The Continual Failure to Understand the Balance Sheet Recession

Ezra Klein and Bill McBride are excited that the government is reducing spending in the next years because he says it’s “real progress on the debt”.  He says:

“Let’s do some quick math. Start the clock — and the deficit projections — on Jan. 1, 2011. Congress cut expected spending by $585 billion during the 2011 appropriations process. It cut another $860 billion as part of the resolution to the 2011 debt-ceiling standoff. And it added another $1 trillion in spending cuts as part of the sequester. Then it raised $600 billion in taxes in the fiscal cliff deal.

Together, that’s slightly more than $3 trillion in deficit reduction. After accounting for reduced interest payments — as there’s now less debt to pay interest on — it’s more like $3.6 trillion. That’s real money!

In fact, that’s about enough to stabilize the nation’s debt-to-GDP ratio over the next decade. If over the next few years, say, there’s another $800 billion in deficit reduction — imagine a new deal that cuts $400 billion from Medicare and other mandatory spending while raising $400 billion in taxes — then the country is put on a declining debt path.”

 Of course, he’s not alone.  This has been a perpetual concern by policymakers and pundits for years running.  And it’s completely wrong.  The saddest part is that this isn’t terribly hard to understand.  The balance sheet recession is a rather simple concept.  We know from Wynne Godley’s sectoral balances that the sum of the private (private), foreign (x-m) and government (t-g) sectors must add up to zero.  In wonk talk, that’s:

(S-I) + (T-G) + (M-X) = 0

If we get a bit more granular we can really break this down to understand how the economy grows.  Monetary Realists like to use this breakdown:

S = I + (G – T) + (X – M)

Which rearranges to:

S = I + (S – I)

This takes the private sector component and breaks it down to shows a clear distinction between households and businesses by showing a focus on private investment.  In other words, the (S-I) piece grows primarily through two pieces – household consumption AND private investment.  But what happened in the last recession?  Private investment and domestic consumption fell in unprecedented ways.  And while both are crawling back we’re still digging out of a deep hole.  So that left two sectors to bring us out of the hole.  The foreign sector in the USA is a current account deficit so it’s a drag  on growth.  That leaves the government sector to drive spending.

The most interesting part about this entire recession is that we’re seeing two real-time experiments play out.  In Europe, where the problems were largely the same, many of the economies are in depression because the government sector pulled back spending at a time when the foreign and private sectors couldn’t sustain growth.  So you ended up with depressionary economic environments in many countries.  But in the USA you’ve seen continued (meager) growth.  Why?  Because the government continued to run a large budget deficit.  This isn’t to imply that deficits are always good and that government spending can’t ever go wrong, but this environment was literally “different this time”.

But still, we hear endlessly about how this deficit has been bad.  We hear about how the debt in the USA, a nation that can’t “run out of money” is somehow going to drive us to bankruptcy.  It’s all wrong.  Yet we still read about the same myths on a daily basis.  It would be funny if it wasn’t so sad.

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.

More Posts - Website

Follow Me:
TwitterLinkedIn

  • matthylland

    Cullen, Love the site keep it up!
    I am relatively new to the Balance Sheet Recession idea, (and economics in general), but am trying to learn as much as I can. I am half way through Koo’s “Holy Grail” and read this site on a regular basis.

    When you say: ” Private investment and domestic consumption fell in unprecedented ways. And while both are crawling back we’re still digging out of a deep hole. So that left two sectors to bring us out of the hole.”

    What are you using to watch the status of the recovery? Some things that would make sense to me would be:

    Total Value of all C&I loans (about 20% below 2007 peak): http://research.stlouisfed.org/fred2/series/EVANQ?cid=32362

    Commercial Paper Outstanding (still at about half the level of 2007): http://research.stlouisfed.org/fred2/series/COMPOUT?cid=32996

    Total Consumer Credit (at an all time high): http://research.stlouisfed.org/fred2/series/TOTALSL?cid=101

    C&I loans from commercial banks (about 10% below peak): http://research.stlouisfed.org/fred2/series/BUSLOANS?cid=33078

    What else are you (or anyone else here) watching to see when loan demand has resumed, so it would be “safe” for the gov’t to start trimming the deficit?

  • MacroTrader

    It’s amazing when you try to explain this and similar concepts to people how they blatantly reject it as being false. Even in an industry where having a correct understanding of reality is key to longevity.

  • http://coppolacomment.blogspot.co.uk Frances Coppola

    Keep saying it, Cullen!

  • Andrea Malagoli

    I can agree that the deficit may not be as bad from a monetary standpoint. Yes, the US will not go bankrupt, but this is not the whole story.

    If we look at the “real economy” implications, there is potential risk that deficit spending is just trying to re-ignite a ‘business as usual’ environment, where people leverage up to buy the same old stuff. In other words, no real structural change of the economy, just going back to over-spending and over-consuming. Look at the automobile industry and the recent growth of consumer credit.

    I remain skeptical that we can have a “beautiful deleveraging”, as Ray Dalio claims. It just hardly ever happens.

  • Tom Brown

    For those of us who haven’t spent much time looking at those equations, I’ll post the relevant part (including definitions) from Cullen’s link above:

    GDP = C + I + G + (X – M)

    Where C = consumption, I = investment, G = government spending, X = exports & M = imports

    Or stated differently;

    GDP = C + S + T

    Where C = consumption, S = saving, T = taxes

    From there we can conclude:

    C + S + T = GDP = C+ I + G + (X – M)

    If rearranged we can see that these sectors must net to zero:

    (I – S) + (G – T) + (X – M) = 0

    Where (I – S) = private sector balance, (G – T) = public sector balance & (X – M) = foreign sector balance.

  • InvestorX

    The problem with higher govt spending is that it is normally less efficient than private spending. Ask the Soviets if you doubt. Another problem is that high govt spending begets even higher govt spending (bureaucracy crawl, interest expense).

    What the U.S. is acieving is:
    1. kicking the can over the ST vs. lowering the LT growth rate
    2. increasing the govt/GDP ratio
    3. redistributing income to the top 1%

  • Tom Brown

    Cullen, suggestion here: That equation you like so much

    S = I + (S – I)

    I really think you should highlight the key sentence from your link above that goes with that:

    “Private sector saving can be decomposed into the amount of saving created by investment “I” and the amount of net financial assets transferred from other sectors (S – I). That is the focus of the equation S = I + (S – I) as it highlights the fact that the private sector is the primary driver of economic prosperity while government is a powerful facilitator.”

    Otherwise, frankly, every time I look at that I just think, “Well, duh! Every 6th grader should be able to get that one w/o knowing what S and I represent:”

    S = I + (S – I)
    S = I – I + S
    S = S
    QED

    Personally your text I quote above helps ME (maybe it’s just me) arrange it in a more meaningful way:

    S = I + (G – T) + (X – M)

    When you speak of “consumption” in the article when talking about (S-I) I find it confusing, because consumption is actually “C” in the formulas you derive it from (in the link). It made me think: wait! Is S ” private spending?” … I had to go look it up.

  • Tom Brown

    Sorry, InvestorX, the above is not a reply to you. That was supposed to be a fresh comment.

  • Alan S

    Isn’t it S = I – (S-I)?

  • Tom Brown

    Yes, I realize you already had

    S = I + (G – T) + (X – M)

    … but then you keep going.

    It’s easier for me to see “net financial assets transferred from other sectors” represented by

    (G – T) + (X – M)

    but again, maybe that’s just me!

  • Tom Brown

    That wouldn’t work. That’d give you S = 2*I. What Cullen is saying is that S = S ;^)

  • TruthNotPropaganda

    Cullen wrote:

    “We hear about how the debt in the USA, a nation that can’t “run out of money” is somehow going to drive us to bankruptcy. It’s all wrong. Yet we still read about the same myths on a daily basis. It would be funny if it wasn’t so sad.”

    What Cullen doesn’t either understand, or is unwilling to admit, is that just because a nation can’t “run out of money” doesn’t mean that the value/purchasing power of the money it prints won’t purchase less and less (and often dramatically less over increasingly shorter intervals), nor that should the U.S. choose to “print its way out of debt,” it will be essentially de facto defaulting on obligations owed to its creditors, both foreign and domestic (if you loan party Y a dollar, and he pays you back in 30 years with 2 cents, did you not get rickrolled?).

    Most importantly, what Cullen either doesn’t understand, or is unwilling to admit, is that by printing fiat currency at higher speeds in larger batches, monetary policy (and fiscal policy, to extent it distributes said fiat) destroys incremental aggregate demand.

    Fiat currency does NOT equal wealth, folks. It is diluted in value as its volume increases.

  • Tom Brown

    Whoops! Scratch that!… that’s give you 2*S = 2*I, or S = I

  • Gerald G

    The solution doesn’t HAVE to be increased government spending, it can be decreased taxes. Either would put more money in to the hands of the people that need it to help increase their deleveraging activities faster or for those that might have already deleveraged sufficiently it would allow them to increase their spending. Personally I’d prefer decreased taxes (or at least not increase them) as I believe that the people are better able to decide what their money should be spent on then the government (e.g. I agree government spending is hugely inefficient).

    But if I’ve caught up sufficiently I would suggest that this would still not be entirely sufficient to return investment to the markets. Real regulatory reform is still required to provide confidence to the masses that their investments and borrowing will not just get sucked up again in some huge ponzi scheme by the banks and financial institutions.

    But what do I know, I’m still only up to reading Cullen’s entries back to 2011! :-)

  • Tom Brown

    Gerald G. I was going to write something similar… I agree also with your regulatory reform sentence. However, I’m not sure the way the GOP wants to lower taxes is best. I don’t know really… but it seems that their proposals would have vastly favored those at the top. I think you’d get a lot more bank for the buck lowering them (proportionately) more on middle income folks.

    Or, if you feel the need to have a government program, just cutting people checks (the “debt jubilee” idea) probably requires minimal bureaucracy.

  • Tom Brown

    Of course the “debt jubilee” is supposed to be a rare event (every ~50 years historically). It represents more of a shock to the system… whereas the tax breaks might make for a more gradual and controlled means of achieving a similar thing. If you’ve got a bunch (majority?) of people though who will NEVER pay down their debts sufficiently… tax cuts might be too slow.

  • Gary_UK

    Ah, the reality of Europe versus the myth of America.

    One will see their currency collapse, one will emerge from depression with a stable currency.

    As if government debt-financed spending was ever good for anything.

    You communists don’t get it, never will, til the game ends.

  • Gerald G

    Tom, I for one agree. I know Cullen loves the ‘beauty’ of the equation as he writes it with ‘(S-I)’ and in theory there’s 0 wrong with that. Heck, mathematicians & physicist do such ‘tautological’ substitutions all the time but they don’t leave their equations that way as they are effectively ‘meaningless’. They would replace the ‘(S-I)’ part with a different variable indicating what it really represents…say ‘N’ in this case for ‘Net Financial Assets transferred from other sectors’ (or any other available variable that doesn’t conflict with a previous definition). Then they’d work on understanding how I & N affect S independently.

    In fact I would suggest that replacing ‘(G-T) + (X-M)’ by ‘(S-I)’ incorrectly highlights private investment (I) as the fundamental component, it’s 1 component but N=(G-T)+(X-M) is equally important, if I understand the point of the equation anyway.

    OR if I keep along this line of thought, it would imply to me that the difference between Private Savings & Private Investment will drive a change in N, or N will drive a change in (S-I). Maybe Cullen is comfortable making the substitution in his head but I doubt the rest of society is & anyone initially coming to it would simply dismiss it as ‘obvious’ and lacking any particular extra meaning.

    Of course I should probably avoid trying to sound like I know what I’m talking about until I know far more than I do. :-)

  • Tom Brown

    Gerald G, you wrote exactly what I’ve always thought:

    “…anyone initially coming to it [that would have been me, for example, upon first seeing it] would simply dismiss it as ‘obvious’ and lacking any particular extra meaning.”

  • Gerald G

    Hi Tom…well now at least were debating the ‘best way to apply tax cuts’…of course Republicans would like to focus more on the top end but at least having them engage in the discussion puts a lie to the idea that the deficit is too large & that’s win 1.

    Then the Dems & Pubs can engage in meaningful discussion of which taxes to cut to positively affect the majority of people & businesses…for instance the FICA tax affects both & the Pubs would be hard pressed to argue that cutting it wouldn’t help business more than individuals…and aren’t the Pubs supposed to be the party focused on ‘plight of the private business owner’?

    Just one suggestion as to me it’s the most obvious, just did an analysis of my own situation for instance…I got a raise in Gross Pay & LOST money in Net pay due to FICA and now I’m less able to meet my spending needs…multiply by millions of employees & the businesses that have to pay for each employee & well…it seems self evident to me.

    Heck, I might even throw the Pubs a bone & go for the corporate tax holiday but I haven’t thought enough about that one & it’s implications for the wider economy aren’t nearly as obvious to me.

  • Tom Brown

    I actually remember feeling annoyed that I had to go try and figure out why that equation had any importance, because it sure didn’t look important! It looked, as you say, “meaningless.” I still feel a twinge of that every time I lay eyes on it!

    BTW, Love the idea of defining a couple of new variables… I was thinking the same thing except using two: net gov spending, and net exports, but yes, I agree that would be an improvement.

  • Tom Brown

    should be “bang” for the buck! bank for the buck… ha ha!

  • Gerald G

    But should we be ‘shocking the system’? I don’t see the current situation as the heart having stopped & needing a ‘shock’ to get it going…if indeed there was a time for that it’s gone past, the heart is beating but it’s rhythm is irregular. So now we need a ‘pacemaker’ approach, something to keep the heart beating slow & steady & not erratically.

    So yes, tax cuts might be a more slow approach but that’s a good thing, we should NOT be ‘greedy’ and over shock the system in my opinion.

    Having said that though, it’s not necessary that tax cuts alone be used…a full ‘debt jubilee’ isn’t necessary either, but since we bailed out the greedy money lenders it might be reasonable to implement policies on helping qualified individuals reduce their debt…I’ve read some articles on here on how to do that that seemed reasonable too.

  • Gerald G

    Well, as individuals we can do what we want, getting others to accept the definitions is the tough part. Math after all is just a language so everyone has to agree on the definitions of the language to make it useful.

    Given your other writings I get the impression you’re an engineer so we have a kindred spirit. I have a masters in theoretical physics but I’m no Stephen Hawking so my life took a decidedly different turn! Math is still my first love though.

    So let’s define the equation as ‘S = I + NGS + NE’, then at least you & I will know what we’re talking about. :-)…and if we had the ability to use proper subscripts we could do better N (sub) GS & N (sub)E…ah where’s MathML (or TeX) when you need it!

  • Tom Brown

    Good thoughts Gerald! … I like it! BTW, didn’t some MMT guy actually run for office under the “Tea Party” banner? Promising tax cuts for everyone? I’m pretty sure he lost…. probably didn’t even get the nomination, … once it became common knowledge what ELSE he believed!

    In general I hate conspiracy theories, and am suspicious of hyperbolic language, but I do enjoy being entertained by a little… uh, shall we say, unsubstantiated ideas sometimes. On the right, I like David Stockman… who’s an Austrian and an austerian as well… so I don’t really agree w/ him too much. But he does think things through, has some interesting knowledge to relate, and is adept at colorful language. I might even buy his book on “crony capitalism.” Mish Shedlock and Chris Whalen are also good too sometimes. Can’t stand Peter Schiff though!

    On the left, I like Michael Hudson. I don’t believe everything he says, and he’s annoyingly sure of himself, but I think he’s fun to listen to…. he’ll make very outrageous and inflammatory statements as if they are the most obvious facts in the world. Stuff like “Causing another depression is EXACTLY what they’re trying to do” when asked about European central bank policies, for example. I think Hudson might say, of the Republicans (Not that he likes the Dems any better, mind you), but he might say that their GOAL is not debt reduction, or deficit reduction or “fiscal responsibility” … he might say their goal is to SQUEEZE the little guy and state, local and federal governments with “austerity” using the debt as an excuse, so the “rentiers” can swoop in and gobble up public and private sector resources at a discount, and erect toll booths on everything, thus consolidating their stranglehold over the economy and our political system. He’d then go on to say, that the GOP lacks the political credibility to carry it off, and thus it’s up to the Dems and Obama to actually do this (which he’s sure they’ll do, BTW). Hyperbolic and inflammatory? Absolutely! Grain of truth to it? Perhaps!

  • InvestorX

    Regarding Europe, we know that the institutional setup isnot like the US one, so comparisons are not fair.

    Then, the US has also positive population growth adding to GDP growth, whereas Europe has no such beneficial factor.

    Finally, you are writing as if GDP growth by digging holes and filling them is the same as higher quality GDP growth. But no, there is no free lunch, so that deficit spending would be a no-brainer. Deficit spending just cements the mis-aligned status quo and prolongs the adjustment process, while implying an even more painful crisis down the road.

    I still have so far never seen any benefit of procrastination before addressing a problem. The quicker one takes the bitter pill, the quicker one can return to soundness and growth. Better short-term pain for long-term gain than the other way around.

  • Tom Brown

    I imagine that Morgain Wrastler guy (see comments in “Dorks” article) cheering the “rentiers” on … cause they’re the winners, and the rest of us “dirty hippies” are loser scum!

  • Tom Brown

    Agreed!

  • Anonymous

    The Balance Sheet Recession is only a hypothesis. Thesis at best. Neither may prove to be correct. I don’t mean to come across as argumentative, but the Balance Sheet Recession idea could be “Baloney” or incomplete of all the factors of a complex global machine.

  • Tom Brown

    :)

  • Android

    I agree with everything you said and I am glad somebody finally said it. However, I would just add a couple things:

    1) If we want to split up the private sector into households and businesses then use subscripts/superscripts to S and I for that designation.

    2) i) (I – S) + (G – T) + (X – M) = 0
    using the fundamental theorem of calculus:
    ii) d(private)+d(govt)+d(foreign) = constant (0?)
    which implies,
    iii) d(private + govt + foreign) = constant (0?)

    the sectoral balances eqn describes the dynamic flows/fluxes of net financial assets through the three systems which can be formulated as a system of PDEs. With the above, I am just trying to take what I see as the most informative eqn and rewrite it, but I don’t really know if I am adding any value, or if I am correct in my assumptions.

    Btw Gerald G, in what direction did your life turn away from theoretical physics. I am just curious. I am a biophysicist and, like you, I love math :)

  • Tom Brown

    You’ve got a lot of good links there. A simple one I like to look at is the overall private debt to GDP ratio. Keen updates it here occasionally:

    http://cdn.debtdeflation.com/blogs/wp-content/uploads/2012/01/010212_2140_TheDebtwatc1.png

  • Tom Brown

    Well that’s three of us (regarding Cullen’s eqn). Perhaps we can get a petition going ;)

    re: your point 2.): Now, wait… so S, I, G, T, X and M are time derivatives of savings, investment, etc? … or you’re adding that? I was thinking of them as the totals over a year… which I guess is the kind of the same in a difference equation sense with a sample rate of 1-year. Either case, I think your statements in 2-ii and 2-iii are correct…. and yes they would be 0 (on the right). I don’t see why not. Adam K mentioned in another post that these “flows” are similar to Kirchhoff’s current law (the sum of the flows into a node, must equal the sum of the flows out).

    Why PDEs exactly? Why not ODEs? Adam K, lluvatar and I had a long set of comments on this in the “Dorks” article (both pages) and the “Robots” article. I suggested (Adam K pointed out, like Steve Keen) we use:

    x’ = a(x,t)

    With “x” and “a” vectors and x’ = dx/dt … i.e. the general homogeneous nonlinear state space DE. Adam K said that there’s a problem with trying to formulate it that way. My homework is to look up his references (Kalecki) and see why… ;) … which I haven’t done yet… but it has to do with “time delays” making “a” hard to formulate… (see Adam’s Dork comments — 1st page).

  • http://www.orcamgroup.com Cullen Roche

    Inflation and devaluation are the constraint I ALWAYS discuss so I am not sure how you came to this conclusion. Also, monetary policy doesn’t “print money” in the sense you seem to think….QE is an asset swap of short duration govt debt for long duration govt debt. No change in pvt sector NFA. That’s what matters.

    Maybe read my paper on the monetary system? I am happy to help you try to understand this all better if you are willing to put in the honest effort.

    http://pragcap.com/understanding-modern-monetary-system

  • Tom Brown

    So in other words:

    Ezra Klein and Bill McBride are excited that the bloodletting is starting to get under way… soon the patient will be rid of the “bad humors” and will make a full recovery.

    Is that the state of understanding of mainstream economic journalists and academics? They’re at the Medieval barber-surgeon stage?

    … it put’s Obama’s nomination of Jack Lew in a new light: “Ladies and Gentlemen, Jack here oversaw three successful bloodlettings in the 1990s, wherein the patient actually survived! It’s that kind of track record that I think superbly qualifies him to be out next chief barber-surgeon.”

  • http://www.orcamgroup.com Cullen Roche

    Yes, that’s how I explain it in the paper on the monetary system (my big one). I just don’t have the time to rearrange it always in these short posts….

  • Gerald G

    This is quite interesting, I hope I can find time to ‘play along’ with the math…if it gets complicated enough I might have to pull out some Complex Calculus books & “Mathematical Methods of Physics” to see if any of it applies.

    As to how my life changed direction…I needed a job! :-) So I took one related to physics but mostly programming but also “IT” (I’m a long time computer geek too.), that went in to Project Management, then Management of that and now I’m in Product Management. Only the first job was significantly related to having a grounding in math & physics in creating a program for radiation therapy using radioactive seeds. In hind sight I’m not entirely sure I’m happier…I actually had a choice to get a PhD in Medical Physics doing some really interesting experiments…but alas that path is closed other than as a hobby…so this discussion actually gets my math juices flowing again…again I have an entirely different ‘real job’ so I can’t get too lost in this great discussion…

    Anyway, sorry to everyone else reading this, entirely off topic I fear.

  • Widgetmaker

    “Deficit spending just cements the mis-aligned status quo and prolongs the adjustment process, while implying an even more painful crisis down the road.”

    Not necessarily. Remember, the US Govt debt to GDP ratio shortly after WWII was 120% (publicly held debt to GDP is less than 80% now). How did the 50′s and 60′s work for us? In fact, debt to GDP declined until 1980.

    There are certain things govts can do better than the private sector – i.e. infrastructure, public protection, education. With so many of our resources idle and unemployed why not put them to good use now, especially when it has never cost less to borrow the money.

    NOW is the time to do it. The farmer does not repair his capital stock when he is at full employment (harvest time) – he takes care of that when times are slow. We need to upgrade our infrastructure – it has to be done eventually, so why not now? And think of the world we’ll be leaving to future generations with the improvements that will be made, not to mention the strengthening of our labor force and the well being of their families.

  • Gerald G

    Hmm, not sure which guy you’re talking about, I don’t recall that…but then again I can’t vote in the US so I didn’t pay as much attention as maybe I should have. I’m only a Permanent Resident not yet a citizen, I’m Canadian by birth.

    I can’t say I don’t enjoy a good ‘conspiracy theory’ once in a while but I usually end up just getting my blood pressure way up as the hyperbole & the absurdity of it grows…either that or I just get a damn good laugh out of it! :-)

    Having said that it doesn’t take a conspiracy theory to recognize that ‘profit motive’ alone is enough to drive public policy in a capitalist country towards profiting those with the money more than those without.

    But the ‘truth will out’ as they say, which is why I’m so happy to have found Cullen’s site. I can’t say I am adept at understanding all the implications (e.g. identifying policy objectives that are good for ‘the people’) but the ‘facts’ of the system as explained make the current policy debates such an obvious ‘lie’ that I can hopefully use the facts to educate. Some people will want to spend in to oblivion when they understand that the “government can’t run out of money”…and some will want to remove all taxes…but eventually the truth of the matter will dawn & the debates will hopefully focus on how to create the system to constrain the profit motive properly to ensure we don’t have such manipulation of the markets as we’ve had…eg. getting the market away from being a ‘casino’ again.

    I can only hope.

  • Gerald G

    Yeah, saw that, skipped it (mostly), the guy seemed so far removed from reality that I couldn’t waste my time…though it was good for a brief chuckle. :-)

  • Tom Brown

    Anybody watch Bill Maher? His 1st guess last week was former Kansas gov/senator Bob Kerrey. The same kinds of things came up there (as they do on Bill’s show frequently, BTW).

    Bill: “Well if Hagel is confirmed [as sec. of Def] I hope he looks at making cuts to defense… we’re pouring money into Def still and we don’t have the money to pay for it!”

    Bob: “Erskin Bowles said to me recently ‘You know we have a treaty w/ Taiwan and we have to go to war w/ China on their behalf should they be attacked? Trouble is we have to borrow from the Chinese to do it”

    Cullen, I’d LOVE to see you as a guest on that show. You would blow his mind… he’d really be curious I think about MR’s position that the US can’t run out of money.

    The opposite idea is so entrenched… amongst everybody it seems, even deep blue liberals like Maher and mainstream Dems like Kerrey that it’s hard to see when, if ever, the idea of what the real constraints are to policy ever gets though to the general public.

  • Gerald G

    I don’t know Cullen, but maybe you should have a mandatory requirement to read your thesis paper & answer a few simple questions about it before being allowed to post…that would seemingly reduce the number of people who claim you are saying something you’re not saying! Just a thought.

  • Explorer

    Re the Europeans trying to cause another depression (in the periphery at least): Maybe in the first year or two they just didn’t believe Koo or didn’t understand sectoral analysis, maybe in the second they were still just very scared of inflation, but now? The definition of insanity is doing the same thing over and over and expecting different results.

    They must at least be willing to force the public sector of the periphery to privatise all salable public assets to recover the most debt and harmonise all social welfare across Europe, even at the cost of depression in the periphery as otherwise the domestic cost of supporting lazy Greeks is too high.

    I would say that they are willing to have a depression in the periphery as the price of German/core support. You only get German social security if you want German help and you sell your assets to pay down excess debt before you get any forgiveness. And from a German point of view, what’s wrong with that.

    Wouldn’t it be the same in a united Europe, a common standard of social support and member states having to sell public assets to pay down excessive debt?

  • Explorer

    Personally I prefer GDP = G+P+E (government + private + net external). It allows anyone to see that if private is shrinking and you shrink government at the same time you likely get a recession unless there is a dramatic change in external balance. Nearly everyone understands that starting a recession means job losses and hardship and falling value of most investments other than cash or near cash and long term government bonds.

    This tends to focus each individual’s mind on what it means to reduce government spending when the private sector is increasing saving/debt repayment and reducing borrowing.

  • Tom Brown

    Good point!

  • Gerald G

    Tom, I perhaps should let Android speak for himself, but I don’t think that’s what he meant. I think he just spawned off to a new thought about taking the derivatives of the sectoral equation.

    BTW I saw that discussion and again found it ‘interesting’ but knew I’d have to spend more time than I wanted to spend just then thinking about it…but how about this, the implications of which seemingly are odd & thus made me believe I had something wrong but I don’t think so…if the sectoral equation variables indeed are continuously differentiable functions of time then the sectoral equation is integrable implying that at any given time ‘t’ the integral of the sectoral equation is a constant…e.g. the sum of all Net Private Savings, Net Government Spending & Net Exports is a constant…can that possibly make sense?…e.g. set the sectoral equation to a function f(t), integrate it from 0 to t and you get F(t) = Constant where F(t) is just the integral of the sectoral equation at time t…

    Am I so far removed from my memory of the Fundamental Theorem of Calculus that I’ve cocked something up? Actually, I don’t think so, all this shows is that there is a finite amount of energy in the world (universe if you want to go that large)…and what we have can’t change it can only be converted from one form into another.

  • Gerald G

    I’ve personally always been for paying for education, I’d almost let people starve in exchange for it! (almost)…

    I’m not (yet) an American, and not to get a huge battle going but perhaps the 5th amendment should have read something like,

    “A properly educated militia being fundamental to the security of the state, the right to a proper education shall not be infringed.”

    Then we could all debate if a 30 book ‘education’ was big enough or if someone should be allowed to hold as big an education as they wanted…and whether an automatic education should be outlawed & only allow a semi-automatic education. :-)

  • Tom Brown

    Some thoughts:

    1) Who ever said bonds, especially the bonds of ANY nation in the EU, should be “risk free?” NY City bonds weren’t risk free.. other state and local gov bonds are not risk free… there’s a chance of default… but that doesn’t mean you should be able to grab the Statue of Liberty if you lose that bet. I get the impression that S. Europe is being sacrificed to make sure some bond holders don’t lose on their gambles. Are they (the European Central Bank, etc.) plunging S. Europe into a depression on purpose just so they have to sell off the Acropolis and a few islands to some wealthy bond holders at fire sale prices? I highly doubt that… but perhaps there needs to be a re-balancing of priorities.

    2) There is a big risk for Germany should S. Europe continue to sink. That’s their market for one. For another is it really a good idea to have sustained 25% unemployment rates in ANY nation… or 50% amongst the angry young people (in Spain). It’s totally understandable that extremist parties have gained support (such as the fascist “Golden Dawn” party in Greece). If nothing else, electing fascists will bring CHANGE… and to desperate people that can sound pretty good!

    3) Germany seems to have forgotten that at the end of WWII, after they’d tried and failed to enslave and then destroy most of Europe, N. Africa, and the Soviet Union… that almost all their debts were forgiven (in an attempt to keep the political situation stable, through stabilizing the economic situation w/in Germany). I believe (but I’m not certain) this included the forgiveness of private sector debts… (most of which were owned to the Nazi party anyway, so there’s another reason to forgive them). Only a few short term debts were honored (paychecks to workers, etc.). Worked great for Germany! How come they seem to have forgotten that lesson? Probably because it was more than 60 years ago… and humans seem to always forget valuable lessons after about that much time (i.e. repeal of Glass-Steagall, etc.). I think WWI was still pretty fresh in the collective conscious at the end of WWII (only 27 years apart), and thus lessons learned there actually DID affect policy later.

  • Tom Brown

    I think you’re on track with integrating to a constant. I also think that constant should be always be 0.

    I like the Kirchhoff’s law analogy: the sum total of the charge over any time interval that enters a node is zero. Also, at any instant of time, the current (time derivatives of the charges) into a node sums to zero.

  • Greg

    Investor

    What is efficient spending? Mentioning “Soviets” might win you points some places but there are ways to spend govt money besides the Soviet way

  • http://www.fanbrowser.com/ Cowpoke

    Haha, which is why we have GFCI’s.. :)

  • Geoff

    Same goes for Jon Stewart. He is usually so good at deconstructing the news to get at the heart of the matter. But when it comes to economics, and particularly govt debt, he falls well short. You may have seen Paul Krugman blast him the other day for his weak analysis of the TDC.

  • Tom Brown

    BTW, does anybody know of a prominent mainstream conservative pundit, opinion writer, commentator or politician who takes the MR position here? Just curious… I guess I’ve assumed that if any mainstream personality would, he/she’d be on the left, but obviously that’s not a requirement. I think Scott Sumner (who says he’s a libertarian) at LEAST doesn’t have some of these silly ideas about running out of money… but then again if Sumner is a celebrity to you, … you’re a serious dork!

    Well here’s another path to disseminate these ideas in the mainstream: be a guest on O’Reilly’s show. I’m sure he’d enjoy ridiculing someone who claims that we won’t run out of money.

    I think I mentioned that I saw Stephanie Kelton on TV… (the show was on at 4 AM on a Sat., but I saw it online later). She was basically defending this concept on a panel on MSNBC… but I think she fumbled a bit and didn’t get to the part that the gov DOES indeed have constraints to spending (even if it minted a $100T coin)… and thus I thought she probably came off a little like a nut to your average viewer.

    I’m glad to be seeing more of Cullen in other venues though recently.

  • Tom Brown

    Yeah, I did! I didn’t see the show in which Steward made fun of the TDC though. I agree about Stewart’s general take on economics… however, I wouldn’t necessarily fault him for making fun of the TDC. I think even among TDC defenders, there’s a lot of room for ridicule on the subject.

  • Gary_UK

    They worked badly,as you lost a huge chunk of your gold reserves, forcing closure of the gold window.

    Selective memories!

    No gold window this time around though, so the dollar will be sacrificed to clear the slate.

  • Gerald G

    Yeah, I see that, that works too…so were going to equate the economy to charge flow or the first law of thermodynamics (if you take my energy argument)…though I wonder if fluid flow & using principles derived from Bernoulli equation’s might not be more relevant…not that I know much in depth about that subject any more, just seems that the chaotic nature of some fluid dynamics might apply better here…just a pure out guess though.

  • http://www.fanbrowser.com/ Cowpoke

    Tom, What letter’s could be used for Margin and Leverage?

  • Anon

    “One will see their currency collapse, one will emerge from depression with a stable currency”

    Or a whole bunch of new currencies – that’s still the likely endgame in Europe. How does Cyprus compete with Germany?

  • http://None Midas II

    But so long as workers are unemployed, taxes to continue their consumption are needed, in addition to the obvious government costs, Justice, Defense, etc. Lower taxes don’t help the unemployed. “Full” employment changes everything.

  • http://None Midas II

    Correct…A shrinking economy.

  • http://None Midas II

    And “owed”, not “owned”, right? Any way I agree people forget, and remember Santayana, “Those who forget the past are condemned to relive it”.

  • http://None Midas II

    Debt Jubilee, isn’t that in the Bible? Nothing new under the Sun.

  • Mathematician

    I saw some helpful posts on this site, but this one looks like a parody on economists. Yet the comments look serious.

  • Android

    Hello Gerald G and Tom Brown,

    I don’t know if you will get this but I just wanted to say thank you for your input and that I enjoyed your comments on the mathematical formulation of MR’s financial equations. I actually copied our posts for further reference and will investigate others (thanks Tom). A side project of mine when I have the time is a new economic theory (or at least a generalization of existing ones, i.e. think unified theorem of economics) starting with MR. I am using the mathematics of differential forms and differential topology which are most relevant to thermodynamics since that is my specialty and where I derive some insights (and I believe the general equilibrium theory of neoclassical economics was inspired by thermodynamics but idk. I do know that some of the econophysics literature is based on thermodynamics. I am not a neoclassical economist but I do believe in econophysics) However, the Kirchhoff’s law and fluid dynamic analogies are certainly appropriate conceptual frameworks in my opinion. There are many valid ways of formulating the economic system based on physical principles. Behavioral and social principles are also important and I don’t believe they are incompatible with the physical ones. This is also a fascinating topic but I think we are way getting to far afield in these posts :)

    I need time to think more on all this but I will make a brief comment on the appropriateness of the sectoral balance equation as a continuously differentiable function of time and therefore using calculus. First, I think we can agree time is a continuous variable. Second, I believe the approximation on continuity (approaching infinitesimally small) is valid at large enough scales relative to the object that is moving. For instance, the differential functions of fluid dynamics and currents involve the movement of matter and charges, which are discrete units, but at the scale of the problems of interest where there are huge numbers of discrete units, the densities and distribution of matter and charge approach a continuum. In the economy and finance money is the discrete unit that flows. But (rhetorical question) is the amount of money in the sectors large enough for a continuous approximation?

  • Android

    S, I, G, T, X and M are totals over the year so my formulation is not totally correct. However, these variables are a function of time and are differentiable. I was trying to cast the equation as a differential form; I think it is still possible but not as I originally wrote it. I agree with the analogy of Kirchhoff’s current law. However, the current law is a conservation law, in = out, right? But do the sectors have a stock, in – out = leftover?

    If time is the only independent variable, then yes a system of ODEs. I understand the basics of x’ = A*x; formulation of the system as a system of ODEs, but I need more detail. You are approaching the problem from electrical engineering and I am approaching from science. I am familiar with linear approximation but not with kalman filters, time delays, and the sort. I too will have to read Kalecki and many other references. So much to do and know, so little time :)

  • hangemhi

    It’s pretty funny to be a long time reader here and seeing TruthNot’s nearly verbatim comment over and over again from brand new readers. Welcome to the site TNP, you’re traveling a well worn path – type your concern or objection into the search box and prepare to see your future arguments discussed time and again in thorough detail. The only question is will you be one of the open minded ones who converts, or (I see Gary-UK is back) one who writes objections and appears to never read the replies.

  • hangemhi

    ahh, no, I’d say it is math and logic. I’m guessing you don’t understand what the BSR is if you just think it is a thesis.

  • hangemhi

    I’d like Cullen’s take on this too. Where do we stand on private sector debt to income, to GDP, etc.

  • http://www.orcamgroup.com Cullen Roche

    Hey guys. Better to look at these.

    http://research.stlouisfed.org/fred2/series/CMDEBT

    http://research.stlouisfed.org/fred2/series/GPDI

    There’s real improvement occurring in there, but my concern is that the govt will pull in the reins here and we’ll see the meager recovery start to turn the other direction. We’re slowly making improvements, but we’re not quite through to the other side just yet….

  • InvestorX

    Well, yes the U.S. needs a lot of infrastructure investment. But it needs to be also carried out at the right cost in order not to be wasting resources, which is not happening. GDP growth is not equal to value creation, understand that. Just to have GDP growth on paper, you waste resources, is equal to capital consumption. This is anticapitalistic.

  • InvestorX

    To all the “Depression avoided” celebrators and “1800s were very poor and volatile”, here are some facts from

    http://www.hoisingtonmgt.com/4C9C3EB3-BBCD-45A9-B8F2-5341E0A8CED4/FinalDownload/DownloadId-E853F31C6FBEE4217B97A4A48A896E65/4C9C3EB3-BBCD-45A9-B8F2-5341E0A8CED4/pdf/HIM2012Q4NP.pdf

    “The one complete decade of the 21st
    century (2000 through 2009) ranks as the 21st
    slowest growth in real GDP of the entire 22
    decades since 1790 (Chart 3).

    Only the experience in the 1930s was
    worse. The 1960s was the last decade when
    the economic growth rate was above the post
    1790 average, indicating that the deterioration in
    economic conditions is not a new phenomenon. In
    the thirteen years of this century, the GDP growth
    rate has averaged just 1.8%, or less than half of
    the 3.8% average since 1790, suggesting that the
    erosion of the economy is continuing.”

    If one looks at the chart to the Depressionary 30s one sees that the difference to the 2000s is very low in terms of real GDP growth (and if one starts doubting the GDP deflator calculation methodology, then the 2000s could be even worse than the 30s). Why is that? Because depressions are deep, but quickly done with, even if they last for 3 years. Afterwards there is only blue sky in terms of growth. The current policy path will spread the pain over 10-20 years. The Japanese, in spite of booming exports markets have not been able to adjust their economy even after 20 years.

    Another interesting observation in the chart is that US GDP growth rate has declined since the Fed was established.

  • Vivek

    Hi Cullen, I fully understand what you are trying to say is that in this private sector BS recession, only the govt spending is what is keeping the US from basically going into recession. But is there any limit to which a govt can go to keep a GDP number up? Is keeping the real GDP positive the only thing that matters?

    Regards,
    Vivek

  • Lukey

    And if the private sector is becoming permanently impaired by the effects of big government (regulatory excess, mal-investment and ever increasing rent seekers) when and how do we ever get off the government spending merry-go-round?

  • William Bedloe

    I fully agree that tax cuts would be a good thing here, but for this to be effective, there needs to be some semblance of permanency. Short term tax cuts may look like “win-win” for the political class, but for the average joe (me), it affects my confidence long term. I don’t want to start a business or make a large purchase if in two years I may no longer be able to afford it. I realize that taxes rise and fall, but in the last 10 years, people have been held hostage by the constant threats back and forth between increasingly partisan hacks in Washington. The failure in leadership there (from the Oval Office on down) has been severe.

  • Tom Brown

    The Depression in the 1930s was not over quickly.

  • InvestorX

    The “recovery” in GDP and stocks started around 1932 after three years.

  • Tom Brown

    I recall reading in John Bogel’s book “Bogel on Mutual Funds” that if you’d put $1 in the stock market in 1929,at the peak of the market, you wouldn’t have recovered it again until the early 1950s. That was a big hole.

    Plus, wasn’t there another downturn in 1936 or so, after some modest recovery?

  • Old Dog

    What is really being said and asked here is: How can we change human nature?

    The debt-based model of Capitalism is simply a reflection of greed. And to a certain extent greed is good.

    Clearly it was overdone by 2006-2007. We have been there before and will be once again.

  • Johnny Evers

    It always seems that the solution to our economic problems is to create more debt. If the public cannot run up its credit card balance and borrow on its housing, then the federal government must borrow money for the health care of old people.
    Never mind that private borrowing (and banks leveraging bets on that borrowing) created the crisis) and that public borrowing to fund the financial and health care industry does nothing to benefit the working class.
    There is something about all these formulas that just doesn’t make sense. Perhaps it is that the formulas treat borrowing as neutral — an asset for the lender, an obligation for the borrower. Maybe you can borrow forever because it’s always a neutral event.
    And maybe the formulas have no answer for that sickening moment when the consumer realizes he can no longer borrow and no matter how much the government borrows, it doesn’t help the man trapped in quicksand.

  • Tom Brown

    Let’s see if I understand the end-game for gov deficit spending:

    The gov continues to deficit spend, moving funds from Peter to pay Paul and issuing NFAs in the process. Interest rates are low, so interest on the gov debt is low.

    As the economy improves, less gov spending is required, fewer NFAs issued, the Fed raises interest rates so those interest rates on the NFAs that are issued are higher.

    More improvement, even less gov spending, perhaps even more gov taxation (or still more revenue anyway), much fewer NFAs issued, higher interest rates from the Fed (so again, those bonds that are issued are at a high rate).

    So is it the idea that as the economy improves, gov spending declines, gov revenue increases, gov taxation MIGHT increase, interest rates climb, and perhaps the gov even starts to pay down its debt? But even though interest rates are higher, the above mechanism tends to keep the interest on outstanding gov debt from overwhelming the gov’s budget? (Since it’ll still be paying low interest on the large amounts of long term bonds issued in the past… and more recently issued debt, though issued under a steeper yield curve, tends to be less in quantity and more focused on mid to short term bonds)

    I wish this were all written down in a mathematical model to play with, and perhaps it is! What are the flaws in my logic above?

  • Boston Larry

    If you bought and held Vanguard Wellesley Income fund (VWINX) at the March 2000 market peak, then you were made whole within 6 yrs. This fund also weathered the 2008 crisis pretty well. VWINX has a 5 yr annualized total return of 7.7% over the last 5 yrs, including the 2008 plunge. It is 35% equities and 65% mostly corporate bonds.

  • Gerald G

    If I may, it’s not the ‘permanency’ it’s the ‘predictability’ that is most important to long term planning & confidence. In other words, if there was some sense that spending & tax policy was based on some well founded economic principle and would be modified only in response to known observable changes & in a predictable way then I would suggest ‘confidence’ would increase greatly. It is the failure of leadership, and by extension the populace (who elect the leaders) to implement sound economic planning & sticking to it that leads to erratic behavior.

  • Johnny Evers

    The flaw in that logic is ‘As the economy improves, less gov spending is required.’
    The mistake there is the assumption that current deficit spending is stimulus; in other words, we have the current deficit because we are spending more in reaction to the recession.
    In reality, we are running higher deficits because a) demographics … the boomers are retiring, and b) government is taking on more responsibility for paying for health care for people who previously either paid themselves or went without.
    Other factors that will keep government spending high — 40 percent of eligible workers are sitting at home, another oil/energy shock is likely, Muslim governments in the Middle East will continue to requie a heavy defense presence.
    Even if (when) the economy improves, the deficits will continue to rise.

  • Anonymous

    I absolutely understand what the Balance Sheet Recession idea is…… it is selective math and logical only in simplicity to understand through anchoring. MR is operational insight into how the machine works. However, it is crucial that you understand the problem the machine needs to solve.

    http://www.youtube.com/watch?v=fJyWngDco3g

    Just as this video shows how a machine will self destruct…… it is crucial MR addresses the right problem.

  • Tom Brown

    Did Bogel play a role in managing Wellesley in his early career… prior to starting Vanguard? I know Wellesley is in the Vanguard family now… or am I thinking of Windsor?

    He has some charts in the book showing what the market as a whole did going back to the late 1800s (I think S&P started off with an S&P 90 index in 1923)… but he must have had to piece it together since I think the current S&P 500 only goes back to the early 70s, correct? He criticizes the Dow for not being properly weighted by market capitalization.

  • Tom Brown

    Ah, it was Wellington:

    http://en.wikipedia.org/wiki/John_C._Bogle

    Got canned for that one too! .. but it’s now part of Vanguard I think, ironically.

  • Pierce Inverarity

    Go away

  • http://www.nowandfutures.com bart

    And there won’t ever be hyperinflation (25%/year per the IASB def’n) either…. -g-

  • http://www.nowandfutures.com bart

    Enough censorship already exists around the world.

  • http://www.nowandfutures.com bart

    Comparisons without taking inflation into account are bogus.

  • Tom Brown

    I don’t know about the Bible… not an expert there, but supposedly this happened in ancient Israel, Babylon, and Sumer.

  • http://pragcap Michael Schofield

    The only thing I would improve on is paying down debt, usually triggers recession/depression. Have to settle for debt growing slower than GNP, let inflation reduce significance of 17 trillion or so… piece of cake. :)

  • Tom Brown

    Check out David Graeber’s “Debt: The First 5000 Years.” He’s done numerous interviews on the subject that you can find too (which take a lot less time to absorb!).

    Basically he argues, from the point of view of an anthropologist, that debt is the basis of money, and has been (on and off) starting at least 5000 years ago in ancient Sumer. He further states that anthropologists, historians, and archeologists have been trying to tell economists this for at least a 100 years, but they’ve stubbornly stuck to their “barter is the basis of money” story with no evidence to back them up. Graeber also touches on barter, and how that fits into the picture, but it does not take a central role… except in those situations in which money has been denied to a group already accustomed to using money (e.g. prisoners).

    Graeber points out that modern primitive societies that don’t use money, instead used a “gift economy,” not barter, for day to day transactions. Barter is more of a special occasion, often occurring exclusively with strangers. He suspects that ancient pre-civilization societies also used gift economies. You can find a clip of Penn and Teller in Egypt encountering a vestige of this (perhaps) in the poor neighborhoods they visit. It played out very much like Graeber describes (although Graeber was really talking about VERY primitive societies, such as in the Amazon River basin). Teller admires a woman’s cherished object, and she gives it to him! This is just like Graeber described… what Teller may not have realized is that he was then obligated to her in some fashion.

  • http://www.orcamgroup.com Cullen Roche

    Lots of moving parts there, but here’s the big concerns.

    1) Govt spending can cause inflation.
    2) Govt spending can cause unproductive spending. So, let’s say the govt decided to build 20 cities in the middle of nowhere and paid the workers from nearby cities to do so. Then no one lived in the cities. What would happen? You’d have inflation as a result of unproductive spending. OR, you can have environments where the govt pays people to do nothing thereby disincentivizing them to actually work and produce. Living standards stagnate as output stagnates and prices rise.

    So, it all comes down to the impact of inflation really. Hope that helps.

  • Tom Brown

    Johnny, good points. I agree that gov spending now is not about stimulus. However the gov does have fewer unemployment benefits to pay as employment rates go up, so at least in that sense they’re spending less. Plus those newly employed are now presumably paying more taxes and contributing to rising GDP levels which in turn leads to more gov revenues, even if tax rates remain the same.

    Thus I would think that deficits *might* decrease and perhaps can even be eliminated. Yes I agree that demographics, gov health care obligations and military requirements might invalidate that simple idea.

    It’s hard for me to play this all out without a complete mathematical model of the economy and solid numbers to plug into it. I guess I’m trying to figure out the simple best case scenario story line. Michael Schofield (below) points out that inflation (presumably low levels) can be the gov’s friend (at least if it comes w/ rising GDP) in paying those debt obligations.

  • Tom Brown

    Yes, it does (me anyway!), thanks.

  • Johnny Evers

    People like TruthNot get blown up in here, but really he’s not saying anything different than Cullen — the constraint on deficit spending is inflation.
    I guess we differ on a) will deficit spending continue to escalate, and b) what are the long-term inflation prospects if that pace continues.

  • Tom Brown

    Well, that and he seems to be confusing monetary policy (QE, etc) with deficit spending, as Cullen points out.

  • Pierce Inverarity

    I didn’t say to censor him, bart. I simply want him to go away. I find he contributes more noise than signal in our discussions here.

  • http://www.fanbrowser.com/ Cowpoke

    Pierce, was it that bad? He just commented on what Gary_UK said. I thought what he said kinda went with the whole UK monetary issues.

    What am I missing?

  • InvestorX

    Look Tom,

    there are many soft factors, besides the structural deficit:
    - reserve currency status of the US + size and liquidity of the market, means that the public debt/GDP ratio or deficits can be higher for longer than with other countries
    - C/A deficit (as a function of the reserve ccy status) normally causes a budget deficit
    - bureaucracy creep: the govt as % of GDP grows constantly; partially due to interest on debt
    - the effect of rising IR on outstanding debt holders and the economy, as well as on stocks (stocks are the major psychology management tool in the West now, besides controlled media spouting propaganda)

    An interesting scene to watch will be Japan in case they manage to achieve their 2-3% inflation target – their JGB IR may rise if not controlled by the BoJ and their tax revenues may be spent only on interest expense or worse they may need to borrow to pay interest. That would be Minsky’s “ponzi finance” phase. Then it remains to watch for the “Minsky moment”. Now Japan is very wealthy, exporter and so on,so it will take more time till the markets “revolt” than usual. I would not bet on that unless I use some very LT cheap options. Shorting JGBs has been the “widow maker” for 20 years or so.

  • Tom Brown

    Thanks for you comment InvestorX. C/A deficit? what’s that?

  • Pierce Inverarity

    Current account deficit. Means we’re importing more goods than we’re exporting.

  • Johnny Evers

    I’ve always been puzzled by the idea that you can import more than you export.
    Presumably, if you are importing items of greater value than you export, isn’t that a good thing?
    When you look at some of the most powerful economies in world history (Rome at its height, Venice in the 15th Century, Holland in the 17th Century, Edwardian Great Britain, today’s America) all of them generated much more value in imports than exports. Venice exported salt and a few manufactured glass products, but imported huge amounts of wheat, silver, spices, silks, etc, most of which it either used or exchanged for gold.
    I recognize there are problems with a trade deficit, but there are some stumbling blocks with the idea that a trade deficit is a bad thing.

    Another question, in a global economy, how do you separate the U.S. from the international markets when there is so much overlap and leakage from one sector to another, not to mention the difficulties of weighing the value of American cultural exports. The difference between South Korea and North Korea, for example, is that the South imported (basically for free) a lot of Western business and religious practices that have helped them grow their economies.

  • Tom Brown

    Good question in your last paragraph. I was thinking the same thing about separation.

  • Tom Brown

    Cullen, I know this is a huge simplification, but in your view, when should we be concerned with deficit spending? Yes I know, we are inflation constrained… and I’m not talking about huge new stimulus packages here… just our normal deficit spending.

    So, mechanically, what do we do? Watch the CPI and when it gets above a certain threshold, cut back? Increase taxes? Does the gov try to co-ordinate with the Fed (interest rates) on this? I think the “end-game” I tried to sketch in this thread above:

    http://pragcap.com/the-continual-failure-to-understand-the-balance-sheet-recession/comment-page-1#comment-136613

    …if it bears any relation to reality, would tend to indicate that by the time the CPI started increasing we **should** have lower gov spending anyway, if for no other reason than unemployment benefits would be less. We’d probably get a bump in tax revenue as well due to formerly unemployed people now working and spending more. Is that the idea?

    If that’s the case, then monitoring the CPI really just helps to put a cap on stimulus spending, doesn’t it? I don’t know. (Johnny, InvestorX, Michael… I know I’m glossing over some of the points you brought up, but I’m just trying to sketch a simple scenario here).

    Under what circumstances do you see the gov looking at CPI (or other data) and deciding “Whoa! we’d better cut spending!”

    Are there circumstances where “austerity” is justified? I can see where you might end up in a situation where the gov was building bridges to nowhere or paying people to sit on the couch… and then cutting back might SEEM like “austerity”… (when in fact it’s just cutting back on inefficiency and disincentives to working)… but I guess that’s not what I’m talking about: I’m talking about making serious cuts to social security, defense etc (perhaps painful ones!).

  • Johnny Evers

    Piggybacking here ….
    1. Which is better — treating inflation when it begins, or avoiding policies that would bring about inflation.
    2. The conventional ‘cure’ for inflation, is to jack interest rates the way Volcker did; however, two problems … 1. the cure is practically worse than the disease for some people, and 2. Can you really raise interest rates to double digits when you have have $20 trillion in debt, wouldn’t the interest payments crush you?

  • Dismayed

    “The problem with higher govt spending is that it is normally less efficient than private spending. Ask the Soviets if you doubt.”

    Unutilized labor is lost forever. Better to put people to work to get something of value produced. Roads, bridges, power grids, public transit. All create real wealth,

  • Tom Brown

    Johnny, good points. re: your point 1.: that’s kind of my question for Cullen. However, I don’t think interest rates are the only means of “treating inflation” once it’s started. Another method could be to raise taxes. That spares the gov the interest rate payments you speak of, and in fact brings IN revenue. Also, see my post above for why I see a possibility that the interest rate issue is self-correcting (in the “usual” case when CPI goes up w/ an improving economy). I’m not saying that’s how it is, because I don’t have the numbers or the correct mathematical models… I’m just saying I see a possibility for that.

    Perhaps a combination of both interest rate increases and taxes is the best alternative in most circumstances (coordination between Fed and gov).

    I think you’re saying that waiting for an indication (CPI increase) could be a dangerous game. Well, perhaps doing the opposite is actually the dangerous game: in other words there may be a danger in treating a non-existent inflation problem!

    Now what if CPI is up, but GDP and unemployment are flat? OK, that’s a great question. Isn’t that the “stagflation” of the late 70s early 80s? My understanding though was that was really due to an “exogenous shock” i.e. the oil embargo and residual high oil prices. Still that doesn’t tell us what the gov and Fed’s best response COULD have been.

  • hangemhi

    Exactly – taxes!!! Targeted at the areas of inflation…. tax cuts to promote supply, tax increases to suppress demand. Of course this requires a Congress who has the slightest idea how the economy really works, and isn’t in the pockets of lobbyists

  • Tom Brown

    hangemhi, so would you favor taxes/tax-cuts over interest rate adjustments in most cases then?

    Also, do you think the IOR/IOER rate, really will be our “natural” rate of (Fed funds) interest for the foreseeable future? (a la’ the Waldman article that brought Cullen into the big online debate in his “Dorks” article)

  • S-I

    and the “S” in C + S + T is not just laymans “S”, money saved in the bank, it includes investment. It is a shame “S” isn’t laymans savings and the equation written as C + S + I + T. We could avoid this S – I thing then.

  • Tom Brown

    What, really? I didn’t know that. That’s Cullen’s definition of “S?”

  • http://coppolacomment.blogspot.co.uk Frances Coppola

    I replace (S-I) with dNFA, meaning the change in net financial assets. Does that help?

  • Tom Brown

    Right!

  • marx-reloaded

    General question regarding some others’ comments: is there a general consensus that government spending is less efficient than private consumers, which, if true, would justify tax cuts versus government spending? I mean, private individuals do not spend money on highways, bridges, education systems, Headstart, science research, etc.

  • Tom Brown

    A general consensus? Not here! There’s not much of a consensus about anything here. Even amongst those that accept the main tenets of the MR “paradigm” there’s plenty of room for debate between those that favor tax cuts over those that favor government spending.

  • http://www.orcamgroup.com Cullen Roche

    Marx,

    Is it not fair to say that govt spending IS less efficient because, if it’s inefficient, there’s no reason for it to get eliminated? If private spending is inefficient or misallocated competition usually kills it over time. You can’t just be a pvt sector business and spend money on useless crap eternally. If you’re the govt, that’s not necessarily the case….There’s no competitive feature in govt spending to “cut the fat”.

    Do you disagree?

  • Greg

    I do think there are problems with using the word inefficient/efficient with spending of any sort. Yes private decisions will eventually run up against real constraints in the competitive market place and if someone else is doing it better and cheaper than you you will lose. Problem is good models can also be driven out of markets with overly strong entrenched interests as well (think WalMart) so its not as simple and clean as is often presented. The loser in a market based game wasnt necessarily worse, maybe just bad timing and powerful entrenched interests. I think our drive to always cheapen things has………….. well, cheapened things…… to our detriment.

    Bottom line is all spending goes to someones income and eventual saving. This can then be recycled and much is put to useful work. One mans boondoggle is another mans way of life. Playing this efficiency game can end up being a fools errand I believe. Who decides? The market doesnt only reward efficiency , just like it doesnt only reward hard work (what IS hard work? Digging? Curing cancer?)

    I remember a few years back when certain ideologically driven politicians wanted to defund certain science based programs like volcanoe monitoring and super colliders saying they were a waste and couldnt understand what they do, suggesting they were redundant even. They got colleagues support and were succesful in cutting them. When someone says “The govt is paying for VOLCANO
    MONITORING !??” People roll their eyes and shake their head and just think immediately ……waste! But that Volcanoe monitoring saved lives and capital by diverting European and world air traffic in the aftermath of the Iceland volcanoe eruption.

    If we arent in business of food,shelter, health care and gun manufacturing we are not doing necessary work. Everything else is window dressing when it comes down to it. Its the other work that allows us to be human, the necessary work is for survival. I want more than survival so I like having all that unnecessary “work” going on.

    I dont know a person out there who, when asked where we should cut spending, thinks the source of THEIR income should be reduced.

    We ALL are pointing at everyone else, and lots of everyone elses are pointing at you!

  • http://www.orcamgroup.com Cullen Roche

    Well, I think that what a lot of this comes down to is different definitions about “living standards”. One side tends to argue that more humanitarian efforts increase our living standards. Things like keeping the environment clean, universal medicine, etc while the other side tends to argue that the only things that improve living standards are the things that are good for business (like Wal-Mart creating efficiencies in our lives by streamlining the consumption process. Neither side is 100% right.

  • Dunce Cap Aficionado

    “Presumably, if you are importing items of greater value than you export, isn’t that a good thing?”

    It can be argued as such, I think so if you view it in context of the US. But to me, most things regarding the CA have to be viewed in relation to the domestic economy and the Sector Balances equation in general.

    I think another way to view it is “if you’re importing items that you would otherwise pay more for produced domestically, you may be benefiting.” Conditional upon the domestic economy still being healthily productive. US is a good example of the CAD not being a wholly bad thing because we still produce so much domestically (think we’re still well above 20% of the world’s GDP).

    If the domestic economy is stagnant or falling in production levels and _compensating_ by importing more, that seems problematic in the long term.

    US benefits from importing from countries who produce cheaper goods, because we can. I would argue, however, the US would be in an even better situation if we operated a CA surplus with no change in the domestic economy- de facto reduction in the public deficit.

    But, I’m no economist.

  • Johnny Evers

    Agree.
    We supposedly ‘benefit’ by importing cheaper manufacturing goods, but that doesn’t measure the social costs of putting the working class out of work.
    My wife was looking for a dining room table recently and reported there are only two very small U.S. companies that still manufacture them. So that’s a loss of jobs for the people who made those tables, not to mention the businesses in their neighborhoods.

  • Dunce Cap Aficionado

    We indeed agree.

    If the private sector isn’t expanding in other (one would assume newer) areas in tandem with the expansion of the CAD then there are corresponding negatives to the positive of cheaper goods.

  • S-I

    Tom, think about it. the GDP eqn says that your income is used for consumption (C), taxation (T), or saved (S). There is no mention of investment. Since C is the same in both the income and the expenditure version of the GDP eqn we know that in the above investment isn’t included in C therefore it can only be included in S.

    So think about it in terms of residuals:

    1. you have income

    2. some is spent on consumption (C)

    3. some is used to pay taxes (T)

    4. whats left is called (S); but …

    5. some of whats left has to include money used for investment (I) (by definition, where else can it come from?)

    so we have:

    C + T + I + laymans S

    If things were defined in this way this entire S – I business would be less messy.

  • Tom Brown

    Ah, interesting. Cullen, what of it?

  • Rob

    GDP = C + S + T

    T=taxes?

    Not all tax revenue collected by the govt becomes part of GDP.

  • S-I

    Tom another reason I think it is more intuitive to write it that way is that if the government ran a balanced budget we can clearly see that national savings is the current account balance:

    C + G + I + X

    vs

    C + T + I + laymans S

  • Tom Brown

    L isn’t taken, is it? I don’t know how those fit. In light of what “S-I” says below, I’m going to have to go back and read that part of Cullen’s write up, because I clearly have less grasp of this than I thought.

  • Johnny Evers

    GDP = C + I + G + (X – M)
    Doesn’t that logically lead to conclusion that deficit spending leads to more GDP. In the formula, deficit spending is always a plus. I think some readings of the formula treat deficit spending as savings.
    MR grants that deficit spending is constrained by inflation; however, the formula doesn’t seem to measure that?
    I guess by the same token, consumer borrowing would always lead to GDP growth?

  • Tom Brown

    I think they’re just adding up were all of the collective households’ money could go: consumption, savings, or taxes.

    Take a look at this:

    http://stopmebeforeivoteagain.org/2010/07/intro_to_economism.html

    It explains it with a bit more detail (and a fancy animation!)

  • Tom Brown