#debt_cycles

Today we are headed to Finland, to see how the Economic Machine is working there.

As always, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something, and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

1. Productivity

Finland is a largely industrialized economy, with manufacturing making up much of the activity.  Trade is also important, with exports accounting for around ⅓ of GDP.  To begin our analysis we first look at Finland’s current GDP Growth Rate, which expanded at 0.20% in the 3rd quarter of 2014.

On average GDP growth rate has been around 0.53% since 1975, with a high around 5% and a low of -6.3%.  At current levels we appear to be in a bit of a trough here, and levels typically rebound after low levels.  So I would expect levels to rise in the future. But that of course is reliant on further analysis below.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Finland at 57% of GDP in 2013 (most recent data available), which is a moderate level, and somewhat healthy.  When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.  At these levels we seem to be in an environment where debt levels are falling.  The government shouldn’t have any problems paying their future bills with debt at these levels, and can take on more debt to spur economic growth if they wanted.  All good signs.

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Finland, which are set by the ECB and are currently at 0.05%, which is as low as they can go, except if they go negative, which has happened in some countries recently.

With rates at this level, central bankers have no room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  That is a pervading problem throughout much of the developed world these days, and will come to the forefront in the coming years.  But at the moment I wouldn’t worry about this too much.

Lets switch to Money Supply (M3)  in Finland, which has see some cyclical moves over the last decade, but overall has been steadily rising since 1980.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Finland is at 0.50%, which is low and somewhat worrisome as the rate has been falling for decades and could potentially slip into negative territory or deflation.  The problem with deflation is that if people want to buy, say, some shoes, but they think that tomorrow the shoes will be cheaper, they will hold off purchasing them today.  That thought process ripples through the entire economy, and purchasing comes to a crashing halt and the economy slows considerably.

Deflation could pose a real problem here, and in much of the world, in the coming years.  Watch this figure closely!!

As well, one can look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10Y increased to 0.40% in February from 0.35% in January of 2015.  The overall trend has been a flight to safety and a crashing of yields in Finland.

The yield on government debt indicates expectations on inflation and debt repayment.  Inflation is typically seen as the primary killer of bond portfolios, as higher inflation typically drives interest rates up, and bond prices down.  I think what we are seeing here, overall, is that the market does not anticipate inflation becoming a problem in the market, as bond yields have bottomed out.  

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Finland Stock market to get a general picture of where financial assets are currently.

This chart clearly shows that the stock market in Finland is cyclical.  We have been rising in the last couple of years, and are nearing the highs in the short term cycle I believe.  This is extremely worrisome to me, as the turn will come at some point, and with such a run up in asset prices I would think we will see a drop sooner rather than later.  

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Finland had been steadily increasing for 40 years, and just saw an enormous spike, which has finally begun to taper a bit.  So government spending is falling in Finland and that may slow economic growth.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP at good levels, interest rates low, and inflation low and could be leading to deflation, stock prices are high and the government is slowing their spending, there are some problems in Finland.  With QE right around the corner I think it would be wise to look for inexpensive opportunities in Europe.  Finland might not be one.

Let’s look at the Short Term Debt Cycle to better understand this economy.

3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been steadily increasing for a decade now, and recently saw a huge spike.  I wonder if this is a peak?

Consumer Credit has also been growing for years, and looks to be plateauing a bit.  Watch for a turn downward in this number.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

Lets take a look at Capacity Utilization to get a picture of production.  In Finland, levels increased to 78.6% in the 1st quarter of 2015.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.

We can also look at Industrial Production, which decreased 0.90% in December of 2014.  Not great for economic growth.

Now, lets pull it all together.

Conclusion:

So the recent growth numbers were ok, but not great, government debt to gdp is at a good level, consumer credit is at a healthy level, and consumer and government spending are strong, so I think that Finland is likely somewhere in the the “Mid-Cycle” - this lasts an average of 2-3 quarters:

economic growth slows substantially

inflation remains low

growth in consumption slows

rate of inventory accumulations declines

interest rates dip

the stock market rate of increase tapers off

the rate of decline in inflation-hedge assets slows.

Today we are headed to the lovely country of Denmark, to see how the Economic Machine is working there.

As always, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something, and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

1. Productivity

Denmark was not blessed with a great supply of natural resources, so much of their economy relies on imports and foreign trade.  It has a liberal trade policy within the EU, and one of the highest living standards in the world.  To begin our analysis we first look at Denmark’s current GDP Growth Rate, which expanded at 0.40% in the 3rd quarter of 2014.

On average GDP growth rate has been around 0.36% since 1991, with a high around 3.89% and a low of -2.4%.  The chart above shows the somewhat wild nature of Danish GDP growth.  However, when it falls it always rebounds, and with the falling euro (The Danish krone is part of the ERM-II mechanism, so its exchange rate is tied to within 2.25% of the euro), and an economy reliant on foreign trade will stand to benefit handsomely.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Denmark at 44.50% of GDP in 2013 (most recent data available), which is a moderate level, and somewhat healthy.  When debt levels get too high government find themselves in situations where they can no longer afford to service their debt, and thus have to cut back on spending, which pulls down the economy.  At these levels we seem to be in an environment where debt levels are falling.  The government shouldn’t have any problems paying their future bills with debt at these levels, and can take on more debt to spur economic growth if they wanted.  All good signs.

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.

One could consider Interest Rates in Denmark.  The central bank of Denmark lowered its main interest rate for the 4th time in 2.5 weeks on February 5th, 2015.  Currently, rate are NEGATIVE, at -0.75%, which means you have to pay the bank 0.75% in order to keep your money there.  Very worrisome!!!

Lets switch to Money Supply (M2)  in Denmark, which has see some cyclical moves over the last decade, but overall has been steadily rising since 1991.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Denmark is at -0.10%, which is deflation, and very bad for economic outlooks.  The problem with deflation is that if people want to buy, say, some shoes, but they think that tomorrow the shoes will be cheaper, they will hold off purchasing them today.  That thought process ripples through the entire economy, and purchasing comes to a crashing halt and the economy slows considerably.

Deflation could pose a real problem here, and in much of the world, in the coming years.  Watch this figure closely!!

As well, one can look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10Y increased to 0.08% in February from 0.37% in January of 2015.  The overall trend has been a flight to safety and a crashing of yields in Denmark.

The yield on government debt indicates expectations on inflation and debt repayment.  Inflation is typically seen as the primary killer of bond portfolios, as higher inflation typically drives interest rates up, and bond prices down.  I think what we are seeing here, overall, is that the market does not anticipate inflation becoming a problem in the market, as bond yields have bottomed out.  

Now, debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Denmark Stock market to get a general picture of where financial assets are currently.

This chart clearly shows that the stock market in Denmark is cyclical, and that we might be at all time high at these levels.  This is extremely worrisome to me, as the turn will come at some point, and with such a run up in asset prices I would think we will see a drop sooner rather than later.  

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Denmark had been steadily increasing for 25 years, and may be plateauing at these levels, but II don’t see anything to suggest this will reverse sharply any time soon.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP high, interest rates low, and inflation low, there are some problems in Denmark.  Still, I like to take a contrarian view point.  You are supposed to sell when people are happy, and buy when people are panicking.  Not that people are panicking in Denmark, but with QE right around the corner I think it would be wise to look for inexpensive opportunities in Europe.  Denmark might be one.

Let’s look at the Short Term Debt Cycle to better understand this economy.

3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has seen some cyclical turns, but has been steadily rising for the last 4 years or so, and I would expect this to continue well into 2015.

Consumer Credit has also seen some cyclical swings, but did push higher in the 4th quarter of 2014 and I expect that to continue into 2015.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

Lets take a look at Capacity Utilization to get a picture of production.  In Denmark, levels increased to 80.30% in the 1st quarter of 2015.

Utilization levels have an upper bound of 100%, but never get there.  Levels at 82-85% are seen as “TIGHT”, and typically forecast rises in prices or shortage of supply in the near term.  Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.  So we are tight at these levels.  Very tight!

We can also look at Industrial Production, which increased 4.75% in December of 2014.  Clear cycles are evident in this chart, in fact, the numbers seem to drastically change each quarter, and I would think that would continue.

Now, lets pull it all together.

Conclusion:

So the recent growth numbers were ok, but not great, government debt to gdp is at a good level, consumer credit is at a healthy level, and consumer and government spending are strong.  The euro is falling (Remember, the Danish Kroner virtually pegged to the Euro through the ERM-II) I think that Denmark is in the the “Mid-Cycle” - this lasts an average of 2-3 quarters:

economic growth slows substantially ( to around 2%)

inflation remains low

growth in consumption slows

rate of inventory accumulations declines

interest rates dip

the stock market rate of increase tapers off

the rate of decline in inflation-hedge assets slows.

Today we are going to take a trip to Namibia.  Let’s take a look at their Economic Machine, and see if there are any opportunities in this beautiful country.  

As we always do, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something and someone buying something.  That is it.

As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:

(1) Productivity Growth

(2) The Long Term Debt Cycle

(3) The Short Term Debt Cycle.

Let’s get started!

     1. Productivity

Namibia’s economy is relatively small, with services accounting for 60% of GDP, and vast mineral resources available.  To begin our analysis we first look at Namibia’s current Annual GDP Growth Rate, which expanded at 2.30% in the 3rd quarter of 2014.

On average GDP growth rate has been around 4.80% in the last 20 years.  The chart above shows a cyclical nature to GDP growth in this country, and I would look for levels to go higher from these levels as we appear to be a valley here.

Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit.  So, to really understand where productivity is going you have to examine the debt cycles.

Recessions/depressions don’t occur because a drop in Productivity, as many economists think.  They occur because a drop in demand, and that is largely due to a drop in credit creation.  

Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt.  The debt-service payments grow faster than incomes, and you have defaults.  That is how we get cycles.

Lets look at the Long Term Debt cycle to clear up the picture a bit.

     2. The Long Term Debt Cycle

Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.

We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels.  And one person’s spending is another person’s income.  So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.

The above events are what cause the long term debt cycle.

This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy.  But this cannot go on forever.  Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt.  That is when the entire thing comes crashing down, and everything works in reverse.

Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.

To begin, the below chart shows the Government Debt to GDP in Namibia at 23.90% of GDP, which is very low, and means that the government shouldn’t have any problems paying future bills, or could even expand spending to drive up economic growth in the future.  All very positive.   

Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens when they become too high (i.e., debt and debt service relative to incomes).

Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.  

A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,

a large number of debtors have obligations to deliver more money than they have to meet their obligations, and

monetary policy is ineffective in reducing debt service costs and stimulating credit growth.

Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.

Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity. One could consider Interest Rates in Namibia, which were last recorded at 6%, which is somewhat high, and has plenty of room to go lower. 

With rates at this level, central bankers have room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.  Within the last 20 years, central bankers have dropped rates dramatically to spur lending and economic growth and I don’t expect that trend to reverse in the foreseeable future.  

Lets switch to Money Supply (M1)  in Namibia, which has been steadily rising for the last 20 years.

With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Namibia is at 4.67%, which is somewhat high, but not terribly out of control, but it could suggest that there is some price pressure at the moment, which can hamper an economy of course.  At these levels I wouldn’t be too concerned at the moment.

Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy.  If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.  

As seen above, Government spending in Namibia had been steadily increasing for 20 years, and I don’t see anything to suggest this will reverse any time soon.

Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.

With Debt to GDP low, interest rates respectively low, and inflation low, things are looking ok in Namibia.

Let’s look at the Short Term Debt Cycle to better understand this economy.

     3. The Short Term Debt Cycle

Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.   

Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation.  If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.

So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.  

Below is a chart showing Consumer Spending, which has been steadily rising for the last decade.  We might be coming to a peak at current levels, and I would watch these figures closely for any sign of a downturn, because it may be coming soon.

As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.  

However, I could not find any reliable data on Industrial Production in Namibia.  So, here I will just have to take an educated guess, and from the above data I believe spending is probably growing faster than production, which is worrisome.

Lets pull it all together.

Conclusion:

So the recent growth numbers were good, but not great.  However, government debt is well under control, and I think we could see an increase in government spending in 2015, and continued growth in consumer spending.  I think Namibia is actually in a healthy position at these levels, and could see a further economic expansion in 2015.

When I look at everything above, I think that Namibia is in the “Mid-Cycle”, which lasts an average of 2-3 quarters, and is exemplified by:

economic growth slows substantially ( to around 2%)

inflation remains low

growth in consumption slows

rate of inventory accumulations declines

interest rates dip

the stock market rate of increase tapers off

the rate of decline in inflation-hedge assets slows.