Wednesday, November 4, 2015

Say "OOF"

Here's what I'm looking at:

Part of this page as of 31 October at six in the morning, my time.

I'm there because of the post. Dillow points out "the general public's lack of understanding of economics" and says: "people underestimate the tendency of emergent processes to produce benign outcomes".

Snort. Maybe people lowball the economy's tendency to produce benign outcomes because the outcomes are generally not benign.

But that's not what got me writing this morning. What got me writing was that I read those two links in his sidebar, the ones in red boxes.

The Search for Yield

"Search for Yield" links to Rational and Behavioural Drivers of Financial Markets: the case of ‘search for yield’ by Silvia Pepino:
The ‘search for yield’ (or ‘reach for yield’) observed in financial markets in recent years is a striking manifestation of the interaction of rational and behavioural factors. During an extended period of low interest rates and volatility, market participants have displayed a tendency to seek higher returns by investing in securities that carry higher credit, liquidity or duration risk.

... financial market practitioners and policy makers generally refer to ‘search for yield’ as the tendency of investors to take on higher risk in exchange for higher expected returns when interest rates are low...

In recent years, against the backdrop of very low interest rates and quantitative easing, a tendency has developed among investors to accept higher duration, credit and liquidity risk in order to boost returns.

... a tendency to ‘search for yield’ in financial markets can become a reason for concern, particularly when it is perceived to become excessive and lead to under-pricing of risk.

The article is about rational and behavioral "drivers" of the search for yield. I'm ignoring drivers. I'm focusing on the tendency of investors to take on higher risk in exchange for higher expected returns when interest rates are low.


Everyday stagnation

"Everyday stagnation" links to Chris Dillow's post at Investor's Chronicle. (You may have to register to read it.)
One of the few drawbacks of working from home is that one is bombarded with annoying phone calls from time-wasters...

All those cold callers give us a daily - well, hourly - reminder that the economy isn't dynamic enough to create sufficient productive and rewarding jobs. In other words, we are in an era of secular stagnation. This phrase has many meanings; it refers to the combination of slow productivity growth, weak investment and low innovation that have given us negative real interest rates...

Stagnation, though, hasn't only given us poor returns on cash. It has also depressed equity returns.

A recent paper by Gianluca Benigno at the LSE and Luca Fornaro at Barcelona's University of Pompeu Fabra points out that economies can fall in a stagnation trap. If people expect low growth they won't invest or innovate and this will cause low profits for other companies, thus exacerbating disincentives to invest. In this way, pessimism can be self-fulfilling.

The problem is that such pessimism might be justified.

One reason for this is that profit rates have fallen. The economics blogger Michael Roberts estimates that returns on capital in G20 countries have steadily fallen since the early 1970s.

Production is the source of profits, the source of "yield". The yield to financial markets pulls yield away from productive markets.

Growing financial profits reduce productive sector profits. Falling profits in the productive sector reduce growth, productivity, investment, and innovation. This leads to lower interest rates and depressed equity returns.

Growing financial profits undermine the source of profits. Let finance gain at the expense of the productive sector, and you set the stage for reduced yield in financial markets.

The problem is not "pessimism". The problem is "OOF": Onerous overgrown finance.

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