Back to Trend? A long look at US Growth

Something happened in 2009 which hasn’t happened since the Great Depression. The US economy failed to recover back towards the previous trend of growth. By a long mile.

Several explanations has been offered for this phenomenon; people get older, the gains from women entering the workforce was a one-off process and the gains of higher education level was a one-off, business lack any semblance of animal spirits and also foreigners save too much.

But is there any way out of this permanently lower growth path? One obvious path is infrastructure spending. When the real expected 30-year rate is close to zero everything changes. When viewed through a cost-benefit analysis, unprofitable programs are suddenly profitable. It makes sense to build highways which only marginally benefit the productivity of the economy, because the government can borrow for their upfront capital expenditure at a zero real interest.

Can we build enough infrastructure to take GDP growth back to previous trend? Maybe

On Uncertainty

The expected outcome of a coin toss is equal to the probability of heads times the outcome of heads plus the probability of tails times the outcome of tails. Early economic literature such as Knight and Keynes underlined how probabilities come in varying degrees of certainty , what we may call probability uncertainty. We propose to add another dimension to this literature by also focusing on the universe of relevant outcomes being, to varying degrees, certain or uncertain. By this we mean not the quantity of the outcome may be uncertain, but the quality.

To help clarify things consider what we may call the random generator. At the press of a button the random generator creates an object from the set of all possible objects using some unknown probability distribution. The object may be an intergalactic starship; it may be a speck of dust. Now imagine the owner of the random generator wants to sell tickets that allow people to press the button and keep whatever it produces. What would the expected outcome be? It is impossible to even try to model expectations in the face of such uncertainty.

This is what we mean by uncertainty as to the universe of possible outcomes or in short universe uncertainty.

Having thus defined universe uncertainty we can illustrate the interplay between probability uncertainty and universe uncertainty.

An entrepreneur about to start a new tech company is to a large degree unaware as to the range of possible futures that may significantly impact his business. As such what he does is not on the basis of lengthy calculation but a spur of will.

On the other hand, a speculator buying and selling stock may vary his perception as to the probability uncertainty depending on the business cycle, but the universe uncertainty stays very fixed throughout. The outcome of playing the stock market is strictly monetary in nature and has no uncertainty with regards to the universe of possible outcomes.

Since the mathematical revolution in the 1970s economics have to a large extent ignored the role of uncertainty; both with regard to probability uncertainty and completely with regard to universe uncertainty. The reason for this is partly the concept of uncertainty is impossible to formulate, but more importantly it was perhaps felt these uncertainties only existed on the fringes and didn’t matter in the aggregate.

However, since the global financial crises most developed economies have failed far below their pre-crisis trend, with none looking likely to catch up the lost potential for the next 10 years. Part of that may be a shift in the general probability uncertainty and a shift in universe uncertainty.

The crisis shows that things thought to be excluded from the universe of possible events were not. Which brings the natural question; what else may be possible.

Before the crises money markets fund were safe, a euro was a euro and Europe’s affection for war had finally been solved. Naturally a producer or consumer would ask himself: Which future states of the world may I have underestimated? Which future states of the world have I not thought of?

As uncertainty leads to inaction, the lack of will leads to economic paralysis.

End of an Era? Boeing to Bow down to Airbus

During the cold war, Boeing was the undisputed leader in the aerospace field and a leader of American innovation and technology. This change, however, and in recent years Boeing’s hold of the commercial flight market has taken a dive.

Ongoing issues with the 787 Dreamliner, lack of innovation and structural issues in the American economy has seen the all-important “moat” of Boeing shrinking – making it unlikely that Boeing can upheld their current valuation. When American Airlines ordered 460 new airplanes, it chose to split the order evenly between Airbus and Boeing. A ground-breaking deal for Airbus into American territory. Furthermore, the 200 Boeing planes AA ordered were an upgraded version of the classic 737, while Airbus will deliver 260 of their A320 flagship. In short, Old Boeing and New Airbus planes are entering the market, giving Airbus an competitive advantage in terms of product-flow. From FT:

“Analysts had warned that if Boeing had gone with an all-new aircraft, which would not have been ready until the end of the decade, the US aerospace group risked ceding the narrowbody market – the largest part of the commercial aircraft market – to Airbus and a number of new entrants led by Canada’s Bombardier and China’s Comac.”

The Defence, Space and Security side of Boeing now contributes with more than 50% of earnings, while the profit margin for the is shrinking, at 5.1% in Q1 with 138 new orders for 2011. The price/book ratio is ~19.

On the other side of the pond, Airbus has a profit margin of ~1% with 1,000 orders for 2011 and a backlog of 4,000. P/B ratio is ~2.2.

So over the next year I expect a short Boeing and long Airbus to pay off.

Disclaimer: Author has been long Airbus/short Boing since 29th June.