Random Musings on Markets 2019: A Hard Day’s Musing

In this week’s edition of our not-weekly collection of quirky stories, Japan shows you the demographic bomb is likely a dud, our notes from another electric House Financial Services Committee hearing and a Venn diagram near and dear to our hearts. Please enjoy the read!

So Much for That Demographics Time Bomb

Sorry to go all serious(ish) here, but we didn’t have any other space to highlight a short observation about some actual data. You see, for eons now, people have feared shrinking populations in several “aging” nations will doom them to shrinking economies. Japan would be the first domino to fall, followed by most of Continental Europe and then the US.

We now have some data to test this demographic “bomb” thanks to Japan’s Internal Affairs and Communications Ministry, which announced Wednesday that Japan’s population shrank for the 10^th straight year in 2018. If you believe the demographic doom narrative, then Japan’s economic output should also have shrunk over this period.

Only, it didn’t. Nominal GDP (not adjusted for inflation or deflation, this being Japan) finished 2008 at ¥520.8 trillion.^[i] Last year’s output? A cool ¥549.0 trillion. GDP grew in 8 of 10 years, shrinking only in 2009 (global financial crisis) and 2011 (Great Tohoku Earthquake, tsunami and Fukushima nuclear disaster). All as the population aged and shrank. This shrinking population was even able to overcome the BoJ’s wrongheaded, deflationary quantitative easing and negative interest rates. That is … pretty good?

Granted this is just one piece of evidence suggesting that bomb is more like a bang snap. But it is a solid early counterpoint nonetheless, bringing new meaning to fears Europe will “turn Japanese.” If turning Japanese means growing despite a shrinking population, that seems pretty ok to us.

A Helpful Guide for Some House Committee Members

Wednesday’s House Financial Services Committee hearing was, as usual, endlessly entertaining. This one featured testimony from Fed head Jerome Powell, including scads of questions about the economy, rates and other policies. But there are usually some oddities, which we love. This latest version featured several questions about Libra, the proposed cryptocurrency backed by Facebook. After several questions on Libra in close proximity drew rather boring answers from Powell about anti-money laundering worries and other concerns, this particular exchange between Georgia Representative David Scott and Powell caught our ear. What follows is our hastily typed transcript of this exchange that takes place about an hour into C-SPAN’s coverage [our comments in brackets]:

Rep. Scott: Now I want to go to, and it’s been mentioned a couple of times already, this Libra business is really disturbing and a serious problem. And let me tell you why. First, I think we all know Libra is the London Interbank Offered Rate. [Wait. What?] Very critical. It has and is the standard for hundreds of trillions of dollars in both overnight and term loans, debt and derivatives. [Oh he actually meant LIBOR.] It is the standard that has been used internationally and in the United States affecting individuals, small businesses and corporations. So we’ve got a big issue here. But because of pervasive manipulation, now it is apparent that Libra [this one may have been leeber, we couldn’t be sure] is going to leave us—or be replaced—within the next year or so. So this creates a big problem. And so I want to ask you, because the most critical part of this is, that parties to both sides of financial contracts should be and must be concerned in the short term about the ramifications of the potential end of Libra, specifically in contracts that do not have a fallback position. As you know, without fallback language or some appropriate established safe harbor until a new reference rate can be used, significant legal challenges are likely to occur. So, with this in mind, as Libra’s scheduled end nears, SOFR, the secured overnight financing rate, apparently will take its place. Tell us Chairman, what can we do what can be done to accommodate the numerous contracts that do not have fallback positions?

Powell: Thank you Mr. Scott. I think you said it very well,^[ii] this is, I think there are $300 trillion contracts in five currencies and um, the manipulation revealed almost a decade ago. And I think the FCA which supervises the LIBOR banks says it won’t compel banks to submit LIBOR past the end of 2021 and LIBOR could then end.^[iii] …

Obviously Rep. Scott misspoke. He meant LIBOR when he said Libra, as the rather involved technical question that followed shows. But, you know, in case that is unclear to other congressman, here is a helpful guide:

• LIBOR: London Interbank Offering Rate. The rate regulators found several large banks manipulating 10 years ago. This is a real thing that may go away soon (although it isn’t required to).
• Libra: The cryptocurrency backed by Facebook and a few others (who seem decreasingly enthused about it). This is not a real thing yet, as it is only in the proposed stages at this point. Yet regulators already seem to want to make it go away.

Glad we are all on the same page now.

More Notes from the Committee

A bit later in the same session, Tennessee Representative John Rose—a self-proclaimed federal debt hawk—peppered Powell with questions on the sustainability of US debt, particularly interest costs. Most of his comments centered on a recent Congressional Budget Office (CBO) report showing net interest payments—which totaled 9.8% of federal revenues and 7.9% of federal spending in fiscal 2018—are set to rise. Rep. Rose repeatedly pounded the table that interest payments, according to the CBO, will surpass defense spending by 2026—which he apparently finds quite unacceptable and unsustainable.^[iv]

Now, our standard reminder here applies: This is all based on long-term forecasts. Projections of spending decisions the government hasn’t made. Interest-rate assumptions. And then the CBO applies a bunch of straight-line math. As we noted recently, it isn’t the CBO’s fault, but these just aren’t reliable. For example, the CBO projects average rates on US debt to rise from 2.4% this year to 3.8% by 2039 and 4.2% by 2049. As Powell noted in the session, these are some sketchy assumptions that hinge on the notion more debt equals higher rates. Japan has been busy destroying this logic for the better part of 25 years.

But wait! If it wanted to, America could mitigate future interest rate risk right now by importing an idea Italy and Austria just successfully deployed. You see, many governments worldwide have gotten into the practice of selling ultra-long maturity bonds—50-year, 100-year debt. That sort of thing. If you are thinking, who buys bonds this long term? The answer is, insurers, bond funds and banks. Anyway, this week Italy—it of the 132% debt-to-GDP ratio and ongoing budget spat with the EU—offered €3 billion in bonds coming due in 2067 at auction. You might think they would have to pay a small fortune in interest to attract buyers. But that would be wrong. They wound up selling the bonds at a low-low ~2.85%. Not only that, they received €17 billion in bids—a high 5.67 bid-to-cover ratio. For those who don’t speak bond-ese, that is high! It shows there was a lot of demand. As for less-indebted Austria, on July 2 it sold bonds due in 2117 at a cost to the government of 1.2%.^[v] Wowzers!

If Italy and Austria can offer long-dated debt at low rates now, surely America could too. And, by doing so, they could lock in lower interest costs for the looooooooong run, rendering the CBO’s estimate off. Not that the US needs to in order to remain solvent! But it could and that is the point. Anyway, we hope Rep. Rose sees this and fires off a few questions to Treasury Secretary Steven Mnuchin the next time he has a chance.

It Ain’t Easy Being Green … but It May Be Profitable?

Here in RandomMusingLandia, there are a few things we really like. The planet, for one. Also beer. And creative capitalists. We really, really like it when things land in the middle of this Venn Diagram.

Exhibit 1: A Venn Diagram We Enjoy

Source: Come on now, we don’t really need to source this.

So how could we not send an Internet high five to Asahi and Panasonic, who have developed a disposable beer mug made of plant-based, compostable resin? It is a delightful “green” alternative to those plastic beer cups that litter stadiums after games and fields after music festivals. The ones all those woke kids leave behind at Glastonbury, much to environmentalists’, birds’ and garbage pickers’ chagrin. Soon, we can take our IPAs outside and compost the cup with a clean conscience. We would like to thank the market for solving this problem before regulators felt compelled to ban disposable to-go cups.

Speaking of which, Chinese regulators have also gone super green, testing a new trash disposal program in Shanghai. Breaking the rules invites fines and shame, as it will link to the country’s Orwellian social credit system—those accidentally throwing their pork bones out with their chicken bones could lose credit points, making it harder to get loans and jobs. We know, you thought Cancel Culture on social media was bad. 

But with red tape comes opportunities for those skilled at navigating it. Like our entrepreneur of the week, a gentleman named Wang Zhongyi. He has studied up on all 46 garbage types and is now in business, along with his roommate, as a trash consignor. They charge about $6 per month to collect a household’s trash and take care of all the complicated sorting and disposal. That spares people from the risk of losing their job because they tossed their clam shells with their lobster shells. It also spares the environment from toxic side effects of those who spray all their trash with pesticides so they can label it all as “soiled” and not bother separating it—a popular workaround, apparently. Wang’s phone is ringing off the hook, and The Wall Street Journal reports at least 20 other similar services have sprouted. If we lived there, we would probably sign up, too. Shelling out a few dollars a month for Uber for Trash, as we will call it, seems much better than getting shamed for throwing cherries out in the same bin as cherry pits. That would needlessly complicate Elisabeth’s pie-making, after all. 

Enjoy your weekend.