Friday, August 15, 2014

Why the U.S. economy is not doomed to a Japan-style deflation or stagnation

10-yr sovereign yields in Germany have plunged to just under 1%, and Japanese yields are a mere 0.5%. U.S. 10-yr yields seem to be following suit, dropping from 3.0% at the end of last year to 2.34% today. Is the U.S. going the way of Japan? Are the industrialized economies doomed to very slow growth for the foreseeable future? The following graphs say no.

The above graph shows the evidence that's grabbed the market's attention of late: yields in Germany and the U.S., which tend to move together, appear to be converging with those of Japan. 

German sovereign yields are to the Eurozone bond market as U.S. Treasury yields are to the U.S. bond market: the risk-free benchmark. Here we see the huge difference between the strength of the German economy and the Eurozone average. Germany is being dragged down by its weak neighbors, but it is still somewhat ahead of the U.S. economy over the past 17 years. But's it's also clear that the Eurozone as a whole is just treading water, much like the Japanese economy until a few years ago, and that provides some justification for the very low Germany bond yields. But the U.S. economy has been far stronger, and continues to be, so there is little or no reason to think the U.S. yields have to converge with German yields.

July manufacturing production in the U.S. rose at a strong, 8.2% annualized pace in the past six months, and has now reached a new, all-time high. After the devastating recession of 2008-2009, manufacturing production has risen by more than 25%. It's a shame it's taken this long to recover to former highs, but the growth and improvement is nonetheless impressive. 

July producer price inflation is up at a solid 2-3% pace, as the graph above shows.

There is no sign in these graphs that the U.S. is in danger of getting sucked into a Japan-style deflation and/or stagnation. If anything stands out here, it's the relatively low levels of U.S. yields in light of the economy's strength and ongoing inflation.


steve said...

what I find most interesting about the first graph is that it appears that US and german bond yields are highly correlated AND converging. either german yields need to rise or US yields to to drop-a lot unless of course that convergence ceases.

Joseph Constable said...

Money flows to the highest risk adjusted after tax rate of return. That is the case in a normal world market. So Japan and Germany having the lowest rates must mean their bonds are the best deals in world. Or, the world market is really screwed up.

William said...
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William said...

Given the gargantuan amount of money invested in the sovereign debt of the Eurozone, Japan and the US {the most indebted nation of all}, I cannot fathom why such investors would accept such ridiculously low returns on 10 year bonds. The vast majority of these investments are one way or another managed by "professionals": insurance companies, pension funds, sovereign wealth funds, central banks and for very high net worth individuals.

Some years from now, we shall be reading analyses about how and why they were all possessed by a form of "group think" - a more massive version of, but similar in origin to, the investment mantra of the late 1960s, the "Nifty Fifty".

Joseph Constable said...

And don't forget the IMF.

Benjamin Cohen said...

Excellent blogging, and fascinating scenarios ahead.

We have heard for five years that inflation and interest rates are going to the moon.

But instead we see sogginess. Not yet deflation--although the boys at George Mason U. say inflation measures tend to overstate inflation. Maybe so.

Chief Yellen is halting Fed QE even though the Fed still below its 2 percent inflation target. Which is supposed to be an average target, not a ceiling. She is maintaining interest on excess reserves too. She is a dove? Check her for talons.

Central banks are independent public agencies. That is a guarantee they will ossify. Every federal agency ossifies and independent agencies most of all.

We have food stamps in a nation of fatties; we have a hyper-mobilized military to face a Soviet Union that has collapsed. The USDA is to help all those small farmers dragging plows with their mules. (Seriously, when was the last time you met a dumb farmer?)

And the Fed is fighting inflation. It will always be fighting inflation.

Even when it ain't there.

BTW, the Reserve Bank of Australia (RBA) seems to get good results by targeting an inflation band of 2-3 percent.

It is a mark of our times that the RBA policy would be greeted with hysteria in some circles in the USA. But the RBA way seems to work.

Unknown said...

The reason for Japanese stagnation, and the reason why the US is *not* going to succumb to the same fate, has everything to do with demographics. The population of Japan has been shrinking for several years now and holds little prospect of reversing course any time soon, unless the Japanese either open themselves to more immigration, and/or there is a sudden baby boom. If they were still a poor nation they could conceivably still grow their economy since there would still be a lot of "upside potential" to raise their standard of living. That is, they could grow their economy by making a stagnant number of people wealthier. However, because they are already a Developed Nation *and* their population is shrinking, they're pretty much out of luck.

Most of Western Europe is facing the same problem, albeit to a lesser extent.

In the US, on the other hand, projections for population in 2040 are for 380 million and 420 million in 2060, up from the current 318 million. That alone will ensure the US economy does not stagnate.

PD Dennison said...

I believe the US is going Japanese, as is Germany, but this is more a political future prediction than a current economic one.

Only growth policies and limited government can change this future, and there is no political will to move in that direction. Just as Japan and Europe only have Left and Center Left parties in power, the US parties have shifted to the Left.

With economies strangled by welfare, red tape and cronyism, growth in the develop world has stagnated. The US used to be the exception, but not anymore.

The way for the US to prevent a Japanese economic future is not to change the political leaders, but to change the electorate...and that is a much more difficult process.

cole said...

How will Obama care alter the GDP ?.
(1) transfer payments from the working to non-working is another tax not even considered a tax
(2) Unlike a tax this does not even hit the treasury & we as a nation get little for it. Reminds me of the stimulus.

William McKibbin said...
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