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  • a critique of pure "ruin" - comments on "the road to ruin"

    i've taken the liberty to reproduce snips from ej's "road to ruin" and inserted some questions and comments.
    ++++++++++++++++++++++++++++



    Since 1992 Japanese policy makers transferred debt from private to public account via bailouts and fiscal stimulus, siphoning off cash flow from households and businesses to repay the loans carried on the books of banks as assets on the side of the creditor-debtor balance sheet where the political power lives, collateralized by buildings, houses, and land, which prices were inflated by the very credit that created in the onerous debts that became ever more so as the Japanese economy shrank.

    Banks and other creditors convince government to pursue policies to deflate the debt against the incomes of households and productive businesses, reducing the debt the slow painful way, [paying it down] dragging the country deeper and deeper into a hole.


    If principal on debts is not reduced by negotiated debt restructuring, the markets will eventually deflate the debt against the monetary unit of the debt, the US dollar. [then why are we not buying hard assets aside from 30% pm’s?]

    What we are seeing today that looks like saving for future consumption is in fact the debt left over from the FIRE Economy sucking the life out of the US economy. [savers will not borrow anew once they’ve paid down their balances?]

    After the asset price inflation ends the savings rate then increases for a year or so as debt is repaid.

    Asset price inflations and deflations exert a perverse effect on saving. First the pool of savings to be spent on future consumption shrinks during the period of asset inflation because households are fooled into believing that asset price inflation is wealth creation, that inflating stock and home prices are doing the saving for them. Income is spent on current consumption. After the bubble pops and the fake wealth is wiped out, briefly the savings rate rises as post bubble recession has not yet expressed itself as rising unemployment and incomes have not yet begun to decline. About a year later then the pool of savings starts to shrink again as unemployment rises, incomes decline, and a greater proportion of income is goes to paying off debts taken on during the boom.

    The duplication by the current administration of Japan's misguided policy to use public and private funds to pay down debt taken on during a credit bubble era is self limiting in the US case in a way it was not for Japan; as long as the debt repayment versus restructuring is pursed, and the banking system is left in its current state of disrepair, the US economy will continue to rapidly decline.

    By our estimates, due to the combined impact of the crushing weight of debt burdens created by the FIRE Economy and maintained by the current Debt Deflation Continuation Plan and absent an immediate and effective, politically independent response to the banking crisis, leading to an intensification of the credit crisis as S&P predicts, real GDP will fall 4% in 2009 and 4% again in 2010. [given today's revision to 2008Q$ gdp to a decline of 6.2%, these estimates seem conservative!] This despite the fiscal stimulus, estimated by Adam Posen of the Peterson Institute for International Economics at $1.5 trillion when TARP and other programs are taken into account. If federal government spending continues to increase outlays at the current rate of more than 10% of 2007 GDP per year[note this hypothesis is not for the maintenance of this year's huge spending plan, but an INCREASE of similar size each year- a big assumption.], and federal government receipts continue decline at a 7.5% annual rate in 2009 and 2010 as in 2008 [plausible if the economy contracts relatively rapidly], the fiscal deficit as a percent of real GDP will certainly exceed 10% in 2010, and the current account deficit on a balance of payments basis rise above 10% percent[this assumes that imports are maintained or increased- a questionable assumption for a rapidly contracting economy- i see only energy imports holding up, and even there we can expect energy consumption to slowly contract], even as imports [sic- i think he means "exports"] fall as previously prodigious capital exporters in the Middle East and Asia suffer current account deficits of their own. [every nation can't be in deficit unless we are importing from mars.]

    If and when its fiscal deficit reaches third world levels, will the US -- with its massive current account deficit financed by the public sector and daily dependence on capital inflows to maintain a balance of payments - finally suffer a balance of payments crisis, rapid currency depreciation, rapidly rising cost-push inflation, and rising interest rates? What we at iTulip.com refer to as a "Poom" portion of a Ka-Poom Theory? [this doesn't seem right to me. the u.s. current account deficit is shrinking, and will not be massive. if our imports are pretty much limited to energy and energy consumption is declining, we still have a deficit but it's not massive. furthermore the deficit is with saudi arabia, canada and mexico. however, we WILL have massive growth in the federal deficit. obama's just-released budget, with its plan to reduce the deficit to a mere half-trillion in 2012 depends on a strong recovery in 2010-12, a doubtful assumption. thus the crisis won't be a balance-of-payments crisis, it will be a funding crisis, as bill fleckenstein has predicted.]

    When the Russian government found itself unable to pay the interest on its foreign debt in August 1998, nor able to borrow more money in the international financial markets, nor increase taxes on its imploding economy, nor locate private capital inside Russia willing to lend it money, it suffered a balance of payments crisis. The result was capital flight, a ruble crash, and a spike of cost-push inflation. [how does a funding crisis play out? assume a huge federal deficit - not hard to imagine. we've cut down on our purchases of toasters and cars, our imports aren't great, so we are not sending dollars to china and japan. thus the asian countries couldn't buy our new debt even if they wanted more, which they don't. the saudi's can recycle their dollar flow, but it won't be big enough to put much of a dent in the government's funding needs. who will buy the debt? BANKS! it just came to me. BANKS! they will borrow from the fed at near zero and buy treasuries paying 1-3%, and that's how they'll recapitalize. the fed won't have to buy the debt directly. so the problem becomes how to expand the fed's balance sheet enough to carry the enormous lending beyond its current already-enormous lending. i am not expert enough on the fed to offer the solution, but i have no doubt a solution will be found. the alternative would be for the fed to print money and purchase the debt directly from the treasury, but by cycling the flow through the banking system the fed can continue to feed its family, the deserving rich of the banking system. furthermore, this protects the banks from the risks inherent in lending to people and businesses, who will remain relatively starved of credit.]

    [the "road to ruin" article goes on to discuss the possibility of a balance of payments crisis and rapid devaluation of the dollar. but if this is the scenario, why hold 70% of one's assets in u.s. dollar cash? why not buy oil, metals, agricultural goods? or is the idea that those things will continue to deflate, and we'll swoop in with our cash in the nick of time?]

    [could a funding crisis lead to capital flight out of the dollar? or to the return of the exported dollars looking for real assets to purchase - the "poom" in itulip's ka-poom theory? to answer these questions, i think we first need to address the question of why the dollar's been rising lately. part of the reason is that the dollar is in many ways the least ugly of a lot of ugly currency choices. the euro, apparently the dollar's competition in recent years, seems to be splitting apart at the seams as its constituent political economies tug in different direction. part of the dollar's recent strength is that - as richard russell observed years ago - all the dollar denominated debt is a kind of dollar short position which generates demand for dollars. this has played out in the markets, as is revealed by the fed's decision to offer swap lines to other cb's for them to lend on to their dollar-needy institutions; institutions that need dollars for all that they are not domiciled in the u.s.

    in the scenario i've outlined above, federal expenditures are overwhelmingly large as the "federal economy" grows to replace the activity lost by the shrinking private economy. the latter is shrinking because it is being drained by its payments on old debts to the blessed banking system. some debt is written off via bankruptcy and cram-downs, but most of the debt is carried, an increasingly heavy burden as employment and with it income shrinks. this process must have some limit, a discussion of which must await further analysis.

    if china and japan are not exporting to the u.s.- or western europe for that matter- what are they doing? china is trying desperately to stimulate its domestic economy, and japan is trying to export capital goods to china. without income from exports, how do china and japan - heavy importers of commodities - pay for their imports? with the big stores of u.s. dollars they have amassed. thus those frozen assets are liquified and released into the global economy. their ongoing sale of treasuries, as they convert them to cash to pay for their imports, helps keep rates up for the u.s. banks to feast upon. of course, china also continues its strategic purchase of commodity producers, not just the commodities themselves. these actions facilitate a continuing dollarization of the global economy - witness china's recent energy deal with russia, paid for with dollars at china's insistence over putin's objections. these actions also result in more dollars sloshing around the globe, and some must find their way home and start inflating u.s. assets which attract foreign purchasers. since current dollar holders become dollar sellers, the dollar drops relative to the creditor nations, which no longer have as much motive to intervene in the currency markets to support the dollar. this might happen rapidly, but need not.

    i am not entirely convinced by my own analysis, and wonder if there is some big hole in this argument. please let me know if you spot it.]




  • #2
    Re: a critique of pure "ruin" - comments on "the road to ruin"

    i'm bumping this in the hope of getting some feedback. i'd like to know whether others agree with this line of reasoning, or see holes in the argument.

    Comment


    • #3
      Re: a critique of pure "ruin" - comments on "the road to ruin"

      Comments in blue inserted:

      Originally posted by jk View Post
      i've taken the liberty to reproduce snips from ej's "road to ruin" and inserted some questions and comments.
      ++++++++++++++++++++++++++++



      Since 1992 Japanese policy makers transferred debt from private to public account via bailouts and fiscal stimulus, siphoning off cash flow from households and businesses to repay the loans carried on the books of banks as assets on the side of the creditor-debtor balance sheet where the political power lives, collateralized by buildings, houses, and land, which prices were inflated by the very credit that created in the onerous debts that became ever more so as the Japanese economy shrank.

      Banks and other creditors convince government to pursue policies to deflate the debt against the incomes of households and productive businesses, reducing the debt the slow painful way, [paying it down] dragging the country deeper and deeper into a hole. Agree. Doesn't paying the debt down this way simply mean that credit was used to bring consumption forward [which is why consumer credit was created, non?], and once the limits of that were fully explored, harvest gave way to winter, which will eventually give way to spring and a new "planting season"? Could the fact that the Japanese owed the money "to themselves", instead of to foreigners, be the reason they were loathe to inflate it away?


      If principal on debts is not reduced by negotiated debt restructuring, the markets will eventually deflate the debt against the monetary unit of the debt, the US dollar. [then why are we not buying hard assets aside from 30% pm’s?] "...eventually deflate the debt against the monetary unit..."], not immediately apparently.

      What we are seeing today that looks like saving for future consumption is in fact the debt left over from the FIRE Economy sucking the life out of the US economy. [savers will not borrow anew once they’ve paid down their balances?] What if we are entering a period of social repudiation of debt, similar to the aftermath of the 1930's depression? What if this shift is supported by developed economy demographics...what if the attitude towards debt of aging boomers heading into their 60s and 70s differs from our attitude when we were all in our 30s and 40s? What if, in the future, those that can afford credit don't want it, and those that want it can't afford it?

      After the asset price inflation ends the savings rate then increases for a year or so as debt is repaid.

      Asset price inflations and deflations exert a perverse effect on saving. First the pool of savings to be spent on future consumption shrinks during the period of asset inflation because households are fooled into believing that asset price inflation is wealth creation, that inflating stock and home prices are doing the saving for them. Income is spent on current consumption. After the bubble pops and the fake wealth is wiped out, briefly the savings rate rises as post bubble recession has not yet expressed itself as rising unemployment and incomes have not yet begun to decline. About a year later then the pool of savings starts to shrink again as unemployment rises, incomes decline, and a greater proportion of income is goes to paying off debts taken on during the boom.

      The duplication by the current administration of Japan's misguided policy to use public and private funds to pay down debt taken on during a credit bubble era is self limiting in the US case in a way it was not for Japan; as long as the debt repayment versus restructuring is pursed, and the banking system is left in its current state of disrepair, the US economy will continue to rapidly decline.

      By our estimates, due to the combined impact of the crushing weight of debt burdens created by the FIRE Economy and maintained by the current Debt Deflation Continuation Plan and absent an immediate and effective, politically independent response to the banking crisis, leading to an intensification of the credit crisis as S&P predicts, real GDP will fall 4% in 2009 and 4% again in 2010. [given today's revision to 2008Q$ gdp to a decline of 6.2%, these estimates seem conservative!] [What would the GDP decline have been if there had been a stimulus package kicking in during 4rth Q 08? Seems to me the massive size of the stimulus proposals will have a measurable effect on tempering the steep decline in '09 and '10, but only in those quarters where the spending hits the economy, so -3% or -4% averaged over the year may be realistic] This despite the fiscal stimulus, estimated by Adam Posen of the Peterson Institute for International Economics at $1.5 trillion when TARP and other programs are taken into account. If federal government spending continues to increase outlays at the current rate of more than 10% of 2007 GDP per year[note this hypothesis is not for the maintenance of this year's huge spending plan, but an INCREASE of similar size each year- a big assumption.], and federal government receipts continue decline at a 7.5% annual rate in 2009 and 2010 as in 2008 [plausible if the economy contracts relatively rapidly], the fiscal deficit as a percent of real GDP will certainly exceed 10% in 2010, and the current account deficit on a balance of payments basis rise above 10% percent[this assumes that imports are maintained or increased- a questionable assumption for a rapidly contracting economy- i see only energy imports holding up, and even there we can expect energy consumption to slowly contract], even as imports [sic- i think he means "exports"] fall as previously prodigious capital exporters in the Middle East and Asia suffer current account deficits of their own. [every nation can't be in deficit unless we are importing from mars.] For the Middle East and Asia to suffer current account deficits implies a trade deficit [that assumes the net factors income portion of the current account is small compared to the value of traded goods and services in these economies...a reasonable assumption I think] which in turn implies goods/services imports - into the USA - from these countries fall [which is how I interpret that part of what EJ wrote]. Working backwards through the above paragraph, to fund the escalating fiscal deficits will presumably require external borrowing by the public sector [there being insufficient domestic savings to fund multi-trillion $ borrowing requirements]; such inflows resulting in a capital account surplus, which must be balanced by a bigger current account deficit [the balance of payments calculation]. In other words the USA continues to consume more than it produces, but now the credit to accomplish this is being extended to the only credit-worthy party left in the economy...the US Federal government.

      If and when its fiscal deficit reaches third world levels, will the US -- with its massive current account deficit financed by the public sector and daily dependence on capital inflows to maintain a balance of payments - finally suffer a balance of payments crisis, rapid currency depreciation, rapidly rising cost-push inflation, and rising interest rates? What we at iTulip.com refer to as a "Poom" portion of a Ka-Poom Theory? [this doesn't seem right to me. the u.s. current account deficit is shrinking, and will not be massive. if our imports are pretty much limited to energy and energy consumption is declining, we still have a deficit but it's not massive. furthermore the deficit is with saudi arabia, canada and mexico. however, we WILL have massive growth in the federal deficit. obama's just-released budget, with its plan to reduce the deficit to a mere half-trillion in 2012 depends on a strong recovery in 2010-12, a doubtful assumption. thus the crisis won't be a balance-of-payments crisis, it will be a funding crisis, as bill fleckenstein has predicted.] Is the US current account deficit shrinking at the moment only because foreign-funded credit has been withdrawn from the private [personal and corporate] sector, and the public sector is just starting to take up the slack? As public sector borrowing needs expand this year, and for many years to come, the current account deficit will probably start expanding again...for as long as foreign lenders are prepared to send the capital to fund it.

      When the Russian government found itself unable to pay the interest on its foreign debt in August 1998, nor able to borrow more money in the international financial markets, nor increase taxes on its imploding economy, nor locate private capital inside Russia willing to lend it money, it suffered a balance of payments crisis. The result was capital flight, a ruble crash, and a spike of cost-push inflation. [how does a funding crisis play out? assume a huge federal deficit - not hard to imagine. we've cut down on our purchases of toasters and cars, our imports aren't great, so we are not sending dollars to china and japan. thus the asian countries couldn't buy our new debt even if they wanted more, which they don't. the saudi's can recycle their dollar flow, but it won't be big enough to put much of a dent in the government's funding needs. who will buy the debt? BANKS! it just came to me. BANKS! they will borrow from the fed at near zero and buy treasuries paying 1-3%, and that's how they'll recapitalize. the fed won't have to buy the debt directly. so the problem becomes how to expand the fed's balance sheet enough to carry the enormous lending beyond its current already-enormous lending. i am not expert enough on the fed to offer the solution, but i have no doubt a solution will be found. [Monetizing the debt, in other words?] the alternative would be for the fed to print money and purchase the debt directly from the treasury, but by cycling the flow through the banking system the fed can continue to feed its family, the deserving rich of the banking system. furthermore, this protects the banks from the risks inherent in lending to people and businesses, who will remain relatively starved of credit.] [Seems entirely plausible, but the consequences must ultimately fall on the exchange value of the US$, if not relative to other fiat currencies, because those governments are busy monetizing too, then relative to gold, oil and other commodities?

      [the "road to ruin" article goes on to discuss the possibility of a balance of payments crisis and rapid devaluation of the dollar. but if this is the scenario, why hold 70% of one's assets in u.s. dollar cash? why not buy oil, metals, agricultural goods? or is the idea that those things will continue to deflate, and we'll swoop in with our cash in the nick of time?]

      [could a funding crisis lead to capital flight out of the dollar? or to the return of the exported dollars looking for real assets to purchase - the "poom" in itulip's ka-poom theory? to answer these questions, i think we first need to address the question of why the dollar's been rising lately. part of the reason is that the dollar is in many ways the least ugly of a lot of ugly currency choices. the euro, apparently the dollar's competition in recent years, seems to be splitting apart at the seams as its constituent political economies tug in different direction. part of the dollar's recent strength is that - as richard russell observed years ago - all the dollar denominated debt is a kind of dollar short position which generates demand for dollars. [Analogous to the Yen carry trade dynamic wherein for most of the past two years the Yen has traded inversely to risk trades. That correlation seems to have played itself out, at least for the moment, as the Yen in recent weeks has been positively correlated with, for example, equity markets. Will the same happen to the US Dollar in due course?] this has played out in the markets, as is revealed by the fed's decision to offer swap lines to other cb's for them to lend on to their dollar-needy institutions; institutions that need dollars for all that they are not domiciled in the u.s.

      in the scenario i've outlined above, federal expenditures are overwhelmingly large as the "federal economy" grows to replace the activity lost by the shrinking private economy. the latter is shrinking because it is being drained by its payments on old debts to the blessed banking system. some debt is written off via bankruptcy and cram-downs, but most of the debt is carried, an increasingly heavy burden as employment and with it income shrinks. this process must have some limit, a discussion of which must await further analysis. [Is the limit imposed by how much additional time lenders can extend to allow borrowers to make good on repayment? Is that not the real reason transferring debt to the public sector is seen as a workable solution; because the taxpayer is the only entity that can wait an infinite amount of time to be repaid?]

      if china and japan are not exporting to the u.s.- or western europe for that matter- what are they doing? [Their economies are contracting. Rapidly :eek:. Even while the popular consensus forecast, among economists, is for China to grow high single digits this year ] china is trying desperately to stimulate its domestic economy, and japan is trying to export capital goods to china. without income from exports, how do china and japan - heavy importers of commodities - pay for their imports? with the big stores of u.s. dollars they have amassed. thus those frozen assets are liquified and released into the global economy. their ongoing sale of treasuries, as they convert them to cash to pay for their imports, helps keep rates up [This is where we may differ. Ultimately I agree with your scenario, but what happens if, for a year or two or three, economic activity, even in greater Asia, is so stagnant that imports to the surplus nations, including commodity imports, fall? There would be no need to liquidate US Treasury holdings...in fact there may for some time be a continued demand because of their "least ugly" status] for the u.s. banks to feast upon. of course, china also continues its strategic purchase of commodity producers, not just the commodities themselves. these actions facilitate a continuing dollarization of the global economy - witness china's recent energy deal with russia, paid for with dollars at china's insistence over putin's objections. these actions also result in more dollars sloshing around the globe, and some must find their way home and start inflating u.s. assets which attract foreign purchasers. since current dollar holders become dollar sellers, the dollar drops relative to the creditor nations, which no longer have as much motive to intervene in the currency markets to support the dollar. this might happen rapidly, but need not.

      i am not entirely convinced by my own analysis, and wonder if there is some big hole in this argument. please let me know if you spot it.]



      Comment


      • #4
        Re: a critique of pure "ruin" - comments on "the road to ruin"

        replies in red inserted by jk

        Comments in blue inserted by grg55:

        Originally Posted by jk
        i've taken the liberty to reproduce snips from ej's "road to ruin" and inserted some questions and comments.
        ++++++++++++++++++++++++++++



        Since 1992 Japanese policy makers transferred debt from private to public account via bailouts and fiscal stimulus, siphoning off cash flow from households and businesses to repay the loans carried on the books of banks as assets on the side of the creditor-debtor balance sheet where the political power lives, collateralized by buildings, houses, and land, which prices were inflated by the very credit that created in the onerous debts that became ever more so as the Japanese economy shrank.

        Banks and other creditors convince government to pursue policies to deflate the debt against the incomes of households and productive businesses, reducing the debt the slow painful way, [paying it down] dragging the country deeper and deeper into a hole. Agree. Doesn't paying the debt down this way simply mean that credit was used to bring consumption forward [which is why consumer credit was created, non? oui! ], and once the limits of that were fully explored, harvest gave way to winter, which will eventually give way to spring and a new "planting season"? Could the fact that the Japanese owed the money "to themselves", instead of to foreigners, be the reason they were loathe to inflate it away? different sectors of society were represented on the 2 sides of the balance sheet- the creditors controlled or influenced the government enough that their interests prevailed over the interests of the debtors. i think ej made this clear.


        If principal on debts is not reduced by negotiated debt restructuring, the markets will eventually deflate the debt against the monetary unit of the debt, the US dollar. [then why are we not buying hard assets aside from 30% pm’s?] "...eventually deflate the debt against the monetary unit..."], not immediately apparently.

        What we are seeing today that looks like saving for future consumption is in fact the debt left over from the FIRE Economy sucking the life out of the US economy. [savers will not borrow anew once they’ve paid down their balances?] What if we are entering a period of social repudiation of debt, similar to the aftermath of the 1930's depression? What if this shift is supported by developed economy demographics...what if the attitude towards debt of aging boomers heading into their 60s and 70s differs from our attitude when we were all in our 30s and 40s? What if, in the future, those that can afford credit don't want it, and those that want it can't afford it? i agree that this is possible, even likely. it represents a profound social/cultural change and the end of the FIRE economy. i think "the road to ruin"'s tone reflects ej's disappointment that the obama administration apparently remains captive to FIRE interests, and is trying to take the same road as japan - protecting the interests of creditors and trying to reduce the debt owed private creditors by slowly paying it down.

        After the asset price inflation ends the savings rate then increases for a year or so as debt is repaid.

        Asset price inflations and deflations exert a perverse effect on saving. First the pool of savings to be spent on future consumption shrinks during the period of asset inflation because households are fooled into believing that asset price inflation is wealth creation, that inflating stock and home prices are doing the saving for them. Income is spent on current consumption. After the bubble pops and the fake wealth is wiped out, briefly the savings rate rises as post bubble recession has not yet expressed itself as rising unemployment and incomes have not yet begun to decline. About a year later then the pool of savings starts to shrink again as unemployment rises, incomes decline, and a greater proportion of income is goes to paying off debts taken on during the boom.

        The duplication by the current administration of Japan's misguided policy to use public and private funds to pay down debt taken on during a credit bubble era is self limiting in the US case in a way it was not for Japan; as long as the debt repayment versus restructuring is pursed, and the banking system is left in its current state of disrepair, the US economy will continue to rapidly decline.

        By our estimates, due to the combined impact of the crushing weight of debt burdens created by the FIRE Economy and maintained by the current Debt Deflation Continuation Plan and absent an immediate and effective, politically independent response to the banking crisis, leading to an intensification of the credit crisis as S&P predicts, real GDP will fall 4% in 2009 and 4% again in 2010. [given today's revision to 2008Q$ gdp to a decline of 6.2%, these estimates seem conservative!] [What would the GDP decline have been if there had been a stimulus package kicking in during 4rth Q 08? Seems to me the massive size of the stimulus proposals will have a measurable effect on tempering the steep decline in '09 and '10, but only in those quarters where the spending hits the economy, so -3% or -4% averaged over the year may be realistic] agreed. the administration's efforts are not sufficient at all to reverse the process, only to slow it. this may well be labelled "failure" and used as an argument against future stimulus packages. i imagine the situation will be dire enough, however, that the government will have enough support to keep throwing money at the problems. that leaves the question of whether they'll figure out smarter targets to throw it at.

        This despite the fiscal stimulus, estimated by Adam Posen of the Peterson Institute for International Economics at $1.5 trillion when TARP and other programs are taken into account. If federal government spending continues to increase outlays at the current rate of more than 10% of 2007 GDP per year[note this hypothesis is not for the maintenance of this year's huge spending plan, but an INCREASE of similar size each year- a big assumption.], and federal government receipts continue decline at a 7.5% annual rate in 2009 and 2010 as in 2008 [plausible if the economy contracts relatively rapidly], the fiscal deficit as a percent of real GDP will certainly exceed 10% in 2010, and the current account deficit on a balance of payments basis rise above 10% percent[this assumes that imports are maintained or increased- a questionable assumption for a rapidly contracting economy- i see only energy imports holding up, and even there we can expect energy consumption to slowly contract], even as imports [sic- i think he means "exports"] fall as previously prodigious capital exporters in the Middle East and Asia suffer current account deficits of their own. [every nation can't be in deficit unless we are importing from mars.] For the Middle East and Asia to suffer current account deficits implies a trade deficit [that assumes the net factors income portion of the current account is small compared to the value of traded goods and services in these economies...a reasonable assumption I think] which in turn implies goods/services imports - into the USA - from these countries fall [which is how I interpret that part of what EJ wrote]. if even the oil exporters have current account deficits, which countries will have surpluses? the sums must balance.

        Working backwards through the above paragraph, to fund the escalating fiscal deficits will presumably require external borrowing by the public sector [there being insufficient domestic savings to fund multi-trillion $ borrowing requirements]; such inflows resulting in a capital account surplus, which must be balanced by a bigger current account deficit [the balance of payments calculation]. In other words the USA continues to consume more than it produces, but now the credit to accomplish this is being extended to the only credit-worthy party left in the economy...the US Federal government.


        If and when its fiscal deficit reaches third world levels, will the US -- with its massive current account deficit financed by the public sector and daily dependence on capital inflows to maintain a balance of payments - finally suffer a balance of payments crisis, rapid currency depreciation, rapidly rising cost-push inflation, and rising interest rates? What we at iTulip.com refer to as a "Poom" portion of a Ka-Poom Theory? [this doesn't seem right to me. the u.s. current account deficit is shrinking, and will not be massive. if our imports are pretty much limited to energy and energy consumption is declining, we still have a deficit but it's not massive. furthermore the deficit is with saudi arabia, canada and mexico. however, we WILL have massive growth in the federal deficit. obama's just-released budget, with its plan to reduce the deficit to a mere half-trillion in 2012 depends on a strong recovery in 2010-12, a doubtful assumption. thus the crisis won't be a balance-of-payments crisis, it will be a funding crisis, as bill fleckenstein has predicted.] Is the US current account deficit shrinking at the moment only because foreign-funded credit has been withdrawn from the private [personal and corporate] sector, and the public sector is just starting to take up the slack? As public sector borrowing needs expand this year, and for many years to come, the current account deficit will probably start expanding again...for as long as foreign lenders are prepared to send the capital to fund it. this doesn't make sense to me. where do the foreign lenders get their dollars to lend to the u.s. government? heretofore they've gotten those dollars by selling goods to the u.s. - toasters and t-shirts and toys and toyotas, and petroleum. during recessions the trade balance improves because imports dive. so china and japan, in particular, will not be earning big dollar balances to recycle. only the oil exporters will still be earning large amounts of dollars with which they can buy treasuries. you might argue, for example, that the stimulus program will consume imported steel, but the "buy american" clause stayed in the bill, and i would guess it will tend to be observed de facto even if, for wto purposes, it is renounced de jure. this is federal spending, and if congressman x, with a steel mill in his district, learns that some stimulus project is looking into brazilian steel, the phone lines will start buzzing.

        When the Russian government found itself unable to pay the interest on its foreign debt in August 1998, nor able to borrow more money in the international financial markets, nor increase taxes on its imploding economy, nor locate private capital inside Russia willing to lend it money, it suffered a balance of payments crisis. The result was capital flight, a ruble crash, and a spike of cost-push inflation. [how does a funding crisis play out? assume a huge federal deficit - not hard to imagine. we've cut down on our purchases of toasters and cars, our imports aren't great, so we are not sending dollars to china and japan. thus the asian countries couldn't buy our new debt even if they wanted more, which they don't. the saudi's can recycle their dollar flow, but it won't be big enough to put much of a dent in the government's funding needs. who will buy the debt? BANKS! it just came to me. BANKS! they will borrow from the fed at near zero and buy treasuries paying 1-3%, and that's how they'll recapitalize. the fed won't have to buy the debt directly. so the problem becomes how to expand the fed's balance sheet enough to carry the enormous lending beyond its current already-enormous lending. i am not expert enough on the fed to offer the solution, but i have no doubt a solution will be found. [Monetizing the debt, in other words?] yes, but via the banks.

        the alternative would be for the fed to print money and purchase the debt directly from the treasury, but by cycling the flow through the banking system the fed can continue to feed its family, the deserving rich of the banking system. furthermore, this protects the banks from the risks inherent in lending to people and businesses, who will remain relatively starved of credit.
        ] [Seems entirely plausible, but the consequences must ultimately fall on the exchange value of the US$, if not relative to other fiat currencies, because those governments are busy monetizing too, then relative to gold, oil and other commodities? i'm not sure. i think the stimulus policy exports deflation. we stop buying foreign goods, so those goods must drop in price [however expressed]. but i'm not sure we get inflation, or a lower exchange value unless e.g. china and japan start cashing in their treasuries as i suggest will happen. and without maintained foreign consumption of commodities, i am not convinced of the dollar dropping relative to commodities, either. i think that we come back to ej's original idea of poom - overseas holders of dollar-denominated financial assets get antsy and start spending those dollars. that's what drives down the dollar's value.


        [the "road to ruin" article goes on to discuss the possibility of a balance of payments crisis and rapid devaluation of the dollar. but if this is the scenario, why hold 70% of one's assets in u.s. dollar cash? why not buy oil, metals, agricultural goods? or is the idea that those things will continue to deflate, and we'll swoop in with our cash in the nick of time?]

        [could a funding crisis lead to capital flight out of the dollar? or to the return of the exported dollars looking for real assets to purchase - the "poom" in itulip's ka-poom theory? to answer these questions, i think we first need to address the question of why the dollar's been rising lately. part of the reason is that the dollar is in many ways the least ugly of a lot of ugly currency choices. the euro, apparently the dollar's competition in recent years, seems to be splitting apart at the seams as its constituent political economies tug in different direction. part of the dollar's recent strength is that - as richard russell observed years ago - all the dollar denominated debt is a kind of dollar short position which generates demand for dollars. [Analogous to the Yen carry trade dynamic wherein for most of the past two years the Yen has traded inversely to risk trades. That correlation seems to have played itself out, at least for the moment, as the Yen in recent weeks has been positively correlated with, for example, equity markets. Will the same happen to the US Dollar in due course?] the yen has been hurt by japan's recent flow of very weak economic numbers. again, we are faced with the fiat currency ugly pageant.

        this has played out in the markets, as is revealed by the fed's decision to offer swap lines to other cb's for them to lend on to their dollar-needy institutions; institutions that need dollars for all that they are not domiciled in the u.s.


        in the scenario i've outlined above, federal expenditures are overwhelmingly large as the "federal economy" grows to replace the activity lost by the shrinking private economy. the latter is shrinking because it is being drained by its payments on old debts to the blessed banking system. some debt is written off via bankruptcy and cram-downs, but most of the debt is carried, an increasingly heavy burden as employment and with it income shrinks. this process must have some limit, a discussion of which must await further analysis. [Is the limit imposed by how much additional time lenders can extend to allow borrowers to make good on repayment? Is that not the real reason transferring debt to the public sector is seen as a workable solution; because the taxpayer is the only entity that can wait an infinite amount of time to be repaid?] i was thinking, too, that the private economy shrinks to its "core," i.e. it's non-FIRE-dependent flows. with the government trying to prop up FIRE institutions, however, it is plausible that we get a "lost decade" or two in the process.

        if china and japan are not exporting to the u.s.- or western europe for that matter- what are they doing? [Their economies are contracting. Rapidly :eek:. Even while the popular consensus forecast, among economists, is for China to grow high single digits this year ] china is trying desperately to stimulate its domestic economy, and japan is trying to export capital goods to china. without income from exports, how do china and japan - heavy importers of commodities - pay for their imports? with the big stores of u.s. dollars they have amassed. thus those frozen assets are liquified and released into the global economy. their ongoing sale of treasuries, as they convert them to cash to pay for their imports, helps keep rates up [This is where we may differ. Ultimately I agree with your scenario, but what happens if, for a year or two or three, economic activity, even in greater Asia, is so stagnant that imports to the surplus nations, including commodity imports, fall? There would be no need to liquidate US Treasury holdings...in fact there may for some time be a continued demand because of their "least ugly" status] yes. the possibility of this global depression scenario supports the decision to hold onto large, liquid dollar balances for the moment.

        for the u.s. banks to feast upon. of course, china also continues its strategic purchase of commodity producers, not just the commodities themselves. these actions facilitate a continuing dollarization of the global economy - witness china's recent energy deal with russia, paid for with dollars at china's insistence over putin's objections. these actions also result in more dollars sloshing around the globe, and some must find their way home and start inflating u.s. assets which attract foreign purchasers. since current dollar holders become dollar sellers, the dollar drops relative to the creditor nations, which no longer have as much motive to intervene in the currency markets to support the dollar. this might happen rapidly, but need not.


        i am not entirely convinced by my own analysis, and wonder if there is some big hole in this argument. please let me know if you spot it.]

        Comment


        • #5
          Re: a critique of pure "ruin" - comments on "the road to ruin"

          JK,

          The idea that the Fed can use the banks to sop up government spending in the form of bank owned Treasuries ... isn't that a perpetual motion machine - or a Fed mobius funding?

          My view is cribbed (as with many things) from Dr. Michael Hudson.

          All this you know - but for the benefit of the audience...

          In Dr. Hudson's model - FIRE is a parasite wrapped around the production/consumption economy. F extracts interest, I extracts fees for spreading risk, RE extract economic rent.

          Where the Fed funding mobius breaks down is in the interchange between the FIRE and PC economies. Although the concept of a FIRE mobius funding works in theory, in reality FIRE still requires the fees from PC: interest, insurance, rent. These fees serve as the grounding to the entire FIRE fantasy.

          They usually take the form of money, but in reality this money extracted is simply a substitution for work done. Without this grounding in work value - you get hyperinflation because those people participating in the FIRE (and rest of economy) will always require some exchange of actual work and/or products - the money is merely a symbolic substitute.

          The Fed and government's actions are crowding out the normal investment needed to maintain PC function - which is already in decline due to years of FIRE lack of productive investment. The decreasing income of work to FIRE from the faster declining PC economy will accelerate the devaluation of the medium of exchange: those desiring something of work value must spend more to obtain food, shelter, etc. This in turn increases the need for numbers of exchange units, which in turn increases the speed and volume of the Fed funding mobius journey.

          In Hudson terms - this is the geometric increase of FIRE debt service interest vs. the more linear 'S' curve of normal economic behavior.

          We have some examples already:

          1) Normal banking functions: interbank lending, 'lend to hold' real estate loans, currency swaps, letters of credit, etc are all collapsing as various direct Fed interventionary behaviors via alphabet soup facilities as well as Fed supported GSEs like Fannie/Freddie, plus nationalized FIRE interests like AIG increasingly make normal operational behavior unsurvivable

          2) Industrial companies once at least nominally in the business of production, increasingly orient operations towards government bailouts (GM, GE, etc)

          I'm sure there are plenty more examples to come.

          I think it is the above spending dynamic which EJ refers to - why stimulus packages must continue to grow. Because the money being spent is not going towards rebuilding the PC economy, but rather the FIRE one.

          Comment


          • #6
            Re: a critique of pure "ruin" - comments on "the road to ruin"

            Is there a chart here at iTulip that shows the Finance, Insurance and Real Estate industries as a percentage of the U.S. economy over time?

            Comment


            • #7
              Re: a critique of pure "ruin" - comments on "the road to ruin"

              Originally posted by c1ue View Post
              JK,

              The idea that the Fed can use the banks to sop up government spending in the form of bank owned Treasuries ... isn't that a perpetual motion machine - or a Fed mobius funding?

              My view is cribbed (as with many things) from Dr. Michael Hudson.

              All this you know - but for the benefit of the audience...

              In Dr. Hudson's model - FIRE is a parasite wrapped around the production/consumption economy. F extracts interest, I extracts fees for spreading risk, RE extract economic rent.

              Where the Fed funding mobius breaks down is in the interchange between the FIRE and PC economies. Although the concept of a FIRE mobius funding works in theory, in reality FIRE still requires the fees from PC: interest, insurance, rent. These fees serve as the grounding to the entire FIRE fantasy.

              They usually take the form of money, but in reality this money extracted is simply a substitution for work done. Without this grounding in work value - you get hyperinflation because those people participating in the FIRE (and rest of economy) will always require some exchange of actual work and/or products - the money is merely a symbolic substitute.

              The Fed and government's actions are crowding out the normal investment needed to maintain PC function - which is already in decline due to years of FIRE lack of productive investment. The decreasing income of work to FIRE from the faster declining PC economy will accelerate the devaluation of the medium of exchange: those desiring something of work value must spend more to obtain food, shelter, etc. This in turn increases the need for numbers of exchange units, which in turn increases the speed and volume of the Fed funding mobius journey.

              In Hudson terms - this is the geometric increase of FIRE debt service interest vs. the more linear 'S' curve of normal economic behavior.

              We have some examples already:

              1) Normal banking functions: interbank lending, 'lend to hold' real estate loans, currency swaps, letters of credit, etc are all collapsing as various direct Fed interventionary behaviors via alphabet soup facilities as well as Fed supported GSEs like Fannie/Freddie, plus nationalized FIRE interests like AIG increasingly make normal operational behavior unsurvivable

              2) Industrial companies once at least nominally in the business of production, increasingly orient operations towards government bailouts (GM, GE, etc)

              I'm sure there are plenty more examples to come.

              I think it is the above spending dynamic which EJ refers to - why stimulus packages must continue to grow. Because the money being spent is not going towards rebuilding the PC economy, but rather the FIRE one.
              we are seeing the fed being intermediated as a counterparty to all bank transactions. the banks don't trust one another because each knows how much garbage is on its own books and assumes that the others are in similar straits. and why borrow from another bank when the fed is ready to lend and the stigma of accepting the fed's offer is gone? further, the fed now pays interest on reserves, so no need to lend them to other institutions to guarantee a return. thus each bank lends its excess reserves to the fed, and each gets needed funds from the fed - the ultimately reliable counterparty.

              if the fed lends to the banks so that the banks can buy treasuries, it does nothing for the pc economy. the pc economy is instead the beneficiary of the government's stimulus spending, which is funded by those treasuries. so the money flow is from the fed to the banks, from the banks to the government, from the government to the pc economy ["shovel ready"]. the banks make a riskless return.

              i don't think the government's borrowing is "crowding out" private borrowing. who wants to borrow these days? instead it is replacing private demand which has dried up.

              the FIRE institutions are not thriving in this model. they are surviving and healing enough to function again, sometime in the future, in their proper role as adjuncts to the pc economy. they will be/have been cut down to size.

              the private sector slowly repairs its balance sheets while the government carefully degrades its own. eventually we hit bottom, like an alcoholic whose will to live is finally triggered by enough degradation.

              but this is built around the notion that the fed can expand its balance sheet to even more gargantuan proportions. and i don't know enough about the fed to understand what might be involved in this process.

              it IS a kind of perpetual motion machine, but it only works as long as the pc economy is prostrate. when and if private demand picks up the government must dial back on its own programs to avoid the "crowding out," and its inflationary effects, that you point to.

              i don't see the domestic "mobius funding" as directly generating inflation. nor is the government spending, as currently appropriated, enough to stimulate inflation. [see e.g. krugman's pieces on the relatively puny size of the stimulus.] again, it is the actions of foreign governments wanting to get something of value for their dollar hoards, which will trigger inflation. i think ej's original ka-poom theory was on the mark.

              Comment


              • #8
                Re: a critique of pure "ruin" - comments on "the road to ruin"

                Originally posted by jk View Post
                we are seeing the fed being intermediated as a counterparty to all bank transactions. the banks don't trust one another because each knows how much garbage is on its own books and assumes that the others are in similar straits. and why borrow from another bank when the fed is ready to lend and the stigma of accepting the fed's offer is gone? further, the fed now pays interest on reserves, so no need to lend them to other institutions to guarantee a return. thus each bank lends its excess reserves to the fed, and each gets needed funds from the fed - the ultimately reliable counterparty.

                if the fed lends to the banks so that the banks can buy treasuries, it does nothing for the pc economy. the pc economy is instead the beneficiary of the government's stimulus spending, which is funded by those treasuries. so the money flow is from the fed to the banks, from the banks to the government, from the government to the pc economy ["shovel ready"]. the banks make a riskless return.

                i don't think the government's borrowing is "crowding out" private borrowing. who wants to borrow these days? instead it is replacing private demand which has dried up.

                the FIRE institutions are not thriving in this model. they are surviving and healing enough to function again, sometime in the future, in their proper role as adjuncts to the pc economy. they will be/have been cut down to size.

                the private sector slowly repairs its balance sheets while the government carefully degrades its own. eventually we hit bottom, like an alcoholic whose will to live is finally triggered by enough degradation.

                but this is built around the notion that the fed can expand its balance sheet to even more gargantuan proportions. and i don't know enough about the fed to understand what might be involved in this process.

                it IS a kind of perpetual motion machine, but it only works as long as the pc economy is prostrate. when and if private demand picks up the government must dial back on its own programs to avoid the "crowding out," and its inflationary effects, that you point to.

                i don't see the domestic "mobius funding" as directly generating inflation. nor is the government spending, as currently appropriated, enough to stimulate inflation. [see e.g. krugman's pieces on the relatively puny size of the stimulus.] again, it is the actions of foreign governments wanting to get something of value for their dollar hoards, which will trigger inflation. i think ej's original ka-poom theory was on the mark.
                I don't believe the examples of inflationary economies that went into hyperinflation showed any material recovery of their economy, or private demand, before the inflation set in. Argentina, Zimbabwe...

                What you wrote here sounds faintly like..."Deficits don't matter" [at least not until the moribund economy finally recovers]

                Comment


                • #9
                  Re: a critique of pure "ruin" - comments on "the road to ruin"

                  Originally posted by GRG55 View Post
                  I don't believe the examples of inflationary economies that went into hyperinflation showed any material recovery of their economy, or private demand, before the inflation set in. Argentina, Zimbabwe...
                  their debts are denominated in foreign currencies, and they had current account crises. our dollars are - so far - accepted everywhere [except the taj mahal and a few similar, notable exceptions.] the currencies were devalued.

                  Originally posted by grg55
                  What you wrote here sounds faintly like..."Deficits don't matter" [at least not until the moribund economy finally recovers]
                  i think they don't matter at this moment. at some point they will matter. the question is "when?"

                  Comment


                  • #10
                    Re: a critique of pure "ruin" - comments on "the road to ruin"

                    Originally posted by WDCRob View Post
                    Is there a chart here at iTulip that shows the Finance, Insurance and Real Estate industries as a percentage of the U.S. economy over time?
                    This is not exactly what you're looking for, but it's one measure of the distortion.

                    Comment


                    • #11
                      Re: a critique of pure "ruin" - comments on "the road to ruin"

                      Replies to the reply, in green by GRG55

                      Originally posted by jk View Post
                      replies in red inserted by jk

                      Comments in blue inserted by grg55:

                      Originally Posted by jk
                      i've taken the liberty to reproduce snips from ej's "road to ruin" and inserted some questions and comments.
                      ++++++++++++++++++++++++++++



                      Since 1992 Japanese policy makers transferred debt from private to public account via bailouts and fiscal stimulus, siphoning off cash flow from households and businesses to repay the loans carried on the books of banks as assets on the side of the creditor-debtor balance sheet where the political power lives, collateralized by buildings, houses, and land, which prices were inflated by the very credit that created in the onerous debts that became ever more so as the Japanese economy shrank.

                      Banks and other creditors convince government to pursue policies to deflate the debt against the incomes of households and productive businesses, reducing the debt the slow painful way, [paying it down] dragging the country deeper and deeper into a hole. Agree. Doesn't paying the debt down this way simply mean that credit was used to bring consumption forward [which is why consumer credit was created, non? oui! ], and once the limits of that were fully explored, harvest gave way to winter, which will eventually give way to spring and a new "planting season"? Could the fact that the Japanese owed the money "to themselves", instead of to foreigners, be the reason they were loathe to inflate it away? different sectors of society were represented on the 2 sides of the balance sheet- the creditors controlled or influenced the government enough that their interests prevailed over the interests of the debtors. i think ej made this clear. I also seem to recall that EJ wrote some time back that the Japanese experienced a hyperinflation once before in living memory and, like Germany, that has induced a "national phobia" against inflationary policies; sort of the inverse of the 1930's deflationary experience that continues to cause the USA to be fearful of a repeat. So it may be that the population of Japan was largely supportive of BoJ and government policies, at least in the initial stages of the debt deflation.


                      If principal on debts is not reduced by negotiated debt restructuring, the markets will eventually deflate the debt against the monetary unit of the debt, the US dollar. [then why are we not buying hard assets aside from 30% pm’s?] "...eventually deflate the debt against the monetary unit..."], not immediately apparently.

                      What we are seeing today that looks like saving for future consumption is in fact the debt left over from the FIRE Economy sucking the life out of the US economy. [savers will not borrow anew once they’ve paid down their balances?] What if we are entering a period of social repudiation of debt, similar to the aftermath of the 1930's depression? What if this shift is supported by developed economy demographics...what if the attitude towards debt of aging boomers heading into their 60s and 70s differs from our attitude when we were all in our 30s and 40s? What if, in the future, those that can afford credit don't want it, and those that want it can't afford it? i agree that this is possible, even likely. it represents a profound social/cultural change and the end of the FIRE economy. i think "the road to ruin"'s tone reflects ej's disappointment that the obama administration apparently remains captive to FIRE interests, and is trying to take the same road as japan - protecting the interests of creditors and trying to reduce the debt owed private creditors by slowly paying it down.

                      After the asset price inflation ends the savings rate then increases for a year or so as debt is repaid.

                      Asset price inflations and deflations exert a perverse effect on saving. First the pool of savings to be spent on future consumption shrinks during the period of asset inflation because households are fooled into believing that asset price inflation is wealth creation, that inflating stock and home prices are doing the saving for them. Income is spent on current consumption. After the bubble pops and the fake wealth is wiped out, briefly the savings rate rises as post bubble recession has not yet expressed itself as rising unemployment and incomes have not yet begun to decline. About a year later then the pool of savings starts to shrink again as unemployment rises, incomes decline, and a greater proportion of income is goes to paying off debts taken on during the boom.

                      The duplication by the current administration of Japan's misguided policy to use public and private funds to pay down debt taken on during a credit bubble era is self limiting in the US case in a way it was not for Japan; as long as the debt repayment versus restructuring is pursed, and the banking system is left in its current state of disrepair, the US economy will continue to rapidly decline.

                      By our estimates, due to the combined impact of the crushing weight of debt burdens created by the FIRE Economy and maintained by the current Debt Deflation Continuation Plan and absent an immediate and effective, politically independent response to the banking crisis, leading to an intensification of the credit crisis as S&P predicts, real GDP will fall 4% in 2009 and 4% again in 2010. [given today's revision to 2008Q$ gdp to a decline of 6.2%, these estimates seem conservative!] [What would the GDP decline have been if there had been a stimulus package kicking in during 4rth Q 08? Seems to me the massive size of the stimulus proposals will have a measurable effect on tempering the steep decline in '09 and '10, but only in those quarters where the spending hits the economy, so -3% or -4% averaged over the year may be realistic] agreed. the administration's efforts are not sufficient at all to reverse the process, only to slow it. this may well be labelled "failure" and used as an argument against future stimulus packages. i imagine the situation will be dire enough, however, that the government will have enough support to keep throwing money at the problems. that leaves the question of whether they'll figure out smarter targets to throw it at. If "smarter" means targets that score the highest political points and cater to the most influential special interests then, yes, I suspect they will get "smarter" with time. Forgive the cynicism, but I am confident that stimulus geared to 2010 will be in much greater quantities than stimulus this year. Not because the situation will necessarily be any more or less dire than now, but because 2010 is a mid-term election year...:p

                      This despite the fiscal stimulus, estimated by Adam Posen of the Peterson Institute for International Economics at $1.5 trillion when TARP and other programs are taken into account. If federal government spending continues to increase outlays at the current rate of more than 10% of 2007 GDP per year[note this hypothesis is not for the maintenance of this year's huge spending plan, but an INCREASE of similar size each year- a big assumption.], and federal government receipts continue decline at a 7.5% annual rate in 2009 and 2010 as in 2008 [plausible if the economy contracts relatively rapidly], the fiscal deficit as a percent of real GDP will certainly exceed 10% in 2010, and the current account deficit on a balance of payments basis rise above 10% percent[this assumes that imports are maintained or increased- a questionable assumption for a rapidly contracting economy- i see only energy imports holding up, and even there we can expect energy consumption to slowly contract], even as imports [sic- i think he means "exports"] fall as previously prodigious capital exporters in the Middle East and Asia suffer current account deficits of their own. [every nation can't be in deficit unless we are importing from mars.] For the Middle East and Asia to suffer current account deficits implies a trade deficit [that assumes the net factors income portion of the current account is small compared to the value of traded goods and services in these economies...a reasonable assumption I think] which in turn implies goods/services imports - into the USA - from these countries fall [which is how I interpret that part of what EJ wrote]. if even the oil exporters have current account deficits, which countries will have surpluses? the sums must balance. Yes, I understand that. But savings rates around the world seem to be rising, not just in the deficit countries like the USA, and more capital appears being diverted out of risk assets of every type in favour of sovereign debt. The recent US Treasury yield increase is likely another factor attracting capital.

                      Working backwards through the above paragraph, to fund the escalating fiscal deficits will presumably require external borrowing by the public sector [there being insufficient domestic savings to fund multi-trillion $ borrowing requirements]; such inflows resulting in a capital account surplus, which must be balanced by a bigger current account deficit [the balance of payments calculation]. In other words the USA continues to consume more than it produces, but now the credit to accomplish this is being extended to the only credit-worthy party left in the economy...the US Federal government.


                      If and when its fiscal deficit reaches third world levels, will the US -- with its massive current account deficit financed by the public sector and daily dependence on capital inflows to maintain a balance of payments - finally suffer a balance of payments crisis, rapid currency depreciation, rapidly rising cost-push inflation, and rising interest rates? What we at iTulip.com refer to as a "Poom" portion of a Ka-Poom Theory? [this doesn't seem right to me. the u.s. current account deficit is shrinking, and will not be massive. if our imports are pretty much limited to energy and energy consumption is declining, we still have a deficit but it's not massive. furthermore the deficit is with saudi arabia, canada and mexico. however, we WILL have massive growth in the federal deficit. obama's just-released budget, with its plan to reduce the deficit to a mere half-trillion in 2012 depends on a strong recovery in 2010-12, a doubtful assumption. thus the crisis won't be a balance-of-payments crisis, it will be a funding crisis, as bill fleckenstein has predicted.] Is the US current account deficit shrinking at the moment only because foreign-funded credit has been withdrawn from the private [personal and corporate] sector, and the public sector is just starting to take up the slack? As public sector borrowing needs expand this year, and for many years to come, the current account deficit will probably start expanding again...for as long as foreign lenders are prepared to send the capital to fund it. this doesn't make sense to me. where do the foreign lenders get their dollars to lend to the u.s. government? Because existing savings all around the globe continue to be diverted from risk assets to Treasuries. As I said, the current account deficit will continue to expand as long as foreign lenders are prepared to send the capital to fund it...and so far [judging by the Treasury auction bid-to-cover ratios which seem to be running consistently above 2:1] there is no sign of a change here. Yet. heretofore they've gotten those dollars by selling goods to the u.s. - toasters and t-shirts and toys and toyotas, and petroleum. during recessions the trade balance improves because imports dive. so china and japan, in particular, will not be earning big dollar balances to recycle. only the oil exporters will still be earning large amounts of dollars with which they can buy treasuries. you might argue, for example, that the stimulus program will consume imported steel, but the "buy american" clause stayed in the bill, and i would guess it will tend to be observed de facto even if, for wto purposes, it is renounced de jure. "Buy America" is one way to reduce the current account deficit, you are correct. this is federal spending, and if congressman x, with a steel mill in his district, learns that some stimulus project is looking into brazilian steel, the phone lines will start buzzing.

                      When the Russian government found itself unable to pay the interest on its foreign debt in August 1998, nor able to borrow more money in the international financial markets, nor increase taxes on its imploding economy, nor locate private capital inside Russia willing to lend it money, it suffered a balance of payments crisis. The result was capital flight, a ruble crash, and a spike of cost-push inflation. [how does a funding crisis play out? assume a huge federal deficit - not hard to imagine. we've cut down on our purchases of toasters and cars, our imports aren't great, so we are not sending dollars to china and japan. thus the asian countries couldn't buy our new debt even if they wanted more, which they don't. the saudi's can recycle their dollar flow, but it won't be big enough to put much of a dent in the government's funding needs. who will buy the debt? BANKS! it just came to me. BANKS! they will borrow from the fed at near zero and buy treasuries paying 1-3%, and that's how they'll recapitalize. the fed won't have to buy the debt directly. so the problem becomes how to expand the fed's balance sheet enough to carry the enormous lending beyond its current already-enormous lending. i am not expert enough on the fed to offer the solution, but i have no doubt a solution will be found. [Monetizing the debt, in other words?] yes, but via the banks.

                      the alternative would be for the fed to print money and purchase the debt directly from the treasury, but by cycling the flow through the banking system the fed can continue to feed its family, the deserving rich of the banking system. furthermore, this protects the banks from the risks inherent in lending to people and businesses, who will remain relatively starved of credit.
                      ] [Seems entirely plausible, but the consequences must ultimately fall on the exchange value of the US$, if not relative to other fiat currencies, because those governments are busy monetizing too, then relative to gold, oil and other commodities? i'm not sure. i think the stimulus policy exports deflation. we stop buying foreign goods, so those goods must drop in price [however expressed]. but i'm not sure we get inflation, or a lower exchange value unless e.g. china and japan start cashing in their treasuries as i suggest will happen. Agree, but I do not see any motivation for them to start cashing in Treasuries at this point. Quite the opposite imo. and without maintained foreign consumption of commodities, i am not convinced of the dollar dropping relative to commodities, either. i think that we come back to ej's original idea of poom - overseas holders of dollar-denominated financial assets get antsy and start spending those dollars. that's what drives down the dollar's value.


                      [the "road to ruin" article goes on to discuss the possibility of a balance of payments crisis and rapid devaluation of the dollar. but if this is the scenario, why hold 70% of one's assets in u.s. dollar cash? why not buy oil, metals, agricultural goods? or is the idea that those things will continue to deflate, and we'll swoop in with our cash in the nick of time?]

                      [could a funding crisis lead to capital flight out of the dollar? or to the return of the exported dollars looking for real assets to purchase - the "poom" in itulip's ka-poom theory? to answer these questions, i think we first need to address the question of why the dollar's been rising lately. part of the reason is that the dollar is in many ways the least ugly of a lot of ugly currency choices. the euro, apparently the dollar's competition in recent years, seems to be splitting apart at the seams as its constituent political economies tug in different direction. part of the dollar's recent strength is that - as richard russell observed years ago - all the dollar denominated debt is a kind of dollar short position which generates demand for dollars. [Analogous to the Yen carry trade dynamic wherein for most of the past two years the Yen has traded inversely to risk trades. That correlation seems to have played itself out, at least for the moment, as the Yen in recent weeks has been positively correlated with, for example, equity markets. Will the same happen to the US Dollar in due course?] the yen has been hurt by japan's recent flow of very weak economic numbers. again, we are faced with the fiat currency ugly pageant. Japan's economy has been weak for a long, long time. I suspect the main reason for the Yen's correlation flip-flop is that the carry trade unwind has finally run its course. Enough risk bets are now off the global buffet table that the demand for Yen to cover the short is no longer there. Perhaps even Mrs Watanabe has now repatriated her currency speculations after getting burned by the Aussie and Kiwi last year...

                      this has played out in the markets, as is revealed by the fed's decision to offer swap lines to other cb's for them to lend on to their dollar-needy institutions; institutions that need dollars for all that they are not domiciled in the u.s.


                      in the scenario i've outlined above, federal expenditures are overwhelmingly large as the "federal economy" grows to replace the activity lost by the shrinking private economy. the latter is shrinking because it is being drained by its payments on old debts to the blessed banking system. some debt is written off via bankruptcy and cram-downs, but most of the debt is carried, an increasingly heavy burden as employment and with it income shrinks. this process must have some limit, a discussion of which must await further analysis. [Is the limit imposed by how much additional time lenders can extend to allow borrowers to make good on repayment? Is that not the real reason transferring debt to the public sector is seen as a workable solution; because the taxpayer is the only entity that can wait an infinite amount of time to be repaid?] i was thinking, too, that the private economy shrinks to its "core," i.e. it's non-FIRE-dependent flows. with the government trying to prop up FIRE institutions, however, it is plausible that we get a "lost decade" or two in the process.

                      if china and japan are not exporting to the u.s.- or western europe for that matter- what are they doing? [Their economies are contracting. Rapidly :eek:. Even while the popular consensus forecast, among economists, is for China to grow high single digits this year ] china is trying desperately to stimulate its domestic economy, and japan is trying to export capital goods to china. without income from exports, how do china and japan - heavy importers of commodities - pay for their imports? with the big stores of u.s. dollars they have amassed. thus those frozen assets are liquified and released into the global economy. their ongoing sale of treasuries, as they convert them to cash to pay for their imports, helps keep rates up [This is where we may differ. Ultimately I agree with your scenario, but what happens if, for a year or two or three, economic activity, even in greater Asia, is so stagnant that imports to the surplus nations, including commodity imports, fall? There would be no need to liquidate US Treasury holdings...in fact there may for some time be a continued demand because of their "least ugly" status] yes. the possibility of this global depression scenario supports the decision to hold onto large, liquid dollar balances for the moment.

                      for the u.s. banks to feast upon. of course, china also continues its strategic purchase of commodity producers, not just the commodities themselves. these actions facilitate a continuing dollarization of the global economy - witness china's recent energy deal with russia, paid for with dollars at china's insistence over putin's objections. these actions also result in more dollars sloshing around the globe, and some must find their way home and start inflating u.s. assets which attract foreign purchasers. since current dollar holders become dollar sellers, the dollar drops relative to the creditor nations, which no longer have as much motive to intervene in the currency markets to support the dollar. this might happen rapidly, but need not.


                      i am not entirely convinced by my own analysis, and wonder if there is some big hole in this argument. please let me know if you spot it.]

                      Comment


                      • #12
                        Re: a critique of pure "ruin" - comments on "the road to ruin"

                        replies-cubed in purple prose by jk
                        Originally posted by GRG55 View Post
                        Replies to the reply, in green by GRG55

                        replies in red inserted by jk

                        Comments in blue inserted by grg55:

                        Originally Posted by jk
                        i've taken the liberty to reproduce snips from ej's "road to ruin" and inserted some questions and comments.
                        ++++++++++++++++++++++++++++



                        Since 1992 Japanese policy makers transferred debt from private to public account via bailouts and fiscal stimulus, siphoning off cash flow from households and businesses to repay the loans carried on the books of banks as assets on the side of the creditor-debtor balance sheet where the political power lives, collateralized by buildings, houses, and land, which prices were inflated by the very credit that created in the onerous debts that became ever more so as the Japanese economy shrank.

                        Banks and other creditors convince government to pursue policies to deflate the debt against the incomes of households and productive businesses, reducing the debt the slow painful way, [paying it down] dragging the country deeper and deeper into a hole. Agree. Doesn't paying the debt down this way simply mean that credit was used to bring consumption forward [which is why consumer credit was created, non? oui! ], and once the limits of that were fully explored, harvest gave way to winter, which will eventually give way to spring and a new "planting season"? Could the fact that the Japanese owed the money "to themselves", instead of to foreigners, be the reason they were loathe to inflate it away? different sectors of society were represented on the 2 sides of the balance sheet- the creditors controlled or influenced the government enough that their interests prevailed over the interests of the debtors. i think ej made this clear. I also seem to recall that EJ wrote some time back that the Japanese experienced a hyperinflation once before in living memory and, like Germany, that has induced a "national phobia" against inflationary policies; sort of the inverse of the 1930's deflationary experience that continues to cause the USA to be fearful of a repeat. So it may be that the population of Japan was largely supportive of BoJ and government policies, at least in the initial stages of the debt deflation. the [financial] generals always want to fight the last war.


                        If principal on debts is not reduced by negotiated debt restructuring, the markets will eventually deflate the debt against the monetary unit of the debt, the US dollar. [then why are we not buying hard assets aside from 30% pm’s?] "...eventually deflate the debt against the monetary unit..."], not immediately apparently.

                        What we are seeing today that looks like saving for future consumption is in fact the debt left over from the FIRE Economy sucking the life out of the US economy. [savers will not borrow anew once they’ve paid down their balances?] What if we are entering a period of social repudiation of debt, similar to the aftermath of the 1930's depression? What if this shift is supported by developed economy demographics...what if the attitude towards debt of aging boomers heading into their 60s and 70s differs from our attitude when we were all in our 30s and 40s? What if, in the future, those that can afford credit don't want it, and those that want it can't afford it? i agree that this is possible, even likely. it represents a profound social/cultural change and the end of the FIRE economy. i think "the road to ruin"'s tone reflects ej's disappointment that the obama administration apparently remains captive to FIRE interests, and is trying to take the same road as japan - protecting the interests of creditors and trying to reduce the debt owed private creditors by slowly paying it down.

                        After the asset price inflation ends the savings rate then increases for a year or so as debt is repaid.

                        Asset price inflations and deflations exert a perverse effect on saving. First the pool of savings to be spent on future consumption shrinks during the period of asset inflation because households are fooled into believing that asset price inflation is wealth creation, that inflating stock and home prices are doing the saving for them. Income is spent on current consumption. After the bubble pops and the fake wealth is wiped out, briefly the savings rate rises as post bubble recession has not yet expressed itself as rising unemployment and incomes have not yet begun to decline. About a year later then the pool of savings starts to shrink again as unemployment rises, incomes decline, and a greater proportion of income is goes to paying off debts taken on during the boom.

                        The duplication by the current administration of Japan's misguided policy to use public and private funds to pay down debt taken on during a credit bubble era is self limiting in the US case in a way it was not for Japan; as long as the debt repayment versus restructuring is pursed, and the banking system is left in its current state of disrepair, the US economy will continue to rapidly decline.

                        By our estimates, due to the combined impact of the crushing weight of debt burdens created by the FIRE Economy and maintained by the current Debt Deflation Continuation Plan and absent an immediate and effective, politically independent response to the banking crisis, leading to an intensification of the credit crisis as S&P predicts, real GDP will fall 4% in 2009 and 4% again in 2010. [given today's revision to 2008Q$ gdp to a decline of 6.2%, these estimates seem conservative!] [What would the GDP decline have been if there had been a stimulus package kicking in during 4rth Q 08? Seems to me the massive size of the stimulus proposals will have a measurable effect on tempering the steep decline in '09 and '10, but only in those quarters where the spending hits the economy, so -3% or -4% averaged over the year may be realistic] agreed. the administration's efforts are not sufficient at all to reverse the process, only to slow it. this may well be labelled "failure" and used as an argument against future stimulus packages. i imagine the situation will be dire enough, however, that the government will have enough support to keep throwing money at the problems. that leaves the question of whether they'll figure out smarter targets to throw it at. If "smarter" means targets that score the highest political points and cater to the most influential special interests then, yes, I suspect they will get "smarter" with time. Forgive the cynicism, but I am confident that stimulus geared to 2010 will be in much greater quantities than stimulus this year. Not because the situation will necessarily be any more or less dire than now, but because 2010 is a mid-term election year...:p here, once more, i lapsed into relative optimism, hoping they'd eventually figure out better things to do with the money. perhaps ej is right, that it will take 20% unemployment to them to do the right thing.:eek:

                        This despite the fiscal stimulus, estimated by Adam Posen of the Peterson Institute for International Economics at $1.5 trillion when TARP and other programs are taken into account. If federal government spending continues to increase outlays at the current rate of more than 10% of 2007 GDP per year[note this hypothesis is not for the maintenance of this year's huge spending plan, but an INCREASE of similar size each year- a big assumption.], and federal government receipts continue decline at a 7.5% annual rate in 2009 and 2010 as in 2008 [plausible if the economy contracts relatively rapidly], the fiscal deficit as a percent of real GDP will certainly exceed 10% in 2010, and the current account deficit on a balance of payments basis rise above 10% percent[this assumes that imports are maintained or increased- a questionable assumption for a rapidly contracting economy- i see only energy imports holding up, and even there we can expect energy consumption to slowly contract], even as imports [sic- i think he means "exports"] fall as previously prodigious capital exporters in the Middle East and Asia suffer current account deficits of their own. [every nation can't be in deficit unless we are importing from mars.] For the Middle East and Asia to suffer current account deficits implies a trade deficit [that assumes the net factors income portion of the current account is small compared to the value of traded goods and services in these economies...a reasonable assumption I think] which in turn implies goods/services imports - into the USA - from these countries fall [which is how I interpret that part of what EJ wrote]. if even the oil exporters have current account deficits, which countries will have surpluses? the sums must balance. Yes, I understand that. But savings rates around the world seem to be rising, not just in the deficit countries like the USA, and more capital appears being diverted out of risk assets of every type in favour of sovereign debt. The recent US Treasury yield increase is likely another factor attracting capital. you seem to be supporting bernanke's "surplus of savings" theory to explain the u.s. current account deficit. i find that line of reasoning unpursuasive, myself. i think the u.s. has to import something and export dollars to get the ball rolling. otherwise, if those savers in china and japan really want to buy u.s. treasuries, where will they get the dollars to make the purchase? remember they need NEW dollars, since the ones they earned in the past have already been stashed into bonds. if the flow really starts with foreign savings then we'd see the dollar rising against their currencies. hmmmm. seems like we are seeing the dollar rising against all currencies, even -lately- the yen. but of course the dollar has also been propped up by intervention, so i'll have to mull this over, grg55.

                        Working backwards through the above paragraph, to fund the escalating fiscal deficits will presumably require external borrowing by the public sector [there being insufficient domestic savings to fund multi-trillion $ borrowing requirements]; such inflows resulting in a capital account surplus, which must be balanced by a bigger current account deficit [the balance of payments calculation]. In other words the USA continues to consume more than it produces, but now the credit to accomplish this is being extended to the only credit-worthy party left in the economy...the US Federal government.


                        If and when its fiscal deficit reaches third world levels, will the US -- with its massive current account deficit financed by the public sector and daily dependence on capital inflows to maintain a balance of payments - finally suffer a balance of payments crisis, rapid currency depreciation, rapidly rising cost-push inflation, and rising interest rates? What we at iTulip.com refer to as a "Poom" portion of a Ka-Poom Theory? [this doesn't seem right to me. the u.s. current account deficit is shrinking, and will not be massive. if our imports are pretty much limited to energy and energy consumption is declining, we still have a deficit but it's not massive. furthermore the deficit is with saudi arabia, canada and mexico. however, we WILL have massive growth in the federal deficit. obama's just-released budget, with its plan to reduce the deficit to a mere half-trillion in 2012 depends on a strong recovery in 2010-12, a doubtful assumption. thus the crisis won't be a balance-of-payments crisis, it will be a funding crisis, as bill fleckenstein has predicted.] Is the US current account deficit shrinking at the moment only because foreign-funded credit has been withdrawn from the private [personal and corporate] sector, and the public sector is just starting to take up the slack? As public sector borrowing needs expand this year, and for many years to come, the current account deficit will probably start expanding again...for as long as foreign lenders are prepared to send the capital to fund it. this doesn't make sense to me. where do the foreign lenders get their dollars to lend to the u.s. government? Because existing savings all around the globe continue to be diverted from risk assets to Treasuries. As I said, the current account deficit will continue to expand as long as foreign lenders are prepared to send the capital to fund it...and so far [judging by the Treasury auction bid-to-cover ratios which seem to be running consistently above 2:1] there is no sign of a change here. Yet. again, grg55, where are they getting the new dollars into which to convert their savings, which savings have been generated independent of exports to the u.s.?
                        heretofore they've gotten those dollars by selling goods to the u.s. - toasters and t-shirts and toys and toyotas, and petroleum. during recessions the trade balance improves because imports dive. so china and japan, in particular, will not be earning big dollar balances to recycle. only the oil exporters will still be earning large amounts of dollars with which they can buy treasuries. you might argue, for example, that the stimulus program will consume imported steel, but the "buy american" clause stayed in the bill, and i would guess it will tend to be observed de facto even if, for wto purposes, it is renounced de jure. "Buy America" is one way to reduce the current account deficit, you are correct. this is federal spending, and if congressman x, with a steel mill in his district, learns that some stimulus project is looking into brazilian steel, the phone lines will start buzzing.


                        When the Russian government found itself unable to pay the interest on its foreign debt in August 1998, nor able to borrow more money in the international financial markets, nor increase taxes on its imploding economy, nor locate private capital inside Russia willing to lend it money, it suffered a balance of payments crisis. The result was capital flight, a ruble crash, and a spike of cost-push inflation. [how does a funding crisis play out? assume a huge federal deficit - not hard to imagine. we've cut down on our purchases of toasters and cars, our imports aren't great, so we are not sending dollars to china and japan. thus the asian countries couldn't buy our new debt even if they wanted more, which they don't. the saudi's can recycle their dollar flow, but it won't be big enough to put much of a dent in the government's funding needs. who will buy the debt? BANKS! it just came to me. BANKS! they will borrow from the fed at near zero and buy treasuries paying 1-3%, and that's how they'll recapitalize. the fed won't have to buy the debt directly. so the problem becomes how to expand the fed's balance sheet enough to carry the enormous lending beyond its current already-enormous lending. i am not expert enough on the fed to offer the solution, but i have no doubt a solution will be found. [Monetizing the debt, in other words?] yes, but via the banks.

                        the alternative would be for the fed to print money and purchase the debt directly from the treasury, but by cycling the flow through the banking system the fed can continue to feed its family, the deserving rich of the banking system. furthermore, this protects the banks from the risks inherent in lending to people and businesses, who will remain relatively starved of credit.
                        ] [Seems entirely plausible, but the consequences must ultimately fall on the exchange value of the US$, if not relative to other fiat currencies, because those governments are busy monetizing too, then relative to gold, oil and other commodities? i'm not sure. i think the stimulus policy exports deflation. we stop buying foreign goods, so those goods must drop in price [however expressed]. but i'm not sure we get inflation, or a lower exchange value unless e.g. china and japan start cashing in their treasuries as i suggest will happen. Agree, but I do not see any motivation for them to start cashing in Treasuries at this point. Quite the opposite imo. their motive will be to fund their own imports once they've ceased generating surpluses by exporting to the oecd countries.

                        and without maintained foreign consumption of commodities, i am not convinced of the dollar dropping relative to commodities, either. i think that we come back to ej's original idea of poom - overseas holders of dollar-denominated financial assets get antsy and start spending those dollars. that's what drives down the dollar's value.


                        [the "road to ruin" article goes on to discuss the possibility of a balance of payments crisis and rapid devaluation of the dollar. but if this is the scenario, why hold 70% of one's assets in u.s. dollar cash? why not buy oil, metals, agricultural goods? or is the idea that those things will continue to deflate, and we'll swoop in with our cash in the nick of time?]

                        [could a funding crisis lead to capital flight out of the dollar? or to the return of the exported dollars looking for real assets to purchase - the "poom" in itulip's ka-poom theory? to answer these questions, i think we first need to address the question of why the dollar's been rising lately. part of the reason is that the dollar is in many ways the least ugly of a lot of ugly currency choices. the euro, apparently the dollar's competition in recent years, seems to be splitting apart at the seams as its constituent political economies tug in different direction. part of the dollar's recent strength is that - as richard russell observed years ago - all the dollar denominated debt is a kind of dollar short position which generates demand for dollars. [Analogous to the Yen carry trade dynamic wherein for most of the past two years the Yen has traded inversely to risk trades. That correlation seems to have played itself out, at least for the moment, as the Yen in recent weeks has been positively correlated with, for example, equity markets. Will the same happen to the US Dollar in due course?] the yen has been hurt by japan's recent flow of very weak economic numbers. again, we are faced with the fiat currency ugly pageant. Japan's economy has been weak for a long, long time. I suspect the main reason for the Yen's correlation flip-flop is that the carry trade unwind has finally run its course. Enough risk bets are now off the global buffet table that the demand for Yen to cover the short is no longer there. Perhaps even Mrs Watanabe has now repatriated her currency speculations after getting burned by the Aussie and Kiwi last year... you're right, japan's been weak for what feels like forever. [though i can remember those glory days when the japanese bought rockefeller center and pebble beach.] it's hard to believe the carry trade has been fully unwound. japan exported a LOT of capital. but it's ceased unwinding for the nonce, that's for sure. maybe mrs watanabe is buying gold.... actually, that gives me an idea. gold purchases are made in dollars. there is lately a currency flow from euros and yen and god-knows-what into gold VIA the dollar, which tends to support the dollar vis a vis every other currency.

                        this has played out in the markets, as is revealed by the fed's decision to offer swap lines to other cb's for them to lend on to their dollar-needy institutions; institutions that need dollars for all that they are not domiciled in the u.s.


                        in the scenario i've outlined above, federal expenditures are overwhelmingly large as the "federal economy" grows to replace the activity lost by the shrinking private economy. the latter is shrinking because it is being drained by its payments on old debts to the blessed banking system. some debt is written off via bankruptcy and cram-downs, but most of the debt is carried, an increasingly heavy burden as employment and with it income shrinks. this process must have some limit, a discussion of which must await further analysis. [Is the limit imposed by how much additional time lenders can extend to allow borrowers to make good on repayment? Is that not the real reason transferring debt to the public sector is seen as a workable solution; because the taxpayer is the only entity that can wait an infinite amount of time to be repaid?] i was thinking, too, that the private economy shrinks to its "core," i.e. it's non-FIRE-dependent flows. with the government trying to prop up FIRE institutions, however, it is plausible that we get a "lost decade" or two in the process.

                        if china and japan are not exporting to the u.s.- or western europe for that matter- what are they doing? [Their economies are contracting. Rapidly :eek:. Even while the popular consensus forecast, among economists, is for China to grow high single digits this year ] china is trying desperately to stimulate its domestic economy, and japan is trying to export capital goods to china. without income from exports, how do china and japan - heavy importers of commodities - pay for their imports? with the big stores of u.s. dollars they have amassed. thus those frozen assets are liquified and released into the global economy. their ongoing sale of treasuries, as they convert them to cash to pay for their imports, helps keep rates up [This is where we may differ. Ultimately I agree with your scenario, but what happens if, for a year or two or three, economic activity, even in greater Asia, is so stagnant that imports to the surplus nations, including commodity imports, fall? There would be no need to liquidate US Treasury holdings...in fact there may for some time be a continued demand because of their "least ugly" status] yes. the possibility of this global depression scenario supports the decision to hold onto large, liquid dollar balances for the moment.

                        for the u.s. banks to feast upon. of course, china also continues its strategic purchase of commodity producers, not just the commodities themselves. these actions facilitate a continuing dollarization of the global economy - witness china's recent energy deal with russia, paid for with dollars at china's insistence over putin's objections. these actions also result in more dollars sloshing around the globe, and some must find their way home and start inflating u.s. assets which attract foreign purchasers. since current dollar holders become dollar sellers, the dollar drops relative to the creditor nations, which no longer have as much motive to intervene in the currency markets to support the dollar. this might happen rapidly, but need not.


                        i am not entirely convinced by my own analysis, and wonder if there is some big hole in this argument. please let me know if you spot it.]

                        Comment


                        • #13
                          Re: a critique of pure "ruin" - comments on "the road to ruin"

                          Purple by GRG55...

                          Originally posted by jk View Post
                          replies-cubed in purple prose by jk


                          replies in red inserted by jk

                          Comments in blue inserted by grg55:

                          Originally Posted by jk
                          i've taken the liberty to reproduce snips from ej's "road to ruin" and inserted some questions and comments.
                          ++++++++++++++++++++++++++++

                          ...By our estimates, due to the combined impact of the crushing weight of debt burdens created by the FIRE Economy and maintained by the current Debt Deflation Continuation Plan and absent an immediate and effective, politically independent response to the banking crisis, leading to an intensification of the credit crisis as S&P predicts, real GDP will fall 4% in 2009 and 4% again in 2010. [given today's revision to 2008Q$ gdp to a decline of 6.2%, these estimates seem conservative!] [What would the GDP decline have been if there had been a stimulus package kicking in during 4rth Q 08? Seems to me the massive size of the stimulus proposals will have a measurable effect on tempering the steep decline in '09 and '10, but only in those quarters where the spending hits the economy, so -3% or -4% averaged over the year may be realistic] agreed. the administration's efforts are not sufficient at all to reverse the process, only to slow it. this may well be labelled "failure" and used as an argument against future stimulus packages. i imagine the situation will be dire enough, however, that the government will have enough support to keep throwing money at the problems. that leaves the question of whether they'll figure out smarter targets to throw it at. If "smarter" means targets that score the highest political points and cater to the most influential special interests then, yes, I suspect they will get "smarter" with time. Forgive the cynicism, but I am confident that stimulus geared to 2010 will be in much greater quantities than stimulus this year. Not because the situation will necessarily be any more or less dire than now, but because 2010 is a mid-term election year...:p here, once more, i lapsed into relative optimism, hoping they'd eventually figure out better things to do with the money. perhaps ej is right, that it will take 20% unemployment to them to do the right thing.:eek: So how does that feel...being an optimist?

                          This despite the fiscal stimulus, estimated by Adam Posen of the Peterson Institute for International Economics at $1.5 trillion when TARP and other programs are taken into account. If federal government spending continues to increase outlays at the current rate of more than 10% of 2007 GDP per year[note this hypothesis is not for the maintenance of this year's huge spending plan, but an INCREASE of similar size each year- a big assumption.], and federal government receipts continue decline at a 7.5% annual rate in 2009 and 2010 as in 2008 [plausible if the economy contracts relatively rapidly], the fiscal deficit as a percent of real GDP will certainly exceed 10% in 2010, and the current account deficit on a balance of payments basis rise above 10% percent[this assumes that imports are maintained or increased- a questionable assumption for a rapidly contracting economy- i see only energy imports holding up, and even there we can expect energy consumption to slowly contract], even as imports [sic- i think he means "exports"] fall as previously prodigious capital exporters in the Middle East and Asia suffer current account deficits of their own. [every nation can't be in deficit unless we are importing from mars.] For the Middle East and Asia to suffer current account deficits implies a trade deficit [that assumes the net factors income portion of the current account is small compared to the value of traded goods and services in these economies...a reasonable assumption I think] which in turn implies goods/services imports - into the USA - from these countries fall [which is how I interpret that part of what EJ wrote]. if even the oil exporters have current account deficits, which countries will have surpluses? the sums must balance. Yes, I understand that. But savings rates around the world seem to be rising, not just in the deficit countries like the USA, and more capital appears being diverted out of risk assets of every type in favour of sovereign debt. The recent US Treasury yield increase is likely another factor attracting capital. you seem to be supporting bernanke's "surplus of savings" theory to explain the u.s. current account deficit. i find that line of reasoning unpursuasive, myself. i think the u.s. has to import something and export dollars to get the ball rolling. otherwise, if those savers in china and japan really want to buy u.s. treasuries, where will they get the dollars to make the purchase? remember they need NEW dollars, since the ones they earned in the past have already been stashed into bonds. if the flow really starts with foreign savings then we'd see the dollar rising against their currencies. hmmmm. seems like we are seeing the dollar rising against all currencies, even -lately- the yen. but of course the dollar has also been propped up by intervention, so i'll have to mull this over, grg55.

                          Working backwards through the above paragraph, to fund the escalating fiscal deficits will presumably require external borrowing by the public sector [there being insufficient domestic savings to fund multi-trillion $ borrowing requirements]; such inflows resulting in a capital account surplus, which must be balanced by a bigger current account deficit [the balance of payments calculation]. In other words the USA continues to consume more than it produces, but now the credit to accomplish this is being extended to the only credit-worthy party left in the economy...the US Federal government.


                          If and when its fiscal deficit reaches third world levels, will the US -- with its massive current account deficit financed by the public sector and daily dependence on capital inflows to maintain a balance of payments - finally suffer a balance of payments crisis, rapid currency depreciation, rapidly rising cost-push inflation, and rising interest rates? What we at iTulip.com refer to as a "Poom" portion of a Ka-Poom Theory? [this doesn't seem right to me. the u.s. current account deficit is shrinking, and will not be massive. if our imports are pretty much limited to energy and energy consumption is declining, we still have a deficit but it's not massive. furthermore the deficit is with saudi arabia, canada and mexico. however, we WILL have massive growth in the federal deficit. obama's just-released budget, with its plan to reduce the deficit to a mere half-trillion in 2012 depends on a strong recovery in 2010-12, a doubtful assumption. thus the crisis won't be a balance-of-payments crisis, it will be a funding crisis, as bill fleckenstein has predicted.] Is the US current account deficit shrinking at the moment only because foreign-funded credit has been withdrawn from the private [personal and corporate] sector, and the public sector is just starting to take up the slack? As public sector borrowing needs expand this year, and for many years to come, the current account deficit will probably start expanding again...for as long as foreign lenders are prepared to send the capital to fund it. this doesn't make sense to me. where do the foreign lenders get their dollars to lend to the u.s. government? Because existing savings all around the globe continue to be diverted from risk assets to Treasuries. As I said, the current account deficit will continue to expand as long as foreign lenders are prepared to send the capital to fund it...and so far [judging by the Treasury auction bid-to-cover ratios which seem to be running consistently above 2:1] there is no sign of a change here. Yet. again, grg55, where are they getting the new dollars into which to convert their savings, which savings have been generated independent of exports to the u.s.? Could this be one source?

                          Release Date: September 29, 2008
                          Federal Reserve Actions
                          The Federal Reserve announced today several initiatives to support financial stability and to maintain a stable flow of credit to the economy during this period of significant strain in global markets...


                          Foreign Exchange Swap Lines
                          The Federal Open Market Committee (FOMC) has authorized a $330 billion expansion of its temporary reciprocal currency arrangements (swap lines). This increased capacity will be available to provide funding for U.S. dollar liquidity operations by the other central banks. The FOMC has authorized increases in all of the temporary swap facilities with other central banks. These larger facilities will now support the provision of U.S. dollar liquidity in amounts of up to $30 billion by the Bank of Canada, $80 billion by the Bank of England, $120 billion by the Bank of Japan, $15 billion by Danmarks Nationalbank, $240 billion by the ECB, $15 billion by the Norges Bank, $30 billion by the Reserve Bank of Australia, $30 billion by the Sveriges Riksbank, and $60 billion by the Swiss National Bank. As a result of these actions, the total size of outstanding swap lines is $620 billion.


                          All of the temporary reciprocal swap facilities have been authorized through April 30, 2009.

                          Dollar funding rates abroad have been elevated relative to dollar funding rates available in the United States, reflecting a structural dollar funding shortfall outside of the United States. The increase in the amount of foreign exchange swap authorization limits will enable many central banks to increase the amount of dollar funding that they can provide in their home markets. This should help to improve the distribution of dollar liquidity around the globe...

                          heretofore they've gotten those dollars by selling goods to the u.s. - toasters and t-shirts and toys and toyotas, and petroleum. during recessions the trade balance improves because imports dive. so china and japan, in particular, will not be earning big dollar balances to recycle. only the oil exporters will still be earning large amounts of dollars with which they can buy treasuries. you might argue, for example, that the stimulus program will consume imported steel, but the "buy american" clause stayed in the bill, and i would guess it will tend to be observed de facto even if, for wto purposes, it is renounced de jure. "Buy America" is one way to reduce the current account deficit, you are correct. this is federal spending, and if congressman x, with a steel mill in his district, learns that some stimulus project is looking into brazilian steel, the phone lines will start buzzing...

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                          • #14
                            Re: a critique of pure "ruin" - comments on "the road to ruin"

                            JK,

                            I guess the substance of the difference between your inquiry and my view is the FIRE/PC linkage.

                            Let me put this another way:

                            What if we looked at productive capacity as the PC equivalent of credit?

                            In this case, Germany, China, and a relatively small number of other nations have all the 'credit'.

                            Recently with the synchronized world economic decline, some of this 'credit' has turned bad as repayment of the investment basis of said credit in the form of exports is failing.

                            Some of this 'credit' is also being neutralized as various 'debtor' nations are now experiencing falling wages - thus evening out a little of the relative 'credit'.

                            But the fundamental structures are such that those who have most of the 'credit' now, will still have most of the 'credit' throughout this process.

                            American salaries are not going to be anywhere competitive with Chinese barring a hyperinflation, nor are German mechanization/efficiency/labor combinations going to be easily competed against.

                            So on one side of the PC 'credit' spectrum, we have China and Germany.

                            On the other side of the PC 'debit' spectrum, we have the US, UK, and a few others like the PIIGS.

                            As the US stokes its FIRE engines, it still requires PC inputs because the American internal PC economy is in ruins.

                            While the trade deficits will decline - they're not going to even out. Wal-mart is still going to be 70% China-made goods. In Russia the ruble fall combined with increasing enforcement of import tax collection is resulting in Belarussian electronics being used to fill otherwise empty store shelves. I haven't seen this first hand, but I also do not anticipate the revival of RCA, Westinghouse, etc or the intrusion of Crown Royal TVs or Corona radios. North America simply doesn't have the PC capability.

                            The idea of the Fed-banking system mobius funding assumes there aren't external and internal needs outside of the FIRE system.

                            My view is that this is an impossibility - else the FIRE system would have long ago detached from its PC host and attained a life of its own.

                            While certainly a funding crisis may be the pin that pops the mobius funding balloon, I see the ongoing need for PC outputs as the equivalent of a 3 pound weight glued to the top of the balloon: a contributing instability and a drain on the system.

                            Yes of course on the last page of inflation, food is all that matters. But Americans don't spend all their money on basic food and housing. The loss of that 50%+ in everyday household luxuries will not be given up easily.

                            As for the paradox of why the PC creditors continue to lend - for China it seems very straightforward: If by continuing to lend, China can neutralize the US' military and other forms of sovereign competition, the bargain is more than fair. China can clearly buy what it needs from the rest of the world just through its ongoing cash flow.

                            Thus the $2T held is not a capital asset - rather it is a strategic weapon.

                            For Germany, the goal is less well defined. They just want to continue their path of prosperity. But the demands of the EU are getting louder - at some point Germany will either have to take on the mantle of EU financial savior, or go its own way.

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                            • #15
                              Re: a critique of pure "ruin" - comments on "the road to ruin"

                              c1ue, most of the goods we import from china are discretionary as far as i can tell. and discretionary goods will no longer be imported. what keeps walmart sales up is the fact that walmart moved into the grocery business. and even groceries are showing a payday bump- as people run out of money before the next paycheck, then go stock up.

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