Finance and Econ From the Web: Leverage Loan Boom, Investors Lazy When Selling, True China GDP

There are some really good pieces on sustainability of high public debt (not always a mess), and the rise of leverage loans. On inequality, we get more confirmation of widening inequality, how universal basic income could work and how US tax cuts mainly helped US corporates. There’s a bunch of bearish articles on China, some ideas for Europe and the revival of Japanese  millennial buying power. I’ve also included some articles on the impact of changes in global trade including the impact of Brexit on the UK and the rest of Europe. Finally, on the financial markets side, a new study finds investors lose most money on poor timing of their selling (rather than buying), new ways to extract central bank expectations from interest rate markets and the odd behaviour of yield curves. In total, I have over 40 articles with short summaries, so make sure to read through to the bottom. Enjoy!

Debt Issues (5)

Debt machine: are risks piling up in leveraged loans?Describes how lev loans have gone above $1 trillion and most are cov—lite, that is do not have ongoing monitoring requirements. The FT articles makes parallels to the run-up in sub-prime before 2008.

Securities Laws and the Choice between Loans and Bonds for Highly Levered Firms In contrast to bonds, levered loans do not require SEC registration. This distinction plays an important role in firms’ choice between funding through loans and bonds and helps understand why the market share of cov-lite loans has increased so much. Compared to cov-heavy loans, cov-lite loans are close substitutes for bonds in that they have similar covenants, have tighter bid-ask spreads, have more trading, and are more likely to be used to refinance bonds than cov-heavy loans.

Is public debt a cheap lunch? Oliver Blanchard recently argued that public debt concerns could be overstated since most the time nominal growth is higher than interest rates. Indeed, this has been the case for the both the US and Euro-zone. This Bruegel pieces summaries the main responses to his thesis. The critics argue that rates have been artificially low due to financial repression, low productivity, Asian current account surpluses and low DM political risk – many of these could be turning. Others point to countries that have large primary deficits would still struggle and that the type of government spending matters. 

Public Debt Through the Ages Excellent IMF reviewing public debt from a long-term historical perspective (back to the Middle Ages!). They find periods when debt-to-GDP ratios rose explosively as a result of wars, depressions and financial crises also have a long history. Many of these episodes resulted in debt-management problems resolved through debasements and restructurings. But less widely appreciated are successful debt consolidation episodes, instances in which governments inheriting heavy debts ran primary surpluses for long periods in order to reduce those burdens to sustainable levels.

More than half of the U.S.’s largest cities are issuing bonds to protect against climate change Less federal and state assistance could lead to more cities turning to debt issuance to fund climate change protection

Financial Markets (5)

Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors Excellent paper that uses data from institutional investors with portfolios averaging $573 million. They find that investors display clear skill in buying, but their selling decisions underperform substantially – even relative to strategies involving no skill such as randomly selling existing positions – in terms of both benchmark-adjusted and risk-adjusted returns. We present evidence consistent with limited attention as a key driver of this discrepancy, with investors devoting more attentional resources to buy decisions than sell decisions.

Why do we bother with stock market forecasts? Research shows people see value in humility after recognising limited understanding when their forecast go wrong. Also in terms of consumers of forecasts, they  can avoid responsibility and blame the forecaster!

A Simple Macro-Finance Measure of Risk Premia in Fed Funds Futures  In markets, we use short-term US rates curves, such as the Fed funds futures contract, to extract the probability of a Fed hike. However, the curve also incorporates a term premia which needs to be adjusted for in order to arrive at the true expectations component. This Fed paper uses a new methodology to estimate the size of the term premia and finds it be around -1bps per month. So if the current Fed Funds is 10bps higher by the end of the year, then adjusting for term premia, it would be roughly 20bps, so almost a full hike is expected.
Weirdly Non-Monotonic Yield Curves Makes the useful observation that recently yield curves are strangely shaped: “ rates initially rising with the time horizon in the normal pattern, then turning aound and declining, then turning around yet again and rising again.” Answers on the back of a postcard as to why this is happening.

Covered Interest Parity Deviations: Macrofinancial Determinants Covered Interest Parity (CIP) argues that the implied interests from FX forwards should be very close to money market interests. However since the 2008 GFC, a gap or cross-currency basis has endured. Explanations forwarded by others include arbitrage limits due to regulation, change in bank balance sheet capacity when the dollar strengthens, and distortions in swap markets. The authors crunch the numbers and find that monetary policy divergence, dollar strength, corporate bond issuance, domestic risk factors and money market reform have all contributed to the widen in Xccy basis. The effects vary over time and across currencies

Fiscal Policy and Inequality (4)

The Trump Tax Cut Is Even Worse Than They Say The economy grew as the Trump administration expected from the stimulus, but the expected increase in tax revenues never materialised. The biggest shortfall in tax revenues was from corporates.

Global Wealth Inequality A review of recent literature on global wealth inequality. Both surveys and tax data show that US wealth inequality has increased dramatically since the 1980s, with a top 1% wealth share around 40% in 2016 vs. 25–30% in the 1980s. Including the rest of the world, the evidence points towards a rise in global wealth concentration: for China, Europe, and the United States combined, the top 1% wealth share has increased from 28% in 1980 to 33% today, while the bottom 75% share hovered around 10%. Recent studies, however, may under-estimate the level and rise of inequality, as financial globalization makes it increasingly hard to measure wealth at the top..

Is India ready for a universal basic income? “Unlike farm loan waivers, universal basic income (UBI)  does not impair credit culture and, unlike farmer-specific transfers, does not seek to tie down people to farming” Good article describing some of the practical dimensions of introducing UBI

Eradicating homelessness in Finland: the Housing First programme In 2007, Finland set itself the target of eradicating homelessness by 2015. It didn’t achieve that lofty goal, but did cut it by one-third. They achieved this by offering new housing with mobile support teams.

All Things China (6)

Ken Rogoff warns China slowdown could be its ‘Minsky moment’ The Harvard prof said: “There will have to be a de facto nationalisation of large parts of the economy. I fear this really could be ‘it’ at last and they are going to have their own kind of Minsky moment,”

What Is GDP In China?  Michael Pettis runs through the problem of China GDP. He shows three very different ways that reported GDP can fail to reflect the underlying economy.The first set of problems relates to the meaning of GDP itself. The second set of problems has to do with how carefully and faithfully Chinese statisticians at the National Bureau of Statistics are calculating the agreed-upon elements that go into measuring GDP. The third set of problems with GDP occurs in a very limited number of cases globally (today, China is the main example).

Chinese President Xi Jinping warns against ‘black swans’, ‘grey rhinos’ amid economic downturn I call them “grey swans”, he calls them “grey rhinos”, but either way we seem to be on the same page J

Will China’s Currency Hit a Wall? Author worries about China’s slowing economy in 2019, not its balance of payments…

China vs. U.S.: IMS Meets IPS Currently both the International Monetary System (IMS) and the International Price Systems (IPS) are dominated by the U.S. The emergence of China, both as reserve currency and as a currency of invoicing, is likely to disrupt this status quo. The authors  provide a framework to understand the forces that will shape this transition and identify sources of instability. They highlight the risk of an abrupt shift triggered by a run on the dollar.

Academic Papers Written to Commemorate President Carter’s 1979 Decision to Normalize Relations with China Good background on changing US-China relations since 1979. Contains a series of papers on different topics like Taiwan, Chinese Americans and China and financial system engagement.

European Matters (5)

The implications of no-deal Brexit: is the European Union prepared? The author, based on a note written for the Bundestag EU Committee, is exploring the possible consequences of a no-deal Brexit for the EU. Argues that in the short-term “There would be immediate very significant administrative and logistical challenges in trade” but “the effects of a no-deal Brexit in the medium to long term are difficult to assess. “

Trans-Atlantic Scorecard – January 2019 Brookings regularly updates the health of relations between the US and Europe. The current score is 3.5 out of 10. Not great. 

What Changes Will the EU See in 2019? Wharton professors discuss their concerns. They include: “The Union has to come to grips with how it is going to work effectively with 27 countries at the table, or 28 maybe (if Brexit does not materialize) – who knows. Who exactly is in charge?” and “ the biggest concerns for the EU in 2019 are its relationship with the U.S”

Retooling Europe’s economy Author argues that Europe is at risk of falling behind its global competitors. In a period of radical technological transformation, European firms are investing too little, with a gap both in tangible and intangible investment compared to the US. This column calls for a ‘retooling’ of Europe’s economy in relation to skills, innovation finance, the business environment, infrastructure, and deepening the Single Market.

Analysis of developments in EU capital flows in the global context Very thorough analysis of capital flows commissioned by the European Commission. Over 200  pages that looks at country-by-country flows to trends in European equity finance to capital controls.

Growth Cycle and Monetary Policy (6)

Does Ultra-Low Unemployment Spur Rapid Wage Growth?  The unemployment rate ended 2018 at just under 4%, substantially lower than most estimates of the natural rate. Could such an ostensibly tight labor market lead to a sharp pickup in wage growth from its recent moderate pace, such that the relationship between wage growth and unemployment is not always linear? Investigations using US state-level data show no economically significant nonlinearity between wage growth and unemployment that would predict an abrupt jump in wage growth

A better way to anticipate downturns A 2010 report from McKinsey. Discusses importance of looking at credit measures.

Japan’s optimistic millennials shed frugal habits and lift spending “ For Japan’s young people, among Asia’s most cautious consumers for some years now, the pessimism that weighed on their spending is lifting in places as the country experiences its longest run of economic growth in decades.”

Pass-through at mildly negative policy rates: The Swedish case It has been suggested that the response of bank lending rates to interest rate cuts may become weaker when the policy rate passes below a certain level. This column argues that in the case of Sweden, the pass-through of policy rate cuts below zero to the economy has been reasonably good and monetary policy has been effective even at negative policy rate levels.

Facts that contradict the standard housing bubble story Tyler Cowen summarises the key points from Kevin Erdmann’s new book “Shut Out: How a Housing Shortage Caused the Great Recession and Crippled Our Economy”. The facts include “Home prices in many developed countries rose at least as sharply as in the US” and “During the boom, the relative income of the typical homebuyer did not decline.”

These are the biggest risks facing our world in 2019 World Economic Forum picks its top 10 global risks: #1 extreme weather #2 failure of climate change mitigation, #3 major natural disasters.

International Trade (6)

Trump’s Japan Agenda Shows the Pitfalls of His Trade Strategy Argues that Japan may not accept US demands from a bilateral deal. Yet, had the US remained in TPP Japan may have made concessions to the US as they could get offsetting concessions from other parties to TPP.

The impact of Brexit uncertainty on UK exports “ during a renegotiation in which tariff hikes are possible, two forces act upon a firm’s entry decision: an increase in uncertainty about future tariff rates…and the non-zero probability that higher `threat point’ tariffs could materialise…the authors estimate that 5,344 firms did not enter into exporting new products to the EU in 2016 [due to Brexit fears], whilst 5,437 firms exited from exporting products to the EU in 2016”

Macroeconomic Consequences of Tariffs IMG paper uses annual data that spans 151 countries over 1963-2014. They find that tariff increases lead, in the medium term, to economically and statistically significant declines in domestic output and productivity. Tariff increases also result in more unemployment, higher inequality, and real exchange rate appreciation, but only small effects on the trade balance. 

Global Value Chains: What are the Benefits and Why Do Countries Participate? Using data for 189 countries, the IMF  finds that GVC-related trade, rather than conventional trade, has a positive impact on income per capita and productivity, however there is large heterogeneity and the gains appear more signifcant for upper-middle and high-income countries. We document that “moving up” to more high-tech sectors while participating in major supply chains does take place but is not universal, suggesting other factors matter.

Economic Theory (5)

Economists Need to Add a Little History to Their Tool Kit  Noah Smith argues for the case that economists need to learn more history and less maths.

2% inflation changes everything Good description of central regimes. Sumner argues that the past 100 years of US history featured three macro regimes: 1. Commodity money, with alternating periods of rising and falling prices. 2. Unanchored fiat money, with rising and falling inflation rates. 3.  2% inflation targeting. He argues that low inflation today means more aggressive “populist” stimuli can be deployed.

Minding Your Ps and Qs: Going from Micro to Macro in Measuring Prices and Quantities Excellent piece on the plumbing of economic statistics. In the US, the Census Bureau collects nominal sales, the Bureau of Labor Statistics collects prices, and the Bureau of Economic Analysis constructs nominal and real GDP using these data and other sources. The price and quantity data are integrated at a high level of aggregation. This paper explores alternative methods for re-engineering key national output and price indices using item-level digital data.

An Ungoverned City Can cities function without a government? The column describes, Canaan, Haiti, where residents are giving it a try.

All you need to know about the drivers of capital flows Good summary of the various capital regimes in EM since the 1990s. It goes through the push/pull factors affecting flows with the latest being unconventional monetary policy from advanced economies.


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