#economic_machine

Today we are going to take a trip to Japan, because I am curious as to where the country stands at the moment.

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!

Productivity

Japan is the 3rd largest economy in the world, that has been struggling through a rough go lately.   To begin our analysis we first look at Japan’s current GDP Growth Rate, which contracted by 0.30% in the 2nd quarter of 2015. 

One of my pinnacle beliefs I’ve learned from studying markets is that movements in GDP growth are typically due to expansions or contractions in credit.  People use credit to buy stuff they can’t afford.  This increases spending, bolsters company profits, pushes up stock prices, and everyone is happy.  But debt service payments become too burdensome, people can’t afford to services their debts, the cycle reaches a peak and comes crashing down.  That is how we get cycles.

Thus, 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 traditional economy theory teaches.  I believe that they occur because of a drop in demand, and that is largely due to a drop in credit creation.  

Let’s look at the Long Term Debt cycle to clear up the picture a bit.

The Long Term Debt Cycle

In previous posts I’ve gone into detail about the Long Term debt cycles, but here I’m going to try to just state some important notes.

It typically occur over a period of 50-75 years.

Results from debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts.

Allows people/countries to essentially spend more than they make.

One person’s spending is another person’s income. 

So, an increase in credit, increases spending, which increases income levels, which increases spending more, 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 Japan. Japan recorded a Government Debt to GDP of 230% of the country's Gross Domestic Product in 2014 (most recent available data).  This, of course, is very high.

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.

Now, lets talk about something very important, and that is deleveragings, which are 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 improved by central banks lowering the cost of money. In depressions,

Many people/countries owe more money than they have, so they can’t pay back their debts, and

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

Typically, monetary policy is ineffective in stimulating credit growth because interest rates are near 0% and can’t be lowered (this produces deflationary deleveragings), or because money growth is used as a hedge against inflation and doesn’t help expand credit growth, in which case you get an inflationary deleveraging.

Central Banks typically print money to end depressions to help ease the pain felt by the reduction in credit, and austerity (if that trap was sprung).

Now, one could consider Interest Rates in Japan, which, as everyone knows, is at 0%.  And has hovered around that number for the last 15 years.

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.  

Let’s switch to Money Supply (M0) in Japan, which has been steadily rising since the 60s, but saw a dramatic increase since 2008. 

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 here is, of course, inflation.

The inflation rate in Japan was recorded at 0.20% in July of 2015.

As well, I like to look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10-year in Japan has increased to 0.33 % on Thursday.

The yield on government debt indicates expectations on inflation and debt repayment.  Inflation kills bond portfolios.  Here’s how….as inflation rises so do interest rates, by and large.  And as interest rates rise, bond prices falls (remember, they move in opposite directions!).  Add to that the principal you get back in say 10 years is worth less if inflation has risen 2% in those 10 years.

There has been a recent up tick in the yield on the 10 year, and I think what we are seeing here, overall, is that the market is exiting out of the 10-year, and might anticipate inflation rising.

Now, very important point here!!!  -  debt problems typically occur because financial assets are bought at high prices with credit.  Let’s look at Japan Stock market to get a general picture of where financial assets are currently.

Obviously, we had a significant pull back in August.  This chart clearly shows that the stock market in Japan has seen some cycles in the last couple of decades, and seems to have reached a recent peak and is on the way down.   This is a bit worrisome as assets might be over-valued at these levels, and this might not be the best time to enter the market.

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 it’s 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 Japan has been increasing since the 80s.  

IMPORTANT NOTE: 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.

Long Term Debt Cycle Summary:  With an expansion in GDP growth, interest rates at 0%, a large money supply with inflation practically non-existent, the main worries right now are the arguably over-valued Stock Market and a high government Debt to GDP.

My next level of thinking though says that we might be climbing up to a another peak, and part of me wonders if this next peak will be the peak of the Long Term Debt Cycle.  We have a scary condition here with 0% interest rates where monetary policy couldn’t spur credit growth if that is what we needed.  I would really need to see some specific data on debt service payments, and I haven’t been able to find a could source for that.

At this time, I think Japan is in OK shape (especially when compared to much of the rest of the world).  But I worry about the next 3-5 years.

Examining the Short Term Debt Cycle will hopefully give us some more insight.  Let’s see!

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 tamp down 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 on a steady climb since the 1980s, but may have reached a peak recently.

Consumer Credit seems to have reached a trough recently, and is on the way up it appears.  This is great for economic growth.

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.  

Let’s take a look at Capacity Utilization to get a picture of production.  In Japan, levels increased to 96.6% in the August.

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 slowed to 0% in July of 2015, a worrisome sign.

Conclusion:

Even considering all the worrisome news you hear about Japan, and the lost decade they have suffered through, I think we will start to see Japan regain its footing and pull itself out of the recent slump.

Economic growth contracted by 0.3% in the 2nd quarter.

Government debt is high at around 230%, which is worrisome, and needs to come down.

Interest rates are at 0%, and have been there for years, probably moving up soon, but its anyone’s guess as to when.

Money supply has been steadily growing since the 80s.

Inflation is really low

The 10-yr is at 0.33%, at the same time we have seen a RISE in the stock market.  

Consumer spending is on the RISE.

Consumer credit looks to be on the rise.

Capacity Utilization is at 96.6%, establishing that there is TIGHT levels right now.

And Industrial Production slowed to 0%, which is worrisome.  

Bottom line:  Japan has problems, but what country doesn’t?  The government is trying everything in their power to remedy the situation.  As such, I believe we are are likely nearing the end of the Recession, and will soon enter the Early Stage of the Short Term Business Cycle.  

Today we are headed to Mauritius, a small country in Africa, 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!

Productivity

Mauritius is one of the most successful countries in Africa, with one of the highest GDPs.  Much of this success is due to a trade led economy that exports textiles, sugar and tourism.  To begin our analysis we first look at Mauritius’s current GDP Growth Rate, which expanded at 0.20% in the 3rd quarter of 2014.

On average GDP growth rate has been around 0.93% since 2000, with a high around 6% and a low of -1.7%.  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.

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.

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 Mauritius at 58% 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 Mauritius, which are set by the ECB and are currently at 4.65%, which is as high.

With rates at this level, central bankers have plenty of room to lower rates if needed to increase growth in debt, which ultimately spurs growth in the overall economy.

With rates falling for the last decade and a half, you would expect an increase in credit and thus spending, increased incomes, increased demand, and fast economic growth.  All of which we have seen in Mauritius.  The only worry of this increase in spending and demand is of course inflation.

Currently, the inflation rate in Mauritius is at 2%, which is a very healthy level.  So I do not have any price pressure concerns here.

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

This chart clearly shows that the stock market in Mauritius is at or near a 20 year peak.  This is 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 Mauritius had been steadily increasing for 20 years, helping to prop up 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 reasonable levels, interest rates high, but falling, inflation at a healthy level, stock prices are high and the government continuing to spend, I think this economy seems to be humming along still.  But, it is definitely going to reach the top of the mountain at some point, and there will be a crash.  Just keep that in mind.

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

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 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 cyclical and steadily increasing for a decade now..  I wonder if this is a peak?

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 Industrial Production, which increased 2.60% in 3rd quarter of 2014, which is good.  Not great.  But good. 

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, inflation is low, and consumer and government spending are good, so I think that Mauritius 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 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, Angela Merkel is visiting the White House to scarf some strudel and pound down some good ol’ German lager with President Obama, and Germany just posted a record surplus, so I thought it only fitting to take a deeper look at the Economic Machine of Germany.

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

Germany is the largest economy in Euro Area, and the 4th largest in the world.  Its economy is an exports based one, and with a falling euro German products are going to get more competitive throughout the world.  To begin our analysis we first look at Germany’s current GDP Growth Rate, which expanded at 0.25% in the 4th quarter of 2014.

On average GDP growth rate has been around 0.29% since 1991, with a high around 2% and a low of -3.4%.  The chart above shows the relatively tame nature of German GDP growth.  Whenever it falls it always rebounds, and with the falling euro, and a trade surplus I would expect it to do just that in the coming quarters.

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 Germany at 76.90% of GDP, which is a high level, and somewhat worrisome.  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 a bit of a plateau, and I wonder if levels will fall or trend back up.  I would watch these numbers closely.

ow, 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 Germany, 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 (M1)  in Germany, which has been steadily rising for the last 4 decades or so.

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 Germany is at -0.30%, which is defaltion, 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 0.37% in February from 0.27% in January of 2015.  Although, the overall trend has been a flight to safety and a crashing of yields in Germany.

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 been falling.  

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

This chart clearly shows that the stock market in Germany is cyclical, and that we might be a 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.  

The only thing preventing that turn from happening in the next year is QE in Europe and the falling Euro.  Both will propel Germany forward in 2015.  But beyond that I just can’t say.  Lets dig deeper.

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 Germany had been steadily increasing for 25 years, and I don’t see anything to suggest this will reverse any time soon.

As well, take a look at Government Spending to GDP, and you can see that we are in a bit of a valley here.  I think Government spending could pick up nicely in 2015, and that means economic expansion.

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 Germany.  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 Germany, but with QE right around the corner I think it would be wise to look for inexpensive opportunities in Europe.  Germany 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 been steadily rising for the last 10 years.  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.

Consumer Credit is in a bottom in the short term cycle at these levels, and I would look for it to increase in 2015, pushing the economy along nicely.

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 Germany, levels increased to 84.60% 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 0.40% in December of 2014.  Clear cycles are evident in this chart, and I think we could see a spike in production in 2015 as we come out of this bottom.

Now, lets pull it all together.

Conclusion:

So the recent growth numbers were healthy, 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 and German exports are surging….as hard as it is to believe, when I look at everything above, I think that Germany is in the The Early-Cycle”  -  this typically lasts for 5-6 quarters

typically begins with the demand for interest rate sensitive items (e.g. housing and cars) and retails sales picking up because of low interest rates and lots of available credit.

it is also supported by prior inventory liquidations stopping and inventory rebuilding starting.  

this increased demand and rising production pulls workweek and employment up.

credit growth is strong

economic growth is strong ( in excess of 4%)

inflation is low

growth in consumption is strong

the rate of inventory accumulation is increasing

The stock market is likely the best investment

And inflation-hedge assets (e.g. gold, oil, natural gas) and commodities are the worst-performing assets.

Germany is at the end of this phase in the cycle, in my opinion, and will slow transition to the mid-cycle phase probably in 2015.

Today we are going to take a trip to one of the poorest and least developed countries in Asia, Pakistan.  Let’s take a look at their Economic Machine, and see if there are any opportunities in this beautiful but troubled 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

Pakistan has seen around 5% GDP growth for the last decade, however it is mired in political instability, weak law enforcement and corruption that has limited foreign investment. .To begin our analysis we first look at Pakistan’s current Annual GDP Growth Rate, which expanded at 4.14% in the 2013/2014 year.

On average GDP growth rate has been around 4.92% since 1952.  The chart above shows a highly cyclical nature to GDP growth in this country, and I would look for GDP to go higher from these levels.

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 Pakistan at 63.30% of GDP, which is a somewhat high level, but not really that worrisome.  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 coming out of a bottom, so we could see debt levels rise here in the next couple of years.  Pakistan’s government has room to increase debt levels to spur economic growth, so for the time being I don’t see this as a major concern, just something to keep an eye on.

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 Pakistan, which are currently at 8.50%, which is 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.  Rates appear to be heading south in Pakistan, and that is good for increased lending and increased economic growth.  Look for a bottom around 7.5% at which point rates will begin to increase.

Lets switch to Money Supply (M0)  in Pakistan, which has been steadily rising for the last 7 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 Pakistan is at 3.88%, which is a health rate in my opinion, so prices are rising largely due to demand, which means production should rise as well, and economic growth should follow.

Keep in mind the drop in oil prices, and Pakistan is a net oil importer, so that should be good news for the consumer.  I just think it is taking some time for the extra money they consumer may now have as a result of lower oil to make its way back into the economy.  

As well, one can look at the Sovereign Bond yields to get an expectation of inflation in a market.  The 10Y increased to 9.85% in February from 9.75% in January of 2015.  While the 10Y increased recently, it has seen a crash of sorts for the last year.

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 prices have been falling.  

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

This chart clearly shows that the stock market in Pakistan is hyper inflated, and is currently at a 25 year high.  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.

Perhaps Fixed Income is the way to go here, as the stock market is clearly very expensive, and when those levels turn, investors will see a flight to safety, which means bond purchases, and rates are going to crash.  So I think bond purchases at these levels might be a good idea.

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 Pakistan had been steadily increasing for 50 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 high but falling, inflation at a good level, and a very expensive stock market, and government spending at a high, there are some problems I see in Pakistan.

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 15 years.  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.  

To examine production capacity we look at Industrial Production, which increased 4.44% in November of 2014 (the most recent data available).  Clear cycles are evident in this chart, and I think this spike in production should hold for a couple of quarters.  The reverse will come in the next couple of quarters, and get back closer to the average of around 2.75%.

Thus, at current levels, spending might not be growing faster than the capacity to produce, so I don’t think inflation is a major concern in the foreseeable future.

Lets pull it all together.

Conclusion:

So the recent growth numbers were healthy, government debt to gdp is at a good level, consumer credit is rising and so is consumer and government spending, and the stock market is at or near an all time high.   

When I look at everything above, I think that Pakistan is in the “Late-Cycle” - typically begins about 2.5 years into expansion, depending on how much slack existed in the economy at the last recession’s trough)

economic growth picks up to a moderate pace (around 3.5-4%)

capacity constraints emerge

but credit and demand growth are still strong

Inflation begins to trend higher

Growth in consumption rises

inventories typically pick up

interest rates rise

the stock market stages its last advance

inflation-hedge assets (3-month TBill; Oil; Gold) become the best-performing investments

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.

Today we are going to take a trip to the lovely Morocco.  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

Morocco is the 5th largest economy in Africa, and the 3rd largest producer of phosphorous, with 50% of GDP coming from the Services sector, and much of its growth coming from tourism and textiles.  To begin our analysis we first look at Morocco’s current Annual GDP Growth Rate, which expanded at 2.70% in the 3rd quarter of 2014.

On average GDP growth rate has been around 4.47% in the last 15 years.  The chart above shows a highly cyclical nature to GDP growth in this country, and I would look for levels to go higher from these levels.

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 Morocco at 61.70% of GDP, which is a somewhat high level, and a bit worrisome.  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 coming out of a bottom, and that worries me as well.  Morocco’s government could run increase debt levels to spur economic growth, so for the time being I don’t see this as a major concern, just something to keep an eye on.

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 Morocco, which are currently at 2.50%, which is low, but still has some 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 Morocco, which has been steadily rising for the last 30 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 Morocco is at 0.40%, which is very low, so there does not appear to be any price pressure at the moment, and I would expect the money supply to continue to grow.

Keep in mind the drop in oil prices, and Morocco is a net oil importer, so that should be good news for the consumer.  I just think it is taking some time for the extra money they consumer may now have as a result of lower oil to make its way back into the economy.  

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

This chart clearly shows that the stock market in Morocco is pulling itself out of a bottom, and looks posed to continue to grow well into 2015.   

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 Morocco had been steadily increasing for 50 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 high, interest rates low, and inflation low, there are some problems in Morocco.  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 Morocco, but with QE right around the corner I think it would be wise to look for inexpensive opportunities in Europe.  Morocco 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 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.  

To examine production capacity we look at Industrial Production, which increased 1.30% in 2nd quarter of 2014 (the most recent data available).  Clear cycles are evident in this chart, and I think this drop in production is only temporary, and these levels will reverse in the next couple of quarters, and get back closer to the average of around 3%.

Thus, at current levels, spending is obviously growing faster than the capacity to produce, so I think inflation could be a concern in the foreseeable future, which is worrisome.

Lets pull it all together.

Conclusion:

So the recent growth numbers were not great, but I think that with the drop in oil prices we are going to see a great improvement to consumer’s in Morocco.  As well, I think Industrial Production will rebound in 2015, and with government debt well under control, I think we could see an increase in government spending in 2015, and continued growth in consumer spending.  I think Morocco is actually in a very healthy position at these levels, and could see a very fruitful 2015.

When I look at everything above, I think that Morocco 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.