Poland’s Economic Machine
Today I am going to examine how the Economic Machine is working in Poland.
As always, I look at each Economy through “transaction-based” approach, which basically means at the bottom of everything, an economy is just someone selling something and someone buying something. That is it.
As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:
(1) Productivity Growth
(2) The Long Term Debt Cycle
(3) The Short Term Debt Cycle.
Let’s get started!
1. Productivity
Poland is the 6th largest economy in the EU, with about 60% or so of GDP coming from the manufacturing sector.
To begin our analysis we first look at Poland current Annual GDP Growth Rate, which expanded at 0.90% in the third quarter of 2014.
For the past 20 years Poland has seen an average GDP growth rate of around 1.02%, with an all time high of only 4.5% or so, and an all time low of around -3% or so. So, the cyclical swings are not very drastic in this economy, and I think we can rest assured that even in GDP growth slides, it won’t slide far and will typically retain growth shortly. Estimates are for around 3.5% or so GDP growth in 2015–2016.
One of my key views is that movements in GDP growth are typically due to expansions or contractions in credit. So, to really understand where productivity is going you have to examine the debt cycles.
Recessions/depressions don’t occur because a drop in Productivity, as many economists think. They occur because a drop in demand, and that is largely due to a drop in credit creation.
Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt. The debt-service payments grow faster than incomes, and you have defaults. That is how we get cycles.
Lets look at the Long Term Debt cycle to clear up the picture a bit.
2. The Long Term Debt Cycle
Long Term debt cycles typically occur over a period of 50–75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.
We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels. And one person’s spending is another person’s income. So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.
The above events are what cause the long term debt cycle.
This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy. But this cannot go on forever. Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt. That is when the entire thing comes crashing down, and everything works in reverse.
Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.
To begin, the below chart shows the Government Debt to GDP in Poland at 57% of GDP, which is modest, but seems to be trending up for the last 15 years. This suggests that the government may continue to increase its spending through borrowing, and that can be good for economic growth, as government spending eventually becomes a citizens income.
Now, the above chart details debt relative to GDP, but it is more precise to look at the debt service payments, and not high debt levels, because it is the service of the debt that we should concern ourselves with. As long as countries/companies/people can afford to service their debt, the party can continue. The party ends when the debt service payments grow to more than we can borrow.
I would like to examine data on Debt Service Payment levels as a % of income, but I could not find any reliable data for Poland on that.
One could consider Interest Rates in Poland, which are currently at 2.00%, which is the lowest levels seen in 17 years. Again, I would like data that goes back 50–75 years, but could not find it.
With rates at this level, central bankers still have some room to lower rates to increase growth in credit, which ultimately spurs growth in the overall economy, but not much.
As seen in the below chart, Money Supply (M0) in Poland have steadily rising for the last few decades, with each peak higher than the previous, and I see nothing to suggest it stopping any time soon.
With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth. The only worry of this increase in spending and demand is of course inflation.
Currently, the inflation rate in Poland is -0.60%, which is a deflationary, and has been for the last few quarters. This is worrisome. As prices continue to fall people will stop making purchases, because they will wait for things to get cheaper, that will cut spending, cut incomes, cut demand and slow the economy. Not good.
As well, one can look at the Sovereign Bond yields to get an expectation of inflation in a market. The 10Y decreased to 2.29% in January from 2.59% in December of 2014.
The yield on government debt indicates expectations on inflation and debt repayment. Inflation is typically seen as the primary killer of bond portfolios, as higher inflation typically drives interest rates up, and bond prices down. The rate on the 10Y has plummeted for the last few decades, as investor put their money in safety. This low rate would also seem to suggest that the market does not expect inflation to be a problem in the foreseeable future.
Keep in mind the drop in oil prices, and Poland is a net oil importer, so that is going to help consumers as well, as they have more money to spend in their pockets, which rises spending and overall demand, and may push up economic growth.
However, debt problems typically occur because financial assets are bought at high prices with credit. Let’s look at Poland Stock market to get a general picture of where financial assets are currently.
As you can clearly see, Poland Stock Market experienced a very cyclical boom and bust around 2008, just like the rest of the world, and since then has seen some re-inflation of asset values. I think there is still more gas in the tank, but I would look out for a reversal at in late in 2015–2016.
Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy. If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices. But, as we saw above, inflation is not a problem at the moment.
As seen above, Government spending in Poland is about 42% of GDP, and seems to be a short term valley at these levels. So I would look for government spending to increase to around 46% of GDP or so, and that should happen sometime in 2015 or 2016.
Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.
With Debt to GDP high and interest rates low, I don’t think debt service payments are a problem in Poland, which would seem to suggest we are no where near the top of the long term debt cycle.
Let’s look at the Short Term Debt Cycle to better understand this economy.
3. The Short Term Debt Cycle
Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.
Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation. If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.
So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.
Below is a chart showing Consumer Spending, which is extremely cyclical, with each peak higher than the previous. I see nothing to stop this from continuing.
Below is a chart on Consumer Credit data. As you can seen, Consumer Credit has been ballooned in the last decade, and that is worrisome for me. Now, the more credit growth, the more overall spending you will see, which will prop up incomes, increase demand and the economy grows, until people can no longer afford to service their debt.
The above two charts are worrisome to me, because credit growth can’t go on forever.
Wage growth in Poland has seen steady growth over the last 15 years, which is good for economic growth because as wages increase, so will spending, and one person’s spending is another’s income, so you see more spending, and more income growth, which pushes economic growth even higher.
As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.
To examine production capacity we look at Industrial Production, which increased 0.30% in November of 2014 (the most recent data available).
But as you can see Production is cyclical, with short term cycles clearly defined. And I think there is some room for growth at these levels, and that is what I would look for in the 2015.
But what drives Industrial Production? Demand, of course. But what drives demand? Incomes drive demand somewhat. But when people want more than they can afford, they leverage up. So credit growth really drives demand. That is why credit creation is so very important to the overall movement of the economy.
To get back to our Short Term Debt Cycle analysis, if spending is growing faster than production we will see price increases, or inflation, which is the killer of economic prosperity. At 0.3% growth in Industrial Production spending is most likely growing faster than that, which means that the deflationary environment we are witnessing now will likely not last.
I would also like to look at Capacity Utilization here, and in the below chart we can see that Poland’s Capacity Utilization has been growing for the last 5 years, and seems to be nearing a peak in the short term cycle at a Capacity Utilization of 78.50%.
This level is healthy, but there is still slack in the economy, which I like to see, because this means there is room to increase production without having to incur additional costs such as building new factories or plants. Levels of around 82%-85% usually indicate inflation is likely coming.
You can also see the cycle peaking around 2008, and the subsequent fall, and that we appear to be climbing out of the following recession still. When CU is high or rising, that usually means that demands is growing, and when CU is falling that typically means demand is falling.
This chart is a positive to me, because if the trend looks to be for CU to continue to grow well in 2015–2016, that typically means demand has strengthened, which is obviously good for economic growth.
Lets pull it all together.
Conclusion:
When we take all the above information and charts into consideration, I think that Poland is in The “Late-Cycle” — typically begins about 2.5 years into expansion, depending on how much slack existed in the economy at the last recession’s trough)
- economic growth picks up to a moderate pace (around 3.5–4%)
- capacity constraints emerge
- but credit and demand growth are still strong
- Inflation begins to trend higher
- Growth in consumption rises
- inventories typically pick up
- interest rates rise
- the stock market stages its last advance
- inflation-hedge assets (3-month TBill; Oil; Gold) become the best-performing investments
I think Poland will continue to see growth throughout 2015 and into 2016. But I worry what happens in 18–24 months. Certainly some upside here, so jump, just keep in mind that 18–24 months horizon, because a pull back will come within that time frame.
But I could be totally wrong. Who knows ;-)
