A 2013 CLIFF DIVE?
Sober Look had an excellent round-up of the potential causes of the coming “fiscal cliff” as the year ends, but The Economist also has a nice piece out tonight on the 30,000 foot view here:
“AMERICANS have watched austerity sweep Europe with a certain Schadenfreude. But eight months from now they may get a dose of the same medicine. The political compromises that have produced much of America’s deficit of 8% of GDP are programmed to go into reverse at the end of the year, two months after the election. A stimulus package consisting of a payroll-tax cut, investment tax credit and enhanced unemployment insurance expires then, as do George W. Bush’s tax cuts (which have already been extended by two years from their original end-date of 2010). At the same time an automatic, across-the-board cut in domestic and defence spending, called a “sequester”, takes effect, cutting about $100 billion from government spending next year.
The economic impact of this fiscal cliff is a matter of some debate. The Congressional Budget Office reckons that the combined effects of the sequester and the expiring tax cuts would add up to 3.6% of GDP in fiscal 2013. But David Greenlaw of Morgan Stanley, which puts the total effect at almost $700 billion at an annual rate, argues that the calendar-year impact is much larger, at around 5%. Others think the effect would be smaller, noting that some people will not experience the full tax hit until they file their returns in 2014.
Even the lower estimates could easily be enough to tip the economy back into recession. Mr Greenlaw says the closest precedent was in 1968, when individual, corporate, excise and payroll taxes collectively rose by the equivalent of 3.1% of GDP, mostly to pay for the Vietnam war and to damp down inflation. The next year, the economy fell into recession.”
It’s no secret by now that austerity has pulverized nations in a balance sheet recession and that budget deficits have helped sustain growth in others. So as we head into late 2012 and 2013 we should be keeping a close eye on developments here. As I’ve previously noted, the balance sheet recession effect is waning in the USA, but pulling the rug out from under us in 2013 could be a colossal mistake….Stay tuned.
PS – Q&A will be finished tomorrow….
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
Follow Me:
18 Comments
Anyone who has any knowledge the world’s financial system knows “”"Schadenfreude”" over the troubles in Europe is unfounded/misplaced. Europe imposing austerity/”"heading for a recession”" will push the USD/EUR higher and as we have learned in the 2nd half of 2008 a rising USD is toxic for the entire financial system.
No, the USD will – IMO – strenghten this year much more and that could/will pull the rug from under the US economy. NOT the taxhikes of 2013. So, the phrase becomes “”It’s the US DOLLAR, stupid”". The taxhikes will only make things worse.
More over it’s extremely doubful whether taxhikes will increase taxrevenues at all.
As I have done many times, I would cite Steve Keen again: “”GDP = Total Income + change in debt”".
Good point on the importance of the dollar; however, I am not sure I completely agree.
In 1933 the Federal Reserve, IMO, made a critical mistake by allowing inflation to get above 2% ( to Bernanke’s credit, during his press conference, had shot down the inflation targeting camp ). In 1932 the United States had begun to recover from the Great Depression, but the pace was not fast enough. Roosevelt came to power….. and had fallen into the hands of George F. Warren, a professor of agronomy at Cornell University. George Warren had convinced the President-elect to pursue a path of “controlled currency inflation”……. a policy of inflation. Bernard Baruch, who had supported Roosevelt, told a Senate committee that he regarded the country’s condition as “the most serious in its history” and inflation as “the road to ruin.” “The mere talk of inflation retards business”.
An appreciating dollar as long as it is gradual will help keep the United States on a path of mild deflation low inflation which will continue to restore the consumer and small business balance sheets. Mild deflation will also help restore balance to the world economies….. especially China.
http://www.ecommcode.com/hoover/ebooks/pdf/FULL/B1V3_Full.pdf
http://www.scribd.com/doc/90062656/George-F-Warren-Farm-Economist-by-Stanton
I’m very bullish on the dollar too next months/2013 (unless it turns down, which it really isn’t right now).
This will have an impact amongst other things in commodities, financial system leverage, carry trades and the balance of trade. All very important to the economy and financial markets.
I doubt treasuries can go extremely lower as we enter the field of negative rates, but they will remain strong for a while. Inflation will go down as well as inflation expectations. We really still are in a deflationary path and haven’t purged much, and central banks can do little to impede it as they have no arms and legs (that’s a no for you, NGDP targeting crew), the emperor has no cloths.
Also the politics of the situation are more delicate than most financial commentators and economists want to admit, not only in Europe but in USA too, which limits politicians and central bankers capacity to maneuver. Amongst other things we have class warfare unravelling and a lot of vested interests. So things will have to get worse before they get better (whichever the ‘solution’ is).
The idea that we can print our way out of indebtedness may seem to work short term, but will be disastrous in the long run.
It is time to get real here. The status quo is not sustainable, and the people have no stomach for the kind of austerity that would be necessary to correct the past fiscal irresponsibility.
This is true not only for the US, but for Europe and many parts of Asia also.
History teaches us that the kind of financial mess the world finds itself in now only ends one way, and that is war.
When you can no longer create organic prosperity, and you have pushed borrowing and money printing to the maximum, the only course left to obtain growth in a stagnant economy is to take the wealth from someone else.
I am afraid that is what you will soon see.
The squabbles between countries now over issues such as drilling, and fishing rights are only the beginning.
War is not only the final solution for failed diplomacy, but for failed economic policy as well.
JH
The theoretical scenerio that we have no other choice but war. Because that is what history ONLY tells us. That is well…our…ONLY option. We MUST now all plan for the inevetable war. Coming to a country near you. What are we destined to fight about…Well it doesn’t matter. War is coming because that is what happens when you print print print. What are we printing again? Oh electronic transactions being held as reserves. We must now kill each other!
Every where I look organic prosperity is being created. IN fact this site is the result of organic prosperity and people coming together. Their is monetary value to this site and its readers. You can advertise here, you can target market here, and you can attract like minded people to your site simply by posting intelligent pieces we read. IN FACT..this site has created such organic growth that the F.T has picked up one of the great young energetic thinkers of our time to op ed. Now…the rest is history. Those all over the world will read the Op.Ed piece and wonder…who is this guy Cullen? What is his blog? I want to know more. You don’t need to kill each other because of fiscal irresponsibiliy. And hopefully as they come here…will read me tell you that killing each other is not an option they should have to lay in bed worrying about. In fact what your saying must occur is damn right disgusting.
The future is bright. You have a shoe company that donates 1 pair of shoes for every one purchased. You want organic growth and progress with out killing each other…go down to Nordstroms and buy a pair of Toms. Everywhere I look good people are moving us forward. Stay focused on what’s in front of you…not the noise that is causing some commentator to become deaf listening to. The War noise that is the ultimate investment loser. And if their is a war…go buy defense stocks.
“War is the only solution”… you ever wonder why people want to be around charasmatic energetic people?
You ever walk up to a lady at a dico and say…”hey, the world is terribel place..we must now go to war and kill each other…want to come home with me tonight?” I’ve met my fair share of crazy ladies from the caberat and even they would not bit on that line.
By the way..it’s http://www.zerohedge.com..you mistyped it and landed here.
This article is an interesting example of why the Fed and government should really coordinate “policy” better. If the Fed (and esp. NGDP targeters), believe you can manage the economy through expectations, then one should be careful about what the eyes give away as the words say something else. I’d be more worried more about another debt ceiling debacle then the success/failure of QEx.
It is quite a surprise to me that today, one day after those Election results, the Euro is up vs. the USD. @Leverage and @Mr. Market, how long must we wait until the USD/EUR finally begins a steady climb? What might be the catalyst for such a strengthening of the USD vs. Euro?
When every asset class (or a number of major asset classes are) is going down in price. Look at 2008: A lot of things were already going down in price (housing, stocks) and then commodities (especially oil) started to go down in the 1st part of 2008. But when everything is going down the drain that’s called “”a crash”" (like in 2008), remember ? So, be careful what you wish for.
And watch the credit markets. These are crucial. Higher interest rates means more forces to deleverage.
And as long as the deleveraging continues the USD will remain chronicly strong (to the dislike of the politicians in D.C. and the FED, who want to see credit growth). A good example was the rising USD in the early 1980s when people shed their commodity holdings (=sell commodities (priced in USD) & buy USD, hence the rising USD)
And what a lot of folks won’t like: Rising US interest rates (and no matter what CR thinks, these are coming (perhaps at the end of this year)) will – IMO – crash (!!) the USD much higher.
“And what a lot of folks won’t like: Rising US interest rates (and no matter what CR thinks, these are coming (perhaps at the end of this year)) will – IMO – crash (!!) the USD much higher.”
To clarify, you are saying that yields on US sovereign bonds are going to rise before the Federal Reserve raises their target rate? Or are you predicting that the Federal Reserve is going to raise their target rate sooner than most people are currently anticipating?
This won’t happen, at least not in the next months, I don’t see it happening either in 2013 (though depends a lot on spending and how credit is doing, and if inflation increases).
But I doubt there will be sufficient levels of spending and credit to support an rise of inflation, less if commodities are turning down and activity is decreasing, more with wage stagnation.
Don’t look only at FX but generally at prices/inflation, there is low inflation in the US right now, most inflation in developed nations is caused by increasing demand of limited commodities in developing nations and the commodity futures speculative bubble build ups on margin. Purchasing power of the USD is increasing on a lot of sectors or at least is fairly stable since 3 years ago.
About FX: Europe has very strong deflationary forces playing right now, that’s why even with all the political uncertainty premium it still is strong (plus it still has strong output and positive current account as a whole monetary area). However, right now price is sitting at a similar low level than in 2009 and USD is much more stronger compared to the start of the crisis in 2008.
There is a secular change going on, if you look at charts you can see the “slow” build up of the euro from early 2000′s until the pinnacle of the credit boom, this trend has reversed since 2007-2008 in a broad range with 3 tops during unstable times. What is novel is now when weakness is coming is not the euro which is rallying but the USD, this is exacerbated by the demand of USD denominated assets (equities and specially treasuries). If European economy is doing worse and output decreasing, the current account gets worse or more balanced(positive feedback loop playing here) and when currency repatriation decreases (selling of assets abroad) the currency is gonna suffer.
As for signals in the short term, look for proxies at commodity markets and the carry trades. Is not only the EUR/USD pair that matters, look at AUD (topping IMO) and the British pound, and the obvious: developing markets currencies which will have weakness when world trade and activity diminish sharply. Volatility right now is low (a new major move is building up) and the dollar index has stabilized and holding the current price level, looks ready to rally.
Economic growth does not come from money printing. The more money/debt they create now, the higher the bill will be later on, meaning the economy will have to grow that much faster. Or, the real value of money will have to decline dramatically. Either way, the bill must be paid with actual wealth. In the first instance, it is paid via productivity. In the second via confiscation through debasement. There is no free lunch.
Recessions and depressions are how the economy clears the excess of inflation, as money/debt creation runs too far ahead of wealth creation. They are like forest fires. Forest fires are destructive. But they also serve a necessary purpose in the environment and they are a part of the renewal process.
Our governments like to pretend that we can have our cake and eat it too. Otherwise they would expose the truth about our corrupt monetary and banking systems. We, as a society need to grow up, face facts and throw out the crooks who foisted the current system upon us.
Europe has the right idea in aggregate. They need to go through a period of adjustment. But once they clear away their debts, they will be in a much stronger position. The problem with Europe is that the bill is being paid mostly by the people and not the financial elites who largely caused the problem.
Like your ‘forest fire’ analogy. To extend it further, if certain basic economic facts were generally understood (see CR’s FT Op-Ed), measures analogous to ‘controlled burns’, etc. could avert catastrophic corrections.
(Concerning your follow-up below, any ‘workers’ in danger of losing their shorts as well should contact CR – see his comment under ‘Buffet’ posting.)
Excerpts from a fresh post by Danielle Park:
The good news about the push back against austerity in Europe now, is that it forces a desperately needed new phase of thinking.
Over the past 3 years, banks have managed to hold governments hostage […} The truth is that the economy has already collapsed. Only through further irresponsible debt issuance have governments and bankers together, been able to create the illusion of some economic recovery.
The truth is that there is only so much cash flow to go around, […]no matter how much governments cut spending–budgets cannot balance while still paying back debts in full to bankers.
The truth is that debt reorganization and write-downs along with austerity are necessary in order to close budget deficits. […]In order to transform debt-paralyzed people and countries back into engines of growth and tax revenue, they have to get first become cash flow positive again. This requires paying out less than one brings in and building up surplus savings.
Banks have tried to hold themselves harmless at the expense of real economies and workers everywhere. But in doing so they have smothered growth and recovery prospects. The workers are down to their tee-shirt and shorts while bankers continue to collect bonuses and doll out dividends. This let-them-eat-cake approach has always been doomed to fail.
Cleaning up after the financial crisis requires the shared sacrifice of all stake holders. […] Governments will have to be downsized. Citizens will have to make do with less.. Yes many banks and individuals will go bankrupt– such is the capitalist way after all!
Getting the crushing weight of extractors like bloated banks and drug cos off individuals will help tax payers everywhere afford more. Money available for productive parts of the economy will then rise significantly: education, conservation, environmental protection, smarter energy, better infrastructure, arts and scientific research will all be affordable once more. But first we will have to earn that recovery in the good old-fashioned ways, like sacrifice, discipline, hard work and tough love.
This http://www.zerohedge.com/news/guest-post-fraud-theft-will-continue-until-morale-improves is also timely and germane to this post.
A key takeaway: “Any rational person knows that income comes from one of two methods: working or investing. A country can only grow by working, saving, investing and living within its means. Money taken from workers and investors and transferred to the non-working and spenders [e.g. via monetary inflation] is NOT INCOME. It is just redistribution from producers to non-producers.”
Amen. We need to create more wealth. Not more debt money.
The fact that movie goers spent $200+ million this weekend to see “The Avengers”
says tons about the “American Consumer”
metaphorically:
1) Were looking for “Real” Hero’s and “Real” solutions
2)”Hulk smash” will come to those with “False promises”
3) If you win the battle you “Earned it”
“The Avengers” is a great movie–go see it–it will make you feal better about the future