Tagged: economics

Do The Math

Anybody ever said to you, “Do the math?”

Yesterday on CNBC’s Squawk Box legendary hedge-fund manager and founder of Omega Advisors Leon Cooperman said the world is crazy.  That’s anthropomorphizing the planet but I agree. He was referring to the math behind negative interest rates, which means paying people to borrow money.  That’s crazy all right, but happening.

He also said, paraphrasing, that if the population of the country grows by 0.5% and productivity increases by 1.5%, that’s 2% economic growth.  Add in 2% inflation and you have 4% “nominal” growth, meaning the numbers add up to that figure.

He said if the S&P 500 trades at 17 times forward earnings, that puts the S&P 500 at roughly 2150, about where it is now, so the market is fully valued but not stretched.

Why should you care in the IR chair? Macro factors are dominating markets, making a grasp on economics a necessary part of the investor-relations job now.

Whether Mr. Cooperman would elaborate similarly or not, I’m going to do some math for you.  Inflation means your money doesn’t go as far as it did – things cost more.  If a widget costs $1 and the next year $1.02, why? Prices rise because the cost of making widgets is increasing.

Making stuff has two basic inputs:  Money and people. Capital and labor.  If you must spend more money to make the same stuff, then unless you can raise prices or reduce the cost of labor, your margins – which is productivity or what economists call the Solow residual – will shrink.

There’s no growth if you’re selling the same number of widgets, even if revenues increase 2%. And if prices rise, there is on the fringe of your widget market some consumer who is now priced out. That’s especially true if to retain margins you cut some labor costs by letting the receptionist go.  One more person now can’t buy widgets.

And so sales slow.

The Federal Reserve is tasked with keeping unemployment low and prices stable (a bad idea but that’s another story). Its strategy is to increase the supply of money, the theory being more money prompts hiring and rising prices are better than falling prices (errant but again for another time).

One simple way to see if that’s occurring is to look at currency in circulation on the Fed’s balance sheet.  There is now $1.5 trillion of currency in circulation, up $82 billion from a year ago.  Our economy is growing at maybe 1.5%.

In 2000, US GDP growth (right ahead of the bursting Internet bubble) was 4.1%.  In 2000, currency in circulation was $589 billion, down $30 billion from 1999 when currency in circulation grew by $100 billion over the previous year. It increased $35 billion in 1998, $31 billion in 1997.

For 2013, 2014 and 2015, currency in circulation grew $74 billion, $80 billion and $97 billion, and since July 31, 2008, before the financial crisis, currency in circulation is up $645 billion, more than total currency circulating in 2000.

Back to economic basics, what happens to the cost of stuff if money doesn’t go as far as it used to?  Prices rise.  Okay, the Fed is achieving that aim. Its plan for remedying the recession was to get prices rising.

But rising prices push some people out of the market for things.  And if to make things you’ve got to put more money to work, then something has to give or productivity declines.

It’s declining.

And if stuff costs more, people who aren’t making more money can’t buy as much stuff.  What you get is weak wages, weak growth, weak productivity. Check, check, check.

Haven’t jobs numbers been solid? We have 320 million people in this country of which 152 million have jobs. If 1% leaves every year for retirement, having kids, going to school and so on, 200,000 jobs each month is 1.5% economic growth at best.

And that’s what we’ve got.

If you want a realistic view of the economy, do the math.  At some point the rising cost of things including stocks and bonds will push some consumers out of the market.  The only head-scratching thing is what math the Fed is doing, because its math is undermining, jobs, economic growth and productivity.  It seems crazy to me.