GLOBAL ECONOMICS AND POLITICS

Leo Haviland provides clients with original, provocative, cutting-edge fundamental supply/demand and technical research on major financial marketplaces and trends. He also offers independent consulting and risk management advice.

Haviland’s expertise is macro. He focuses on the intertwining of equity, debt, currency, and commodity arenas, including the political players, regulatory approaches, social factors, and rhetoric that affect them. In a changing and dynamic global economy, Haviland’s mission remains constant – to give timely, value-added marketplace insights and foresights.

Leo Haviland has three decades of experience in the Wall Street trading environment. He has worked for Goldman Sachs, Sempra Energy Trading, and other institutions. In his research and sales career in stock, interest rate, foreign exchange, and commodity battlefields, he has dealt with numerous and diverse financial institutions and individuals. Haviland is a graduate of the University of Chicago (Phi Beta Kappa) and the Cornell Law School.

 

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FINANCIAL FOREST FIRES: US GOVERNMENT DEBT (c) Leo Haviland August 15, 2012

The United States Federal Reserve Board and its central banking allies have furiously battled the fierce financial forest fires of the ongoing worldwide economic crisis that emerged five years ago. As the disaster developed and traveled across the financial landscape, their accommodative approaches evolved. Although central bank methods have varied to some extent, they generally have included deluges of money printing and pinning nominal policy rates (Federal Funds and so forth) close to the ground. These central bank actions not only helped to spark and sustain economic recovery, but also bought politicians time to solve, or at least substantially mitigate, troubling fiscal deficit problems.

Nevertheless, debt levels and deficit spending in America and many other countries generally remain substantial. Efforts targeted to assist recovery partly explain the size of gaping fiscal deficits of recent years. Yet in America and many other nations, they arguably reflect and are structurally sustained by a culture of entitlement. This culture, although not universally shared, extends across the economic spectrum. In any event, government budget deficits in the United States are not a new phenomenon.

However, even without specifically concentrating on its long term fiscal challenges, the US probably is much closer these days to a big debt problem than many believe. Focusing on the near term US government deficit and debt situation in the context of several other nations highlights the danger.

Everyone knows of the Eurozone (Euro Area) crisis. America’s fiscal balances are much more in deficit over the 2008-2017 span than the overall Euro Area’s.

However, from the general government gross debt viewpoint, and especially with a view on 2012 and thereafter, the US problem looks at least as fearsome as the overall Eurozone difficulty. First, the US level exceeds the European height every year, from 2008 out to 2017. Second, the IMF indicates a fall for the Euro Area after 2013, but not for the US.

Inflation is not the only potential source of higher interest rates. The lesson of the Eurozone sovereign debt crisis shows that government interest rates can climb sharply in crisis nations (Greece, Portugal, Ireland, Spain, Italy) even if inflation is moderate. Ability to pay debts (and borrow money), not just inflation levels and trends, matters for interest rate levels (and sovereign credit spread differentials). A badly stretched debtor may have to pay up to find money, right? So rising government interest rates in some cases may reflect a dreadful debt crisis, not a sunny economic recovery.

Closely nearing or reaching a point of no return on the US fiscal front therefore probably would be reflected by a spike in UST yields. The 10 year US Treasury note offers a benchmark for US yield watchers. In recent years, rising government interest rates often have been roughly tied to ascending US stocks (S+P 500), not just an economic recovery. If US equity benchmarks such as the S+P 500 start to decline significantly, and roughly “alongside” the increase in yields (thereby breaking from the guideline UST/stock relationship of recent times), that probably would confirm the existence of a debt crisis.

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Financial Forest Fires- US Government Debt (8-15-12)
US Treasury 10 Year Note Chart (8-15-12)

AMERICAN CORPORATE PROFITS AND THE S+P 500 (c) Leo Haviland August 1, 2012

In recent decades, the overall United States debt outstanding relative to nominal GDP has substantially increased. America’s national willingness to accumulate debt (borrow and spend) generally has played an important role in the generation of its economic growth. It of course is not the sole factor. This national debt increase thereby has tended to boost (be a bullish factor for) equity prices, at least up to now. A significant cut in America’s debt burden (deleveraging) probably will promote a decline in the nominal after-tax profit to GDP ratio from current elevated levels. This reduction also may encourage a slowing of after-tax profit rises, or even encourage an actual decline in profitability levels. These processes in turn probably would be bearish for US equities. Debt levels and trends are not the only factor influencing US GDP, corporate profits, and stock levels and patterns. Will American corporate profits forever keep rising? History is not destiny, but they often have declined.

Besides, growing debt does not inevitably guarantee economic health, corporate profitability, or soaring stocks, whether in America or anywhere else. Sustained Federal Reserve monetary easing buys time and sells hope, but it does not solve the US national debt problem. History reveals that at some point more and more national debt can generate grave problems. America probably is at or very near the danger level from its current and near-term debt situation, not just over the so- called long run horizon.

Let’s place American after-tax profits in the context of economic output. The average United States yearly ATP level relative to nominal GDP from 1946 to 2011 is about 6.2 percent. However, during the marvelous Goldilocks economy, and even up to the present despite the ongoing worldwide economic crisis, this indicator has been remarkably strong. Recall lows of

3.1pc in 1986 and just under 5.0pc in 2001. Before the 2004 to the present period, the last high over eight percent was 1950’s 8.6pc. From 1951 through 2004, it exceeded seven pc only three times (1978, 1979 and 2004). Over 2004-2011’s span, the average jumped to 9.0 percent.

The ratio in 2004 was 7.8pc, rising to 9.7pc in 2005 and 10.1pc in 2006. Calendar 2006 thus established a new pinnacle (going all the way back to 1929 not just 1946). In the year the global financial crisis emerged, 2007, it remained high, at 9.2pc. Even in 2008’s savage US and worldwide downturn, accompanied by the plummeting S+P 500, ATP relative to GDP were almost 7.4pc. The S+P 500 reached a major low on 3/6/09 at 667. In 2009, that ATP/GDP relationship was 8.4pc. What about the fairly sunny recovery years thereafter? The ATP total for 2010 bordered ten pc of nominal GDP, with 2011 elevated at 9.8pc.

What was the ratio of ATP for first quarter 2012 relative to GDP? Nominal 1Q12 GDP was about $15.48 trillion (annualized). Corporate profits were about $1.67 trillion (annualized). This is about 10.8pc of 1Q12 nominal GDP, thus marching beyond 2006’s joyous Goldilocks Era height to establish a new record height for that measure.

Though 2Q12’s earning reporting season has not ended, news reports suggest the nominal ATP level is approximately in line with 1Q12’s, and maybe even a couple of percentage points higher. US 2Q12 nominal GDP inched up to about $15.60 trillion from 1Q12’s $15.48tr. Thus the nominal ATP/GDP ratio probably remains around record levels.

Alongside these lofty 2012 profit levels, the S+P 500 attained new highs relative to its 2009 abyss (4/2/12 at 1422, 5/1/12 at 1415). These spring 2012 levels neighbor the S+P 500’s final summit at 1440 on 5/19/08, though they remain quite a bit beneath the major high on 10/11/07 at 1576.

An army of intertwined variables interrelate to propel the S+P 500 up, down, or sideways. However, suppose ATP slide lower relative to first half 2012 heights and that the ATP to GDP relationship retreats to fairly near the long run 6.2 percent average. All else equal, this probably will be a bearish factor for the S+P 500.

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American Corporate Profits and the S+P 500 (8-1-12)

MARKETPLACE CLIFFS © Leo Haviland June 25, 2012

Ongoing and mounting concern regarding European problems, especially within the sovereign debt and banking sector, has distracted many marketplace observers from concentrating closely on similar major American issues. The global economic crisis is a long way from being surmounted. Fiscal, banking, debt, and leverage challenges in Europe and the United States (and elsewhere) remain substantial. For the near term, the international crisis probably will worsen. Many perceive the S+P 500 as a rough benchmark measure for overall economic strength. The S+P 500 will head downhill, perhaps precipitously at times. It probably will decisively break beneath its early June 2012 low at 1267.

The International Monetary Fund’s “Fiscal Monitor” (“FM”, April 2012) provides helpful numbers. Analysts can debate which tables illuminate the situation best. Events since April 2012 would adjust the data somewhat.

The FM “general government” tables include state and local government debt with that of the national governments. Look at Table 1, General Government Balance. The United States was -9.6pc (a deficit) of GDP in 2011. The FM predicts -8.1pc in 2012 and -6.3pc in 2013. The overall Euro area deficit is actually lower for these years than the American one; it was -4.1pc in 2011, with -3.2pc for 2012, and -2.7pc in 2013. The US deficit falls only to -4.4pc in 2017, notably above the Euro area’s -1.1pc that year. What about some specific Euro area nations about which many tremble? In 2012, Italy’s general government balance is -2.4 percent, well under that of America’s. Portugal’s 2012 hole was -4.5pc. Spain’s 2012 balance, -6.0pc, also is beneath America’s (though an update to the FM probably would raise Spain’s deficit, placing it closer to the US 2012 range).

Review Table 7, General Government Gross Debt. The US gross debt was 102.9pc of GDP in 2011 (soaring from 66.6pc in 2006). The IMF predicts it will be 106.6pc in 2012 and 110.2pc in 2013. It stays at a plateau with 2017’s 113.0. Thus there is no progress in reducing it. Moreover, the US gross debt percentage exceeds that of the Euro area. Euro area gross debt was 88.1pc of GDP in 2011. The FM predicts 90.0pc in 2012, 91.0pc in 2013, and 86.9pc in 2017. Thus the US fiscal situation is worse than that of the Euro area as whole from this viewpoint as well.

In addition, note the US’s 2012 out to 2017 gross debt levels in comparison with those of Euro area crisis/bailout nations other than Greece. Admittedly Greece’s gigantic 153.2pc is larger, and its problems interrelate with those of the Eurozone as a whole. In 2012, Italy’s debt is 123.4pc of GDP, Spain’s 79.0pc. That of Ireland is 113.1pc, Portugal’s 112.4 pc. The average for 2012 of Italy, Spain, Ireland, and Portugal is 107.0pc. However, this is almost exactly that of the US’s 2012 debt of 106.6pc.

So this perspective underlines that as the Euro area has a scary fiscal (sovereign debt) problem, so therefore does the US.

Yet travel further and look at US total credit marketplace debt US (nonfinancial, financial, and rest of the world sectors combined), not government debt alone. In 1951, it was about 132.4pc of nominal GDP. It ascended gradually to 168.1pc by 1981. It climbed to 250.8pc in 1995, marching to just under 300 percent in 2002. During the marvelous Goldilocks Era economy, total US credit marketplace debt flew even higher, touching 362.8pc of GDP in 2007. It advanced more as the economic crisis emerged, reaching a pinnacle of 381.6pc in 2009.

So where is this total credit marketplace debt now? At the end of 1Q12, it remained at a very lofty altitude, 353.6pc. Not only does the long run increase in total credit marketplace debt display devotion to (economic reliance on) debt. The only slight slide from the 2009 peak to the 1Q12 level indicates that at some point more debt reduction (deleveraging) for “America as a whole” lies ahead, and thus a significant probability of a weaker economy (and even recession).

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Marketplace Cliffs (6-25-12)