DEBT IS STILL THE PROBLEM AND DEFLATION IS THE PAINFUL SOLUTION
We understand that we have discussed the debt problem in this country for what seems to be forever, but we can’t stop talking about it now that the debt is clearly the catalyst for the latest stock market downturn. Debt is discussed by the pundits on financial TV also, but in almost every case the discussion revolves around government deficits relative to GDP or government debt relative to GDP. They are constantly comparing the U.S. government debt to every other country in the world (especially Portugal, Italy, Ireland, Greece, and Spain-PIIGS). We believe that the government debt should be taking a back seat to the private debt which is much larger and must eventually be deleveraged.
(Exhibit 1)
The private debt is about 6 times larger than our government’s public debt; about 4 times larger than our government’s gross debt (including the government debt used to fund our Social Security shortfall); and about 2.5 times the gross government debt plus the total state and local debt. Household debt alone is equal to 96% of GDP; private domestic nonfinancial debt is 183% of GDP; total credit market debt is 357% of GDP (see first chart Selected Debt Measures as a % of GDP). Please note that the only form of debt that isn’t rolling over is the government debt.
(Exhibit 2)
We have been predicting for over 3 years that the government debt (including public, gross, and state and local governments) will increase substantially, while the private debt (all forms) will roll over and decline substantially. In round numbers total credit market debt is $55 trillion and government debt is $15 trillion, leaving private debt at approximately $40 trillion. We have drawn debt cones (see 2nd chart-debt cones) to illustrate the concept. We believe the government debt will rise towards the $30 trillion level while the private debt will drop towards the $20 trillion level. This coincides with the Cycle of Deflation (next chart) which we authored years ago.
(Exhibit 3)
(Exhibit 4)
Most bears on the stock market are fearful that the Administration and Fed are printing far too much money that this will result in potential runaway inflation. We, on the other hand, do not think the results of the Fed’s balance sheet increasing through quantitative easing (QE) will result in inflation in the next few years, although it could very well be a serious problem further down the road. We believe the private sector debt will continue to decline (deleverage) regardless of what the Fed and Administration do to attempt to jolt the economy.
The reason that the attempt at money printing to juice the economy will not work, in our opinion, is that the whole private sector is frozen due to the fear of losing more money. Corporations are continuing to build up cash positions and individuals are afraid of taking risk in this environment. The latest economic releases verify our opinion that the private sector is losing confidence. Corporations are afraid to take on more employees—we gained only 33,000 jobs in the private sector in May and just last week reported a disappointing gain of 83,000 jobs in the private sector. It would take average monthly increases of over 130,000 jobs just to keep up with the average gain in the labor force. Last week the Conference Board reported that the Consumer Confidence index for June declined to 52.9 from 62.7 in May.
(Exhibit 5)
New single family home sales collapsed 32.7% from April to a record low rate of 300,000 (see the next two attached charts). There are estimates of about 10 months of shadow inventory of foreclosed homes currently off the market and not included in the national inventory. The national inventory of homes available rose to 8.5 months supply in May. Today it was announced that demand for mortgages to buy homes dropped 2%. It was the 8th weekly drop in the 9 weeks since the credit for home buyers expired on April 30th. We just recently wrote a comment dealing with the potential for a second dip in housing prices on June 10th titled “The Dire Outlook for Housing”.
(Exhibit 6)
The Fed believed that Quantitative Easing (QE) would stimulate the economy much more than it did. QE includes all of the measures the central bank takes to increase the monetary base, hoping that this translates into increased money supply. However, in the current credit crisis QE is not working as well as the Fed and Administration expected. While it has succeeded in jump-starting the monetary base it has failed to increase the money supply or velocity (the ratio of economic transactions to the money supply). Thus, while the banks now have the ability to make new loans, not enough qualified borrowers are interested in borrowing money, and banks are not willing to loan money to anyone that is not a prime borrower. What we need to stimulate the economy is “velocity” which measures the rate at which money in circulation is used for purchasing goods and services. The velocity of money is computed by dividing the nation’s output of goods and services by the total money supply (circulating currency plus checking account deposits). Velocity of money is also influenced by interest rates. When rates are low, people hold more money in cash, when rates are rising, they put more money in interest paying investments.
(Exhibit 7)
When velocity is low the nation essentially winds up in a “liquidity trap” which is a situation where monetary policy is unable to stimulate the economy either through lowering interest rates or increasing the money supply. This was the condition that Japan found itself enveloped in from 1989 to present. We expect the same problem in this country and hope (really hope) to be wrong. If we are lucky we will be able to go through the slowdown we expect (or double dip) and repair the household balance sheets enough to grow out of this mess in less time than it is taking Japan.
If we are lucky we will be able to go through the slowdown we expect (or double dip) and repair the household balance sheets enough to grow out of this mess in less time than it is taking Japan. Comstock
No luck would be needed if new money was just given to the debtors and savers (everyone). Warren Mosler’s idea of eliminating the Payroll Tax could add up to 12.4% to the take home pay of workers or at least 6.2% Politically, how could the evil Republicans be opposed to a tax cut?
Also, it is time to quit using the word “stimulus”. It carries an unhealthy association with drug use. “Debt relief” is more accurate though it will offend many too. But it shouldn’t since savers would also get a tax cut or a debt relief check.
We should be grateful to the Japanese for showing US what won’t work. Debt relief should not be thought as radical but as the only remaining option.
Yes, we are in a mess. What would one expect of an inherently dishonest money system? It’s time for reform.
i think Comstock has been reading Pragcap……..much to their credit.
goodmorning F……buddy i agree w/the slinging out TPC notes idea,to some degree.
OFF subject so don’t read if you didn’t like forrest gump:
sent money to NJ guy to rent house in keys(craigslist—wwwwuuuuuu aaa-oooo) hadn’t heard from guy got worried, talked to him last night finally, hes a “canyon” fishermen—sportfishing up there…….they go out n stay for days cause its 120 miles to gulfsream…..anyway we not due to get in there til week from saturday,he apoligizes, says hell, the keys under the matt, you can get in NOW for free….we scrambling around trying to get going ASAP…laptop n flyrod—check….from concern to euphoria in one day… a box of chocolates it is.
like the market.
Is it too late for
1: lowering taxes via extending Bush tax cut expiration and
2. total moritorium on payrol tax
3. privitising Govt. (any/all) services
4. accelerated depriciation (200% – 300%)for CAPEX
5. future flat tax
?
Privatizing government services is simply transferring a public monopoly into private hands in desperation (ie a reduced cost below what that asset is really worth). Not only is that transparently unconstitutional (ie the act of privatizing a public monopoly is clearly against the general welfare and is an act of individual welfare). It won’t work to boost the private sector and foster economic growth either.
Economic growth does not arise from monopoly – public or private. It arises from competition and Schumpeterian “creative destruction”.
There are ways of getting government out of the business of doing what they shouldn’t be doing in the first place. But “privatization” as it has been practiced over the last 30 years (worldwide more so than in the US) is NOT the solution. Rather, that sort of privatization is precisely the sort of lazy-thinking cronyism that undermines honest government.
Sadly, when it comes to reversing previous government overreach, there is a lot of truth to the Maine saying “You can’t get there from here”. I live in that part of the US where the consequences of federal overreach are most clear — the Mountain West where the feds are the biggest crappiest most irresponsible landowner and where the effects of that landownership have for decades so constricted/gutted the local economy that there are no people here. That consequence – controlling the population by controlling water supply and land development so that the region cannot compete with established population/power centers in Congress – was quite deliberate. I am far more in favor of eliminating this federal stranglehold than you can ever be.
But please please. Don’t just throw around bumpersticker phrases as a “solution” when you clearly haven’t thought about the issue (ie you transparently want government action to distort investment/economy via CAPEX but don’t supposedly want government action to distort anything else). The use of “privatization” as a bumpersticker phrase merely encourages laziness of thinking — and that laziness is what allows cronyism.
F. Beard
“if new money was just given to the debtors and savers”
That’s sounds like a trick that could keep prices of real estate high in La La Land and lower the value of obligations and debt outstanding.
That is basically bailing out debtor by inflating or if you prefer offsetting deflation by giving new money to the debtors and savers (everyone) as you suggest.
This would show up immediately in the federal reserve report and the reaction would be that holders of trillions of dollars in bonds would understand the coming devaluation of there financial assets. The market would adjust and demand higher rates. Bond price would fall and the economy might fall in to a deeper recession. The US as enough problem as it is with huge financial assets that are often priced mysteriously and not necessarily on a Mark-to-market basis. The last thing we need now is that there priced be wipe away.
If a person purchased 10 houses for a flip in Florida I wont cry. if a person can’t take a few minutes to read a mortgage contract he has now just received a free education, if a person had no credit, paid no interest and some one sold you him such a stupid mortgage, well he can take the keys back to the bank since he just had a free ride in a house that was never is.
This would show up immediately in the federal reserve report and the reaction would be that holders of trillions of dollars in bonds would understand the coming devaluation of there financial assets. The market would adjust and demand higher rates. Bond price would fall and the economy might fall in to a deeper recession. first
First, reflation is not the same as inflation. Second, a new distribution of legal tender would provide new funds to lend without leverage. Third it is morally justified; savers were cheated out of honest interest rates and borrowers were driven into overpriced real estate.
If a person purchased 10 houses for a flip in Florida I wont cry. if a person can’t take a few minutes to read a mortgage contract he has now just received a free education, if a person had no credit, paid no interest and some one sold you him such a stupid mortgage, well he can take the keys back to the bank since he just had a free ride in a house that was never is. first
It would be no skin off your nose since you would receive an equal distribution. Plus, it is not like we have an honest money system. Instead it is a government backed counterfeiting cartel. Of course it has perverse incentives. How could it not?
F. Beard
“morally justified”
Not the same for all.
From the money that was borrowed was against overvaluation a very large percentage was spent on consumption Cars, B.B.K., Boats etc.. all against those overvalued assets.
To that extent they are paying spending not mortgages with same and somewhat devaluated dollars.
From the money that was borrowed was against overvaluation a very large percentage was spent on consumption Cars, B.B.K., Boats etc.. all against those overvalued assets. first
And whose fault is it that those assets were overvalued? Surely the banking system is to blame.
“reflation is not the same as inflation” ?
I will try that with a deflated balloon I suspect it will get back to the same place.
Just kidding but……
You like reading read “End The Fed”.
I’m almost finished with Ellen Brown’s Web of Debt. Her solution is to nationalize the banks. It will be a shame if capitalism never figures out how to do money properly.
@F. Beard
I’ve read alot of your posts regarding sound money, and a much of it makes “morally intuitive sense” given some of the on going abuses by the central banks. However, what it sounds like you propose is a modern version of the individual “banknotes” of the late 19th century. I don’t see how having 250 competing, but sound, currencies is preferable to the current situation. ( Further those are just as easily debased as dollars, maybe more so, no?)
I mean we had a Gold Standard, and we evolved of of it because economic activity was limited to how much gold we had. So we went floating and convertible.
Plus, you can go to market and buy whatever you want with your dollars, any time you want. So you can save in rubles, pounds, Yen or oil barrels…
At some point a central clearing house must be empowered by law to enforce what is and what is not money, and its supply. There’s no getting around that without reverting to barter-ville.
Has the Money Supply expanded wildly beyond the amount of goods and services in the US over time? Meaning, sure a dollar doesn’t buy as much as it did 100 years ago, but 5% of all the dollars buys ALOT more than 5% of all the dollars did 100 years ago. Has our currency really failed us? Or our politicians?
The dollar is trusted more than any other currency. It facilitates international trade in a way competing banknotes cannot.
It is fungible and transferrable, and cleared in milliseconds.
I hear what your saying man, and yes the dollars has its issues, but compared to what? We have not evolved here by accident.
Sound money is a nice catch phrase, but much easier said than done.
I’ve read alot of your posts regarding sound money, and a much of it makes “morally intuitive sense” given some of the on going abuses by the central banks. However, what it sounds like you propose is a modern version of the individual “banknotes” of the late 19th century. I don’t see how having 250 competing, but sound, currencies is preferable to the current situation.
The free market would decide on the balance between number of currencies and convenience. Who are you to decide?
( Further those are just as easily debased as dollars, maybe more so, no?)
Historically, leverage is limited to about 2-1 by market forces.
I mean we had a Gold Standard, and we evolved of of it because economic activity was limited to how much gold we had. So we went floating and convertible.
I don’t advocate a gold or any other government enforced standard for private monies. Gold as money is barbaric, BTW.
Plus, you can go to market and buy whatever you want with your dollars, any time you want. So you can save in rubles, pounds, Yen or oil barrels…
Common stock is an ideal store of wealth and a excellent money candidate.
At some point a central clearing house must be empowered by law to enforce what is and what is not money, and its supply. There’s no getting around that without reverting to barter-ville.
I disagree. The free market could easily perform those functions. Government involvement in private money supplies is exactly what is to be shunned except for the usual laws against fraud and insolvency.
Has the Money Supply expanded wildly beyond the amount of goods and services in the US over time? Meaning, sure a dollar doesn’t buy as much as it did 100 years ago, but 5% of all the dollars buys ALOT more than 5% of all the dollars did 100 years ago.
Who knows what amount of price inflation is ideal? I presume it should approach zero at least in the medium to long term. Let’s let the free market decide, eh?
Has our currency really failed us? Or our politicians?
The system has failed US, imo. Let’s see if liberty can’t find better solutions, I say.
The dollar is trusted more than any other currency. It facilitates international trade in a way competing banknotes cannot.
It is fungible and transferrable, and cleared in milliseconds.
Computers and modern communications make any plausible number of currencies doable. The dollar may lose it’s status because our banking and money system is destructive to society.
I hear what your saying man, and yes the dollars has its issues, but compared to what? We have not evolved here by accident.
Yet we are in a major world-wide recession again with cheated savers, underwater homeowners, insolvent banks and bankrupt state governments. On the horizon are trade wars and the scapegoating of aliens and the poor.
Sound money is a nice catch phrase, but much easier said than done. scharfy
I don’t advocate for any particular money form so don’t presume you know what I have in mind. I imagine gold and silver certificates, commodity backed certificates and common stock would be some of the forms. In addition, the government could issue money that was legal tender for government debt only.
We shall see. Don’t expect the population to put up with needless austerity. Money solutions will be found and they won’t necessarily be benign.
Excellent, Mr. Beard, but why do you say gold is barbaric when it is the free market preferred money through history and is the element with the best money characteristics?