GDP, M&A, EBITDA, P/E, NASDAQ, Econo-thread Part 11

[DanS]

"That gut instinct of yours makes we want to smash the wall in. Everything's good, little pinky fluffy clouds everywhere..."

Geez dude, you're dour.

"You can't run that deficit ferever. When you no longer do, you'll invest less or consume less. If you invest less, then net investment is about zero - and that means no output growth."

No, not forever. But I would guess that it's possible to run those deficits for a while, even if not at quite those magnitudes. (But then again, perhaps even at those magnitudes.)

"And foreign capital didn't flow into the US for the pinky fluffy clouds, but it wanted to play the bubble."

It flowed in for a lot of reasons, not only the bubble.

"Only during the bubble"

Well, maybe the 80% number. But then Europe has most often been 50%+.

[el freako]

Originally posted by Sten Sture

The US is able to borrow money at 2% real. For 3% of GDP, please! Its immaterial. If you personally make 100k (after taxes) how big a deal is it to borrow 3k at 2% real? BFD.

You make two errors here, the first one is a minor one regarding the real interest rates:
The US is not borrowing at 2% real after all. The current rate on US 10 year bonds is 4.7%, inflation (currently 1% using the GDP deflator) will probably be around 2% during that period raising your forecast of the real interest rate by more than a third.
However that only applies to government borrowing, as I am sure you are aware the majority of borrowing is by corporations - here the 10 year bond rate is 6.5%.
Assuming 30% of the overseas financing is going to the government and 70% to business that gives a weighted interest rate of 6% - or 4% real, double what you were assuming.

The second (and far more important error) is that you are not taking into account that that 4% interest on 3% of income is added each year to the amount to pay - which means that although in the first year it will amount to 0.12% of income after 10 years it would be 1.04% (assuming a 3% rise in real income and 2% inflation over that period).

So after a decade your real income will have risen by around a third but your interest payments would have risen 12-fold, and your net debt will have gone from 3% of your income to 26%.

[Roland]

"We will continue, greatly to the annoyance of Roland , to be able to import vast amounts of capital."

Nope. Dollar recycling has its limits.

"The US is able to borrow money at 2% real. For 3% of GDP, please! Its immaterial. If you personally make 100k (after taxes) how big a deal is it to borrow 3k at 2% real? BFD."

BFD ?

"Geez dude, you're dour."

I'm realistic. You're a believer. I also think now that Greenspan really believes most of the crap he's uttering. I would not have expected such a level of intellectual degenration, not even in the US.

[el freako]

Originally posted by Roland
"The US is able to borrow money at 2% real. For 3% of GDP, please! Its immaterial. If you personally make 100k (after taxes) how big a deal is it to borrow 3k at 2% real? BFD."

BFD ?

I think he means 'big ****ing deal' - however this shows an error of thinking which I showed up in my previous post

I also checked my data after the BEA released it's 'peliminary' estimate of GDP (as opposed to the 'advance' estimate) - and in Q2 foreign financing was not 79% of net investment, it was 91% !!!

[Sten Sture]

Originally posted by el freako


You make two errors here, ...current rate on US 10 year bonds is 4.7%...

Uhh, lets see... You are assuming that the US Government borrows with the ten year treasury, which is a note, not a bond by the way. That is emphatically not the whole case. The ten year is actually a somewhat unused maturity. Most government borrowing is in much shorter maturities to take advantage of a (usually) positively sloped yield curve. The current average duration of tradable USTreasury (UST) debt longer than one year is 6.03 years. However, that is only 68% of the tradable debt, 32% is in Tbills which have an average duration of 0.39 years, making the weighted average duration of traded UST debt around 4.25 years. The yield on the debt at monthend was actually 2.88% nominal.

However that only applies to government borrowing, as I am sure you are aware the majority of borrowing is by corporations - here the 10 year bond rate is 6.5%.

Unfortunately you are mistaken in your assumptions again, one about the average maturity of corporate borrowing, and two about the majority of borrowing. Consumer borrowing dwarfs corporate borrowing, for an example, the mortgage bond market is the size of the corporate bond market and the USTreasury market combined. And those two are roughly the same size.

Assuming ...overseas financing is going ... 70% to business that gives a weighted interest rate of 6% - or 4% real, double what you were assuming.

Besides assumption errors, the aggregate amount of Corporate borrowing is somewhat irrelevant to the extent of Treasury borrowing, and the afordability of such financing to the US Government. To be sure, the miniscule amount of net foreign UST ($US1.3B)purchases in the first half of this calendar year point to a relatively healthy level of internal financing.

The second (and far more important error) is that you are not taking into account that that 4% interest on 3% of income is added each year...

Of course if the Government debt is being financed at 2.88% nominal and you have a 2% deflator, while the real GDP is growing north of 0.88%, the economy stands a very good chance of outpacing the Treasury debt since net tax revenue growth has a high correlation to real GDP growth. The figures you proposed for the result should actually be the other way around.

This is no social crisis, just another tricky day...

[Roland]

That's all nice pink fluffy clouds all over again. Well, no.

The current level of interest rates is irrelevant. The problem is that taking a rough 5 % real return on capital in the entire economy, US interest rates have been artificially low for a time and are even lower today. This goes all the way, from the fed short rates to structured risk "elimination". The flip side of that is asset bubbles and excessive spending.

While the banks and Freddies find that great, finance alone does not an economy make. The misallocation of resources has to be simply gigantic.

There is no pool of savings to support the US spending binge. The gap is bridged by Alan's confetti. He truly is the John Law of our time.

"The US is able to borrow money at 2% real."

Well the US could borrow at 0 %. Just take the printed money right to the treasury. Your point ?

[pchang]

I think Roland will like this article

http://moneycentral.msn.com/content/P29427.asp?special=deflation

US and Japan - more alike than you think

[el freako]

Sten,

I probably am incorrect in some of the assumptions I made about the interest rates for financing the US's $500bn current account deficit (you seem to be confusing my argument about the affordability of overseas financing with that of governmental), I will certainly agree with your better-researched figure of 2.88% for government borrowing, however...

Originally posted by Sten Sture
Consumer borrowing dwarfs corporate borrowing, for an example, the mortgage bond market is the size of the corporate bond market and the USTreasury market combined. And those two are roughly the same size.

I'm pretty sure that Corporations will have to pay more for their debt than the government and consumers will probably pay more than the corporations so the real interest rate on all borrowing is probably considerably above the 2.88% you quoted (although what the rate is on foreign financing I have no idea but it's probably not too far from the rate for the whole economy).

Originally posted by Sten Sture

Of course if the Government debt is being financed at 2.88% nominal and you have a 2% deflator, while the real GDP is growing north of 0.88%, the economy stands a very good chance of outpacing the Treasury debt since net tax revenue growth has a high correlation to real GDP growth. The figures you proposed for the result should actually be the other way around.

Sorry but you're making a huge implicit assumption here yourself - namely that said debt is not being added to, however it is being added to (the current account deficit was 4.8% of GDP in the second quarter) - using your example of someone making $100,000 and borrowing 3% of their income each year (again with 3% real income growth and 2% inflation) then even if the interest rate was at japanese levels (0.02%) this hypothetical person's debt/income ratio (and so, with a constant interest rate their interest/income ratio) would have risen 9-fold after a decade.

Here is an example spreadsheet to show you what I mean, you can fiddle around with the assumptions but I think you will find that unless you put in extreme figures (negative nominal interest rates or inflation rates of over 1000% a year) that the ratio's of debt and interest to income will always grow unless the borrowing ceases.

[Roland]

Originally posted by pchang
I think Roland will like this article

http://moneycentral.msn.com/content/P29427.asp?special=deflation

US and Japan - more alike than you think

Thanx. Fleckenstein is one of my favourite bears, I just thought he was banned from CNBC....

I did a trick on Kautilya once in one of the bubble debates. I took a good post-bubble analysis from the BOJ and put it in present tense ommitting Japan. Was perfectly clear I was talking about the US to anyone.

Still, I'm now at roughly 50:50 for the odds of the US doing a Japan. The scariest thing are all the clueless economists out there. It's simply ****in' unbelieveable.

[DrSpike]

Hehe, unfortunately the most vocal people that write on economics are predominantly journalists, and hence I often share your opinion. That doesn't mean that real economists are clueless though. Most share your concern, although I along with most professionals would still put the probability at no more than 1/3, for good reason. There are some parallels to post-bubble Japan, but also key differences.

What is your line of work Roland?

[Roland]

"That doesn't mean that real economists are clueless though."

Well if you do not include the clowns on the FOMC in those, and the clowns in the so called blue chip forecast, and those at the OECD and IMF, then yes....

Seriously maybe 5-10 % of economists saw this coming say 2 years ago. Given the track record of bubbles from the UK, German reunification and Japan, it's simply unbelievable.

[pchang]

telling secrets

Roland is really a law professor.

[Roland]

Yeah, econ is just a hobby after I've seen what gets taught as econ at university...

[Colon™]

Sten, we call 10 year stuff bonds too. (and also the other stuff with a shorter maturity) 30 year stuff isn't very widespread in Europe AFAIK.

[pchang]

University

at what level? I found there was a huge gap between econ for 1st and 2nd year undergraduates and econ for upper classmen and graduate students. The big difference was the level of math involved.