Monday, June 29, 2015

A Greek default does not rise to the level of a systemic risk

Greece is out of money, and its current government and economic policies are not supportive of a lasting solution. All the money it's borrowed has been wasted, flushed down the statist drain, in order to support Greece and its citizens in a style they can't afford. What's happening now is like musical chairs: when the Greek music stops (coming soon), someone (e.g., the EU, ECB and IMF) is going to have to record the loss on their balance sheet. The question is not whether Greece will default, but how it will do it and who will pay the eventual price.

Meanwhile, despite the strong likelihood that Greece will not find a lasting solution in the coming days, financial markets are not displaying any signs of distress. To be sure, there is lots of worry out there, but markets are still quite liquid and functioning normally. This makes sense, because a Greek default is not an earth-shattering event that comes out of the blue. It's been a long time coming, and Greece is a very small cog in the global financial markets.

The chart above shows 2-yr swap spreads in the U.S. and Eurozone. At current levels, swap spreads are well with the zone of normality. As such, they are saying that financial markets are liquid, and systemic risk is low. If a Greek default were a serious threat the stability of the Eurozone financial system and economy, swap spreads would be much higher—like they were when the PIIGS crisis reached a peak in late 2011.

The chart above shows the Vix index, a barometer of the market's level of fear, uncertainty and doubt. It's jumped up from 12 to almost 20 in the past six days, and that's telling us that markets are worried that something might go wrong. But if this were a really serious worry, the Vix would be a lot higher than it is today.

Putting the two together, it's obvious that markets are nervous, but it's comforting that there is virtually no sign that an unpleasant resolution to the Greek crisis presents any threat to financial markets or even the Eurozone economy.

If anything, a painful resolution to the Greek crisis would be a reminder to other countries that unproductive economies with bloated and inefficient governments are unsustainable and ultimately very painful for everyone. The best solution for Greece would be to grow its way out of debt, by reducing the size of its government and adopting pro-growth economic policies.

Friday, June 26, 2015

Healthy consumers

As a postscript to my post earlier this weekend (Healthy households), I offer updated versions of the following charts that illustrate the dramatic improvement in consumer finances since the Great Recession:

The 2008 financial crisis and deep recession taught consumers that having a lot of credit card debt was not a smart thing to do. Credit card debt outstanding now is about the same as it was 12 years ago, despite the fact that personal incomes have increased over 60% since 2003. As a percent of personal income, credit card debt was 7.4% in 2003, and it fell continuously to a low of 4.5% today.

By eschewing credit card debt, consumers have become much less likely to be delinquent on their credit card debt payments. Delinquency rates are as low as they have ever been since data was first collected in 1991.

With lower delinquency rates, it is not surprising that credit card companies wrote off only 3% of their outstanding loan balances in the first quarter of this year. That was the lowest chargeoff rate since 1985.

Today's consumer is a lot smarter, and a lot more careful with taking on debt. This reinforces the theme that I've been emphasizing for years: the Great Recession was so traumatic that its memory still lingers, making this the most risk-averse recovery in modern history. Risk aversion has been one of the hallmarks of this recovery, and that is one of the reasons why the recovery has been so tepid. It is also a good reason not to fear another recession: optimism is in short supply. The time to be worried is when everyone is optimistic and taking on lots of risk.

Thursday, June 25, 2015

Relative price "inequality" continues

In light of the persistent media focus on income and wealth inequality, which has surged since the publication of Thomas Piketty's Capital in the Twenty-First Century, and about which I and many others have written in protest, I can't help but highlight an under-appreciated and continuously growing gap between the prices of durable goods and all other things under the economic sun. The chart says it all:

The data for this chart comes from the BEA's calculation of the price deflators for Services, Non-durable, and Durable Goods. Prior to 1995 there were times when some prices grew more or less than others, but post-1995 is the first time since the Depression that the prices of some things fell continuously while others rose.

The likely culprit for two decades of persistent deflation in the durable goods sector? China comes to mind, along with huge leaps in technological progress. In the process of industrializing and modernizing its economy, China figured out how to make things much cheaper than anyone else in the world by using Western capital and technology to greatly enhance the productivity of hundreds of millions of its workers that were formerly vastly underutilized.

Is this a bad thing? Well, let's think about it.

Consider this quick and dirty analysis: The deflator for Services is a decent proxy for real wages, since the service sector of the economy is far larger than the manufacturing sector and the major component of services is labor. As proof, I note that real personal income over the same period as the chart rose by 73%, only slightly more than the 66% rose in the prices of services. Now compare the 66% rise in the price of services to the 32% decline in the price of durable goods. That huge and "unequal" gap means that a unit of work today for the average person buys him or her 2.44 times as much in the way of durable goods as it did in 1995. Put another way, the prices of durable goods on average have declined some 60% relative to incomes.

While grossly "unfair" to US businesses individuals engaged in the manufacture of durable goods, this huge, unequal and growing gap in prices has been the biggest boon in history to nearly everyone else. Thanks to this rising inequality, just about everyone you see on the streets today carries a smartphone, a device capable of feats that were unimaginable two decades ago, and which can be bought for about two week's worth of work at the prevailing minimum wage. Meanwhile, thanks to its export earnings, China today is importing roughly 15 times as much from the US as it did two decades ago.

Inequality of wealth and prices is everywhere these days, and thank goodness. Andy Kessler in today's WSJ reminds us that great inequalities of wealth almost necessarily spring from great advances in technology, manufacturing, services and general productivity.

A company’s profits are the minimum value of the work it does for you and for society. Google, to take another example, generates huge profits. CEO Larry Page has an estimated net worth of $30 billion. But Google offers you a valuable service, and society benefits to the tune of trillions, yes trillions, of dollars in commerce that happens thanks to Google searches, mail and maps. Similarly, an iPhone 6 is worth a heck of a lot more than $600; you can hail a car, trade stocks, call your mom, all without being chained to a desk. 
Everyone should stop focusing on an entrepreneur’s wealth and instead focus on the value the customers gained from his products. I can’t dig for oil, let alone frack, but I am happy to pay Exxon a premium for my high-test gas. Collectively, we are richer because of Exxon. So inequality is not a bug of capitalism; it’s a feature.