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Best economic indicators

Ok, there are no "best economic indicators".  People form models, either intuitively or mathematically formalized, using a very tiny subset of all available data (of varying quality), and everyone uses a different subset.  If I want to construct a supply side model then factors like non-residential construction,  purchases of durable (depreciation schedule) goods for production, ...; If I want to construct a demand side model then factors like consumer credit levels and growth, recreational air travel, the home improvement world (solar ... net durable upgrades).   I'll bet there are many models out in the world for which there is zero overlap in factors.

Could there ever be a set of, say, 5 measures of the economy that "everyone" could agree are important, with the dispersion in other unique factors by group having only secondary or lower level impact?

I don't have 5 I agree on with myself.   In the current day in age I think the behavior of the 10yr TSY is the best indicator of world wide financial capital sentiment.   But beyond that things degrade rapidly.  On the more demand side rail traffic seems a top candidate.

So what are the candidates for the next 3?

I've learnt to value the following indicators when it comes to assessing the probability of a recession or financial crisis:

1. The evolution (change) in the private debt/GDP ratio.

This one comes from professor Steve Keen, considered by some to have been the earliest and most vocal warner of the 2008 crisis: https://www.youtube.com/watch?v=Zc2t6X-gla0. Ray Dalio also heavily emphasises this metric in his books and templates, amongst others. The basic argument is that the change in private debt corresponds to the net credit provided to the private sector in a given year, which drives the economy in the short term (what Dalio calls the short term debt cycle). If this credit is used for productive pruposes, then the expanding private debt (which is expected in an endogenous money economy, with bank credit creation amounting to the majority of the money supply) is met with expanding GDP, and the private debt/GDP ratio is more likely to stay stable or decrease than increase very fast. However, if such credit is used for non productive purposes, such as asset speculation, the private debt/GDP ratio rises because higher private debt isn't accompanied by higher GDP.

What people like prof. Steve Keen, Ray Dalio and prof. Richard Werner (whose quantity theory of credit basically argues dividing credit creation for productive and non productive purposes goes a long way in understanding many economic phenomenon, including crises) show is that in fact most financial crises are preceeded by greatly increasing private debt/GDP ratios, reflecting excessive credit creation that is not translating proportionately into economic growth (see video above). The number itself is not the most important, although Keen argues numbers above 10 p.p. increases in the ratio per year are very worrisome and Dalio shows in his debt template the private debt/GDP ratio increased by an average of over 7 p.p./year in the financial crises he studied. During the crisis, the change in the ratio often goes from positive to negative, reflecting deleveraging and economic rebalancing.

I think this is an increadibly intuitive, common sense indicator that is yet seldom paid attention to, given most people and media find looking at public debt more fun, even though most crises start in the private sector and are only later reflected in the public sector as it attempts to cushion private sector deleveraging with its own leveraging.

2. Evolution in the real effective exchange rate (REER) and current account balances.

The development of external imbalances is usually reflected in increasing REERs and current account deficits, which we know how they tend to end: capital flows suddenly stop, IMF intervenes by lending to enable debt payments and prevent defaults and in turn demands differing mixes of currency devaluation and austerity, which do not bode well for the economy in the short term and ususally precipitate a contraction. These imbalances usually also accompany rising private debt/GDP ratios.

There are also many examples of this dynamic at work (Eurozone crisis, Asian crises, some south america countries,...).

3. Yield curve.

Much debated indicator, whose predictive power I find intuitive: excluding the term premium, long term interest rates reflect market nominal growth expectations; in turn, short term rates are set by the CB and reflect their expectations for nominal growth. An inverted yield curve means the market expects short term rate to decrease (since long term rates are short term rates compounded), which means the market thinks current short term rates set by the CB are too agressive and will choke the economy by decreasing credit supply and demand. In other words, it's the market's way of saying they think the CB's expectations for nominal growth are too high. If the CB remains too tight, a contraction is more likely in the short term, which leads to the CB cutting rates and the curve returning to positive again.

Oftentimes central banks increase short term rates to try to curb speculative credit creation, reflected in fastly rising private debt/GDP ratios, and end up killing the real economy in the meantime.

 

Just my opinion on what I think are relevant indicators of trouble to come and that I like to follow and why. Open to any opinions!

For the most part I'm looking for indicators of the real economy, which things like rail traffic, housing starts, etc. provide some useful information.   The 10yr TSY is a financial indicator but it provides useful information about trends in global financial capital flows.

While I'm familiar with Keen's work I'm of the view, like Werner, that debt levels are completely dependent on the end use of the debt funded consumption, and dependent on the carrying cost.

In my physical (coupled differential equations) model I have only physical parameters.  Money and credit and debt does not appear, only real Thermodynamic variables.   Granted for labor that is easy, but for consumption of physical capital it's more complicated.   We can use labor and capital to produce more capital, some of which is consumed (e.g. food) and some of which may be used to produce more capital.   So it's factors which represent these components that are of the greatest interest.

All that matters is the forward-looking performance.  That determines what to use.