Of bailouts and bullet- biting

It may be illuminating to compare what I wrote in RGD to the various ways countries mentioned in it have responded to the debt crisis. Consider the following quote from the book:

“According to Austrian theory, the effects of the housing bust on the overall economy should be much greater in countries like Estonia, Spain, and Ireland than in Austria, Germany, and Poland, and to the extent that inexpensive debt was made available to that and other sectors of the economy, we would expect to see that signs of the resulting economic contraction are similarly greater as well. Therefore we should see unemployment rising faster, prices falling further, GDP contracting more, and government deficits growing larger in the three housing boom countries than in the three non-boom ones.”

From today’s NYT on the Spanish bank bailout:

Two weeks after Prime Minister Mariano Rajoy of Spain vowed “there will be no Spanish banking rescue,” and after days of delay in which Mr. Rajoy pressed European officials for sounder rescue terms, Spain has now joined Greece, Ireland and Portugal as the latest bailout recipient. Catastrophe averted? Hardly.

Spain, check. Ireland, check. But no Estonia? What happened there? Why hasn’t Estonia required a bank bailout? The answer can be found in the rationale given by Fitch Ratings decision to affirm the little country’s credit rating.

“The rating decision reflects “the country’s near seamless transition to full membership of the euro zone starting on 1 January 2011, coupled with a more balanced economic recovery and the continued deleveraging of the private sector”…. Estonia was the only euro-area member to report budget surpluses for the last two years and had the lowest public debt among the region’s 17 members in 2011 at 6 percent of gross domestic product.”

Translation: Estonia is the only one of the three housing boom countries I noted in RGD that chose to bite the bullet and accept economic contraction and debt default rather than attempt to put off dealing with it in the interest of its banking sector. As even Paul Krugman has begrudgingly noted, they’ve hit bottom and are now in an ongoing process of recovery. But first they took a 20 percent hit to GDP, which is very much in line with what I said would have to be the case in RGD. All the multiple bailouts in Europe and the USA have accomplished is ensure that the trough will have to be bigger and deeper in the end.


If I sounded a little less than fluid in the interview with CTV yesterday, the reason is, ironically enough, that the two Canadian producers prepared me extraordinarily well for it. I was very impressed with their thoroughness and the quality of their questions; I’ve been on a number of national news shows before and I’ve never seen anything like it. After a 30-minute pre-interview going over the debt ceiling debate and how it related to some of the concepts in RGD with one of the producers the day before, I produced two charts that we both thought would be useful as well as nicely visual, after which I was sent me the six questions I was to anticipate.

However, there was just a bit of a curve ball in the interview itself. Not only did they use a different picture than the one I provided, (understandably, since they must have wanted color), and they didn’t make use of the charts I made, (which was fine, I used them in today’s column), but some of the questions asked by the anchor were somewhat different than the ones I’d been provided. Her questions weren’t bad ones, by any means, but they were just far enough afield so I didn’t have the statistics on things like “historical tax revenue as a percentage of GDP” immediately to hand.

Note that I’m not complaining here, merely observing how the process was very different than my experience with American TV and radio.

Anyhow, I found that I was thinking “wait, what?” the entire time I was trying to answer the anchor’s questions. “Did I mishear that? Am I even answering the right question?” Anyhow, since I thought the producer’s questions were pretty good ones and I prepared for them, I thought I might as well post my notes for the interview here.

You recently wrote in an article that the issue is not so much the debt ceiling, but the debt itself. Can you explain exactly why?

The U.S. federal government has spent three years keeping the economy artificially propped up by substituting $4.1 trillion in new government debt for $3.6 trillion in household and financial sector debt-deleveraging.  Washington cannot keep playing ostrich without raising the debt ceiling.  The reason you’ve seen the number $2.4 trillion bandied about is because that buys them another six quarters at the current rate of $365 billion in new debt per quarter, enough to get them past the 2012 elections. But all this accomplishes is to delay the day of reckoning and increase the eventual cost.  Since the housing market and employment numbers have actually gotten worse during this period of extend-and-pretend, it should be clear that raising the debt ceiling isn’t even a potential fix for the problem.
In your book you look at the patterns that led to the Great Depression, and the Heisei boom In Japan that led to it’s famous ‘lost decade”- and you believe it will happen again, only this time it will be worse. What leads you to believe this?

First, the debt-to-GDP ratio is worse than it was in the Great Depression or Japan in 1999.  It was 2.6 in 1933, it peaked at 3.7 in 2008 and it is 3.5 now.  Second, in the 1930s, it was only the USA that attempted to fight the post-1929 economic contraction with Keynesian stimulus policies and only the USA suffered a Great Depression.  In England, the contraction stopped in 1932, France never saw double-digit unemployment, and the Japanese economy was actually enjoying significant growth.(1)  This time, Europe, China, and Japan all followed the US lead and applied their own stimulus plans in 2009, which we are already seeing is now in the process of backfiring on everyone.
In a chapter of your book entitled “No one knows anything” you explain that many of the governments calculations for GDP are misleading that they contain wide margins for error and cannot be trusted- why is that?
Because they’re verifiably wrong.  Look at the recent first quarter.  All three reports, from Advance to Final, had U.S. GDP growth at 1.8 to 1.9%.  Then, in the second quarter report, there is an inexplicable revision from 1.9% to 0.4%.  That’s a $225 billion mistake, which is almost five times more than the $60 billion growth now being reported.  These revisions are so out of control that if you bother to look back at the 2001 numbers, you’ll see that the 2001 recession has been revised out of existence.  It’s complete fiction.  On the employment side, the game is to not count people who don’t have jobs as unemployed.  That’s why they claim the unemployment rate is only 9.2% when it’s really closer to 20%.

You say that a boom fuelled by easy credit must be followed by a bust of equal size and duration. Instead, it has been FED policy to re-inflate bubbles and they collapse, which only creates bigger bubbles- You say we are currently in the biggest bubble yet- what could pop it?
What will pop it is a reduction in the rate of growth of government spending, an increase in interest rates, or a major sovereign investor’s refusal to continue buying Treasury bonds.  Any of the three will suffice to put the USA into a debt-deleveraging spiral.  The problem with depending upon debt-based economic growth is that eventually, you run out of people who are willing and able to borrow money. And that’s when the contraction starts.

There is a large backlog of home foreclosures in the United States- what would happen if that backlog were to suddenly be cleared? Are there other potential triggers out there?
Clearing the backlog would put the economy into the equivalent of heart failure because it would instantly kill a lot of banks.  The $600 billion decline in household sector debt is deceptively small because over 7.5% of all mortgages have been delinquent for more than 90 days.  The banks aren’t writing those bad loans off yet because to do so would bankrupt them.  Based on the FDIC statistics, I estimate that about $3 trillion of the $7.5 trillion in assets presently claimed by the big four, Bank of America, Citi, Wells Fargo, and JP Morgan Chase, are worthless.
What are the options for the global economy- what are the best and worst case scenarios?
Pay a high price now, or pay a higher price later.  Deflation, default, and economic contraction aren’t fun, but they are perfectly survivable.  The best case scenario is we go through the global equivalent of the Great Depression, what I’ve called Great Depression 2.0.  It will be very difficult for a lot of people, but the basic governmental structures will survive and there won’t be cannibalism in the streets or anything like that.  The worst case is that the politicians keep kicking the can down the road until the entire global financial system finally collapses overnight.  In that case, we’re probably going to see wars, civil wars, and fundamental change of the sort most of us find impossible to imagine.

(1)thanks to the invasion of Manchuria, of course, but the GDP statistics are what they are.

Not quite nobody

I believe I have pointed the connection between reduced government spending and reduced GDP on occasion as well:

The entire premise of the alleged “recovery”, in the words of Ben Bernanke, has been about pumping asset prices. But they won’t remain “pumped” when we take our medicine. They’ll go down.

A lot.

How much? Oh that’s easy – we know for a fact what the minimum contraction will be. It’s right here: That’s about 12% of GDP or about $1.8 trillion dollars. Why? Because GDP is simply defined as “C + I + G + (x – i)”, and “G” is government spending. Decrease it by that 12% of GDP and GDP falls by (at least) 12%. This is simple math – subtraction.

Yes, we need to do this. Yes, people will raise hell. But it will make, at least for a short time, unemployment worse and pain will increase among Americans. We will not buy those iPhones and cable TV and nights out at the bistro, and the follow-on effects cannot be avoided.

The problem with everyone pontificating on this is that nobody – other than I – is talking about what happens when, not if, we take our medicine. See, we must at some point. But as the chart makes clear up above we’ve been in an economic Depression we have refused to admit to for the last three years, just as someone on a monstrous multi-year bender will refuse to admit they’re addicted to some substance.

Of course, Karl is leaving out the so-called “multiplier effect”, for the very good reason that it does not exist despite the Keynesian myth-making. This is probably just as well because if it did, GDP would decrease even more than the 12% contraction in G(overnment spending).

In RGD, I anticipated that the decline in GDP would ultimately approach 35%: Utilizing total credit market debt as a proxy for the relative size of the contractions, I estimate that Great Depression 2.0 will be approximately one-third worse than the Great Depression. This indicates a 35 percent decline in real GDP over a five-year period, indicating a nadir of 9,455 sometime between the end of 2012 and the middle of 2013.

Now, obviously the time frames are off given the reckless decision by the Washington elite to stave off the inevitable declines in total debt outstanding and GDP by the gargantuan increase in Federal borrowing and spending over the last three years. But, once those efforts end, whenever that might be, there is no question that a statistically visible contraction will begin. It is mathematically assured. In light of Karl Denninger’s 12% figure, I think it may be worth noting that the contraction of private debt already amounts to 9.7% of its Q3-2008 peak.

It’s official

It appears I was eight months early in predicting mainstream recognition of economic depression “towards the end of 2010” in RGD:

We can only hope that the politicians huddled in Washington and Brussels succeed in averting these threats. But here’s the thing: Even if we manage to avoid immediate catastrophe, the deals being struck on both sides of the Atlantic are almost guaranteed to make the broader economic slump worse.

In fact, policy makers seem determined to perpetuate what I’ve taken to calling the Lesser Depression, the prolonged era of high unemployment that began with the Great Recession of 2007-2009 and continues to this day, more than two years after the recession supposedly ended.

Of course, Paul Krugman has no idea what he’s talking about. This is not a lesser depression, it is a larger depression. The full scale and scope simply isn’t apparent yet.

That’s why I referred to it as “the Great Depression 2.0” in RGD. In the 1930s, only the USA exacerbated the situation with Keynesian stimulus policies. In the 2000s, China, Japan, and the European countries all engaged in such policies, with China and Japan spending an even greater portion of their GDP on them than the USA. Therefore, we can expect the Great Depression 2.0 to be a genuinely worldwide one, as opposed to a mostly American one in the 1930s. It’s not that Europe didn’t experience a depression, but it wasn’t known as a “Great” depression because it was largely over by 1933.

“Europe’s subsequent decline was gentler, shorter, and smaller as European governments did not engage in the same heroic attempts to fight the effects of the contraction that the U.S. government did. There was no European Reconstruction Finance Corporation or New Deal to prolong the downturn, so the European economies hit their collective nadir in 1932 and had already grown past their pre-depression levels in 1936. With the exception of Germany, which suffered from the economic complications of a socialist government, crushing war reparations, and the famous Weimar Republic hyperinflation, unemployment in Europe was lower than in the United States. While U.S. unemployment reached an estimated peak of 24.9 percent in 1933, British unemployment peaked at 17 percent in 1932 and French unemployment never even reached double digits. Japan saw neither a big pre-1929 boom nor a massive post-1929 bust….”
– RGD, p. 178

UPDATE: Okay, this comment made me laugh.

I’m honestly sorry to say this, but when you start your article with “Amanda Marcotte is right,” you’ve pretty much just taken your credibility, shot it in the back of the head, and are now frantically digging a hole to bury the corpse in before somebody comes to investigate the loud noise.

Credit contagion

Well, three of five isn’t bad as the Eurozone is on the verge of melting down again:

The EU authorities have begun to vent their fury against Ireland over its refusal to accept a financial rescue, fearing that the crisis will engulf Portugal and Spain unless confidence is restored immediately to eurozone bond markets…. A simultaneous bail-out for both Ireland and Portugal might run to €200bn, depleting much of the EU rescue line. The European Financial Stability Facility (EFSF) can raise up to €440bn on the bond markets but only two thirds of this would be available. The IMF is expected to loan a further €3 for every €8 from the EU under the bail-out formula.

The great concern is that the crisis could spread to Spain, which has a far bigger economy that Greece, Portugal, and Ireland combined. Foreign banks have €850bn of exposure to Spanish debt.

In RGD, I correctly identified Ireland and Spain as the likely culprits for the modern version of 1931’s Creditanstalt collapse. But I have to admit, I did not see Greece or Portugal being a probable issue; Estonia doesn’t count because it is not part of the Eurozone until 2011, assuming that there is still is Eurozone in 2011. But Greece was faking its economic statistics – they released yet another and increasingly bad debt/GDP report yesterday and I only looked at Portugal’s real estate sector, so presumably their excessive debt was concentrated elsewhere.

“According to Austrian theory, the effects of the housing bust on the overall economy should be much greater in countries like Estonia, Spain, and Ireland than in Austria, Germany, and Poland, and to the extent that inexpensive debt was made available to that and other sectors of the economy, we would expect to see that signs of the resulting economic contraction are similarly greater as well. Therefore we should see unemployment rising faster, prices falling further, GDP contracting more, and government deficits growing larger in the three housing boom countries than in the three non-boom ones. Due to the Austrian doubts about the reliability of macroeconomic data, greater credence should be given to historical statistics that are less easily manipulated, such as government deficits and interest rates, rather than GDP, unemployment, and inflation.”

Ireland is right to refuse the EU-IMF bailout. Notice that the bailout is not, as it is improperly characterized, a bailout of Ireland per se. It is actually a bailout of the banks that invested in Irish government debt and it is intended to put the people of Ireland on the hook for it in much the same way that Americans were put on the hook for the cost of the TARP bailouts.

Although it isn’t mentioned in the article, I noticed that Australia’s bond spreads have risen even higher than Portugal’s in the two-year. Australia has had a serious housing bubble too, one that continued into 2010, so don’t be surprised if there is news of a Australian crisis in the near future.

Mailvox: reflections on RGD

Stilicho’s summary:

I received my copy of RGD on Friday and finished it last night. Excellent work. Funnily enough, just as I was starting to read the Saint Bernanke/green shoots scenario at the end, there was a power outage and I finished by flashlight. How apt. At any rate, I’m not sure I’ve grokked the full implications of your theories yet, but the first reading sure was an eye opener. There are a lot of thoughts I had while reading that are still bouncing around in my head that may take a while (and more reading) to fully digest, but I’ll share a couple with you:

1) The conventional Austrian theory that a switch from capital production to consumer production causes contractions doesn’t seem logical to me. Rather, it seems that such a switch would be a symptom rather than a cause. I don’t think you classified it as such, although you did express doubt that it was a casual factor. Why did the Austrian school think it was a casual factor?

2) I too was quite sympathetic to the WZI scenario until recently. I still think there may isolated incidents as certain industries or sectors experience mini bubbles induced by an excess of credit that is available and actually used in said industries/sectors. However, after reading your thoughts about the depth and breadth of secular debt issues, I don’t think that general inflation will be an issue for some time. If and when there is some recovery on the far side of TGD 2.0, do you think the WZI scenario is likely to occur given the monetary authorities adherence to neo-keynesian and monetarist theories?

3) I wonder how long we can keep limping along in what amounts to great recession mode until the bottom finally drops out? Isn’t that what Japan’s lost decade(s) amount too? A great recession scenario? But given the world-wide nature of the current crisis, you have convinced me that the bottom will drop eventually. How many bullets does Bernanke have left?

4) The neo-keynesians must have an absolute disdain for microeconomics. Either that, or it would be just too damned inconvenient to acknowledge verifiable microeconomic principles that might cast doubt on their macro theories. A bit of both perhaps?

1) I simply don’t know. My feeling is that because so much Austrian theory was not developed ex nihilo as so much Marxian and Keynesian theory was, but built rationally on the work of previous economic theorists, the conceptual model was somewhat influenced and therefore limited by the various pre-classical, classical, and neo-classical ideas that influenced them. What is strange about it to me is that Rothbard points out the exact limits of demand that I propose as a causal mechanism, but he only applies it to the market for labor. In any event, I agree, the shift from one form of production to another is a symptom rather than a cause. This probably makes me impure from the doctrinaire Austrian perspective, but hardly a heretic. The model works to describe and correctly predict regardless of which mechanism is favored. The advantage of my “limits of demand” mechanism is the way it explains how Austrian theory applies to financial services and other markets in which there is no distinction between capital and consumer goods.

2) No, I think the entire structure will collapse of its own weight first. Debt implodes faster than money can be printed. And I reject what appears to be the revised inflationist notion that a deflationary loss of confidence in a currency can be reasonably labled hyperinflation.

3) Not long. Not any. Most of the positive exit scenarios involve the Federal Reserve being either thrown aside by the US government or supplanted by the IMF.

4) Yes, they have ever since Keynes first voiced the idea that perhaps a macroeconomy behaved in a different manner than a microeconomy writ large.

Interview with Vox Day part II

UPDATED (July 2): AS PROMISED, YOUR DOUBLE DOSE OF DAY. You’ve read the first part of my Vox Day interview on WND. Now to the sequel, exclusive to Barely A Blog:

• Ilana: To mention the Fed today as anything but a hedge against inflation is to qualify as “Worst Person in the World.” Early Americans were not nearly as baffled about what the Fed did. Comment with reference to the on-and-off attempts to eradicate this Federal Frankenstein. What good would an audit of the money mafia do?

Vox: Keith Olbermann should have stuck to sports. He has no idea what he’s talking about when it comes to economics. The Fed isn’t a hedge against inflation, it is the primary engine of inflation just as its three predecessors were. A genuine audit of the Fed will immediately end its political viability and probably its existence, which is why the Fed is fighting so desperately against the Ron Paul bill. But the end result is inevitable. The Fed can’t hide behind fictional statistics forever, as with the Soviet Union, people eventually begin to notice that they are not, in fact, wealthy and well fed.

Interview with Vox Day

The lovely and libertarian Ilana Mercer turns it around and interviews me about The Return of the Great Depression. This is the first part of a two-part interview:

The “infamous Internet Superintelligence,” Vox Day, author of “The Return of the Great Depression,” needs no introduction. My WND colleague and fellow libertarian dishes it out on the impending depression, D.C. dummies (down to their position under The Bell Curve) and a dark future. As always, Vox makes this glum stuff fun.

Ilana: Republican President George Bush was as good if not better than Clinton and Carter at laying the legislative foundation for the minority mortgage meltdown. Comment with reference to the thesis of your book (and mention some other Republicans who’d like ditto-heads to forget their political pedigree).

Vox: Like Carter and Clinton, George W. Bush pushed government programs designed to boost homeownership among low-income families that couldn’t afford to meet the debt obligations they were assuming. These programs were focused on minorities, particularly Hispanics, which is why the four states where the majority of defaults have been located to date are California, Arizona, Nevada and Florida. However, it should be kept in mind that these inept and bipartisan housing programs were not the cause of the core problem; they were merely a consequence of the overall problem of debt chasing a dwindling pool of borrowers.

I would be remiss if I did not point out, as noted in the book, that the heavy lifting on where the home defaults happened was done by Steve Sailer.

“A landmark project for the new decade”

It may not have hit #1 like Aaron Klein’s new book, but recent events appear to be on the verge of proving the case made in RGD to be correct. You’ve probably noticed that no one is insisting that debt isn’t a big deal anymore.* Anyhhow, I somehow managed to miss this review of RGD, which appeared back in February courtesy of Jim Fletcher:

Vox Day, the Mensa-soaked columnist for WorldNetDaily, is one of those rare individuals who tells it like it is even when we don’t want to hear it. And once the pain subsides, we realize he might just have saved our lives.

His new book, “The Return of the Great Depression,” is that important.

Look, you can listen to MSNBC or read the dream weavers at the New York Times, who still worship the first non-American American president, but going to a place of fantasy in our minds is not going to help us fight our way to whatever economic recovery is possible.

For those who want to pretend that the Chinese don’t hold our debt in their hands … don’t read this book. If you still believe that entitlement programs – even those now for banks – is the way to go, read Oprah’s latest spiritual guru. Maybe that will make you feel better….

If I were an economics professor anywhere, I would make “The Return of the Great Depression” the capstone of my semester’s reading list. Vox Day has managed to make a real-life horror movie an absorbing page-turner. If you have been urged to read this book – and that’s exactly what I’m urging – and you don’t do it, you have only yourself to blame.

I fully expect this book to be a landmark project for the new decade.

And, of course, it’s like $2 on Kindle at Amazon…. By the way, the Dow just dropped nearly 900 points on word that European lending had frozen up.

*It may amuse some of you to note that I wrote this post about 90 minutes before the markets tanked.

UPDATE – I should have a better idea what’s going on tomorrow morning. As I wrote in RGD, the real problems are in Spain, Ireland, and the UK. Greece is small enough that it doesn’t matter except as the first domino.

UPDATE II – Our favorite Doommonger sees unmistakable signs of the Eschaton in all of this: “I doubt anyone’s enjoying the sound of ice cracking beneath our feet, but some of us are less surprised than others. We fans of Peter Schiff, Marc Faber, and Vox Day are just sitting at our desks nodding glumly and saying: Yep. Yep. … From Vox’s wonderful suicide-inducing new book, chapter title “What Can Be Done,” just the headlines:”

The calm before the storm

In response to Dr. Helen’s question, the answer is an unequivocal “yes”.

Glenn just got Vox Day’s new book in the mail, The Return of the Great Depression, so I picked it up and started reading. It is not for the faint of heart or the economically hopeful…. I have noticed that house sales (at least in the lower prices) in our area seem to be picking up and people seem to be out buying again–or at least, they are in the stores. I wonder if this is just the calm before the storm or whether things are improving?

This graph on debt outstanding by sector should explain why things look superficially as if they are improving, while they are actually doing absolutely nothing of the kind. Keep in mind that Q2 2010 – in other words, now – marks the beginning of the end of the massive federal stimulus plan that has allowed the substitution of G for C over the last six quarters. But as the first graph shows, that substitution cannot continue indefinitely. It would require deficits that are multiples of Obama’s record-setting 2009 and 2010 deficits and it wouldn’t ultimately work any better than either the Bush or Obama stimuli did.

And this is an amusing aside from Dr. Helen’s husband:

SORRY, WE’RE STILL SCREWED: Reihan Salam says we’re heading into a decade-long economic buzz saw. “We are propping up the most rotten sectors of the economy and diverting talent that would otherwise shift into the new interrelated systems that are slowly emerging—and this emergence will prove very slow indeed once the inevitable tax burden required to prop up aging yet politically powerful sectors hits.” Let’s hope this is wrong, but it’s basically an explanation of why a powerful federal government, unconstrained by traditional limits, is a bad idea. Oh, well, at least I’ve got Vox Day’s book to cheer me up . . . .