Private Domestic Investment and Real Economic Growth: Why the Dearth?

Those connected with econometric data are all too aware of the first chart. Less attention and focus goes to the components of real gross domestic product (GDP) and their trends, particularly private domestic investment (PDI), which historically leads to real economic growth and job creation. The correlation for this comes from looking at the change in real GDP, which responds to changes in PDI [1].

The historical trend for PDI has been relatively weak and muted, despite its multiplier effects on real growth and jobs. The period of the greatest compounded annual growth rate (CAGR) in PDI since 1947 occurred from June 1992 to June 2000 (9.3%; $985B to $2.01T). At the same time, growth in government expenditures was relatively flat (1.4%). Speaking to our trade deficit crisis, net exports (exports-imports) increased negatively at a CAGR of -36.6% (-$36B to -$439B). Personal consumption grew steadily (4.2%) with real GDP growth (4.0%), confirming the moniker "consumer-driven economy."

Since the "prolific" 1992-2000 period, the trend has reversed on PDI. From June 2000 to June 2011, PDI shrank with a negative CAGR of -1.1%, and the current value is stuck at around 2001 levels. While it is true that real GDP and the components kept growing until the 2006-7 pop in the mortgage bubble, PDI has not robustly recovered since the 2008 plunge. A large contributor came from the plunge in residential fixed investment, which we may classify as synonymous with personal consumption, given the hefty progression of homebuyers and speculators that took on mortgage debt and refinancings to finance further consumption. But what about nonresidential fixed investment? Why is it not showing healthy robust growth? Embarrassingly, government expenditures have outpaced at a 1.6% CAGR, and real GDP and employment remain flat to down.

What are the plausible causes of the dearth in PDI, specifically the contributions coming from nonresidential fixed investment? I provide a list below, which is by no means complete:

• Government regulations are too many, too costly, without justifiable cost benefits
  
  • EPA, Labor Dept (employment regulations), Sarbanes-Oxley, Dodd-Frank, ...
• Monetary and tax policies support/induce consumption/speculation, not investment (nonresidential PDI) that leads to solid job creation
  • Zero interest rate policy (ZIRP) and quantitative easing (QE) induce speculation and malinvestment, distorting risk-reward
  • Significant overseas profits remain unavailable for domestic investment due to punitive corporate tax policy
  • Tax code growth has coincided with providing vote-buying tax subsides linked to consumption; increasing complexity and uncertainty in the code represent a fundamental drag on business growth
• Government expenditures crowd out PDI, and may have as damaging an effect in the future as mortgage debt consumption did in the recent past
  • Government stimuli (including subsides), social "entitlements" and welfare ($9T+ marketable Treasury debt, $5T+ non-marketable debt, $100T+ off-balance-sheet liabilities)
  • False safety in Treasuries and the sovereign credit rating

The bottom line is that unless we address the inhibitors to PDI, specifically nonresidential fixed investment, we risk stagnant growth (or worse) for the foreseeable future.

[1] The charts showing the correlated trend between real GDP and PDI, and total non-farm payroll and real GDP, are shown below:

Global Debt Watch: $95T and Counting

As of Dec 2010, worldwide marketable/tradable debt outstanding neared some USD$95Trillion, according to the Bank of International Settlements (BIS). The historical data above indicates that debt markets have more than doubled from Dec 2002 to Dec 2010, with the largest increases stemming from domestic issuances, at first (2002-2007) from mortgage and asset-backed security issuances, and then more recently (since 2008), from sovereign government issuances. The United States maintains the largest debt market, at some $32.5T, ~35% of the worldwide total market [1].

Gauging and tracking marketable/tradable debt is key to understanding global capital market stability. Though total debt levels can also contain "nonmarketable" debt, such as nonmarketable sovereign government debt, it is the marketable debt that has the greater systemic influence across debt, equity and derivatives markets, since market participants price and trade that debt; however, the influence of nonmarketable debt levels should not be understated. I have started to maintain a "Global Debt Watch" page HERE, with the intent of providing historical trends and data analysis at regular intervals from a variety of international sources.

The fantastic growth in the debt markets has been assisted by three primary factors: (a) the reduced borrowing costs made possible by central bank monetary easing policies worldwide; (b) the aggressive use of short-term funding markets, such as the repurchase agreement (repo) and commercial paper (CP) markets, to borrow cash short and buy longer-dated, higher-yielding debt; (c) government policies that promote debt issuance, and government-sponsored entities (GSEs) that "back" such issuances. Government sanctioned credit rating agencies have also been a factor in the growth of debt markets.

The growth and decline of the repo and CP markets in the last decade coincide with that of the growth and decline of mortgage and asset-backed securities (MBS/ABS) and collateralized debt obligations (CDOs), structured pools of MBS/ABS. The total repo market size between the two largest markets, U.S. and Europe, stood at approximately $12.6T Dec 2010, after falling from a 2008 high of $17.5T [2]. Unlike the CP markets, the repo markets are not reported in the BIS debt data above; repo markets are (usually) very fluid, with the majority of transactions composed of overnight or very short-term maturities. The relative opacity of repo markets, plus their vulnerability to liquidity issues due to collateral quality, counterparty risk and capital cushions, make tracking these markets imperative to gauging stability and "systemic risk." Conceivably, the more transparency in the repo markets, the better able the system would be to handling (greater) market liquidity dislocations, such as that experienced from the credit crisis of 2007/8. However, such transparency does not solve the problem of debt accumulation sponsored by central bank monetary and sovereign government fiscal policies.

[1] The Securities Industry and Financial Markets Assoc. (SIFMA) estimates U.S. debt markets at $35.5T, ~37% of the total worldwide market. SIFMA includes offshore centers and CDOs issued in USD.
[2] I assembled these estimates from two sources, the NY Federal Reserve (Fed) and the International Capital Market Association (ICMA). The NY Fed data only reports primary dealer repos, from a survey of Fed primary dealers, and does not count private OTC repos handled by bank holding companies. That may likely increase the U.S. total by some 30%, according to BIS.