SHI 11.27.24 – Financialization

SHI 11/20/24 – The Things We Don’t Yet Know
November 21, 2024
SHI 12.4.24 – DOGE
December 11, 2024

Yes.  That is a real word.     

 

Financialization” is a word used to describe the ongoing global transition from an “industrial” based economy — one where the production of products, goods, or those things comonly known as “real assets” is centric to the economy —  into the “service” economy, one where real assets take a back seat to “financial assets,” which is the world we find ourselves in today.  

 

 

Today’s word:   A quadrillion. 

 

 

Why does this matter?  Well, I guess I’d say it matters because it’s happening behind the scenes and outside our general perception; it matters because it is often misunderstood and confused with a version of debt monetization; and, finally, it matters because along with the technology revolution spreading across the globe like wildfire, the slow and ubiquitous conversion of the global economy from goods to services, and more precisely  financial  services, definitely impacts your life in ways you may not be aware. 

This is important stuff.   And along with advancements in information and technology, it will definitely have a big impact on your future.  

 

Welcome to this week’s Steak House Index update.

 

If you are new to my blog, or you need a refresher on the SHI10, or its objective and methodology, I suggest you open and read the original BLOG: https://www.steakhouseindex.com/move-over-big-mac-index-here-comes-the-steak-house-index/


Why You Should Care:   The US economy and US dollar are the bedrock of the world’s economy.   But is the US economy expanding or contracting?

Expanding … according the ‘advanced’ reading just released by the BEA, Q3, 2024 GDP grew — in ‘current-dollar‘ terms — at the annual rate of 4.7%.

The ‘real’ growth rate — the number most often touted in the mainstream media — was 2.8%.   In current dollar terms, US annual economic output rose to $29.35 trillion.

According to the IMF, the world’s annual GDP  expanded  to over $105 trillion in 2023.   Further, IMF expects global GDP to reach almost $135 trillion by 2028 — an increase of more than 28% in just 5 years.

America’s GDP remains around 25% of all global GDP.  Collectively, the US, the European Common Market, and China generate about 70% of the global economic output.  These are the 3 big, global players.   They bear close scrutiny.

 

The objective of this blog is singular.

 

It attempts to predict the direction of our GDP ahead of official economic releases.  Historically, ‘personal consumption expenditures,’ or PCE, has been the largest component of US GDP growth — typically about 2/3 of all GDP growth.  In fact, the majority of all GDP increases (or declines) usually results from (increases or decreases in) consumer spending.  Consumer spending is clearly a critical financial metric.  In all likelihood, the most important financial metric. The Steak House Index focuses right here … on the “consumer spending” metric.  I intend the SHI10 is to be predictive, anticipating where the economy is going – not where it’s been.


Taking action:  Keep up with this weekly BLOG update.  Not only will we cover the SHI and SHI10, but we’ll explore “fun” items of economic importance.   Hopefully you find the discussion fun, too.

If the SHI10 index moves appreciably -– either showing massive improvement or significant declines –- indicating growing economic strength or a potential recession, we’ll discuss possible actions at that time.


 

The Blog:

 

Viktor Shevets is a brilliant man.  A couple years ago, he wrote what I consider to be one of the three best ‘historic economic’ books ever written.   In my opinion.  The book, titled “The Great Rupture,” is described on the Amazon site as:

 

“Modern technologies are disrupting our societies, altering every facet of our lives, from the nature of work and what we intrinsically value, to how we are informed, entertained, and educated—it promises to be a far deeper disruption than Industrial Revolutions. Humanity is at a major turning point, and how we respond to the merger of technology and financialization will decide our future.  Will it be capitalism or communism, feudalism or despotism?

By learning from the past and projecting into the future, global market strategist Viktor Shvets explores the weakening nexus between freedom and prosperity and what that means for the future of humanity. From the birth of our modern world, pivotal events in human history have led to the collapse of non-Western civilizations—Mongol warriors sweeping across Eurasian steppes; the Black Death and a re-awakening of human spirit; Zheng He’s voyages and the collapse of Novgorod republic; and finally, the ban on printing in Arabic. What can we learn from these events to better prepare ourselves for the future?

As we hurtle toward that uncertain future, we must decide whether our cherished individual freedoms are still necessary for success and prosperity, or if in adapting to new technologies, non-Western civilizations are now better positioned for this new world, creating illiberal orders that might no longer suffer from stagnation of ideas. For the first time in at least five centuries, we have an opportunity and tools to build a different society and economy. Will we embrace the challenge?”

 

Published in 2021, I thoroughly enjoyed Viktor’s creativity and characterization of world history thru the lens of economic ebbs and flows.   Fast forward to today, Victor has published his next epic:  “The Twilight Before the Storm.”   It’s next on my “to read” list and I am excited to dig in.   From the Amazon description, I gather it tackles some of the common ‘fractures’, ‘tensions’ and ‘conflicts’ we citizens of the world face today.   

I’ll save my book review for later.   🙂

For today, I’d like to discuss a really great newsletter published by Bloomberg that highlights some of Viktor’s current thoughts.   Here’s the link if you want to go directly to the source and read his entire piece (right click, open link in new tab):

https://www.bloomberg.com/news/newsletters/2024-11-27/viktor-shvets-on-why-this-time-really-is-different

Once again, Viktor does an impressive job contextualizing a set of very large, very complex systems into intellectual bite-sized pieces.   He credits Paul Volcker, the FED chair during the 1980s US hyper-inflation years with “launching” the “highly financialized world” in which we find ourselves today.    Prior to the 1980s, Viktor says, financial assets were broadly on par with real assets.   Meaning the relationship was, essentially, one-to-one.  

Permit me a brief, but important, tangent here:   I would suggest to Mr. Shevets, if he were interested in a discussion and debate, that it was not Volcker who triggered and launched the epoch of financialization, but Richard Nixon.  Yes, Richard Nixon.   In 1971, President Nixon was faced with a seemingly never-ending drain on US gold reserves resulting from the de facto US policy permitting the conversion of the US dollar into gold.   Yes, gold was flying out of Fort Knox at and increasing rate because US inflation was out of control

In my blog dated 3.28.18, I discussed this concept in greater detail and wrote:

 

“On the afternoon of Friday, August 13, 1971, Nixon and his cabinet made a few unprecedented decisions:

1.  They decided to “suspend” the convertibility of US dollar into gold. The “gold window” previously open to foreign governments holding US dollars was closed. Instantly and indefinitely.

2.  They enacted a 90-day freeze on wages and prices, an action intended to control inflation, the first time since WWII.

3.  They added an “import surcharge” of 10% to all goods and services being imported into the US — effectively a 10% tariff across the board.

Why did the US make these choices? And what were the long-term effects?

Let’s start with ‘why?’  Remember the US was deep into the Vietnam war during the 1960s.  The financial cost of the war was staggeringly high.  In order to pay for it, the FED increased US money supply.  In fact, the FED increased money supply by over 50% in the 10 years preceding 1970.   And this increase triggered a spurt in the inflation rate.  By the mid-1960s, inflation had crept up into the 3s.  And by 1970, inflation was flirting with 6%.

You may be thinking that an expanding money supply, as we’ve experienced in the past 10 years, does not, in itself, cause the inflation rate to spike.  You would be right.  But there was a unique difference between then and now.

Beginning at the end of WW2, the US dollar was convertible to gold at the “pegged” price of around $35 per oz.   Even as more dollars were printed and circulated, the price of an oz of gold remained static.   In 1960, one oz cost about $35.  And here the price remained … until 1968 when an oz of gold jumped 22% to about $43.  It remained in this range until Nixon’s announcement.

The second problem was more practical:  Year after year, significantly more dollars began to circulate, both here and abroad.  And as foreign nations increasingly swapped dollars for gold, the US was in a bit of a pickle.  (Remember:  As U.S. money supply increased, each dollar was worth less than it could buy in gold.)  So countries around the world made the intelligent financial decision to swap bucks for gold.  By 1971, the Nixon administration decided this was a serious problem.  If this trend continued, the US would be out of gold and the US dollar would be completely debased.

I’m simplifying this a bit, as the 1960s were extremely turbulent from a monetary perspective.  There was a new financial crisis just about every year — and gold seemed to be at the center of each crisis.  (It’s worth noting that the U.S. owned about 65% of the world’s gold reserves a the end of WW2.)

Let’s get back to the Nixon speech.  The following Monday, Nixon spoke to the nation. You can find both the YouTube video of the speech and the written content on the internet.  Here are a few of Nixon’s comments to the American people:

  • “We must protect the position of the American dollar as a pillar of monetary stability around the world.

  •  I have directed (Treasury) Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.

  •  Now, what is this action — which is very technical — what does it mean for you?  Let me lay to rest the bugaboo of what is called devaluation.

  •  If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less.  But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.  The effect of this action, in other words, will be to stabilize the dollar.”

I’ve highlighted a few terms above.  First, notice the word temporary.  No, the change was permanent.”

 

Here’s the blog post if you wish to read it again:

 

SHI 3.28.18 History Repeats

 

This was the single most important economic event ever in the Post WWII global economy.  This, I contend, was the trigger.   The permanent elimination of the peg between gold and the dollar.   Volcker simply tried to put the genie back in the bottle.   Frankly, in my book, he was relatively successful.  But as every solution plants the seeds of a new problem, Volcker definitely planted an entire forest.   But he had no choice.   And he saved the world at the same time. 

OK, back to Viktor Shevets.   He claims that by the time Alan Greenspan became FED chair, financial assets were 2X the size of the economy.   And by the time of Bernanke, that had expanded to 3X.   You may recall Bernanke’s famous 2005 speech where he first mentioned the global savings glut.   Essentially, this is what Chair Bernanke was talking about.   Here’s that speech:

https://www.federalreserve.gov/boarddocs/speeches/2005/200503102/

Today, Viktor claims, according to the Financial Stability Board than number is approaching $500 trillion — a number equal to about 6X the GDP of the economies within the sample. 

The Bank for International Settlements (BIS) and the International Swaps and Derivatives Association, the global derivatives market expanded to the highest level ever in the first half of 2024.   How much, you ask?   Here’s the number:  $730,000,000,000,000.  That’s $730 trillion.   Here’s a chart showing annual progressions since 2021. 

 

 

For context, remember that the US economy, our GDP, is currently about $30 trillion.    Annual global GDP is around $105 trillion.   Global derivatives total 7 X that amount. 

Finally, Viktor suggests the “cloud of finance” is now about 10X the real economies, a number known as 1 quadrillion.    As a result, he claims, “Capital is now the dog, while the real economy is just its tail.”   I love that line. 

All of this, I contend, began with the elimination of the peg between gold and the US dollar.   Perhaps it would have happened, eventually, anyway.  Perhaps as the world became more complex and globalization spread, financial asset growth would have blossomed.   But I believe Nixon precipitated this outcome.   And while his actions do not fit the traditional definition of “monetizing the debt,” one could argue that’s precisely the result.   Some economists contend the outsized growth of financial  assets is inherently inflationary.   I would agree.   Shortly after Nixon told the middle-east oil cartel they could no longer exchange their “petrodollars” for gold, the cartel raised the price of oil about 10X.   

What’s the point of all this?  

Essentially this:  A whole lot has changed in the past 50 years.  Beginning with Nixon’s elimination of the dollar/gold peg, his visit to China, China’s admission to the WTO, the rapid expansion of globalized supply chains and China’s rise to a manufacturing powerhouse, the US, and in fact the world at large, have experienced a MASSIVE expansion in financial assets than now dwarf real assets.   Instead of making things, advanced nations now lend on things.  Instead of making things, advanced nations we now invest in things.   Of course, some things are still made.  They must be.  But financial assets, and the returns on/from financial assets now dwarf the returns on/from the making of things. 

Is this good news?  Bad news?  Who knows.   But it’s real and factual.   This is the state of the world.   And here’s an interesting observation:   As financial assets grew in size, globally and over time, fertility rates fell.   Are these things correlated?   Probably.   But that’s another discussion for another time. 

For now, we’ll leave the discussion here:   Bernanke’s “savings glut” is larger and more wide-spread than ever.   And this fact has significant implications for the future world.    According to Viktor, one outcome is far greater, far more manipulative, financial management of advanced economies by their central banks.   Recessions are fewer and smaller.  Sure, this make sense.   But I see two (2) even more important take-aways for you.

First, some level of inflation is now a permanent global fixture.   This was not always the case.  In the past, there were centuries where prices did not change.  They do now.  The inflation rate, too, will be closely managed by central banks.   But it is not going away.  A counter-balance will be aging economies.   The sheer size of the financial asset glut will overwhelm that metric.  Inflation is here to stay.   That is, of course, unless someone pops the balloon.   I don’t anticipate this.   Nor do any of the central banker members of the BIS.   Let’s hope they are all correct.   I really don’t want to live in a cave.  

Second, over the long term, interest rates will be low and will trend lower.   Toward zero.   This is a long-term phenomenon.   Kenneth Rogoff talks about this fact in many of his excellent economic papers.   I generally agree with Dr. Rogoff’s conclusions.  

To the steakhouses.

 

 

Well, this is interesting.   Reservation demand in our most expensive steak houses is rather tepid.   Dallas is downright amazing:   You can find a table for 4 at just about any time you want this coming Saturday.   It’s almost as though they’ve given up on steaks in Texas.   Could this be true?   Naaaaaa…..   Not a chance.    And clearly few are spending this holiday weekend in Las Vegas.   There was a time when a reservation at Gordon Ramsey’s Steak House was impossible to snag within a month.  Now, if you’re hankering for a ‘Vegas steak, Gordon is likely to welcome you in and shake your hand.   Here’s the longer term trend chart:

 

 

 

This week’s “spread” is the largest we’ve seen this year, suggesting the economy is weakening.   But my take is this:   Tomorrow is Thanksgiving.    It’s very late this year.   Saturday will be a day for turkey leftovers, not a sizzling T-Bone at Mastros.   I think this reading is aberrational.   We’ll see. 

A fair amount of economic data was released today; some, apparently, because of the holiday.   Atlanta’s GDP Now forecast for Q4 is up to 2.7% today.   That’s strong.  And in the “Personal Income” report from the BEA, it turns out that consumer spending is strong, wages are UP, and corporate profits are UP, reaching a new high water mark:

 

 

Remember, ‘Corporate Profits’ are quoted in ‘current-dollars.’    If we ‘deflate’ the $3.41 trillion figure by the change in the CPI since 2020, the number in ‘real’ dollars is closer to $2.8 million. 

We have a new president.  I’ve talked to a lot of people about the election results.   As you might guess, feelings are mixed.   Regardless of how anyone voted, I suspect (almost) everyone hopes the new Trump administration proves successful.  Our economy depends on it.  For all of our sake, I truly hope they make everything “great.”   Fingers crossed.

And here’s something else I hope we can all agree on:   Let’s all come together around the concept of MCSGA!   Right.  Clearly, this acronym doesn’t have a catchy-tag like MAGA, but please join me on this one:  MAKE CRANBERRY-SAUCE GREAT AGAIN!   Have a very Happy Thanksgiving!

Gobble. 

<::>  Terry Liebman

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