Going past what is sustainable… Another market failure
There are quite a few shifts happening in the global and domestic economy. I have been observing for the past week. So many people are getting confused. Here is a list of concerns…
- China is slowing down.
- Some emerging markets are facing capital outflows and are tempted to raise their central bank interest rates. Argentina is all over the news now, but we saw in early December here on Angry Bear that there was trouble brewing.
- Inflation exists in emerging markets leading to more temptation to raise CB interest rates.
- US stocks have sent a psychological message that their is serious concern for further advancement in the economy. I say serious because the “correction” of last week was more than a correction. Barry Ritholtz called it a 90/90 day, when more than 90% of the volume and 90% of the stocks are down.
- There are calls for more easing by the Fed. Case in point is this article by David Llewellyn-Smith called Will China stop Taper? There is concern that the economic momentum of the last couple quarters will not continue.
- On the other hand, there is pressure building in the US to raise the Fed rate as signs of economic growth appear. But inflation remains muted as rumors spread of its rise.
This is a character defining moment in capitalism, when the majority are not aware that the end of a business cycle is forming. There is asymmetric information, if you will. A few understand it. The majority do not. So what should be a time of seeking a sustainable level of output to establish a stable base for future growth to benefit society, will turn out to be an increasingly unstable game of seeking non-existent profits and protecting self-interests.
Some may simply point to inefficient investments in China as bringing down the economy. Yet China is up against our own effective demand limit, because they rely heavily on our consumption. They saw the writing on the wall. They saw persistently limited demand in the US. They knew they had to start raising wages there. and they have been doing that. But it won’t be enough to keep their over-production from slowing down. Their household consumption as a percentage of GDP is still decreasing.
The low Fed interest rate has been an illusion tempting people to take advantage of all the spare capacity out there. Yet, the spare capacity itself is constrained considering weak effective demand. So people are led like cattle beyond what should be sustainable. The Fed’s forward guidance is producing false delusions of what the economy is capable of in a sustainable way.
Economists seem to live in a world believing that their ideas are complete. Although some have recently mentioned that a revolution in economic thought must happen. It is true. This time IS different. An unnoticed factor in the past is making an appearance… Effective Demand. A poorly understood concept from Keynes. Effective demand is well below full employment for the first time in a long time. The result is that we blindly keep walking past a sustainable state that has higher marginal social benefits than where we are headed.
Effective demand is understood, what is being learned is our effective demand relative to other effective demand in the globe. So relative trade terms need to be established to equilibrium, this takes time.
So we look for signs of who still has spare capacity and demand. China is running out of that real fast. The US has very little left. Many emerging countries are banking on export markets with China and the US. Not much effective demand in these two countries left.
Japan is kind of off the map with no vibrant effective demand. Wages are still stagnant there.
What about Europe? Are they growing enough? If you look at the UK, productivity has been stalled for quite a while, which is a sign of being against the effective demand limit too.
Germany is holding its own, but depends on exports. So Germany does not depend on its own effective demand, but on that of other countries.
The equilibrium being established will be against the effective demand limit. We are reaching that point. So there is a limit to the time to establish that equilibrium. The limit will determine the equilibrium.
China was not able to slow down gracefully into a stronger domestic demand. The US looks like it still wants to weaken domestic demand, because the word is that companies are still aggressively cutting costs. That includes wage gains.
I see that we are reaching the limit and it is unwise to push too hard to go past it.
“Effective demand is well below full employment”
Could you clarify that, very very briefly? Thx.
Real GDP will hit effective demand before the economy returns to an unemployment under 6% like most expect. And likewise, capacity utilization will not rise back to normal levels.
When it is the question of China, the analysis should not be done on the premise of conventional Classical frameworks and assumptions, as the country is not entirely capitalist (though they are using the market forces for their own benefit).
To start with, the analysis on China should be done on the Reproduction Schema. You will find that after swearing in of Xi Jingping, the economy has changed its trajectory from a export led investment model to a more consumption-led growth model. Yes, they are giving more emphasis on increasing domestic demand, keeping the coming days in mind when growth rate across the world will not be enough for the country to sustain its own.
I think they are surely changing their advancement model to a consumption led one, but the progress will be slow and there are no chances of default or anything like that. In fact, the growth rate of the country will also remain moderate, hovering around 7%. So, from now on the world will look at a balanced growth of the economy.
I don’t think there is anything to worry about China right now.
Your points are well taken. There is no “present” concern about China, but as the years go by, the imbalances in their economy will become more and more apparent.
Effective Demand Limit is about whether US consumers are reaching the limit of their capacity to spend and consume.
See Page 2 of this:
The Durable Good Orders for December were down by 4.3% month over month when Morningstar expected them to be up 1.5%.
Computers and Electronic products orders for 2013 were down 2.8% year over year. And this was 5 years after the beginning of the recession.
Electrical equipment, appliances, and components orders were up .7% year over year.
Motor vehicles and parts orders were up 10.2% year over year but back in August it was reported that the average age of US automobiles was 11.4 years which was a record. So this increase is not much of an indicator of consumer confidence. (Up 10.2% from previous dismal sales stats?)
Notice in this chart that the increase in years is .1 until 2010 after which it goes up by .3, .3, .2, and .1. This looks like that in 2012 and 2013, consumers started to replace a few more vehicles, probably the oldest or the increase in the average age would have gone up more. (Legitimate pent up demand!) Also this chart confirms that consumers have been under pressure for a long time or the age of the fleet would not have been consistently increasing. (What changed their behavior.)
AVERAGE AGE OF PASSENGER CARS AND LIGHT TRUCKS
Year Passenger Cars Light Trucks Total Light Vehicles
2002 9.8 9.4 9.6
2003 9.9 9.5 9.7
2004 10.0 9.5 9.8
2005 10.1 9.5 9.8
2006 10.2 9.5 9.9
2007 10.3 9.6 10.0
2008 10.4 9.8 10.1
2009 10.5 10.1 10.3
2010 10.8 10.5 10.6
2011 11.1 10.8 10.9
2012 11.3 11.1 11.2
2013 11.4 11.3 11.4
Source: Polk. Figures are based on a snapshot of vehicle registrations taken Jan. 1 each year.
I would expect that as consumers replace old automobiles, they will buy fewer other durable goods.
This is about the US economy. We are THE net importer. If our economy slows then the countries exporting to us will have additional problems. Their effect on the US consumer is minimal, if they raise prices at this point, the US consumer will just buy fewer imported items. If they buy less from us it will just make us less able to import.
Nothing to contradict your work on effective demand here.
Good work… We don’t have 4th quarter real GDP, but you are showing early indications of underlying weakness going into 2014.
I just realized that I skipped a step.
“Effective Demand Limit is about whether US consumers are reaching the limit of their capacity to spend and consume. ”
Should be replaced with:
“Your Effective Demand Limit formula includes Labor Share as a direct input. As Labor Share goes up so does the Effective Demand Limit and as it goes down so does the Effective Demand Limit. And as Labor Share goes up, laborers/consumers have more money to spend and vice versa. So I tend to think of the Effective Demand Limit as about whether US consumers are reaching the limit of their capacity to spend and consume.”
That is what I meant and didn’t write.
There’s massive excess capacity, even with some destruction of capacity in this deep depression, which began in June 2009 (e.g. $5 trillion of additional federal debt, workers who’ve been unemployed and underemployed too long, early forced retirements, more going on disability, extended unemployment benefits, etc.).
Once jobs are available, many people, who dropped out of the workforce, or stopped looking for work, will come back in. So, the unemployment rate will likely rise with faster job creation. Over 12 million jobs are needed to reach full employment. Non-financial corporations are hoarding $2 trillion in cash or cash equivalents, earning enough interest for capital preservation, while banks are hoarding over $2 trillion of excess reserves.
We not only have massive excess capacity (e.g. labor and capital), we also have weak demand, which will likely remain weak, because this year we began substantial contractionary fiscal policy, and also the “middle class” will pay more for health care and spend less on everything else. We need economic policies that will turn people receiving government benefits into taxpayers.
Actually, over 20 million full-time jobs are needed, which include part-time workers who want full-time jobs, the unemployed, and those who stopped looking for work.