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Why Fiscal Sustainability Is An Unsustainable Concept

Why Fiscal Sustainability Is An Unsustainable Concept

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4 years ago

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One frequently encounters variations of the phrase "unsustainable debt trajectory" (or similar) in statements by mainstream economists. The phrase is popular as it offers what appears to be a sophisticated criticism of some fiscal policy setting that is disapproved of, but without having any content that can be used to prove the speaker wrong. Modern Monetary Theory (MMT) largely rejects that "debt sustainability" has theoretical validity for a floating currency sovereign. I will focus on the analysis of a paper by Scott Fulwiler to justify this stance.

(Note: This article is a draft section in a chapter on fiscal policy in my MMT primer. I will cover some important concepts in earlier sections, but not repeat them here. The first is the notion that inflation is the constraint on fiscal policy, which comes from Functional Finance (primer). The next concept is that a floating currency sovereign can always avoid default. I would note that this chapter is covering much of the material seen in Chapter 7 of Understanding Government Finance.)


The concept of "debt sustainability" is the usual alternative to the argument that inflation is the only constraint on floating currency sovereigns. Technically, there is the related idea of the inter-temporal governmental budget constraint, which is a mathematical construct that appears in neoclassical models. I discussed this constraint in Section 7.4 of Understanding Government Finance. The complexity level of that constraint is beyond what I wish to discuss in this text. Unless one wants to get into the mathematics, the notion of "fiscal sustainability" I use here covers most of the issues of the governmental budget constraint.

This section is based on some of the discussions found in the paper "The debt ratio and sustainable macroeconomic policy," by Scott Fullwiler.[1]  I am simplifying certain concepts, and not attempting to cover all the topics in that paper; they will be addressed in later sections. Much of the content of that paper is a critique of neoclassical theory. Since I am not assuming that my readers are familiar with that theory, discussing that material would be mainly a source of confusion. Readers with a more advanced knowledge of economic theory would be advised to read that article if they wish to have further details on what distinguishes MMT from neoclassical theory.

Sustainability

A formal definition of fiscal sustainability is that the interest burden of government debt does not rise beyond the productive capacity of the economy, or alternatively, the debt-to-GDP ratio does not become arbitrarily large.[2] (The looser way of describing the debt-to-GDP ratio condition is to say that the ratio does not go to infinity.) For simplicity, I will drop the discussion of the interest burden, and just use the notion of the debt-to-GDP ratio being bounded.

The first thing to keep in mind is that we are looking at a ratio, and if we assume that the economy is growing forever, both the level of debt and the size of nominal GDP will become arbitrarily large ("go to infinity"). The absolute level of debt does not matter, what matters is its size relative to the economy.

In less formal discussions (such as opinion columns), mainstream commentators are typically using a looser version of this definition. The issue is not what is happening at times infinitely far in the future, rather a concern about the debt-ratio on some forecast horizon (like 75 years). Shortening the horizon is reasonable, as we should not be worried about what is happening to government debt long after the Sun has reduced the Earth to a cinder. However, by moving away from this formal definition, "fiscal sustainability" is quite vague, and it does not have much more theoretical content than saying "Gee willikers, the debt-to-GDP ratio will get really high!" (What percentage is "really high"?) This lack of precision on such an important topic is rather awkward.

Primary Deficits and Long Run Averages

We cannot really hope to create an exact forecast of the long-run trajectory of the economy. We mighty be able to get a handle on the upcoming year, but we do not what will cause future business cycles. The usual convention is to assume that the economy will revert to a long-run average behaviour.

The usual assumption made is that the economy will revert to some average growth rate in real terms, which cannot be controlled by policymakers. The idea is population growth cannot be determined by policymakers, and the productivity of workers will follow trends in technology. Although this might be misleading, it is safe to say that there is no easy method for a country to decide that it would like its output to grow faster; development economics is a difficult problem.

Conversely, average inflation rates appear to be under the control of policymakers. For example, if inflation is too high, there are many mechanisms by which a recession can be forced, and recessions tend to reduce inflation rates. One may note that countries like Canada were able to hit their 2% inflation targets from the mid-1990s until the Financial Crisis (but many were below target afterward).[3]

Taken together, we can see that nominal or GDP growth is assumed to tend to some average level, with average nominal GDP growth equaling real GDP growth plus the inflation target.

We then need to come up with a way of specifying the long-term tendency for fiscal policy settings. The conventional way of specifying fiscal policy is in terms of the primary fiscal balance (which can either be a deficit or surplus). This is the fiscal deficit without interest expenses. For example, if the fiscal deficit is 4% of GDP, and interest expense is 3% of GDP, the primary fiscal balance is a deficit of 1% of GDP.

The apparent reason for looking at the primary fiscal balance is that it is the difference between taxes and programme spending -- and programme spending is to accomplish desired goals (medical care, military, welfare programmes). Interest expenses are just welfare payments for bond holders. The long-term tendency of fiscal policy is expressed by assuming that the primary fiscal balance is steady near some value.

Sustainability Conditions

Whether or not a steady state fiscal policy is sustainable depends upon the relationship between the growth rate of the economy, and the interest rate on debt. Please note that the relationship described here is outlined in the Fullwiler paper, but I am giving a longer explanation that explains it without relying up on the use of equations.

We can understand this easily by approximating the relationship that determines the debt-to-GDP ratio in a particular year. It is the sum of two terms.
  1. Take the previous debt-to-GDP ratio, and multiply it by the factor of one plus difference between the interest rate on debt minus the GDP growth rate. (This can be described as the growth differential between the debt stock on its own, and GDP.) For example, if the interest rate is 4%, and the GDP growth rate is 5% (variables could either be both real or nominal), multiply the previous debt-to-GDP ratio by 0.99 (=1 - 1%). If the debt-to-GDP ratio was 50%, the new ratio is 50(0.99) = 49.5%. Note that this term is multiplying the debt ratio, not adding to it.
  2. Add the year's primary balance as a percent of GDP. So if the primary deficit in the previous example is 4%, the debt-to-GDP ratio is 53.5% (=49.5% + 4%).
(Author's note: I might add a technical appendix to justify that claim. The approximation comes from assuming that we are working with annual data, and more importantly, using a first order approximation of debt and GDP growth rates. The error would be small for small growth differentials, which is normally the case. It would start to break down if the differential 10% or above.)

If we assume that growth rates and the primary deficits are constants[4], we can use the above approximation to see that the debt-to-GDP ratio will remain bounded if GDP growth is greater than the interest rate. In that case, the first term in the approximation is shrinking by the growth rate different. Once the debt-to-GDP ratio is large enough, that shrinkage will be larger than the addition provided by the primary deficit.

For example, assume that the primary deficit is a whopping 10% of GDP, while the GDP growth rate is 1% greater than the interest rate. If the debt-to-GDP ratio somehow reached 2000%, the first term of the approximation tells us that the debt-to-GDP ratio falls by 20% (1% of 2000%), then the primary deficit adds back 10% -- so the debt-to-GDP ratio would fall. According to the approximation, the two terms imply an equilibrium ratio of 1000%. (The growth differential implies a drop of 10%, and the primary deficit adds back 10%.)

Conversely, if the interest rate on government debt is greater than the GDP growth rate, the debt-to-GDP ratio will spiral off to infinity unless there is a primary surplus to stop growth. As the debt-to-GDP ratio rises, larger surpluses are needed to stop the spiral.

Implausibility of an Ever-Rising Ratio

The possibility of the debt-to-GDP ratio rising to infinity is quite curious. If we were to take the model seriously, the economy would evolve such that interest payments are more than 100% of GDP. That is, bond holders receive more interest from the government than is needed to buy everything produced by the economy, and put the excess income into buying more bonds.

This seems like an implausible outcome. Why would you want to hold more debt, when you can already buy everything within the economy? Instead, you might as well bid up the price of goods and services, so that you get a bigger portion of real output (remembering that it is extremely unlikely that all the debt is owned by a single individual, and that workers get incomes that will also want to buy goods and services).

Fullwiler describes the situation as follows:
In other words, a primary budget balance not at least as high as 0.6 percent of GDP on average would grow deficits, the national debt, and debt service all to the point that eventually paying the debt service would result in high and rising inflation. While this second row puts the convergence ratios at infinity for convenience, in fact at some point the increased debt service would simply pass through to inflation to raise nominal GDP in kind. Thus, CBO’s [CBO = U.S. Congressional Budget Office] regular practice of assuming a long run nominal GDP growth rates equal to the potential real GDP growth rate plus inflation at around 2 percent is inconsistent with its own projections of unbounded growth in debt service payments.
The problem appears straightforward: the assumption that long-run GDP growth rates and interest rates are fixed (at "natural rates") makes very little sense. If we look at stock-flow consistent (SFC) models (as discussed in my book An introduction to SFC Models Using Python),we see that SFC models do not exhibit such behaviour. An increase in government debt implies that private sector wealth is rising, and we should see increased consumption out of that wealth. If the increase in nominal demand is beyond the capacity of the economy to provide real goods and services, the price of goods and services would be bid higher. That is, the debt-to-GDP ratio would be inflated away by nominal GDP growing faster than the nominal interest rate.

In other words, the entire premise of debt sustainability analysis is based on obviously defective macroeconomic models. It is abundantly clear that the debt-to-GDP ratio will not go to infinity, rather the issue is the inflation risks posed by excessive aggregate demand.

Continuing the Discussion

The next article in this sequence will turn to the meatier aspects of the Fullwiler paper: the issue of what determines the interest rate on government debt. To spoil the argument, the interest rate is a policy decision, and not set by natural laws of economics.

Footnotes:

[1] Fullwiler, Scott T. "The debt ratio and sustainable macroeconomic policy." World Economic Review 7 (2016): 12-42.

[2] If we allow for permanently zero or even negative interest rates, we might have to drop the notion of interest burden, and just look at the debt-to-GDP ratio. For example, if we lock the interest rate at 0%, interest burden is always zero, no matter what the debt-to-GDP ratio is.

[3] The exception to this might be Japan, which was unable to hit a 2% inflation target; instead inflation was below target. I am unconvinced about the seriousness of the desire to hit that target; it may have been announced to stop the lectures by Western neoclassical economists.

[4] If we wanted a more realistic situation where these variables are changing, we would need to put bounds on these variables. For example, we could assume that the primary deficit is no larger than 5% of GDP.

(c) Brian Romanchuk 2020

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“I Can’t Even Save”: Americans Are Getting Absolutely Crushed Under Enormous Debt Load

"I Can’t Even Save": Americans Are Getting Absolutely Crushed Under Enormous Debt Load

While Joe Biden insists that Americans are doing great…

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March 15, 2024

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"I Can't Even Save": Americans Are Getting Absolutely Crushed Under Enormous Debt Load

While Joe Biden insists that Americans are doing great - suggesting in his State of the Union Address last week that "our economy is the envy of the world," Americans are being absolutely crushed by inflation (which the Biden admin blames on 'shrinkflation' and 'corporate greed'), and of course - crippling debt.

The signs are obvious. Last week we noted that banks' charge-offs are accelerating, and are now above pre-pandemic levels.

...and leading this increase are credit card loans - with delinquencies that haven't been this high since Q3 2011.

On top of that, while credit cards and nonfarm, nonresidential commercial real estate loans drove the quarterly increase in the noncurrent rate, residential mortgages drove the quarterly increase in the share of loans 30-89 days past due.

And while Biden and crew can spin all they want, an average of polls from RealClear Politics shows that just 40% of people approve of Biden's handling of the economy.

Crushed

On Friday, Bloomberg dug deeper into the effects of Biden's "envious" economy on Americans - specifically, how massive debt loads (credit cards and auto loans especially) are absolutely crushing people.

Two years after the Federal Reserve began hiking interest rates to tame prices, delinquency rates on credit cards and auto loans are the highest in more than a decade. For the first time on record, interest payments on those and other non-mortgage debts are as big a financial burden for US households as mortgage interest payments.

According to the report, this presents a difficult reality for millions of consumers who drive the US economy - "The era of high borrowing costs — however necessary to slow price increases — has a sting of its own that many families may feel for years to come, especially the ones that haven’t locked in cheap home loans."

The Fed, meanwhile, doesn't appear poised to cut rates until later this year.

According to a February paper from IMF and Harvard, the recent high cost of borrowing - something which isn't reflected in inflation figures, is at the heart of lackluster consumer sentiment despite inflation having moderated and a job market which has recovered (thanks to job gains almost entirely enjoyed by immigrants).

In short, the debt burden has made life under President Biden a constant struggle throughout America.

"I’m making the most money I've ever made, and I’m still living paycheck to paycheck," 40-year-old Denver resident Nikki Cimino told Bloomberg. Cimino is carrying a monthly mortgage of $1,650, and has $4,000 in credit card debt following a 2020 divorce.

Nikki CiminoPhotographer: Rachel Woolf/Bloomberg

"There's this wild disconnect between what people are experiencing and what economists are experiencing."

What's more, according to Wells Fargo, families have taken on debt at a comparatively fast rate - no doubt to sustain the same lifestyle as low rates and pandemic-era stimmies provided. In fact, it only took four years for households to set a record new debt level after paying down borrowings in 2021 when interest rates were near zero. 

Meanwhile, that increased debt load is exacerbated by credit card interest rates that have climbed to a record 22%, according to the Fed.

[P]art of the reason some Americans were able to take on a substantial load of non-mortgage debt is because they’d locked in home loans at ultra-low rates, leaving room on their balance sheets for other types of borrowing. The effective rate of interest on US mortgage debt was just 3.8% at the end of last year.

Yet the loans and interest payments can be a significant strain that shapes families’ spending choices. -Bloomberg

And of course, the highest-interest debt (credit cards) is hurting lower-income households the most, as tends to be the case.

The lowest earners also understandably had the biggest increase in credit card delinquencies.

"Many consumers are levered to the hilt — maxed out on debt and barely keeping their heads above water," Allan Schweitzer, a portfolio manager at credit-focused investment firm Beach Point Capital Management told Bloomberg. "They can dog paddle, if you will, but any uptick in unemployment or worsening of the economy could drive a pretty significant spike in defaults."

"We had more money when Trump was president," said Denise Nierzwicki, 69. She and her 72-year-old husband Paul have around $20,000 in debt spread across multiple cards - all of which have interest rates above 20%.

Denise and Paul Nierzwicki blame Biden for what they see as a gloomy economy and plan to vote for the Republican candidate in November.
Photographer: Jon Cherry/Bloomberg

During the pandemic, Denise lost her job and a business deal for a bar they owned in their hometown of Lexington, Kentucky. While they applied for Social Security to ease the pain, Denise is now working 50 hours a week at a restaurant. Despite this, they're barely scraping enough money together to service their debt.

The couple blames Biden for what they see as a gloomy economy and plans to vote for the Republican candidate in November. Denise routinely voted for Democrats up until about 2010, when she grew dissatisfied with Barack Obama’s economic stances, she said. Now, she supports Donald Trump because he lowered taxes and because of his policies on immigration. -Bloomberg

Meanwhile there's student loans - which are not able to be discharged in bankruptcy.

"I can't even save, I don't have a savings account," said 29-year-old in Columbus, Ohio resident Brittany Walling - who has around $80,000 in federal student loans, $20,000 in private debt from her undergraduate and graduate degrees, and $6,000 in credit card debt she accumulated over a six-month stretch in 2022 while she was unemployed.

"I just know that a lot of people are struggling, and things need to change," she told the outlet.

The only silver lining of note, according to Bloomberg, is that broad wage gains resulting in large paychecks has made it easier for people to throw money at credit card bills.

Yet, according to Wells Fargo economist Shannon Grein, "As rates rose in 2023, we avoided a slowdown due to spending that was very much tied to easy access to credit ... Now, credit has become harder to come by and more expensive."

According to Grein, the change has posed "a significant headwind to consumption."

Then there's the election

"Maybe the Fed is done hiking, but as long as rates stay on hold, you still have a passive tightening effect flowing down to the consumer and being exerted on the economy," she continued. "Those household dynamics are going to be a factor in the election this year."

Meanwhile, swing-state voters in a February Bloomberg/Morning Consult poll said they trust Trump more than Biden on interest rates and personal debt.

Reverberations

These 'headwinds' have M3 Partners' Moshin Meghji concerned.

"Any tightening there immediately hits the top line of companies," he said, noting that for heavily indebted companies that took on debt during years of easy borrowing, "there's no easy fix."

Tyler Durden Fri, 03/15/2024 - 18:00

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Sylvester researchers, collaborators call for greater investment in bereavement care

MIAMI, FLORIDA (March 15, 2024) – The public health toll from bereavement is well-documented in the medical literature, with bereaved persons at greater…

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March 15, 2024

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MIAMI, FLORIDA (March 15, 2024) – The public health toll from bereavement is well-documented in the medical literature, with bereaved persons at greater risk for many adverse outcomes, including mental health challenges, decreased quality of life, health care neglect, cancer, heart disease, suicide, and death. Now, in a paper published in The Lancet Public Health, researchers sound a clarion call for greater investment, at both the community and institutional level, in establishing support for grief-related suffering.

Credit: Photo courtesy of Memorial Sloan Kettering Comprehensive Cancer Center

MIAMI, FLORIDA (March 15, 2024) – The public health toll from bereavement is well-documented in the medical literature, with bereaved persons at greater risk for many adverse outcomes, including mental health challenges, decreased quality of life, health care neglect, cancer, heart disease, suicide, and death. Now, in a paper published in The Lancet Public Health, researchers sound a clarion call for greater investment, at both the community and institutional level, in establishing support for grief-related suffering.

The authors emphasized that increased mortality worldwide caused by the COVID-19 pandemic, suicide, drug overdose, homicide, armed conflict, and terrorism have accelerated the urgency for national- and global-level frameworks to strengthen the provision of sustainable and accessible bereavement care. Unfortunately, current national and global investment in bereavement support services is woefully inadequate to address this growing public health crisis, said researchers with Sylvester Comprehensive Cancer Center at the University of Miami Miller School of Medicine and collaborating organizations.  

They proposed a model for transitional care that involves firmly establishing bereavement support services within healthcare organizations to ensure continuity of family-centered care while bolstering community-based support through development of “compassionate communities” and a grief-informed workforce. The model highlights the responsibility of the health system to build bridges to the community that can help grievers feel held as they transition.   

The Center for the Advancement of Bereavement Care at Sylvester is advocating for precisely this model of transitional care. Wendy G. Lichtenthal, PhD, FT, FAPOS, who is Founding Director of the new Center and associate professor of public health sciences at the Miller School, noted, “We need a paradigm shift in how healthcare professionals, institutions, and systems view bereavement care. Sylvester is leading the way by investing in the establishment of this Center, which is the first to focus on bringing the transitional bereavement care model to life.”

What further distinguishes the Center is its roots in bereavement science, advancing care approaches that are both grounded in research and community-engaged.  

The authors focused on palliative care, which strives to provide a holistic approach to minimize suffering for seriously ill patients and their families, as one area where improvements are critically needed. They referenced groundbreaking reports of the Lancet Commissions on the value of global access to palliative care and pain relief that highlighted the “undeniable need for improved bereavement care delivery infrastructure.” One of those reports acknowledged that bereavement has been overlooked and called for reprioritizing social determinants of death, dying, and grief.

“Palliative care should culminate with bereavement care, both in theory and in practice,” explained Lichtenthal, who is the article’s corresponding author. “Yet, bereavement care often is under-resourced and beset with access inequities.”

Transitional bereavement care model

So, how do health systems and communities prioritize bereavement services to ensure that no bereaved individual goes without needed support? The transitional bereavement care model offers a roadmap.

“We must reposition bereavement care from an afterthought to a public health priority. Transitional bereavement care is necessary to bridge the gap in offerings between healthcare organizations and community-based bereavement services,” Lichtenthal said. “Our model calls for health systems to shore up the quality and availability of their offerings, but also recognizes that resources for bereavement care within a given healthcare institution are finite, emphasizing the need to help build communities’ capacity to support grievers.”

Key to the model, she added, is the bolstering of community-based support through development of “compassionate communities” and “upskilling” of professional services to assist those with more substantial bereavement-support needs.

The model contains these pillars:

  • Preventive bereavement care –healthcare teams engage in bereavement-conscious practices, and compassionate communities are mindful of the emotional and practical needs of dying patients’ families.
  • Ownership of bereavement care – institutions provide bereavement education for staff, risk screenings for families, outreach and counseling or grief support. Communities establish bereavement centers and “champions” to provide bereavement care at workplaces, schools, places of worship or care facilities.
  • Resource allocation for bereavement care – dedicated personnel offer universal outreach, and bereaved stakeholders provide input to identify community barriers and needed resources.
  • Upskilling of support providers – Bereavement education is integrated into training programs for health professionals, and institutions offer dedicated grief specialists. Communities have trained, accessible bereavement specialists who provide support and are educated in how to best support bereaved individuals, increasing their grief literacy.
  • Evidence-based care – bereavement care is evidence-based and features effective grief assessments, interventions, and training programs. Compassionate communities remain mindful of bereavement care needs.

Lichtenthal said the new Center will strive to materialize these pillars and aims to serve as a global model for other health organizations. She hopes the paper’s recommendations “will cultivate a bereavement-conscious and grief-informed workforce as well as grief-literate, compassionate communities and health systems that prioritize bereavement as a vital part of ethical healthcare.”

“This paper is calling for healthcare institutions to respond to their duty to care for the family beyond patients’ deaths. By investing in the creation of the Center for the Advancement of Bereavement Care, Sylvester is answering this call,” Lichtenthal said.

Follow @SylvesterCancer on X for the latest news on Sylvester’s research and care.

# # #

Article Title: Investing in bereavement care as a public health priority

DOI: 10.1016/S2468-2667(24)00030-6

Authors: The complete list of authors is included in the paper.

Funding: The authors received funding from the National Cancer Institute (P30 CA240139 Nimer) and P30 CA008748 Vickers).

Disclosures: The authors declared no competing interests.

# # #

Journal

The Lancet Public Health

DOI

10.1016/S2468-2667(24)00030-6

Article Title

Investing in bereavement care as a public health priority

Article Publication Date

13-Mar-2024

COI Statement

The authors declared no competing interests.

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Copper Soars, Iron Ore Tumbles As Goldman Says “Copper’s Time Is Now”

Copper Soars, Iron Ore Tumbles As Goldman Says "Copper’s Time Is Now"

After languishing for the past two years in a tight range despite recurring…

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4 hours ago

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March 15, 2024

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Copper Soars, Iron Ore Tumbles As Goldman Says "Copper's Time Is Now"

After languishing for the past two years in a tight range despite recurring speculation about declining global supply, copper has finally broken out, surging to the highest price in the past year, just shy of $9,000 a ton as supply cuts hit the market; At the same time the price of the world's "other" most important mined commodity has diverged, as iron ore has tumbled amid growing demand headwinds out of China's comatose housing sector where not even ghost cities are being built any more.

Copper surged almost 5% this week, ending a months-long spell of inertia, as investors focused on risks to supply at various global mines and smelters. As Bloomberg adds, traders also warmed to the idea that the worst of a global downturn is in the past, particularly for metals like copper that are increasingly used in electric vehicles and renewables.

Yet the commodity crash of recent years is hardly over, as signs of the headwinds in traditional industrial sectors are still all too obvious in the iron ore market, where futures fell below $100 a ton for the first time in seven months on Friday as investors bet that China’s years-long property crisis will run through 2024, keeping a lid on demand.

Indeed, while the mood surrounding copper has turned almost euphoric, sentiment on iron ore has soured since the conclusion of the latest National People’s Congress in Beijing, where the CCP set a 5% goal for economic growth, but offered few new measures that would boost infrastructure or other construction-intensive sectors.

As a result, the main steelmaking ingredient has shed more than 30% since early January as hopes of a meaningful revival in construction activity faded. Loss-making steel mills are buying less ore, and stockpiles are piling up at Chinese ports. The latest drop will embolden those who believe that the effects of President Xi Jinping’s property crackdown still have significant room to run, and that last year’s rally in iron ore may have been a false dawn.

Meanwhile, as Bloomberg notes, on Friday there were fresh signs that weakness in China’s industrial economy is hitting the copper market too, with stockpiles tracked by the Shanghai Futures Exchange surging to the highest level since the early days of the pandemic. The hope is that headwinds in traditional industrial areas will be offset by an ongoing surge in usage in electric vehicles and renewables.

And while industrial conditions in Europe and the US also look soft, there’s growing optimism about copper usage in India, where rising investment has helped fuel blowout growth rates of more than 8% — making it the fastest-growing major economy.

In any case, with the demand side of the equation still questionable, the main catalyst behind copper’s powerful rally is an unexpected tightening in global mine supplies, driven mainly by last year’s closure of a giant mine in Panama (discussed here), but there are also growing worries about output in Zambia, which is facing an El Niño-induced power crisis.

On Wednesday, copper prices jumped on huge volumes after smelters in China held a crisis meeting on how to cope with a sharp drop in processing fees following disruptions to supplies of mined ore. The group stopped short of coordinated production cuts, but pledged to re-arrange maintenance work, reduce runs and delay the startup of new projects. In the coming weeks investors will be watching Shanghai exchange inventories closely to gauge both the strength of demand and the extent of any capacity curtailments.

“The increase in SHFE stockpiles has been bigger than we’d anticipated, but we expect to see them coming down over the next few weeks,” Colin Hamilton, managing director for commodities research at BMO Capital Markets, said by phone. “If the pace of the inventory builds doesn’t start to slow, investors will start to question whether smelters are actually cutting and whether the impact of weak construction activity is starting to weigh more heavily on the market.”

* * *

Few have been as happy with the recent surge in copper prices as Goldman's commodity team, where copper has long been a preferred trade (even if it may have cost the former team head Jeff Currie his job due to his unbridled enthusiasm for copper in the past two years which saw many hedge fund clients suffer major losses).

As Goldman's Nicholas Snowdon writes in a note titled "Copper's time is now" (available to pro subscribers in the usual place)...

... there has been a "turn in the industrial cycle." Specifically according to the Goldman analyst, after a prolonged downturn, "incremental evidence now points to a bottoming out in the industrial cycle, with the global manufacturing PMI in expansion for the first time since September 2022." As a result, Goldman now expects copper to rise to $10,000/t by year-end and then $12,000/t by end of Q1-25.’

Here are the details:

Previous inflexions in global manufacturing cycles have been associated with subsequent sustained industrial metals upside, with copper and aluminium rising on average 25% and 9% over the next 12 months. Whilst seasonal surpluses have so far limited a tightening alignment at a micro level, we expect deficit inflexions to play out from quarter end, particularly for metals with severe supply binds. Supplemented by the influence of anticipated Fed easing ahead in a non-recessionary growth setting, another historically positive performance factor for metals, this should support further upside ahead with copper the headline act in this regard.

Goldman then turns to what it calls China's "green policy put":

Much of the recent focus on the “Two Sessions” event centred on the lack of significant broad stimulus, and in particular the limited property support. In our view it would be wrong – just as in 2022 and 2023 – to assume that this will result in weak onshore metals demand. Beijing’s emphasis on rapid growth in the metals intensive green economy, as an offset to property declines, continues to act as a policy put for green metals demand. After last year’s strong trends, evidence year-to-date is again supportive with aluminium and copper apparent demand rising 17% and 12% y/y respectively. Moreover, the potential for a ‘cash for clunkers’ initiative could provide meaningful right tail risk to that healthy demand base case. Yet there are also clear metal losers in this divergent policy setting, with ongoing pressure on property related steel demand generating recent sharp iron ore downside.

Meanwhile, Snowdon believes that the driver behind Goldman's long-running bullish view on copper - a global supply shock - continues:

Copper’s supply shock progresses. The metal with most significant upside potential is copper, in our view. The supply shock which began with aggressive concentrate destocking and then sharp mine supply downgrades last year, has now advanced to an increasing bind on metal production, as reflected in this week's China smelter supply rationing signal. With continued positive momentum in China's copper demand, a healthy refined import trend should generate a substantial ex-China refined deficit this year. With LME stocks having halved from Q4 peak, China’s imminent seasonal demand inflection should accelerate a path into extreme tightness by H2. Structural supply underinvestment, best reflected in peak mine supply we expect next year, implies that demand destruction will need to be the persistent solver on scarcity, an effect requiring substantially higher pricing than current, in our view. In this context, we maintain our view that the copper price will surge into next year (GSe 2025 $15,000/t average), expecting copper to rise to $10,000/t by year-end and then $12,000/t by end of Q1-25’

Another reason why Goldman is doubling down on its bullish copper outlook: gold.

The sharp rally in gold price since the beginning of March has ended the period of consolidation that had been present since late December. Whilst the initial catalyst for the break higher came from a (gold) supportive turn in US data and real rates, the move has been significantly amplified by short term systematic buying, which suggests less sticky upside. In this context, we expect gold to consolidate for now, with our economists near term view on rates and the dollar suggesting limited near-term catalysts for further upside momentum. Yet, a substantive retracement lower will also likely be limited by resilience in physical buying channels. Nonetheless, in the midterm we continue to hold a constructive view on gold underpinned by persistent strength in EM demand as well as eventual Fed easing, which should crucially reactivate the largely for now dormant ETF buying channel. In this context, we increase our average gold price forecast for 2024 from $2,090/toz to $2,180/toz, targeting a move to $2,300/toz by year-end.

Much more in the full Goldman note available to pro subs.

Tyler Durden Fri, 03/15/2024 - 14:25

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