walkitout (walkitout) wrote,

HSBC, Titanic analogy, weird analysis

TL;DR territory here with no executive summary possible. Probably skip this, unless you think listening to wonks is fun.

I'm not blaming the BI person who summarized this (I haven't read the underlying piece, so I'm assuming he has done a competent job -- if I find out otherwise, I'll update this). I'm poking at the underlying analysis that he is summarizing.


No, it is _not_ the horror novelist. It is Chief Economist over at HSBC. I'm getting so irritated at some of these let's-angst-over-the-economy pieces that I think I'm going to start deconstructing them to show why they are so foolish.

There are, in general, two memes? tropes? that economists love to drag out when thinking about "the next recession". (I'm ignoring inflation is coming! because that was stupid and it is now Over, since the Eurozone actually went back into deflation for a while.)

(1) If the Fed can't manage to raise rates, how will they lower them during the next recession? Lowering rates seems to be the only tool imaginable to these economists. You'd think they were living in 1840 or something, with vestigial national governments that did nothing other than collect excise taxes and fund the military, and courts that routinely struck down income taxes as unconstitutional.

(2) Stock prices are generally a multiple of the underlying companies profits (P/E = price to earnings). The multiple is considered a sort of "how do we feel about the future" indicator, so if earnings rise, the price will tend to rise to maintain the same multiple UNLESS people's feelings about the company, the business environment, the economy in general change in a positive (leading to higher multiples) or negative (leading to lower multiples) direction. For a while now, earnings have been rising so the stock market has been going up. The stock market going up in the wake of a bad recession (such as what we had in 2008) triggers all those negative feelings that people have when something _good_ happens, after a major loss (grandma died, type of thing, followed by new boyfriend will tend to make someone superstitious and twitchy that the new boyfriend Can't Last). The meme, in this case, is that current stock prices reflect a belief that corporate earnings will continue to rise (future earnings), and this belief will prove false and stock prices will come back down into line with the "correct" multiple of actual (i.e. trailing) earnings. This particular analysis is focused on the idea that wage growth will cut into corporate profit, reducing earnings, leading to stock prices coming back down, followed by a crash.

Both of these memes are present in this analysis. Here's why these memes are silly.

(1) There are other, better options for juicing the economy, than lowering rates. This hyperfocus on a single, crude intervention is, in fact, the cause of most of our woes, pre-bust and post. We talk about those other, better options, but rarely implement them (viz. infrastructure funding).

(2) If wages rise, then presumably labor will have more money to spend on goods and services. More money to spend on goods and services should translate to more business done by business: more sales, more revenue, more profit. Not all corporations will benefit equally, obviously. But asserting that you could have wage growth WITHOUT increases across the board in sales, revenue, profit is essentially an argument that corporations make the most money when they are selling less and have less revenue. Which is pretty fucking bizarre argument. It can happen in particular companies, but it shouldn't happen across an entire economy. It would be super weird if it did (and would probably imply that we'd crossed NAIRU a long time back and accelerated, so basically, Wage Growth = Lower Profits is a disguised inflation argument).

The argument has a few more points.

"Non-bank financial systems like insurance companies and pension funds will increasingly not be able to meet future obligations. This will cause a huge demand for liquid assets, forcing people to rush to sell despite no matching demand, triggering a recession."

The financial status of insurance companies, pension funds and other Stuff that has future obligations is driven almost entirely by the state of the economy and markets as a whole. If asset prices are low, they go under. If asset prices are high, it looks like no one will ever need to contribute a dime again (see: 2007 coverage of college endowments and how they would have more than enough money forever and ever and maybe they wouldn't even have to collect tuition any more). Saying they will not be able to meet future obligations is roughly equivalent to (a) asserting that we would decline to save our economy if threatened by a Systemically Important institution failing (b) our increased regulation of Systemically Important Institutions has been for naught and (c) there could possibly be any more demand for liquid assets than their already is. None of these three propositions is at all plausible.

"Forces beyond the Federal Reserve's control, including the possibility that China's economy and its currency could collapse. Weak commodity prices could also cause collapses in several emerging markets, as could continued strength in the US dollar."

This one is a little incoherent. First, it's fucking _hilarious_ to think that China's currency could collapse. It can't collapse. If the state quit manipulating it, it might _soar_. This is like sitting on a powerful spring for days and saying you dare not get up off of it, because it might _not_ go SPROING. Silly. Weak commodity prices almost certainly _are_ causing collapses in at least one emerging market (poor Venezuela!), altho it is unclear how that is any kind of risk outside of those particular markets.

Continued strength in the US dollar is an _interesting_ risk to point out. The issue here is that people borrow money in USD (or Euros), even tho they do business in something that sounds like real/rial/yen/yuan/won. That's great, when the real/rial/yen/yuan/won buys more and more dollars on foreign exchange markets. It sucks rocks through a coffee stirrer when the real/rial/yen/yuan/won buys fewer and fewer dollars on foreign exchange markets. Basically, someone might not be able to pay back their dollar denominated debt. I don't _think_ that this is a systemic risk, but I actually don't know. I'll tell you this, tho. You'd be hard pressed to find someone with a lot of dollar denominated debt that didn't also have a lot of Euro denominated debt, and the Euro denominated debt moved in the opposite direction from the dollar debt, so what HSBC's Stephen King is worried about is that a lot of somebodies out there had too much dollar exposure. Doesn't sound so worrisome any more, now, does it? I mean, who the fuck has unhedged risk in Forex these days? (Okay, the Swiss deciding to unpeg _was_ a surprise, so surprises can happen, but this particular surprise seems pretty damn unlikely to be a surprise.)

"The Fed could cause the next recession by raising interest rates too soon, repeating the mistakes of the European Central Bank in 2011 and the Bank of Japan in 2000."

I could almost forgive Stephen King the rest of this nonsense, because _this_ actually is the real risk.
Tags: economy, politics

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