CAN WE MAKE IT TO 2013/2014?

Over the last few years I’ve been fairly negative on the economy.   I underestimated the effectiveness of the fiscal stimulus in 2009, but on the whole the economy has remained sluggish at best.  Despite this, I’ve never swayed from the balance sheet recession approach which I first began using in 2008.

The theme has been generally consistent – in a balance sheet recession the government must step in and fill the spending void.  This would create the mirage of a recovery, but it would help avoid something far more disastrous from developing.  Underneath this mirage lies the balance sheet recession and she lurks to this day.  That said, I’ve been deeply critical about the calls for austerity in the USA and the persistent calls by those who said hyperinflation was lurking or sudden rate surges were on the horizon (they were wrong).  Luckily, we’ve been able to fend off the fearmongerers thus far.  We even passed a payroll tax break (albeit a small one), but we largely offset it with the QE2 program (which I also said would fail with flying colors).   So my euphoria over the tax cut was to be short lived.    But in this disaster zone known as economic forecasting I’ve gotten the macro picture far more right than wrong.

I’ve previously discussed why I believe the balance sheet recession in the USA could end by 2013 or 2014.  And now we’re beginning to get a clearer picture of what will come out of the debt ceiling debates.  For now it doesn’t look like the cuts are likely to be as harsh as some might fear.  But they’ll be a drag on the economy given the extraordinary stimulus we’ve seen in recent years and the continuing de-leveraging trend.

In a recent note Societe Generale analysts provided their baseline scenario:

“Our baseline economic forecast for the US reflects policymakers continuing to raise the ceiling every time the country nears it, fearing the consequences if they do not. We have not factored in any austerity aside from the planned expiration of the 2010 fiscal stimulus package over the next two years. The political calendar, which has the 2012 elections on the near horizon, provides only a small window of opportunity to come to an agreement on a long-term deficit reduction plan. Under this baseline, the deficit-to-GDP ratio will shrink after this year, but begin to rise again later in the decade; while the debt-to-GDP ratio will continue to rise (see charts 4 and 5). See the table at the end of the document for more details on our US economic outlook.”

If we just assume that the recent current account trends continue (3-4% of GDP) and that SG’s baseline scenario is somewhat accurate we should expect government spending to become a major drag on economic growth in 2012.  SG has a baseline growth rate of 3.5% in coming years.  I’ll take the under on that.  The dwindling fiscal stimulus is already creating drag in 2011 and the risk going forward certainly appears to be to the downside.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

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.

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  • chris

    Why do you favor Social Security (payroll) tax cuts? They impinge on the SS trust fund and hurt SS in the long run. They also give deficit-hawks ammunition with which to attack SS. How about growing the economy instead with revenue sharing and creation of a new WPA to stimulate employment and demand?

  • MMTer

    Tax cuts have been the only politically feasible fiscal response.

  • PARK

    One objection. As always. Hard landings are good for the economy.

    Read below:

    Of course, as the article mentions, the option for a hard landing
    is only available when there are no other options…

  • Adam

    You need to read up on MMT to better understand how our monetary system really works…

    You will then understand that payroll taxes (or any tax) funds nothing.

  • Cowpoke

    The reason payroll taxes can hurt is because corporations are less inclined to give pay pay raises thus hinder long term net gain for the employee.

  • But What Do I Know?

    So what do you think, CR? If the projected tax increases happen in 2013 (2012 for the payroll tax reduction), will the balance sheet depression be exacerbated?

  • El Viejo

    I thought the Payroll tax cuts were brilliant psychologically. A one time tax rebate goes right into the bank or credit card payoff, but a subtle increase in pay tends to be spent thus stimulating the economy. Everyone understands the phenomenon of personal spending rising to meet the income.
    There is nothing wrong with growing the economy or WPA. Most are looking for a quick panacaea fix. That’s what Americans do. Give us a pill and be done with it. The solution for today is many small solutions and time.

  •!/jdstein J.D. Stein

    I agree that you have gotten the macro picture correct. More challenging is navigating the vagaries of capital markets to make money for clients. It becomes a serious case of game theory because while a contained depression view will ultimately be vindicated, most investors and gov’t officials are trading and setting policy from a completely different playbook. The key is to combine the correct long term macro view with the correct short to intermediate view of market sentiment. One could get bearish from an MMT perspective by 2003, yet capital markets and economies didn’t collapse until. 2008.

    Always enjoy your writings.

  • JH

    There is a lot of skewed logic in this piece.
    First, it does not address the real root cause of our economic trouble, which is the loss of jobs and the negative real earnings of the working class.
    Second, it ignores the fact that the so-called improvement in the economy was financed by the government, and is now a liability that has to be serviced. It has had no real permanent value, and will decline when government stimulus is removed.
    No matter how much the truth is twisted to make a trap for the fools, the fact remains that like everything else in the universe, in the financial world, every action induces an equal and opposite re-action. The path to real sustainable financial recovery goes through austerity. The path to financial ruin goes trough ever increasing debt.
    We are playing a fools game where only the wealthy who can manipulate the laws and lawmakers will benefit. We are seeing our future happening now in Greece with the selling off the people’s assets to the same people who caused their financial disaster in the first place.

  • Pod

    JH – don’t be silly, there is such a thing as “free lunch” when you are the sole-issuer of your currency.

  • jeffc

    Why do you see 2013/14 as a potential bottom of the balance sheet recession? Are you looking for the bottom of credit destruction or stabilized house prices? I’m trying to understand how one would know when the “bottom is in” a bs recession.

  • JH

    And Santa Claus, and the Tooth Fairy are real….

  • Rahul Chawla

    Government spending only creates a mirage of a recovery because most (but not all) government spending is basically a malinvestment that leaves behind debt particularly if it is politically driven. It crowds out private sector investment and deleveraging that is needed to reignite growth. Unfortunately all goverment spending and borrowing adds to the GDP, the way it is calculated, so politicians are able to claim credit for this fake recovery. Ultimately the government spending driven recovery will fail because there is no real return on the projects the government is funding but there is a real cost of the borrowing that accumulates over time.

  • Cahn

    “We even passed a payroll tax break (albeit a small one), but we largely offset it with the QE2 program (which I also said would fail with flying colors).”

    I’m no economist; so would really appreciate your explaining why payroll tax break was offset by QE2.

  • Coolidge Low

    The capital flows are moving the same as they did in the 1930’s. To give a flash back on history, the Great Depression was a two phase event. Phase I was a normal speculative correction with the typical 60% decline. Phase II, was the beginning of the sovereign debt crisis. Remember the famous bank holiday came during Phase II, not Phase I of the Great Depression ( ) Brilliant summer read.

    The Sovereign Debt Crisis that is unfolding will wipe out trillions in wealth. The reason there has not been massive hyper-inflation thanks to the trillions of dollars injected during Phase I of the downturn, is due to the rise in money supply that merely offset the collapse in velocity that is increased through LEVERAGE.

    Greece by not being allowed to default has to be Bernanke worst nightmare! The capital flows we are witnessing will ensure Phase II of our depression. Equities & Gold could explode later this year to the upside as capital flows back to the United States pushing up the dollar. The Euro should rally here in the short term as well as all other investment thesis that follow (china included as they peg to our dollar).

    Keynes did not advocate perpetual deficit spending. (remember Keynes became outraged at what took place post World War I with German Reparations that he feared would lead to economic chaos. If he was alive today he might be a blogger) Government debt will bring down the United States. Communism as well as socialism will always fail because they steal the concept of future from the people and dictate what it would be from there on out. The Wealth of Nations as Adam Smith pointed is that it all depends on the core concept of future. Governments cannot force markets to do what is economically unsustainable. We are in an unsustainable world where markets only rally when socialism injects.

    It is the debt that will destroy the United States as it will destroy Europe and Phase II is beginning to unravel. Bernanke has lost control. Greece must default and Europe has to go through its process or the United States is toast economically and ultimately a complete melt down in our markets around 2013/2014.

  • reader xyz

    Question, what will the effects of the “Health-Care Reform” legislation be on the economy ???? My premiums have gone up to over $400 per month and that’s with a 50% subsidy from a part time job with CalPers. Every year it goes up about 25%, it’s no wonder that disposible income for average people have continued to drop. At the current rate of increases I expect to pay $800 per month by 2014. Is there any chance they will bring back a public option to control costs ??? Which I really doubt.

  • first

    Government spending is either your money which you could have spent any way,or valueless paper over and above real GDP growth which dilutes existing money.

    Notice that Market up = Dollar down since 2008 the only way and times that the dollar moves up now is on fear not prosperity.

  • Tom Hickey

    What about the next financial crisis? The span recently has been about 10 years. The estimate is now narrowing to about 5 years. That puts the next on in the range of 2012-2015. I would venture to say that the “next” financial crisis is the next leg down in this one.

  • Mgkurilla

    Why is it that projections and forecasting always have things turning around immediately with future estimates? SG projects the deficit dropping from nearly 10% in FY11 (which itself is still a partial estimate) to just a tad above 6%. Is this realistic at all? I understand that the figures are based on current law, but then the Bush tax cuts were suppose to expire for FY11. Medicare always has planned cuts to reimbursements that never materialize. How accurate have demographic projections been? SS outflows are likely higher now than projected even a couple of years ago because of limited employment options for the 60+ crowd.

    How accurate was Mark Zandi’s projection of unemployment rates with and without the stimulus? The likely scenario for FY12 is a continuing resolution of FY11 with whatever increases in SS, Medicare, and deby interest. There’s unlikley to be meaningful change to the current tax code (in order to get a debt ceiling deal) so the revenue side is constrained. What about dealing with Freddie and Fannie; where’s that factored in? We recently learned that ongoing war efforts are more expensive than previously estimated and now we have Libya as well. Does anyone believe that student loans default rates will remain at current levels given increasing tuition costs and employment options for recent grads?

    Exactly where is the economic growth to drive employment gains suppose to come from with Europe going austere? Finally, does anyone actually believe that between now and 2021, the US will not experience a recession?

    The SG graph looks more like something from a re-election campaign promise than credible financial reserach and forecasting.

  • Gerald P

    Stick with intermediate bonds and mid cap growth index, period. Forget the greed of Wall Street and the ignorance of Washington. There is nothing you can actually do about them, and you will sleep better. If your bonds go down you still have income which is what matters, ’cause that is what you can spend. And you may have noticed that bond value rises when the the market tanks, nothing new about that. You can gamble to try to get rich, but it ain’t worth the stress. The rich only sleep well AFTER they have the wealth. All things being equal, you will live longer. SAVE, SAVE, SAVE!

  • Gerald P

    This does not prevent you from appreciating the knowledge of understanding MMT, or the insight of CR.

  • Ben W

    My guess: QE2 led to speculation in commodities, which raised prices in food and gas. The money saved from the temp payroll tax cut was offset by the inflation, so the consumer is no better off than before.

  • rhp

    “gov’t spending is malinvestment”………I think that is a gross generalization.

    Do you feel NASA is malinvestment, interstate highway systems, defense, soc security, student loans??

    I believe a strong case could be made that the biggest malinvestments were made by the TBTF banks in the mortgage industry, leading to massive overbuilding to be paid for by people who could not pay, and the gov’t bailed out those that “malinvested”. Also, right now, as Cullen often points out, a very large percentage of our GDP is being invested in the FIRE sector which has little useful productivity at times. Is it a good investment for our top brains to go into the FIRE industries as opposed to technology, biotech, science, and non-financial industries??

    Do you feel that US corporations investing everything overseas is good investment? By what parameters are you measuring? If simply in dollars “saved” by the corporation by using lower paid workers in Malaysia, then perhaps “yes”. If measured in terms of building of communities and local economies here in the USA, then perhaps “no”.

    Was it a good investment for California to pay China to build the new Oakland Bay bridge, as opposed to US workers?? Yes, it “cost’ less, but that money that might have gone to US workers did not circulate in the US economy any longer. It simply ended up buying US treasuries (by China) or land in Africa (by China). -

  • VRB II


    I don’t seperate TBTF banks vs. govt. spending. I dont’ take sides here.
    Govt. spending is wastfull. Govt. bail outs are disasterous. the private sector should never ever ever be bailed out. If they are TBTF then you better let them fail ASAP before they get bigger. I know how much failure scares everyone so how about…reorganized…receivership…unwound. Much softer.

    A bridge should be built by the company who will do it best at a price that makes sense with out bribary or kickback for those handing out the contracts. That is how we make decisions. We don’t give money to American companies who can’t control costs just because they are american. There’s nothing American about awarding contracts based on social contracts. If you can’t compete you fail in this country. That’s what makes us great. And why we are dynamic.

    China is not the largest buyer of treasuries. WE are. What China does or doesn’t do with the money we give them is not our business. They like us have the right to invest where ever they think is in their best interest.

    Your right we shouldn’t pay the Chinease to build a bridge and they shouldn’t hire us for our services. We should all just self invest and turn inward. All U.S companies should not be allowed to get contracts outside of the U.S and puerto rico.

  • b_b


    QE2 is now finished and ten year T’s have spiked to 3.17%.

    Knowing the T rate is the expectation of future cash rates, is now the time to go long 10 year T’s and take advantage of the fear perpetuated by the ill informed ie: Gross.

    Would really appreciate your views.

  • rhp

    well, i’m certainly not CR, but here’s some thoughts. 10 year note is basically a risk off trade as people go for safety. As QE2 wound down,uncertainly caused trsys to spike higher (lower yield) and equities were dropping. Currently, the situation is at least temporarily reversed and equities are climbing again. If Cullen does not have time to respond to you (and I’m amazed at how much he DOES respond, but the boy never sleeps……..) be aware that his current algo is “risk on”, and he is buying the dips in equities, which probably would point toward T bills going lower (higher rates) as people are not being scared off by Greece, debt ceilings, china, or whatever.

    Whenever his algo kicks in to “risk off” trade, would be my bet on going long Tbills.


  • Cahn

    Thank you Ben for the explanation. That makes great sense to me.

  • b_b

    I appreciate your thoughts

  • Andrew P

    I don’t see the problem. The Treasury can finance itself in 3 ways – borrowing, tax receipts, and money printing (or its electronic equivalent). If Congress won’t raise the borrowing limit and tax receipts won’t rise, the Treasury is simply obligated to print up the difference in order to spend the appropriated funds. The Fed can partially sterilize the effect of all this seinorage by selling the T-bonds on its balance sheet, but this printing would still be inflationary. So what? It is the judgement of Congress to print rather than borrow. The USA does not default. It prints.

  • Scott

    I gauge “malinvestment” not only as effective (doing the right thing), but also as efficient (doing the thing right). Government programs such as the interstate highway system and student loans may be hugely valuable, but the question needs to be asked, “were/are these programs designed and managed effectively to minimize cost and maximize gain?”. In many/most cases, I’d argue the answer is “no. Nor should we expect them to be when design and execution is guided as much by political expediency as anything else. Furthermore, when people are using other people’s money, they have no skin in the game and no incentive work harder/smarter or do more with less or take prudent risks. There are many wonderful programs managed by federal, state and local governments, but I think very few of them are run well. That begs the question,”Are private market versions better alternatives?”.

  • rhp


    totally agree. I was taking issue with the generalization….. it is always a question of efficient allocation of resources, as Cullen often points out. In my more personal case, I grew up listening to my father (major architect of many student loan programs and congressional legislation) weigh in against gov’t direct student loans because of the waste he felt was inherent in the gov’t bureaucracy. But I suspect he had no idea of the predatory lending that would develop in the private sector in such a short time span.

    Which sector is more efficient? I used to believe almost always private. Now, I’m not so sure……….