The past ten years were a lost decade for America (as described in Some Americans worry about we’ll have a lost decade. Bad news – we just had it.). Most American households either lost ground (economically) or stagnated. Worse, valuable time was lost — years essential to prepare for the challenges ahead. And, perhaps disastrously, we had an orgy of borrowing. What comes next?
- “The Spend-And-Borrow Economy“, Nouriel Roubini, Forbes, 27 August 2009
- “An Uncomfortable Choice“, John Mauldin, Thoughts from the Frontline Weekly Newsletter, 28 August 2009
- “Our quarter-century penance is just starting“, Ambrose Evans-Pritchard, op-ed in the Telegraph, 29 August 2009
(1) “The Spend-And-Borrow Economy“, Nouriel Roubini, Forbes, 27 August 2009 — Excerpt:
In the last few months the world economy has been saved from a near-depression. That feat has been achieved by a range of extraordinary government stimulus measures: In the U.S. and in China, and to a lesser extent in Europe, Japan and other countries, governments have pumped liquidity, slashed policy rates, cut taxes, primed demand and ring-fenced and back-stopped the financial system. All of this has worked, but at a cost. Governments have been spending and borrowing like never before. The question now is: how do they stop?
This is not a simple problem. Restore normality too soon and the risk is that a weak recovery will double dip into a second and deeper recession. Restore it too late and inflation will already be ingrained.
… Necessary as the stimulus has been, it cannot go on indefinitely. Governments cannot run deficits of 10% or more of GDP, and they cannot go on doubling the monetary base, without eventually stoking inflation expectations, pushing up long-term interest rates and eventually eroding their very viability as sovereign borrowers. Not even the U.S. can do that.
The fiscal implications of the current policy package are particularly serious. For the time being, fiscal policy has been put at the service of survival, but the current price of survival is that net public debt is going to double as a share of GDP between 2008 and 2014. Even using the very optimistic forecasts of the Congressional Budget Office, which anticipate growth of around 4% over the next few years, the net debt burden will rise from 40% of GDP to 80%–that’s an increase in the debt stock of about $9 trillion.
… A combination of higher official indebtedness and monetization has the potential to yield the worst of all worlds, pushing up long-term rates and generating increased inflation expectations before a convincing return to growth takes hold. An early return to higher long-term rates will crowd out private demand, as lending rates on mortgages and personal and corporate loans rise too. It is unlikely that actual inflation will emerge this year or even next, but inflation expectations as reflected in long-term interest rates could well be rising later in 2010. This would represent a serious threat to economic recovery, which is predicated on the idea that the actual borrowing rates that individuals and businesses pay will remain low for an extended period.
Yet the alternative–the early withdrawal of the stimulus drug that governments have been dispensing so freely–is even more serious. The present administration believes that deflation is a worse threat than inflation. They are right to think that. Trying to rebuild public finances at a deflationary moment–a time when unemployment is rising, and private demand is still contracting–could be catastrophic, turning recovery into renewed recession.
History offers more than one example of this error. It happened in Japan in the late 1990s when the Japanese government feared the effects of fiscal deficits and of an increase in inflation as the economy was beginning to recover after almost a decade of deflation. Consumption taxes were raised too soon and the “zero interest rate policy” was abandoned. Within a year the economy was back in recession.
It also happened in the U.S. in the 1930s. President Roosevelt instituted a massive stimulus package when he came to office in 1933, to push the U.S. economy out of the depression, but by 1937 the administration was worrying that inflation was returning and that deficits were too large; so it cut spending and raised rates and the Fed tightened monetary policy. By 1938 the economy was heading back into near-depression.
So policymakers are between a rock and a hard place. Stop spending now and risk renewed recession and deeper deflation (stag-deflation). Keep spending now and risk renewed recession amid rising inflation expectations (stagflation).
(2) “An Uncomfortable Choice“, John Mauldin, Thoughts from the Frontline Weekly Newsletter, 28 August 2009 — Excerpt:
And technically he is right. If there were adults supervising the party, it might be possible. But there are not. The teenagers are in control. Instead of fiscal discipline, we are hearing increased demands for more spending. Please note that the very rosy future-deficit assumptions assume the end of the Bush tax cuts at the close of 2010. But raising taxes back to the level of 2000 does not make the projected future budget deficits go away.
I mean, seriously, does anyone think Pelosi or Reid are going to lead us to fiscal constraint? Obama talks a good game, but he has not offered a serious deficit-reduction proposal, other than further tax increases. And by serious, I mean we need cuts on the order of several hundred billion dollars. The Republicans lost their way and their power (deservedly, in my opinion). Just as at the high school prom, the very few adults are being ignored.
It is the proverbial rock and the hard place. Cut the stimulus too soon and we slide back into a deeper recession. Let the budget spin out of control for a few years and we will see inflation return, with higher rates and a recession. Raise taxes by 1.5-2% of GDP in 2010 and we are shoved back into recession.
There are no good choices. If we do the right thing and cut the deficit, it means very hard choices. Can we keep our commitments to two wars and our massive defense budget? Medicare and Social Security reform are not painless. Education? Research? The “stimulus”? But cutting the deficit by hundreds of billions while raising taxes by even more than is already in the works, is not the formula for sustainable recovery.
Have we grown up? Are there adults in the room? Sadly, I don’t think there are enough. We are still a nation of teenagers. We will do whatever we can to avoid the pain today. We will kick the can down the road, hoping for a miracle. Will we grow up? Yes, but the lessons learned will be hard.
There are no statistical signs of an impending recession. We are not going to get an inverted yield curve this time, which made it relatively easy for me to predict recessions in 2000 and 2006. We are in a deflationary, deleveraging world. A far different world than in the past.
I see little room for us to avoid a double-dip recession. It would take the skill and speed of former Cowboys running back Tony Dorsett hitting a very small hole in the line to break us into the open. I see no running back in our national leadership with such ability. As I have outlined above, recession could be triggered again in any number of very different economic environments. It all depends on the choices we make. But the choices lead to the same consequences, at least in my opinion.
(3) “Our quarter-century penance is just starting“, Ambrose Evans-Pritchard, op-ed in the Telegraph, 29 August 2009 — Excerpt:
“The current financial crisis is unlike any others,” says the Bank for International Settlements. Lasting damage has been done. The “cumulative output loss” is likely to reach 20pc of GDP in the major economies.
The message is the same at the International Monetary Fund. “The world is not in a run of the mill recession. The crisis has left deep scars. In advanced countries, the financial systems are partly dysfunctional,” said Olivier Blanchard, the Fund’s chief economist.
Mr Blanchard said an IMF study of post-War banking crises led to an unpleasant finding. “Output does not go back to its old trend path, but remains permanently below it.”
Then the sting: we are exhausting the limits of fiscal stimulus. “The average ratio of debt to GDP in the G-20 economies was high before the crisis, and is forecast to exceed 100pc in the next few years”.
We cannot add debt, so the IMF says we must draw down our future pensions and future health spending to keep today’s economy afloat. “A modest cut in the growth rates of entitlements can buy substantial fiscal space for continuing stimulus.”
… We know what caused this crisis. The West kept short-term interest rates too low for a quarter century, luring society into debt: and the East held down long-term rates by flooding bond markets as a side-effect of their mercantilist strategy (ie suppressing currencies to gain export share).
The outcome was over-investment, excess capacity, and too much debt among those supposed to buy the goods. Has any of this changed? No. Have we cleared the excess plant? No.
Jeff Wenniger from Harris Private Bank says an army of baby-boomers have seen their old age plans shattered by the housing bust. Their nightmare is here. They will have to spend less, and save more. “Generational destruction of a society’s balance sheet down not rectify itself in a matter of months”.
How about a quarter century?
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For more information about this topic
To see all posts about the new era now being born:
- About America – how can we reform it?
- About the Financial crisis – what’s happening? how will this end?
- About the End of the post-WWII geopolitical regime
Posts with speculation about the future, about structural changes to America and the world:
- Treasury Secretary Paulson leads us across the Rubicon, 9 September 2008
- Say good-bye to the old America. Welcome to our new socialist paradise!, 17 September 2008
- German Finance Minister Peer Steinbrück explains how the world is changing, 30 September 2008
- America has changed. Why do so many foreigners see this, but so few Americans?, 1 October 2008
- America is changing. Read some chillling words from a liberal economist, 2 October 2008
- Does this economic crisis make the State stronger – or is it another step in the decline of the state?, 16 January 2009
- This financial crisis is the transition to a new world; like birth, it is painful, 11 February 2009
- Everything written about the economic crisis overlooks its true nature, 24 February 2009
- A look at the new world – after the downturn, 19 March 2009