World Dollar Liquidity Crashes as Does Marginal Utility of Debt

-edited

Lacy Hunt at Hoisington Management has another sterling post in its third quarter review and outlook.

Here are some snips from the latest Hoisington Management Quarterly Review by Lacy Hunt.

World Dollar Liquidity

The Fed’s balance sheet constriction reduced world dollar liquidity, which is defined as the monetary base plus foreign central bank holdings of U.S. Treasuries at the Federal Reserve Bank in New York. This quantity effect also served to underpin strength in the U.S. dollar, which has had the result of draining foreign central bank holdings of U.S. Treasuries impacting foreign financial markets.

World Trade Volume

The more restrictive monetary conditions spread worldwide as the velocity of money fell sharply in all their countries to levels far below the United States. Not surprisingly, global economic growth moderated in concert with U.S. economic moderation. World trade volume, which has fallen over the past year, clearly points to the universal nature of current global downturn and the result has been a disinflationary pricing of goods.

Debt Overhang

Despite the evidence that monetary policy works with long lags, the Fed appears to be waiting for a downturn in the coincident economic indicators before attempting to “get ahead” of where the market has priced interest rates. The lags between initial inversion and recession have been variable but the market is presently within the historical lagged periods. The current overrestraint of Fed policy is why 5, 10, and 20-year Treasury security yields have not set new record lows, but it is only a matter of time.

Slumping Marginal Revenue Product of Debt

For the current three-year period, using the partially available data for 2019, each dollar of global debt generated only $0.42 of GDP growth in the major economic sectors, which was down 11.1% from ten years ago. This deterioration was greater in all the major foreign economies than in the United States.

The largest percentage decrease in debt productivity, of more than 38%, was registered in China over the past ten years. The decline in the marginal revenue product of debt in Japan, the United Kingdom (U.K.) and Europe were all more than two and one-half times greater than in the United States. Over the current three-year period, the debt productivity in the U.S. was $0.40, versus $0.38, $0.36 and $0.34 in the Euro currency zone, the U.K. and China, respectively.

Outlook

The global over indebtedness has clearly restrained growth, and therefore has had a profound disinflationary impact on every major economic sector of the world. This fact, coupled with an overzealous U.S. Central Bank have created the conditions for an economic contraction in the U.S. and abroad. This has also created a worldwide decline in inflation and inflationary expectations.

A quick and dramatic shift toward greater accommodation by the Fed could begin to shift momentum from contraction toward expansion. However, policy lags are long and slow to develop, therefore despite the remarkable decline in long term yields this year, we are maintaining our long duration holdings. A shift towards shorter duration portfolios would be appropriate when the forward-looking indicators of expansion, in the U.S. and abroad, begin to appear.

Quiet Bond King

I am pleased to have Lacy Hunt as a friend. We chat frequently.

Hoisington has been at the long end of the curve, and accurately so, for long time.

Last year, Lacy informed me that Hoisington's average duration was 20-21 years.

I asked again this morning, and got the same answer. Hoisington's average duration is still 20-21 years.

When Lacy shifts duration dramatically lower, it will represent a major tuning point for bonds.

I expect that is still off in the distance.

Meanwhile, please recall all the accolades given to the alleged "bond king" Bill Gross.

Yet, how many incorrect bond market tops did Gross call?

The quiet bond king all along has been Lacy Hunt, seeing no notoriety or fame, but deserving both.

Mike "Mish" Shedlock

Comments (39)
No. 1-18
Bam_Man
Bam_Man

Kudos to Lacy Hunt and Hoisington for their masterful understanding of the global debt situation.

Casual_Observer
Casual_Observer

Bonds have outperformed stocks the last 1+ year and may do so for 2019 as well. The issue this time around is we face a debt supercycle the likes have which hasn't been seen. How much debt can the system take ? Productive debt is dwindling and it takes more dollars to generate less growth. This is not productivity growth but just growth period.

ElPendejoGrande
ElPendejoGrande

If we win any harder, I'm gonna need a barf bag!

RobinBanks
RobinBanks

The IMF are finally waking up to the corporate $19 trillion corporate debt time bomb.

Larry Elliott is always worth following. Pro-Brexit even though he works at the Guardian.

Tony Bennett
Tony Bennett

Lacy Hunt?

I am an unabashed Groupie.

Consistently on the mark. AND backs his work with numbers. Not guesses.

Kudos

KidHorn
KidHorn

Maybe the FED needs to do more Not QE'ing.

AWC
AWC

All fine, as long as one believes there will always be a greater fool to sell that 20 year duration to?

Provided, that is, that the exit doors aren’t nailed shut when “fire” is yelled?

STB Fatman
STB Fatman

The marginal utility reduction for Chinese debt, given the numbers shown in the table, is 47% not 38%

Maximus_Minimus
Maximus_Minimus

The GDP-to-debt rations must be total debt outstanding; otherwise the numbers wouldn't add up? Regardless, more debt produces less and less GDP. And to create more debt, requires lower and lower interest rates. There is some logic there, but I can't see it.

Greggg
Greggg

Cheap money was just begging for a place to be wasted for years, so here we are kiddies!

LB412
LB412

If the Chinese liquidated $41B of USA treasuries last month wouldn't that mean they collected $41B in USD, which might be held in reserves not at Fed banks? Honestly... not exactly sure how this works.

Harry-Ireland
Harry-Ireland

Mish, Any chance of a co-authored piece by you and Lacy Hunt on the future of interestrate politicies in both Europe and the US?

truthseeker
truthseeker

Mish did you happen to ask Lacy his opinion on price of gold?

Mish
Mish

Editor

was on the road today - sorry for the late replies

Maximus_Minimus
Maximus_Minimus

"Meanwhile, please recall all the accolades given to the alleged "bond king" Bill Gross. Yet, how many incorrect bond market tops did Gross call?"

Not to mention the Reinhart-Rogoff magic spreadsheet, that self-corrected for errors about which "policy makers wanted to know more."

RB2
RB2

Thanks sheds a great deal of light on the mismanagement of the fomc. Since 2008 it has been clown car of silly actions.

KidHorn
KidHorn

You can't measure the effectiveness of debt in terms of how much the GDP grew vs how much debt went up. You probably could prior to about 20 years ago. But, now debt doesn't just boost GDP, it also keeps GDP from collapsing. So, in order to determine its effect on GDP, you would have to know how much GDP would have contracted without the added debt. I suspect the change in GDP would be similar to what it used to be if taken into account.

niceconstable
niceconstable

I must be against more World Dollar Liquidity since I am against more base money.