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US economic update. Everything that follows is a result of what you see here.

8 June 2012

Summary:  This cycle (a series of crisis, response, euphoria, repeat) has lasted so long that it’s easy to forget the larger dynamics at work.  The forest is more than the trees.  Here we briefly review what’s happened, what’s happening, what might happen — focusing on the US.

Contents

  1. The storm begins
  2. Phase 2: the cure fails, the storm returns
  3. Phase 3: rinse, repeat
  4. How will this cycle end?
  5. For more information

(1)  The storm begins

This cycle started with the 2008-09 crash.  My opinion then was the same as Dr Lanning said in the movie I, Robot “Everything that follows is a result of what you see here.”  This global deflationary episode will continue with the inevitability of a falling rock until a new equilibrium appears and the massive global imbalances get resolved (despite the hysteria, debt is only part of the problem).

This event (Fall 2008 – Spring 2009) was similar in magnitude and scope to 1929-30.

Unlike 1929-30, the world’s governments responded after after several months with massive fiscal and monetary stimulus programs — first aid that prevented the crash from becoming a depression.

(2)  Phase 2: the cure fails, the storm returns

The 2nd phase began in Spring 2010.  The massive stimulus programs had faded (since they did nothing to address the underlying problem, as many top economists said when they were devised).  No self-sustaining recovery recovery had ignited, and the developed nations were slowing.  This was a minority opinion then, as Fed Governor Janet Yellen showed in her speech yesterday, in this slide of the March 2010 consensus forecast by Blue Chip Economic Indicators — vs. the actual 2011 GDP (the lower 2011-2012 black line should be red dots).

.

From Yellen 6 June 2012

Then the euro-crisis began.  As before, in broad outline this was expected (i.e., the rescue package had been crafted in late 2009).

“It is a national and imperative need to officially ask our partners in the EU for the activation of the support mechanism we jointly created.”
— Prime Minister George Papandreou, requesting a 45 billion euro loan from the Troika (EU, the European Central Bank, and the International Monetary Fund), 23 April 2010

Europe responded with a series of too small, too late, poorly crafted “rescue packages.”  The US responded in Oct-Dec 2010 with QE2 and a massive but poorly designed fiscal stimulus.  Neither provided more than a palliative to the fundamentally weak US and EU economies.

(3)  Phase 3: rinse, repeat

Now we begin the 3rd phase, with slowing in America, China and Europe (probably India and Japan as well).  Are we, USA, the world’s save haven?  US economy has been relatively strong, buoyed by our high fiscal deficit:  $1.2 trillion for the 12 months ending May (8.5% of GDP!) — and $5.9 T since Nov 2007 (boosting our total public debt by 113%).

What’s the Blue Chip forecast for the US (as of May 2012, source)?  They’ve marked 2012 down a little since their March 2010 poll, but not 2013.  I suspect both are probably still too high.  The Fed staff is too optimistic, as usual (as in their 2007 reports showing that there was no residential real estate bubble).

From Fed Forecast May 2012

The actual data does not look good, as in this presentation yesterday by Philip Suttle of the International Institute of Finance.  These are QoQ numbers, and so do not fully reflect the slowing in the past week’s durable goods and employment reports (e.g., over the past 2 months manufacturer’s new orders are down 15% SAAR).

From Suttle, IIF, 6 June 2012

Another IIF graphic, from “Sovereign Debt and Banking Problems: Quo Vadis?” by Hung Tran, comparing us to those profligate socialists in Europe. We make Europe look good.

http://fabiusmaximus.files.wordpress.com/2012/06/20120606-iif-tran-us.jpg?w=600&h=325

Our credit metrics are among the worst of the major nations.  This has not been recognized yet, despite repeated warnings from the ratings agencies, the IMF, and the BIS.  When it happens, perhaps during the “fiscal cliff” negotiations later this year, the effects might be severe.  Also from Hung Tran’s presentation:

From Tran, IIF, 6 June 2012

Moody’s provided another perspective in their March 2010 Aaa Sovereign Monitor.  This proved accurate (much of their analysis is of excellent quality, more so than their ratings).  For more details see this post.  The lower right quadrant is a bad place to enter, and painful to leave.

Moody’s Aaa Sovereign Monitor, March 2010

(4)  How will this cycle end?

“In the long run we are all dead. Economists set themselves too easy, too useless a task if, in tempestuous seasons, they can only tell us that when the storm is long past the ocean is flat again.”
— John Maynard Keynes in A Tract on Monetary Reform (1923)

I do not know how this cycle will end.  I believe that conditions will get worse before they get better.  Even wise decisions by the great nations, perfectly executed, will create a transitional period of turmoil.  Should decisions be delayed until the turmoil begins, so that they’re made in haste under pressure, then the odds increase of policy and execution errors.  A lot.

Another effect of governments taking the necessary steps only after the chaos begins: under stress people tend to narrow their circle of care.  Who is “us” and who is “them”.  Coordination both within and between nations becomes less likely; conflict becomes more likely.

No matter what the result, eventually these things will sort themselves out.  The US has many strengths, as do the other great nations.  These events will become memories for our children, then footnotes to their grand-children.  But the effects will ripple into the future, since those nations that do well will become leaders in the 21st century.

(5)  For more information

  1. A status report about the US economy (we party so hard we cannot hear the alarms ringing), 27 March 2012
  2. About America’s economic recovery: the good news and the bad, 1 May 2012
  3. About the May jobs report – a few new jobs, bought at great cost, 1 June 2012
  4. The Titanic’s lessons for us about the coming economic crisis, 4 June 2012
  5. America is rich and powerful because we can borrow. Will this debt build a stronger America?, 5 June 2012
  6. The Fate of Europe has become visible. Only how and when the break comes remains uncertain., 6 June 2012
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27 Comments leave one →
  1. Pluto permalink
    8 June 2012 10:55 am

    Nicely done, as usual. I’m emailing this to my usual group of people who should be interested in these things but they are getting fatigued. The ongoing continual drumbeat of not-so-good news (multiple years now, as you noted in your article) has reset their risk-tolerances and they merely regard this as the new normal and continue to slog ahead assuming that things are unlikely to get worse.

    I, on the other hand, have probably over-reacted to the gathering storm clouds and headed to the cellar too soon. But I tend to prefer “safe” over “sorry” having just finished recovering from the 2000 recession in 2006. By contrast I recovered from the 2008 crisis by the end of 2009. Sometimes once bit, twice shy really does work.

    • 8 June 2012 1:27 pm

      There are only two options (in the real world). Too early. Too late.

  2. 8 June 2012 1:00 pm

    “The Fed staff is too optimistic, as usual (as in their 2007 reports showing that there was no residential real estate bubble).”

    And couple that with this:

    “In the long run we are all dead. Economists set themselves too easy, too useless a task if, in tempestuous seasons, they can only tell us that when the storm is long past the ocean is flat again.”
    — John Maynard Keynes in A Tract on Monetary Reform (1923)

    These two are examples of a major reasons I come back here. Wisdom. Tongue in cheek, understatements (versus hyperbolic panicness). Good historical perspectives. What a long strange (and unique) trip it has and will be.

    Breton

    • 8 June 2012 1:25 pm

      To produce these our highly trained teams of blind squirrels search 24-7 for acorns of insight. So every now and then they find one…

  3. Frank permalink
    8 June 2012 2:10 pm

    Make sure all your debt is at a fixed and low rate… If we stay depressed and rates go lower, you may be able to refinance, but another course might be inflation… Especially if we don’t use this crisis to tackle the pension, medical, higher education, and tax reform situations…

  4. Duncan Kinder permalink
    8 June 2012 2:10 pm

    “But the effects will ripple into the future, since those nations that do well will be leaders in the 21st century.”

    Those organizations that prevail will be leaders in the 21st century. While entropy in general matters here ( see, eg. Peak Oil ) , the nation state is in decline while the various transnational organizations are heralds of a new, yet unformed order much as the bandit gangs of late Ching / early Republican China were heralds of the Chinese Revolution.

    Some states may survive – but, then, so has the British monarchy.

    • 8 June 2012 3:02 pm

      Warning: don’t assume the validity of your theories. The “decline of the state” is a theory. So far nation-states have outlived many people who predicted their demise.

  5. lhw0 permalink
    8 June 2012 2:39 pm

    Confidence Men

    … the economic “A-team” helped get the president elected and in the “japan-or-sweden” solution they were going to choose “sweden” … but they were also going to hold those on wallstreet accountable … the president then appoints the “B-team” which selects “japan” solution (many who participated in the bubble and were not going to hold accountable those responsible).

    and “Zombie Banks” Has intro Sheila Bair saying the gov. chose the “Japan” zombie bank solution. and goes into more detail on effects of choosing the “japan” solution, propping up the failed institutions, and not holding accountable those responsible (although there are some disingenuous comments about wallstreet not knowing what it was doing).

    I mention here wallstreet folklore that much of this was kicked off after loosing bid to be next CEO of AMEX, set out to build something bigger (major person behind repeal of Glass-Steagall and enabling too-big-to-fail). {garlic.com discussion) and that institution was the too-big-to-fail institution with the largest amount of triple-A rated toxic CDOs being held “off-book” … four largest too-big-to-fail were still holding $5.2T at the end of 2008: {dead Bloomberg link} wallstreet folklore about a major driving force behind too-big-to-fail, also mentioned here (Garlic.com)

    CBO has report that last decade that tax revenues were reduced $6T and spending increased $6T, for a $12T budget gap (compared to baseline which had all federal debt retired by 2010). Most of this started after congress allowed fiscal responsibility act to expire in 2002. Last decade, the Comptroller General would include in his speeches that nobody in congress was capable of middle school arithmatic (based on what congress was doing to the budget after they allowed fiscal responsibility act to expire).

  6. John Cardillo permalink
    8 June 2012 6:43 pm

    “Rinse and Repeat” The analogy.describes a system that has become unstable. Try driving a car without shock absorbers or calling into a radio talk show with your radio on. Closed loop systems that allow positive feedback will quickly race out of control and crash into their physical limits, often self destructing. The financial system is behaving this way. There is nothing in place to attenuate the positive feedback or “the euphoria” that draws the masses into one financial bubble after another. The only thing I can spot having dampened some of this behaviour during the relative calm between the great depression and today are higher capital gains tax rates.

    1913 – 1921: 7%
    1922 – 1934 12% — Great Depression 1929
    1942 – 1978 25-30%
    1980 – 1985 20% — Black Monday 1987
    1986 – 1999 28%
    2000 – 2002 20%
    2003 – today 15% — Great Recession 2010

    References:
    http://seekingalpha.com/article/189189-u-s-dividend-cap-gains-tax-rate-history-possible-relevance-to-future-taxation
    http://en.wikipedia.org/wiki/Financial_crisis

    • david jones permalink
      9 June 2012 3:21 pm

      Yes! This is why the central-bank-finance/economist professions need to get with the industrial / aerospace control systems people. They’ve been developing and deploying techniques to analyze and steer deeply unstable systems for decades.

  7. 8 June 2012 6:48 pm

    Last I checked, total debt is 52 $trillion in US. This is up from 42$trillion in 08. Student loans up 1$trillion, govt deficit up ca 7 $trillion, the rest is on various expanded balance sheets largely enabled through Fed asset purchases of God knows what. Debt is not the only problem, but it is a huge problem. The coming (automatic-just as for gains) pass through of Fed (realized-very important) losses to the Treasury and the predictable political finger pointing may be what comes next. It all depends on how a possible second leg down hits various asset classes and how much we continue to lie to ourselves about the losses. Blind squirrels indeed.

    • 8 June 2012 9:40 pm

      Total debt usually excludes that of the financial sector. They are intermediaries (ie, including them is double-counting), and their unique nature requires seperate analysis. Their assets (eg, loans) are assets to the rest of the economy; their liabilities (eg, CD’s) are assets to everybody else.

      Non-financial debt is $38 trillion. Household, business, and government debt are all roughly equal in size: $13 trillion, $13.5 T, and $11.6 T (note that much small business debt is on household balance sheets, not business).

      Note the changes since the recession started (the 4 years, Q3 of 2007 to Q3 of 2011). HH -4%. Federal +1-4%. State/local +5%. Business +8%. Total non-financial debt +18%. In other words, no deleveraging. Private sector debt up; government debt up a lot.

  8. 8 June 2012 11:03 pm

    Just asking: what happens when “forced deleveraging” occurs (i.e. there is no one left to pick up the losses and make even partially good the bad loans)? Something I don’t really understand is about most of this debt. It is “owed” primarily to ourselves, right? I mean, the banking and finance industry may take a hit or the government could tax the “earners” of the interest enough to allow the “payers” of the interest to remain solvent. I am missing something here.

    Iirc, Debt jubilees were part of Babylonian culture due to debt rising on an exponential curve while economies rise on an S curve, right? So…is there some way that the finance industry can actually avoid the inevitable (i.e. debt can not be sustained)?

    • 10 June 2012 10:19 pm

      Forced deleveraging means mostly default (ie, bankruptcy for private sector entities and local governments; States and Federal do not bankrupt).

      “It is “owed” primarily to ourselves, right?”

      Define “ourselves”. As in the joke:
      Lone Ranger: “Looks like we’re surrounded by Indians, Tonto!”
      Tonto: “Speak for yourself, Paleface.”

      Massive defaults can destabilize the distribution of political and economic power within a society, which can cause social and economic turmoil.

  9. 9 June 2012 9:42 am

    I don’t know about everyone else, but my thinking on this. That the ‘great reset’ doesn’t come, but no natural growth returns to the economy until the private debt is paid down and this means stagnation for a long time — maybe decades. No inflation either, though, since wages aren’t going anywhere. All that European money is looking for somewhere to go and that will keep rates down in the USA, and if rates creep up at all, there’s always the Fed to come in and buy up even more bonds. So that means for now fixed income is the place to be, even though the interest rates suck. Take the low interest and be happy with it. Debt is going to continue to rise, interest rates are going to be low, the economy is going to be sluggish, but not collapsing, and we’re just going to get use to it.

    With rates this low the pension plans are all going to either take huge risks to get high return, or they’ll just die. I expect we’ll see yet another round of massive bailouts, massive cutbacks, or massive failure — something bad.

    • 10 June 2012 10:20 pm

      Wild guessing accomplishes nothing. We could just as easily describe a dozen equally likely scenarios.

  10. lhw0 permalink
    9 June 2012 11:30 am

    I’m not sure the reference to “dead link” regarding just the four largest “too-big-to-fail” still having $5.2T held “off-book” at the end of 2008 … I’ve double checked it several different ways: “Banks’ Hidden Junk Menaces $1 Trillion Purge: David Reilly“, Bloomberg, 2 March 2009.

    Another bloomberg link is that there was a total of $27T done during the last decade (aka $27T is more than enough to create a bubble/burst)

    and lots of behind the scenes activity trying to clear all of it (that is separate from the $12T budget gap that congress created last decade). $10T as of 2010 efforts to clean up the mess: Federal Reserve’s ‘astounding’ report: We loaned banks trillions, Christian Science Monitor, 1 December 2010. $30T as of end 2011: “Bailout Total: $29.616 Trillion Dollars“, The Big Picture, 9 December 2011.

    with all of the above, there is little different that they appear appear able to do: “Geithner, Bernanke have little in arsenal to fight new crisis“, Washington Post, 11 August 2011.

    this mentions that june2011, there was $700 trillion in derivative bets … nothing appears to have been done to slow down the gambling.

    despite all the rhetoric about controlling derivatives and can’t put a stop to risky gambling, Sheila Bair in the last week in TV interview claimed it is actually quiet easy to differentiate between use as straight insurance to cover potential losses and the enormous amount of gambling that continues to go on (hard to come up with scenario that the $700 trillion is for insurance).

  11. Thomas More permalink
    10 June 2012 4:51 am

    “So that means for now fixed income is the place to be…”

    The treasury 20-year return just turned negative. Parking your money in an investment vehicle guaranteed to produce negative returns? Not so good…

    • 10 June 2012 5:16 am

      {deleted; no discussion of investments on the FM website}

    • 10 June 2012 10:42 pm

      The purpose of the FM website is geopolitics, broadly defined. There are thousands of websites for people to chat about investments. These tend to hijack threads. All future comments like this will be deleted, per standard policy.

  12. roger erickson permalink
    11 June 2012 2:50 am

    Fabius,
    you proved your total ignorance about existing currencies when you mixed countries with & without their own, fiat currencies in one chart. Better stick to military history if this is indicative of what you’re going to write. You’re a bit out of your element, and it shows. Here are some remedial hints:

    HEARINGS BEFORE THE COMMITTEE ON FINANCE UNITED STATES SENATE, 13 February 1933

    All countries that mattered gave up on the gold-std by 1933 (we were the last). From 1944-1973 the USA alone reinstated a gold/currency exchange (for other govs). Post 1973 nearly everyone was on a fiat std (except for those idiots that pegged their currencies to some other currency).

    Spain, Greece, Ireland & other “euro” countries ceded their fiat currency to the ECB, starting in 1999. Note: There is NO equivalent of the US Treasury for the euro-using states. Euro-using states have the same problem Arkansas has – they’re using a currency someone else issues, and (unlike Arkansas) the ECB is NOT subservient to a European-wide Treasury or government.

    If you’re totally confused about how fiat currency works, then:

    1. look up the word “fiat” in a dictionary, then think about what it means & implies;
    2. read these 4 links:

    “Almost everybody talks about budget deficits. Almost everybody seems in principle to be against them. And almost no one, literally, knows what [they are] talking about.” Robert Eisner, The Misunderstood Economy, p.90;

    Teaching the Fallacy of Composition: The Federal Budget Deficit, L Randall Way, 25 March 2006

    The 7 Deadly Frauds of Economic Policy, Warren Mosler, posted at his website “The Center of the Universe”, 7 June 2009

    Fiscal sustainability 101 – part 3, Bill Mitchell posted at “billy blog”, 17 June 2009

    • 11 June 2012 3:00 am

      Reading fail by Mr Erickson! A combination of ignorance and arrogance seldom seen in the 21,303 comments on the FM website.

      “you proved your total ignorance about existing currencies when you mixed countries with & without their own, fiat currencies in one chart.”

      The chart was from a presentation last week by the International Institute of Finance (the brighly colored words are “links”; click on them to see information). From Wikipedia:

      The Institute of International Finance, Inc. (IIF) is the world’s only global association of financial institutions. It was created by 38 banks of leading industrialised countries in 1983 in response to the international debt crisis of the early 1980s.[1] The IIF now serves its membership in three distinct ways:

      • Providing analysis and research to its members on emerging markets and other central issues in global finance.
      • Developing and advancing representative views and constructive proposals that influence the public debate on particular policy proposals, including those of multilateral agencies, and broad themes of common interest to participants in global financial markets.
      • Coordinating a network for members to exchange views and offer opportunities for effective dialogue among policymakers, regulators, and private sector financial institutions.

      The Institute’s 30-member Board of Directors is led by Chairman Josef Ackermann; Vice Chairmen Francisco González, Roberto Setúbal, and Richard E. Waugh; and Treasurer Marcus Wallenberg. The IIF’s Managing Director is Charles Dallara, who has held the position since 1993. The Institute is headquartered in Washington, D.C., and in November 2010 opened its Asia Representative Office in Beijing.

    • 11 June 2012 3:34 am

      A note of background information. Not for Erickson, since ignorance at that level is usually hopeless.

      1. There are dozens of posts on the FM website discussing these subjects, at a high level of detail.
      2. Many of these are reposted at some prominent economic-themed websites. Such as Roubini Global Economics (run by Nouriel Roubini), where two recently have been their “featured posts of the day”.
      3. Erickson lists several articles about Modern Monetary Theory, which is a fringe theory among economists. That doesn’t mean that it’s false; it’s just not the certainty he describes it as.

      From the post: “Our credit metrics are among the worst of the major nations.”

      Hung Tran (Senior Director of the IIF) compares US credit metrics to those of the UK, France, New Zealand, Canada, and Australia. While France does not have its own currency, it is still an interesting comparison — since so many Americans believe that our situation is so superior to those of those socialist Euro-hellholes.

  13. 11 June 2012 2:31 pm

    “….since so many Americans believe that our situation is so superior to those of those socialist Euro-hellholes.”

    THAT is just incredible, isn’t it? But to hold any other position would/does require some substantial work and study.

    Oh and also…. “Not for Erickson, since ignorance at that level is usually hopeless.”

    Man there were some zingers in these Comments to comments! Producing a smile every now and again is certainly appreciated.

    Breton

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