World Economy Unbalanced: What will Crash Next?

Today, I talked to a young woman who was convinced Real Estate was the secret to untold riches.  She told me that the market was appreciating rapidly so she was becoming an agent.  I smiled, and left her to her dreams.  Later, I reflected on other people who told me similar things.  Right before the Real Estate crash in 2007, several of my acquaintances told me they were becoming mortgage loan officers, bulk mortgage securities traunchers, or even real estate agents.  All of them were attracted to the perceived easy money in the field.  Some of them were very unlikely candidates to occupy white collar job titles.  One was a hot water heater installer, another operated a print shop, and some were indigent.  Reminds me of Joe Kennedy's shoe shiner. 

The conversation with the young woman brought back those memories from a decade ago.   Like the other acquaintances, she was an unlikely candidate. The last I knew she was going to Graduate school, yet today she showed up married and on the trail of easy riches in Real Estate.  The Real Estate market in Portland OR has boomed back compared to the dark days of 2009.  People are moving to Portland, so they will drive the price of housing up.  However, this conversation showed an overall weakness in the economy.  I perceive a bubble in Real Estate because unlikely people are flocking to the industry.

Let's take a look at major problems:

Gold Prices go down steeply

Wholesale Prices Decline in US for 4 Months

Dollar's Value Surges

Oil Prices Drop Again

Stock Prices Decline for a Third Week

Fears of Destructive Deflation

Tech Stock Bubble (Whenever someone says no bubble, there really is)

Student Loan Bubble

Easy Mortgage Loans  (Real Estate bubble reforming)

Negative Sovereign Debt Interest Rates



Mike Bird from Business Insider has an interesting theory.  He thinks a strong dollar is leading to some kind of financial market crash.  And his rating of strong dollar really means incredibly strong dollar.  He has a chart that shows a strong US Dollar related to major events. 

 From Business Insider

The strong dollar prior to Lehman Brothers being allowed to fail was weaker than today's dollar.  The failure of Lehman Brothers led to the mortgage melt down.  Mike Bird's theory has merit, but not entirely for the reason of his chart.

Part of the Kondratiev and the end of a Kuznets cycle is the prediction of deflating prices.  Perhaps the Keynesian interventions in the US and foreign economies held deflation at bay, and today's strong dollar is a symptom of delayed problems. 

We are at a perfect alignment of several forces, as seen by the links to various pieces of the economy that are showing weaknesses.  In any event, several possibilities exist:

• Nothing will happen.  The dollar will continue stronger, and then grow weaker.  People will be happy as the prices of their groceries go down, but something will happen that makes prices higher.
• The government will intervene and this crisis will fade.  The Fed will raise rates, or change money policy.  Perhaps the government will rescue an industry.
• Something will break.  Several possibilities exist, none of them palatable:
• Stock Market Crash
• Interest Rate Increase
•  Financial market system freeze or collapse
• Destructive Deflation Cycle begins
• Other events may occur that are not predictable.

  Under any analysis or scenario, there are too many places where the macro economy is going wrong.  Once we get past the merge point of all these crises, we will know and understand why the dollar is so strong today.  We are definitely in uncharted waters, and caution should be the watch word of the day.

Market Watch Misses the Mark

I was reading Market Watch where Cody Willard made a short-sighted statement.

He said,

"Oil's collapse has been a function of cyclical oversupply after a long boom/bubble period, and that such a drop in energy prices is decidedly not deflationary."

Perhaps oil's decline is more about supply and demand than deflation.  That is possible.  However, energy prices underlay every sector in the greater economy.  The effects of such a drop in oil prices will be deflationary because prices in all industrial sectors will become lower.  The reduction in asset values for oil companies who had to list non-produced oil at $95 a barrel due to SEC rules will lead to deflation on some small scale.

On the face of it, his statement is correct, but ignores the larger picture.

An additional interesting conclusion from his statement indicates that the Kondratiev and Kuznets long economic cycles are alive and well.  A lack of demand is a classic symptom of Kondratiev winter.

I think the lower oil prices will create temporary deflation.  I don't think we'll get a destructive spiral.

Mixed GDP results: Deflation is Winning

You might be wondering  what inflation and GDP (Gross Domestic Product) growth have in common.  The two measures are different, but connections between the two exist.  If GDP is not adjusted for inflation, then inflation becomes part of the GDP growth.  If an economy grows at a real GDP rate of 1% with an inflation rate of 1.5%, then the GDP will grow at a 2.5% rate.  Most economies need a reasonable amount of inflation to maintain a healthy growth level.  A gradual rise in prices helps economic activity.  At the same time, if an economy has a deflation of 1.5% with a growth of 1%, then the economy will shrink by 0.5% in nominal GDP.  Deflation, just like inflation, tends to spiral to higher and higher levels. 

The biggest danger in deflation is that debt takes on a higher value, and capital assets (like your house) take on lower values.  As debt becomes more valuable, and assets are worth less, people tend to get paid less, thus weakening the economy even more.  This is a spiral, and each time the cycle repeats, values become lower and lower. 

An era of deflation makes sense when the current Kondratiev cycle tapered in stagnation while waiting to generate a new cycle.  The Kuznets curves indicate that infrastructure is not growing right now, and that is reflected in the current low oil prices.  The Saudi Arabians need more defensive hardware, so they are forced to sell their oil even in the face of market saturation.  Or the doomsday theorists think the Russians or the Saudis want to shut down the oil shale business.  Oil shale costs a lot to exploit and low oil prices mean the market value of the oil will not exceed the cost of production.  Either way you cut the argument, we are in an era of economic dysfunction.

I'm reading a lot about very modest GDP growth the world over.  Articles never seem to note if they are using real GDP (Amounts adjusted for inflation) or if they are using nominal GDP.  Usually when comparing GDPs, economists will use real GDP. Most nations seem to be posting very mild GDP growths, all under 1%.  Japan seems to have whipped their recession for now with a GDP growth of 1.5% annualized.   India, whose other distinction is being an emerging economy, is posting 7 - 8% growth.  This is actually mild because an emerging economy should post over 10% growth.

The US has mixed economic news.  A Wall Street Journal article points to stronger results in GDP due to increases in health care spending. Another article points to oil companies counting their assets at $95 per barrel, rather than the real oil value of $48 to $58 per barrel today.  In itself, this development could create deflation.  Other sources stated that China is facing the deflation specter, and the same source talked of larger economies like the US, Germany, France, etc. having similar problems.  The fear of deflation is raising its head in large economies that shouldn't be concerned.  

The most potent weapon in the Central Banks arsenal for fighting deflation is decreasing the spot interest rate.  This is the so called over night rate banks pay for transfers between each other.  Central Banks reduce this rate to zero, or close to 0, in the face of negative economic news in the hopes of stimulating the economy into growth.  However when this rate goes to 0%, the Central Banks, in a rational world, can't lower the rate anymore.  Or can they? Several sovereign debt issuers have lowered their interest rate to a negative amount. This means for every $1,000 invested, the return is less, perhaps $990. 

The synthesis of these facts reveal a world economic system that is still reeling in the face of the Great Recession of 2007-2009.  I believe the Great Recession is a symptom of a Kondratiev long cycle coming to an end because the root cause of the Recession was an asset devaluation and crash of the banking system.  The long wave cycle will have to play out prior to prosperity, as seen in the late 90s, returns. 

My short term suggestions are divest energy companies, and balance your portfolio so you have plenty of diversity.  Right now is a hard time to tell which companies and industry sectors will do well in the coming few months. 

Innovation vs. Differentiation

I'm seeing a lot of press on the new Apple watch.  I love seeing new technology, and even better scoring new technology for my personal use.  I hear some of the Apple watches will cost thousands. 

Perhaps prices as rich as that reflect excitement for the new wearable technology. 

The last few large product introductions Apple rolled out are mere differentiation rather than innovation.  For example the iPhone 6 and 6+ both seemed to build on the success of the Galaxy line of phones.  while the 6 and 6+ were likely innovative for Apple, they seem to be a method to hold on to a limited product market.  The same is true of the watches.  Ebay has plenty of blue tooth watches that will work with any phone, 2,281 for sale on March 8th.  Apple's will be fancier, cooler, and designed better than the examples on E-Bay, but functionally will be similar to what came before.  Apple seems to be trying to catch up to Samsung, because an Apple Watch seems to be a direct parallel of Samsung Gear.  Coincidentally Samsung Gear is Samsung's line of already introduced watches.

This means the innovation cycle is starting to peter out for phones and phone tech just like it has for desk top computers.  By the way, desk top style computers are supposed to post a 1% increase in sales this year, which proves the form factor is still needed.  Everyone who needs a desk top computer now has one, and sales are based on broken or time obsoleted computers. 

I think Berry, Kim and Kim (1993) expressed this trend well:

 Preservation  of market  share  emerges  as a key issue,  and  investment  shifts  from  innovation
to  product  differentiation  in  the  attempt  to  create  and  protect  market  niches.  Image  is all
important  in  the  process  of  introducing  “new  and  improved”  products.

The phenomena of differentiation emerges once innovation has run its course. 

Everyone should enjoy the excitement the genius marketing promotion Apple will start.  Teh energy will be wonderful, but the long and short of it is that Apple's new  product will be differentiation rather than innovation.

On an interesting side note, Berry, in his book, Long-Wave Rhythms in Economic Development and Political Behavior predicted the Great Recession of 2007-2009 based on the conjunction of Kuznets and Kondratiev cycles in 1993. 



 Berry, B. J. L., Kim, H., & Kim, H. (1993). Are long waves driven by techno-economic transformations?: Evidence for the U.S. and the U.K. Technological Forecasting and Social Change, 44(2), 111-135. doi: 10.1016/0040-1625(93)90022-Y

Lenovo Thinkpad Tablet 2, ca. 2012 +/-

Yes, I'm a certified antique.  Just ask my family.  In these days of product differentiation rather than product innovation, I find being a late adopter is really inexpensive compared to the early part of the product life cycle curve.

With me, everything is a process.  I own a really nice Galaxy Tab 3 10.1" 16Gb tablet.  I like the tablet a lot, but Samsung's bloat ware is killing an otherwise good product.  I found that my tablet was running out of memory all the time, and some of the reason was due to the Samsung apps I had no need for.  I love the size for reading scientific papers while sitting in comfort, but running out of memory all the time revealed that I needed a more capable tablet.  With that said, I had a variety of needs to fulfill.

• I'm handicapped (I like to think mildly, but if you met me you would see the problem quickly).  Since I'm handicapped, the weight of a good laptop gets heavy.  Therefore, I needed something light.
• I needed something on the small side, because I like to carry a small messenger bag.  
  
  
  
• While Android is a great Operating System, based on my favorite Linux, I would like a tablet with more connectivity to my Brother multi-use printer.  An OS with a little more power would be nice.  Android never worked right even with the Brother App loaded and running.
• I want to be able to hook the tablet up to projectors or conference room video systems for work and presentation.
• Some kind of dock would be nice too, I like to be able to set up my tablet neatly on the desk and hook into video, network, etc.
• I wanted to stick with a tablet because I don't always need a keyboard.
• I have a Lenovo Thinkpad addiction

I went to Best Buy.  They had a variety of laptops, ultralights, and tablets.  I checked out the laptops, but they seemed expensive, particular compared with capable older laptops.  They had a really nice Yoga Tablet that came with a keyboard, but it was only 32Gb, and I was worried about running out of memory.  I decided that the Internet would give me a better insight into what I needed.  

I found an interactive tablet guide on the Internet, and the process of answering questions helped me focus my needs on a specific type of tablet.  I can't find the web site now, but any site that explains tablet specifications category by category will help.  The answer was startling.  Without knowing it, I wanted a Windows tablet because I have an Excel habit.  I also discovered I am better off with a full sized usb connector, and an hdmi connection.  The tool thought I would like a Lenovo tablet called the Tablet 2.  I found this odd, since the tablet wasn't manufactured anymore.  Checking into places to buy it, I found a new one cost $300.  

I wound up finding a refurbished one complete with keyboard on Ebay.  The price was reasonable, so I bought the tablet.  I'm impressed by the tablet. 

Windows 8.1 works flawlessly (this is a Windows Flawless, not a Linux Flawless aka perfection), and I can hook the tab up to my network printers.  I can also use the full sized USB slot for a full sized keyboard.  I found a dock for the device (easier said than done), and I like the way it charges quickly on the dock.  Windows 8.1 on a touch sensitive surface works really well.  And I like the concessions made for people who grew very used to Windows XP. I like being able to use familiar programs like Calibre.  

All in all, I think this is a great replacement for the Samsung tab.  I like getting something top of the line, even though it is an older model.  This one is working well for me, would anyone like to buy a lightly used Samsung galaxy Tab 2 10.1"?