The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

[EJ]

The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat

“Politics is the gentle art of getting votes from the poor and campaign funds from the rich by promising to protect each from the other.”
– Oscar Ameringer

The contraction phase of the Great Recession left America with a $1 trillion gap between actual and potential economic growth. The economy must grow at a rate of at least 4% per year starting now in order to reach growth potential before the next recession opens the gap further a few years from now. If we fail to meet this deadline, the American political economy will enter a second circle of hell as chronic economic pain from high prices and low wages morphs into a self-destructive cycle of class conflict and political deadlock. The stakes are high, yet the only escape from the output gap trap isn’t even in the menu of mainstream debate.

Our dire situation is summed up in the two presentations below.

Email this presentation to a friend or embed it on your site.

The American Output Gap Trap: No Way Out?

Email this presentation to a friend or embed it on your site.

“Politics is not the art of the possible. It consists in choosing between the disastrous and the unpalatable.”
– John Kenneth Galbraith

US policy makers must among three options to escape the output gap trap or enter the second circle of economic hell. Which is the least disastrous and most palatable, to whom, and why? What will happen if none of them are pursued? This question defines the new era, the Output Gap Trap era that has replaced the Bubble Cycle era that we identified early in the last decade. As we make our case for how the next decade will look, we build our model of the complex dynamics that will determine the direction of assets globally.

(This analysis forms one of the three essential building blocks of our Next Ten Years forecast.)

The American Output Gap Trap – Part II: Inflation, deflation, and the un-debate

When the people lose faith and don’t know what to believe in, they don’t believe in nothing, they believe in anything.

CI: In the Ask EJ section of iTulip a subscriber asks you “What do you think about all this hyperinflation-is-coming stuff that’s been circulating on the Internet lately?” You answer the question there [tk], but before this interview you told me you have a comment on the subject of extreme forecasts overall.

EJ: I attribute the recent flurry of extreme ‘flation forecasts, of an impending deflation spiral or conversely of imminent hyperinflation, to the perverse effects of the recession on the advertising revenue driven mainstream and blogger business model.

CI: Explain.

EJ: Think back to before the crisis. October 2006 we warned of a massive financial crisis and recession starting by the end of Q4 2007 as the inevitable fallout of the housing bubble. Even though anyone who was paying attention could see that the economy had rolled over by the middle of 2007, a year after the housing bubble started to deflate, the dominant storyline on the economy in the mainstream was that the housing bust is no big deal, and even if it turned into a crisis it certainly won’t be bad enough to cause a massive recession.

Fast-forward two and a half years. After the crash, what’s the dominant storyline now? There are several but two dominate.

One is the double dip recession and deflation we’ll get if we cut public spending to stimulate the economy. The other is the debt and currency crisis and inflation we’ll get if we keep trying to expand the public debt to pay for stimulus programs. These policy bookends frame the economic policy debate. Problem is, the framework is out of context with the economic reality. It’s an “as if” ideology-charged framework of belief systems.

CI: As-if economics...

EJ: Yes. The double-dippers argue that ongoing fiscal stimulus is the road we must take to avoid a second recession in a repeat of 1938, as if public spending will make the credit bubble era debt go away in a few quarters rather than commit the US to a decade of rising public debt and government spending dependence, as if the US in 2010 is Japan in 1995, with a huge trade surplus and capital account deficit, and as if we as a net foreign debtor can afford to expand the public debt for 15 years to muddle our way through a balance sheet recession to avoid a political confrontation with the banking lobby. The debt crisis prognosticators, on the other hand, understand the limits of a debtor nation’s balance sheet but they offer an equally fantastical solution, to cut spending and the deficits, as if the US was in a business cycle recession not a balance sheet recession and millions of households didn’t have trillions of debt payments to make.

CI: Who’s right? more... $ubscription...

iTulip Select: The Investment Thesis for the Next Cycle™
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For a concise, readable summary of iTulip concepts read Eric Janszen's September 2010 book The Postcatastrophe Economy: Rebuilding America and Avoiding the Next Bubble.

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[krakknisse]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

Welcome to hell. Can't decide whether it will be the seventh or eighth circle.

[Fiat Currency]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

When I click on the 2nd presentation it just takes me to janszen.com ... is that right?

[zoog]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

When I click on the 2nd presentation it just takes me to janszen.com ... is that right?

Same here. If you move your mouse over the blue line in the middle of the chart (or thereabouts), there is text that pops up in the lower area detailing different periods.

[rant]
One of the problems I have with Flash websites etc. is that the open-ended nature allows designers to create interactive navigation methods which, while no doubt obvious to the creator, are not always intuitive to the public at large. To be safe, you really have to be captain obvious with this stuff. One possible solution: some fairly large, colorful dots in the areas where the mouseover happens. Even though you don't actually have to be exactly on the dot for it to work, it may provide enough of a clue to encourage viewers to move their mouse there to see if anything happens.
[/rant]

[Fiat Currency]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

Ah ... thanks zoog. Since the first one was a "click on" I had just assumed the 2nd was too. My bad.

[LargoWinch]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

I would like some clarity on the following if possible: What are the assumptions behind the Real Potential GDP curve?

Shouldn't at some point the exponential nature of such curve hit the wall of limited resources?

[EJ]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

I would like some clarity on the following if possible: What are the assumptions behind the Real Potential GDP curve?

Shouldn't at some point the exponential nature of such curve hit the wall of limited resources?

Real Potential Output is a garbage economics idea that gets hauled out from time to time to justify inflationary monetary and fiscal policies. Michael Hudson reminded me in an interview Thursday, that we'll publish next week, that he had meetings at the White House in the 1970s the last time the potential output concept was promoted as a policy tool, by the Arthur Burns Fed. Back then the concept was harder to justify because the FIRE Economy had not yet produced the necessary trillions in credit to grow the economy on the curve as it has. Then the debate was over the angle of the curve and where you start and so on. Forty years later the Real GDP curve fits well to a constant Potential Real GDP curve.

As you say, credit expansion played a critical role in this expansion. Since private credit stopped expanding and began to shrink during the recession, government credit has been expanded to take up the slack, as we forecast. But as the recent employment data suggest, the "pump priming" of government spending is acting more like the economy's iron lung. The iron lung of government spending runs on foreign and domestic credit. If the dollar weakens too quickly, we'll see a "run on the bank" as foreign private creditors race to capture the remaining value of their investments in the US and foreign official holders fail to fill the gap because doing so will import US inflation. That's the idea behind Ka-Poom Theory.

We'll see how things go at the IMF meeting this weekend. The foreplay over the past few weeks was rough, but I suspect that our trade partners will ratchet up the threats if the US doesn't drop its unilateralist posture. We'll see more than currency swap deals among trade partners to avoid dollars in international trade. They'll escalate to the next level. If gold bolts to $1400 next week we'll have our answer.

Why do an the output gap analysis if I think the concept is garbage? Because what matters is not what I think the policy markers should be thinking but how they actually are thinking. I exchanged emails with a financial reporter at the Washington Post on a recent analysis he did. After that I decided it was time to update our January 2009 output gap analysis. I'm starting to notice the concept coming out of the Bullhorn. Are we being sold an inflationary policy? We shall see.

Thanks for the question.

[Fiat Currency]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

We'll see how things go at the IMF meeting this weekend. The foreplay over the past few weeks was rough, but I suspect that our trade partners will ratchet up the threats if the US doesn't drop its unilateralist posture. We'll see more than currency swap deals among trade partners to avoid dollars in international trade. They'll escalate to the next level. If gold bolts to $1400 next week we'll have our answer.

Indeed, and "foreplay" is a good word for it. I could have posted 80% of the articles in the last 4 weeks into my "Global Fiat Currency Differentiation Watch" thread. The "Road to the Final Four" for global fiat currencies is "slowly" heating up.

EJ - do you think the probability of the $USD losing it's World's Reserve Currency Status is increasing, and if so ... same question for the time horizon?

[LargoWinch]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

Thank you EJ for the insightful response.



As a bonus, I can now look forward to yet another unique article by iTulip!

Michael Hudson reminded me in an interview Thursday, that we'll publish next week, that he had meetings at the White House in the 1970s the last time the potential output concept was promoted as a policy tool, by the Arthur Burns Fed.

[metalman]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

Same here. If you move your mouse over the blue line in the middle of the chart (or thereabouts), there is text that pops up in the lower area detailing different periods.

[rant]
One of the problems I have with Flash websites etc. is that the open-ended nature allows designers to create interactive navigation methods which, while no doubt obvious to the creator, are not always intuitive to the public at large. To be safe, you really have to be captain obvious with this stuff. One possible solution: some fairly large, colorful dots in the areas where the mouseover happens. Even though you don't actually have to be exactly on the dot for it to work, it may provide enough of a clue to encourage viewers to move their mouse there to see if anything happens.
[/rant]

when i click on the 1st chart i get a new chart & comments. no matter how fast i click i get a new chart... no janszen.com. i get text if i mouseover anywhere on the 2nd chart. slick as shit, if you ask me.

[ThePythonicCow]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

when i click on the 1st chart i get a new chart & comments. no matter how fast i click i get a new chart... no janszen.com. i get text if i mouseover anywhere on the 2nd chart. slick as shit, if you ask me.

By the "1st chart", I presume you mean the first chart in EJ's Post #1, with the title "Output Gap Trap: What is it?" and the slowly changing "Rolodex" of graphcs.

If you click on it (on the text or title, not on the Roladex graph, which is special - see below!), then the normal web page fades and a overlaying chart comes up, with the title "Great Depression 1930-1941". Once that pop-up overlay chart comes up and full paints on your computer (could take a few seconds I suppose on a slow link or slow PC) then there are a few "Hot Spots" on that overlay chart. These Hot Spots are:

1. upper left corner, labeled "PREV", to go to the previous chart
2. upper right corner, labeled "NEXT", to go to the next chart
3. bottom right corner, labled "CLOSE X", to close the pop-up overlay and return to the normal web page
4. bottom left to center, a hot link labled something beginning with "Output Gap Trap: ...", which takes you to http://www.janszen.com.

The Roladex of graphs will roll over to the next slide, updating the text as well, when you click on the graph, such as on the first graph labeled "Output Gap -- The difference between actual and potential economic growth". There may be a delay on this "click on graph to see roll over to next one" action. When I first load the page, this click on graph action seemed to do nothing. Perhaps I had to wait until it fully downloaded to my computer. I cannot reproduce that delay now. Everytime I click on that Roladex of graphs, I get the next one reliably.

The "PREV" and "NEXT" in the pop-up overlay are not visible until you wave your mouse cursor over their hot spot.

So this seems to mean that there are two ways to view the slide show:

1. Keep clicking on the Roladex graph visible in the main page, or
2. Click on the text associated with that graph to pop-up the overlay, then keep clicking NEXT.

The link to http://www.janszen.com seems to be only visible in the second of these methods, on the pop-up overlay, lower left to center.

The text associated with each graph seems to be only visible in the first of these methods, except that some of the text for the two slides with the text titles of

• "The Output Gap Trap: The Great Recession at 1% per year", and
• "The Output Gap Trap: The Great Recession at 3% per year".

there seems to be no way that I can find to see all their text. For these two slides, there is more text than fits and the text area does not scroll.

One more twist -- you don't have to click on the Roladex graph on the main web page to see the next slide. It automatically rolls over to the next one every 60 seconds. So now we are up to three ways to see the show -- the third one being just to sit and wait for the 60 second rollover. Only one of these three ways gets you that http://www.janszen.com link, and only the other two ways get you (most of) the text associated with each slide.

Final thoughts:

1. Someone at Macromedia (creators of Flash, the whiz bang technology on display here) has too much time on their hands.
2. I could not guess from your brief description metalman where you got lost in this maze. Unfortunately the complete description of the maze, as I have just attempted above, may be tedious enough that you get lost there as well. Don't sweat it if that's the case; I won't mind.

Aha - final final thought. I'll bet you were clicking on the Rolladex graph that shows up on the normal web page (not on the pop-up overlay) -- right metalman? If so, click on the text (white characters on black background) to the right of the graph to get that pop-up overlay, where you will find the infamous http://www.janszen.com along the bottom of the pop-up, left side toward center.

P.S. -- I did not even realize that I could view the slides without clicking on the white on black text area to get the pop-up overlay, or that I could see the different text associated with each slide, until I went through the above tedious documentation effort, because (1) when I move my mouse over the Roladex graph, it does not switch the cursor to a visible indication of a place I can click, and (2) I never waited 60 seconds to see if the Roladex graph would automatically do something.

[c1ue]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

What I understand from this is that we will inflate - since both Debt Jubilee and a Short Victorious War are both off the table.

What I still don't agree on is why the inflation will necessarily be controlled at just the 100% above natural rates.

Nor do I see how the US political system and way of life will necessarily hold together as this inflationary process unfolds.

The US today is a largely urban nation; a 30% (or more) drop in standard of living means true suffering for a large part of the population; and furthermore in the US this population has votes and will use them.

If you think the Tea Party now is nutty - similarly that Palin's ongoing (and burgeoning?) presence is an indicator of doom, how then will the political situation look like when the standard-of-living-reversion-to-mean occurs?

The inchoate anger being tapped into by the Tea Party and Palin will increase exponentially.

[Jay]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

What I understand from this is that we will inflate - since both Debt Jubilee and a Short Victorious War are both off the table.

I see the possibility of inflation through a Medium Length Unwinnable War though. It's the fail safe, not that it will work as planned and go well, whatever well might mean in those circumstances.

[dbarberic]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

I'm assuming that the 3 year window is being driven by the next anticipated round of oil price spikes due to Peak Oil. Correct?

[FRED]

Re: The American Output Gap Trap – Part I: We have three years to escape or we’re dead meat - Eric Janszen

I'm assuming that the 3 year window is being driven by the next anticipated round of oil price spikes due to Peak Oil. Correct?

As explained in the first presentation on the Output Gap Trap, there are at least three potential triggers:

1) Reflation politics: fiscal stimulus is withdrawn and the money supply and economy shrink.
2) US runs out of foreign credit needed to roll over existing debt.
3) Next Peak Cheap Oil Cycle

A 4th is a global currency crisis, a 5th an expanded ME war, and a 6th is a property crash in China. The next Peak Cheap Oil Cycle may trigger some or all of the above.