Tag Archives: Recovery

Positives Signs in Europe

Recently, multiple economies in the Eurozone experienced serious downturns. One the most troubled economies was Greece. In fact, Greece was the origin of this economic crisis in Europe. This can be seen with a decrease in yield for Greek bonds. According to a chart in the Wall Street Journal, Greek bond yields have dropped to 6.828%. During the peak of Greece’s economic problems, which were in 2012, the yields were very close to 35%. In the near future, there will be a €8 billion, or $11 billion buyout to pay back bonds that are maturing. The country is also feeling optimistic. Alpha Bank expects the economy to grow 1.1% this year.

Greece’s silver linings could be attributed to the positive outlooks for the rest of the Eurozone. There is an article by David Jolly in the New York Times about this. Part of this economic growth is the unexpected improvement in the French economy. The article discusses Markit’s composit index of economic activity, which is based on a survey of purchasing managers. If this survey were to generate a reading of 50 or higher, then this would mean that there is economic growth. Anything below 50 would represent contraction. The reading for this month was 53.2, which means that there is growth. Last month’s reading was 53.3, which is the highest reading in the last 32 months.

An article in the Washington Post from about a month ago explores growth in various countries in the Eurozone. The GDP grew by about .3% from October to December, which contributes to an analyzed rate of 1.2%. According to this article, growth in the third quarter was a little slow, but it picked up in the fourth quarter. Part of the reason for this was activity that was higher than expected in Germany, France and Italy, some of the Eurozone’s biggest economies. These fourth quarter growths were .4%, .3% and .1%, respectively. The Netherlands achieved growth rates of .7%, and two other troubled economies, Spain and Portugal grew by .3% and by .4%, respectively.

In a previous post, I mentioned that there is more than what meets the eye in economic data. Mankiel confirms this in his book. Previous trends are not always the best way about making investment decisions because an investment moves in a random pattern. There is no way to be sure if it will go up, down, sideways or back and forth. The same can be said about an economy. Recent figures have shown that Europe is seeing economic recovery. Even some of the troubled countries, such as Greece, Spain and Portugal are recovering. The Markit index for France is showing a reading above 50, so we know that its economy is growing. However, we do not know what will happen in the future. Some event, such as another liquidity crisis, could happen that could have a large impact on the Eurozone. If this were to happen, a lot of economies would tank. We have no way of predicting this, much like how we have no way of predicting where an investment will go in the future.

 

Shedding Light on the Labor Force Participation Rate

Last Friday, February job report came with a little surprise of higher than expected job growth of 175,000 and an increase in the unemployment rate to 6.7%. The increase in the unemployment rate came from non-participants getting into labor force in last month. While we watch the FED’s move to wind down QE and plan on raising the interest rate as the economy slowly recovers, we should look at more data to see whether the recovery is bringing back the U.S. economy to the track. A recovery should bring back the economy to the long run trend.

The puzzle we see after the recession is a historically low level of the labor force participation rate. The labor force participation rate is unchanged February at 63.0%, which is the lowest in 35 years. The following graph shows the labor force participation rate (LFPR) for the total population and population from age of 25 to 54.

LFPR

It is now clear that the LFPR for the total population has been decreasing since the onset of the recession. This decrease has partially been linked to the baby boomers’ retirement since 2010. But increasing data we see is that the LFPR for the group of age of 25 to 54, the prime age workers, has also been decreasing during the recovery. For this group, retirement is less relevant to the decreasing LFPR. Therefore, we should worry that there might be a cyclical decline in the LFPR.

Timothy Dunne and Ellie Terry have recently written on the subject of low LFPR. According to them, a decrease in the LFPR for prime age workers is a key contributing factor to the low overall LFPR. They separated the effect of a change in the LFPR of each age group on the overall LFPR change. The following chart shows how change in the LFPR decomposes:6a00d8341c834f53ef019b034b7184970c-800wiin their own words on the result:

Three key results emerge. First, increases in labor force participation for the youngest age group boosted overall labor force participation by 0.075 percentage points. Second, the growing population share of the 55+ age group reduced LFPRs over the period by 0.21 percentage points, accounting for roughly 40 percent of the overall decline. Third, labor force participation for prime-age workers continued to fall. The combined within effect for the prime-age individuals (25–34, 35–44, and 45–54) reduced the participation rate by 0.28 percentage points—or a little over half of the overall decline in labor force participation. Additional declines in labor force participation were associated with the reduction in population shares of prime age workers.

In other words, we see that much of the decline in the LFPR has come from decrease in the LFPR for workers of age of 25 to 54. For this group, the LFPR was 82.5% when the recession ended; whereas it is now 81.1%. A question we should ask is whether the labor force participation rate can get back to its highest level of above 84% once the unemployment rate reaches its natural rate and the economy recovers (we should define when a recovery ends).

From the first graph, it seems like the LFPR reached its highest level at around 66%. Considering increase in retirement of baby boomers in coming years, getting back to this level of LFPR is unlikely even after a solid recovery. However, the recovery should bring the LFPR for the prime age workers back to its pre-recession level unless there are some structural factors that are reducing the rate. There is high possibility that the LFPR for prime age workers might not reach its high level as the economy recovers and the unemployment rate decreases. In this case, Christopher J. Erceg and Andrew T. Levin have suggested the  monetary stimulus policy to continue until some other labor market conditions, specially the labor force participation rate, pick up, not just until the unemployment rate drops to low level if the LFPR is still relatively low.

Detroit on the right path

Coming back from being the largest municipal bankruptcy in history is not a position any city wants to be in. But that’s exactly where Detroit finds itself as its population, and in-turn tax revenues, have diminished over the past few decades. This week, Detroit filed its restructuring plan to the federal court, and focused much of its spending on removing blight in the city. Blight, which is defined as an “ugly, neglected, or rundown condition of an urban area,” has sadly become a defining feature of the once-great city. I believe that targeting blight is the first step in a long recovery for the city.

Detroit’s blight comes in the form of abandoned houses littering the city. This, of course, is due to the 1 million plus residents who have left the city since its peak in the 1950s. Detroit's population

By prioritizing the removal of blight from the city (in the form of dedicating $500 million to the task), Detroit can target many of the issues holding back a population inflow. First, abandoned houses are hosts to crimes including sexual assaults, drug abuse and even murders. Andrew Arena, who runs the local non-profit Detroit Crime Commission, explains, “The criminals who were there are like cockroaches. If they’ve no place to hide they move on.” In addition, over 60 percent of the fires in Detroit occur on blight ridden properties. By removing these abandoned lots and homes, the city will create safer, more attractive neighborhoods that have a chance of bringing in new families and development growth.

“‘If you address Detroit’s blight problem, you make the rest of the city’s problems easier to solve,’ said Brian Farkas, executive director of the Detroit Blight Authority.” (Huffington Post)

But there are certainly losers from the restructuring plan. Former Detroit city workers are seeing their pensions cut in half by the proposal, something they aren’t – and shouldn’t be – happy about. There isn’t much to be said about that issue, however, when considering how to move forward. When the bankruptcy was announced, it became all but clear that those pensions weren’t going to be paid back at 100%. While unfortunate, and potentially crippling, to retired workers still relying on the city for their monthly paycheck, the city has to start by doing what will attract new taxpayers.

The ultimate solution is to increase the population and city tax revenues so that debts can be paid in the future. By taking the first step and targeting the city’s blight, and in-turn increasing safety throughout the city, Detroit’s city officials have taken an important first step towards a resolution. Detroit should be optimistic that their revamped downtown areas and inflow of young talent to fill newly created jobs will start to fill those neighborhoods as they slowly transform into safer communities.

 

 

[Revised] An Analysis of ‘How the Economic Machine Works’: Part 3

In my last blog post, I discussed the short-term debt cycle and began to talk about the long-term debt cycle. This is the third post in the set and will focus on the long-term debt cycle. It will also begin to look at some of the data backing up Dalio’s claims.  In the short-term debt cycle (STDC) spending is restricted only by the willingness of lenders and borrowers to provide and receive credit, but as was discussed at the end of the last blog post, the STDC doesn’t give us a full picture of what’s going on. The long-term debt cycle gives us a broader view of what is happening.

3. The Long-Term Debt Cycle (LTDC) (60-80 years)

The LTDC is the final of the three factors that Dalio asserts drives the economy. The LTDC has three parts: (i) leveraging (50+ years), (ii) depression (2-3 years), and (iii) reflation (7-10 years). The main idea is that over the course of about 60 to 80 years, the economy undergoes a large cycle, starting with a period of above-average productivity growth (leveraging), which eventually falls dramatically (depression), and then starts growing again (reflation). Let’s take a closer look at each part separately.

The leveraging period has been discussed throughout my past two blog posts and is directly tied to the idea that credit allows people to increase income growth beyond productivity growth in the short run. During the leveraging period, the economy is undergoing short-term debt cycles of expansions and recessions, but each cycle’s bottom and top finishes with more income per person and more debt per person than the last one. At first, incomes increase faster than debts do, and as long as borrowers’ incomes rise faster than their debts, they remain creditworthy. This is what is known as ‘a bubble’– with asset values and incomes growing quickly, lenders are still willing to lend even though the public debt burden is increasing. Goods, services, and financial assets are all being bought with borrowed money. At some point, however, this false paradise must end. The bubble pops at precisely the moment when debt repayments start growing faster than incomes. Queue the depression.

In a depression, the large debt repayments cause incomes to fall dramatically. Many borrowers can no longer afford to pay back their debts with income, so they resort to selling assets. Since many borrowers are selling assets at once, the market is flooded with supply causing asset prices to plummet. Plummeting asset prices mean that the value of borrowers’ collateral drops as well, making them even less creditworthy. Incomes drop, credit disappears, asset prices fall, and borrowers can’t repay their debts, making for a self-perpetuating disaster. It’s the same negative feedback loop I talked about in the last blog post, except it’s of epic proportions.

Take a look at the following graph that illustrates the U.S. debt to GDP ratio from 1916 to 2012. Notice that the debt/GDP ratio increased steadily before both 1929 and 2008, spiked upward right after, and then falls dramatically:

U.S. Debt to GDP Ratio

This graph is not a full justification of Dalio’s claims, but it does illustrate a certain cyclical nature in the debt/GDP ratio, which gives credence to the LTDC. It’s pretty clear that after the Great Depression was over by the mid 1940’s, debts began to grow steadily until 2008. That’s about 50 years and resembles the characteristics of the LTDC leveraging period I discussed earlier.

In the next blog post I will take a closer look at the strategies government use to deal with large-scale recessions and further explain the reflation period of the LTDC.

An Analysis of ‘How the Economic Machine Works’: Part 4

Hey guys, hope everyone’s exams went well. I concluded my last post with a rather dramatic graph of the U.S. debt to GDP ratio from 1916 to 2012. Although it does not completely justify Ray Dalio’s economic model, it does provide some solid proof for the existence of the long-term debt cycle (LTDC)– the third and final pillar of Dalio’s model. This blog post will continue the discussion about the long-term debt cycle. I will try to do touch on a couple of points in this post: (1) reiterate what causes a depression, (2) clarify the difference between a depression and a recession, (3) summarize what a government can do to recover from a depression, and (4) briefly discuss the last part of the LTDC– the reflationary period.

1. What Causes a Depression?

I answered this question in the last blog post, but I got a question about it yesterday, so I thought I’d restate the explanation in a more clear, concise manner: According to Dalio’s model, an economic depression is the second part of the long term debt cycle and it occurs after a long (~50 year) leveraging period. A depression begins precisely at the moment when lenders realize that the debt repayments on the loans they gave out are growing faster than borrowers’ incomes. As soon as the debt growth rate overtakes the income growth rate, borrowers lose creditworthiness. Lenders refuse to lend (aka credit disappears) à spending decreases à people’s incomes decrease à people sell assets to compensate à flood of asset supply makes assets lose value à people’s wealth decreases à lenders refuse to lend even more…and the vicious cycle repeats.

2. What Is The Difference Between a Depression and a Recession?

Technically this is a matter of how you define each term, but the way Dalio distinguishes the two concepts is that a depression is a long-term phenomenon that happens once every 60-80 years (once every LTDC), and a recession is a short-term occurrence, happening once ever 5-8 years (once every STDC).

The economy experiences many smaller recessions throughout the ~50 years prior to the large scale depression, but these recessions can be curbed by the Fed lowering interest rates and stimulating spending. The key difference between the less menacing STDC recessions and the LTDC depression is that unlike a recession, a depression cannot be tamed by lowering nominal interest rates. Why? Because interest rates are already low when a depression begins. In this situation the Fed faces the problem we discuss so much in class: the zero lower bound on nominal interest rates. Even if the Fed is able to decrease interest rates slightly, the change is not enough to extinguish borrowers’ large debt burdens.

3. What Can A Government Do To Recover From A Depression?

The government’s role in a depression is a tricky one. It requires an extremely careful balance between the use of four key strategies: (1) Cutting Spending, (2) Reducing Debt, (3) Redistributing Wealth, and (4) Printing Money.

Cutting spending is necessary in order reduce the government’s debt burden in the long run, but there’s a problem with this strategy: after government spending decreases, the public debt burden gets worse initially. In the short term, a spending cut causes incomes to decrease, prices to drop, and unemployment to rise. Accordingly, the government must be careful not to cut too much spending in the beginning of a recovery because it may push the economy into an even deeper hole.

Reducing debt essentially involves the organization and facilitation of debt default and debt restructuring programs. Most of the time banks handle this, but government can play a role in incentivizing them to do so. During a depression, there are inevitably lots of borrowers who cannot pay back their debts. However, since banks would much rather get at least some of the repayment back than none, they agree to restructure certain loans in order to make them more manageable for the borrower to pay off. However, much like cutting spending, reducing debt also increases the public debt burden initially because people’s incomes decrease as a result of paying back the restructured loans. Even lower incomes = even less spending.

Redistributing wealth is a necessary tactic to encourage low and middle-income citizens (aka the majority of a country’s population) to find jobs and start spending money on goods and services again. Governments start running deficits to increase spending on stimulus and unemployment benefits. Furthermore, the government raises taxes on the rich in order to at least partially fund the stimulus programs. It must be careful not to tax too dramatically though. Not only can social tensions escalate quickly as a result of heavy taxation, but also incomes drop. And as we know very well by now, lower incomes = less spending.

The final strategy typically used in depression recoveries is printing money and buying assets. The central bank prints money, and then uses the money to buy financial assets and government bonds. It buys existing assets and bonds from the public, and also buys newly issued bonds from the government. In turn, the government uses the money it got from selling newly issued bonds to fund its fiscal stimulus, raising incomes and eventually pushing the public debt burden down. Again though, the government must be careful when printing money/buying assets because buying up financial assets drives up their price (inflation) and increases the government debt burden.

Phew. That’s a lot to digest for one blog post but the main idea is this: In a depression recovery the government must strike a keen balance between strategies that cause deflationary pressures (cutting spending, debt reduction, wealth redistribution) and strategies that cause inflationary pressures (printing money + buying assets). If the balance between these pressures is struck correctly, the recovery pulls the economy out of depression and the last phase of the LTDC begins: the reflationary period. Growth is slow initially, but incomes increase, credit becomes available again, and debt burdens finally begin to fall.

Higher Quit Rate, Better Labor Market

If I say that there’s a higher quit rate in the labor market means the labor market is recovering. Do you believe that? I found it incredible when the first time I read about this phenomenon(Why It’s a Good Thing More People Are Quitting Their Jobs). According to the article, there are two main reasons why people quit their current job, the first one is that more are being lured away by other employers or that they are confident enough in their job prospects that they can leave before securing a new position and the second one is they really, really cannot stand the position they have.

In either case, if people are leaving their jobs for better options, either real or perceived, we can bet that money is one of the issues. Real wage growth has been stagnant in the U.S. for a decade, which is one reason the economy continues to putter along, given that consumer spending is such a large component on GDP. Pressure on employers to lift wages ultimately lifts spending.

Again, WSJ posted an article about the optimistic view of quitting rate in US earlier today. “U.S. workers are slowly getting a bit bolder. The percentage who voluntarily left their job—the nation’s “quit rate”—hit 1.8% in November, the highest in the recovery and up from a low of 1.2% in September 2009, according to the Labor Department. About 2.4 million workers resigned in November. Some retired or simply chose not to work. But most quit to hunt for a new job or because they had already found one.” (Workers Shed Caution, in a Healthy Sign for Labor Market: More People Quit Their Jobs, as Optimism Grows)

Economists say part of the reason the quit rate is rising is that more of the jobs the economy is creating are in industries like retail and restaurants, known for higher turnover and relatively low pay. Roughly 20% of November’s quits were in the “accommodation and food services” sector, up from 17.5% in the same month two years ago. By contrast, only 5.2% of November’s quits were in manufacturing, which tends to pay more, down from 5.9% two years before. As the share of jobs in high-turnover sectors grows, the overall quit rate would be expected to rise.

It seems US is doing a good job in this way. But there’s still other concerns, the aging population, for example. Because older people change their jobs less frequently than young people. It effects the quit rate as well. And if this continues going on, a higher long-term unemployment rate will happen again in a near future.

 

Is the U.S. soon to recover from the recession?

In recent news, the United States economy has been showing overall signs of improvement. There are still  factors that could possibly lead the economy into regression, but many economists predict the economy to be advancing quickly. The root to success has been a rise in exports, consumer spending, and business investment.

Furthermore, GDP has grown at a seasonally adjusted annual rate of 3.2% in the fourth quarter. This rate is less than the third quarter’s rate of 4.1%, but overall the final six months of the year yielded the strongest since 2003, when the economy was thriving.

The potential risk for the U.S. economy relates to the currency crises in emerging markets, disappointing numbers on jobs, and housing has also declined. Four years after the recession ended, this rebound has been weak compared to past recoveries. In regards to the housing market, an index measuring contracts to buy existing homes fell by 8.7% in December. Some economists blame the decline in sales on the unusually cold winter weather, others question whether or not the decline will only be temporary. Most agree that one significant factor of the decline in housing sales roots back to rising interest rates and housing prices.

On the other hand, many economists believe that the Federal Reserve’s recent taper was meant to grow the underlying strength of the economy. Consumer confidence has risen and manufacturers are busier because of increased demand. Consumer spending is pivotal because it accounts for roughly two-thirds of economic activity. Consumer spending has grown by 3.3%, which is the fastest pace in three years. Also, more U.S. business have been making longer-term investments after years of delaying such spending. Bill Simon, chief executive of Wal-Mart commented, “I never cease to be amazed at the American consumer… They figure out ways to make it work. Long term, I’m very optimistic”.

In my opinion, I also have optimism for the full recovery of the U.S. economy but I have my doubts as well. Recently, domestic investment in real estate has fallen and also the turmoil in emerging economies is yet to unfold. If the outcome of this situation did not favor the United States, our exports would take a hit. If investors anticipate the changes in international markets to be unfavorable, this would also affect Americans’ investment portfolios. This in turn would leave less room for consumers’ discretionary purchases. For these reasons, I believe that the outcome of the emerging market economies will play a crucial role in determining the future recovery of the U.S. economy.

How New Immigration Policy Can Save America’s Economy

According to the WSJ, 2014 will be a great year for the American job market.  Total jobs is projected to pass it’s pre-recession peak, while adding almost 200,000 jobs per month. (WSJ: Signs Point to Healthier Job Market in 2014).  Nevertheless, even the aforementioned, optimistic WSJ article concedes that there is still considerable room for improvement, particularly given the distribution of new jobs.  In January of 2014, the Bureau of Labor Statistics released projections for job growth until 2022.  Unfortunately, with respect to salary levels, the jobs projected to experience the most growth pay very low wages.  Specifically, of the top five jobs projected to grow, 3 of them barely exceed the federal poverty level for a three-person family (annual income of $19,090), and 1 of them is below this poverty threshold (see graph below for details from MetroTrends Blog).  This data seems to suggest that job recovery in the United States is extremely one sided; low-wage employment is making a recovery while high-wage employment is not.  In this way, while the unemployment rate is falling, the Untied States definitely still has an employment problem

Job Growth

Interestingly, according to an article in Forbes titled “The Cities Creating the Most High-Paid Jobs, And Why They’re Good for Low-Wage Workers Too,” points out that if we focus on growing high-wage jobs, the low-wage job growth will follow (Forbes: The Cities Creating the Most High Paid Jobs…). This article points out that high-wage jobs, typically those requiring a large degree of specialization and existing in export-oriented industries (like technology, which siphons money into silicon valley from outside the region), have a very large “multiplier effect.”  Because they draw in so much money, high-wage jobs created a demand for services that pay low wages, like grocery services, food prep, and health aids.  Thus it seems logical that policymakers should focus on increasing high-wage employment, as the multiplier effect will help local economies maximize growth.

But how do we increase the amount of high-wage jobs?  One potential solution is to refocus immigration policy.  Specifically, the United States immigration department, by issuing more H1-B visas, can increase the level of high-wage employment (note: an H1-B visa is a visa granted to non-immigrants who temporarily come to the United States to work in specialized occupations like biotechnology, medicine, business, or engineering).  Indeed, data supports that issuing H1-B visas has an extremely positive impact on domestic employment.  In 2008, Bill Gates stated that “Microsoft has found that for every H-1B hire we make, we add on average four additional employees to support them in various capacities” (Immigration Policy Center).

It is logical to suspect that issuing fewer H-1B visas would force American corporations to rely on domestic labor for the “specialty labor” that foreigners provide.  But this does not seem to be the case.  A survey by the National Foundation for American Policy found that 65% of firms respond to low limits on H-1B visas by moving operations oversees where these firms can freely access the specialty labor they need (Immigration Policy Center).  Furthermore, H-1B visas allow non-immigrants to “temporarily” work in the United States.  In this way, they allow firms to create high-wage employment opportunities domestically by hiring foreign experts to get the ball rolling.

Certainly, adjusting immigration policy is just one way to increase the amount of high-skilled labor in the United States, and I would certainly enjoy hearing additional ideas.  The key takeaway, however, is that increasing the amount of high-skilled labor is a far more effective way of fueling economic recovery than growing low-wage employment.  By fueling high-wage job growth and taking advantage of the multiplier effect, US policymakers can accelerate this country’s economic recovery.

Does the recent low interest rate induce more investment?

As Keynes argued that the solution to the Great Depression was to create more investment through a reduction in interest rates, one of the goals the Fed pursued through its near zero interest rate policy was to lower overall interest rate in the economy and create more investment. As we studied from IS-LM model, I(nvestment) part of the model is a decreasing function of the real interest rate. But, of course, IS-LM model is very simplified but useful to see effects of certain changes in the economy isolated from other factors. If we naively assume the model’s argument and recent economic condition since the recession, we would expect total investments to be risen since the Fed has shifted to zero interest rate policy. As the monetary policy makers lowered the interest rate to near zero, the economy has been seeing the only period of below zero real interest rate which wasn’t created by high inflation as it was in the 1970’s.

Historical real interest rate ( 10 year rate minus personal consumption expenditure inflation rate)

Historical real interest rate ( 10-year rate minus personal consumption expenditure inflation rate)

We would expect businesses to borrow money with negative real interest rate and invest it to their businesses, right? Recent research done by by Federal Reserve staff economists Steve Sharpe and Gustavo Suarez showed that businesses investors were inelastic to low interest rates. According to the paper,

The vast majority of CFOs indicate that their investment plans are quite insensitive to potential decreases in their borrowing costs. Only 8% of firms would increase investment if borrowing costs declined 100 basis points, and an additional 8% would respond to a decrease of 100 to 200 basis points.

Strikingly, 68% did not expect any decline in interest rates would induce more investment.

In addition, we find that firms expect to be somewhat more sensitive to an increase in interest rates. Still, only 16% of firms would reduce investment in response to a 100 basis point increase, and another 15% would respond to an increase of 100 to 200 basis points.

Read more: http://www.businessinsider.com/business-investment-sensitivity-to-interest-rates-2014-1#ixzz2qXqvjHoN

In other words, one of the goals, namely to increase investment, that the policy makers hoped to achieve through the low interest rate policy hasn’t been achieved.

Private non-residential fixed investment, federal funds rate, and real interest rate

Private non-residential fixed investment, federal funds rate, and real interest rate

If we look at the above graph, business sector hasn’t been really responding to the historically low real interest rate. It may be due to the uncertainty created by the Fed’s policy tools.

Overall, total real private investment hasn’t gotten back to a level it was at before the recession.

GPDIC96_Max_630_378

This slow increase in private investment has been one of the reasons the recovery has been slow since the recession. The Fed should increase the business and consumers confidence to increase investment.

 

Link

Buy More Assets and Print More Money was the slogan that Professor Kimball used in his blogpost to explain possible ways to stimulate the economy in recession. Rather than highlighting the endless potential on “Buy More Assets” aspect, I would like to focus on where we stand on the “Print More Money” side of the story and discuss its ramifications on a global scale.

Much debate had been going on about Ben Bernanke’s Quantitative Easing (QE) and its tapering. The quantitative easing in short just means that Federal Reserve will purchase large volume of bonds so that more money would be floating in the economy, working as a strong stimulus. Ben Bernanke’s proposition to “taper” was to reduce the size of the bond buy-back program on the belief that the economy is regaining its strong hold. Bernanke announced his plan on May 22nd of 2013, and hinted that tapering is a viable option. The tapering, as we all know, did go through. Just not on schedule.

I still remember the excitement my roommate had when QE tapering in third quarter did not happen. He is a trades on the market, with a focus on macro investing. Ever since Bernanke’s announcements, second half of US stock market experienced a turmoil in anticipation of less money being injected into the market. When the tapering did not go through, bullish market made my roommate a quick fifteen-hundred dollars. The market rallied almost 30% last year, which is highest since 2009.

The tapering did not happen until December 18 of 2013 and it has been almost a month since the QE was downsized. What are some of the results we see around the world? It seems like Ben Bernanke’s decision was right. Despite the tapering, US stock market is doing quite well. US economy indeed is regaining its foothold.

How about the other parts of the world then?

inflows0114

The decline in the capital inflow to many countries raised the risk among some developed countries. According to the Wall Street Journal,

Mutual fund flows and portfolio investment drop the most, with bank lending and foreign direct investment largely unaffected. Growing demand from the world’s largest economy, the U.S., helps offset the rise in borrowing costs, the bank says.

The bank, however, doesn’t rule out a faster exit, saying a 100-200 basis points spike in interest rates is possible if the Fed accelerates its timetable or overshoots its economic targets. That could cut capital flows by 50%-85% for several quarters.

The real concern of a sharp tightening in capital flows, says Andrew Burns, the chief author of the bank’s flagship report, is where economies have large trade deficits, high private sector indebtedness, and big foreign currency exposures.

Historically, become-rich-by-making-neighbors-poor method proved to be a dangerous approach in the macroeconomic world. While US should be alerted in the general welfare of the world economy, the other parts of the world should also be mindful that there is always competition. Although it was only been a month since the tapering, bond and portfolio investors should be very mindful of the heightened risks in some of the developing economies as they may be vulnerable to the worries mentioned above.