Preface
Acknowledgments
Contents
About the Author
List of Figures
List of Tables
1 Why Finance Matters for Economics: The Story of Financing the Railroad
The Relationship Between Credit Growth and Economic Growth
Growth and Debt Finance
The Global Case for Credit and Growth
Sector Links—The Links of Finance and the Economy at the Sector Level
The Specific Issue of Private Credit
Market Price Framework
Price Signals in the Linkages Between Markets
Shifting Benchmarks: What Is an Investor to Do?
Policy Benchmark: No Single Number But the Result of Many
A Fixed Dollar? How About Not
No Simple Benchmarks in a Complex Economic World
The Challenge of Anchored Benchmarks and Establishing Market Pricing
Normalization of Interest Rates?
Commodity Prices
Equities
Foreign Exchange Rates
Silos Four Markets: Seeking Out the Linkages
Benchmarking Nominal GDP: Growth and Inflation
Money and Nominal Growth
Asset Prices and Nominal GDP
Isolationism Is Not a Viable Approach to Market Interactions
Three-Dimensional Chess
Interest Rates and Nominal GDP Growth
Moving to Another Level
The Costs and Benefits of Capital and Growth
Financial Markets: The Economy’s Fraternal Twin
So, Where Do These Market Observations Take Us?
Markets in Disequilibrium: Certainly Not Simultaneous Equilibrium in All Four Markets
Gauging Economic Change: Economic Signals
A Historical Context for an Effective Decision-Making Process
A Duality in Frameworks: How We Make Decisions—Not By Economic Numbers Alone
Framing Bias, Risk, and Uncertainty
The Anchoring Bias: In the Data and in Policy
Economic Evolution—Cycles and Structural Breaks
Fed Balance Sheet—Structural Breaks and an Asymmetric Impact
Inflation: The Unreachable Star?
Equity Values Rise as Economic and Profit Growth Slows
Credit Cycles
First the Bad News—Well Not All Bad News—Banking
Consumer Credit: A Threshold Effect?
Monetary Policy, Decision Making, and Cognitive Bias
How Long Is Transient?—The View of Inflation in Monetary Policy in 2020
Modeling Inflation: An Exercise in Ptolemaic Economics?
Policymaking as a Source of Financial Market Dynamics
Public Policy and Private Decision Makers
Administered Versus Market Prices Creates Disequilibrium
Moving from Points to Process: Where Are We Versus Where We Were
Movement from a Focus on Points to Process
Four Cases of Persistent Disequilibrium: What Is to Be Learned?
Constant Disequilibrium and the Discovery of Neptune
Interactions and the Role of Expectations
Identifying Change, Evolution, and Regression to the Mean
Evolution of the Economy—And Financial Benchmarks
Non-linearity
Regression to the Mean? The Past?
Do Rising Rates Cause (Granger) Recessions?
Identify Change, Distinguishing Trend and Cycle
Inflation: Heading to Success Despite the Evidence
Assume the Ideal Outcome in an Imperfect World
References
2 The Story of the Original Boom and Bust in Western Finance: The Mississippi Bubble
Cycles, Trends, and Corrections: Creating a First Impression
What Generates these Cycles Around the Trend?
None Come to Pass: Expect a Trend, Get a Cycle
Trend Growth Despite an Up/Down History
Inflation: Heading to Success Despite the Evidence
Assume the Ideal Outcome in an Imperfect World
Expectations of Mean Reversion: Getting Back to Normal
Debt Finance
If Not Normal, Where Are We in the Cycle? Late
Late Cycle Pricing of High-Yield Credit
Credit Standards: Move to Tighter Standards
For Whatever the Reason: A Flatter Yield Curve
Decision Making and Cognitive Biases
Benchmark Evolution
Linkages Between Markets
Price Adjustment
Evolution of Irrationality: Expectations Overwhelm the Fundamentals
Euro Sovereign Debt
Net Percent of Banks Tightening Credit on Commercial & Industrial (C&I) Loans
Shifting Investor Motivations: From Income to Capital Gains
Credit Today, Payments Tomorrow
The Interactions Between Expectations and Shocks
Living Life with Negative Static Stability II
Disruption is Good, Disruption Without Direction is Chaos
Signals on the Path to Negative Static Stability: The Race to the Bottom
Assumption of Positive Static Stability Today
Neutral Static Stability: Stay at New Altitude
Before You Put that 2019 Outlook to Work—Benchmark for Expectations/Actuals, Dynamism/Change
“Visiting Grandma’s House at Thanksgiving”: The Price of False Precision
Three ingredients to Watch for Negative Static Stability
Mid-Cycle as Misleading Benchmark for Decision Making
Reality as Unreliable Guide
Introducing Change and Adding Dynamism to Cycles
Midnight Strikes: Cinderella Loses a Shoe, Lives to Dance Another Day?
Yield Curve: Flatter not Inverted
Finance and Real Economic Growth: Trends and Cycles
Over the Horizon Radar: On the Other Side of the Recession Mountain
Where We Are is Not Where We Are Going
Looking at the Internals of Corporate Finance
Nature of the World Disequilibrium
When the Music is Over, Turn Out the Lights—Part I
Private Markets, Public Policy, Recessions, and Depressions
Shock to Market Equilibriums—Generating Negative Static Stability
Overshooting and Irrational Exuberance: Up and Down Excesses
Monitoring the Cycle: Three Rising Pressure Points
Fed’s Inflation Target Met
Shrinking Margin for Error: A Sign of Imbalance in the Equity Market
Change Information, Change the Framework of Market Interactions
Real Final Sales: Displacement Downshift
Inflation: PCE Deflator
Benchmark Treasury Rates
References
3 Price Determination in a Multi-Sector Global Economy
The Story and Motivation for Price Discovery
The Story of Inflation, Interest Rates and the Dollar in the Administration of Jimmy Carter: Motivation for Price Discovery
Price Determination Web of Interactions Between Markets
Growth and Goods Inflation: One-Way Link
Domestic Demand and the Price of Capital
Completing the Web: Dollar, Interest Rates, and Inflation
Prices as Signal
Time-Series Analysis: Do It Once—With Unrevised Data
A Framework for Prices in Four Markets
Price Determination over Both the Short and Long-Run
Intellectual Challenges to Conventional Views of Market Interactions
The Challenge of Interest Rate Parity
Anchoring Bias for Inflation Target: When Actual and Policy Targets Diverge
For Investors Let’s Start at Naught
There Are No Prompter Screens at Investment Meetings
Works in Theory, Works in Practice
Price Shock from the Supply Side
Exchange Rate Surprise: The Plaza Accord
A Focus on Price Cycles: Not Busts
The Benchmark 10-Year Treasury Rate
Evolution of Prices: When Slow-And-Steady May Not Win the Race
The Equity Earnings/Price Ratio: Another Complex Pattern
Prices and the Economy; The 2020 Experience
Tracing Through COVID with Market Prices: Exercise in Price Adjustment
Prices and Economic Data—What Is the Point?
Price Determination: Cycles, Trends and Playing from a Different Playbook
Price Discovery: Cycles, Trends in Three Interlinked Markets Part II
Dollar/Euro Value: Long Cycle or a Downtrend?
Rate Setting in Global Capital Markets
Price Determination, Policy Indetermination
Benchmarking the Light at the End of the Tunnel
The Disequilibrium World for Price Determination
Vladimir and Estragon Search for the Perfect Price
Isolated Actors in Interdependent Markets
Structural Break
Decide Today—Discover the Price Tomorrow
The Element of Surprise: New Information in One Market Alters Price Expectations in Another Market
On the Exchange Rate Front
On the Trade Front
On the Monetary Policy Front
Searching for the Perfect Price: Life in an Action-Adventure Movie
Silos Fall in a Financial Windstorm: Reality TV for Investors
Cross-Silo Lessons from the FOMC’s Non-move
Lessons from the Chinese Devaluation—2015
Lessons from Disappointing Growth
Price Discovery—Our Never-Ending Journey
Housing—Both Cyclical and Secular Forces
That Risk-Free Rate—A Benchmark for Investors
Wages, Productivity and Inflation: Linkage of Factor and Output Markets
Multiple Markets, Multiple Surprises: A Bumpy Road Ahead?
Irrational Prices as a Challenge to an Economic Framework
Short-Run Movements Around a Longer-Run Trend: Would the Real Long-Term Value Stand Up? (A Tell the Truth reference)
Irrational Prices and an Uncertain Framework: Equities
What if No Price Is the Right Price?
Economy at Non-market Prices
References
4 Credit Allocation and the Role of Interest Rates as the Price of Credit
Credit Allocation and the Role of the Price of Credit: Housing 2005, Corporate Debt 2020
A Framework for Credit Allocation
Price Determination, Policy Indetermination
Tension in the Yield Curve and the Allocation of Capital Over Time
Interdependent Markets
Credit Allocation: The Story Behind the Curtain
Interdependent Markets as Framework to Examine Credit Allocation
Timing Issues: Interest Rates as a Video Not a Snapshot
The Thankless Job for Private Investors and Central Banks
Interest Rates: Income and Substitution Effects
Evolving Framework, Fed Balance Sheet, Forces for Inflation
What Did We Learn about Our Evolving Framework?
Inflation: What to Say at Our Next Strategy Meeting?
Introduce Change: When Actuals Do Not Equal Expectations
A Comparative Look
Interest Rates and Federal Finance: Role on Non-Price sensitive Buyers
A New Player Enters the Credit Market: Fed Balance Sheet, and Benchmark Treasury Rates
Fed’s Balance Sheet Drives Benchmark Treasury Rates
Yes, the Size of the Balance Sheet Drives the Ten-year Treasury
Does the Composition of the Balance Sheet Matter?
Political Outcomes, Expectations, and Long-Term Benchmark Yields
Multi-factor Determinants of the Yield Curve
Lessons of 2019: Optimism on Rates, Expectations, and Outcomes
Inflation: What You Get, What You Expected—Betting on Economic Policy
Nature of the world disequilibrium credit allocation
Interest Rates as the Price of Credit: Altered Fundamentals
Back to Normalization: Administered Rates to Market Rates
Altered Fundamentals: Altered Market Prices
Interest Rates: Setting the “Normal” Benchmark
Central Banks, Administered Rates, and the Purposeful Mispricing of Credit
Market Interactions in 2018–2019; Principles Matter
Essay Interrupted; Principles Continue to Matter
TINA: There Is No Alternative
Tipping the Bond Market Equilibrium in the Corporate Sector
Disequilibrium—Fed Can Be Patient but Markets Are Always Moving
Overcoming Obstacles in Developing an Investment Strategy
Incomplete and Imperfect Information: Another Aspect of Credit Allocationin the Real Economy
Domestic Yields in the Global Context
Exiting Financial Repression Era-Correcting Mispricing No Easy Matter
References
5 Short-Term Credit: Bridging the Next Few Years
Story and Motivation
Why Am I Reading This?
Barings Bank and the Louisiana Purchase Credit Availability on the Upside
Credit Shortage on the Downside: 1990–1991
Supply and Demand for Short-Term Credit
Between the Lip and the Cup: The Evolution of Credit Demand
Between the Lip and the Cup: The Evolution of Credit Supply
Short-Term Credit: Just in Time Finance
Evolution of Short-Term Credit Markets
Introduce Change: Dynamism as the True Character of Credit Markets—Not a Move from One Equilibrium to Another
Cyclical Pattern of Bank Lending
Short-Term Credit: Both a Supply and Demand Story
Focusing on Commercial & Industrial Loans as Cyclical Barometer
The Bank Credit Cycle: Mean-Reverting but the Credit Cycle Remains
The Cyclical Character of Credit Remains After 2009
Profits: Actual and Expected Part of Cyclical Demand
Credit Per-Covid Shutdowns: How Did It Look?
A More Resilient Financial System—The Fed
Senior Loan Office Opinion Survey—Demand and Supply Sides of the Credit Market
FDIC: Quality Standards for the Banking System Itself
Delinquencies on the Decline: Welcome Sign
Short-Term Credit: Aftermath
Noncurrent Loan Rates: Paint It Black
Charge-Off Rates—High & Dry
The Special Situations File: Banking and the 1990 Recession
Decision-Making as an Essential Ingredient: Evidence of Intellectual Bias in the Credit Cycle
5a. Aftershock
Stimulus to Action: Whatever the Intentions, Action, and Inaction, Have Their Impacts
Yes, the Size of the Balance Sheet Drives the Ten-Year and Alters Credit Allocations
Fed’s Dual Mandate and Credit Allocation
The Great Recession and the Fed Funds Rate’s Effectiveness
Yes, This Time Is Different for the Fed Funds Rate
Credit Allocation
References
6 Capital Markets: Financing Business Over the Long Term
Financing the Credit Cycle—What’s Behind the Demand and Supply of Bonds
A Framework for the Market for Long-term Finance: Supply and Demand
Supply of Bonds
Longer-Term Fixed Income Credit: Framework for Analysis
Short-Term Debt and Interest Rates: Linking Quantity and Price
Corporate Leverage: Debt-to-Equity Ratio
Debt and Equity: Trends, Spikes, and the Leverage Issue
Back to Basics Once More: Supply and Demand in the Bond Market as Engines for a Procyclical Behavior of Bonds: Recent Evidence
Linkages and the Bond Market: Pretzel Logic
Finance for the Long Term: The Multiple Forces in Corporate Bond Markets
Die Another Day
Expectations and Cognitive Biases: Rebounds in Credit
Low Costs to Finance
Incentive to Finance: Capital Spending Plans Out Run Internal Funds
Business Loans, Cash, Debt, and Equity: Financial Options
A Look Back at the Early 1990s and the Channels of Influence
Too Much of a Good Thing?
Creating Disequilibrium: Cycles, Trends, and Structural Breaks in Credit Pricing and Availability
Interaction of the Real Economy and Finance
Demand for Credit: ProCyclical
Suppliers for Credit: Who is Buying?
Benchmarking Corporate Benchmarks and Corporate Leverage
Interest Coverage: Cyclical Patterns Subject to Exogenous Shocks
Short-Term Versus Long-Term Debt and the Funds Rate
Dealing with Disequilibrium: The Age Before 2020
Linkages from Balance Sheet to Real Economic Activity
Putting the Financing Gap to Work
One Last Driving Factor of Corporate Finance: From the Inside
Interest Rates and Corporate Financing
Market Incentives and the Sources of Corporate Funds
Short-term, Long-term Debt: Secular Change for the Manufacturing Sector
Interest Coverage Ratio and GDP: Who is in Charge? Growth
Distinguishing Trend and Cycle in Nonfinancial Corporate Finance
Falling Share of Short-Term Debt
Corporate Bonds Rise as AA Rates Decline
Bank Loans as Debt Finance: Smaller Share Since 1980s
Shocks: The Perennial Change in Public Policy
What About Bond Rating Agencies and Credit Default Derivatives?
References
7 Dynamics of Corporate Finance: What Motivates Change?
Lessons from a Prior Cycle
Putting Corporate Debt into Perspective
Internal Dynamics of Corporate Finance
Looking Behind the Veil of Corporate Debt
Interest Coverage Ratio and GDP: Who is in Charge? Growth
Causality: From Equity Markets to Credit Markets
Corporate Leverage: A Note on the Influence of Changes in Corporate Benchmark Yields
Introducing Change: The Role of Inflation and High Yield Spreads
Forged in Fire: Indicators of Tensile Strength in the Nonfinancial Corporate Asset Market
Once Again, the Importance of Cognitive Bias Recognition Not Just Number Following
The Character of Manufacturing Finance Leading Into 2018
Profits, Growth, and the Economic Cycle
Sector Linkages
Evolution of Growth and Interest Coverage
Recognizing Evolution in Financial Benchmarks
First Half of 2018: Prelude to Covid Shutdowns and Recession
References
8 Evolution of Household Finances
On the Road to Irrationality: Housing Finance in the 2000s
Two Sides to the Household Balance Sheet
Evolution of the Balance Sheet
Importance in Understanding Household Behavior
Evolution of Both Sides of the Balance Sheet
Liabilities: Growth Rates also Change
Net Result: Trends and Structural Breaks—Not Constant
Assets/Liabilities and Structural Breaks
Households: Both a Consumption/Saving and Portfolio Decision
Life Cycle Behavior—More Than Just a Cyclical Pattern
Credit Cycle: Short-Term View
Demand and Supply of Credit Over the Economic Cycle
Consumer Short-Term Credit: Another Exercise in Pro-Cyclical Behavior
A Closer Look: Cycles in Credit, Economics, and Auto Finance
Monitoring the Cyclical Patterns of Ratios: Debt Service and Financial Obligations
From the Income Statement: Debt Service Ratio
Financial Obligations Ratio
The Consumer Debt Issue Post WWII and into the 1980s: Interplay of Markets
Household Balance Sheet 1970s
Exogenous Shock: Home Prices Can Decline
Volatility Is the Character of the Housing Market
Evaluating Credit Pressures Amid Unpredictability
Animal Spirits and Economic Cycles: Explaining Abrupt Behavior
The Household Balance Sheet—not a Partial Score
Focus on the Household Balance Sheet—Not Just Debt
2019 Before 2020 Shutdowns: Looking at the Balance Sheet
Household Credit: Another Look at the Supply and Demand
Consumer Credit: The Federal Reserve Bank of New York—Quarterly Survey
Secular Change in Household Debt
What to Watch for—Delinquency Rates in the Covid-19 Shutdown Era
Consumer Finance: An Evolving Economic State
References
9 Capital Flows: The Dollar and Global Capital Allocation
Global Capital Flows: Credit Allocation Across Borders and the Associated Exchange Rates
Optimism on the Dollar: An Economic Driver and Rider Both
The Linkages Between the Four Economic Sectors
After Accounting for Growth: Dollar and Interest Rates
Stronger Growth Drives Multiple Factors
For Decision Makers: Getting Beyond the Headlines
Capital Flows, Interest Rates, and Asset Prices
Capital Flows and Equity Markets
Top Holders of U.S. Treasuries: Finance Asian Style
Capital Flows: A Brief History of Variability
Capital Flows and Market Prices
Interdependence, Spillover, and Repercussion Effects
Linkages
Evolution of Capital Flows and Exchange Rates
Sourcing Capital on a Global Scale
Sourcing Capital on the Global Scale
Three Sources of Disturbance in a Market in Constant Disequilibrium
Igniting the Fire on the Domestic Front
Exogenous Increase in Export Demand: A War-Time Tradition
Shifting Preferences: Buy local—The Patriotic Pocketbook
Thinking Beyond Step One
Dollar as a Price: Global Allocation of Resources
Failure at a Distance: The Many Linkages in Exchange Rates
Balance of Payments: Growth, the Exchange Rate, and Interest Rates
Failure at a Distance—Again
Linkages in a Non-Recursive Economy
Decision Making in a Non-Recursive Global Economy
Domestic Policy in a Global Capital Market
What About Fed Easing in an Era of Perceived Economic Strength?
But There Is a Bigger World Out There
What Difference Would Monetary Easing Make—Let Us Ask Lord Kelvin
Disequilibrium in the Four Sectors of the Market Prices: Exchange Rates, Interest Rates, and the Expected Return on Capital
What About Expectations?
Reviewing Past Cycles: All Else Is not Equal for Capital Flows
Spillover Effects and the Canadian Experience: Exogenous Increase in Export Demand
The United States: Endogenous Increase in Fiscal Expansion and Dollar Appreciation
The United States: Endogenous Increase in Monetary Policy Restraint
The U.S. Experience in 2014–2019: Above Average Global Growth and Interest Rates
Disequilibrium in Europe: The Case of Below Global Growth and Rates
When the Tide Goes Out
Cotton Bonds: Gone with the Wind
The Euro: If at First You Do Not Succeed—Quit
Shocks in the Commodity Markets: A Long and Dismal History—Brazilian Coffee
Commodity Shocks, Corn Laws, and Post-Napoleonic Europe
Shocks in the World of Imperfect Capital Mobility
References
10 Profits: Rewards and Incentives in an Economic System to Allocate Capital
The Story of Profits in the Wilderness: the Colonies Get Their Start
Profits: Engine of Enterprise
Profits, Growth, and Their Symbiotic Relationship
Profits: Overlooked Contribution to Growth and Lower Rates
Profits and Raising Capital Funds: One Input to the Economic System
Exposure to Global Economy: Linkages as Another Part of the System
Linkages
Profit Margins: Top-Line Growth and a Mid-Cycle Peak
Shrinking Margin for Error
The Globalization of Opportunity: Profits Earned Abroad
Is There Value in the “Profits Recession?” More Guidelines, Not Rules
Role of Profits in a Four Sector Economic Framework
Profits as Return to Entrepreneurs and Risk-takers
Role of Profits in the Economy
Statistical Character of Corporate Profit Growth
Examining the Behavior of Profit Fundamentals in the 2010 expansion
The Why and How of Cyclical Variation for Profits
The Cyclical Character of Corporate Profits Opens Up the Opportunity to Identify Three Pressure Points in the Cycle
Three Rising Pressure Points for Investors
Fed’s Inflation Target and Expectations for Market Interest Rates
Room to Move
Cyclical Dynamic: Economic Accelerator and Financial Outcomes
Profit Growth: What about Late in the Economic Expansion?
Tension on the Profit Margin Front: Current Policy Proposals
Profit Margins and Public Policy: The Equity Market Correction in 1999
Change in Investor Behavior: Expectations: From Income to Capital Gains Again
References
11 Equity Finance: Financing Innovation and Long-Term Household Wealth
Dutch Joint Stock Company: A Combination of Funds to Promote Trade
The Equity Market—And Its CoConspirators
So, Galileo What Do You See?
Money, Interest Rates, and the Missing Invited Guests
OK Mr. Kepler, with These Observations What Are Your Laws?
Yet, There is One Final Twist to the Story
Galileo, Kepler, and Isaac Newton
Equity Markets and Their Role in an Economy: The Efficient Allocation of Capital
Equity Allocation
Equity Market: The Returns and Cost of Capital
The Equity Island—With Bridges Attached
What Are the Details Behind the CAPE Ratio?
Three Factors Driving Corporate Profit Growth and Equity Prices
Profit Margins
Corporate Taxes and Capital Spending: Not So Clear a Story
Unit Labor Costs
Interest Paid
Expectations, Equity Prices and Earnings
Income and Capital Gains
Best Laid Plans: Expectations and Surprises
Financial Benchmarks and the Economy: Nominal GDP, Interest Rates, and Equity Valuations
Benchmarking Resource Allocation: Altering the Capital Stock of a Company
Tax Policy and Capital Adjustments
Recognizing Change in Financial Asset Markets
Evolution of the Cost of Capital Over the Business Cycle
The Earnings-Price Ratio: Another Non-Mean Reverting Series
Economic Policy, the Cost of Capital, and Economic Growth
Evolution of the Cost and Returns to Capital Over the Economic Cycle
Cost of Capital: Many Routes to the Same Target
Returns to Capital: Variability Over the Cycle, Financial Returns Are not Mean Reverting
Interest Rates, the Dollar and, Yes, the Yield Curve
Shocks on the Upside: Excessive Risk Premiums on the Advent of Structural Change
References
12 Sovereign Finance: When Economic Growth and Sovereign Debt Are a Mismatch
Historical Curiosity or Shot Across the Bow?
Keynes—Economic Consequences of the Peace
Something Has to Give, Something Will Give
In the Short Run All Appears Calm
Dynamic Process of Stimulus, Change, and Market Interactions
The Greek Marathon—of Financial Crisis and Reform
The Sovereign Bond Market—Another Playground in the Credit Market
A Framework for Analysis
USD/Euro Budget Deficits and Growth: The Benefit of Exorbitant Privilege
Far, not so Good
Pricing Federal Debt in a Four Sector Framework
Sovereign Debt Finance: The Assumption of Unlimited Demand—Until It is Not!
The Dynamic Effect: Expectations Altered
Growth Matters: Rising Interest Rates, Diminished Growth Expectations
What is the Character of Economic Factors and Sovereign Debt?
Changes and Dynamic Character of Sovereign Finance and the Economy
Debt Monetization
The Impact of Growth, Interest Rates, and Inflation: A Change in the Pattern
Pricing Character of Sovereign Debt
Flatter Sovereign Yield Curve in the 2010 Expansion—Why?
Future Imperfect Uncertainty-Questions from the Road
History: Germany, Dawes and Young as U.S. Precedent?
Disequilibrium: How Quickly the Outlook Changes
A Sense of Complacency
Shock: Putting the 1980s Deficit Shock in Perspective
Capital Flows: Interest Rates and Treasury Finance
Expectations Revisited
All Else is not Equal for Capital Flows
Outlier or Warning Signal? August 2011
The United States as Net Debtor and the Specter of John Law
Finance Via Fiat Money
References
Conclusion
Index