Some folks have asked us to be a little more explicit in our forecast. We are happy to oblige. Our view is that the economy has been weakening for several decades, being periodically juiced with a bubble, but not stemming the stagnation of incomes per capita or fundamental growth overall. The decline was masked on one hand by growing household and corporate debt and on the other by pushing the lower end of the income scale down further, essentially making them walk the plank to lighten the load and keep the boat afloat for the rest of us. The political framework has been taken over by corporate oligarchs who now, in the line of James K. Galbraith, feed on the body politic for the benefit of a few elites and enforcing an inefficiency and blindness to the future that is detrimental to virtually everyone else. Meanwhile the educational, social and physical infrastructure that is the real source of economic vitality has been lost to a concerted program of government bashing.
The financial crisis is the Minsky moment that recognized the condition of increasing indebtedness. Similar shocks in the postwar period have been resolved messily by inflations that have allowed the fulfillment of debt contracts in nominal terms, while realizing losses in real terms. It was messy, but it avoided the debt deflation that was the dynamic of the Great Depression and is that of the current Great Recession.
Among other things, the Minsky moment has reversed the so-called strength of the consumer and has prompted the business sector to cut jobs aggressively to maintain debt service. The government has responded with deficits and programs that keep profits up, particularly to the financial sector, but do not address the roots of the crisis. We note that deficits of eight or ten percent of GDP have produced growth measured as 2.5 percent.
Monetary policy has failed to produce inflation or any relief for the real economy. Fiscal policy is stuck in damage control mode.
So, the forecast is: Envelope please
Continued recession ameliorated only by government spending. I and David Rosenberg will be the exceptions that prove the rule of "everyone says we are in recovery." No new investment. Continued and higher unemployment. Serious new financial failures in residential and commercial real estate. Permanent damage to the economy from not providing productive work to its citizens.
Gee, that's not very specific. And it's mostly about the past.
There are specific numbers up on the forecast site, but they are not new, and I'm not sure that they.... Well, I'll look.
We were slow to get to 2.5 percent growth. It looks like we predicted that to happen in the 4th quarter, and the stagnant situation to set in for next year. Shoot. This is shape the consensus is predicting, though they have it probably a point and a half higher. Likewise our unemployment number peaks at 12 percent, a point higher, but pretty much the same shape we've been hearing recently. Hey! These guys are cribbing off us.
We may have to go more negative. It's hard to keep this downside leverage. I guess I'll predict before the end of 2010 another severe blow to the financial sector. We are in a condition of systemic failure in the financial system. The working parts are nationalized. The nonworking parts are paying back the government with its own money they didn't use to help the economy.
So, we do not see a recovery, we do not see resuming consumer spending, we do not see surging investment or trade rebalancing. One month of only ten percent unemployment does not fill us with euphoric expectations of any better. And we are not interested in jumping up and down on our spreadsheets to figure out some precise number that will be compared to the preliminary data and then forgotten by the time the revised and final numbers come out. Besides, we're four to six months ahead of everyone now. (As if I was paying attention.)
We have made a call for a significantly weaker dollar. We're not drawing attention to that today, however.
Now, the Deficit. And we'll throw in the jobs summit
Demand Side is removed from popular media by a sensitive stomach condition, so we have not participated in the deficit drama, nor the parade around the jobs summit. So forgive us if we are not completely conversant with the talking points.
Hoopla around the federal deficit is completely misplaced. Federal debt as a percentage of GDP is lower now than it was after the Reagan program. The crippling debt is in the private sector. GSE and governmental agency debt is immense, on the same scale as federal debt. These are Fannie Mae and Freddie Mac. Financial debt and asset backed securities have both ballooned since Reagan. Corporate debt is half again as big or bigger than government debt. And household debt is nearly as large. Household debt to income is now over 120 percent, having grown from about 60 percent in 1960 to about 85 percent in 1999 and adding the other 40 percent in the past seven or eight years.
The federal debt will be repaid because the government controls the money. Absent inflation risks, it could simply write a check. Households and businesses, on the other hand, have debts that cannot be repaid. Since they cannot be repaid, they will not be repaid, and the question becomes whether it will be organized or disorganized. Reducing this debt is absolutely essential to getting the economy breathing again. And it is the lenders who are going to have to take the hit. I understand these are real people, real pension funds, and pain will be felt by us all. It may be possible to invent some sort of contingent security that can be carried along until things get better, or paid from a different source.
So the federal deficit is not worth the hot air expended on it, and in fact, should be expanded to fund states, as James K. Galbraith outlined in last week's relay. Being sure states don't game the support. All that said, Demand Side -- as you know if you've been paying attention -- sees plenty of economically efficient taxes in financial transactions, gasoline, and high rollers.
The jobs summit. Again, we don't pay too much attention to the details. Sorry. The way to create jobs is by getting hysterical about climate change. This is the challenge that is on the scale of World War II that can reverse the economic decline while producing something economically valuable, a habitable planet.
But jobs should be produced from the demand side. Not by subsidizing businesses and corporations with ins in Washington. Buy infrastructure -- particularly the smart grid we will need for 2100 , finance energy efficiency and building retrofitting, build educational and physical infrastructure. Let companies bid for projects, take advantage of the grid, sell to the consumers who are produced by having a job, and so on. The supply side subsidies will not work. Payroll tax holidays, such as Robert Reich and others advocate, are parallel to zero interest for the banks. They allow workers to carry their current burdens, but they do not produce anything other than a zombie decline.
How's business? What does that mean? Will you ever hear, Great! I got a subsidy to hire workers. No. How's business always gets answered by the number of customers. By funding the demand side and setting price signals with appropriate taxes -- by which I mean, for example, using taxes on gasoline to substitute for the environmental costs and thus bring those costs into view for the market -- we get the public goods we need and the entrepreneurial economy can work without needing to game the public sector.
Surely we need to fund R&D. Supporting our educational system is the appropriate level of funding. Otherwise we could -- as Jonathan Frost has said many times on this podcast -- commit to buying products with enlightened energy profiles.
For example, We will buy x number of zero emission buses and locomotives, if they have the power requirements we need. At no more than x price. Give us a bid. This is the way to generate innovation. No need to pay for it if it is not produced. The private sector does all the investing and developing -- very economically stimulative.
But within the context of the jobs summit. As many jobs as possible as soon as possible in as straightforward a way as possible would be good. Other forms of stimulus are not so good in getting the spending into the real economy and perhaps reversing some of the deflationary bias. How about the WPA or the CCC?
I continue to marvel on how we are tracking the Great Depression. We are still in the period of Hooverism, too little, too timid, although there is not so much of the "prosperity is just around the corner" out of the White House since Bush left. True we have the New Deal safety net, but it's not a hammock and we should not stay in it too long.
And there was a set-to between noted economist Paul Krugman and the eminent climate scientist James Hansen over cap and trade this past week.
Hansen wrote an op-ed in the New York Times in favor of a fee-and-dividend system, which would apply a tax to carbon and they remit that tax to the public. This is exactly the price signal we referred to above.
Krugman replied by saying Hansen was "unhelpful" and, in part,
"Oh, and the argument that if you create a market, you’re opening the door for Wall Street evildoers, is bizarre. Emissions permits aren’t subprime mortgages, let alone complex derivatives based on subprime; they’re straightforward rights to do a specific thing. It will truly be a tragedy if people generalize from the financial crisis to block crucially needed environmental policy."
Subsequently, we learned that indeed, a prime author of the cap and trade carbon derivatives is the creator of credit default swaps. Yes. In a possibly extreme treatment from a blogger which we reproduce our blog today, we find that Blythe Masters, a JP Morgan employee is deep in both activities.
But we digress. Krugman goes on.
"Things like this often happen when economists deal with physical scientists; the hard-science guys tend to assume that we’re witch doctors with nothing to tell them, so they can’t be bothered to listen at all to what the economists have to say, and the result is that they end up reinventing old errors in the belief that they’re deep insights. Most of the time not much harm is done. But this time is different."
Economists have no room to complain about errors leading to economic problems. Theirs -- ours -- have led the charge into the abyss. Beyond this, I at least, find cap and trade to be complicated, untried and dependent on a worldwide coordination never before seen. The Hansen plan seems to me to be simple and easily administered unilaterally.
Be sure to listen in on tomorrow's relay of an Al Gore speech in which he outlines his new book, "Our Choice: A Plan to Solve the Climate Crisis." Don't have time to read the book, listen to the podcast. It's riveting.
Now, as we promised last week, how money is created. Listen up, Ben.
we will continue to beat up on the Fed and the rest of the cabal at Treasury and the White House. But Demand Side has special license to rant. We never gave Bernanke credit and have lampooned him from the beginning. We remember his "complex chain of causalities" that led to the systemic collapse of the banking sector. And he still has no clue.
If he did, something would be working by now.
You will remember the TARP fiasco. Then debate was whether recapitalizing the banks was better than buying their garbage. The enlightened view was that the money multiplier from recapitalizing would generate multiples of the garbage option. The money multiplier is essentially the fractional banking system in a healthy economy. When it works according to the plan -- which it doesn't, but that's another story -- let's say, when it works according to the Neoclasscial textbook -- a dollar of reserves translates to seven, eight, nine dollars of economic activity because the banks lend it out.
Surprise. All that money to the banks generated larger reserves in the banks and a bunch of trading games utilizing zero percent financing. The carry trade, commodity speculation, and the strange rise in the stock market.
It was not just Bernanke, but the gathered wisdom of 95 percent of economists, including most progressive economists, who favored the capital to the banks. Demand Side was a follower in this regard. We deferred to the Stiglitz, Kuttner and Krugmans of the world, while still voicing the question, "How can these guys lend when nobody can make a profit on borrowing?" Well, they didn't lend, but now they are congratulating themselves on paying back the TARP. It is more like GM, paying back some of its loan from the escrow account.
It turns out that economists have known for nearly twenty years that rather than fiat money being produced first, and credit money after, the process is exactly the reverse. This was the finding of no more conservative economist than Edward C. Prescott who with Finn Kydland published Business Cycles: Real Facts and a Monetary Myth in the spring of 1990.
As Steve Keen notes: Their empirical conclusion was that rather than fiat money being created first and credit money following with a lag, the sequence was reversed: credit money was created first, and fiat money was then created about a year later. He quotes Prescott and Kydland.
“There is no evidence that either the monetary base or M1 leads the cycle, although some economists still believe this monetary myth. Both the monetary base and M1 series are generally procyclical and, if anything, the monetary base lags the cycle slightly. (p. 11)
The difference in the behavior of M1 and M2 suggests that the difference of these aggregates (M2 minus M1) should be considered… The difference of M2 – M1 leads the cycle by even more than M2, with the lead being about three quarters.” (p. 12)
So the financial system creates the money it wants to finance its booms and then ratifies that by way of the Fed after the fact.
No wonder monetary policy doesn't work. The guys running it don't understand money.