Summary: The current economic situation of the US is fascinating. Repeated disappointments in the past, great optimism about the future, confusion about today, all occurring amidst one of the greatest monetary experiments in history. The stakes are high. Growth will force perilous withdrawal of the current massive monetary stimulus; a slowdown will force more stimulus in ways difficult to predict. See the links at the end for more information about these complex matters.
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Contents
- A nickel summary of the US economy
- A note about QE3
- For More Information
- Trust in Chairman Bernanke
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(1)Â A summary of the US economy
(a)Â The US has been running near the “stall speed” of 2%, with the government applying fiscal or monetary stimulus when we fall below it.
(b) Wall Street, Fed, and CBO economist for the past 3 years have annually predicted a breakout from this trend. See chart 6 above! With Q1 at 1.77% and Q2 perhaps 1%, we will need a big second half to get 2.5% for the year. They do expect big results. Perhaps incorrectly; see Do you see the coming boom?.
(c) There are many reasons for this, but mostly from confidence that QE3 will work, largely by inflating asset prices. See The World of Wonders: Monetary Magic applied to cure America’s economic ills. It might work; it might not work. It is The greatest monetary experiment, ever. Unless there is a large wealth effect boosting spending of top quintile households (the bottom 4 have too few assets to matter), which I doubt, I do not see what will drive the acceleration later this year.
(d)Â These repeated failed forecasts might indicate an analytical failure in their models. Richard Koo talks about this as a failure to understand the “balance sheet recession”.
(e)Â Correct or not, these forecasts of accelerating growth prompt forecasts that the Fed will begin “tapering” — a slowing of the Fed’s QE3 buying of securities, followed by increased interest rates.
(f)Â That might not be the only reason for tapering. It might not even be the primary reason. Last month Bob Januah of Nomura gave what might be the actual explanation:
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“But the Fed is NOT going to taper because the economy is too strong or because we have sustained core (wage) inflation, or because we have full employment – none of these conditions will be seen for some years to come. Rather, I feel that the Fed is going to taper because it is getting very fearful that it is creating a number of significant and dangerous leverage driven speculative bubbles that could threaten the financial stability of the US. In central bank speak, the Fed has likely come to the point where it feels the costs now outweigh the benefits of more policy.”
(g) While growth might accelerate later this year, now the economy is probably slowing. Estimates of Q1 real GDP have quickly dropped from 2%. Many are in the 1% – 1.3% range (QoQ, seasonally adjusted, annualized), Barclay’s is at 0.6%. If so, this would be the 3rd sequential quarter of slow (<2%) growth. Now there are even more contractionary forces at work:
- The rise in oil prices (WTI is up 1/4) and rates (the yield on the 10 year Treasury has doubled), both are bad for housing and autos (although producing a quick buying blip before higher rates hit).
- Most of the sequester’s effects have taken effect, but some will continue to hit through end of September.
- Monetary velocity continues to fall.
(h)Â The brightest spot in the economic picture is growth in jobs. But not all employment indicators are shiny.
- The good news: New claims for unemployment insurance have been steadily dropping (down 6% YoY).
- Also good: 196 thousand new non-farm jobs per month for the past 3 months, although with several anomalies. Also, the birth-death addition (not reliable) was the largest as a share of the total since last June (31% of the total). Next month we will see if the pattern of large semi-annual revisions continues (generating revisions of -1.2 million in July 2012 and -2.9 million in Jan).
- Not good: the U-3 unemployment rate (the “official” number) has been flat at 7.6% for 4 months, and February was only 7.7%.
- Bad: the other Unemployment numbers (U-4 to U-6) are at 4-month highs.
(i) How unfortunate that we are too smart to use this opportunity borrow at low rates to rebuilt America’s infrastructure at relatively low cost, and stimulate the economy. Instead we rely on monetary stimulus on a scale never successfully attempted. Future generations will never understand.
(2)Â A note about QE3
Key to the reflation story, especially with weak growth in household income, is more borrowing! Credit growth is up only 2.5% YoY (NSA, excluding Federal education loans, the new subprime) and up the same YTD (total, seasonally adjusted). Here’s an acute analysis by Chris Wood of CLSA: “Addiction and lack of conviction”, 4 July 2013:
The bull case is, therefore, clear. If house prices keep rising the amount of negative equity in the system will continue to decline, household balance sheets will recover, as has already begun to happen, and the path should be set for the resumption of the credit multiplier in what remains a consumption driven economy.
Thus, US household net worth (total assets less liabilities) rose by 10%YoY in 1Q 2013 and is up 35% from the recent low reached in 1Q 2009 to a record US$70.3tn at the end of 1Q 2013. Owners’ equity in household real estate also rose by 29%YoY and is up 45% from the 1Q 2009 low to US$9.1tn at the end of 1Q 2013 (see Figure 3). Similarly, CoreLogic reported that 850,000 more homes returned to positive equity during 1Q 2013. The number of residential properties in negative equity declined from 10.5m, or 21.7% of all residential properties with a mortgage, at the end of 4Q 2012 to 9.7m or 19.8% at the end of 1Q 2013.
… The above thesis of an investment property boom, as opposed to a conventional housing recovery, raises another consequence of unconventional orthodoxy. This is that the practical way these policies work is to lead to ever more extreme wealth distribution, as reflected in America’s Gini coefficient which measures the degree of income inequality. The Gini coefficient has risen from 0.386 in 1968 to 0.47 in 2006 and was 0.477 in 2011, according to the US Census Bureau. This is because the wealthy are geared into rising asset prices, particularly prices of financial assets, whereas ordinary people are geared into average hourly earnings growth. In this respect the Gini coefficient had apparently reached in 2006 the previous high seen in 1929, prior to the Great Depression.
This is a reminder that capitalism’s natural way of dealing with excesses is via business failure and liquidation; which is why wealth distribution would have become much less extreme as a consequence of the 2008 crisis if losses had been imposed on creditors to bust financial institutions, for example owners of bank bonds, in line with capitalist principles; as opposed to the favoured ‘bailout’ approach pursued for the most part by Washington.
(3)Â For More Information
Posts looking at the economy today:
- The greatest monetary experiment, ever, 20 June 2013
- Status report on the US economy. Recession? Collapse?, 25 June 2013
- Look at the US economy. Do you see the coming boom?, July 2013
- Good news about the US economy!, 2 July 2013
- The June jobs report: continued slow growth, bought at a high cost,
5 July 2013
For more information about the US economy:
- A certain casualty of the recession: the US Government’s solvency, 25 November 2008
- Beginning of the end of the Republic’s solvency. Soon come the first steps to a reformed regime – or a new regime., 14 August 2009
- The Robot Revolution arrives, and the world changes, 20 April 2012 — about structural unemployment
- America is rich and powerful because we can borrow. Will this debt build a stronger America?, 5 June 2012
- America’s strength is an illusion created by foolish borrowing, 10 October 2012
(4)Â Trust in Ben Bernanke, Chairman of the Federal Reserve
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“the Fed is going to taper because it is getting very fearful that it is creating a number of significant and dangerous leverage driven speculative bubbles that could threaten the financial stability of the US.”
This is depressing. So many resources pumped into the financial system — going to speculation instead of productive investment, with yet another bubble looming.
“This is a reminder that capitalism’s natural way of dealing with excesses is via business failure and liquidation;”
This is not the natural way, but the ideal way — which rarely occurred in the real world for upper-crust, well-connected moguls. SMEs, on the other hand, have it rough.
This really is not that difficult to comprehend….State of the US Economy, that is. (So many are afraid to confront the basic myths foisted on the unaware.)
Cash Flow
Income (disparity)
Net Asset Value at disposition.
“Mark to Market” suspension.
Actual not nominal value.
This will not go on (oh, maybe longer than some think but…)
Anyone who has been at this for very long, entrepreneurial types (and fewer and fewer each year) are cognizant of the new meme—Get In and Get Out, asap. The financialization of much has made capital creation a remnant of the past.
You sort it out or it will sort you out.
Breton
“This really is not that difficult to comprehend”
Can we see links to your super-accurate predictions over the past few years?
In fact the state of the US economy is almost impossible to comprehend, which is why forecasts are so difficult. It is large, complex, changing — and embedded in a still larger, more complex, and faster changing world.
Worse, the science of economics is immature. So the tools we use are inadequate.
It’s not about prediction, though. Financial collapses are like earthquakes in California. No one can predict, but if you wait long enough, eventually you do get one. The trick is to be aware of this, and to plan for it, but not to get overwhelmed by the possibility either.
“Financial collapses are like earthquakes in California”
That is literally true, but not in the sense it is most often said. Super-large earthquakes are extraordinarily rare in California, as are “financial collapses”. The Great Recession was not a US “collapse”.
Discussions of almost everything in America are often dominated by exaggerations, like climate and economics. DOOM BOOM…
Bubbles are an inherent aspect of free market economies. They were frequent before the creation of central banks, despite the assertions of right-wing believers of faux-economics. They often occur in rapidly growing nations (eg, canal & rail bubbles in 19thC UK), and are not “collapses”.
A purely economic collapse is quite rare in developed nations (except as a secondary effect, such as from wars). They are more common in emerging nations, usually a result of dysfunctional political systems.
No, you cannot see my super accurate Predictions as I will not show you my Balance Sheet!
Ha….only half in jest, sir.
Look at your own.
If you do not engage in and are not a part of the Debt Structure in the USA outside of your primary depreciating asset that is your home then you have a small chance of seeing what is happening.
If you are not in the Rentier Class (as I most assuredly am) and cash flow is a monthly check from some Company then you will miss a lot.
If you are not a Bank and you do eventually confront Mark to Market on your holdings (besides your house) then the Econ is not confusing!
If you are an “investor” in the faux Stock Market and really think your holdings are real (in value) and not a nominal snapshot for today only, then surely you may feel confused.
Confusion comes around for those who do not understand MMT or who think tomorrow will assuredly be like today.
Get in and Get Out!
Good luck!
Breton
FM is absolutely right that the US economy is huge and constantly in motion in unexpected and difficult to measure ways but certain very high-level trends have a huge impact on the economy and can be discussed (at least briefly) in an intelligent way. For example, financial bubbles always have a simple and (in retrospect) unsustainable theme.
In 2000 the theme was that that the internet and the stock market were going to grow forever and be incredibly profitable. In 2008, the theme was that housing values would continue to expand forever.
I have said since 2011 that asset prices were being inflated to bubble-like proportions by the unreasonable faith that the US government and the Federal Reserve can fix all of our current fiscal problems without causing any sort of pain to any of the new plutocracy that has been slowly emerging. Since the plutocracy seems to have an extremely wide variety of interests and motivations, it seems unlikely that this theme will always be true. The logical outcome is that at some point in the future the theme will be proven to be inaccurate.
I cannot say when this will occur or how severe the consequences will be because so far the government and the Federal Reserve have successfully met the challenge posed by the plutocracy and the plutocracy are much wealthier and more powerful for it. I pause briefly to note that this has been an impressive achievement by the government and the Fed.
But this success has encouraged the plutocracy to further expand their interests in order to further expand their influence and wealth and it has become a vicious cycle from the perspective of the government and the Fed. Unless something fundamental changes, this will eventually cause the current situation to fail. Like a rubber band being stretched, the further this goes, the more severe the eventual consequences when we hit the breaking point.
“For example, financial bubbles always have a simple and (in retrospect) unsustainable theme.”
It’s not that simple. These days the net overflows with people who think they’re Lord Keynes because they “knew” real estate was a bubble. But there are many predictions of bubbles for every actual bubble.
Furthermore the consequences of a bubble bursting are seldom obvious. In 2008 many people saw the real estate mortgage problem (real estate prices were not the core of the problem). But almost nobody saw the weakness of the developed nations’ banks. In fact, US banks were believed to be in unusually strong condition.
The collapse of so many banks was the primary link converting a US real estate problem into a global crash.
All of your statements are true, FM, particularly the part about people claiming to know things when they do not have enough knowledge/facts to predict anything. This includes myself, by the way. My earlier post was an indulgence in opinion backed by insufficient information because nobody can know enough to successfully predict something as vast and as diverse as the world economy.
For example, I successfully predicted the real estate bubble but not the timing (I thought it would be a few months later) nor the full extent of the consequences, nor the reaction of the central banks.
In 2008 I saw something coming, but grossly underestimated its size, nature, and effects. I was even more wrong about what came after. but I avoided the folly of specific predictions, and so avoided adding another error to the Smackdowns page.
Fighting overconfidence — even hubris — is one of the missions of the FM website, one which has frustrated many commenters (used to the all nonsense tolerated if it flatters our politics policy of most websites). One of the more extreme examples was this to Tom Grey.
“Unless something fundamental changes, this will eventually cause the current situation to fail. Like a rubber band being stretched, the further this goes, the more severe the eventual consequences when we hit the breaking point.”
I don’t mind predictions without a time limit so much, but this is just too vague. If there are negative consequences of quantitative easing to the elites and you have some idea of what they are, I think it makes a much better case if you’re specific. What exactly is the rubber band that’s stretching? High stock prices and low interest rates? At least the right-wingers are more specific about their doom and gloom predictions. I don’t see anything to discuss here, really, other than to criticize vagueness.
The middle class is being squeezed from every direction and in Japan, which has been going through QE since the 90’s we’re seeing the consequence of this — women just stopped having babies. This is my prediction — that faced with limited options the middle-class will choose self-extinction by avoiding reproduction. I guess the issue, then becomes, how does this affect the elites? Do they even need a middle-class anymore?
“This is a reminder that capitalism’s natural way of dealing with excesses is via business failure and liquidation; which is why wealth distribution would have become much less extreme as a consequence of the 2008 crisis if losses had been imposed on creditors to bust financial institutions, for example owners of bank bonds, in line with capitalist principles; as opposed to the favoured ‘bailout’ approach pursued for the most part by Washington.”
Yes. This is a great point. The bailouts made the divide between poor and rich greater. The ultra-rich, even going back to Long Term Capital Management have a safety net. 2008 was no different — free money for bankers. When things go bad there’s the fed to make sure that some parties don’t suffer any losses. When ordinary people are hit by something like Katrina, middle-men leech everything. For everyone else, you have your crappy Walmart job, whatever money you can scrape up, and your friends. When you run out of money, fend for yourself on the streets or in the shelters and subways. No place to sleep, no place to go the bathroom. Life itself becomes a criminal activity.
“in Japan, which has been going through QE since the 90’s we’re seeing the consequence of this — women just stopped having babies. This is my prediction — that faced with limited options the middle-class will choose self-extinction by avoiding reproduction.”
That’s a testable theory. Does fertility in Japandvary with income? My guess is that this theory is false, and that fertility has fallen due to Japan’s absurdly high population density plus social changes.
http://www.indexmundi.com/g/g.aspx?c=gr&v=25
Birth to income is going to be affected by other class and cultural factors, so that’s going to be noisy data. I suggest this chart here. The birth rate in Greece, which is going to be culturally about the same country now that it was in the year 2001, except with a financial squeeze. The birth rate drops from 2000 to 2012 from 9.8 to 9.1. Put the screws on the middle-class and they stop breeding.
Per capita real income in Japan has not fallen during its long stagnation since 1989. It is not remotely like Greece.
That’s a good point, I’m not sure how to resolve that with the money desperation I feel from Japanese people — I rarely get the impression from them that the economy is going well. The jobs that pay well enough to raise a family are rare or have crazy long hours. Women I talk to are eeking out an existence at retail jobs, which seem to exist in vast numbers, or they live in tiny apartments with high rents that ban either children and pets. Over here in the USA I’m sometimes envied because I can keep a house cat. This is a luxury.
http://jp.fujitsu.com/group/fri/en/column/message/2011/2011-01-31.html
“As things stand now, one cannot expect much from domestic demand. The average working person has suffered from falling wages for the past 12 years.”
This site has a graph of Japanese wages over the years. Looks like down almost 9% from 93 to 2010 or so. I suspect that the younger generations shared a larger portion of that decline, though this doesn’t break it down that way.
That and though the property bubble popped, rents ratcheted up substantially following the real estate boom and never fell to pre-boom levels, so people were squeezed between high rents, and declining wages.
Long term monetary trends are misleading if not adjusted for inflation. By the same logic as the article you cite, middle class households in America have grown immensely rich since 1970 since nominal wages have risen so much.
Which is why experts look at real — price adjusted — trends. Japan has experienced persistent deflation during the past two decades, offsetting falling nominal wages. The US has experienced persistent inflation, more than offsetting rising nominal wages.
Cathryn: “I don’t mind predictions without a time limit so much, but this is just too vague. If there are negative consequences of quantitative easing to the elites and you have some idea of what they are, I think it makes a much better case if you’re specific. What exactly is the rubber band that’s stretching?”
This is a valid criticism but I don’t have a valid answer. The best I can do is explain some things about the current state of economics, which FM correctly identifies as an immature science and add my own thoughts (properly identified as such). I apologize in advance for the length of my response but, at the same time, it is criminally short and incomplete.
Part 1
The best economists build models and compare them against test data, this pattern is based the hypothesis model of basic science (make a prediction, test the prediction, adjust the prediction based on the test, retest). The problem with this model for modern economics is that there is no laboratory in which to test our predictions. In a lab, we could create a situation where we can test just one part of our theory using placebos, etc.) without causing widespread havoc. Chemists and physicists have repeated their tests thousands of times under slightly differing circumstances to arrive at fundamental truths. Economics can only test things in the real market, which is influenced by tens of thousands of unexpected factors that are constantly changing.
People are usually hesitant to apply untested economic theories to a market where tens of millions of people may be negatively effected and there is no predictable way to undo the damage. This causes economists to primarily work from historical models. This is good from the perspective of avoiding causing damage but bad from the perspective of getting reliable test data. First, you can’t repeat the experiment because conditions will change every time, thus leading to the saying “history never repeats but it frequently rhymes.” Another problem is that history frequently fails to provide enough documentation for economists to predictably identify the primary factors in an event and then to derive the correct answers. To use a biological equivalent, economists know that leaving food out in the open eventually causes it to go bad but history doesn’t give them enough information to understand why.
The result is that two economists, each working from the best available models (and there are thousands of models out there) can arrive at vastly different predictions using the same information.
Now let us briefly look to John Maynard Keynes, the Einstein of modern economics. Working primarily with extremely incomplete data sets from before and during the Great Depression, the man arrived at a remarkable number of testable theories such as the Paradox of Thrift. These discoveries catapulted economics from the equivalent of 17th century medicine (where visiting a hospital if you were ill would predictably shorten your lifespan) to the equivalent of medical care of about 1840 (visits to doctors can help but results vary widely).
Modeling work since the mid 1950’s has improved economics to the medical stage of about 1880 (a period where medical knowledge was growing rapidly but for most people was dominated by self-remedies and snake oil salesman).
This ends the fact portion of my response.
For a description about the ill-effects of sustained quantitative easing see this chapter of the hot-off-the-press BIS 83rd Annual Report: VI. Monetary policy at the crossroads.
That does not necessarily mean that QE should not be continued in the US and Japan. That a medicine has side-effects does not mean it should not be used, esp for life-threatening illnesses. It just means that the benefits must be balanced against the side-effects to determine dosage and duration of the treatment.
Part 2
I should have ended my last comment with “this ends the pure fact portion of my response”
In the 1990’s a fairly large group of economists started developing the theory that economics was now mature enough that it could predict and even neutralize economic downturns.
I am a cautious person by nature and at the time I found these comments to be extremely naive because of the lack of valid test data but they were very convenient for certain political agendas and so fundamental changes were made across the entire world banking system. Needless to say, the people making these statements had the best credentials and arguments for their theories whereas I am a nameless hobbyist with no credentials. If I were in the positions of the politicians, I’d have believed the economists over myself.
As you already know, the 1990’s were, in general, a very good economic period in history, which seemed to validate the economists points of view even though there was great disagreement within their own ranks as to how to treat an economic malaise if one should occur.
In 2000 the Internet bubble popped, theories were put to the test, and mostly failed. Prior to 2000, the post WWII recession lasted about 9 months and ended with a quick strong recovery (employment gains in the range of 300-400,000 per month). This one ended reasonably promptly but the recovery didn’t kick in until 2003 and was weak until the housing boom went into high gear.
Economists world-wide spent a lot of time thinking about what went wrong in 2000 and how their theories should be patched. Although the data set was large and recent, it still didn’t give economists any obvious factors into what caused the failure. Theories diverged, models popped up all over the place, and the Fresh water vs. Salt water and the Keynesian vs. Austerity arguments were born.
2008 rolled around and the models (new and old) were put to the test again. The US went with a combination of the oldest and most central Keynesian theories combined with some of the newer theories about tax cuts and rescuing key companies in an industry.
Nothing went as predicted. Obama’s brand new administration failed to ask for enough money to predictably solve the problem and was slow in disbursing it. The tax cuts went mostly to the wealthy, who refused to spend the money (back to the paradox of thrift), rescuing key companies worked but warped the financial system in unexpected ways (a more cynical way to describe what happened is that a lot of wealthy people gamed the system and got what they wanted regardless of the original goals).
The rest of the world tried other solutions, mostly relating to austerity, and found that they caused considerable pain without any observable gains. Europe, for example, has stuck with the Austerity approach in spite of the remarkable damage it is doing to them. This has more to do with internal politics than it does economic theory.
Economists are now buried in a massive avalanche of data but there are no unarguable factors that caused the problem or adequately describe why the recovery has been so slow. As a result, they’ve built ever larger models which have ever wider implications and are increasingly untestable because they increasingly rely on psychological, sociological, and anthropological factors (also very incomplete sciences) that are poorly understood.
This ends part 2 and we now head into the land of personal speculation
Part 3
The question “What exactly is the rubber band that’s stretching?” prompted these lengthy posts.
I said earlier that bubbles are built on simple unsustainable themes. Looking back on the past two posts, do you really think that economists know what they are doing? The science of economics is too primitive and yet we keep putting ever larger amounts of faith into economic theories that have less and less provable foundations.
In large part, I would argue the 2000 and 2008 crashes relate to the faith that THIS TIME the economists really do know what they are doing.
Remember when I said that “People are usually hesitant to apply untested economic theories to a market where tens of millions of people may be negatively effected and there is no predictable way to undo the damage?” But that is what we have done and continue to do with increasing vigor and ever less predictable results.
All bubbles end when faith ends. When will that be? I don’t know, my prediction dates are all in the past.
How big will the fall be? I don’t know but I do know that bubbles tend to grow the fastest shortly before they pop. The US stock market is up something like 22% so far this year on minor growth in revenue and profits. But I’m not about to predict that this is the top. In theory it can go on for several more years with ever more dizzying results. Or it could end tomorrow.
Why is the stock market up so much? Because people believe that we are finally turning the corner and the recovery is about to begin. But I just don’t see it. Recoveries occur when faith in the future is at its lowest ebb, 1933, 1937, and 1982 are all examples of this. That’s not what is happening this time.
What will be the side-effects of the fall? I have no idea other than the size of the side-effects will be roughly proportional to the size of the fall.
Stocks values come from earnings, and I’ve been trying, for personal reasons, to determine if equities are in a bubble, and so far I haven’t really been able to convince myself. I’m not seeing huge P/E, really. Maybe slightly high from a historic perspective, but I don’t see how it falls more than 50% with current earnings. Could go down, but if there’s a bubble I haven’t found it as long as those earnings aren’t fraudulent (and maybe there is some of this out there.)
To me, what is more alarming is that earnings have continued to be good, but that unemployment has stayed stubbornly high, wages have been stagnant. I’m not sure exactly how this is happening — but this can’t go on forever, right? I would think eventually what happens is the middle-class is decimated and then who buys all the stuff? The point of failure being the rising inequality resulting in a future where the super-rich, huddled in their walled compounds count their billions in electronic dollars while the world outside goes Detroit/New Orleans.
Cathryn,
These are interesting and relevant issues. However, investments are over a red line border for the FM website. It’s not geopolitics, tends to take over comment threads, and there are a thousand other websites about investments.
One word of advice: avoid use of the term “bubble”. It’s become a stop button of the mind. There is a moderately specific definition among economists, which is mostly ignored by non-economists.
I’m not an expert on P/E levels but I do know that you need to be VERY careful when considering what data to use. For example using predicted earnings (which is what Wall Street prefers) is ridiculous because nobody really knows what future earnings will be. You also need to be concerned about accounting gimmicks that inflate earnings. This has always been a problem on Wall Street but it has been taken to a new level since 2008.
The Schiller 10 year P/E ratio is generally considered to be the most reliable measure.
The reason earnings are high is simple, the companies cut workers (their largest expense) in 2008 and have found ways to avoid replacing them. Your concerns about the death of the middle class are completely justified in the long run.
NO more discussion of investments. Please see my reply to Cathryn.
Further comments about investments will be deleted.
Total private sector debt as a percent of GDP has grown exponentially since WWII. The r squared fit coefficient is .99. Starting in the early eighties interest rates have declined consistently. I believe these tow trends are causally linked. As total debt climbs the debt service burden saps the economic growth rate. Central banks respond by lowering the short (discount window) rate which promotes new borrowing and growth of total debt leading to another debt service downturn and so on. We are now at the end of that process because short rates are zero.
The Fed is buying long paper from the banks in return for cash (the shortest paper of all). They do this because banks borrow short and lend long profiting from the spread between short rates and long rates. Bu lending short term funds at zero and buying long term paper thus supporting long rates the Fed is saving the banks from failing. The problem is the huge private sector debt and the crushing burden of servicing same. This burden must be reduced for growth to resume. If we use normal market clearing by discounting the unpayable debt to bottom fishers who will acquire the debt for ten cents on the dollar and foreclose the underlying collateral causing severe economic dislocation and suffering. This happened in the Great Depression and I fear it will happen again if our leaders don’t see what is coming. As to our economics profession, salt water schoolers believe total private sector debt is irrelevant because for every debtor there is a saver and they net to zero. This IMO is wrong and debt does matter because it’s wrong but this is a separate issue.
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Peter Blogdanovitch says:
So has the U.S. economy since WW II. In fact, America’s total per capita indebtedness reached a peak during WW II which it has never remotely regained, yet the American economy boomed as never before in the years immediately following 1945. I believe this claim is a veiled reference t the Reinhart-Rogoff paper which alleged a correlation twixt high national debt and low GDP growth, a claim which has since been definitively debunked.
By itself this tells us nothing. The r squared fit coefficient between the number of preachers and the number of prostitutes in America from 1776 to 1900 is also .99, but that’s because both are due to general population growth, not because one causes the other. Correlation does not imply causation.
Yet another implicit reference to the debunked Reinhart-Rogoff paper. This is just another repetition of the top 1%’s favored fairytale — namely, that public services like medicare and social security are causing an explosion in the national debt which is destroying America’s GDP growth. It’s a fairytale because the numbers don’t add up, there’s no evidence to support the claim, and in any case it’s just a smokescreen for gutting the safety net so as to funnel more trillions in tax cuts to America’s top 1%. If these people were genuinely serious about reducing America’s national debt, their top priority would be to reduce America’s circa 1 trillion dollar annual military spending, and agitate for sharp tax increases on the top 1%. The fact that they don’t tell us this whole argument is a scam designed up to cover a vast transfer of wealth from the bottom 99% to the top 1% by means of social service cuts + tax cuts for the weathy.
Krugman has done a far better job than I ever could of debunking these austerians who keep screaming about nonexistent inflation, so if anyone needs further evidence, just search his past columns on the subject.
These things are complex. Few economic relationships have a simple inherent meaning, other than in their specific context.
Peter: “Total private sector debt as a percent of GDP has grown exponentially since WWII.”
Thomas: “So has the U.S. economy since WW II.”
Peter refers to the ratio of debt to the economy, so that the economy has grown is not relevant. The growth of debt is pro-cyclical, not contractionary — until the economy reaches its maximum carrying point (ie, it Minsky point). Which it might have reached in 1929, and might have reached again in 2007.
Thomas: “In fact, America’s total per capita indebtedness reached a peak during WW II which it has never remotely regained, yet the American economy boomed as never before in the years immediately following 1945.”
Peter specifically refers to private sector debt, which by the end of WW2 was a very low share of GDP: paid down or defaulted during the Depression. Thomas is thinking of government debt, which was quite large after WW2. Government debt does not have the same dynamics as private debt, and does not have a Minsky Moment.
Yes. If we are having a Minsky moment and the core problem is crushing private sector debt my policy prescription is to use huge deficits monetized at low rates by the Fed to purchase private sector debt and to then judiciously forgive, restructure, or hold that debt on the public balance sheet (for example as an asset at the Fed) to maturity.
The key is to avoid the dislocation that foreclosure and other collateral calls would wreak if trusted to the private sector. My nightmare is the same sociopathic financiers who got us into this mess are allowed to liquidate the remaining assets they don’t already own in a destructive end game feeding frenzy. For example the Fed should not sell the MBS debt it is now buying at $45 billion a month at deep discount to the sharks of Wall street. They should forgive some, restructure some, and hold the rest to term. Capitalism’s creative destruction is too much to bear sometimes and this is one of those times coming IMO.
“If we are having a Minsky moment and the core problem is crushing private sector debt”
Should be said in the past tense. We had a Minsky Moment in 2008. Since then corporate debt loads are down and rising again. Household debt levels are lower, and still falling — albeit slowly (mortgage debt falling, consumer debt rising).
Unless we have a severe recession, US private sector debt loads are no longer a systemic problem.
In 1929 just before the crash PSD/GDP was about 2.5. In 2008 it was about 3.5 with 56 $trillion private sector debt and 16 $trillion GDP. Today much of GDP includes substituted government spending to make up for reduced aggregate demand per Keynes. I’m not sure we can do that much longer if growth stays down and I fear it will stay down until the ratio PSD/GDP (without govt. stimulus) comes down.
A classic catch twenty two; can’t get debt down without growth, can’t get growth without lowering debt first. This I prefer to the liquidity trap diagnosis proffered by neo-classicals like Krugman. It is consistent with Koo’s balance sheet diagnosis though Japan may be using the debt forgiveness dynamite I propose out of desperation before we do.
It’s the paying down of the debt that’s a drag the economy. Instead of buying stuff people send the money back the bank where it goes to die. If the Fed forgave some of the private sector debt it could speed up this process, get us back to organic growth more quickly. Of course — not going to happen.
>Japan may be using the debt forgiveness dynamite I propose out of desperation before we do.
Possibly. The difference, as I see it, between Japan and the USA, is that while the USA is run by corrupt banks, Japan is ruled by corrupt industrialists/construction companies. So Japan is more likely to put in policies that irritate the financial sector to save the physical economy..
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