Blogs y opiniones de economia en ingles

Some time ago, I was asked by a reader to write about Central Bank Digital Currencies (CBDC) and the latest thinking around this new form of payment/asset. And while I am on record as being sceptical about Bitcoin and other first-generation cryptocurrencies, I am quite optimistic that CBDC will become a reality and an important and possibly the dominant form of digital currency in the future. There is a lot of research going on in this field with 86% of all central banks surveyed by the BIS last year stating that they are engaged in CBDC work. That is up from 65% three years earlier. And let’s not forget that in 2020, the central bank of the Bahamas became the first one to issue retail CBDC.

However, there are so many things going on in the world of CBDC that it is impossible for me to summarise everything in one post. So, I came up with a series of four posts to explain the four key issues around CBDC. Starting with this one, every Wednesday, I will write about CBDC. In this first part, I will describe what I mean by CBDC and what the reasons are for a central bank to consider creating them. Next week, I will write about the operational challenges of CBDC as a replacement for physical cash and in part three about the risks of CBDC. In the final part, I will focus on the relationship between CBDC and physical cash and monetary policy. If you haven’t planned any vacation this summer, this should be something fun to look forward to.

What are CBDC?

To start with, let’s be clear that when I use the term CBDC I will mostly talk about retail CBDC, that is digital currency issued by a central bank, accepted as legal tender in a country, and widely available in public. There are also wholesale CBDC which are designed for special purposes like trade finance that I will ignore in this series. And then there are synthetic CBDC, i.e. digital currencies backed by central bank assets that could be issued by commercial banks or money market funds, in theory. The problem with synthetic CBDC is that they are unlikely to become legal tender while cash and CBDC are. And if you ask me what it means to be legal tender, I will not go into a lengthy discussion of the legal requirements and simply state that for all practical purposes, legal tender is everything that you can pay your taxes with. It is this status as legal tender and the fact that it is issued by a central bank that differentiates CBDC from other forms of electronic money and makes it a form of cash.

Difference between CBDC and other forms of digital and physical currency

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Source: Kiff et al. (2020)

Why CBDCs?

But if CBDC are just a form of digital cash, why do central banks want to issue that in the first place? There are several reasons why CBDC might be a good idea:

• Financial stability: At the moment, we witness a proliferation of digital currencies. While the supply of any one digital currency like Bitcoin may be limited, there is absolutely no limit to how many digital currencies are created and put into circulation. I once read a story about a guy who wanted to create a cryptocurrency for cosmetic and plastic surgery… You may say that this “democratisation” of finance and money is a good thing, but I can assure you, it is possibly the most dangerous side effect of the current cryptocurrency boom. There is a good reason why central bank currencies were invented in the first place. If you study medieval Europe when every principality issued its own currency, you will quickly learn that trade and economic activity were severely hampered by this plethora of currencies. At every transaction, people had to look up the exchange rate between one currency and another, and the exchange rate varied over time and as a function of distance from the nearest bank who would accept it as a form of payment. Think about a world in which you would have the US Dollar, British Pounds, Euros, Romanian Leus, Mongolian Tögrögs and dozens of other currencies all used at the same time at the same shop. Good luck figuring out how much something costs and if you have been ripped off by the vendor.

  In fact, even with one single currency in place, the cost of paying with cash is much larger than most people are aware of. Studies have shown a cost of using physical cash to private businesses (mostly the retail sector and banks) of 0.2% of GDP in Norway and Australia, 0.5% of GDP in Canada, and 0.6% in Belgium. Creating a plethora of digital currencies competing with each other would increase these costs significantly and increase the risk of currency crashes within an economy and reduced financial stability. Thus, if you can’t avoid the rise of digital currencies, you at least can make sure they are designed and managed in the safest and cheapest way possible.

• Payment efficiency: The significant costs of payments performed with physical cash and other forms of payment may be reduced with digital currencies if they are fast enough to handle the thousands, if not millions of transactions per second that are done in cash every day. First-generation digital currencies are unable to handle these transaction volumes (another reason, why I think they are merely a gimmick), but central bank digital currencies are designed from the get-go as an efficient means of payment and would provide central banks more control over a crucial part of our financial infrastructure and thus further reduce risks of financial instability.

• Payment safety: Contrary to what private companies may want you to believe, it is in the best interest of businesses to spend as little on IT security as possible. IT is a crucial balancing act. Spend too little on IT security and your data will be stolen and you may even go out of business. Spend too much and your profit margins will shrink and your share price declines. Thus, for a private company, the incentive is to always spend as little as necessary to avoid major disasters. A central bank does not have these profitability concerns and only has to maximise the trust in its digital currency. Thus the incentive of a central bank is to spend as much on IT security as possible in order not to endanger a loss of trust by the public in CBDC.

• Antitrust: With the use of digital currencies comes the ability to collect an enormous amount of data on how people use the currency. Private companies can use this data to sell it to advertisers and other businesses (see Google or Facebook). Furthermore, if a company is big enough, it can effectively prevent any competition from rising due to its market power (see here for a discussion). 

• Financial inclusion: This is arguably not a big issue in developed markets as can be seen in the chart below, but in emerging markets, there are often millions of unbanked citizens and people who are unable to even get access to a bank. The success of electronic payment systems like PayTM in India shows that with the help of digital currencies, millions of people could get easy access to money.

• Monetary policy implementation: Finally, many central banks think about CBDC as a means to enhance the implementation and effectiveness of monetary policy. This is such a wide-ranging and (in developed markets) important topic, that part 4 of this series will entirely be dedicated to this topic.

The reasons for CBDC

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Source: BIS

Much has been said about the decline of the value premium in stock markets. For at least a decade now, value investors have had a terrible time and the resurgence of value stocks this year has been pretty mild in the United States, though much stronger in the UK, for example. 

But the question if value is dead is one that still haunts us and when it comes to US stock markets (but not the UK or Europe), so does the question if small-cap stocks really earn a premium.

In this respect, I like the approach by Simon Smith and Allan Timmermann who looked at 23,000 US stocks from 1950 to 2018 and calculated not just the risk premium for value stocks, small-cap stocks, and other factors over time, but also tried to identify breakpoints in the performance of these stocks. The chart below shows the identified breakpoints for risk premia since 1970. The four “regime changes” happened at the oil price shock in 1972 that triggered the high inflation era of the 1970s, the change in monetary policy by the Fed in 1981 and the switch to interest rate and inflation targeting under Volcker, the crash of the tech bubble in 2001 and the financial crisis and introduction of zero interest rates in 2008.

Ex post identified breakpoints in stock markets

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Source: Smith and Timmermann (2020)

How momentous these events would be for stock markets and investment styles like small-cap or value investing would only become clear years after the fact, but they significantly changed the risk premia earned with these styles as shown in the chat below.

Change in risk premia of different risk factors

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Source: Smith and Timmermann (2020)

The risk premium due to equity market risk (the famous beta of the CAPM model) has basically disappeared since the Fed changed its monetary policy to focus more on inflation and stabilising the economy. And where there is less economic volatility, there is less systematic volatility in share prices and the equity premium disappears. The equity premium got a revival between 2000 and 2010 but that turned out to be short-lived.

The value premium, meanwhile, has lost more and more of its appeal with every breakpoint. Less inflation in the 1980s reduced the value premium. Even after the tech bubble burst, the outperformance of value was not so much due to a resurgent value premium but more to a resurgence of other risk factors that overlapped with the value premium. But ever since central banks have introduced zero interest rates and QE, the value premium has definitely disappeared.

Small-cap stocks, meanwhile have stopped outperforming pretty much the moment the size premium was documented by researchers in the late 1970s. IT seems that more macroeconomic stability introduced by the changed Fed policies in the early 1980s has led to a shrinking premium for small-cap stocks in the United States since small-cap stocks are typically more sensitive to economic swings. 

Instead, what has increased over time is the momentum premium. Markets have started to trend more and these trends have lasted longer and longer, giving momentum approaches to investing an edge and increasing performance.

Of course, the problem with this entire analysis is that we just had another massive shock to the system in the form of a pandemic. We will only know in a couple of years if this has triggered another change in market dynamics and risk premia for value, momentum, and small-cap stocks. In my view, the best way to invest is to assume that there was no break in market regime, simply because, as I have explained in my 10 rules for forecasting, as an investor, it is never a good idea to assume massive changes or extreme outcomes. It is tempting to listen to all the people who claim that the world has changed and we are now entering a new era, but in reality, the world changes less than we want to believe and for investment performance, it is usually better to assume that things haven’t changed all that much after all. To me, this means that while I am optimistic for value stocks in the short term (i.e. over the next 12 to 24 months), I don’t see a bright future for value in the long run.

Episode #333: Startup Series – Rob Forster, Wonderbird Spirits, “Making Gin Is Truly An Art”                 Guest: Rob Forster – A native of south Louisiana, Rob came to Oxford in the footsteps of his father, an Ole Miss Law alum. Rob is a graduate of the University of […]

The post Episode #333: Startup Series – Rob Forster, Wonderbird Spirits, “Making Gin Is Truly An Art” appeared first on Meb Faber Research - Stock Market and Investing Blog.

Apple Inc. (AAPL) experienced soaring growth over the past fifteen months, outperforming the S&P 500 and rising by approximately 100.0% compared to the S&P’s gain of about 35.2%. Despite solid growth, many hedge funds and institutions sold the stock in the first quarter. So, Apple saw a slide in its rating on the WhaleWisdom Heatmap to 40 from 8.

Apple is a multinational technology company that designs, manufactures, develops, and sells personal computers, networking applications, portable music players, and mobile communication and media devices, including wearable technology (wearables) and touchscreen tablets. The tech company also offers various online services such as Mac App, a digital distribution platform for its applications, and iTunes, a media library and store. Despite the coronavirus pandemic that negatively impacted many businesses, Apple has thrived and shown record levels of growth. Pandemic-induced government stay-at-home orders had consumers reaching for their Macs, iPads, and iPhones, many purchasing more devices to meet the needs of remote learning, living, and work.

Hedge Funds Are Selling

Hedge funds appear to be trimming Apple from their portfolios. Looking at the first quarter of 2021, the aggregate 13F shares declined to approximately 1.4 billion from about 1.5 billion, decreasing approximately 6.7%. Of the hedge funds, 34 created new positions, 183 added to existing holdings, 38 exited, and 334 reduced their stakes. Aggregate holdings by institutions experienced a milder decrease of about 4.3% to approximately 9.4 billion from 9.8 billion.

(WhaleWisdom)

Encouraging Estimates Continue through 2022

Analysts anticipate that earnings will rise over the next two years, bringing earnings to approximately $5.32 by September 2022. Revenue estimates are also favorable, with year-over-year predictions that could bring revenue to $355.5 billion by 2021 and $369.0 billion by 2022.

High Expectations

Analysts are bullish on the stock, as Apple has reached new heights in financial performance. J.P. Morgan Chase & Co. analyst Samik Chatterjee recently raised his price target on Apple’s shares to $175 from $170. Chatterjee cited strong outlooks for iPhone and Mac computer sales. From Citigroup, Inc., Jim Suva also shared a positive outlook as he raised quarterly earnings estimates.

(WhaleWisdom)

Favorable Outlook

Analysts share long-term optimism for Apple as the company continues to flourish, with shares hitting record highs in the past year. Apple worked through the challenges of the coronavirus pandemic and experienced growing demand for its products and services. Optimistic multi-year estimates offer patient investors motivation to acquire and hold onto shares.

By now we know that investors in sustainable equity funds are somewhat different from investors in traditional equity funds. For example, the sustainable funds with the highest ratings attracted inflows from investors at the height of the pandemic while conventional funds suffered heavy outflows. Investors in sustainable investments are also willing to pay more for these investment products even if they have somewhat lower returns. In short, the money invested in sustainable equities is stickier and more forgiving of short-term underperformance.

And that is a good thing, especially, if we think about saving for retirement and other long-term goals where one of the key problems for financial advisers is that their investors don’t always stick to their investment plans during the hard times of a recession or a bear market.

What sustainable investments provide investors is a form of expressive value as they call it in the literature. In plain English: Investors are proud to be invested in sustainable funds (or more so than in traditional funds) and can brag about their investments at the golf club.

I am normally not a fan of investments with bragging rights because most of the time these investments are often fashionable bubbly investments that don’t have particularly attractive long-term return prospects. Or they are outright fraudulent investments like the funds of Bernard Madoff. But as I said, I don’t think that sustainable investing is a fad or something that has necessarily lower returns than conventional equities.

And now, it seems I have come across another positive effect of sustainable investments. They seem to entice people to put more of their retirement nest egg into equities and thus create larger retirement nest eggs in the long run. A study of 913,000 French employees with investments in more than 6,500 pension funds showed that the introduction of sustainable funds as possible investments in pension funds in 2017 had some significant impact on the portfolios of the insured. On average across all employees, the equity allocation in their retirement savings rose from 12.1% to 14.2% a 17% relative increase. And lest you are surprised about the low level of equity allocations in French pension plans, welcome to the world outside the Anglo-Saxon equity investment culture. In countries like France, Germany, or Italy, these kinds of allocations are pretty normal.

But going back to the 2.1 percentage point increase in equity allocations, the study showed that this was almost entirely due to the increase in sustainable equity funds. The introduction of new traditional equity funds to a pension plan did not change the appetite for equities much, but when a sustainable option was introduced to the plan, the appetite for equity investments in the affected plans rose by 7.2%. And when you save for thirty to forty years in your pension plan, that makes a huge difference in the size of your nest egg.

Ironically, in the United States, the country of equity worship, the Department of Labor has introduced new rules that prevent pension plans from considering anything but financial criteria when selecting investment options. And while there are reasonable objections to some ESG investments as misleading and effectively greenwashed, the new rule may lead to worse outcomes for the insured because they simply don’t invest as much in these plans as they otherwise would.

Why women are the MBA minority and how that could change While law school and medical school have achieved the 50% mark for women enrolled, that has yet to happen in MBA programs. The Forté Foundation, a nonprofit focused on gender parity in business, reports that among its 52 member schools, just 38.5% of full-time MBA students are women. This reflects an undeniable gender gap, but also points to some progress: As...

The post This Week in Women appeared first on The Belle Curve.

A selection of correspondence

Below is a chart of Visaka Industries Ltd. from 2003 to 2021 reflecting the year-over-year (YoY) percentage change. We are going to review the periods when Visaka Industries was at the same level in year over year performance (red arrows) … Continue reading →

Below is a chart of Visaka Industries Ltd. from 2003 to 2021 reflecting the year-over-year (YoY) percentage change. We are going to review the periods when Visaka Industries was at the same level in year over year performance (red arrows) … Continue reading →

Episode #332: Mebisode – Journey to 100X     Guest: Episode #332 has no guest, it’s a Mebisode. Date Recorded: 7/18/2021     |     Run-Time: 54:25 Summary: Episode 332 is a Mebisode. In this episode, you’ll hear Meb talk about his journey investing in over 250 private companies since 2014. He explains why he chose to do […]

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Football is a funny game. It is a team game, so superstar players like Lionel Messi or Christiano Ronaldo can’t win championships on their own. Yet, while “money doesn’t score goals” the teams with high-class superstar players like Real Madrid and Bayern Munich constantly win not only the trophies at home but also the trophies at the European level. This is obviously what drives many second-rate teams to invest in individual superstar players to improve the team. Yet, the track record of clubs with these individual superstars and a mediocre rest of the team is pretty bad. Meanwhile, there are the occasional no-name teams that work so well together that they win championships. Just think of Leicester FC winning the Premier League in 2016 or FC Kaiserslautern winning the Bundesliga in 1998 after being newly promoted to the highest tier in German Football.

In essence, it seems that in football a team has to be pretty balanced to be successful. Too much of a difference between the superstar and the rest of the team and the team fails. Nowhere is this easier to see than on the national level where players cannot be bought or sold. Teams like the Italian national football team of today and many of their best teams in the past tend to be void of global superstars but have a range of players that are all world-class. Similarly, the Spanish team that won everything from 2008 to 2012 were full of world-class players without an individual superstar. Meanwhile, Neymar as the lone superstar in the Brazilian team or Ibrahimovic in Sweden didn’t do them any favour and these teams were often better without their superstar than with him.

According to a study amongst chess players, this superstar effect is pretty universal and rooted in the psychology of social interactions. The study looked at the individual performance of chess players when they faced a superstar player like Magnus Carlson or Gary Kasparov. In theory, there are two ways a player can handle the superstar. Either he is intimidated and employs less effort and hence plays worse, thinking that the opponent is so good he has no chance of winning anyway. Or the weaker player uses the superstar as an inspiration to get better and improve his game.

It turns out that the direct effect of the superstar is always negative. When facing a superstar opponent, all players played worse and exert less effort. And when they have a superstar on their team, players exert less effort because they expect the superstar to take care of it.

On the other hand, the secondary effect of a superstar player can be positive or negative. If the skill gap between the superstar is small, the weaker players can see that with some effort they can get on that level and they exert more effort and get better over time. If the skill gap is too large, however, they give up and simply get demoralised and do a worse job.

The lesson should be clear if you are trying to build a team of fund managers, analysts, or whatever team you are building in your business. Try to build a team like Chelsea FC, Manchester City or the Italian national football team where all the players are world-class and none of them is the standout global superstar. If you can’t do that (because who has the money that Manchester City has?), try to build a team of people with relatively equal skill sets and use the ones with the slightly higher skill sets than the rest as leaders to train the group and get them on a higher level. This way, you are creating something like Leicester FC. A team without stars that consistently plays above its level where the sum of the parts creates something bigger.

But please, don’t build a team like the Brazilian national team with Neymar or Manchester United with Wayne Rooney. A team where one superstar is above everyone else and thus the team doesn’t play as a team but just expects the star to take care of everything or get the glory for any successes, deservedly or not. That is a recipe for failure.

I've been using the DEGIRO as a broker for more than 5 years. Read my honest DEGIRO review to hear my thoughts as a long-term investor

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Following the highly successful global financial bailout in 2008, central banksters were hailed by this Madoff acolyte society as the saviours of systemic fraud and criminality. Therefore it was inevitable these fake gods of modern alchemy would continue to overuse monetary policy until such time as their virtual simulation of prosperity did more harm than good. But not before it became widely bought and believed as the secret to effortless wealth, and the secret to eliminating all recessions. The only question being why did no one try this sooner?

Unfortunately, history will say that it never happened sooner, because it first took a populace with the average IQ of a gerbil to believe this would actually work. 

What is amazing at this juncture is the fact that so few pundits today are concerned about this self-evident policy failure. Any blind man can see above that the "reflationary" impact of monetary policy has declined for the past decade. Now, at this late juncture the intended economic effect of balance sheet expansion wears off immediately since asset reflation is skewed  entirely to the benefit of the ultra wealthy. The second order commodity reflation effect wears off next as over-leveraged speculators get margined out - a process that is well underway. Which finally leaves the direct financial effect of central bank bond purchases which is to drive bond yields lower absent higher inflation expectations. And as global bond yields decline, the hunt for yield ensures that ALL markets converge back to the global deflation impulse. Which means that fund managers are forced to rotate out of reflation trades back into long duration trades (bonds, Tech) as a result of the falling discount rate.

The impotence of monetary policy at the 0% bound, is often called "pushing on a string": 

"Pushing on a string is a metaphor for the limits of monetary policy and the impotence of central banks. Monetary policy sometimes only works in one direction because businesses and households cannot be forced to spend if they do not want to. Increasing the monetary base and bank reserves will not stimulate an economy if banks think it is too risky to lend and the private sector wants to save more because of economic uncertainty"

Or, because interest rates have been at 0% for a decade and everyone is already maxed out on debt in the largest asset bubble in human history. 

It's clear that central banks will be the last to know that their policies have failed humanity. Not for lack of trying mind you. 

"We pledge to keep the deflation impulse stronger for longer"

  

Add in the central banks sponsored effects of record leveraged speculation, record valuations, and squandered stimulus buffer, and it's clear that monetary policy is now doing far more harm than good. It's putting the system that it sought to save in 2008 at far greater risk. Amid record wealth inequality driven by central bank policies, does anyone honestly believe there will be another Wall Street bailout this time around? We have reached the inevitable Humpty Dumpty phase of this NeverNeverLand economic expansion. The driving theory of the day is that as long as no one worries about risk, then there is no risk. Which is not exactly how it works.

The biggest risk to this entire gong show is now the sell order. All it will take is one cry of "fire" in this crowded theater to set off human history's biggest clusterfuck. Case in point, as the Delta variant spreads, another lockdown would render this market a smoking crater. And we know from past experience another lockdown is highly conceivable in this old age home. Regardless, when margin clerks are involved, the sell order doesn't need any more catalyst than the 200 day moving average.

Here we see that cyclicals are now becoming ever-more volatile as result of the imported global deflation impulse. These are not insignificant declines:

This chart below of NYSE breadth mirrors the disintegration of the reflation trade seen above. As the S&P 500 rolls higher, the internals of the market are in a waterfall crash lower:

Which leaves Tech stonks which are currently getting buried under an avalanche of new IPO issuance as Wall Street takes upon itself to underwrite another liquidation sale of Silicon Valley's mainstay output, junk stocks. 

But, like everything else in this Potemkin society, it's not what's taking place behind the curtain that matters, it's only the superficial that captures attention.

In summary, this society is deep under the spell of FOMC:

Fear of Missing Crash

The other day I wrote about new research from the IMF that showed that in the Eurozone at least, government spending was far more effective in an environment when real interest rates were lower than real potential GDP growth (i.e. r-g<0). The chart below summarises the results of that research. In an environment where interest rates are low compared to growth, businesses and households have little incentive to save and at the same time grasp that the government may not have to enact austerity measures to pay for higher deficits. And the longer such a low-interest rate environment persists, the more effective government spending becomes, because fewer and fewer people hold on to their money to save for potentially higher taxes in the future.

Fiscal multiplier depending on the level of interest rates vs. growth

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Source: IMF

This is great news because it shows that the recent government spending measures to get us out of the recession of 2020 were highly effective and have definitely helped to speed up the recovery.

But there is a flip side to this story. We know that once an economy is back to full capacity any additional growth will trigger labour shortages and thus higher wages. And it may also trigger excess demand for raw materials that cannot be matched by the existing supply. The result is, of course, higher inflation. And this is where the chat above becomes a bit disconcerting. Because the fiscal multiplier of government spending doesn’t decrease over time, but instead slightly increases, any government spending in years 3, 4, 5, etc. will become even more effective. But typically, in years 3, 4, or 5 after a recession, the economy is already back to full capacity. Currently, economists expect the US and UK economies to fully recover from the pandemic lows by late 2021 and in the Eurozone in 2022. Any additional government spending beyond that point will push inflation higher. And that includes the fiscal spending that was part of the pandemic rescue packages enacted in 2020 and 2021 but scheduled to be spent only in later years.

Is that going to be enough to create high inflation for years to come or even a runaway inflation scenario like the 1970s? No. According to my calculations, the government spending enacted so far should lead to somewhat higher but not worrisome inflation. In the United States and the UK inflation may in the long run level off at 2.5% instead of 2%, while in the Eurozone, inflation may level off around 2% instead of 1.5%. And that assumes that central banks just sit on the sideline and do nothing. But they are of course already toying with the idea of tapering asset purchases and guiding the market to interest rate hikes in 2023 or potentially sooner. And I am pretty sure, that if they see inflation remain high for too long, they will accelerate their rate hikes and help push inflation lower. But they will also be happy to let inflation run slightly above 2% for a while, so realistically, we should probably expect inflation to run above 2% in the next five years or so, but not by much.

Published July 2021 In recent months, China has cracked down on bitcoin mining, which means other countries, and particularly the US and Canada, are gaining a larger share of the mining network. This article takes a look at Compass Mining, one of the investment opportunities that exists for investors in that space. Bitcoin Mining: Coming […]

Episode #331: Phil Nadel, Forefront Venture Partners, “The Best Companies Are Founded By Folks Who Personally Feel The Pain Point”                 Guest: Phil Nadel co-founded Forefront Venture Partners (formerly Barbara Corcoran Venture Partners) in 2014 and has been its Managing Director ever since. Phil is also one of […]

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It is common knowledge among economists though not always with investors that fiscal stimulus is more effective when the economy is in recession than when it is growing. The fiscal multiplier that measures the change in GDP for every dollar spent by the government tends to be below 1 in boom times and above 1 in recessions. In other words, additional government spending in boom times tends to be a wasteful exercise where some of the government spending does not enhance economic growth. But in a recession, government spending significantly boosts economic growth and accelerates the recovery from the depths of the recession. That is why I am very much in favour of the government stimulus programmes enacted during the pandemic. Governments were doing the right thing at the right time.

But a new study by the IMF indicates that the fiscal multiplier of government spending may not only be higher than normal during a recession but also in boom times when economic growth is larger than the level of interest rates. Looking at 10 countries in the Eurozone, they estimated fiscal multipliers for two different regimes. Instead of the usual recession/boom split, they used the difference between real short-term interest rates and real potential economic growth (the famous r-g) as a differentiating factor.

If the real interest rate is lower than the real potential economic growth (i.e. r-g<0) then additional fiscal spending may lead to additional budget deficits, but because growth exceeds real interest rates, there might not be the need to increase government revenues (read ‘taxes’) in the future to pay for today’s spending spree. Higher growth, in this case, may lead to higher tax revenues that outpace the higher interest expenses from the additional spending. Note, that in the Eurozone, we have been in this regime since the financial crisis of 2008 and in the United States and the UK, we are currently definitely in this regime.

If, on the other hand, real interest rates are higher than real potential growth, additional spending causes a larger increase in interest cost than can be made up by higher tax income from higher growth. In this case, it is pretty likely that at some point in the future, the government will have to increase revenues to pay for the spending of today. This is the regime that the United States, the UK, and Europe were in throughout much of the post-WW2 period and it is what still determines the mental models of many investors.

Businesses and households who understand that the government cannot spend forever, but at some point, have to pay for its debt will take that into account when deciding how much money to save or spend. And if they think that the government will eventually have to increase taxes to pay for current spending (i.e. the second case of r-g>0) then they will ever so slightly increase their savings and reduce consumption and investments. The result is that government spending to incentivise businesses to invest or to incentivise consumers to spend may be less effective.

But in an environment when interest rates are low (i.e. the case of r-g<0 prevalent today), businesses and consumers are less incentivised to save and at the same time less reluctant to spend because they grasp that governments can afford to spend more due to lower cost of debt. So why save some of your income to pay for higher taxes that may never come?

The result is that in a low-interest rate environment, fiscal multipliers for government spending are not only larger than 1, but they tend to grow larger over time. In other words, as more and more people realise that the government won’t need to enact austerity measures to rein in debt, they start to spend and invest more and more, thus making government incentives like child tax credits, government grants for research and development or government infrastructure investments even more effective and powerful. At least in the Eurozone, where we now have ten years of experience, this is what happened and it seems likely to me that a similar effect will take hold in the UK and the United States in coming years.

Fiscal multiplier depending on the level of interest rates vs. growth

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Source: IMF

Below are the downside targets based on the work of Edson Gould. The targets, as noted in the chart above are: $168.51 (conservative target) $141.34 (mid-range target) $114.17 (extreme target) There is no indication that the price of Moderna Inc. … Continue reading →

Below are the downside targets based on the work of Edson Gould. The targets, as noted in the chart above are: $168.51 (conservative target) $141.34 (mid-range target) $114.17 (extreme target) There is no indication that the price of Moderna Inc. … Continue reading →