A little over a year ago, I ran some of the unfortunate math behind our economic plight.  I said:

“the initial stimulus plan helped give the appearance of recovery, but it did not solve the actual problem.  It merely papered over the problems and injected some short-term relief.  The problem of debt was still (and still is) brewing under the surface.  Now as the stimulus effect wears off we are realizing that the household sector remains incredibly weak, but there is no political will to attempt to solve the problems at hand.

…What this all likely means is that growth will remain well below trend as the consumer continues to de-leverage.  This creates a particularly uncertain environment for corporations and leaves the economy highly susceptible to exogenous risks (China, European debt crisis, housing double dip, etc).  Political gridlock and continued misdiagnosis in government will certainly not help.”

My thinking was relatively simple – the balance sheet recession was putting unusual downside pressure on consumer spending and the paper recovery due to government deficits was slowly peeling away, but the deficit remained large enough to avoid any sort of collapse.  Since then, the U.S. economy has weakened, but not collapsed.  In other words, the balance sheet recession (BSR) has persisted, but so has the government aid to a large degree.

Can the Balance Sheet Recession be modeled?

I’ve been working on trying to build an economic model that would accurately reflect my work on the balance sheet recession.  When I was building the model I expected the historical data to be a poor reflection of the general economic conditions of the last 50 years, but the results surprised me.

What I’ve built here is a model for future expected GDP growth using a combination of the sectoral balances approach along with a private sector credit element.  My goal was to capture the story that has been ravaging the U.S. economy for the last few years.  For those who aren’t aware of the balance sheet recession – it is essentially what occurs following an era of private sector credit accumulation resulting in a boom/bust phase.  The asset price correction leaves the debtors servicing pre-bubble era debts with post bubble era cash flows.  The result is a rare reallocation of spending to saving as the spenders focus on paying down their debts.

This has always been a sustainable and self correcting process over the years because the U.S. consumer has always been below the threshold of unsustainable debt:income levels and the U.S. government has generally run deficits that exceeded minimum required levels, thus providing a natural stabilizing element.  That all changed with this most recent recession when household debt to income levels ballooned to over 125%.

Some economists have called the BSR theory “inadequate”, but I have argued that these economists are working under a defunct economic model that misunderstands the important difference between certain creditors and debtors within the economy.  They claim that “for every creditor there is a debtor”, but fail to understand that all debtors and creditors are not created equal.  More recently, they have claimed that the household balance sheet position is not as bad as the BSR theorists claim.  I think the evidence points to the contrary as consumer borrowing has experienced a once in a generation collapse.

Anyhow, there are lots of moving parts in these inputs for the model (current account estimates, CPI estimates, etc) and it’s still very much a work in progress that I hope to have completed some time next year, but what I’ve built is a fairly simple preliminary model which attempts to predict economic growth based on private credit expansion and an understanding of the importance of the sectoral balances and the ways that the three sectors of the economy interact.  The math behind the model essentially shows contracting horizontal money and insufficient vertical money creation to bring the economy back to anything resembling healthy growth.  I fully understand that trying to model so many moving parts is an imprecise exercise to some degree, but I think we can acquire a better understanding of the likely path of the U.S. economy using this data. *

I’ve assumed a relatively consistent current account deficit (3.5%) and utilized the CBO’s 2012 and 2013 estimates for government deficits (roughly 8.6% and 4.5% of GDP).  I’ve also assumed that private sector credit growth will moderately improve over the coming two years from a negative position to a neutral position (one could easily argue that this is optimistic, but I am erring on the side of reduced government deficits resulting in less debt reduction than is currently necessary).  The math does not lead to a rosy outlook for the coming years and even given some margin of error, the odds of strong economic growth are low at best.

What are the findings of this model?

The output from this model shows a rather stunning lead time over the last 7 recessions (to my surprise, it appears that our current predicament is not quite as unique as one might originally believe – it is only far larger).  The model leads every recession by several quarters with the exception of the early 90’s recession which was shallow by any metric.

The current data does not bode well for the U.S. economy.  Based on this model, the U.S. economy is likely to begin officially contracting in 2012 as the balance sheet recession continues and government spending slows.  The good news is that the model is not predicting a contraction that is  deep like we saw in the tumultuous 70’s.   The bad news is that our government does not understand that we have been in one long balance sheet recession this entire time and as private sector credit growth continues contracting (or flatlining), they will be required to offset the lack of growth via higher than normal budget deficits.  You can see that the current recession was well on its way to becoming a disaster like the 70’s until Q1 2009 when the deficits exploded.  The problem currently, is that the Federal budget deficit is likely to remain high in 2012, but then peel off to a level of 4.5% of GDP in 2013 (again using CBO estimates and assuming no further stimulus of any kind).  That’s worrisome as I have estimated that the BSR will persist into 2013 without a surprise resurgence in private sector credit (which will be unsustainable anyhow).

(Contractions highlighted in red, recessions in blue areas)

The bottom line is that this model is showing an economy likely to begin moderately contracting in 2012 (~0.88%) although I would argue that we’re splitting hairs talking about the difference between real growth and real contraction when the economy is as weak as it is.  The truth is, we’re in a balance sheet recession and as the government slowly peels away the spending that has propped up the U.S. economy, the consumer will prove weak once again.  So, the bad news is we’re still in for a muddle through period.  The good news is the deficit will remain large enough to avoid substantial economic contraction.  But the worst news is that our government and the world’s leading economists still have no idea what is causing the current malaise so the risks in this environment remain far higher than they should be.

The upside risks to this outlook are a vast improvement in private sector credit expansion and/or a sizable increase in the government’s budget deficit.  The downside risks are all exogenous in my opinion – China, Europe, continued BRIC slow-down, cost push inflation via oil or other commodities, etc.  

** This is not an economic forecast, but rather a new model I am still in the process of working on.  


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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  1. I already covered Beckworth’s claim that the BSR view is inadequate.

    In all honesty, I find it staggeringly silly to claim that household balance sheets are fine and merely aren’t being enticed to spend money (Rognlie’s focus on corporations also highlights how QM’s miss the focal point of the current household crisis). Rognlie also claims that household balance sheets are just perfectly fine. How detached from reality can one really be? Economics requires a certain level of common sense. This view that the consumer’s balance sheet is just fine just smacks of economists sitting in their classrooms and not getting out in the real world enough….

    Most importantly though, the point they miss is that it’s not about assets and liabilities. It’s about debt relative to income. Then again, these are the same economists who model the economy without including the banking system…..

  2. Beckworth also claims there is a debtor for every creditor so the BSR view doesn’t matter. But again, this completely ignores the fact that this is a consumer driven economy and the consumer is abnormally weak. All creditors and debtors are not the same in this economy and the fact that it’s the consumer who is the weakened debtor matters enormously.

  3. You raise an important point. Because they don’t include the banking system in their models they entirely misunderstand how banking works and the fact that money is created endogenously. Beckworth says:

    “Thus, a significant portion of the money supply is being hoarded and not spent. This is the excess-money-demand problem.”

    He adds:

    “I like to call it an excess money demand problem. Either way the key problem is that there are households, firms, and financial institutions who are sitting on an unusually large share of money and money-like assets and continue to add to them. This elevated demand for such assets keeps aggregate demand low and, in turn, keeps the entire term structure of neutral interest rates depressed too.”

    So Beckworth’s solution is simple:

    “Had the Federal Reserve been targeting nominal GDP at this time, it would have provided enough liquidity to fully offset the spike in liquidity demand. Such a response would have stabilized actual and expected nominal-GDP growth in 2008–09 and prevented the collapse of the economy. It is that simple.”

    Except, it’s way more complex than that. The Fed doesn’t add liquidity. They don’t really print money. That’s why Beckworth said QE2 would work:

    In short, because they don’t understand monetary operations and modern banking they totally misinterpret the channels through which monetary policy can actually impact the real economy.

  4. This is also why they support programs like negative int rates. They think we need to force money out of banks so it can sprout wings and fly away into the arms of borrowers! If only lending worked like that…..

  5. Cullen, how likely do you think it was that demand from China’s infrastructure boom spilled over into the US and acted as a fiscal stimulus for us? China looks at risk of a hard landing and falling into their own BSR. Wouldn’t that drag the US down with it? If so, I would say what happens in China is key to predicting what happens here. Let me know if I’m misunderstanding anything.

  6. Cullen, i’m curious how much things change when you alter the current account deficit assumotion in your model? I ask in the sense that, (X – M) = (S – I) + (T – G) – and, in my view one of the primary causes of this mess was a trade balance issue caused by administered currency rates and negative real rates (which are obviously interrelated). Any light you could shed on current account deficits within the framework you use?

  7. Nice work.

    So to what extent does this get you to a sense of earnings over the next couple of years?

  8. Negative interest rates might work if they were actually applied to everyday borrowers. I imagine a lot of people would go take out loan for a car or whatever if they could actually get PAID money to do so.

    Try this as a pitch car dealers;

    “Come on down to Riverside Ford today and walk away with a brand new Explorer, we’lll even PAY YOU 150/month to take it off our lot. Limited time only !!!”

  9. debtors and creditors..LOL

    I am capital positive.A baby boomer witha life times accumulation.I am that creditor. The debtor has already got more than he can service at current income levels. As a creditor I find little or no demand for my money so the retrun on that drops which inhibits my income and ability to consume …pop so much for the creditor and debtor theory ..

  10. Hi cullen, My internet connection is very slowly, but i like your posts, inspirative and innovative.
    Keep your posts update, thanks you very much….

  11. Great commentary as usual, CR. The only point I would dispute is the assumption that the deficit will be 4.5% of GDP in 2013. As you know, CBO’s estimates are based on the non-indexation of AMT and the end of the Bush tax cuts. If these two things happen, I think it will cut substantially into whatever economic growth (and corresponding withholding tax growth) they envision. On the other hand, if these two programs are extended, the deficit will not be cut anywhere near the baseline estimate.

    I don’t know if that makes a big difference in your argument, but using the CBO baseline is to assume unicorns, IMHO. (I’m not knocking CBO–they are forced to produce these estimates this way.)

  12. Consumers were spending their home equity for years. Many people were becoming “richer” when the stock market was cruising nicely. Personally, I made as much on my portfolio as I did in income for a few years. Those conditions no longer exist. With an uncertain future, deleveraging is the only logical thing to do. Unless you have at least $5 million saved, any spending has to be based on income. There are not too many consumers in that comfort zone and there won’t be anytime soon. And income is shrinking.
    Deficit spending will have to be accompanied by significant tax cuts to get this economy rolling. Anybody see that politically feasible?

  13. IMO, it is wrong to focus only on aggregate demand. Companies will be steadily adapting to the reduced demand for their services, and new ones will be being started that will be well adapted to the conditions right from the start. When enough companies have done enough adapting, confidence will start to grow – and then money will start to flow again. Then investment (financed by private borrowing) will grow – and we’ll be back in a virtuous circle.

  14. Cullen, you have got Rognlie and Beckworth wrong. Neither of them assume monetary policy works by pushing funds through the banking system to increase the money supply. Rather, both assume that the Fed works through the signalling channel to increase aggregate demand. That is, by changing expectations about the future path of monetary policy the central bank can affect current spending decisions of the non-bank public. In this story, banks respond to improved economic activity of the non-bank public, they don’t drive it.

    For example, see this post by Rognlie, or this one by Beckworth,

  15. The Fed can increase liquidity – bank liquidity. It had to shore up the financial payments system with massive increases in reserves. We can argue that was to reduce interest rates, but the 0.25% payment on reserves was to ensure that banks would hold excess reserves to enable smooth settlements. Payments on reserves isn’t necessary for interest rate maintenance, unless you want to target a reserve level.

    The point is that bank liquidity does not equate to household liquidity. Of course healthy corporations were able to take advantage and refinance debt (I wonder how much of corporate earnings increase was due to lower interest expense, which is pretty much a one-time benefit). That is the extent of the Fed’s fiscal impact, with perhaps some asset speculation thrown in.

  16. Great work & something you’ll never see in the msm even though its probably the best way to model the reality of the current world we live in.

    One thing that I find hard to quantify, yet is certainly in play is the virtuous/vicious cycle which can ensue when the data shifts (+/-).
    Per your * – “The downside risks are all exogenous in my opinion – China, Europe, continued BRIC slow-down, cost push inflation via oil or other commodities, etc.”

    Am I wrong in my thinking that if we get the start of “official” negative growth (even a -.5%) that the reaction in terms of business capex, inventory build, confidence, etc. and consumer discretionary spending & savings trends could in fact spiral in a vicious cycle which creates a self-fulfilling deep recession?

  17. I fully understand that trying to model so many moving parts is an imprecise exercise to some degree, but I think we can acquire a better understanding of the likely path of the U.S. economy using this data. Cullen Roche [bold added]

    I would agree if we truly had a free market including, of course, private currencies. But we don’t have that. Instead the usury and counterfeiting cartel, our banking system, has a choke-point on the economy via its money monopoly.

    Bankers have long known how to create depressions – just stop lending. If we truly had a free market it would essentially say to the bankers “Fine, we’ll create our own monies interest-free”

    Good luck with the model, Cullen. If we had a true free market, your task would be impossible, imo. As it is, I expect you to have great success modelling our banker fascist system.

  18. Cullen,

    I have some comments/questions on your graph of Expansion/Contraction. First, the contractions around 1976 and around the double dip in the early 1980’s are large in comparison to the other contractions in your model. Why were they so large?

    The contractions for our current period and slightly in to the future are small in comparison to the 70’s and 80’s contractions. As a predictive model, you are indicating that out to 2013 we have contraction but nothing like the 70’s and 80’s (yes, this is repetition). How credible is this outlook? What could turn the contraction environment over the next 1 to 1.5 years in to a 70’s or 80’s contraction.

    At this present time I am convinced the Republican party will gain the presidency in 2012 and they will also gain control of the Senate and the House. They say they will apply “kitchen table logic” to government. If they drastically reduce government spending how will this alter the depth/length of the contraction in going forward as depicted by your model?

    Can you include in your model, any effects of significant changes in the euro zone?

  19. Beard, do you have any citations on how a “private currency” system would work? You throw around loaded words like “fascist” “cartel” “counterfeit” and “fraud” a lot, and it makes it hard to take you seriously. If you have any source material, I’d love to read it. Or, if you can present a level-headed argument as to how an alternative system would actually work, versus vilifying the current, operational one, I’d be all ears.

  20. Beautiful work Cullen! Keep fine-tuning your model and the next step is what policy interventions could best impact our condition. krb

  21. I certainly shouldn’t bunch Rognlie in the “banks lend reserves” camp, but unless Beckworth has changed his position, then he certainly seems to believe so. Marshall and JKH spent an entire post explaining all of this to him about a year ago. If he’s changed his position then I am out of date…..

    They still misinterpret the issue which is really rather basic. There is certainly some hoarding of cash going on in the US economy, but it’s not occurring at the consumer level, which is the only level we should really be focused on. Who cares if Apple is hoarding cash? Who cares if Exxon is hoarding cash? In the aggregate, American businesses do not feel incentivized to invest this cash back in America via jobs, infrastructure, etc. The real problem is because domestic revenues are too low. And domestic revenues are too low because the US consumer remains weak. So, rather than spending, they’re allocating an unusual amount of the their income to paying off debt.

    Krugman is out with another piece this morning saying he can’t understand this. I know they’ve never run a business, but come on. How can you be so out of touch with reality that you make the argument that the consumer is just hoarding all of their money because they have too much of it and not enough cool things to spend it on. The problem is that incomes relative to debt levels have fallen and it’s causing a reallocation of spending at the consumer level…..

  22. do you have any citations on how a “private currency” system would work? Pierce Inverarity

    No, but I am confident the private sector could and would create any number of private currencies once the government enforced/backed counterfeiting cartel was abolished.

    You throw around loaded words like “fascist” “cartel” “counterfeit” and “fraud” a lot, and it makes it hard to take you seriously. Pierce Inverarity

    They are loaded – with truth. And I have substantiated them in detail. Btw, I rarely use the word “fraud”.

    If you have any source material, I’d love to read it. Pierce Inverarity

    You could Google “F. Beard”. I would love to suggest other writers but I fear they are all gold-bugs. Certainly primitive money forms should be allowed for private debts but we should insist that non-usury money forms such as common stock be allowed too.

    Or, if you can present a level-headed argument as to how an alternative system would actually work, versus vilifying the current, operational one, I’d be all ears. Pierce Inverarity

    It’s pretty simple and derives from Matthew 22:16-22 (“Render to Caesar …”) – separate government and private sector money supplies. Basically, the government would create, spend, tax and provide free storage and account transaction services for its fiat. The government would not borrow money, it would not lend money and it would not pay interest on fiat stored with it. Nor would the government recognize any other monies.

    As for the private sector, let it come up with its own money solutions without any government privileges such as a lender of last resort, legal tender laws for private debts, government deposit insurance, the capital gains tax on potential private money alternatives, and government acceptance of private monies for government debts (taxes and fees). The government should simply enforce the laws against fraud and insolvency and have nothing else to do with private monies.

    As vilifying the banks, do a Google on “banking quotes” and you’ll see that some of the most famous men in history have done so.

  23. I can actually change the estimates in the model fairly easily. Here’s a balanced budget in 2012 for instance. Changes the outlook a little bit, huh? :-)

  24. I don’t think they quite get the fact that when households in aggregate pay off their credit card bill the money disappears.

    They must still think that money goes somewhere. Sure the banks will try to leverage their capital as best they can, but where are the takers?

  25. Could it be that they’re looking at the aggregate money supply data and concluding that since M3 hasn’t declined since 2006 that the money must be hoarded? I am sure this is true to some extent, but the problem with the US economy certainly isn’t that US consumers are hoarding cash and can’t get enough income…..Maybe they’re looking at the corporate component and making the sweeping conclusion that we just need to give corps an inventive to invest?

  26. Cullen,

    I do think Beckworth has subtlety change his views thanks to MMTers as is evident in the link I gave above. Also, I don’t think they say consumer are hoarding cash, but money assets in general. That post Ralph left above is a good example of that thinking. And what I find most intriguing about that post is the last figure in it that shows a strong negative relationship between the velocity of money and the money share of assets households hold. That has to mean something.

  27. Interestingly, I just spoke with Greg Valliere last night (Political Strategist) and he firmly believes that the tax cuts will expire Dec 31, 2012 under a Obama win or loss scenario.

  28. It’s super frustrating because government response has actually been to encourage the consumer to increase their debt levels.

    Where I live, the government responded by increasing the FHA conforming limits to $740k for homes, although it has recently decreased to $625k. The household income was $90k prior to the recession. This is a 6-7 DTI for a houshold (two income households are the norm here). The indebted state government also handed out $8k rebates to buy homes (which was subsequently wiped out by further declines in housing).

    This is where extended ZIRP monetary policy is dangerous in my opinion. Both monetary and fiscal policy are currently aimed to encourage the consumption of more credit. However, increasing debt at low interest rates will make those dependent on high asset prices to support the debt very sensitive to interest rate hikes in the future (we’re talking 1-2%, not hyperinflation).

    We also have extended ZIRP wrecking havoc with underfunded pension liabilities, which are being hidden using account tricks since they cannot meet the target of 7.75%. These accounting tricks can not last for long, as the balance sheet recession is causing tax receipts to come in below expectations right as an aging workforce / forced early retirement increases pension withdrawal.

    I am not sure you are aware of this Cullen, but the California budget is also around $700 million in the red from lower than expected tax receipts. It was -$300 million in the month of September alone. At -$1 billion, and -$2 billion austerity measures will automatically kick in through trigger cuts.

  29. Yes, as Rognlie says in his balance sheet reality story, they essentially believe that the US consumer’s balance sheet is not that bad. Do you think it’s credible to argue that US consumers have so much “money assets” that they just find themselves overwhelmed to the point of not knowing what to do with it all?

  30. I guess we’ll have to wait and see. If a Republican wins the White House I think this one pretty much resolves itself. But that’s another moving part here, huh?

  31. Great stuff. An additional article with some sensitivity analysis or alternate scenarios would be very interesting to the readers, imho. (balanced budget vs. keeping payroll tax cuts vs. full implementation of jobs bill vs. additional stimulus (aka fantasy-land), etc.)

  32. It just goes to show much the govt spending has propped up the US economy in recent years. We would literally be spiraling out of control without it….

  33. Good idea Ted. This model of mine is fresh out of the oven so I am still tweaking it and working on it. I am surprised by its historical accuracy though so it leads me to think I am onto something at least somewhat accurate….

  34. Cullen:
    A higher trade deficit would have an expansionary effect would it not?
    Then why are we trying to increase exports and reduce imports?

  35. perhaps the issue is the marginal debtor does not equal the marginal creditor.

    people pay down their debt, the creditor wants to re-lend but there are few new borrowers.

    less borrowers than before = reduced new debt = contraction

  36. thanks cullen for all your work, the voice in the wilderness does seem like a lonely job, but one thing that i feel everyone is missing is that there may not be a return of consumer spending anything like what it was in the past. just one point is the reduction in good paying manufacturing jobs, from roughly 25% of the workforce to 8% now and probably dropping. the economy does need something to give it a jump like when the automobile came on the scene or tech in the 90’s but i don’t have a crystal ball to look into. again thank you.

  37. Unless international trade agreements are amended going forward, jobs will continue to be exported.
    Unless government is drastically cut and government pensions rolled back, government will continue to run inflationary deficits.
    The consumer borrowing that is continuing, is shifting from discretionary, to necessities.
    To do what is needed to insure long-range economic health, will cause short-term economic pain.
    When this is all taken into account, the most probable outcome going forward is higher unemployment, higher inflation, larger disparity between the classes, deficits in government’s ability to support infrastructure and entitlements, and a population that indebts themselves increasingly for survival rather than the acquisition of assets.
    Not a pretty picture.
    Of course there is always the possibility that world wide depression will cause world leaders to increasingly lash out and blame other nations for their peoples suffering.
    That usually ends in war.

  38. Another way to interpret this is, our whole economy is linearily related to spending and there is nothing we can do viz a viz productivity, inventiveness, freer markets etc. to improve our lot in life (i.e. standard of living, reduced unemployment). Maybe it’s true, but sad anyways.

  39. The international trade agreements are fine, The US has the right under the WTO to impose trade barriers “needed to restore equilibrium to the trade balance”. Our politicians don’t tell us that because there’s more money to be made if we don’t know.

    the [Buffett] program does not distinguish between countries, and thus it does not unduly disadvantage some countries to the benefit of others. This approach is consistent with [WTO] Article XII provisions regarding the avoidance of unnecessary damage to trading partners

  40. Who needs IC’s? Squanderville isn’t attributable to the USA. As long as we have politicians who understand our monetary system there should be no need to tax imports as we run large enough deficits to offset the negative outflows….

  41. “As long as we have politicians who understand our monetary system…”

    Alas, that’s where things fall apart. Such politicians do not exist. My point is that changing the subject to the trade deficit is the least harmful way to harness the crazy.

  42. Lots of good discussion here and on the “Misunderstanding BSR” post – really getting to the root(s) of the problem. Just to highlight and add to what I think are important points of emphasis :

    – Distribution matters. Not just of incomes , but of debt and wealth. Aggregates are misleading. The problems we’re seeing reside primarily in the bottom 80% +/- of the income distribution.

    – Related to distribution are MPC concerns , which many deny even exist. The top 1% , who capture ~ 25% of all income , have a much lower average and marginal propensity to consume than those in the lower income ranges. This difference was even more stark during the credit bubble , of course , when the MPC from incomes of the lower income groups was > 1.0

    – Sumner et al. can’t provide a transmission mechanism for MP that can be expained at street level. The exception might be a Bernanke ‘helicopter drop’ into the back yards of the lower and middle classes , but that really looks more like fiscal than monetary policy , right ?

    – One point that Koo makes that’s often overlooked relates to a ‘behavioral’ aspect of a BSR. People traumatized by foreclosure , bankruptcy , repeated job difficulties , etc. , have a tendency to stay away from accumulating debt thereafter. This is not just a matter of months , or even years , but rather FOREVER in many cases. This was true in Japan , and also here following the GD. We shouldn’t ignore this likely developing trend in modeling how our economy – one that’s been dependent on debt for so long – will operate going forward. Borrow a dollar -spend a dollar , is gone. It’ll be more like : earn a dollar – save a bit – spend the rest.

  43. Jeremy Rifkin (‘The Third Industrial Revolution: How Lateral Power Is Transforming Energy, the Economy, and the World’) portrays the following:

    “the third industrial revolution is about lateral power, it favors small and medium-sized businesses coming together in networks to create new economic opportunities. The third industrial revolution will create thousands of new businesses and millions of new jobs. Manufacturing renewable energies, converting buildings to micro power plants, storing renewable energies in the form of hydrogen across the infrastructure, transforming the electricity grid and power and transmission lines into an energy internet, and revolutionizing the transport and logistics sector. [It requires] an ongoing relationship between local state and federal government, industry, and communities…[and] comprehensive planning, which brings into the picture local governments as well as local businesses and communities.”

    Descriptions of current exemplars in places like Germany are the most convincing part. If you can believe in it, it certainly provides an optimistic vision.

  44. “[T]he paper recovery due to government deficits was slowly peeling away, but the deficit remained large enough to avoid any sort of collapse. Since then, the U.S. economy has weakened, but not collapsed. In other words, the balance sheet recession (BSR) has persisted, but so has the government aid to a large degree.”

    What if the gap is structural and trending stable or even wider due to demographic inevitabilities? What if US deficits at 10%-12% of GDP persist indefinitely in order to avoid painful domestic adjustments? MMT tells us that it shouldn’t matter to the USA; Japan is Exhibit A, and the current Treasury market is Exhibit A-1. However, investor and market psychology, and the self-fulfilling fear trade and investor herding behaviors, are potent wild cards. Capital tends to sit in the face of uncertainty, but once it decides risk is excessive it can move with great (and disruptive) rapidity. Risk “feels” very high right now for the US, Europe and China, and weak leadership adds uncertainty.

    Trading on Wall Street is dominated by SkyNet; regular investors have fled. That enhances volatility, the risk of herding and another flash crash. The relative resilience of markets in the face of all of this tells me that there is real opportunity here for the patient and the bold, but God help you if you are caught leaning the wrong way at the wrong time.

  45. F. Beard,

    I agree with your key words – fascism, counterfeiting, cartel (and fraud is related to counterfeiting).

    Could you give us some background on yourself and how you come to these conclusions?

    I personally am analyst / portfolio manager on the buy side and my work is made very difficult (to impossible) by all the distortions this system produces (and my career / portfolio performance, wealth growth etc. are quite slowed down to a disappointing level)

  46. Walter,

    euro and china in a race to take down the planet. i guess the only thing that can PUT OFF an exponential debt bubble pop…is more exponential debt…..

    you can put out a match by throwing it in gasoline fast enough….but i wouldn’t try it.

    historically, Shanghai(SSEC) is 3 months ahead of NYSE.

    if you look at it right now, it isn’t pretty:


  47. Great work. I always appreciate your perspective, and the theory makes sense. I think the overall trend of cleaning up balance sheets continues in both personal and corporate finance. Fundamentally, corporations continue to strengthen their balance sheets although share price remains low. Share price being a factor of future cash flows, that would point to exactly what you’re saying: Pre-bubble debt is being serviced with post-bubble cash flow, leaving no room for excess expenditure and no current expectations of increased future cash flows. I personally think this trend will continue for at least another 2 to 4 years, and hope that government emmulates the trend sooner rather than later.

  48. I am not sure that the issue is necesarily with corporate reaction to the current consumer environment. I think that corporations are aware of this, and high unemployment reflects that. I think the biggest deal is that consumers need to clean up their balance sheets. This is the big catch-22 of the economy right now: The economy depends on strong consumers to add capacity, but consumers are not able to increase consumption because of low wages and employment levels.

  49. “A higher trade deficit would have an expansionary effect would it not?
    Then why are we trying to increase exports and reduce imports?”

    Trade deficit subtract from GDP. Now if we were at full employment (which Bill Vickrey thought under 2.0%), trade deficits would allow us to divert excess aggregate demand around our employment/output capacity, like those floodgates upriver from New Orleans. With a large enough trade deficit, our GDP could exceed Potential GDP without excessive demand-pull inflation (to be sure, Vickrey also thought we needed tools to control cost-push inflation).

    Alas, we’re not at full employment (and every single economic theory in support of free trade assumes we’re at full employment). In the real world, we have a tremendous amount of idle workers and industrial capacity. Our $550B or so trade deficit creates a demand leakage that drains both employment and output, flood gates aren’t such a good idea during a drought. If we increased our budget deficit to fill this demand leakage, it wouldn’t be a problem, but the politicians fear deficits like zombies fear fire. This is become a problem even when the economy is recovering. On this sectoral balance chart, check out where domestic private sector savings are just before the 2001 and 2009 recessions.

    When the size of budget deficit falls below the size of trade deficit, domestic private sector savings begins draining away until, out of the blue, the economy implodes. It will happen again unless we bring trade into equilibrium first.

  50. Any chance you can expand on how you constructed the model (which variables you used, what kind of equations, etc)?

    I understand if you don’t want to share it, but asking never hurts ;-)

  51. Getting private debt income down from 125% to 80% would take 9 years at 5% a year, taking you to 2017, assume the debt payback moderates back down to 70% this could take a couple of years at 5% a year or 10 years at 1% a year.

    5% a year plus 3% foreign net saving means the deficit has to be 8% plus bank/business saving until 2017…not 4.5%, I can’t see that being the deficit until 2017 if de-leveraging moderates to 1% a year…panic over.

    So that means some conflict from 2013-17 around the 4-8% plus deficit…and that’s assuming 8% plus corporate can hold for the next couple of years.

    I can’t say I share your optimism! ;)

  52. …bump for follow ups…

    Oh, realistically I’d expect a smoother deleveraging change of gears in say the 2015-19 mid period…whatever way you look at it, it’s another sluggish decade, but needn’t be a disastrous reduced living standards one like the last for those from Masters Level down, the 97%, as opposed to Ph’Ds, Lawyers, Doctors (and Bankers?).

  53. Thanks for countering the idea that ‘trade deficits don’t matter’.

    Even in good times, I am not convinced that sizable trade deficits are long-term sustainable. They may be part of a ‘structural reason’ (such as ‘marx-reloaded’ inquired about in another post) for the creation of the ‘consumer debt bubble’, and other deleterious effects on national economies.

  54. Cullen,

    In your new graph are you only removing the deficit amount from current numbers in 2011?

    What happens as you decrease the amount of the balanced budget?

  55. Cullen, I am very disappointed by you. We would not “literally be spiralling out of control”. i assumed this was some meta-ironic hipster meme to propogate the word “literally” as a synonym for “figuratively”. I never expected to find it here. :(

  56. Cullen, if you can play with tthehe model easily, i’d be VERY curious to see what it looks like if you were to make the seemingly unrealistic assumption of a current account deficit of 0%. I say this because i am convinced that trade imbalances have played an under appreciated role in the mess. Id be very curious to see what the output on your model looks like with that assumption.

  57. Growth moves to approximately 3%….Pretty healthy recovery we’d be having assuming the budget deficit we are expecting for 2012….

  58. See Steve Keen’s debt deflation blog and his book Debunking Economics.

    Steve has done huge work on modelling an economy with debt flows.

    Steve was one of the very few who argued that the GFC would occur. The question for those who say your model/debt based models is inadequate is: “What did your models predict for 2008 in June 2007?”

  59. I have not reviewed Steve’s most recent work, but last time I checked he was not including the vertical component which is sort of like studying the human body, but leaving out the brain…..

  60. Cullen, any chance you can give a very rough outline of the methodology behind your model. Not asking for the secret sauce, just rough guidelines.

    Presumably you either forecast C, I, G, and E based on some other variables which you think lead them and use that forecast Y?

  61. Do you have any comment on the Godley-Lavoie SFC models? Are they also missing these components? I have briefly looked into them, and they seem more consistent with MMT views. But still quite complex stuff, so need to spend more time on them. Very interested to here your opinion…

  62. So 0 current account balance moves 2012 GDP growth from -0.88% to approx 3% without increasing deficit… Is there any other monetary or fiscal policy tool that can do this?

    “Without increasing deficit” is an arbitrary, senseless constraint, but since it controls our lawmakers, it controls the rest of us too.

  63. Seems pretty straightforward, right? In an economy where the pvt sector is this weak, the govt sector drives the majority of the growth, but they don’t see the CA as a leakage so we’re at risk of contraction because the govt won’t run large enough deficits. All in the name of a bankruptcy that isn’t going to happen….

  64. I asked you about backdating it to 2009 (presumably we’d add approx 3.6% to each quarter’s GDP?) because its political poison for Obama in the general election. Its not like Import Certificates were suggested by bloggers or Republicans. It was put forward by his friend and advisor Warren Buffett (and sponsored in the Senate in 2006 by liberal favorite Russ Feingold).

    Obama’s going to be out next year attacking Republicans with his Buffett Rule– (millionaires shouldn’t pay a lower tax rate than middle income families).
    Since Romney has already endorsed tariffs on China, he should counterpunch by taking the trade issue to the next level– Rename the Import Certificate plan, “the Real Buffett Rule”(X = M). He could show on a chart (your chart!) the lost opportunity for higher GDP growth and lower unemployment, possible without any new govt spending or higher deficits. Obama lost this opportunity because he thinks Tim Geithner knows more about the economy than Warren Buffett. Political poison, I tell you.

    Incidentally, from China’s perspective (and ours), an IC market is better than a China-only tariff. With ICs, China is free to continue to manipulate their currency by using their dollar reserves to outbid everyone else for the necessary US Import Certificates. So China could keep on exporting to us the same amount at the expense of our other trading partners. We’d have a 0 current accounts balance, in any event, so it wouldn’t be our problem. Win-Win!

  65. isn’t there a rational argument that credit growth could actually be a bit of a surprise package in this mix, given your assumptions. That’s not the desirable fix i’m looking for, but shouldn’t there rationally be an upward bias to household liabilities: household disposable income, given where rates are?

    If you’re using the CBO 4.6 on deficit, and you’re assuming 3.5 on current account. given that, (X – M) = (S – I) + (T – G) ; that would imply that you’re looking at a much smaller positive on S-I. So IF we see fiscal deficit in the 4s, and CA deficit at 3.5, there would be a net gain on I, relative to S, relative to 2011, right?

    Personally, I look at the X – M picture as being much, much more important than most people do. Particularly when you look at it on a global basis and compare trade balances to historical trend balances. That’s where things really got ugly, in my view and that’s where the imbalances stem from, to my mind. Any thoughts on this, cullen?