in 2000 an economist named Ben Bernanke offered a number of proposals for policy at the “zero lower bound.” True, the paper was focused on policy in Japan, not the United States. But America is now very much in a Japan-type economic trap, only more acute. So we learn a lot by asking why Ben Bernanke 2011 isn’t taking the advice of Ben Bernanke 2000.
Back then, Mr. Bernanke suggested that the Bank of Japan could get Japan’s economy moving with a variety of unconventional policies. These could include: purchases of long-term government debt (to push interest rates, and hence private borrowing costs, down); an announcement that short-term interest rates would stay near zero for an extended period, to further reduce long-term rates; an announcement that the bank was seeking moderate inflation, “setting a target in the 3-4% range for inflation, to be maintained for a number of years,” which would encourage borrowing and discourage people from hoarding cash; and “an attempt to achieve substantial depreciation of the yen,” that is, to reduce the yen’s value in terms of other currencies.
Was Mr. Bernanke on the right track? I think so — as well I should, since his paper was partly based on my own earlier work. So why isn’t the Fed pursuing the agenda its own chairman once recommended for Japan?
We’ll see what Ben Shalom has to say soon enough. But I note that gold buyers would have to be salivating at the idea that the Fed would target a 4% inflation rate. I just wonder why Krugman doesn’t go all the way and call for electronic currency that actually degrades in face value over time.
And give Rick Perry some credit, if firing that public shot across Bernanke’s bow was sufficient to intimidate him. And we would be remiss to fail to note another downward revision to GDP.
Gross domestic product growth rose at annual rate of 1.0 percent the Commerce Department said, a downward revision of its prior estimate of 1.3 percent.
Don’t worry, they’ll revise it into negative territory long after the fact, just like they did for 2008.
UPDATE – “Federal Reserve Chairman Ben S. Bernanke said the central bank still has tools to stimulate the economy without providing details or signaling when or whether policy makers might deploy them.”
Translation: No QE3 until after the autumn round of market crashes.
Readers here are aware that I have staunchly maintained the U.S. economy has been in an economic depression since 2008. I have done so despite NBER declaring the “recession” over in 2009 and in the face of seven straight quarters of positive GDP growth statistics because I don’t believe that either the agencies or the statistics they report have much, if anything, to do with the observable economic reality.
To give one example, the U3 unemployment rate is presently reported at 9.1%. But this is a heavily massaged number which not only depends upon survey-based employment estimates, but upon the subsequent manipulation of the raw data. Since it’s not possible to radically alter the number of reported “employed” without looking as if they are blatantly manipulating the numbers, the BLS manages to keep the official unemployment rate artificially low by reducing the size of “the labor force”, chiefly through reducing “the participation rate”.
However, is it reasonable to believe that people are any less inherently willing to work in these difficult economic times than they were in the year 2000? I don’t see any justification for it. The suggestion that something is amiss can be seen when comparing the labor force participation rates with the employment population ratios (EPR) for 1973 and 2000 versus today. Given that the percentage of women participating in the labor force has methodically risen from 44.7% in 1973 to 59.2 in 2009, and that this increase has outpaced the exit of elderly men from the labor force since 1973, the current overall participation rate should be significantly higher than it was in 1973. But this is not the case, according to the BLS.
Now, if we simply compare the present number of reported employed to the present size of the civilian, non-imprisoned population, but calculate the labor force based on the 2000 participation rate, we get an unemployment rate that is 50 percent higher than the currently reported rate of 9.1%. Note that numbers given are in thousands as per the BLS.
239,671 Civilian non-imprisoned population x.673 participation rate equals
161,299 Labor Force minus 139,236 Employed equals 22,063 Unemployed
22,063 divided by 161,299 equals 0.13678
This means the current U3 unemployment rate according to the BLS metric should be 13.7%, not 9.1%. Note that this is higher than the “unemployment rates” reported in the first two years of the Great Depresion, 1930 (8.9%) and 1931 (13.0%). Please also note that the two historical “unemployment rates” are estimates made well after the fact as the BLS didn’t track unemployment statistics until 1948. Finally, one also must take into account that the current rate would be considerably higher were it not for the 2,868,000 more people that are now employed by the federal government than were employed in 1940, much less before the New Deal of 1933. Including these extra 2.8 million government workers in the unemployed list, as one must do in order to make a reasonable comparison between 2011 and 1930-31, indicates a comparable “unemployment rate” of at least 15.5%.
A second sign is the woeful state of the housing market. “A telling sign of how bad things have gotten for the housing industry: Prices have dropped more since the recession started, on a percentage basis, than during the Great Depression of the 1930s. And it took 19 years for prices to fully recover after the Depression.”
Of course, we can always apply Paul Krugman’s reasoning and launch an alien war to solve the economic problem. If we can simply arrange for 30 million people to be slaughtered by the aliens, that will reduce the labor force and lead to full employment overnight.
People on twitter might be joking, but in all seriousness, we would see a bigger boost in spending and hence economic growth if the earthquake had done more damage.
Ladies and gentlemen, give that man another Nobel Prize!
I swear, Neo-Keynesians must never look at debt statistics. I mean, they literally NEVER seem to look at them! Our favorite Nobel Prize-winner comments on what is supposed to be the mysterious failure of interest rates to rise in line with the massive expansion of government debt since 2008 and erroneously concludes that this proves his belief in unicornsthe ability of government to borrow indefinitely without affecting interest rates:
I mean, common sense — or at least common sense as the WSJ sees it — would tell you that massive government borrowing would send interest rates soaring. And that’s certainly what the WSJ editorial page told its readers would happen. Only us fancy-schmancy Keynesians said otherwise; and here’s what actually happened:
Yes, interest rates have declined from 4.7% in 2007 to 2.3% in 2011 even as government borrowing has almost doubled, but what Krugman fails to point out is that the neo-classicals at the WSJ were assuming, incorrectly, that the private demand for debt, (a 12x larger factor), would continue to increase, and therefore increased government borrowing added on top of that would cause overall debt to expand in excess of its average annual post-WWII rate of 8.7%. This OVERALL increase in demand for debt would increase the price of debt, thereby causing interest rates to rise. All very sensible and perfectly in line with both post-war economic history and basic economic theory alike.
However, what the WSJ failed to anticipate was that despite the 82.9% increase in government borrowing since 2008, total debt outstanding only grew 4.8% in 2008 and actually SHRANK 0.32% in 2009 and 0.87% in 2010. That’s not a liquidity trap, that’s a 22.5% demand gap between the overall amount of debt anticipated and the actual amount borrowed!
Even an Econ 101 student knows what happens to price when supply goes up and demand goes down. The price goes down. Interest rates are at historic lows for the obvious reason that OVERALL demand for debt, relative to GDP, is at historic lows as well, even though the federal government sector has increased rapidly. The WSJ made what at the time appeared to be a safe and perfectly reasonable assumption, given that between 1946 and 2007, there had never been a single year in which overall debt grew less than 4%. Their assumption also happened to be absolutely wrong, but the incorrect nature of that assumption does not mean that Krugman and his fancy-schmancy Keynesian-imagined exception to the law of supply and demand is therefore correct.
I’ve noticed that there is considerably more public discussion of how WWII, and not the New Deal, brought the USA out of the Great Depression. However, there is still some confusion as it wasn’t the war spending itself that did the trick, but rather the breaking of the windows of the rest of the planet’s industrial infrastructure. See RGD and Vox’s Broken Window Theory, Revised, which states that Bastiat’s Broken Window is no fallacy, so long as you break all the windows in the next town over as well as the legs of its glaziers.
So, barring any flattening of an alien planet and the subsequent development of interstellar trade, Paul Krugman’s fantasy of preparing for an alien space war is unlikely to lead to economic recovery:
PAUL KRUGMAN, NEW YORK TIMES: Think about World War II, right? That was actually negative social product spending, and yet it brought us out.
I mean, probably because you want to put these things together, if we say, “Look, we could use some inflation.” Ken and I are both saying that, which is, of course, anathema to a lot of people in Washington but is, in fact, what fhe basic logic says.
It’s very hard to get inflation in a depressed economy. But if you had a program of government spending plus an expansionary policy by the Fed, you could get that. So, if you think about using all of these things together, you could accomplish, you know, a great deal.
If we discovered that, you know, space aliens were planning to attack and we needed a massive buildup to counter the space alien threat and really inflation and budget deficits took secondary place to that, this slump would be over in 18 months. And then if we discovered, oops, we made a mistake, there aren’t any aliens, we’d be better –
ROGOFF: And we need Orson Welles, is what you’re saying.
KRUGMAN: No, there was a “Twilight Zone” episode like this in which scientists fake an alien threat in order to achieve world peace. Well, this time, we don’t need it, we need it in order to get some fiscal stimulus.
The amazing thing isn’t the fluid way Paul Krugman moves from one fantasy to the next – remember, his inspiration for becoming an economist was Isaac Asimov’s Foundation novels – but that he does so while remaining convinced that he is the only serious economic realist in the debate. The guy is seriously strange, and at this point, I’m not entirely sure he’s even sane.
In this week’s podcast, I interview Australian Post-Keynesian economist, Steve Keen, who is among the first economists – if not the very first – to systematically incorporate debt into a Keynesian macroeconomic model. Interestingly, he appears to harbor even more contempt for the Neo-Keynesian likes of Krugman and Stiglitz than I do; he believes them to be little more than conventional neo-classicals subject to most of the same errors of assumption as their Chicago School rivals. He even goes so far as to state that if their Samuelsonian formulas are Keynesian, then he must be an Anatine economist.
John Maynard Keynes on “the gold cage” and the benefits to Great Britain of exiting the gold standard:
My favorite part is when he announces that prices won’t rise as a result of going off the gold standard. The price of gold then was around £5. Today, it’s £1,095. And of course, as we all know, Great Britain is still the industrial powerhouse of the world….
The Federal Reserve said it will keep its monetary policy stimulus for “at least through mid-2013” in an effort to support a flagging economy and fragile global markets that faced considerable internal dissent.
The Fed really does appear to have a terminal case of martellus clavus. Their only hammer is a loose money supply, therefore the problem MUST be a nail. Hit it again! And by the way, for those who don’t speak Fed, this announcement of zero interest money for a minimum of two years in advance is about as close as Ben Bernanke is ever going to get to admitting that the economy is in a depression until it becomes a matter of public record.
Over the last two months, numerous political commentators, as well as leading Democrats and Republicans, have vehemently insisted that a deal on the debt ceiling was necessary to avoid debt default and credit downgrades. Unsurprisingly, these happened to be the same commentators and politicians who did not see the crisis of 2008 coming and who have swallowed whole the ludicrous claim of “economic recovery” still being pushed by the Federal Reserve and the Bureau of Economic Analysis.
And once more, all of these public Panglosses have been proven wrong by events. This time, however, it took only three days to demonstrate their observable incompetence. The downgrade of U.S. credit was inevitable because the salient issue was never the debt ceiling or the inability of the federal government to borrow more money, but rather, the fact that it was already borrowing too much.
Daniel Indiviglio makes some relevant points in his article about the downgrade at The Atlantic and he was one of the few who correctly saw it as a real possibility, but I think he ultimately goes off-track when he calls into question S&P’s decision to downgrade the U.S. sovereign credit rating:
S&P was not happy with the $2.2 trillion minimum debt reduction plan. That’s understandable. A bigger deal would certainly have been preferable from a fiscal soundness standpoint. But does the agency really estimate that the deal is is so dangerously small that there’s a realistic chance that the U.S. could now default at some point in the future? In particular, does U.S. debt really look significantly riskier now than it did in, say, April?
The bond market certainly doesn’t think so. Treasury yields are near all-time lows, despite all that political nonsense. And remember, the interest the U.S. pays on its debt is far, far smaller than its tax revenues. If the Treasury prioritizes interest payments, then there’s no conceivable way the U.S. could default.
I defended S&P’s initial decision to put the U.S. rating on negative watch back in May when politics were becoming poisonous. But to actually downgrade the U.S. after Washington managed to avoid its self-created crisis is another story. S&P should have acted like the other agencies and affirmed the U.S. rating, but kept it on negative watch until more deficit reduction plans were put in place over the next couple of years, as I explain here.
In fact, this might not turn out well for S&P. The firm might think it’s acting boldly or proactively. Instead, the market may question S&P’s reasoning skills. The rating agency is acting here on an assumption not shared by its peers at Moody’s and Fitch: that U.S. politics are so screwed up that they could render the nation unable to live up to its debt obligations. That’s despite pretty much everyone agreeing that the nation will be financially able to pay for its debt in the short-, medium-, and long-term.
Indiviglio did a great job of demonstrating that the U.S. downgrade was be almost perfectly in line with the historical Japanese downgrade, which took place when its net government debt reached 60% of GDP. (It is presently around 225%). However, he reaches the wrong conclusion, as many have, by getting sidetracked over the way in which S&P’s analyzed the political situation in the U.S.A. And while there was never any question of short-term default, (despite the scare tactics of both Democrats and Republicans), I very much disagree that the nation will necessarily be able to pay for its debt in the medium- and long-terms.
The real reason that the downgrade was not only inevitable, but correct, and not only correct, but the first in a series of downgrades, can be seen in projections based on the historical patterns in the Z1 debt sector charts. These show the S&P’s worst case scenario to be far too optimistic to be credible.
While the debt figures don’t match up perfectly, as August “Net debt held by the public” is a little different at $9.78 trillion than Q1-2011 “federal government debt outstanding” at $9.65 trillion, they are close enough for the purposes of comparison. Utilizing the Q1 figure provides a federal debt/GDP of 64.3%, which is much lower than 74% presently estimated by the end of 2011 by S&P’s. However, we can see how they reach that number by plugging in the expected growth in the amount of debt at the post-2008 quarterly average of $365 billion. This indicates an end of year federal debt figure of 10.74 trillion and a GDP figure of $14.513 trillion.
In other words, S&P’s is probably assuming that either GDP will contract $490 million in the second through fourth quarters or the rate of federal borrowing will slow down. Either way, the so-called “double-dip recession” already appears to be baked in the S&P’s cake, assuming that its analysts are as capable of reading the Federal Reserve reports as Karl Denninger is. But that’s not the interesting aspect, from my perspective. What is interesting is the debt/GDP projections under the three future scenarios, Upside, Base Case, and Downside. Consider these projections of future federal debt to GDP ratios:
Where I suspect S&P’s has gone amiss, (and perhaps it had no choice in the matter due to its professional obligations), is by taking the CBO scoring figures seriously and thereby utilizing GDP estimates as the primary variable. Based on my calculations, it is also possible that S&P’s is simply plugging in the 66-year average rate of increase of federal debt, 5.92%, into their spreadsheets. But it isn’t GDP that has changed so drastically over the last three years and significantly modified the debt/GDP ratio, it is the rapid 82.89% increase in the federal debt over the last 11 quarters. If we utilize federal debt as the primary variable and plug them into S&P’s GDP estimates, we get some very different results. (I’m going to ignore the inflation and tax estimates in order to reduce the number of variables; these are estimates for the purpose of critical comparison, not predictive projections.)
The S&P’s GDP estimates are as follows:
UPSIDE: 3% GDP growth + lapsed tax cuts BASE CASE: 3% GDP growth DOWNSIDE: 2.5% GDP growth
However, net GDP growth over the 13 quarters from Q1 2008 to Q2 2011 is $729.9 billion, or 5.1%. That is an annual rate of growth of 1.57% and assumes that overall credit continues to remain flat at $52.6 trillion while federal debt continues to rise at the rate that private debt contracts. Call it the CURRENT CASE. Plugging in 1.57% annual GDP growth and 22.7% annual federal debt growth provides the following debt/GDP ratios if one begins with the firm numbers from the end of year 2010.
CURRENT CASE: 2011 77%, 2015 164%, 2021 509%
And if we substitute actual rates of federal debt growth for the S&P estimates of it that are based on the notoriously unreliable CBO scoring, it becomes very clear that the debt/GDP projections are wildly inaccurate regardless of what rate of GDP growth is assumed and shows that the problem is not one that economic growth can possibly solve. In fact, the revised UPSIDE case which takes historical debt growth into account is much worse than the Base Case that does not.
Notice that while the end of year 2011 figure (actually 76.8%) isn’t much worse than S&P’s is projecting at 74%, it is considerably worse than the DOWNSIDE in 2015 (164% vs 79%) and more than six times as bad in 2021 (509% vs 85%). But are these astronomical ratios even remotely possible? Could federal debt really rise to $26.1 trillion in 2015 from $9.6 trillion at present? After all, that would amount to 39.4% of all U.S. debt outstanding, assuming that the private sectors shrank at the same rate that the federal government sector expanded, and would indicate a Game Over default sometime in between 2016 and 2018.
This chart, which shows the historical percentage for each of the major debt sectors since 1946, demonstrates that at least the 2015 rate is clearly within the bounds of possibility. The Federal Government sector represented more than 39.4% of total U.S. debt until 1955. Furthermore, it also shows that the decline of Financial sector debt, which has contracted $3 trillion since 2008 and fallen from 32.7% of the total to 26.8%, could conceivably continue to dwindle away to less than one percent of the total, which would amount to an additional $11.2 trillion in debt-deleveraging that would need to be replaced by federal debt in order to prevent concomitant economic contraction. (It also, by the by, shows very clearly the real source of America’s current economic woes.) Government spending and borrowing is not the root cause of the problem, it is merely a failed attempt to cure the disease of massive private sector debt expansion and contraction.
Now, I am not making any predictions here, other than a general one that because private sector debt will continue to fall, there will be tremendous pressure to continue to increase federal spending and borrowing at rates more similar to that of the last three years than the historical norm. This is because the alternative is an immediate and sizable contraction of GDP. As ugly as it appears, the CURRENT CASE scenario I have outlined is not a worst case scenario because it does not account for the economic contraction I expect to finally begin showing up in the GDP numbers later this year and in 2012. The determining factor will be whether the rate of increase of federal debt is closer to the 22.7% annual rate of 2008-2011 or the 5.9% rate of 1946-2011. Just out of curiosity, I looked at the latter, which in combination with the 1.57% 2008-2011 GDP growth produces the following scenario:
Which of these five scenarios appears to be playing out should be readily apparent by the time the Q4-2011 debt sector numbers are published in the Federal Reserve’s Z1 report. If the Household and Private sectors continue to decline and end-of-year federal debt/GDP is over 75%, then CURRENT CASE is probably in effect.
UPDATE – More like 3 in 3, I would say: “A Standard & Poor’s official says there is a 1 in 3 chance that the U.S. credit rating could be downgraded another notch if conditions erode over the next six to 24 months. The credit rating agency’s managing director, John Chambers, tells ABC’s “This Week” that if the fiscal position of the U.S. deteriorates further, or if political gridlock tightens even more, a further downgrade is possible.”
