Macro Roundup: Week of January 27, 2025
Summary of Economic Articles & Papers From Ed Conard’s Researchers
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Data Update 4 for 2025: Interest Rates, Inflation and Central Banks! Aswath Damodaran Musings on Markets
.@AswathDamodaran defines an “intrinsic risk-free rate,†the sum of real GDP growth and inflation, which he finds is more predictive of 10-year yields than the FFR. He argues “Interest rates ultimately are driven by macro fundamentals.â€
Over the last two decades we have come to accept the notion that central banks set interest rates. [I] argue that interest rates ultimately are driven by macro fundamentals, and that the power of central banks comes from preferential access to data about these fundamentals, their capacity to alter those fundamentals (in good and bad ways) and the credibility that they have to stay the course. [I define] Intrinsic risk-free rate = Inflation rate in period t + Real GDP growth rate in period t. In the chart, I compare my estimates of the intrinsic risk-free rate to the observed ten-year treasury bond rate each year. While the match is not perfect, the link between the two is undeniable, and the intrinsic risk-free rate calculations yield results that help counter the stories about how it is the Fed that kept rates low between 2008 and 2021, and caused them to spike in 2022. I am not suggesting that central banks don't matter or that they do not affect interest rates, because that would be an overreach.
Related: The Fed and the Secular Decline in Interest Rates and The Move in Long Rates Is Very Unusual and Our Thoughts on Large US Deficits and Their Impact on Bond Yields
Germany’s Economic Model Is Broken, and No One Has a Plan B Tom Fairless and Bertrand Benoit Wall Street Journal
German industrial output has fallen by 15% since 2018 and manufacturing employment is down 3%, as German exports slow amid increasing global competition from Chinese manufacturers.
Germany’s industrial output has fallen by 15% since 2018, and the total number of people employed in the manufacturing sector is down 3%. Manufacturers in Germany’s metal and electrical industry, weighed down by costs, could lay off as many as 300,000 workers over the next five years said Stefan Wolf, president of a lobby group for the sector, noting “Deindustrialization is in full swing.†Over €300 billion in investment capital has flowed out of Germany since 2021. Exports support roughly one in four German jobs. More than two-thirds of cars produced in Germany are exported. Since the mid-1990s, exports’ share of Germany’s GDP doubled, reaching 43% of GDP, four times the share in the U.S. and twice as high as China.
Related: Why the U.S. Economy Is Trouncing Europe’s and How German Industry Can Survive the Second China Shock and Will China Take Over the Global Auto Industry?
European vs. US Stocks: Which Market Comes Out On Top? Jesper Rangvid Rangvid's Blog
Once at par with Europe’s American equity markets pulled away since ~ 2015. One dollar invested in the MSCI US index in 1970 would be worth $268 in 2025, vs. $141 for a dollar invested in the 1970 MSCI Europe index.
We often hear about the strength of the US stock market, which is widely perceived to have vastly outperformed its European counterpart. However, since MSCI data collection began in 1970, the difference in performance is relatively modest, averaging just 0.8 percentage points per year. A one-dollar investment in the US in 1970 would have grown to USD 47.8 by 2007, while the same investment in Europe would have reached USD 83.9. This means that the gain from a US investment would have been just 57% of the gain from a European investment. That said, a significant shift occurred around the time of the financial crisis. One dollar invested in the US stock market index in 1970 would have grown to USD 268 by 2025. Over the long term—55 years, 1970-2025—the US stock market has outperformed the European: if you had invested one dollar in the European stock market, it would have grown to only half as much as the US stock market—USD 141.
Related: Why the U.S. Economy Is Trouncing Europe’s and Data Update 2 for 2025: The Party Continues (for US Equities)! and US Exceptionalism: Drivers of Equity Outperformance and What’s Needed for a Repeat
Concentration & Correction – What To Do Next Peter Oppenheimer, Sharon Bell, Guillaume Jaisson and Lilia Peytavin Goldman Sachs
A GS note argues volatility around the release of DeepSeek is a correction and not the start of a bear market. The US equity market “does not represent a bubble based on irrational exuberance but is rather a reflection of superior fundamentals.â€
The equity markets' correction, triggered by news of the DeepSeek LLM model, has been the first fall of more than 3.5% of the Magnificent 7 since last Autumn. In our view this is a correction and not the start of a sustained bear market. Overall levels of valuation had reached very high levels, particularly in the US, and P/E multiples have increased meaningfully since Q4 2023. In the case of the US, while much of this reflects the largest technology companies, the equity market remains expensive relative to history even if we exclude large cap technology (the second column). Furthermore, while other equity markets around the world are much cheaper than the US, most are not particularly cheap relative to their own history. The main exception is China. The dominance of US equity market, technology sector, and dominant companies does not represent a bubble based on irrational exuberance but is rather a reflection of superior fundamentals.
领英推è
Related: A Severe Case of COVIDIA: Prognosis For An AI-Driven US Equity Market and AI: To Buy, Or Not To Buy, That Is The Question and DeepSeek and the Sincerest Form of Flattery
Pettis On Krugman Michael Pettis @michaelxpettis
Responding to @paulkrugman @michaelxpettis notes that “foreign capital pours into the US not just when times are good, but also when times are bad. US deficits are almost permanent and they don’t reflect US economic conditions.â€
We disagree on what drives capital inflows. Krugman argues that rising US productivity in the late 1990s and early 2000s attracted foreign investment, and this is how economics should work: the US economy does well, imports capital, and runs deficits. However, I disagree. Capital flows into the US not just in good times, but also in bad, and US deficits are almost permanent, not reflecting US economic conditions. Another issue is the role of Asia. While China’s economy grew faster than the US’s, it had no capital inflows and instead exported large amounts of capital, which contradicts economic theory. This was due to policy interventions in China, like capital controls, an undervalued currency, and government-managed credit allocation. These conditions forced China to export capital, mostly to the US, even as the US economy weakened by 2005-06. Thus, foreign capital inflows to the US were more about conditions abroad than US performance, including the post-Asian Crisis reserve accumulation by developing countries. The US economy still had to adjust to this imbalance.
Related: Rethinking Trade Imbalances and China’s Very Bad, No Good Trillion-Dollar Trade Surplus and A User’s Guide to Restructuring the Global Trading System
Rethinking Trade Imbalances Paul Krugman Krugman Wonks Out
Challenging @michaelxpettis @paulkrugman argues that trade deficits are the obverse side of capital account surpluses. As “the US economy was doing well, it was attracting a lot of foreign investment. And the balance of payments balances.â€
There was definitely a period of a decade or so [~1990-2005] when the U.S. was really figuring out what to do with IT and the rest of the world was not. And so the U.S. pulled ahead and is still ahead, although a lot of the divergence took place during this relatively brief period. You'll see that that's exactly when the United States began running big trade deficits. And the reason is that because the US economy was doing well, it was attracting a lot of inflows of foreign investment. And the balance of payments balances. The trade balance plus net inflows of foreign investment equals zero. So if we're getting a lot of money coming to America to take advantage of the opportunities, we run a big trade deficit. Hard to see how any of this is objectionable or a problem. This is international macroeconomics working the way it's supposed to. Capital flowing to areas that offer high returns to investment, which for a while was the United States. Okay, now the reason people think it's a problem is that we have definitely de-industrialized.
Related: China’s Very Bad, No Good Trillion-Dollar Trade Surplus and Trade Intervention for Freer Trade and A User’s Guide to Restructuring the Global Trading System
Gramm and Summers: A Letter on Tariffs From Economists to Trump Phil Gramm and Larry Summers Wall Street Journal
Phil Gramm and @LHSummers argue that tariffs should not be used as a “general tool of economic policy†as they distort domestic production decreasing American productivity and could “inflict long-term harm on the economy.â€
Our united opposition to non-defense-related tariffs is based not on our faith in free trade but on evidence that tariffs are harmful to the economy. Protective tariffs distort domestic production by inducing domestic producers to commit labor and capital to produce goods and services that could have been acquired more cheaply on the international market. That labor and capital are in turn diverted from producing goods and services that couldn’t be acquired more cheaply internationally. In the process, productivity, wages and economic growth fall while prices rise. Contrary to the repeated claim, there has been no hollowing out of American manufacturing. Industrial production in the U.S. is at an all-time high. The U.S. is producing 2.5 times as much real industrial output as it did when we last ran a trade surplus in 1975. We are producing that record output with the smallest percentage of the labor force involved in manufacturing since America became fully industrialized. This has been a great success for productivity and not a failure of trade, as today’s full employment attests.
Related: China’s Very Bad, No Good Trillion-Dollar Trade Surplus and Trade Intervention for Freer Trade and A User’s Guide to Restructuring the Global Trading System
Also Noted