the far right of capitalism.

However, it’s conceivable that the US & Russia could also draw closer as many of their interests merge. Russia is now a non-communist country, albeit still autocratic; Mr Trump’s style is autocratic, albeit the country adhere’s loosely to a democratic veneer. Both countries’ governments have played others to their own advantage, and in some theatres such as Syria it may suit the US & Russia to be on the same side at times (simultaneously, unlike in Afghanistan).

A dealmaker first & last

All of the above is about position-taking, some for commercial gain, some for international power.

Mr Trump looks at all of this in terms of dealmaking, which he emphasised during his press conference last Thursday: “I want to bring the greatest people into government, because we’re way behind. We don’t make good deals anymore. I say it all the time in speeches. We don’t make good deals anymore, we make bad deals. Our trade deals are a disaster. We have hundreds of billions of dollars of losses on a yearly basis – hundreds of billions with China on trade & trade imbalance, with Japan, with Mexico, with just about everybody. We don’t make good deals anymore.

“So we need people that are smart, we need people that are successful, and they [his Cabinet appointees] got successful because generally speaking they’re smart.”

A family of traders, with connections

Outside the political sphere, Mr Trump’s life has been about commercial deals, and his wider family has followed the same trajectory. Attempts are being made to separate family commercial life and political roles, but there are natural crossovers. For instance, Mr Trump’s daughter Ivanka and her husband, Jared Kushner, are moving to Washington for Mr Kushner to take on a role in Mr Trump’s administration.

The Washington Post noted last week that Mr Kushner’s family had donated to pro-Israel causes, hardly surprising given that the New York property development family is Jewish. But it is that kind of connection that makes it so much harder for Mr Trump to lock himself into a “for everybody equally” role.

Those Jewish connections will have a bearing on his view of the Security Council resolution, and also of the countries that voted for it, New Zealand among them. ‘Where was that country again? Oh, yes, I went there one day, cold & blustery, they didn’t like me, didn’t like me.’

In contrast to “draining the swamp” of insider vermin, all Mr Trump’s business & family relationships make connections to the swamp – to financiers, Goldman Sachs in particular, to people who can pull levers – that much more important for a person who’s spent his life combatting regulators. And now it’s the swamp dwellers who are rising to lead positions in Mr Trump’s Cabinet.

Outcomes

You see a president (swearing in Thursday) bent on certain courses – Israel, China, corporate power, finance sector.

The tariff wars are already underway. China already had tariffs on imports of corn-based animal feed from the US, and has increased them. Mr Trump has threatened a 45% tariff on all imports from China, effectively a calculation to make up for alleged currency imbalance, and has threatened carmakers manufacturing in Mexico.

Most of the American focus is on Mr Trump & his outbursts, little on what Mexico might do or how it will cope with the sudden departure of whole industrial sectors. This is the kind of action that can set off international turbulence. China has already been lifting its internal trade, trade around Asia rather than with parties outside Asia may rise, the Silk Road routes will increase trade across continental Asia and over to India & Africa.

The Trump argument is that China has been devaluing its currency to make its exports more competitive. The New Zealand way of doing this is for the Reserve Bank governor to remark that the $NZ is overvalued and for nothing much to change. The US has effectively devalued by printing billions of dollars through quantitative easing since the global financial crisis began, but its exchange rate has climbed over the last 4 years.

Unilateral trade actions can easily flow into redirection of trade, and will certainly encourage affected nations to move away from the greenback as international currency.

The anti-UN tirade unleashed

Fast & determined action on a number of fronts by Republican politicians means a vote to pull the US out of the United Nations and oust the United Nations from New York could well pass this time, spurred on by the UN Security Council vote to pillory Israel for continuing to develop West Bank settlements.

The bill received little support when former Congressman Ron Paul introduced the American Sovereignty Restoration Act in 1997 (and he continued to introduce it annually for the next decade). Other senators, including Ron Paul’s son Rand, have tried with similar bills without success.

While the US under new management is determined to assert its right to police its trade routes, a decision to send the UN packing would be a fitting conflicting conclusion to the withdrawal from pax Americana. It could make that policing so much harder, in a world where the US would have far fewer friends.

Impacts will flow

None of the above is directly related to property development, investment or regulation, which are the main topics on this website. But all of the above concerns international commerce, which fluctuates like the tides. Except, sometimes, somebody builds a wall where it shouldn’t be, and the tide gets angry.

The disaffected of America got angry and elected the outsider candidate as president. Together, they want to hurl their anger at others. In politics and in commerce, that can unleash powerful repercussions.

How does all this affect us in New Zealand?

On Wednesday, I’ll write about some New Zealand issues, again not all directly related to specifics in property, but related when you think about it.

Links:
World Economic Forum
Silk routes
New York Times, 11 January 2017: Press conference transcript
Washington Post, 7 January 2017: Trump’s son-in-law poised to resign as CEO of real estate company
New American, 6 January 2017: Bill to get US out of UN introduced in new Congress
The Balance, 22 October 2016: Why the dollar ($US) is the global currency
World Economic Forum, 26 June 2016: Why is China building a New Silk Road?
World Economic Forum, 2 January 2017: 5 leadership priorities for 2017

Earlier stories:
14 August 2016: Propbd economic update Sun14Aug16 – the greenback’s future
4 July 2016: East Asia & Pacific central banks shift bond fund into local currencies
1 May 2016: Propbd economic update Sun1May16 – Rethinking boundaries, Silk Road unity
Propbd economic update M8Feb16 – Big investors’ targets, ETFs to keep growing, Chinese planner positive, Portents of crash, Silk Road, global way forward
World property Wed14Oct15 – LJ Hooker IPO, Goodman UK fund, Silk Road forum
World property T2Jun15 – Stepping stones across Central Asia
1 July 2015: NZ formally signs up to Asian infrastructure bank
30 March 2015: China & IMF agree reform programme
2 May 2014: Canadian professor says conflicting trade views mitigate against TPP success
16 December 2006: Bernanke tells China to free currency, become consumer society
17 December 2004: NZ joins Asia Bond fund

Attribution: 1983 recollections, US news observations, New York Times, Washington Post, New American, World Economic Forum, The Balance.

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Corrected: Fed lifts rate

The US Federal Reserve has raised its federal funds rate overnight to a range of 0.5-0.75% (I originally wrote the range it came from, 0.25-0.5% – corrected 2 February 2017).

The committee also released its economic projections this morning (links to both releases below).

The committee said it expects “economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”

Full release (mostly blah): Federal Reserve issues FOMC statement
Federal Reserve Board & Federal Open Market Committee release economic projections from the December 13-14 FOMC meeting

Attribution: Bank release.

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Out by a very valuable decimal point

When I quoted a figure of $US1.3 trillion as the estimated increase in the US federal deficit for the 2016 financial year on Wednesday, it seems I was already out of date. A reader quickly informed me it had reached $US1.4 trillion by the end of the financial year last Friday, 30 September.

That was the increase. The total has been estimated at $US19.6 trillion.

Plenty of websites run estimates, forecasts & clocks on US debt in particular, and a few on other countries, but the Government, through the White House Office of Management & Budget, isn’t quite so quick to produce final figures. Its last estimate of the deficit was $616 billion. I haven’t waded through the rest of its many tables, but the link is below.

Simon Black, who runs the Sovereign Man website, said the US Government closed out the 2016 fiscal year that ended last Friday, 30 September, with a debt level of $US19,573,444,713,936.79.

That’s an increase of $US1,422,827,047,452.46 over last year’s fiscal year close.

The US Government Debt website, run by Christopher Chantrill, said that, by yesterday, federal debt had risen by another $US86 billion to $US19,659,460,647,160.83 ($US19.66 trillion), or $US60,250/person.

That website estimated total government debt at the end of the 2016 financial year, including federal, state & local, would be $US22.4 trillion.

Time magazine ran a story in April putting national debt in perspective (and not just the US case), making comparisons with family finances.

Links:
US Treasury
US Office of Management & Budget
Sovereign Man, 3 October 2016: It’s official: US government ends fiscal year with $US1.4 trillion debt increase
Sovereign Man, 6 October 2016: Global debt hits all-time high of $US152 trillion; billionaire warns of “big squeeze”
Time, 22 April 2016: 5 things most people don’t understand about the national debt

Earlier story:
5 October 2016: Infrastructure frailty puts US financial woes in perspective

Attribution: Debt websites, US Budget Office.

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Infrastructure frailty puts US financial woes in perspective

Economist & financial commentator John Mauldin put a lot of US financial woes in perspective this week in his column, Thoughts from the frontline, where he highlighted the frailty of the country’s infrastructure and the likelihood that funding will prevent it being maintained or upgraded adequately.

Those infrastructure woes pitch the US into a role of coming from behind. One issue has been recognised but not resolved: funding of its road network has not kept up, the rising proportion of pensioners leaves fewer motorists to pay for it, and improved vehicles reduce the fuel use that taxes are levied on.

Other issues are arising, much the same as in New Zealand, except that more complicated governance structures make resolution harder. After 70 years of suburban development, water supply & waste removal are 2 areas of concern.

From afar, we see a streamlined country that knows how to run its affairs (apart from the temporary question of finding a president). What Mr Mauldin sees – backed up by a report from the independent analysts at the Congressional Budget Office in a report in August on the national budget & economic outlook for the next 10 years – are the likelihood of early recession and rising deficits which won’t go anywhere near covering infrastructure requirements.

Mr Mauldin summarised what is a quite long opinion piece, and I’ve reduced the summary further:

  1. The next president is likely to face a recession early in their term; current monetary & fiscal policy will ensure it’s fairly serious, and the recovery even slower than last time
  2. The fiscal deficit will swell to at least $US1.3 trillion and likely more. That will leave little room for fiscal spending & stimulus, and certainly not much for the usual infrastructure spending that is called for
  3. The state of US infrastructure is appalling. It needs at least $US3.6 trillion worth of repairs, and that does not even include what we need to do to prepare us for the 21st century. We have dug ourselves a very deep hole of massive failures on infrastructure upkeep, and we are continuing to dig
  4. His solution on where to find the money
  5. Necessary tax & regulatory reforms, and then he notes: “If we do none of the above but stumble along doing what we have been doing, the investment environment is going to be exceedingly stressful; and pension funds & insurance companies are going to have massive difficulties staying in business, not to mention meeting the needs of tens of millions of retirees”.

Same issues apply to Auckland

Some of that warning could equally be applied to Auckland, which is still spending less on infrastructure upgrades than it should, although the advent of the super-city has streamlined the ability to make that provision.

Auckland is also going down a new route of escalating suburban housing development, led by a government that wasn’t awake soon enough to the bottlenecks being created by insufficient land supply around the region. Those bottlenecks occurred as the regional council was responsible for monitoring land use and contested urban conversions while having no power to implement alternatives – such as the present move to intensification.

Changing land use was primarily in the hands of territorial councils until the super-city took over in 2010, and those councils had very different – and competing – intentions. As residential development is promoted ahead of all other uses, some of those pre-merger intentions should be kept in place, such as providing more local jobs and encouraging business clusters outside the centre.

At the moment, the helter-skelter rush to lay out new suburbs requires infrastructure to be in place, at greater cost/residence than more intensive development, and with long-term maintenance costs that are likely to be much higher.

Just as Auckland Council has worked out the costs & requirements of a steady growth in infrastructure, it is being pressured to meet hasty new demands based on an old model that the US is demonstrating has high risks when demography & funding systems militate against the “forever onward” approach.

US economy “running at stall speed”

Back to the US, where Mr Mauldin argues that the economy “is running at stall speed, and any shock that comes from outside the US – from Europe or Japan or China – or from an actual honest-to-God initiation of interest rate hikes by the Fed, which would force a repricing of bonds & equities, could set off a recession that would become self-reinforcing”.

One of those potential external disrupters is Deutsche Bank – in trouble, at the heart of the international financial system, not to be bailed out according to German president Angela Merkel, requiring a rescue according to Mr Mauldin.

“Pay attention to Deutsche Bank,” he wrote. “The bank is deeply connected with the entire global banking market, and just as Lehman Brothers triggered a rolling wave of panic, Deutsche Bank has a similar potential. Even though Merkel swears she is not going to bail out Deutsche Bank, she will have no choice. They will probably have to wipe out shareholders and maybe even some subordinated debt, but they cannot let the bank itself go under, because it is at the centre of a massive financial spiderweb. Which means that the German central bank will have to be at the centre of the rescue, and it gets its capital from the ECB (European Central Bank). Watch how quickly Italy, Spain & the rest of Europe demand that the ECB bail out their banks, too. So the last thing Germany will want to do is bail out Deutsche Bank.”

Projections are for escalating debt, no answers

The Congressional Budget Office, in its report on the state of US public finances, said: “The deficit under current law is projected to be larger this year, but smaller over the 2017–26 period, than the office projected in March. Since January, the office has reduced its projections of gdp growth & interest rates over the coming decade.”

It stated the obvious, that growing deficits projected through the next 10 years would drive up public debt, and it’s projecting the federal deficit will reach 4.6% of gdp by 2026, pushed upward by the continued growth in spending on social security, Medicare & net interest. It said these costs would outstrip growth in revenues, resulting in larger deficits & increasing debt.

In the Congressional Budget Office’s projections, federal outlays rise by $US2.4 trillion/year (or about 60% percent) from 2016-26: “Relative to the size of the economy, outlays remain near 21% of gdp for the next few years – higher than their average of 20.2% over the past 50 years. Later in the coming decade, the growth in outlays would exceed growth in the economy and, by 2026, outlays would rise to 23.1% of gdp. That increase reflects significant growth in mandatory spending & interest payments, offset somewhat by a decline, in relation to the size of the economy, in discretionary spending.”

The office said that, if current laws generally remained unchanged, revenues would gradually rise – by $US1.7 trillion, or about 50%, from 2016-26 – increasing from 17.8% of gdp in 2016 to 18.5% by 2026. They’ve averaged 17.4% of gdp over the last 50 years.

“As deficits accumulate in the office’s baseline, debt held by the public rises from 77% of gdp ($US14 trillion) at the end of 2016 to 86% of gdp ($US23 trillion) by 2026. At that level, debt held by the public, measured as a percentage of gdp, would be more than twice the average over the past 5 decades.”

In sum

In short, the rising infrastructure debt is not matched by an ability to pay, and the US Government is not producing ways to resolve what will become a critical failure at the heart of the international financial system.

Its effects will be widespread, right down to the number of wars the US can fight. A symptom at the moment is the level of interest rates, seen mostly from the perspective of a financial system struggling to get traction. The finance world has been promoting ever-lower interest rates, which support higher asset prices.

There is another side to this, not mentioned by Mr Mauldin or in the Congressional Budget Office report, and that’s the preference of governments to get interest rates down – and exchange rates rebalanced in their favour – when their repayments are high.

New Zealand’s Reserve Bank has been bleating that our exchange rate is too high, but it’s not going to beat the requirements of more powerful nations on that score.

Links:
John Mauldin, Thoughts from the frontline, 2 October 2016: Start moving some dirt
Congressional Budget Office
Congressional Budget Office, 23 August 2016: An update to the budget & economic outlook: 2016-26

Attribution: John Mauldin, Congressional Budget Office.

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Absurdity still wins at the Fed

The absurdity weighs on inflation calculations, which weigh on central bank cashrate decisions: the drop in price of a commodity as fundamental to western business as oil is bad.

Forget the widespread value a lower oil price – or lower price of any commodity – can offer to business, it reduces the obviously flawed international measure of trade performance, gdp (gross domestic product, which measures the total of inputs & outputs).

The US Federal Reserve’s open market committee referred to this ‘unfortunate’ reduction in price of a basic commodity in its federal funds rate decision on Thursday: “Inflation has continued to run below the committee’s 2% longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.”

For central banks, the solution since the debacle of the global financial crisis in 2007-08 has been to inject inflation by printing vast sums of money to stimulate economies. The central bankers were asking people at large to believe that the people who manipulated them into a crisis also just happened to know how to manipulate them out of it.

Who’s best placed?

The people most able to benefit have been commercial bankers and investors in a position to take advantage of asset revaluation. Wealthy at the start, percentage gains alone are going to separate you even further from the run-of-the-mill citizen. Others have joined the game of acquiring capital assets yet, through all the contest for limited supplies of fixed assets, the inflation inherent in this trade has been largely excluded from counts of consumer inflation.

The mistake of the central banks has been to believe that obscene increases in the wealth of the wealthiest would permeate down into lower levels of the economy, but holding asset portfolios and accepting their value gains doesn’t equate to productive use of money.

As usual, the Fed committee excluded these factors from its consideration this week. As usual, it stated the theoretical intent of its role: “Consistent with its statutory mandate, the committee seeks to foster maximum employment & price stability.”

The very nature of how the Fed’s stimulative campaign, quantitative easing (printing money), has had far less constructive effect than it anticipated, should by now have told this central bank to try something else. Instead, it is relying on an economic factor called “time” to provide the fix. It could have done that in 2008, without flooding the wrong bank accounts with deposits.

Myopic

On Thursday, the Fed committee spouted much the same bland myopia it’s spouted for 8 years: “The committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labour market conditions will strengthen somewhat further. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2% over the medium term as the transitory effects of past declines in energy & import prices dissipate and the labour market strengthens further. Near-term risks to the economic outlook appear roughly balanced. The committee continues to closely monitor inflation indicators and global economic & financial developments.”

None of that gradual improvement in economic performance has anything to do with the policies of the central bank; it’s more a statement that, despite the central bankers’ 8 years of determinedly slowing revival, ordinary people are still keen to improve their lives.

The bank doesn’t expect to raise its funds rate for a while yet, ensuring that asset accumulation will remain an investor target. Meanwhile it will watch “measures of labour market conditions, indicators of inflation pressures & inflation expectations, and readings on financial & international developments. In light of the current shortfall of inflation from 2%, the committee will carefully monitor actual & expected progress toward its inflation goal.

“The committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”

Net outcome: more asset accumulation

All of that means asset accumulation will remain an investor focus internationally as low interest rates stay a central bank priority, so assets in New Zealand such as housing will also remain a target.

While all the media noise at these announcements is about the headline action or inaction, the Fed has built itself a nest egg from printing money and isn’t keen to reduce it, which is the opposite of the stance it would take if it were to stand outside the room and look in at how its policy has been a failure.

It said: “The committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing treasury securities at auction, and it anticipates doing so until normalisation of the level of the federal funds rate is well under way. This policy, by keeping the committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.”

There is one change, though, and that’s in the numbers wanting to see a rise in the funds rate. Back in March, Federal Reserve Bank of Kansas City president & chief executive Esther George was alone in wanting to raise the target range by 25 basis points, while the other 9 voted to keep it at 0.25-0.5%. This time, Loretta Mester (Cleveland) & Eric Rosengren (Boston) supported her.

Attribution: Fed release.

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