Friday, February 27, 2009

Why the Feds are feeding the zombies

Martin Mayer on the huge invisible house of cards in the sky hanging over the banking crisis (this is why they can't do anything but feed the zombies):

  Twenty years ago, Michael Milken of Drexel Burnham and a staff of razor-sharp Wall Street kids set up a hugely successful half-billion-dollar "bad bank" to rid Mellon Bank of its doubtful assets and distribute them to investors without any government support. The deal had a terrible press when new, but Mellon, Milken and the buyers of the stuff all did great.

  This well-understood process has not been available in the current crisis, mostly because some $30 trillion of credit-default swaps stand between the owners of the "troubled" loan and debt obligations and anyone's assessment of what they are "worth." Each of these hundreds of thousands of swaps is a sort of stand-alone bastardized insurance policy against the prospect that some loan will not be repaid. Anyone can and anyone does write these individual loan guarantees; anyone can and anyone does reinsure them. Source

Huff and puff and they’ll blow the house down, and they don’t want to do that.  But it’s only a matter of time, as the housing market is not coming back.  It’s the off-balance sheet stuff that needs illumination.

Thursday, February 26, 2009

History by economists vs. economics by a historian

Niall Ferguson is a terrific speaker and historian who has a relatively sanguine outlook for the next decade or so in an article in the Globe and Mail entitled, however, “There will be blood.”  His PBS program below is really fun.

I say his outlook is sanguine because he doesn’t foresee any ekpyrosis, as economists Straus and Howe do (as detailed in this post).  He doesn’t foresee any wars other than regional, civil-type wars (no “world war”) because America is simply too powerful for anyone to contemplate taking on.  And he doesn’t foresee the social contract in America breaking down, as Democratic redistributionist tax policies take hold. 

But in the back of my mind I am wondering:  what happens if the whole post-WWII Bretton Woods monetary system, fatally injured when Nixon took America off gold and currencies started to float, goes supernova and no one knows what is money anymore?  The economists Strauss and Howe are careful to characterize history as a nonlinear process, full of surprises, and Ferguson seems to be thinking more like a trend-extrapolating economist in the article referenced above.

In the afterglow of Obama’s shockingly awesome budget speech that validated the ever expanding Bernanke bailouts I have noticed a certain deadness entering the tone of the blogosphere, and I think it is this thought creeping into consciousness, that if the U.S. hyper-inflates all bets may be off as barter comes back into style. 

See a couple of charts for America’s current fiscal and monetary “settings.”

Tuesday, February 24, 2009

It’s the debt, stupid

A classical liberal myself, I’m so sick of the liberal hue and cry for bigger deficit spending.  The problem is not that the government is not spending enough money, it’s that there’s a wad of bad debt clogging up the banking system, and more government spending isn’t going to make that go away.  It looks like the government is just going to turn lots of bad private debts into taxpayer burdens, and ultimately, very possibly, into bad public debts.

Keynes once wrote that most politicians and policymakers are merely repeating the words of some academic scribbler from fifty years ago.  This is true of the liberal push for ever bigger fiscal stimuli without preconditioning it on writing down bad private debt.  They’re confusing the real economic effects of the recession with the financial effects.  In unemployment terms, the current slump is approaching the severity of 1981-1982, and my models point to a stabilization of real output soon; unemployment will continue to rise, but probably will not hit double digits.  But the way things are going, the banking system will probably remain clogged up.

Fiscal deficit spending only makes sense if the banking system writes off its bad debts—doesn’t add them to the government debt.  Otherwise we’re just bailing out the wealthy, and adding to a mountain of debt that will likely crush us in time.  But why should our ruling class care?  They will have had their cake and eaten it too.

America has more debt than it can handle.  Fiscal “stimulus” (deficits) that includes covering bad private debt will lead to ruin, if history teaches us well.  See previous post for details. 

Otherwise I’d guess we are indeed headed toward the crisis at the end of the saeculum.



Comment written after President Obama’s speech:  Okay, Ben, so you’re not going to nationalize, you’re going to pump in money “as needed” to capitalize what most experts agree is a on-net insolvent banking system—and then take “disciplinary action” (actually write off bad debts?) when?  After putting another few trillion on the taxpayers’ tab? 

It may just be that I’m tired, but I don’t get it.

.     .     .

Comment written at 4:00 A.M.:  Why not just lower capital requirements to recapitalize banks?  The public doesn’t care, so long as their deposits are safe.  No toxic assets would be turned into Treasury obligations.  We still get zombie banks, which is what both Geithner and Bernanke seem to fancy, but these banks can in principle still lend while working off their losses.  The Fed and Treasury could recapitalize the whole system with a $10 preferred injection to each bank and an infinitesimal capital requirement.  If it comes to a choice between lowering capital requirements and the Treasury injecting capital that will never be paid back by the banks but will sit on the Treasury’s books for a generation, I’ll go with lower capital requirements—and, one would hope, more effective regulation—any day.  We’re pissing our national treasure away at light speed to bail out the plutocrats on Wall Street….


What defines a good 'bad bank'?
   Lessons for the US from the Swedish Bank Crisis

Sunday, February 22, 2009

What Barack needs to do to prevent the collapse of the United States

First, the President needs to put the three or four weakest of the largest banks in the country into receivership, guaranteeing all deposits, firing the existing managements, and selling all toxic assets into a market on an as-is no-recourse basis.  The business assets of the banks will also be sold or reconstituted as new banks under new management.  If necessary, the Fed will write a check to capitalize the new banks, taking preferred.  No taxpayer money will be used (explicitly) to capitalize the new banks.  Toxic credit cultures produce toxic assets.  We need to write off vast amounts of toxic private debt that are weighing down our system—not have the taxpayers bail out the investors.

Second, the stimulus bill will be amended as follows:  all tax cuts will be repealed, as employed folks will benefit from a deflationary tax cut in the coming years and are doing well anyway; taxes on incomes over $200,000 will be increased to a marginal rate of 50%-67% in recognition that these folks have gotten a very good deal out of one of the richest countries in the world that is now in need of their help; taxes on business should be lowered as they are higher than other nations’ and make us an unattractive place to set up shop to some extent; a poverty-level income support or dole will be enacted as a negative income tax for the working poor and unemployed, without a time limit, to inspire confidence in the system and to allow for self-organized reallocation of labor resources during the massive structural adjustment the economy is going through; access to national health care shall be established for all those not covered by an employer plan through Medicaid, to prevent the rapid depreciation of human capital that can occur during a national melt-down.  Finally, the federal government should assist state governments about to be bankrupt with federal deficit dollars over a temporary interval of several years as necessary for the states to find a new budgetary equilibrium, with special attention to improving education at all levels.  And given the gyrations of the federal budget and monetary policy recently, the President will have to use his influence to ensure that monetary policy does not permit a hyperinflation or deflation to occur. 

Third, the President needs to quash plans to initiate martial law in the United States of America.  The people are a lot smarter than Homeland Security gives them credit for being.  The psychological impact of such an action would be devastating and would do more to destroy any remaining shred of a viable social contract than any locally-handled chaos might do.  Efforts to take guns away from Americans will fail and will only further decrease faith in the government.  The founders knew what they were talking about here.

Fourth, the United State and China—“Chimerica”—need to agree to a long-term plan to achieve more balanced trade, which will benefit Chinese consumers as they will be monetized to consume their own production, and American producers, as their products are demanded more.  The Japanese need to be included in such an agreement as well in similar terms.  As part of this agreement among the major economies of the world, it must be agreed that the dollar will undertake an orderly decline relative to the renminbi.  As such, given the chaos in Europe and the seemingly imminent collapse of the Euro, the dollar may continue to enjoy viability as a reserve currency in oil transactions.  Part of this agreement may be to require the parties to continue to transact their oil purchases in dollars.  The U.S. has extracted enormous rents from the rest of world while the dollar has been the reserve currency; we must convince the world we will not hyper-inflate.

Fifth, the United States should withdraw from foreign military adventures that it has not a chance of “winning” in any meaningful sense, such as Afghanistan.  The U.S. spends as much on its military, roughly, as the rest of the world’s spending altogether.

Sixth, assistance to those with underwater mortgages should be limited to a 15% cram-down of principal, possibly with an interest rate subsidy, and these deals should be made available only to homeowners who can’t afford their current payments on standard debt-to-income ratios.  Just because the mortgage is underwater doesn’t mean assistance is warranted.  Rich people pay rent too.  Otherwise, the house should be foreclosed and resold.  The vast majority of Americans handle this major investment well and will resent others being subsidized.  The market has a long way down yet reach sustainable price levels. 

Seventh, given the incapacity of Congress to act in a responsible manner, many of these actions may need to be taken as Executive orders.  A majority of American voters elected Barack Obama because he appeared to be straight, not a captive to special interests.  Financially, his campaign was not.  In office, however, as a young and relatively inexperienced leader, he is doing what leaders do well, adjusting to prevailing norms, trying to find a parade and get in front of it.  But the prevailing norms are corrupt; his primary financial advisors are a disaster.  Barack Obama is going to have to trust his acute historical sense, of his likeness to Lincoln, and of the ideals expressed in the Constitution that America has tried to live up to through its tribulations.  He will need to look far beyond the limited viewpoints of his current advisors, keeping the Constitution open before him as a vision of a republic of semi-autonomous states.  Modern network theory tells us sparsely connected networks are more stable than highly connected ones.  He needs to remember that the Constitution is the best the world has yet to implement.  He needs to bring the nation to a realization that we have indeed been living beyond our means and that while the adjustment is painful, we can live together sharing the new burdens fairly.

America is a rich country.  There is enough here for everyone to have a good life.  Our poor live better than most of the rest of the world.  But the great long-wave final act villains of credit over-extension and rampant income and wealth inequality have caught up with America.  The house of cards is collapsing and the wealth is all held by a few.  This is called a collapse of effective demand.

The only thing preventing President Obama from taking the necessary steps outlined here to get demand flowing at a lower, more appropriate level is the entire entrenched class system that controls Congress and the biggest corporations in the land.  But presidents before him have taken on the special interests, and he can too, if he chooses to fulfill his historical destiny.

I pray he succeeds.

Toxic credit cultures produce toxic assets

I added the following over at as a comment regarding the Treasury proposal to offer non-recourse loans to investors in toxic assets:

Toxic credit cultures produce toxic assets.

At some point, to clean up the mess, President Obama is going to have to make character judgments and stop doing business with the same financial tricksters that got us into the mess (Rubin, Summers, and Geithner for starters). But who is his closest advisor? Rahm Emanual, who got rich quick with a hedge fund in between political gigs.

Franklin Roosevelt, in the Depression, confident in his place in the aristocracy yet having his own principles, was content to fire the managements of bad banks and make any number of other judgment calls required to restore some sense of propriety and ethical integrity to the financial system. Many people loved him for it, although not many Republicans.

Does the current President have the judgment, courage and confidence (all three are required) to clean up the financial system? Not so far. He will need to clean his own house before the American people are going to buy into any Treasury plan.

Half of Americans opposed the [extraordinarily ill-conceived] stimulus bill, according to the surveys I've seen. A majority of Americans oppose giving the banks any more money.

My working hypothesis, borrowed from Strauss and Howe, is that the American social contract is broken, and that the crisis gets worse until Americans feel they've got a fair system again.

Geithner's proposals are laughable. They're like a jobs act for unemployed investment bankers, and yet another opportunity for massive wealth extraction from tax-paying Americans by the plutocrats (aka oligarchs) in New York and their friends.

Toxic credit cultures produce toxic assets. The President needs to see this, and do the right thing. Get some fresh blood in to advise him before these guys try to blind us all with [junk] science again.

Thursday, February 19, 2009

A Couple of Charts



The projected deficits are going to approach 10 percent of GDP over the next few years, so both macro policy measures will be pedal to the metal.

Wednesday, February 18, 2009

Monday, February 16, 2009

“Comparative Theory of Superpower Collapse”

From Dmitri Orlov’s blog, Cluborlov, via Global Guerillas:

… I would like my insights to be of help during these difficult and confusing times, for altruistic reasons, mostly, although not entirely. This is because when times get really bad, as they did when the Soviet Union collapsed, lots of people just completely lose it. Men, especially. Successful, middle-aged men, breadwinners, bastions of society, turn out to be especially vulnerable. And when they just completely lose it, they become very tedious company. My hope is that some amount of preparation, psychological and otherwise, can make them a lot less fragile, and a bit more useful, and generally less of a burden.

Women seem much more able to cope. Perhaps it is because they have less of their ego invested in the whole dubious enterprise, or perhaps their sense of personal responsibility is tied to those around them and not some nebulous grand enterprise. In any case, the women always seem far more able to just put on their gardening gloves and go do something useful, while the men tend to sit around groaning about the Empire, or the Republic, or whatever it is that they lost. And when they do that, they become very tedious company. And so, without a bit of mental preparation, the men are all liable to end up very lonely and very drunk. So that's my little intervention.

If there is one thing that I would like to claim as my own, it is the comparative theory of superpower collapse. For now, it remains just a theory, although it is currently being quite thoroughly tested. The theory states that the United States and the Soviet Union will have collapsed for the same reasons, namely: a severe and chronic shortfall in the production of crude oil (that magic addictive elixir of industrial economies), a severe and worsening foreign trade deficit, a runaway military budget, and ballooning foreign debt. I call this particular list of ingredients "The Superpower Collapse Soup." Other factors, such as the inability to provide an acceptable quality of life for its citizens, or a systemically corrupt political system incapable of reform, are certainly not helpful, but they do not automatically lead to collapse, because they do not put the country on a collision course with reality. Please don't be too concerned, though, because, as I mentioned, this is just a theory. My theory. [emphasis added]

We are now witnessing the struggle between the young, green administration and the financial oligarchs so reminiscent of what has happened in Russia.  This view of the historical moment is consistent with one of the outcomes envisioned by The Fourth Turning in the last post.

First we had massive denial about the stock market bubble (“It’s different this time”), then about the real estate bubble (“They’re not making any more land”) and now we have the lunatics (economists) running the asylum in massive denial that the U.S. might be broke (cf. Paul Krugman’s “Failure to Rise” stimulus-not-man-enough column).

I’ll repeat my observation that the problem is with the distribution.  America is a rich country and could easily provide basic food, shelter and health for all its citizens if it had a social contract that called for it.  Our social contract is broken.

But one thing the government does seem to be figuring out is that if the nation has too much debt, and a lot of it is private, that they better quickly write off a lot of the private debt of the zombie banks so the government can continue to borrow.  So it appears more likely we’ll see some nationalization. The collapse of the European credit sector appears even worse than ours, which suggests that the greenback will hold up a while longer and U.S. will be able to engage in another half-decade or so of self-delusion that it can borrow and spend its way out of this structural imbalance of too much debt.  The “animal spirits” update indicates an upturn, or at least stabilization, is imminent.  If the recovery is weak, we might not get another long cycle of ~8 years, but a short, impaired cycle, with the next cyclical downturn in about 2012 being even sharper.  Although the inflation this decade was in asset prices, the Oh-Oh’s are likely to require several recessions to wring the excess leverage out of the system, just as the ‘Sixties required recessions in ‘69-‘70 and ‘73-‘74 to wring some inflation out, and it took the double-dip of ‘80-‘82 to bring the last big CPI inflation “under control.”

As I used to tell my students, “make the adjustment.”


Sunday, February 15, 2009

Onward to Ekpyrosis, Death and Rebirth of American Society

Since I read it a dozen years ago, The Fourth Turning by Williams Strauss and Neil Howe has lingered in my imagination because it has captured so much of the historical movement of the time since.  Their approach is nonlinear, like my business cycle forecasting model.  Although they are economists, their theory is a qualitative one of a generational long-wave spanning the length of a long human lifetime, the saeculum, with each of four generational archtypes changing places as the seasons turn.  They discern a pulse of about 80 year length in Anglo-American history, punctuated by crises (p. 259): 

  • Wars of the Roses (1459-1487), Late Medieval Saeculum
  • Armada Crisis (1569-1594), Reformation Saeculum
  • Glorious Revolution (1773-1794), New World Saeculum
  • American Revolution (1773-1794), Revolutionary Saeculum
  • Civil War (1860-1865), Civil War Saeculum
  • Great Depression and world War II (1929-1946), Great Power Saeculum

I quoted at length in a previous post, “The Crisis at the End of the Saeculum,” passages that I thought captured many elements of the Panic of 2008, which they would call the catalyst of the Crisis.  If you haven’t read it, I suggest you read the prior post before continuing.  The Crisis has only just begun, in the authors’ view, from this catalyst, and can be expected to mount in intensity until a crescendo in about 2020, plus or minus a few years:

   Soon after the catalyst, a national election will produce a sweeping political realignment, as one faction or coalition capitalizes on a new public demand for decisive action.  Republicans, Democrats, or perhaps a new party will decisively win the long partisan tug-of-war, ending the era of split government that had lasted through four decades of Awakening and Unraveling.  The winners will now have the power to pursue the more potent, less incrementalist agenda about which they had long dreamed and against which their adversaries had darkly warned.  This new regime will enthrone itself for the duration of the Crisis.  Regardless of its ideology, that new leadership will asset public authority and demand private sacrifice.  Where leaders had once been inclined to alleviate societal pressures, they will now aggravate them to command the nation’s attention.  The regeneracy will be solidly under way.

   In foreign affairs, America’s initial Fourth Turning instinct will be to look away from other countries and focus total energy on the domestic birth of a new order.  Later, provoked by real or imagined outside provocations, the society will turn newly martial.  America will become more isolationist than today in its unwillingness to coordinate its affairs with other countries but less isolationist in its insistence that vital national interests not be compromised.  The Crisis mood will dim expectations that multilateral diplomacy and expanding global democracy can keep the world out of trouble.  Even before any conflicts arise, people will feel less anxiety over the prospect of casualties.  Old Unraveling-era strategies (flexibility, stealth, elite expertise, stand-off weaponry, and surgical goals) will all be replaced by new Crisis-era strategies (mass, intimidation, universal conscription, frontal assault, and total victory) more suitable to a fight for civic survival.  By then, people will look back on the Unraveling as the time when America evolved from a postwar to a prewar era.

   The economy will in time recover from its early and vertiginous reversals.  Late in the Crisis, with trust and hope and urgency growing fast, it may even achieve unprecedented levels of efficiency and production.  But, by then, the economy will have changed fundamentally.  Compared to today, it will be less globally dependent, with smaller cross-border trade and capital flows.  Its businesses will be more cartelized and its workers more unionized, perhaps under the shadow of overt government direction.  And it will devote a much larger share of its income to saving and investing.  Fourth Turning American will begin to lay out the next saeculum’s infrastructure grid—some higher-tech facsimile of turnpikes, railroads, or highways.  The economic role of government will shirt toward far more spending on survival and future promises 9defense, public works) and far less on amenities and past promises (elder care, debt service).  The organization of both business and government will be simpler and more centralized, with fewer administrative layers, fewer job titles, and few types of goods and services transacted.

   Meanwhile, Americans will correct the Unraveling’s social and cultural fragmentation by demanding the choice that era never offered:  the choice not to be burdened by choice.  As people again begin to trust institutional authority, they will expect that authority to simplify the options of daily life—at the store (with more standardized products), on TV (with fewer media channels), at the office (with one pay scale and benefit package), and in the voting booth (with one dominant party).  Institutions will be increasingly bossy, limiting personal freedoms, chastising bad manners, and cleansing the culture.  Powerful new civic organizations will make judgments about which individual rights deserve respect and which do not.  Criminal justice will become swift and rough, trampling on some innocents to protect an endangered and desperate society from those feared to be guilty.  Vagrants will be rounded up, the mentally ill recommitted, criminal appeals short-circuited, executions hastened.

   Time will pass, perhaps another decade, before the surging mood propels America to the Fourth Turning's grave moment of opportunity and danger:  the climax of the Crisis.  What will this be?  Recall… that a climax takes a form wholly unforeseeable from the advance distance of twenty-five years.  Imagine some national (and probably global) volcanic eruption, initially flowing along channels of distress that were created during the Unraveling era and further widened by the catalyst.  Trying to foresee where the eruption will go once it bursts free of the channels is like trying to predict the exact fault line of an earthquake.  All you know in advance is something about the molten ingredients of the climax, which could include the following:

  • Economic distress, with public debt in default, entitlement trust funds in bankruptcy, mounting poverty and unemployment, trade wars, collapsing financial markets, and hyperinflation (or deflation)
  • Social distress, with violence fueled by class, race, nativism, or religion and abetted by armed gangs, underground militias, and mercenaries hired by walled communities
  • Cultural distress, with the media plunging into a dizzy decay, and a decency backlash in favor of state censorship
  • Technological distress, with cryptoanarchy, high-tech oligarchy, and biogenetic chaos
  • Political distress, with institutional collapse, open tax revolts, one-party hegemony, major constitutional change, secessionist authoritarianism, and altered national borders
  • Military distress, with war against terrorists or foreign regimes equipped with weapons of mass destruction

… Eventually, all of America’s lesser problems will combine into one giant problems.  The very survival of the society will feel at stake, as leaders lead and people follow.  Public issues will be newly simple, fitting within the contours of crisp yes-no choices.  People will leave niches to join interlocking teams, each team dependent on (and trust of) work done by other teams.  People will share similar hopes and sacrifices—and a new sense of social equality.  The splinterings, complexities, and cynicisms of the Unraveling will be but distant memories.  The first glimpses of a new golden age will appear beyond:  if only this one big problem can be fixed….

   Emerging in this Crisis climax will be a great entropy reversal, that miracle of human history in which trust is reborn…. In the moment of maximum danger, that seed will implant, and a new social contract will take root.  For a brief time, the American firmament will be malleable in ways that would stagger … today’s Unraveling-era mindset.  “everything is new and yielding,” enthused Benjamin Rush to his friends at the climax of the American Revolution.  So will everything be again.

       Even if the nation stays together, its geography could be fundamentally changed, its party structure altered, its Constitution and Bill of Rights amended beyond recognition.  History offers even more sobering warnings:  Armed confrontation usually occurs around the climax of Crisis.  If there is confrontation, it is likely to lead to war.  This could be any kind of war—class war, sectional war, war against global anarchists or terrorists, or superpower war.  if there is war, it is likely to culminate in total war, fought until the losing side has been rendered nil—its will broken, territory taken, and leaders captured.  And if there is total war, it is likely that the most destructive weapons available will be deployed.

   With or without war, American society will be transformed into something different.  The emergent society may be something better, a nation that sustains its Framers’ visions with a robust new price.  Or it may be something unspeakably worse….

   The Crisis resolution will establish the political, economic, and social institutions with which our children and heirs will live for decades thereafter…. Crisis climax will recede into the public memory—a heart-pounding memory to all who will recall it personally, a pivot point for those born in its aftermath, the stuff of myth and legend for later generations…. (pp. 275-279)

Our politics still looks more Unraveling than engaged in the “great entropy reversal” that the authors say will characterize a successful resolution of the Crisis phase, putting a new social contract in place.  But it is still early in the new administration—and earlier yet in the Crisis era, if our authors have their fingers on the pulse.  The egalitarian, gung-ho, can-do, WWII GI “spirit of America” has yet to return.  We are at the point of recognizing that our social contract is very broken.

Will it take a war to get the “spirit of America” back?  See The Elephant and the Donkey in the Room.  I hope not.

We live in interesting times.

Friday, February 13, 2009

The Elephant and the Donkey in the Room

The vast sums committed by our government to fiscal stimulus and banking bailout in the past few months boggle the mind.  Prior to the Panic of 2008, many people thought we were already too much in debt, but courtesy of Clusterstock, drawing on documents from Credit Suisse, here's a view into the denial taking place at high levels regarding U.S. debt-to-GDP ratios.  What is amazing is that the folks at Credit Suisse present the chart below and assert that on its basis, our debt-to-GDP ratio is not problematic (note that their ratio differs from ours presented previously drawn from authoritative sources, but let’s play along):


Now, casual empiricism is a game anyone can play.  The geniuses at Credit Suisse see no problem with recent private debt ratios, but I see them shooting up to levels above 1929’s, into territory associated with crashes and depressions.

The denial is not limited to Credit Suisse.  The economists on the liberal side such as Paul Krugman demanding greater stimulus than our government is already providing seem to forget that in 1929 the United States was a “huge creditor nation” not dependent on a huge developing nation ATM to finance its twin trade and fiscal deficits.  When we were living beyond our means before the panic, why should we try to return to that level?

Let me make my position clear:  I am a bleeding heart classical liberal.  The United States is a rich nation that can afford to provide health insurance and a poverty level dole to people who lose their jobs because some greedy financial tricksters fleeced the nation and tanked the economy.  Americans are hard-working people; few will stay on a dole if they can get a job.  Such a program also happens to be the most effective fiscal stimulus, because it will be spent.  Similarly, the deficits of the states, which must run in balance overall, should be made up during the slump.

So what do we get?  The flint-hearted Republicans would never support anything so compassionate as national health insurance or a dole (nor, of course, any Democratic stimulus bill).  The Democratic economists, proudly riding astride their “Depression economics” hobbyhorses (this is a debt-deflation, but it isn’t a depression yet) are going to get their wish to incur more debt.  The non-partisan CBO estimates the bill will not increase output at all over ten years, although it might increase jobs slightly in the short run.

And the financial tricksters on Wall Street see their opening with our industry-captive Treasury Secretary, and the new shell game he seems to want to play with the zombie banks’ bad assets.  Count on the Wall Street geniuses to blind us all with science again, if we let them.  Even Forbes is now saying we need to nationalize the zombie banks and write down the bad debt (recognizing that Noriel Roubini might actually be right about something, an unusual demonstration of independence of thought from an outfit that has told us for a decade that trade deficits don’t matter).

What is really going on?  We’re still reading from the old script, the now stretched-to-the-limit plutocratic social contract that is currently failing.  We’ll add more debt; there will be, in a few years, another round of debt-deflation as the likely banking non-solution fails.  The stimulus bill will benefit the upper-middle class, and one might guess, contractors of a Democratic stripe.  The Bush tax cuts on the very wealthy are being left in place “for now” (for-ever?).

And of course we’re beefing up our troops in Afghanistan, throwing another $70 billion on for that, even though every invading army that has tried to tame Afghanistan in the past 2000 years has failed.  Apparently there’s a pipeline involved.  I don’t know whether someone threatened the President’s life, or whether it’s just the water in D.C., but he sure looks like more of the same.  Unless he acts now, the crisis the Republicans engineered will preclude any of his major initiatives, like national health care. 

So what’s beneath it all?  The military-industrial complex that’s been calling the shots in America for the past 60 years is looking forward to the next war.  When the greenback fails, as it must when we begin to inflate (we’re not as big as we once were, relatively, and getting smaller), we’ll call in the cavalry to go get our oil.  Let’s create a really big crisis, because we’re still biggest and we can win, appears to be the thought process--whether conscious or unconscious.  Or as George Friedman says, we don’t need to win our little foreign wars, we just need to keep the enemy off guard—and by spreading chaos abroad, keep the greenback the reserve currency.  This is how the American empire might destroy itself.  Go for broke!

We Americans must come up with a new social contract (see previous post), one that’s fair and that permits us to live decently, at peace with our global neighbors, within our national means.  It will require our government to commit to both more economic equality and more institutional responsibility than they do now.  I believe the history of the world over the past few centuries shows that improvement is possible; see for example Steven Pinker’s talk on the myth of violence.

We’ll see how bad the banking bill turns out to be.  But for those of us who supported Obama and thought that we were beating the system by sending in our money over the Web, his first month in office has been a big disappointment.

I can’t comprehend the amount of debt we’re taking on.  The reputable puts the amount of new spending since December 2007 (including the stimulus) at over $3 trillion, with another $7 trillion of potential authorized spending, against a current dollar GDP of $14.3 trillion.  This is a blow-out.

Wednesday, February 11, 2009

The Crisis at the End of the Saeculum

From Strauss and Howe's 1997 work of "prophesy," The Fourth Turning:

Sometime around the year 2005, perhaps a few years before or after, America will enter [the Crisis]....

The new mood and its jarring new problems will provide a natural end point for the Unraveling-era decline in civic confidence. In the pre-Crisis years, fears about the flimsiness of the social contract will have been subliminal but rising. As the Crisis catalyzes, these fears will rush to the surface, jagged and exposed. Distrustful of some things, individuals will feel that their survival requires them to distrust more things. this behavior could cascade into a sudden downward spiral, an implosion of societal trust.

If so, this implosion will strike financial markets--and, with that, the economy. Aggressive individualism, institutional decay, and long-term pessimism can proceed only so far before a society loses the level of dependability needed to sustain the division of labor and long-term promises on which a market economy must rest. Through the Unraveling, people will have preferred (or, at least, tolerated) the exciting if bewildering trend toward social complexity. But as the Crisis mood congeals, people will come to the jarring realization that they have grown helplessly dependent on a teetering edifice of anonymous transactions and paper guarantees. Many Americans won't know where their savings are, who their employer is, what their pension is, or how their government works. The era will have left the financial world arbitraged and tentacled: Debtors won't know who holds their notes, homeowners who owns their mortgages, and shareholders who runs their equities--and vice versa.

At about the same time, each generation's approach to its new phase of life will set off loud economic alarms, reminding people how weakly their Unraveling-era nation prepared for the future. The Boomers' old age will loom, exposing the thinness in private savings and the unsustainability of public promises. The 13ers will reach their make-or-break peak earning years, realizing at last that they can't all be lucky exceptions to their stagnating average income. Millennials will come of age facing debts, tax burdens, and two-tier wage structures that older generations will now declare intolerable. As all these generations enter their Crisis constellation, the Unraveling era's wry acceptance that people might never get much back from Social Security will crystallize into a jolting new fear that everything from Treasury bills to remortgage instruments to mutual funds could become just as suspect.

At some point, America's short-term Crisis psychology will catch up to the long-term post-Unraveling fundamentals. This might result in a Great Devaluation, a severe drop in the market price of most financial and real assets. This devaluation could be a short but horrific panic, a free-falling price in a market with no buyers. Or it could be a series of downward ratchets linked to political events that sequentially knock the supports out from under the residual popular trust in the system. As assets devalue, trust will further disintegrate, which will cause assets to devalue further, and so on. Every slide in asset prices, employment, and production will give every generation cause to grow more alarmed. With savings worth less, the new elders will become more dependent on government, just as government becomes less able to pay benefits to them. With taxes hiked, the new midlifers will get to pocket even less of their peak-year incomes. With job offers dwindling, the new youth will face even taller barricades against their future.

Before long, America's old civic order will seem ruined beyond repair. People will feel like a magnet has passed over society's disk drive, blanking out the social contract, wiping out old deals, clearing the books of vast unpayable promises to which people had once felt entitled. The economy could reach a trough that may look to be the start of a depression. with American weaknesses newly exposed, foreign dangers could erupt.

From this trough and from these dangers, the makings of a new social contract and new civic order will arise. In the initial, jerry-built stages, people will not be entitled, but
authorized to receive whatever they get from government. This will lead to conflict, as people do battle to establish where, how, and by whom this authority is to be exercised....
Step up to the plate, President Obama, use the authority you were given to get us closer to the kind of social contract you preached about, instead of kow-towing to Wall Street. Make the bankers and their investors eat their bad debts. Don't be a stooge, a Dubya II.

Let's see a little of that vision thing. Be strong, man. The plutocracy will sink us if you let them.

Dump Rubin, Summers, and Geithner. Find some heartland economist types who aren't slaves to Wall Street. Listen to Volcker, man. Look what he did for Reagan.

Any good the stimulus bill does will be undone by piling like trillions of debt on Americans to bail out the banks.

It's the debt, dude. We got too much of it. Write the bad debts off.

You're a one-term president if you blow this.

Friday, February 6, 2009

‘Animal Spirits’ Update

The Panic of 2008 is over. American confidence levels will rebound early in 2009 from generational lows as Americans become adapted to the new realities of the economy. Americans will feel as if they've "been down so long it looks like up to me."

This forecast includes unemployment rate, yield curve and Michigan consumer sentiment series data to month-end January.

The forecast is for a return to positive real GDP growth likely to be slow. The model has been accurate in back-testing for over 50 years and has called the last two turning points in real time well ahead of consensus.

The "animal spirits" of Americans can be modeled accurately by

A = - (U - UMEAN)/Stdev(U)

where U is the current unemployment rate, UMEAN is an exponential moving average over the past three years, and Stdev(U) is the standard deviation of U over the past three years. This measure correlates highly with the Michigan consumer sentiment index (green; blue is forecast based the unemployment rate forecast below).


"Animal spirits" hover at very low levels. However, continued increases in unemployment will have little negative effect on confidence. We are at or very near the nadir of "animal spirits" for this cycle that typically coincides with the end of the recession. A close-up shows that the Michigan series, which tends to lead the “animal spirits” indicator slightly, has turned up briefly recently.


To understand why we are at or within a few months of the confidence low it is important to understand that after rises in the unemployment rate, people get used to it. In the 1980s, when unemployment began to drop from its highs over 10 percent, confidence soared. The adaptation level is now catching up with the current rate. Other things equal, confidence will increase as the difference between the two decreases. The blue line below is the adaptation level.


The blue line below represents a one-year unemployment rate forecast, which is not meant to be indicative, but to gauge the response of “animal spirits.”


The other thing impacting confidence in the model is how much volatility people are used to. In part due to excessively accommodative efforts to "stabilize" the American economy in recent years, unemployment volatility fell to very low levels. The risk of over-insuring a society is that it loses the ability to respond coherently to perturbations. The blue line in the graph below represents what will happen to volatility over the next 12 months if unemployment rises to over 9 percent over the next 12 months as shown above.


The net result of the adaptation level rising to catch up with current unemployment and volatility rescaling perceptions of the gap between adaptation level and current unemployment is that even if unemployment increases as shown to over nine percent in 2009, confidence will turn up. And this generally signifies the end of a recession in the American economy.

The "animal spirits" variable can be combined with the slope of the yield curve, a powerful forecasting tool in its own right, to create a recession forecasting model that gives an estimated "probability" of a recession occurring from a full year in advance without forecasting any explanatory variables. This model has forecast the onset of the last two recessions in real time well ahead of the consensus of professional economic forecasters, and now forecasts an end to the current recession in early 2009. The model was featured in Nature's prestigious Science News column in August 2001 when it was forecasting a recession and the consensus was not; see references. Here is the current recession “probability” forecast (blue)—no recession in sight:


This model has an excellent record over the past 55 years as the next graph shows.


The model's forecasts are qualitative, of the sort generally found most useful by practical people. As one of my professors in graduate school used to say, "It is better to be approximately correct than precisely wrong." There is a rough proportionality between the size of the forecasted recession's probability and severity of the ensuing recession, but not much should be made of this in light of the current global slump in economic activity. The parameters of the model worked well over the postwar period, but the parameters may have changed. If there is a recovery in GDP growth in 2009, it will be from a far lower level for the simple reason that much of recent GDP (especially consumption) was debt-financed, and much of that isn't happening any more (“home equity ATM”). The best we can expect is an "L-shaped" recovery at a much lower run rate of GDP in 2009, probably. But a depression does not seem to be in the cards.

The unemployment rate will probably remain elevated for some time as it has tended to lag the cycle the last two cycles. In the opinion of this commentator, the government should make income support for the involuntarily unemployed its top priority. Most are the victims of a systemic credit crisis not of their own making. Also, income support to the unemployed is guaranteed to be spent. It will enter the spending stream faster than any other fiscal stimulus. Extending unemployment insurance benefits is not enough. There needs to be a livable poverty-level dole for the unemployed.

The forecast also draws into question the treatment of debt and deficit problems by policy makers. First, it suggests, at least in the classical terms of “counter-cyclical stimulus,” that the stimulus will be mistimed. The long lags in the stimulus package and the relatively little support for the unemployed are serious flaws. If Americans could face the fact that there is “enough for all” if Americans would learn to share (especially the plutocrats who have been draining the country’s wealth at such a high rate), everyone would be fine. We are still one of the richest countries in the world.

Second, it appears the United States has too much debt; our national debt-to-income ratio is at or near record highs.


Much of this debt is in the household sector, which is having trouble paying it back.


Corporations, instructed by modern finance, have also piled on the debt. Somewhat surprisingly, compared to some other developed countries, our federal government debt is less than 100 percent of GDP. However, it has doubled as a percent of GDP since 1980 when Reagan and “supply-side economics” put in the first of many tax cuts without spending reductions.

But we have more debt than we can pay back, in the view of many, which leaves the question: On which debt should we default? And how, explicitly or through inflation?

I submit that the current efforts to tidy up the private bad debts of plutocrat-run financial institutions on the backs of taxpayers are exactly counter-productive, as for the foreseeable future the creditworthiness of U.S. Governments (bonds) is instrumental to the financing of our government and trade deficits. We need to write off a large amount of private debt to get the country’s debt-to-income level back to something sustainable. The banking bailouts are going to put the onus for paying back these bad private debts on exactly the wrong obligor, the U.S. Government and its squeeze, the American taxpayer.

The American economy is beginning a massive structural adjustment from a largely debt-financed consumption-led economy with zero or negative household savings to a government-investment-led economy, with a significantly smaller share of GDP probably going to consumption. In a consumption-based economy, business investment is a “derived demand” from the demand for consumer goods. In the current situation, we’re seeing a great example of multiplier-accelerator interaction, as paused consumer spending impacts business spending with a bang. The good news is that multiplier-accelerator interaction operates both ways.

Massive structural adjustments take time. So estimates of “required stimulus spending” to hit some level of GDP or unemployment by back-of-the-envelope calculations using questionable multipliers from even more questionable econometric models that have, in aggregate, missed every turning point in the postwar period—this is all highly suspect activity.

Stimulus spending should inject government investment to replace lost consumption and its derived business investment demand, sure, but we don’t really know how to do this--we need to slow down. If we are going to share the sacrifice, it makes a lot more sense to take care of the people who are hurting mostly through no fault of their own and plan our next moves carefully. There is enough to go around. The rate of growth of government debt is beyond the capability of anyone to grasp. We need to be more careful. Our policymakers have been operating in panic mode and that needs to stop.

And what about China? What about the massive amounts of money the U.S. borrows every year from its trading partners, now about to shoot skyward? Will they want to lend to us? So long as the dollar remains a viable reserve currency, maybe they will, even if they lose holding it—but maybe they won’t. Will Uncle Sam need to sow chaos in Europe or Japan to knock out the Euro or yen? This is George Friedman kind of thinking. Do we really want to do that?

The American people need to set up a hue and cry for things they need:

  • health care for everyone
  • income support for those that need it
  • carefully monitored government investment in infrastructure, education and energy
  • getting rid of tax cheats and pawns of the plutocracy (Wall Street types whose primary loyalties are to Wall Street) in the government

You do this by calling your Congress people and emailing them and basically screaming your head off. They are near deaf but can hear a loud noise. Why President Obama is listening to people like Larry Summers or Bob Rubin and Geithner, architects of the regulatory fiasco that produced this crisis, suggests that being inside the beltway is too much for him to handle and that he’s caving under the pressure from the plutocracy.

Pray that President Obama can deliver on the promises of accountable government and social justice that got him elected.

And then scream your head off.

Otherwise, we are indeed a banana republic with nukes, and we’re going try the old Vietnam trick of inflating our way out of our debt, throwing gasoline on the fire, while beefing up for the Big Oil War in ten years or so, when our greenback will be toilet paper and we’ll have to go steal what we need, using the military bases George II built in Iraq, with an army drawn from our sons and daughters.

Let’s not go there.

Addendum: the non-partisan Congressional Budget Office estimates that the stimulus bill approved today will actually do more harm than doing nothing over the next ten years.


Middleton, E., ‘Animal spirits’ and expectations in U.S. recession forecasting,, 8 August 2001. This paper provides citation for Middleton (1996) "Adaptation level and 'animal spirits'", JEconPsych.

Ball, Philip, “Hard times ahead: depressions caused by lack of economic confidence might be predictable,” Nature,, 15 August 2001.