Links 2-18-2009

• Martin Wolf of Financial Times on U.S. debt load by sector (relevant to “The Elephant and the Donkey in the Room”).  Write off bad debt or die!
• The Economist gushes that the world is turning bourgeois (i.e., “middle class”) .

“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.”

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.

The U.S. Government is Bankrupt

John Williams of ShadowStats.com tells WorldNetDaily the U.S. Government is BK:

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 USBudgetWatch.org 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.

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.

‘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.

References

Middleton, E., ‘Animal spirits’ and expectations in U.S. recession forecasting, http://arxiv.org/abs/nlin/0108012, 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, http://www.nature.com/news/2001/010815/full/news010816-12.html, 15 August 2001.