re: What is your outlook on the economy?

So Benny, you think this country is capable of raising taxes and reducing spending to avoid a crash? The coming debt of SS and Medicare/Medicaid is staggering.

What makes you think we will have the ability to get thru that? And avoid getting drawn into an expensive war in the near future?

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Presidents get much more blame than they ever really deserve, but one thing I legitimately hold against Bush Jr. Was not taking a shot at entitlement reform in '04-'06, he had a clear mandate and all of Congress. Instead they decided against it because they didn't want to use theor political capital on it.

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Oh for frick's sake. Sorry, but there's no way in hell I'm going to let that lie slide.

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I'm going to just ignore this.

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I'm serious. In a world where mortgage debt is backed/underwritten/guaranteed by the federal government, and mortgage interest rates are suppressed to an acceptable level by the federal reserve, mortgage debt loses most of the characteristics that once distinguished it from a government bond. Sure, it has refinancing risk and odd maturity calculations and all that, but when push comes to shove, the risk and payoff has effectively converged with government debt. That was part and parcel of the fed's plan to blow home prices back up to their previous bubble level. Remember, asset prices rising faster than the cost of funding those assets; it's a keystone to modern fed policy. Unfortunately, a brief consideration will soon convince any sentient lender that they're be better off holding the asset than the debt, so it's not a sustainable state.

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I can not agree with the default portion, not because I don't think its a possibility, but because I think eventually some action would have to be taken

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Once again, we diverge from the point being discussed. I say default would have happened without QE, you say eventually some action would have to be taken. I'm not disputing that something would have been done eventually, I'm saying that other than monetizing debt, there was no alternative but default. Cumulative government deficits (not just ours) over the next few years would have approached the size of the entire money supply. The funding for an adequate level of fiscal stimulus did not exist, not in a world where economies were left to the vagaries of a banking collapse.

Two choices, print or default and those will be our choices next time too. So what should have been done? I don't know, but I do know that the aftermath of this round of stimulus will be worse, because more unproductive debt has been created, and the debt is still growing faster than the economy. But now the central banks are the ones holding risk assets, and the eventual demise of their balance sheets and subsequent currency collapse will be an unprecedented human catastrophe.

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Carry trades happen and correct over time

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These carry trades will correct in a snowball of bond market failures. The JGB market is moribund, owned and controlled by the BOJ and some lackey pension funds. Almost half of Japan's annual budget is deficit spending and they no longer have a trade surplus to finance it. To top it off, they're extremely dependent on external energy. When will it fail; I have no idea but the result will be a carry trade tsunami that sloshes around world.

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How did foreign debt have any part of the asset bubble?

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The BOJ was trying to weaken the yen vs the dollar, in order to maintain exports. Rather than let export based dollars flood back out into the FX market, the BOJ absorbed the dollars and used them to buy US Treasuries. In the process, they inflated the domestic money supply and kept interest rates too low. The result, as expected, was a destructive inflationary asset bubble.

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How is the US "hollowed out"? Refer to my points on the US above. Also the US has the ability to be a net importer due to our overall economic strength which in turn benefits all of these other countries that are able to increase their wealth and advance their domestic economies.

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Of course it's hollowed out. We consume more than we produce, and have for decades. We spend more than we earn, and have for decades. We ship jobs overseas and treat the resulting unemployment with social programs financed by debt. We burn foreign oil and pay with freshly minted greenbacks. This is "Decline and Fall of the Roman Empire: Beyond Thunderdome". Do you really think foreign governments see this as increasing their wealth, lending us money to buy their stuff and then we pay them back with by increasing our money supply? I think they're just waiting for whatever moment best suits their interests to blow the whole thing up.

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Keyens said you had to tighten policy as things get better and loosen when things get worse. How is that not what we're doing this and next year?

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We've run a budget deficit every year since 1970 or thereabouts. Continuous fiscal stimulus. Despite that rising debt, public/private debt compounding 3% faster than the nominal GDP since the early 80's by my calculations, the federal reserve has lowered interest rates steadily since Volcker started cutting in about 1982. Minor fluctuations around a very steady decline. Continuous monetary stimulus. This fiscal year we'll run a half trillion dollar budget deficit, 5 years into a "recovery", and interest rates are still below the rate of inflation. Every cycle is more extreme. Next time we'll run $5 T dollar deficits and celebrate when it dips back to $2 T.

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And why do you keep saying interest rates will stay at zero/depressed forever? The Fed has already hinted many times next year they will likely start raising rates.

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I say that because I've looked at the debt numbers. Almost $18 T federal, another $4 or $5 T state and local. Another approximately $40 T of debt in various other sectors. Housing prices that are too extreme for the average buyer, except at subsidized below market interest rates. At every cycle peak since the mid 80's, our economy has tanked at a lower peak interest rate. At every trough it takes lower rates to get it started again. Too much debt. We can't tolerate higher real interest rates, it blows up the economy. It will this time too, or they'll just never allow rates to rise and inflation will eventually spiral out of control.

Don't get me wrong, I don't think the US is headed for 2nd tier status. I think all the tiers are headed for rubble status.

I'll give you my final thoughts and let it rest. Over the long term, debt for consumption is not sustainable, because it does not produce a positive ROI. Instead, it has to be paid for with lower future consumption. Debt for production can, if used wisely, pay for itself, but artificially suppressed interest rates and moral hazard (bailouts) lead to unwise debt even in the productive sector.

We have ventured far from a sustainable debt model, over many decades. All the excess debt fueled consumption will be followed by a long period of reduced consumption and that will wreak havoc on a consumption based economy. Attempts to thwart that correction will cause currency destruction on a widespread scale.

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Doc Fenton

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Well put!

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In any case, in terms of U.S. politicians taking serious steps toward resolving the entitlement behemoth since WWII, there is George W. Bush, there is Paul Ryan,

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Rand Paul probably deserves mention there, though obviously not in conjunction with passing GWB's programs.

Also would be a thought-provoking OP if you cross-posted it to the PTB.
Good stuff

I learned in Econ 2030 that the USA having debt is not a bad thing because we never have to pay it off because the USA won't die like a person will


So we should be good in that category

This has been one of the most interesting/informative threads I've ever read. I check out debates on economics often, but I've never seen one quite like this.

Excellent work Wdhalgren and Benny. Would definitely read again.

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What is your outlook on the economy?
This has been one of the most interesting/informative threads I've ever read. I check out debates on economics often, but I've never seen one quite like this.

Excellent work Wdhalgren and Benny. Would definitely read again.

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I came to say the same thing. Great stuff.

But after that hijack, I think it's important for people to distinguish among different levels of economic outlooks.

There are short-term considerations that are mostly based on consumer demand analysis and credit risk. It's important for planning corporate investments, but it doesn't tell you much of anything about long-term productivity growth.

Longer-term asset planners seeking to optimize portfolio rebalancings will get into more sophisticated "secular cycle" theories, and these are more of where my interests are. There are also actuarial types of analyses that cover government debt and pension plans, but those can be kind of dry, and by their nature they cannot factor in big-event qualitative changes in the nature of how society decides to structure its political economy.

Finally, the part I care most about is the long-term productivity and demographics angles, and this is where you necessarily get involved with politics and sociological theories about inequality, the bifurcation of society into separate classes due to education and welfare policies, etc. It's what I care most about, and it's also the part you can quantify the least.

Everyone tries to measure worker productivity growth, but really, it seems to me that such a metric is mostly just a statistic calculated by seeing what will balance out other macroeconomic equations. It's not easy to judge how truly productive workers are, and it's not easy to measure true technological progress with GDP statistics.

With all that being said, here is where I would put my own outlook for the economy on various different levels:

short-term stability -- seems good, or at least better than before; the recovery has been so bad that it seems that there is plenty of room to go up

asset valuation -- seems like there are a lot of danger signs here, and that there will likely be poorer returns on both equities and bonds than what has historically been the case, for a long time going forward

long-term growth prospects -- doesn't look very good; it looks like we might be trapped into a new normal of lower per capita GDP growth, well below potential long-term growth; globally, however, there is cause for a lot of hope as the developing world catches up to us, there should continue to be a lot of returns to scale in being able to produce better goods cheapers