A Value Investing Blog

Posted on 06 Mar 2017 by Steve Johnson

Blame Central Bankers for the Lack of Productivity Growth

Blame Central Bankers for the Lack of Productivity Growth


They get the blame for a lot these days. Asset bubbles, moral hazard, banking crises, deflation, inflation. It’s all the fault of the central bankers.

Some of the criticism is warranted. Some of it is not. As Sebastian Mallaby concluded in his excellent biography of Alan Greenspan, central bankers don’t have the power many people attribute to them. One contributor to the financial crisis was the widespread assumption that Greenspan had the power to avert it.

But I would like to lay one more issue at the central bankers’ feet. Is the long term decline in productivity growth a consequence of modern monetary policy?

Continue reading “Blame Central Bankers for the Lack of Productivity Growth”

Posted on 15 Feb 2017 by Gareth Brown

Europe Takes Off

Europe Takes Off


There is a strong correlation between general economic health and the number of people taking to the skies. It’s held across most individual markets for more than 50 years. Specifically, commercial passenger numbers have grown around 1.5-times real (after inflation) GDP over the long term.

Short term data is noisier. It’s knocked about by factors like oil prices, terrorism fears, pandemics and the health of airline balance sheets. So short term passenger number growth might not be a particularly accurate economic thermometer. With those caveats in mind, we might be seeing early evidence of a ruddy recovery in Europe.

I track a lot of airport data. The below table highlights passenger growth over the past year at large European airports. Each entry shows the percentage change in passenger numbers from the same corresponding month a year earlier.


Growth seems evident, once you understand a few important exceptions. Paris-Charles De Gaulle and London Heathrow are both butting up against capacity constraints, which is why you see little growth in the busier (northern) summer months, but some growth in the off-peak months. Both did well considering their constraints. I’ve added the numbers for secondary London airports Gatwick and Stansted as a counterpoint to Heathrow.

Brussels had a tough year. The terrorist attack at its airport in late March 2016 hit hard. Frankfurt was another underperformer. Lufthansa pilots went on strike later in 2016, but that didn’t coincide with the main weakness in the middle of 2016. The company’s second quarter financial report cites terrorism fears and weather events – but those excuses don’t stack up versus other European airports. The more likely cause is shrinking capacity at Lufthansa. The German national carrier provides about 60% of the airport’s traffic and is burdened by particularly large unfunded pension obligations.

Europe Takes Off

Exceptions aside, passenger growth across most European airports was strong over 2016. An acceleration is evident over the past 2-4 months at most locations. Where more detail has been provided by airports, intra-European growth has generally been higher than growth to or from the rest of the world. And ‘periphery’ countries like Spain and Ireland are growing faster than ‘core’ EU countries, although the core is clearly also doing well.

Even Athens is killing it, though that’s probably more about inbound tourists than in- or outbound business people. Any sunny European spot perceived as safe has been growing recently at the expense of Turkey, Egypt and Tunisia.

I wouldn’t go basing any large macro bets off this (or any other) data. But it’s a good sign for Europe. Economies that are in the doldrums don’t tend to grow passenger numbers at an annual rate of 5-10% or even more, not for long anyway. It’s worth keeping a sharp eye on European passenger numbers over the next few months.

Posted on 21 Sep 2016 by Gareth Brown

UK’s Brexit Trump Card

UK's Brexit Trump Card


If the world really is short of demand, as many economists argue, then novel monetary policy measures like Quantitative Easing (QE) strike me as an inefficient way to stoke it. It’s too indirect and may actually be counterproductive. And let’s not even bother discussing the potential for asset price bubbles.

If demand stoking is the aim, better to run a fiscal deficit. The bulk of incremental additional spending should be directed to one-time, efficiency-adding infrastructure projects.

I’ve argued that the UK has a golden opportunity to ramp up infrastructure spending to help offset Brexit pains. If you’ve been stuck on the M25, in the skies over Heathrow, or on the Piccadilly line you’ll know there are a lot of efficiency gains up for grabs. There’s a difficult transition period approaching. And long term borrowing rates are as low as they’ve ever been. Now is as good a time as any for the government to borrow to invest in the nation’s efficiency. It would surely beat negative interest rates as an alternative. Continue reading “UK’s Brexit Trump Card”

Posted on 02 Jun 2016 by Gareth Brown

Why the Wealth Effect Won’t Help Consumption

Why the Wealth Effect Won't Help Consumption


All things being equal, lower interest rates spur both housing development and the price level of the existing housing stock.

Clearly new housing development adds directly to economic activity. But there’s also the economic theory that higher prices for existing houses (share prices and other assets) creates a ‘wealth effect’ – windfall recipients feel richer and spend some of that largesse, boosting the economy in the process. Call me sceptical. Continue reading “Why the Wealth Effect Won’t Help Consumption”

Posted on 11 May 2016 by Steve Johnson

There’s no Need for Government, Negative Gearing Will Fix Itself

There’s no Need for Government, Negative Gearing Will Fix Itself


My wife, being South African, finds a number of things about Australian culture strange. Friends turning up at your house and eating your food whenever they feel like it, for example. Or special security guards in pubs making sure you don’t drink too much. In South Africa, she says, that is the point of going to the pub.

But the strangest thing about Australia is its obsession with tax losses. Perhaps biased by my father being one of the first locals she met in this country, she finds it odd that he has spent his whole life running a farm at a loss just to avoid the tax man. We are not alone – the Germans love a good tax dodge too – but, to her, it is unbelievable that someone is prepared to spend more than $1 million on a house just so they can “negative gear” it. In South Africa, you buy houses where the rent is more than the interest payments. Again, she says, that is the point of an investment – it generates you income.

Continue reading “There’s no Need for Government, Negative Gearing Will Fix Itself”

Posted on 23 Jan 2015 by Forager

Europe’s Unplanned Oil Stimulus

I worry about the effect of quantitative easing (QE) on already stretched European asset prices. And I feel that QE is a great excuse to postpone many needed structural reforms on the continent, patents and pensions to name just two of many.

But otherwise, I don’t feel qualified to comment on the pros and cons of the European Central Bank’s (ECB) recent decision to start its own QE program. It may well work.

There is, however, one issue nagging at me. Are they chasing a deflationary bogeyman that doesn’t really exist, at least on a continent-wide basis?

Annual inflation in Europe has fallen from a little under 1% 12 months ago to -0.2% at last count, the dreaded deflation. But are all forms of deflation, well, deflationary?

Europe’s Unplanned Oil Stimulus

About 0.7% of that price fall (ie most of it) was caused by the falling price of oil—0.53% from the falling price in fuels for transport, and 0.17% from cheaper heating oil. Natural gas prices didn’t have much influence in 2014, but the longer oil stays low, the better the chances that Europe will also source cheaper gas for its massive winter needs.

Falling oil prices might make deflation statistics look even scarier. But that’s missing the forest for the CPI number.

Economic meddlers, sorry central bankers, fear deflation for rational reasons. When the prices of cars, computers or houses are falling, people sensibly delay purchase and risk stalling the economy in the process.

But oil is a price inelastic consumable. When the price of petrol or gas falls, people keep driving to work and keep heating their homes as they did last year. The main difference is that they have more money left in their pockets to use elsewhere. Oil deflation is more like food deflation (good, on average) than longer life products (arguably bad). More so when crude oil and gas are mostly imported from outside the EU.

So, unlike some forms of deflation that retard economic growth, oil price deflation is an economic stimulant for an importer like Europe.

The particularly juicy bit about stimulus from lower oil prices is that it’s rather democratic. Yes, rich people use more oil and gas than the proletariat—flying around the world, powering BMW SUVs and heating larger homes, for example. But they don’t use that much more oil per capita.

And considering that middle and less well-off folk far outnumber rich, the savings disproportionately end up in their hands. They’re likely to spend those savings, boosting their standard of living and the economy in the process.

None of this is to suggest that Europe is or will sail through its troubles. Nor is it any proof that deflation isn't a real threat or that European QE is a bad idea.

But the ironic thing is that Draghi and his minions have been waiting for a negative inflation number to be reported so that they could convince the Germans to allow them to flick the QE switch. With much of that deflation coming from a lower oil price, it’s actually rather stimulative in nature. Europe is currently being aided by two stimulus programs, and only one of them is planned.

Posted on 20 Nov 2013 by Forager

And the next Fed chairman is…

By Gareth Brown in our one-man Vienna office

It’s a strange job, this chairman of the Federal Reserve gig. Some people (including most of the media and some in political power) seem to think of the chairman as the maestro of the entire global economy.

To those of us who know the real story—that the economy actually is, left to its own devices, a bottom up, complex adaptive system—the idea of a captain tweaking the controls is either laughable (in its impotency) or maddening (in the damage being caused).

Personally, I’d prefer to see the whole role made redundant, or at least savagely demoted. And I’d like to see the chair and much of the entire board wrestled back from the academics that have dominated it for around 25 years. That other great experiment in top down, planned economics, the Soviet Union, lasted about 70 years. So respite might take a while yet.

I was very happy when Larry Summers dropped out of the race for next chairman, mainly because I wouldn’t trust him to run my son’s $500 government-guaranteed bank account. But Janet Yellen might be no better, and may be worse. Yellen’s view of savers is scary indeed.

But life is too short to stress over things unchangeable. Let’s instead have some fun with it. Given the role of selecting the next Fed chair, who would you pick? Assume that political connections, plausibility nor desire for the job are requirements. You’ve got a pool of 7.125 billion potential candidates. Who would you give the job?

Assuming we must have a Fed chairman manipulating the price of money in the first place, then I think their most important role is to identify bubbles and lean into the wind. At the very least, they should not be inflating bubbles deliberately to achieve some short term economic and political goals.

So for me, the choice is an easy one—Jeremy Grantham of GMO LLC must be among the best in the bubble-hunting business. He spotted every bubble that Greenspan and Bernanke missed, and he won’t miss any of the ones that Yellen is likely to miss.

If you don’t read Grantham’s quarterlies, head to the GMO website and sign up (it’s free).

Do you have a better candidate?

Posted on 01 May 2013 by Forager

Wir Wollen Mehr: May Day Madness in Vienna

May Day is an exasperating time to be a free market libertarian living in one of the reddest part of a very red town (red meaning socialist, not Republican). And it’s not just the fact that I have to work while everyone else gets a day off.

By Gareth Brown in our one-man Vienna office

Tag der Arbeit (Labour Day) started as an ancient May Day spring festival in Europe, and one can still see giant maypoles all over the (conservative-leaning) countryside at this time of year. But, for more than 100 years, the day has been one of international solidarity among workers. It continues a tradition started in Chicago when a union decided that, from 1 May 1884, workers’ days would be a maximum 8 hours long—setting off a long and unfortunately often bloody battle.

Wir Wollen Mehr: May Day Madness in Vienna

I’m all for the rights of workers and for their right to bargain collectively when it suits, as long as individual members are free to join or abstain without threatening their job prospects or safety in any way. Our rights as workers are likely far superior to where they’d have been if not for the often extremely brave striking workers of yesteryear.

But, at least from an outsider’s perspective, Tag der Arbeit in Vienna is no longer about working rights, I’d be surprised if half the protesters have jobs. This is a political movement, a voting bloc sending a clear message to governments, not employers.

On the day, red shirt-wearing marchers emerge mainly from their city-sponsored housing (a whopping 60% of Viennese live in subsidised housing, with almost 1-in-3 in an extremely cheap or free council flat). Some are young workers and students, many are retired (here, that can be surprisingly young). They congregate out front of their heavily subsidised housing, down the road from their free hospital and up the road from their free university. They take the subsidised underground to the centre of town, and meet with thousands other red shirts. They often march under the banner of the SPÖ, the socialist party that has ruled Vienna (unbroken, I believe) since WWII.

At the risk of offending someone more knowledgeable on the nuances, the message seems crystal clear. The current benefits that flow from the city, the state and, increasingly, the continent, are not up for negotiation. And they want more.

Make no mistake, these people do not live like kings, they’re generally the city’s poorer half. And who am I to judge someone who wants a better life? My concern is, if they want more and they want it from government, who’s going to pay for it?

You see, like in Australia but more extremely, the tax burden falls disproportionately on the middle class in Europe. Really rich citizens, and there’s a lot of them in Austria, including Didi Mateschitz (Red Bull), Frank Stronach, the Flicks, Wlascheks, Porsches (yes, that family), Swarovskis, parts of the Rothschild family and some descendants of the Hapsburgs, would wisely have their income-producing assets mainly in corporate structures. And while I’m sure that the left-leaning parts of the national government would love to have a much higher corporate tax rate, corporations are mobile and wont to up and leave. The corporate tax rate is a fairly competitive 25%, and explains why families like the Flicks (of German origin) actually moved to Austria for a tax break. A low corporate tax rate is seen by both sides of politics as good for job creation in Austria, and it means someone like Mateschitz is unlikely to be paying an effective average tax rate much above 30%. The rich are doing fairly well in a global context.

The middle class, however, gets walloped. The top marginal income tax rate is 50%, and kicks in at annual earnings of just €60,000 (A$76,000). The rates on salary below €60,000 are also taxed more harshly than in Australia. Additionally, employees must also contribute directly towards their pension plan (no 9% on the top as in Australia) and there’s compulsory public health insurance. Then there’s a sales tax of 20% on almost all purchases. Citizens also incur a raft of quirky taxes, such as television tax and church tax (introduced, ironically, by Hitler). Catholics (the vast majority of the population) and Protestants automatically have 1.1% of wages paid directly to the church unless they deliberately leave, which means finding alternative arrangements for marriages and funerals, with afterlife consequences also threatened.

By the time a doctor, accountant, tractor dealer, microbiologist or funds manager pays income tax, church tax, compulsory insurance and sales tax on their living expenses, well over half of their earnings has gone to government. Facing such a burden, young people that might otherwise shoot for the stars instead don’t bother, don a red shirt and march on city hall. Or, like four of our friends, they move to America for a system more suited to their ambitions.

The emerging entitlements culture in Australia, which I mostly pin on John Howard, is a growing shame. But it’s nothing like you see in many parts of Europe. And it’s not just a socialist thing. Right-leaning rural constituents, particularly small farmers, have also been in on the gig for decades.

While the red shirts march for more, it’s becoming increasingly obvious that Europe cannot even afford its current entitlements system. And the tax system is a massive disincentive to those who might otherwise dig deeper and, in the process, help the continent out of its malaise. It’s also a huge disincentive to attracting skilled migrants (I’m here for love, not the tax system). Changing that entitlement culture, if even possible, is a long and very difficult road in a left-leaning democratic system. I suspect Europe’s underlying structural problems won’t be resolved anytime soon.

Posted on 13 Dec 2011 by Forager

I Can Feel A Stimulus Coming On

Apologies to those who didn’t grow up in the Eastern states. Matt tells me that he’s never heard the advertising jingle I can feel a XXXX coming on. It works for me though, I get the feeling the Chinese are working on something big.

The Chinese economy is being buffeted by two unrelated winds. The first is Europe’s woes and the second is an inert US economy. Both are proving a serious drag on China’s export growth. Export and import growth have slowed dramatically and net exports are expected to contribute less than 3% of GDP this year, down from 7% in 2008.

The external environment is problematic. Internally however, the problems are bigger. The FT recently reported dangerously low levels of property market transactions in China’s largest cities. China Vanke, the country’s largest property developer, reported November sales 36% lower than the previous year.

A property crash is a big issue in any country. It is especially problematic in China, where fixed investment comprises more than 50% of GDP and, according to UBS, residential property investment accounts for more than 20% of fixed asset investment.

If the investment part of GDP growth takes a hit and exports get smashed, China’s 9% growth rates are going to get annihilated.

So what will they do? There’s not much they can do about Europe, apart from hurling platitudes across the continent (China, like Germany, seems to think that the whole world should do what they do and run trade surpluses), nor is there much they can do to inject life into the sluggish US economy.

Investment on the other hand the Chinese authorities can do something about. In 2009, they rescued their economy from the global recession by stimulating the investing part of the equation. Not surprisingly, it looks like they are about to give it another shot.

This could be good news for Australia. As you can see in the graph below, exports to Europe are inconsequential relative to China. And it’s the infrastructure and property boom in China that’s been driving rampant demand for Australian resources (you can almost see the Chinese stimulus feed the purple line in the graph below). Additional stimulus would mean continued heavy demand for Australian resources.

I Can Feel A Stimulus Coming On

As regular Bristlemouth readers will know, I’ve been petrified about the consequences of China’s misallocated investment boom, and positioned accordingly, for a long time. Perversely, Europe’s troubles may delay the day of reckoning, and make it all the more painful.

PS I probably have the most ‘anti China’ portfolio of any ASX-focused fund manager. That graph still scares the life out of me.

Posted on 11 Oct 2011 by Forager

China’s Boom: It Won’t Last But it Won’t End Now

China’s Boom: It Won’t Last But it Won’t End Now

So the problem with Japan – and indeed with every other country I can think of that suffered very long periods of post-boom stagnation – was massive over-investment based on a very distorted investment-driven growth model. The period of stagnation was partially caused by the struggle to service excessive levels of debt, partly caused by the continued capital misallocation, albeit at a slower pace, and partly caused by the effective writing down of all that overstated GDP.

These – with the possible exception of the debt – are not the problems from which the US or Europe are suffering. They suffer from a typical debt-fueled overconsumption boom, whereas Japan suffered from a typical debt-fueled over-investment boom, and Japan’s period of over-investment was much, much more extreme (centralized investment booms can last much longer and go much further than decentralized consumption booms). This is why I think the Japanese experience tells us almost nothing about what Europe and the US will go through.

On the other hand, it might tell us a lot about what China will go through. In fact we can make a more general point. Command economies (Japan, the USSR, Brazil and many others during their “miracle” periods) tend to have much more rapid investment-driven growth during the good times and much more difficult and longer-lasting adjustments. Capitalist democracies are more prone to consumption-driven booms, which aren’t as extreme and don’t last as long, and their adjustments tend to be brutal but relatively quick. – Michael Pettis, August 2011

Michael Pettis is a professor at Peking University's Guanghua School of Management, a Senior Associate of the Carnegie Endowment for International Peace and my favourite commentator on the Chinese economy (I have included some interesting links at the bottom of the page).

When the US, Europe and most of the developed world entered a recession in 2008, I expected the impact on China’s ‘export-driven’ economy to be dramatic. So did most of the world’s investors. Commodity prices plunged, the Aussie dollar traded down to US60 cents and … the Chinese economy grew 9.1%, only slightly less than the prior year.

The intriguing part was that the trade component of China’s economy did indeed collapse. Net exports contributed 8% of GDP in 2008 and only 4% in 2009. Yet the overall economy still grew healthily. It seems the Chinese economy isn’t that export driven at all.

Those worried about another global recession impacting China and its demand for Australian resources shouldn’t be losing sleep at night. In fact, net exports represent only 5% of Chinese GDP today. Even if the contribution halved again, that would only subtract 2.5 percentage points from China’s very healthy growth rates.

If China is not an export-driven economy, then, what is driving the growth?

The four components of China’s GDP – consumption, investment, government spending and net exports – are shown in the 30-year chart below. You can see net exports down the bottom of the graph, contributing strongly to growth in the early part of the 2010 decade and then declining rapidly towards the end of it. But now take a look at the consumption and investment lines. Consumption has declined from more than 50% of GDP – a low but relatively normal level for a rapidly growing economy – to 36% in 2010. So much for China’s consumers saving the world.

China’s Boom: It Won’t Last But it Won’t End Now  China’s Boom: It Won’t Last But it Won’t End Now

Investment, or fixed capital formation, has taken up the slack, particularly in the last decade. It grew from 35% of GDP in 2000 to almost 50% of GDP today (for comparison, in the US consumption and investment represent 71% and 15% of GDP respectively. In Australia the numbers are 54% and 28%).

The chart also explains how China sailed through a global recession; it simply stimulated investment even further to take up the slack from declining net exports. It also explains why demand for Australian resources has been so voracious; it takes a lot more iron ore to build a city or a high speed rail line than it does to make a Big Mac.

But it also begs many questions about the future. How long can this investment driven growth be sustained? What are the long-term consequences of an investment binge this large?

It’s not immediately obvious why an investment bias should be a problem. In fact, many observers see China’s new cities and shinny fast rail networks as signs of its progress. A comment on last week’s blog entry is a perfect example:

I'm sitting here having breakfast in a very nice hotel in Shanghai. I'm looking out the window at all the impressive architecture of their new "Wall Street". Yesterday I went to the Shanghai Urban Planning Centre. I looked at the details of their 2006 to 2020 urbanisation plan which is on public display. They have done so much already and it’s another 9 years to go on this plan alone.

My tour guide tells me there are dozens of inland cities that haven’t even started yet. "China hitting the skids ??" I would say there is a long way to go in the China story yet. Of course there will be ups and downs but history will probably tell us they were blips in this long story.

It’s true. Investment is generally a good thing and I’ve been a strong advocate of using Australia’s resources windfall to improve our own country’s infrastructure. In China, however, investment has become the driver of GDP growth, as opposed to one component of a healthy, growing economy. In an editorial piece for the New York Times, Pettis explained why this over-reliance on investment is a problem:

In all previous cases of countries following similar growth models, the dangerous combination of repressed pricing signals, distorted investment incentives, and excessive reliance on accelerating investment to generate growth has always eventually pushed growth past the point where it is sustainable, leading always to capital misallocation and waste.  At this point – which China may have reached a decade ago – debt begins to rise unsustainably. 

China’s problem now is that the authorities can continue to get rapid growth only at the expense of ever-riskier increases in debt.  Eventually either they will choose sharply to curtail investment, or excessive debt will force them to do so.  Either way we should expect many years of growth well below even the most pessimistic current forecasts.  But not yet.  High, investment-driven growth is likely to continue for at least another two years.

It’s no different to the housing boom in the US and Spain. Distorted incentives and price signals led to a construction boom on a grand scale. Those construction numbers get included in GDP at the time. Then you turn around a few years later and realise there are way too many houses, they aren’t worth what it cost you to build them and that the GDP you reported a few years back was a furphy. If you funded the construction with debt, you also have a potentially insolvent banking system.

It happened in Japan in the 1980s. And it’s happening in China now. A recent Wall Street Journal article quoted Fitch’s estimates of the debt explosion in the Chinese economy: ‘the ratio of outstanding credit to GDP rose from 124% at end-2007 to 174% at end-2010, and is on pace to reach 185% in 2011. Adding in black-market lending and the increasing use of IOUs to settle payments takes the total even higher.’.

So where does this end? As Pettis points out, there’s no constraint just yet:

‘My guess, and it is only a guess, is that China can continue with the current growth model for at least another four or five years before it runs out of debt capacity – although when it does, it runs the risk of falling into the debt crisis that has stopped every previous example in history of an investment-driven growth miracle. Of course I am hoping that the leadership radically changes the model long before we hit the debt capacity limit.

But the point is that I don’t think we are there yet. Debt levels are very worrying, and the structure of the debt – when you can actually figure it out – is even more worrying, but I believe we are not yet on the verge of a debt crisis…’

In fact, it’s unlikely there will be a debt crisis. China’s economic ‘miracle’ will end with an economy riddled with non-performing loans and underutilised assets. The authorities will then have to trade off short-term pain, in the form of unemployment and economic contraction (the American way), against dragging the adjustment out over 20 years and enduring a lost decade or two (Japanese style).

China’s leaders are likely to choose the socially acceptable later option. Whichever way it plays out, though, assuming the current level of demand for Australian resources is sustainable is very risky businesses. Assuming recent growth rates are sustainable is nothing but folly.

Note: Below I have linked to some interesting Michael Pettis references. If you find other useful material, add it via the comments box below.

Pettis’s China Financial Markets blog contains all of his recent thoughts. Recommendations include Big in Japan and Some Predictions for the Rest of the Decade.

FT Alphaville’s first (and only, as far as I can tell) podcast was with Pettis and summarises succinctly the entire landscape.

Then there’s China’s Debt Monster on the New York Times site and why we should Get Used to Slower Chinese Growth on the Wall Street Journal.

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