2014: Desperately seeking demand

ScreenHunter_900 Jan. 17 10.38

By Leith van Onselen

Patrick Chovanec, chief strategist at Silvercrest Asset Management, has released his first quarter Investment Strategy Note, which argues that the global economy remains afflicted by a lack of demand and excess capacity, which is likely to pose a major obstacle to growth in the year ahead. Below are some key extracts:

The main obstacle to stronger economic growth is lack of sufficient demand.  Though consumer spending is rising, the economy is still operating way below capacity.  U.S. non- financial corporations are sitting on a record $1.25 trillion in cash because they are unsure where to invest it.  Portfolio investors are in the same boat, with $2.7 trillion parked in U.S. money market funds.  Former Treasury Secretary Larry Summers posits that the U.S., like Japan since the 1990s, has entered an era of “secular stagnation” where the “natural interest rate” (the rate where the desire to save is matched by the willingness to invest) has fallen below zero, meaning return expectations are so low or uncertain that investors essentially must be paid to put their money to work (or penalized, via inflation or other means, for not doing so).

There are many domestic reasons, in the U.S., why demand is depressed.  They include cyclical causes like the wealth effect from assets that lost value during the financial crisis, especially housing, as well as the delay in household formation due to high unemployment among young people.  There are also structural reasons, which may prove more persistent.  We are in the midst of a technological revolution that, alongside globalization, is reducing the need for and the value of the sort of routine mental and physical labor that long provided the foundation for mass middle-class employment in the US…

These kinds of efficiency gains are good for the U.S. economy.  They mean we are doing more with less.  But they also mean the rewards to value-creation are often spread among fewer people, and many people with more mundane skills may struggle to add much value at all.  Before the crisis, the impact on consumer purchasing power was masked by easy access to consumer credit: what people could not earn, they could borrow.  Not anymore.

The conventional response, among economists, is that the government must take action to boost domestic demand in the United States, with either monetary or fiscal stimulus, or by redistributing wealth.  But the limits of intervention are also apparent.  While Fed QE was essential to preventing a credit collapse during the financial crisis, a nearly fourfold increase in the base money supply has done less than one might expect to get people lending and spending again.  The case for more aggressive policies must be weighed against legitimate concerns they could destabilize the economy’s future by piling up too much debt, distorting incentives, or inflating asset bubbles.  In any case, the political impasse in Washington makes any agreement on these matters nearly impossible…

For the past several decades, the U.S. has served as the world’s consumer of last resort.  That allowed developing countries – namely Japan, and later China – to turbo-charge growth by producing more than they consumed, confident in the knowledge that Americans would provide the demand by consuming more than they produced.  (A parallel pattern emerged within the EU, with Germany playing net producer and the rest of Europe net consumer).  The surplus countries kept the game going by taking their export proceeds and lending them back to their customers so the deficit countries could keep buying.  This is the global growth model we all became comfortable with…

We’re not going back to the past.  The old growth model is broken.  Here’s what will replace it, with a number of positive implications:

1) China faces a major correction.  As its credit binge is either brought under control, or buckles under its own weight, GDP growth will fall, perhaps abruptly. We may see signs of financial stress, or instability.  The end of China’s investment boom will hurt metals and mining, as well as makers of capital goods, on a global basis…  Far from being a catastrophe, a correction that forced China to transform its huge accumulated savings into demand could turn the Chinese consumer into a major driver of global growth…

2) It will become increasingly evident that other Europeans can’t earn their way out of Germany’s debt until the Germans start saving less and buying more.  Until the EU’s leaders recognize this, Europe is simply marking time between crises…

3) Abenomics is an experiment, a calculated bet that printing money will spark controlled inflation which, along with much-needed structural reforms… I’m cautiously optimistic, but I suspect all the good news is already priced into the market, while the toughest choices are yet to be faced.  Meanwhile, the risk of some kind of armed conflict with China, over disputed islands in the East China Sea, is quite real and cannot be ignored…

4) The American consumer isn’t going to re-leverage and drive global demand, and the government is in no position to replace him.  Domestic demand will grow, but mainly on the back of a production story driven by global rebalancing, which we are already seeing take shape.  The U.S. will capitalize on traditional strengths in agriculture and technology, as well as new ones, such as its energy cost advantage from shale oil and gas.  Stagnant wages may be hurting domestic demand, but they are making the U.S. more competitive.

As the U.S. economy gradually gains momentum, the Fed will have to taper, then unwind, its QE bond purchases.  Interest rates will rise…

The shift to a new global growth model is a positive story, but it’s also an extremely disruptive one.  People who don’t see it coming will be inclined to panic in reaction to the changes it involves.  Investors who understand it will find opportunity where others see only uncertainty and upheaval…

The full report, which is worth reading, can be downloaded here.


  1. “Karl Marx had it right. At some point, Capitalism can destroy itself. You cannot keep on shifting income from labor to Capital without having an excess capacity and a lack of aggregate demand. That’s what has happened. We thought that markets worked. They’re not working. The individual can be rational. The firm, to survive and thrive, can push labor costs more and more down, but labor costs are someone else’s income and consumption. That’s why it’s a self-destructive process”

    N Roubini.


    • Karl Marx had it completely wrong with his labour theory of value and other nonsense.

      Free market capitalism is much less destructive than all the alternatives. But it seems like we are saddled with central banks and fiat money, and there hasn’t been a free market in banking and money for a good century now.

      • Love ‘straya…

        The labour theory of value is not completely wrong, and with regard to this post is just a bit of a red herring. Hm?

        A disillusionment with fiat money and central banks (as much as I empathise) does not address the above issue. Unfortunately.

        Capitalism being “…much less destructive” is debatable, but still irrelevant, if it remains destructive enough to extinguish itself. No?

        Please argue how diminishing aggregate demand, or the lack of ‘sufficient demand’ (as Chovanec puts it) will pave the future for a self-sustaining capitalism.

    • I think Henry Ford said the reason why he pays his workers well is he wants them to be able to afford his car.

      At this rate it is going, we will have no middle-class to drive demand. All of us will be sweeping chimneys and eating dust for the fat lazy cats.

    • Exactly right, Ortega. Even if free-market capitalism is the least destructive system, it doesn’t mean it can’t and won’t collapse. There is too much hubris and greed and short term thinking out there to have any confidence in the long term sustainability of free market capitalism.

  2. Sorry I can’t remember the figures but I read a report a couple of weeks back pointing out that the supposed $1.25 Trillion that is sitting on balance sheets is very deceptive.

    Apparently a very large proportion of it is held in the hands of a few majors – Apple, Microsoft and Google etc. with many smaller companies actually in quite vulnerable positions with low equity positions or net cash and net debt on balance sheet.

  3. All else aside, this should be an obvious consequence of the aging population and passing of the demographic dividend peak right?

    Probably was delayed due to demand being brought forward due to credit expansion.

  4. Good thing we’re on to it. Maintain rising house prices while putting downward pressure on labour prices, sell public assets and slash government expenditure to shift debt from public to private balance sheets, keep moving taxation burden from capital/land onto labour/consumption, allow higher Chinese incomes to flow into our economy, encourage foreign ‘private’ sector (i.e. state owned enterprises) investment in our key export sectors, remove environmental impediments to investment, blame the Unions, stop the boats, flame the culture wars. Rinse and repeat.

  5. What the global economy suffers from is not a lack of demand and excess capacity but, as usual, too much production of things people don’t want to buy and not enough production of things they do want.

    Wake up, economists!

      • It would help if economists diagnosed the problem correctly first. And it’s not really something politicians can address, other than by ensuring free markets.

  6. Chovanec wrote that technological revolution is eliminating those jobs that require routine menial physical labour.

    I think even the creative thinking jobs are being eliminated as well. We can blame bloody Google for that. This fascinating book explains how

    The Google Trap: How Internet Aggregators Enrich the 1%, Impoverish Creative People and Threaten to Decimate the Middle-Class

    Very soon, we wouldn’t have a middle-class anymore. Sigh!

    • Yes, but Id see it slightly differently – its just the effect of “Internet scale”, which means in any given field there are likely to be far fewer winners globally than before. Amazon itself being a great example.

      The point is, to make a living out of something in the Internet age, you need to be ridiculously good at it. In addition, winning companies need far far less employees.

      The result of this is pretty obvious – much much less of a living to be made by many whilst a few become billionnaires.

      We’ve got some issues to sort out, we need a new Internet-type thing, in fact we need a few hundred 🙂

      • I think it is not enough to be ridiculously good nowadays. This book made a very interesting point that the Internet today is no longer a meritocracy. The best don’t rise up to the top nowadays.

  7. from the link:

    “Assuming China can avoid mass capital flight, however, it can draw on its $3.7 trillion in foreign exchange reserves to cushion the blow by sustaining consumption levels.”

    Is this correct Leith? I think I remember Pettis arguing that China’s foreign exchange reserves could not be used in this way.

  8. The mistake I’ve made in the cycle so far was to assume this lack of demand would manifest as deflation the central banks might not be able to outrun.

    We have seen currencies devalued beyond what was ever thought reasonable, we’ve seen bail-ins, euro-pegs, negative rates, QE and the game has only just begun.

    There is no trust in governments maintaining any of the elements of a currency as a store of value.

    Demand may be low and things may be deflationary, but that will have little impact on asset values, other than a shock period that can be arbitraged before fiat deflation continues apace.

    • Agree AJ – I have made that mistake too…though you have to remember that the demographic cliff is only two-three years old in Australia and China peaks about here…

      And what has that created here…the lowest interest rates in a generation AND rising unemployment.

      So there is still alot of water to go under the bridge yet…and I think we may have a hard time pulling out of deflation as China goes, and I can’t see how China is going to get themselves out of it with the sort of demographic situation they face

  9. Though our dollar dropping will create imported inflation as well so I guess perhaps more in and out of deflation

    Guess we have to see, but this ain’t the time to be levering into growth assets IMO – that was April 2009

  10. I have no reason to change my long held opinion that we will have both (we have it already) inflation and deflation at the precise same time but in different areas of the economy.
    The way its shaping up, wages may adjust and be competitive in a very short time. However the pain will be extreme for those at the bottom of the heap…. as it is always.

    • Agree Tony totally…

      Though in that I think it is likely that we cycle in and out of out right deflation for years as credit is extinguished and then stimulus kicks in to give a bout of inflation again (we are really in a the up cycle at the moment)

      What is likely is that once the RBA and Government starts to run out of bullets, the up cycles will get shorter and more anemic

      If you look at the recent property “boom” and consider the state of interest rates and what things would be like if rates were “normal” you can see what is likely to transpire

      It is going to be one heck of a rocky ride ahead with potential opportunities but I do feel sorry for the many who simply don’t understand it as many innocent prudent people will be hit severely and I agree the people on the bottom and those who gorge on cheap credit are likely to be first in line

      • I think we all have to study finance and in this way everyone would be able to understand what is going on. I only wonder who would work as a teacher, a doctor, a farmer etc….. maybe the Chinese???

  11. Ah yes, perfect exposition of the classic “Overproduction/Underproduction” fallacy:


    “Is there, then, such a thing as overproduction? Manifestly, there cannot be, in any general sense, until more wealth is produced than is wanted.”

    Very funny how this one keeps springing up despite infiinte evidence small children can understand with great ease.

    Like we say – avoid the experts and avoid misadventure. They are paid highly to keep you blind.