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The Expectations Game

Investment is a tricky thing. You put up a lot of money in the expectation that you’ll have a small return year over year. Currently, the expected rate of return is historically small in the developed world, on the order of a few percent. It has to be weighed against the risk that the initial investment will never be paid back, winding up in default.

The slowdown in the global economy is not actually a decline in output all over the world, but a pause in the rate of growth. It wasn’t expected, either, which is the real problem. The developed world is largely stagnant, save some hope in the US for better times ahead. The developing world need to catch up, but appears to be taking a breather after a tremendous run.

As we consider the next few years and the potential for a genuine boom ahead, it is becoming clearer that we aren’t ready for anything more than muddling through until there is a reckoning and a realization of how the next economy will work – for everyone. That will take some patience and public investment all over the world.

Demand for oil didn't rise as fast as expected, so supply got ahead of it.

Demand for oil didn’t rise as fast as expected, so supply got ahead of it.

The price of oil is the clearest sign that things aren’t right in the world. Global demand for oil was expected to increase by a bit over 2% in 2014, from 90M bbl per day to 92M bbl per day. It wound up increasing by only 0.9M bbl per day, with the rest stockpiled in large tank farms. Supply has been running ahead of demand for nearly a year now, and the result has been a general collapse in the price.

The reasons for this have everything to do with the restructuring of the global economy. The US economy is firing up with little change in overall demand for oil, stuck at around 19M bbl per day since 2010. Europe isn’t growing much, and demand is also stagnant.

Growth is expected to come from the developing world, but the second largest consumer of oil, China, is facing a decline in its incredible rate of growth. They are still expected to consume 10.7M bbl per day in 2015, but that’s up only 0.3 bbl per day or 3%.

Did you get our jobs?

Did you get our jobs?

The reason for this is a general slowdown in China that has their incredible rate of growth slowing down below 8% per year for the first time in two decades. Their expectation was that they could continue growing like that forever, and it’s priced into everything. The slowdown has made investors nervous for about a year and a half now, with many expecting a general failure of their banks as a result. When loans are made under the assumption that growth will be robust, everything has to run like clockwork to make it happen.

Failure to meet expectations is a failure. Growth has to be more than good, it has to be perfect.

The central bank of China has responded by lowering the capital requirements for banks in an effort to free up money for investment across the nation. Foreign investors are reasonably nervous about this strategy for obvious reasons. The slowdown in demand, either for Chinese goods in developed nation or as internal Chinese demand by their still-waiting-to-develop middle class, cannot be goosed by more investment money. There is only so much a central bank can do.

Increasing the supply of investment capital makes sense when there is a shortage of it.  There sure isn't now.

Increasing the supply of investment capital makes sense when there is a shortage of it. There sure isn’t now.

It is a mirror of what has happened throughout the developed world in that everything is being run by central banks. They are only able to control the supply of money, which is to say how much cash is available for investment. This is what “supply side” economics is genuinely about – the money supply. The theory is that more cash available to invest creates more investment, which creates jobs, which fires everything up.

It doesn’t work that way when there is a general slowdown in demand.

The alternative, demand side management, is trickier. It’s often called Keynsianism after its first big promoter, John Maynard Keynes. He was the one who called for direct job creation programs in the Great Depression of 1929 in order to stimulate demand for goods, which would in turn create more production and create opportunities for investment. Central banks can’t do this – it’s up to governments and private industry (not necessarily in that order, of course).

What this comes down to, however, are the expectations of people in their own private lives. Will more gadgets and more consumption make us all happier? If you ask the developing world, the answer is generally a solid “Yes!”. They don’t like being left behind. If you ask the developed world, however, there is every reason to believe that stagnant population growth and lower expectations resulting from years of Depression have people much happier with less – at least in terms of more every year.

At some point, money doesn't buy happiness - in only buys more waste.

At some point, money doesn’t buy happiness – in only buys more waste.

This thing called an “economy” remains nothing more than a collection of values, after all.

How can we increase demand around the world? The short answer is that we probably can’t, at least in the short term. The restructuring to the next economy is far from complete, and the values of the people who make up this great big global economy have not been determined. The developing world has its own infrastructure and civil problems to take care of before they can say they have a stable consumer class.

Expectations have been running high since the world pulled out of the worst of this Depression starting around 2012. They shouldn’t. We are doing fine on our own, and some activity such as a slowdown in the growth of oil consumption will be good for everyone in years ahead. It just makes it harder to set big expectations for a quick turnaround. Where high growth has been priced into investments, such as in the stock market, there is only a setup for disappointment.

16 thoughts on “The Expectations Game

    • We don’t. However, the rise of the developing world will certainly pick up at some point, assuming they get their acts together. The rise of a real middle class is not going to wait forever in many of these nations, like Malaysia, Indonesia, Brasil, etc. We can expect it to come in fits and starts, but the trend is inevitable, IMHO.
      As for the US, I think we are well situated assuming we get some much needed reforms through. The retirement of the Baby Boomers will open up jobs and put upward pressure on wages – which as I’ve shown we are just starting to see. It’s all a matter of managing the aging population appropriately, and to that end we have some things in place but not enough.
      But I think we’ll do fine, if not very well. We aren’t Europe or Japan, which have huge demographic and structural problems. They could drag the world down even more than they are now.
      And then there is China. If they develop a working middle class everyone will be fine. I have no idea what that will take. They may have to have a long pause and some political turmoil before that happens, which will be painful.

  1. A “pause” is a good thing. We consume way too much & save almost nothing. If that is bad for the economy well I don’t know what’s good for it. Maybe in the short term it seems bad but we will be healthier all around if we are wiser with money.

    • I could not agree more! If you want a healthy supply of investment, the key has to be savings. That democratizes the investment market and helps everyone out in the long run. This separation between an investment class and a working class is not good for anyone. The solution is that everyone has some investment income and everyone works – and there are rules in place that truly democratize and open up all the processes.
      I should write about this more. I do have a bit of a vision.

  2. Oil always goes up and down, that’s not new. Like your explanation of Supply Side Economics, it makes sense to me now. Do you think it was the right thing to do in the 1980s? I can see that it isn’t working now but this is a different situation. But it seems to have worked under Reagan & I wonder what you think of that.

    • I have to reluctantly agree that Supply SIde management is the best cure for Stagflation, the situation at the start of the 1980s. This is a Kondratieff “Summer”, a situation that occurs once every four business cycles, or about 70 years as it runs now. There is also a time for Keynsian Demand Side Management, which is right now, also every 70 years. In between, solid management with an eye towards a free market that is truly accessible by everyone is the way to go.
      Wonder what it takes to have that kind of long-term wisdom in a democratic republic, eh? Seems unlikely, but we have to try.

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  4. Are you still mad at Alan Greenspan?


    Most things I’ve read say the US started losing its post WW 2 productivity edge in 1973.

    • Normative responses to inquiries based on the relative attitude towards a public figure generally produce a sub-optimal degree of enlightenment vis a vis the prevailing economic climate.

      I would like a link for that – I see a lot changed around 1968, but I wasn’t aware we had a productivity issue.

    • I see what you mean. I have to think about this. That’s a long period of relative stagnation. But it does fit into what I’ve noticed before, which is that income inequality has been growing for a very long time (I’d say since 1968).

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