2013-10-15
The daily news flow tends to be of the breathtaking variety. This is assumed to influence financial markets. And indeed, moment by moment, we can observe price volatility as asset markets weigh up all kinds of evidence, impressions, emotions in setting prices.
The same perceived volatility is often imparted to the progress of the real economy, in the way spending decisions are made, production is planned, the labour force is managed.
There certainly is a link. But perhaps there is a far greater robustness operational in the real economy than observed in hyper-intensive financial markets.
At least, large supermarkets don’t see their daily turnovers jump around like asset markets in response to daily happenings, though there can be seasonal patterns, even intra-day, weekly and monthly.
So if the daily global news flow is crucial to asset market price formulation, where should the main focus be when trying to assess the ups and downs in the real economy?
A first observation, firmly linking financial markets and real economy, is that events can shock, and invite shock-like adjustments.
Whereas of the instant variety in financial markets, as prices are made in real time, real sector adjustments appear to need more time to show. This reflects that spending and production decisions may be more infrequent and that more time may be needed to evaluate incoming information and then respond.
But the essence of the reaction is essentially the same.
Shock events catch people unawares and potentially wrongly positioned. Fear intrudes when uncertainty (lack of clear information and understanding thereof) occurs about what is taking place.
When in doubt, turn more cautious. Do not continue on the same path with the same confidence. Hang back, wait for new information, reassess the future prospect before resuming the journey, if necessary by a different route.
Not much difference between a Stone Age hunter and his modern equivalent in the concrete jungle.
A shock event deeply changing our understanding of the situation may therefore cause an initial defensive reaction, even a withdrawal, and thereafter a shift in timing, direction and speed of action taken.
If shocked enough, a household may decided to change its immediate priorities. Big ticket purchases can often be postponed as the old ones may still have some life in them. Some item purchases may be non-essential and can be done without for a while. Necessary purchases can be economised in quantity. Across the entire spending spectrum there may be trading down to cheaper product. Cash flow may be better preserved and any increased surplus used to redeem debt. To the extent additional work can be taken on by more family members, more income can be generated from more diversified income sources.
Thus the household facing danger/shock is not all that different from a human body fully mobilizing when sensing or confronted by increased danger to its existence.
But all this happens when confronted by unexpected major discontinuities which are potentially devastating.
What happens when the surprises are less dire? Do we take things in our stride? Do we have a longer term view that sees recovery and a limited need to react now?
Markets discount, too, often counterintuitively, ignoring immediate news in favour of what is expected thereafter.
Markets work for financial gain. Households work towards satisfying more basic needs and wants. There is a difference, even if only one of timing.
Whereas a market may reprice an asset in response to a bit of information, a household consumption unit may decide to keep munching, at least for the moment.
This suggests a slower household consumption adjustment to everyday events.
Companies, like markets, are risk/return oriented. But like households they too have timing issues.
Do they cut production in response to every twitch of information, or are the penalties too big, the issues too difficult to read, requiring time for a better grasp of things? If so, inventories are a flexible adjustment buffer.
Investment and labour hiring are even longer term adjustment mechanisms triggered by specific quantitative hurdles.
Governments are today big players in modern economies, as spenders and employers. Governments are far stronger than individual households or businesses, with a far greater capacity for risk, besides which there may be political calculation in proceeding in a certain way.
Governments tend to panic less to everyday events, riding things out, unless they have used up all their creditworthiness and are effectively in receivership.
Then there are still labour unions and financial lenders to be taken into account, whose decisions may add further input to the mix of responses in the economy.
If these five domestic player elements weren’t complex enough, there is still the interaction with the broader world, with over 200 independent countries, and all the variety this injects into the modern decision matrix.
How then to evaluate real economic unit decision-making and progress over time?
It would seem to be a very rough interplay between resource availability (meaning income and its immediate substitutes such as wealth and borrowing capacity) and confidence.
If household income falls off, it may not immediately lead to a spending reduction, though it will probably register in mood (confidence), even if only minor.
If the income decline is big enough, and no buffers exist that can absorb the loss, a spending cutback decision may be triggered.
As the income, wealth and borrowing distribution is heavily skewed in most societies, not all will be affected in the same way by some event.
Instead, there might be some spending erosion in part of the household spectrum. But if simultaneously there were windfall effects elsewhere at some households (and winners and losers can often be identified on opposite sides of events), there may be counterbalance and the net effect neutral, or even positive, further adding (greatly) to observed complexity.
Companies, especially the bigger dominating ones, are financially strong and able to ride out events if this is deemed profitable. Smaller businesses don’t have such buffers, and are more like households in their responses.
Governments and their central banks potentially have very large resource bases, operating on yet another level, so graphically illustrated these past 5 years.
The underlying principle, however, seems to be the same. As income disappointments occur, confidence suffers cumulatively. If windfalls occur, confidence tends to gain, too, with improving willingness reinforcing the improving ability to spend and risk.
If the daily news flow has any relevance for the real sector of the economy, it is the ability to shock. But as the shock value diminishes in intensity, the focus shifts to other forms of evidence.
Is real income improving or eroding? Is confidence at household, business, government level improving or eroding? Are spending decisions changing to a sufficient degree that it changes the overall context?
Whether income is improving or not can be open to wide interpretation. A union may think, as some apparently still do in SA, that by demanding more wages, workers can increase demand in the economy, creating jobs.
Employers will tell you that higher wages, if not fully compensated by higher worker productivity or higher product prices (in turn taxing consumers and reducing their real disposable income), have the effect of reducing profits, and giving companies less reason to invest or hire.
On balance, the key question to answer daily is what is happening to real income (ability to spend) and what is happening to confidence (willingness to spend).
This kind of information becomes available only very sporadically, mostly quarterly, that is once every 8 million seconds. That’s a different time scale from real time market trading.
Proxy data sources can be used, such as company trading statements (twice annually), tax receipts and credit data (monthly), industry output and sales data (monthly)and informal opinion surveys.
And of course the real time asset price discovery in trading markets, bringing together much that is known, believed, surmised, expected, feared, hoped, with a dash of often imperfect insider information, and then taking all information that can be brought to bear, and not only the immediate state of real income, spending & confidence.
Reading the economy, therefore, remains a very imperfect science in terms of what has happened and is happening. Describing the prospect ahead is a matter of projecting all these variables, with increasing potential for new surprises the further out in time.
Which brings us back to the daily news flow.
A civil war in Syria, a government crisis in Europe, a central bank bend on tapering (perhaps), a government in suicidal mode (shutdown) or mood (debt showdown), unions bend on destroying whole sectors – these are exciting things, but how does it affect flow of real income and level of confidence?
Is the news potentially shocking enough, to the point of shifting expectations, or is the audience experienced enough to see through events, if not simply bewildered and preferring to focus on its rugby, golf or tennis (opting out from the irrational games of others)?
As the world integrates further, as more learning is done and experience accumulates, as the depth of voting pools increases, one must allow for eroding shock value of events, and greater understanding about options.
This does not mean big shocks may be becoming less likely, far from it. But our ability to handle complexity may be improving even as the complexity increases.
Every bit of news should be evaluated as to meaning. But the impact on any economy, even fragile ones, may not be so self-evident as it once was.
There is learning, experience, flexibility, adjustment, forward thinking, greater defense in depth, and more buffers.
Still, we want to know what real income is doing and what confidence is doing if we want to project growth. These remain imperfect attempts, given the information flow and our interpretation abilities.
Internationally, it appears both real income and confidence is very gradually improving.
The US economy is steadily reinventing itself after the banking and housing debacles, with renewed housing activity (from very low levels), an energy revolution (fracking based) and rejuvenation of manufacturing. A better priced Dollar assists exports, but the changing energy balance will be most important in halving the US current account deficit. This despite fiscal headwind.
In Europe, too, there is great emphasis on regaining trade competitiveness, even if public austerity drives still have to end and bank credit channels still have to improve further.
Japan has embarked on an aggressive refloating policy while China is trying to maintaining 7.5% growth.
In contrast, in SA we note loss of terms-of-trade as commodity export prices declined, constrained private risk-taking, fixed investment and new staff hiring, and restrained consumer spending, all of it reflected in negative confidence surveys.
These conditions are complex in origin and seemingly long-lasting, suggesting subdued growth for the time being even as the world economy perks up a notch.
It would seem most of our problems are domestic sourced rather than global in nature, even if our external exposure remains fragile.