We argue that top down analysis no longer makes sense in the current economic context

1. 1
Les Réflexions de Comptoir
du Café de l’Economie
It seems that the world is going in the bad direction, at least, from an economic perspective. The high level of
debt that fuels the weak economic growth (or perhaps this is the other way around?) would be the main risk
for the world and in the end, a big financial crisis would be inevitable. This diagnosis is made by numerous
experts and is becoming the “mainstream view”.
We fully disagree. And we are tired of hearing all these analyses that rely on nothing more than fear and (bad)
intuition.
The world continues to change at a very fast pace. That’s the good news. It has always been the case since the
15th
century and there is no reason to think that this secular trend will stop soon (let’s find a cure for cancer
first!). However, this change has intensified recently with the coincidence of several events and it seems that
the legacy of this intensive period is hard to bear.
In 2016, we are left therefore with some economic agents that continue to advance but others that stay
behind. What are we talking about here? To make it short, although we can divide the economy in many parts,
we can group them into two groups: the one that we call the “new economy” (mainly non financial services
sectors) and the other one that we call the “old economy” (commodity, industry, finance, construction). At the
global level, the trajectory of these two economies has been very similar in the 2000/2010 decade but it
appears that it was just a coincidence. Now their trajectories are diverging again and this is, in our opinion,
the main problem of the world economy today.
Thus, the main problem is NOT the weak economic growth worldwide, the problem is the weakness of the
“old economy” all around the world. And the countries in which the “old economy” is important suffer the
most whilst the countries that are more geared towards the “new economy” continue to grow.
The “top down analysis” is dying with the rise of this divergence. If we look at France, where citizens like to
moan, to complain about what is bad, where we can find experts saying “social security charges are too high”
we can clearly see the divergence between the new and the old economy. We show below the dynamic of the
employment, split into industry and services as a proxy of the new and old economy. The message is crystal
clear: the problem of the French economy is the weight of the underperforming old economy.
Source: Bloomberg
75
80
85
90
95
100
105
110
115
120
2000 2003 2006 2009 2012 2015
France - Services
France - Industry
US Total
Base 100
= Jan.00
Employment: France vs. US

2. 2
The debt problem is not universal; it concerns developed countries first of all. Knowing that the industry sector
is more capital intensive by nature than the services sector and knowing that, by definition, a debt is a legacy,
we understand very well why the debt problem is without any surprise related to the old economy in the old
world.
How did we get there? Our understanding is that monetary and budgetary authorities in the developed world
have not accepted to see the collapse of the old economy. We mean that authorities are sensitive to the
social cost of the technology cycle. In other words, because the social well-being of a nation is the #1
objective (in economic terms this notion is called “minimizing the unemployment rate”) central banks have
to lower rates and budget policies have to be expansive to support the failing parts of the economy.
That’s a key point.
Experts say “monetary policy does not work”. The fact is that addressing the weakness of an old factory by
lowering its funding cost will for sure bring limited results in the end. Everybody understands that. The old
factory needs a stronger order book and decreasing interest rates from 2% to 0% will not change dramatically
its fate.
So why interest rates are so low today? 1) because the old economy is in a deflationary mode and 2) the social
cost of letting it collapsing is too high for governments. The policies that address the old economy are not very
efficient but it has to be seen as a strategy to save time.
Also, from this perspective, the level of debt in developed countries can be seen as an indicator mixing the
weight of the old economy, the efficiency of this old economy and the willingness of the government to
support this falling economy.
Source: Bloomberg
The question of the inflation rate is not important. Inflation is a consequence, not a cause. The above chart
reflects the two economies story. The services economy is back to trend so inflation in the services sector is
back to trend. The old economy is in a distressed situation so inflation in the old economy is flirting with
negative territory.
We understand here that there are two possibilities to see inflation becoming a genuine threat: 1) the new
economy becomes so strong that its inflation rate overshoots or 2) the old economy stabilizes, escapes the
deflationary zone and its inflation rate recovers towards 1%.
-3
-2
-1
0
1
2
3
4
5
1995 1999 2003 2007 2011 2015 2019
Goods ex
Food&Energy
Services ex-
Energy
Inflation rate in the US

3. 3
The equity market is telling us nicely this story. Looking at the relative performance of the Nasdaq against the
FTSEMIB index (the Italian equity index) the natural human reaction would be to argue that “the ratio is too
high, trees cannot grow to the sky, there is big risk of reversal”. The reality is that if this ratio is high, it is
simply because the profits of the Nasdaq have grown far faster than the profits of the FTSEMIB. The Nasdaq is
made of companies that will rule the world tomorrow whilst the two biggest listed Italian companies are Enel
and ENI.
Source: Bloomberg
So make your choice: do you want to be the shareholder of Google and Facebook or do you want to be the co-
shareholder (with the Italian Ministry for the Economy and Finance) of companies that produce electricity and
oil?
We do not know if trees can reach the sky but we think that these companies of the new economy can bring us
very high in the sky.
In sum, there is no anomaly to see on one side the Nasdaq index at an all time high, and on the other side,
high debt and high unemployment in the most inefficient parts of the old developed world. There is no
contradiction here but two different trajectories and public intervention to reduce this divergence.
We stop here as we are neither journalist, nor writer and we do not pretend we have an idea on everything.
Economic sciences are extremely complex so our goal here was just to offer another angle of thinking
regarding the “global growth analysis”. Things are never binary, the mainstream view is not necessarily the
correct view.
Tristan Abet
0
50
100
150
200
250
300
2000 2003 2006 2009 2012 2015
Base 100
= Mar.00
Nasdaq / FTSEMIB ratio
the anomaly in history