The Most Common Misconception About the Economy…
James Galbraith was recently interviewed in the University of Texas Alumni magazine and offered an opinion on the “most common misconception about the economy” (via The Alcalde):
“The Alcalde: What’s the most common misconception about the economy?
Galbraith: The fear that we will go bankrupt. The concept of bankruptcy doesn’t apply to a country like us; the U.S. is going to be just fine, long-term. Europe is another story, because the coordinating mechanisms between countries there are dreadful. The U.S. is more resilient than it may look.
My message is the financial position of the U.S. government is far stronger than a great many people think it is. Recently we’ve been seeing this notion that we’re heading toward some unprecedented, apocalyptic territory. You saw that with the panic over the debt-ceiling issue last summer. But the people who were actually buying and selling treasury bonds weren’t flustered in the least. In fact, bond rates went down.”
He doesn’t quite go into the detail that I did in this post, but he’s 100% right. This idea that the USA (a currency issuer) is similar to a household, business or Greece (all currency users) remains the most destructive myth in America today.
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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86 Comments
I’m increasingly doubting this core MMT belief. Of course the US government can go bankrupt: If it chooses to. It MAY choose to do so by collecting too few taxes, debt ceiling ir otherwise. State default is primarily a political risk. It is the same with Greece: They CHOOSE to go bankrupt, after all they are a sovereign country. Just credit bank accounts, no default. It is the same with banks btw: The government sets the rules WHEN a bank is considered insolvent, and has various institutions in place protecting them from default. The government could theoretically do this even with the average citizen. There is no necessary reason for me to be bankrupt if I can’t honor my promises any longer by my own cash flows. The government could bail me out. I think it is this POLITICAL power of the state which is really important. It IS in our powers to adjust any sort of social/political/economical relation. After all they are just human constructs. The question is more what’s sustainable and what not.
1. This has zero to do with MMT. We stopped using MMT last year. See here. http://pragcap.com/how-is-mr-different-from-mmt
2. Yes, the govt could choose to go bankrupt. Just like Warren Buffett could. That doesn’t mean it would be rational. The key is, the USA can always procure funds by harnessing the banks as conduits (PD’s must bid at auction) or using the Fed in a worst case scenario. The Fed, like any bank, can create money from thin air so saying the USA will “run out of money” is just silly. Unless you have a Federal Reserve in your basement then your comparison using a household is inappropriate. I doubt you have a Federal Reserve in your basement.
3. The true constraint is inflation. And this is a very different constraint than solvency.
“3. The true constraint is inflation. And this is a very different constraint than solvency.”
Cullen,
Love the site.
With regards to the inflation constraint, I find the “technical” differences between outright inflation and solvency to be one used often for convenience. Of course as the issuer of currency, every debt obligation can be satisfied, true insolvency is off the table.
But the unconstrained ability of the gov to issue debt or the FED to print does not in the slightest protect us from the very fears of a “worthless” currency or to the damaging effects of a hyper-inflationary environment. I keep hearing, it’s OK we can’t run out of money as an excuse to justify it. Because we can’t run out of money doesn’t mean we turn a blind eye to the damage uncontrolled printing has on our lives.
I find that MR/MMT is found lacking in this (inflation) area, they seem to hide behind the solvency argument and not adequately address this. Granted I don’t know all that much about the discipline (besides your work), so maybe you could explain the treatment of inflation in this regard?
As for the article, the opinion expressed by the author has no backing at all, no evidence whatsoever was presented as to why “The U.S. is more resilient than it may look”.
Poly, you might read my paper on this. I have an entire section on the inflation constraint. http://pragcap.com/understanding-modern-monetary-system
Will do, thanks for the reply.
Famous last words: It can’t happen here.
I am so relieved to know this truth.
In fact, it has completely turned my life around.
I used to be miserable and depressed.
Now I am depressed and miserable.
Don Levit
Cheer up Don. It could be worse. You could be living in a currency constrained nation like Greece. Now that’s depression.
I think the biggest misconception/ myth amongst economists is the belief that when average people say a country is going bankrupt the people mean it will go into a court and file for bankruptcy proceedings. What the average person really means is the country will enter severe financial difficulties and either default, devalue, or have some other sort of financial / currency crisis. Most people don’t know the details of national finance issues, so they use the word bankruptcy because it is relatively familiar. Even personal bankruptcy has many different meanings in a legal sense, it can be as serious as complete default, or merely some breathing room to restructure.
Galbraith then makes the further error of conflating national bankruptcy with a country doing fine. If he really wants to talk about the health of the U.S. then talk about that, not national bankruptcy.
Going on to read the rest of his articles there seem to be some pretty big holes in his 5 step plan:
1. Concentrate on restructuring and reforming the financial sector, which was a major source of the crisis. It’s still not fixed.
2. Reduce our reliance on oil. This is a tough one to fix, and I don’t believe in miracle cures, but we have to find alternatives.
3. This step has three components—all relatively small changes that would affect many people. One, let’s recognize that a lot of unemployed people—older people—will not get new jobs. Offering them early retirement would open up jobs for younger workers.
4. Next, let’s raise minimum wage, which discourages undocumented workers.
5. And finally, a right-to-rent law. This would say, if your house is in foreclosure, you can stay in the house and pay rent set by a neutral party and then buy it back in a few years if you wanted, if you could. That would change the incentives facing the banks, which are dragging out this process. They would have a much stronger incentive to renegotiate than they do now.
Step 1 – I agree with completely. Let the TBTF Zombie banks fail and then create laws to keep them from returning.
Step 2 – is a good idea as well, but easier said than done, it will take decades
Step 3 – will not be achieved except through basically making unemployment to be permanent for older folks, or extending SS to cover younger folks, which I guess will work, but aint going to happen, and it’s not really clear how that helps. All it really does is make the official unemployment numbers drop, but the actual numbers will remain the same.
Step 4 – just seems more of the same, government intervention as the solution. Realistically it would put more burden on business, and wind up reducing overall employment. And what does undocumented workers have to do with the deficit!?
Step 5 – Again, this has nothing to do with the deficit, or it’s causes. Foreclosures are certainly not the root cause of the deficit or our economic troubles, nor is keeping people in their former houses. All it really tries to do is prop up home prices at a level above where they should naturally be. Those high prices themselves are the symptom of the problem.
So 1 out of 5 valid points. I haven’t read any of his other stuff, but from that one article I can only conclude that while a small portion of what he is saying makes sense, he generally has no idea what he’s talking about, or is actually not concerned about the deficit.
” he generally has no idea what he’s talking about, or is actually not concerned about the deficit.”
Why should we (currently) be concerned about the deficit?
Galbraith states in his article that the deficit is a symptom of a problem.
quote from Galbraith’s interview:
“A deficit owl believes that the deficit is a result, not a cause, of economic difficulty… In my opinion, the deficit is a symptom, not a disease in itself.”
If there is a disease, one should be concerned.
Agree completely that ‘bankrupt’ means different things to different people. To me, bankrupt means the checks stop going out, and we’re closer to that than people think.
The argument that, ‘We can’t go bankrupt, silly, because we can always print money,’ doesn’t deal with the negative consequences of printing money.
Of course it “deals” with it. Cullen is saying that money printing doesn’t = inflation necessarily. All of you hyperinflationists have been wrong for years now. How come you never try to learn from your mistakes?
Johny didn’t say printing = inflation, he said that printing to prevent bankruptcy has negative consequences.
The government isn’t running out of money. I trust you agree with that, right? The Fed has a printing press.
So the threat is inflation. So we need to understand how money printing causes inflation. Right? I think that’s Cullen’s broader point here. Obviously, with inflation in the low 2% range we’re looking a lot like Japan who has huge levels of sovereign debt, but hasn’t gone bankrupt. So obviously, there’s a big difference between having high sovereign debt levels and being bankrupt.
Thank you, hyperinflation is not the only danger.
One of the problems we face right now is that we are borrowing so much money that there is no political consensus on money for useful things like infrastructure, for example, or for things like a space program.
…
Another one: if Ben Bernanke came out tomorrow and said, ‘We’re going to just credit the Treasury with $1 trillion tomorrow because we can,’ what do you think the market response would be?
The printing press creates currency, not money. Money is, at it’s very root a representation of wealth, and the printing press does not create wealth.
The government can run out of money, it cannot run out of currency.
Today debt, combined with a high deficit, is the threat, not inflation. Inflation is arbitrary. It’s fine to have high inflation in a high growth economy, as long as it’s not much higher than the growth rate. The problem is significantly higher inflation than the economic growth rate. Obviously not the problem now, but the debt burden, like inflation, cannot grow faster than the economy over the long term. If it does it will ultimately result in a default, devaluation, or high/hyper-inflation.
Japan is not a model I would like to follow, and yet it is pretty much the best case scenario for high debt loads, and has many advantages over us in it’s ability to handle a high debt load. But still 20 years of a stagnant economy, and no end in sight is not the path I would want to travel down.
The relationship between high debt / deficit and economic trouble is pretty strong, and merely having a printing press does not free a country from having to manage it properly.
Have you been to Japan? It’s a pretty nice place. By almost all human measures (longevity, populace satisfaction, international competitiveness, etc.) it’s tops. I’m not saying we SHOULD model ourselves after Japan, but you do realize that Japan CHOSE to “be Japan” by misunderstanding the fact that their government cannot run out of Yen. We’re following that same path, for better or worse.
There’s lots of nice places that I wouldn’t want to model my economy after. And following their economic mistakes will not make our society nicer.
Their #1 economic mistake was the one we *are* following: believing our government can go bankrupt. You’re missing the point.
I think you are missing the point. It is irrelevant whether some people use the term bankrupt, what they are really worried about our economic future and are just using the word bankrupt because it is the most familiar.
The concern is not whether we will go bankrupt but what our economic situation will be going forward. The words are not the issue, the ultimate outcome is.
Patrick, the problem is this. We are in a balance sheet recession and as the private sector de-leverages, it’s inevitable that the economy will shrink if they pay down debt and fail to spend on the things that drive the economy. The solution in this environment is to run big budget deficits which allow the private sector to heal their balance sheet AND continue living their lives without driving us all into a depression. It’s simple math. If the govt doesn’t spend to offset the decline in spending from the de-leveraging in the pvt sector then output goes unsold, unemployment rises, and the economy contracts. Study the sector balances if you don’t understand this. It doesn’t lie.
People like you, who believe the govt “can’t afford” to spend are telling us we need to be more like Greece. We need to drive ourselves into depression so we can rebalance some imbalance or something. It’s the old “no pain, no gain” idea of economics as if we need to go through some pulverizing depression just so we can learn a lesson or something. It’s working great in Greece. Their economy has been decimated and their stokc market is down 90%. Great. If the USA had taken this advice in 2008 we’d be in the same exact hole. Luckily, the fear mongering hyperinflationists/defaultistas have lost out so far. We can only hope they continue to.
I might have mischaracterized your outlook, but I’ve been defending my positions (most of which have been right) for years now and the tune you’re singing is the “we can’t afford to run budget deficits” mantra. It’s wrong. We can afford it. We can always afford it. And we need it right now. The math doesn’t lie.
my response is below as the columns are now to narrow.
Why this emphasis on HYPERinflation ? In between zero inflation and HYPERinflation there is moderate inflation like 200 o 300 basis point higher than treasuries and other so called “safe” investments. A government can always proceeds toward financial repression and infact it’s what’s happening now in many countries. The huge public debt in US and UK after WW2 was “payed” this way + real strong growth. Now we don’t have real strong growth because the pillars of strong growth have disappeared. But financial repression is here to stay for at least a generation. It’s not that you can’t fight the FED, you CAN’T FIGHT the goverment. Never.
I wouldn’t say that it ignores the negative consequences of printing money. Rather, it points out that the consequences are different for the two, between printing money and stopping sending out checks (bankruptcy).
I can’t imagine a scenario for bankruptcy that doesn’t involve the government grinding to a halt, and almost certainly interest rates increasing.
For money printing, the consequences demands entirely on the demand for money (reserves). We’re “printing money” right now; our government is running a deficit and the Fed is buying up Treasuries. But the new supply of reserves that are flooding banks are far in excess of what they need or want, so it’s non-inflationary. Banks are currently constrained in their lending, because of reduced capital or lack of investment opportunities or who knows what, so the money isn’t circulating.
I’m Back Bitches…hide your woman.(my poor son has a lifetime with me)
Well- Ireland is a Union nightmare. Mafia like to the U.S corporations. Having spent time visitng with a V.P at a biotech firm who took over Pfizers facilities they are ruthless and want Merkel dead becaus as they said over many free Guiness- “Eurobonds are the answer” Eurobonds are the fountain of youth to those who couldn’t do what they agreed to. It’s their way out of the trap they walked into by way of action and who they elected. As Justice roberts said, “it is the responsibility of the people for the federal government they have elected”.
France is wonderful- and the people were amazing. I’ve been there several times and everything you here is wrong. Everyone we spoke with did everything in their French blood to be accomadating and kind to us.(and we had a loud girl from Austin,TX with us). Remember, when someone asks someone from America where there from only citizens from the Nation of Texas say..”Texas”….to which every Frenchman/woman responded with a smirk…”ahh..Geoorg Buuuush” “you like Georg Buuuush”
The French were amazing! the other thing they did when they didn’t speak english was to immediatly respond, “i do not understand but I will try my best” Every Cab driver and waiter said this to us. I could not really claim any insight on Hollande popularity. But if the Euro continues lower I would go straight to Paris!! the people were wonderful!!
London- Nuts- The place is just bonkers. It’s New York on steroids. Really cool, expensive and alive.
Back to the topic: MMR has nailed it! But..we need to get to why we are discussing why we need to spend this much money. Why are we in this position. Why have all these dicks been allowed to fill our capital floors and why are they so friendly with those in Conn. and NYC? What’s the point of agreeing on spending if we NEVER get to why. Like Vinny from Sham wow “I can do this all day” Untill we get to fixing this system that is cloogged up with crap we’ll just keep doing this every 5 years.
Why are we supporting finacial markets which wanted to fail. The banks are begging to die…why are you saving them Mr. Govt. The politicians are begging to be lynched why are you pardoning there actions Mr. Public? Why are they allowed to divert funds into those areas and away from education, health and infrastructure. Why are we cutting govt. services we need so that we can continue to pay for pensioners and beurcratic boards/councils to continue to decide on matters that they have shown they can’t. At the end of the day we can spend and spend but the only thing that matters is that we spend on what was guaranteed to the policy makers who ran for office. Now their job is to protect there family by handing out more spending to those they have helped lose jobs.
Yep I’m back from holiday…now let’s get some shit done. Time to get off your ass and stick it to your elected official/Bankster/economist. Many of you already have.
Nice update Cullen on the site. It takes alot to run a business and keep it changing. Impressive Mr. Roche…you have an Entrepreneurs spirit like those who built this great country of ours. Hell you even started your own Monetary Theory. Any body out there want to do something difficult…try starting your own theory.
Uh ! A wonderful post VII !!!
But if you liked France, well you have to go to Italy… food is better and wine and people as good as in France
I agree on that. No better food than Italy.(Don alfonzos in Sorrento!!!) All I do in Europe is eat and drink.
Re your salutation: What do you think this place is? Zero Hedge? (OK, they always spell it with a ‘z’.)
Welcome back.
Just remember I write because I like. Zero Hedge is my financial porn site I read in the dark in my bathroom when my wife is gone.
Glad you’re back VII.
Would anyone besides me like to see a bigger font size on the text? Sure, I can blow it up in Chrome, but only at the expense of losing the right side of the page, which, Cullen, is exactly where the links that pay the freight are. Alternatively, I can also use Ad Block to *remove* those elements completely, and leave the page set to very large. Frankly, there is a way to do this, Cullen, and either you do it or I will.
Lance, upped it one font size. Let me know if that’s better.
The headers are wonderful, Cullen, but then they always were okay. But the article text and replies are still too small for me. Oddly, when you quote, as you do in the body of this article, the quoted material is a nice, large, readable font. Why not use the same size for the rest of the text and the replies? Yes, it costs some vertical space, but then we’ve all read down this far anyway.
I’m 62, Cullen. When you get to be my age I’m going to send you email you’re going to need a magnifier to read. ^_-
I just altered it so maybe try closing your browser (your cookies are probably saving the old font size) and reopening to the site. It should adjust larger. Let me know if that’s better.
It *is* better after closing and reopening. Thanks, Cullen.
Great, I look forward to the emails you’ll be sending. Can you also mail the magnifying glass? The lost ad revenue is on you after all and there’s no way I can afford a good magnifying glass now! Just kidding of course. Thanks for the heads up.
Cullen, in response to your post from at 5:08 PM
The real economy will shrink either way. All we are doing by deficit spending adding government spending, which will reduce some of the shrinkage temporarily, will result in a less healthy and functional economy in the long run. You seem to believe there is a pain free way out of this situation, but there isn’t. The time to avoid the pain was 10 years ago, now the question is what type of pain, and for how long. We’ve been spending at huge deficits for years now, and it hasn’t worked, and shows no signs of working. It’s not the end of the world for the economy to shrink, it’s happened in the past and will happen again in the future.
I have no problem with large deficits when debt is low, as you have the luxury of time when the economy is fixed to deal with it. I even agree that deficits can go on permanently, but not at the rate we are running them. You can’t overspend the growth of the economy in the long run. As long as debt growth is kept in line with economic growth things can move on just fine, but we are way over that line, and there is no sign of that changing, nor is there even a sign of it helping at this point. But high deficits combined with high debt are a recipe for disaster.
Debt is a problem because the more you have, the more you must spend servicing it. At our current debt growth rates we will be at 200% of GDP in less than 10 years, and 300% ten years after that
Do you think we can grow our debt faster than our growth indefinitely? If not, how long can we do it for? When do you see our debt growth coming into line with economic growth?
Unemployment has been flat for years at this point. It’s really bad to be deficit spending for things like food stamps, pointless wars, unemployment insurance, and enriching the already massively wealthy. It’s really, really bad to spend it on keep businesses alive that should fail because of their own incompetence. You might as well burn the money.
Greece is where it is not because of austerity, but because it has failed to take the steps necessary to correct it’s issues, it’s problems were there long before austerity. It’s entire economy was based on debt, and when people realized it will never repay, or even service the debt, their debt service rates skyrocketed. They have not corrected the issues that led to the debt, and therefore their economy is where it is today.
You point to Greece, I point to Iceland, which did the moves I believe we should have done, and while it went through pain it is doing better than most economies now, and is one of the very few countries that suffered dramatically from the 2008 meltdown and is actually healthy now.
1. I never ever said there was a “pain free way” out. We have undergone substantial pain. How many people have lost their jobs, their homes, their companies, etc? You call the last few years “pain free”? Come now. There has been substantial pain.
2. Iceland lost 90% of their stock market value. I’d like for you to lose 90% of your net worth and come back and tell me that you enjoyed that or thought it was “necessary”. Those people will never regain their 2005 standard of living. Not in this life time. That might be a world you want to live in, but not me. And I don’t think it’s necessary to crush every being in this country just because a few million people decided it was okay to live beyond their means. A 90% correction in net worth is not what’s necessary here. Yes, a lot more of the losers need to lose and probably should have lost, but that doesn’t mean there is no balance in what we can do to stop a system from bleeding out. You seem to believe in some barbaric form of natural selection in a free market collapse as the only way to achieve prosperity after a boom. Assuming “prosperity” is a 90% collapse in net worth. I am all for allowing losers to lose, but I am not in favor of letting an entire system collapse because 25% of the population decides to go crazy during a boom….And this doesn’t even get into the wreckage that was Iceland’s “growth” plan going into the boom. It’s not remotely comparable to what happened in the USA.
“2. Iceland lost 90% of their stock market value. I’d like for you to lose 90% of your net worth and come back and tell me that you enjoyed that or thought it was “necessary”. Those people will never regain their 2005 standard of living.”
I disagree CR. It is no ones job to be captain save a ho. Iceland is better off today for that. In fact…I doubt Icelanders would have lost 90% of there stock accounts? 1. why would they invest in Iceland Stocks only? 2. it went down because most sold. And most of those who cause the harm lost. 3. Those who did lose will never let this happen again because they don’t have money left to squander.
NO one allowed Iceland to lose 90%! They did. Let’s get accountable. NO ONE forced them to do what they did. They however in 18 months…clensed a system that has taken the U.S 12 years of a yo yo market. In fact if you take the losses of the Nasdaq, Real estate, Commodities and then SPX from 2000-2012 the cumalitve loss is probaly about 90%.
It is not barbaric to get out of the way of a person or institution from destroying itself. It is the responsibilty of every man and woman to make sure they do this so that future generations are better off.
I have a responsibility to those who did right to make sure I do not protect, condone or sign off on reckless poor stewardship of capital. It is not MY fault because the SPX should lose 75% of it’s value to prevent it. It is our responsibility to the future to make sure those who took risk bear all the responsibility of that risk. Protecting them or babying them for fear of them or I losing money is the best way to weaken a society. To coddle them because the outcome is tough. More…I would have sold my SPX and bought lower. Turning their liquidation of assets from weak investors to stronger investors. I would profit…exactly as the system was meant to work.
I disagree on this. NO ONE should be protected under the guise of being a nice guy. Your doing NO ONE a favor. Especially the future of this country. Iceland is better off for exactly what they allowed to happen.
This is not a “cleansing”. This is a decimation. It is an entire country in ruins. To call it “better off” is not right. These people have been ruined. Decimated.
Do you really believe the USA needs to undergo this sort of collapse just to “cleanse” the country? We need the S&P 500 to utterly collapse just because 25% of the country decided it was okay to buy a house they couldn’t afford? We should sink the whole fleet just because a few ships can’t float? Sorry, but I just think that’s wrong.
I tend to disagree with you on this one, Cullen. Mostly due to the fact that the majority of individuals in this country do not own stocks, and something like 40-50% of financial wealth in the U.S. is owned by the 1%. I say it is high time for the wealthy elite of this country to take some pain.
Jay, 50% of Americans own stocks in some form through their employer of personal retirement or brokerage accounts. 30% of the country works for a publicly traded company. And 100% of the country is in some way attached to the thousands of companies listed on exchanges. These companies represent the lifeblood of the entire nation. They are not just some select group of companies representing a bunch of fat cats. Either way, a collapse in publicly traded shares does not mean the rest of the economy goes untouched. This would filter through to the entire economy whether listed on an exchange or not. To decimate these companies is to decimate the country. All for what? Because some people decided to gamble on housing? Sorry, but I don’t think my ship (and hundreds of millions of others) deserves to sink because a minority of the country decided to be irrational.
Fair points, certainly. But I do believe the policy response to the credit-bubble was very poor. Instead of bailing out the bondholders and shareholders of zombie banks and financial services companies, the gov’t should have guaranteed the deposits and wiped the bondholders and shareholders out.
Maybe that is another topic altogether…
Agreed!!!! I was all for letting the banks shareholders lose. I am totally agreeing with you. There were better ways to let the losers lose and build a wall around them so they wouldn’t sink the entire economy into depression. All I am saying is that a few broken eggs doesn’t mean you throw out the whole carton….
You’re right. And I was wrong to lead on that a 90% equity market wipeout is something that was ‘necessary’ or something like that.
I’m just frustrated by the still moribund economy (could be a lot worse, however…thank goodness for deficit spending) and Bernanke’s failed QEs.
There are lots of moving parts here and the conversation of disjointed because I agree with a lot of what you originally said (but didn’t detail that) so the miscommuncation is understandable.
It was not a 90% stock market drop, but a 90% index drop. The index was made up of 15 companies, 3 of which were the massive Iceland banks that failed and accounted for nearly 75% of the total index value.
I touch on this in my reply below, but notice the shape of that chart, a huge bubble appears from late 2003 to the end of the bubble. This was not Icelanders running their stock market, it was foreign investment that fled after they took the necessary measures that they did.
The stock market is not the economy. Most people’s wealth comes from their labor, not investment. Even if 50% of people owned stocks, only a very small percentage own it as a significant portion of their net worth.
GDP and unemployment are much more important for individual well being. Iceland’s unemployment is almost back to where it was before the crisis, while their GDP dropped quite a bit (I believe between 10-15%) at the trough it is now growing quite strongly.
Come on Patrick. That’s very misleading. The stock market doesn’t perfectly represent the economy, but it certainly represents a big chunk of the health of the economy. To claim that a 90% decline in a nation’s stock market would not have enormously negative and even decimating effects is misleading. These companies are in some way attached to all of our lives. The shoes you wear, the shirts you own, the cars you drive, the houses you sleep in, the diapers your children wear, the food you eat. Ever single thing in our lives is attached in some form or another to a publicly traded company. And as I mentioned before, if the stock market falls 90% you can be 100% certain every private company will feel that pain also as the stock market just represents the macro environment.
Actually your 90% number is the misleading one. It has nothing to do with the real scenario. In fact almost 75% of that 90% drop was due to the 3 big banks being taken over by the government and their stocks dropped to 0.
The 90% is not representative of what really happened, and it’s not even really representative of the stock market itself as it was just an index, made up of 15 companies, the 3 largest of which made up almost 75% and went bankrupt simultaneously.
The index is also defunct, and it’s replacement is up 15% YoY and 21% from the trough, handily outperforming the S&P 500.
Handily outperforming the S&P from our trough? Hardly.
Always focused on the semantics eh? Here’s the clarification: handily outperforming over the times stated.
Of course the fact that the Iceland stock market is outperforming the U.S. stock market over the last year and a half is not the important part, it’s that the 90% index drop (or more accurately the failure of the 3 largest Iceland banks) has nothing to do with the reality of the Iceland experience.
Either way, it’s an apples to oranges comparison with the USA. Iceland had a massive foreign denominated debt issue so its not even remotely comparable to the USA’s situation.
It’s irrelevant whether it’s foreign denominated. Debt is the problem, now how it’s denominated. And letting banks fail is necessary for a recovery from a crisis caused by financial incompetence / malfeasance.
Iceland also did deficit spending after letting the banks fail, the point is that you must cut out the cancer, and then you put on bandages. We failed to cut out the cancer, and it will cost us dearly. That’s why deficit spending makes no sense today because we never dealt with the actual problem.
The debt Iceland owed was in a foreign currency. There were limited policy options when the crisis occurred so total collapse was the only option. The USA is not even remotely close to being in the same position. There are policy options that can reduce the pain while allowing the losers to lose.
Just so we’re clear – what is your preferred policy response now Patrick? Do you think we should just cut the budget deficit and let the cards fall where they may?
They were fortunate that they didn’t have the options we had, as they couldn’t choose foolish measures.
The USA was in the exact same position at the exact same time, and made the wrong choice.
I asked a few questions above:
“Do you think we can grow our debt faster than our growth indefinitely? If not, how long can we do it for? When do you see our debt growth coming into line with economic growth?”
I’ll answer your question in good faith, but I’d like an answer to mine as well.
I’ll post as a fresh post as I don’t like it when the responses get too narrow.
Cullen-
Did you just post an Iceland graph that shows a bubble formed(i.e investors made money) then like all bubbles it collapsed then connect all of Icelands populations well being to that graph and claim they were decimated?
They were no more decimated than Enron Shareholders, Argentina, Russia or U.S citizins during the great depression.
When one ties an emotional human element to a graph it will be used incorrrectly by those who benefit from this not happening. Mainly anyone but the citizens who would have been burdent with the debt Iceland chose to restructure.
There is alot to cover in this discussion but as a general view It’s not that I want anyone to fail. Or that we should sit idle while others struggle. Quite the opposite. I believe it’s paramount we allow people to succeed and prosper. BUT..should a country, investor or individual ignore all prior advice and warning then in order to protect the other ships we must let some die. Not that we encourage them to. But that we have done all we can to help and some are incapable of assitance. Now…this is not MY(VIIs) Choice. This was those who invested in an economy that had no business with the valuation the markets gave it. This is no different than what we do daily. You and I.
Further Howard Marks said it best in his latest Missive. “Bob O’ Leary …said “our bisniss is often an examination of flawed underwriting assumptions”…in other words, it’s their raison d etre to profit from the mistakes of others”.
IN PREVENTING LOSSES OR THINKING YOUR HELPING YOUR DOING MORE HARM TO THE SYSTEM! YOU ARE PREVENTING SOMEONE ELSE FROM PROFITING WHO SPENT TIME AND LABOR TO DISCOVER THAT ICELAND WAS SCREWED ALL ALONG.
I don’t look at Icelands chart and see peak to trough losses on the people of 90%. I see someone who profited on the way up and someone who likely positioned correctly to profit by others mistakes. In fact this is a vital piece of the market. Likewise when someone makes money long somewhere someone is losing trying to short Iceland on the way up.
H.Marks-”Cycles are big sources of error, and pro-cyclical behavior is one of the biggest destroyers of capital”
In the same letter to shareholders Marks brings in Charlie Munger “it’s not supposed to be easy..” We should not protect a group of investors(this is not the iceland people..this is british banks who lost out btw) who assume that Icelands market is going to the moon. That is silly.
And remember as Marks says, “Yes, JP Morgan(ICELAND)lost- big but as MR has pointed out, someone else won”
That’s the bottom line on ALL investing. There’s generally a right side and a wrong side to ever investment. Which will you be on?”
This isn’t about the people of Iceland! Since that restructuring Iceland has been freed of the debt. Fitch has raised their rating and GDP is hasgone back 2004 levels(4/4/2011). Iceland has been on the mend ever since. The article I read on Iceland quotes an icelander who says..Svanhvit Ingibergs, 33 “I had no part in causing those debts, and I don’t want our childern to risk having to pay them. It would be better to settle this in a court”
And so a nation of 320,000 once again has been liberated from the debt and mistakes of Domestic and foreign financial instituions.
Iceland is the model to which Greece should follow. That chart doesn’t come close to telling the truth of what happened to free icelanders from years of taxation and austerity to bail out banks.
1) Pain from now, to get out of our current situation, which is far from ideal today.
1a) You said “no pain, no gain”, which implies a pain free alternative.
2) This is actually a bunch of points
a) The stock market is not the economy, most of those losses were from foreign investment in a massive bubble starting in late 2003. If you look before that the market is down about 50% from pre-bubble. Still pretty bad, but average people have only a small fraction of their wealth in the stock market.
b) I have no idea where your “crush every being” or “barbaric” stuff comes from. Please explain. I certainly believe in the free market. I think the present situation shows that government intervention is not the solution, and we certainly aren’t operating in a free market when certain parties are rewarded for incompetent management, and criminal activities to the detriment of the middle class. I basically believe the government should get out of the way and make a simple and fair framework for all parties to compete on level ground.
c) Again, 90% stock market collapse is not the same as net worth loss, especially when a huge portion of the losses were due to massive amounts of foreign investment brought in by the very cause of the collapse in the first place. Their GDP dropped by somewhere between 10-15% while they were going through their pain, and while bad, it’s nowhere near 90%. Now they are back in strong and solid growth territory, which is not based on a bubble.
d) The reality of Iceland’s situation is that it’s unemployment levels are at 5%, it’s turned a trade deficit into a surplus in a few short years, emigration has stopped and in fact they are now importing some workers, economic growth is far superior to ours (and almost any other country in the developed world). The Icelandic people are once again happy and their country is doing well. A few years of pain for the right reasons can lead to an excellent outcome. On the other hand they would probably be worse off than Greece today had they not done what they did.
Correction: the single most destructive myth in America today is that massive govt spending works. This myth persists despite 3.5 years of the Obama presidency, a $5 trillion increase in debt, and persistent inflation higher than it was ever supposed to go
Sorry “persistent unemployment”
In response to your question above from 07/11/2012 at 9:22 PM:
Just so we’re clear – what is your preferred policy response now Patrick? Do you think we should just cut the budget deficit and let the cards fall where they may?
No, it’s more complex than simply cutting the budget and letting the cards fall where they may, but honestly I’d rather do that than continue doing what we are doing now.
But from my perspective the issue is much greater than simply debt or deficit, which are really only a symptom of the underlying problem, which is legislative capture. It’s really too big to get into in a single comment, but I’ll try for the best summary I can.
The most important thing is to fix the problem in the system:
1) Cut the cord on the banks, return to mark to market, and break up the TBTF banks. The fact that TBTF banks have only gotten bigger is clear evidence that nothing has been fixed.
2) Reinstate Glass – Steagall.
3) Next prosecute whatever criminal behavior was done in the credit bubble run-up and since then, such as fraudulent lending, fraudulent foreclosures, MF Global / PFG type activities, etc. There are seriously too many to list, but no true fix has been accomplished if the criminal behavior has not been prosecuted.
At this point a number of banks will fail (probably many) and there will probably be financial turmoil, and here is where the government can actually be useful. It needs to provide the stability in the financial markets, in a similar fashion to 2008, but hopefully more effectively and more to the benefit of the nation than the banks.
Now it gets really tricky… like I’ve said previously, I’m not inherently opposed to deficit spending, but it must be focused and part of a plan. Today there is no plan, and there is really no focus, unless the focus is to enrich the wealthy at the expense of the middle class.
A reduction in the deficit must be gradual, and the money must be spent effectively. I would cut back on things like food stamps and unemployment and spend that money on infrastructure and training. At least make unemployment insurance come with the requirement that the people engage in productive activity. Social Security and Medicare must be addressed, it’s pretty simple, just gradually raise the qualifying age. Ultimately there should just be a cap on the number of people that may qualify, such as the oldest 5%, or whatever number is convenient.
So basically a planned reduction in the deficit over a number of years, and some structural changes to how our finance system works. There’s much more detail that could be gone over, but I have to run.
Looking forward to your answers to my questions above.
Yo Patrick,
I am all for your:
“1) Cut the cord on the banks, return to mark to market, and break up the TBTF banks. The fact that TBTF banks have only gotten bigger is clear evidence that nothing has been fixed.
2) Reinstate Glass – Steagall.
3) Next prosecute whatever criminal behavior was done in the credit bubble run-up and since then, such as fraudulent lending, fraudulent foreclosures, MF Global / PFG type activities, etc. There are seriously too many to list, but no true fix has been accomplished if the criminal behavior has not been prosecuted.”
Agree wholeheartedly. Kudos.
Thanks Jay!
Patrick,
I like your prescriptions, though you notably omitted the precursor to creating those prescriptions: getting the corrosive effects of mega-dollars out of the political system.
I take exception with cutting food stamp subsidies. The program provides quite a bit of living wage productive work (farming), and has the added benefit of allowing children to eat.
Thanks, and I definitely agree the money needs to be eliminated from politics! My suggestions above are probably impossible until that is corrected… but there was only so much room and time for one comment…
I don’t mean to eliminate food stamps, I mean cut it back significantly, but gradually over time. When 1 in 6 Americans is receiving subsidy, something is wrong (and that’s just on food stamps). Programs like food stamps, unemployment are great when they exist to keep people from falling through the cracks, but when the crack becomes the size of the grand canyon it’s an indication that something much bigger is going on, and simply expanding the program is not the solution. This applies to many other programs.
Personally I think social welfare is important, but is important, but only useful when done in small doses to protect the most vulnerable, and it’s really easy to get people into a cycle of dependency on it, so there should always be limits, or ways of making the programs less and less pleasant for recipients. I ultimately would cut all social welfare to a small fraction of the budget and cap the total amount that can be spent on such projects as a percentage of the total budget, maybe 1-2% (I’m flexible on the exact number).
I personally believe that when these programs get too big they create a bigger problem than they are trying to solve.
There’s also loads of corporate welfare that would need to be cut.
I would also drastically cut the military budget, by like 90% if I had my way, again over time.
I basically believe government has grown way too large and the only long term solution is reduction, but it obviously has to be done gradually over time. It’s not a partisan issue as both parties are equally responsible for this growth in their own pet projects.
+1 Roger.
I also agree with some of Patrick’s points below (eg military spending – and add medical costs). But welfare spending is tricky – I agree its current high levels are symptomatic of deeper problems; but you don’t deal with these by attacking the symptoms – and the vulnerable victims – of the problems.
I would suggest that administering most welfare programs at the state and local level – with federal funding support – might be a more effective way of meeting real needs and limiting cycles of dependency.
Patrick,
Starting a fresh thread here. Again, we’re back at an inflation constraint. I don’t find much meaning in debt:gdp ratios. Why? Because they’re as meaningless as money supply figures. If you don’t put it into context then it means nothing. If the govt spends a trillion dollars and it all gets captured by banks who are starving for capital then there won’t be inflation. The same idea applies with debt to gdp ratios. It’s a meaningless concept unless put into concept. And since our constrain is an inflation constraint then the amount of debt we have is rather meaningless if it doesn’t cause an inflation problem. Japan is a fine case study. I’ve watched JGB bond traders fall on their swords betting against govt bonds for a decade. They all said the same things you’re saying now: “The country is insolvent, the debt needs to be repaid, the yields wills surge!”. Wrong, wrong wrong. We now have a clear precedent for our scenario.
So, to be short, I would answer your question by saying that yes, debt to GDP shouldn’t be able to grow disproportionately forever because I would assume that if it got way out of whack we’d have an inflation problem at some point. But are we there yet? Well, with 2% inflation, 79% capacity utilization, 8% unemployment, etc I’d say that inflation is the least of our worries.
I’m not entirely sure if this is an answer to my questions above, so if I’ve misinterpreted this please forgive me.
It seems you are saying yes debt can be a problem, but not now as we are in a low inflationary environment, and that at a certain it becomes an inflation problem, which is exactly my point. High debt loads lead to high inflation. I believe you phrase this as the inflation constraint, but from my perspective high debt levels ultimately result in high inflation, so the inflation is baked into the future.
The other parts of my question were how high a debt level is sustainable, and when will we be able to reduce our deficit to ensure we do not cross that threshold.
Regarding debt/GDP, if it’s the GDP part you have a problem with then I agree, I use GDP because it’s readily available and understood. If it’s the ratio of debt to anything that is the problem then we disagree, everything must have a ruler.
Regarding bond traders, I don’t think the debt load has any impact on short term trends, the issues involved in debt play out over years and decades.
Regarding the spending trillions captured by banks, I understand the point, but that’s another topic as that’s a spending matter, not a debt matter. On top of that it’s not the current situation as government spending is going directly into the economy, and even that being captured by banks is subsequently leaked out into the economy.
Patrick,
I’ve been pointing out that inflation is the concern to you for weeks now and you keep talking about default. High inflation and default are not the same thing. So I am now totally confused about your position as you seem to be coming around to my original point. I agree that inflation is always the true constraint. That’s been my point since day one. But I disagree with your idea that high debt = future inflation. Japan clearly proves that wrong.
Cullen
To me high inflation combined with low is not the concern, it is an outcome of high debt loads, and high debt/ deficit is the concern.
I’m not sure why you say I keep talking about default, particularly in response to my above post, as I didn’t mention default.
I have mentioned default in other comments, but I have also mentioned devaluation and high / hyperinflation in a number of comments. All of these are potential outcomes of high debt loads. No nation has to default, but many choose to, for various reasons.
Personally I doubt the U.S will default, but if the U.S. doesn’t change it’s ways soon, I believe we will have to choose one of those possibilities, or one will be forced upon us. But in that scenario default is the best case as it is the least severe of all the options. If only Greece could solve it’s problems by a simple default!
I’m also not clear why you think I’m coming around to your position. My position is that the in general high debt loads are a problem, particularly with a high deficit (which I define as significantly above the economic growth rate). In particular the U.S. meets these criteria and we need to do something about it ASAP. Have we actually been in agreement on this matter the whole time?
Japan has proven nothing as Japan’s economy is still troubled, and getting more so. As I’ve pointed out many times here, their debt load and debt growth are unsustainable. I’ve pointed out that although they have kept their inflation low, their economic growth has suffered, and their situation is quite unique (being that 95% of their debt is held within the country). Their debt has constrained their growth, and their ability to keep low interest rates is based on their ability to sell bonds to their population. At a certain point those people will begin to retire and will become net sellers rather than net buyers. I don’t know exactly when that will happen, but it will, and it’s probably not more than 10 years away.
Japan was once the number 2 economy by GDP, now it’s 3rd by quite a large gap, and by some measures it has fallen behind India, and it’s continuing to fall in position.
My understanding is that you believe that the U.S. must spend at a high deficit now (please correct me if my understanding is wrong), but when do you expect this to cease to be a requirement, and more importantly, how do we get there from here?
i didn’t realize there was any fear of the nation going bankrupt. the national debt has increased every year for decades and the projected national debt is increasing sharply. yet, the economy remains stagnant. how much debt would satisfy the Keynesians?
Re: the scary Iceland stock market and other stuff.
1. Presumably the Iceland stock market will be fairly valued again; either it will return to its pre-bubble highs or it was too high to begin with. I know people who ‘lost’ all their money in our stock market bust; but really, they are forgetting all the gains that happened before.
2. Now, I do know many people who have lost serious money in real estate, which is a much bigger part of their wealth, and nobody helped those people. Nor should they. That guy is a loser, unfortunately. Now the entitity that held the mortage; well, Uncle Sam made him whole and is still conducting policy as if it would be a disaster if JPM doesn’t get paid.
3. It’s very rare that losing capital cripples a man as an economic actor. He can still work, still produce. In fact, not having to service debt frees him up to be more productive. Losing money, deleveraging, rarely impacts future activity. That’s why Iceland, the Baltic states, it looks like Ireland now, have been able to write down their losses and bounce back so quickly, while nations like Japan just limp along endlessly, sacrificing an entire generation of young people (the social costs in Japan are sobering, fewer marriages, fewer people having families). Even banks that go broke can be replaced pretty easily. Probably the same people just cross the street and work for a new bank, or a regional bank that comes a major player. Look at BAC, which is pretty big now, but 20 years ago was a minor player, and probably should be out of business today.
4. The big issue with deficit spending is that when you look out ahead you can easily see the Fed’s balance sheet growing to $50 trillion or more because there is no discipline to address the entitlement issues if you believe that debt only matters if you see inflation.
5. What we need is a Debt Jubilee. Everybody wipes the slate clean and we start over. Maybe that wipes out the traders, but the good ones would all sell their houses and cars, get up the next day, and go back to work.
A debt jubilee is not a good idea. Our entire monetary system is a credit based system. You don’t just scrub it when people decide they can’t pay it back. Default is moral bankruptcy. An entire society that defaults is morally bankrupt.
Again, I disagree here. Default is not inherently moral bankruptcy, propping up businesses that do not properly manage their risk is moral bankruptcy. Businesses do it strategically all the time.
Default is part and parcel of lending, there is always the risk of default. That’s why you structure the loan in such a way to make it more unpleasant to default than to just meet the terms.
Stop paying your car loan, your car is repossessed, preferably publicly.
Don’t pay your mortgage, you lose your home.
It’s also why unsecured credit cards have much higher interest rates, since there is nothing to recover under default (although realistically they can garnish wages, but it’s a much bigger pain, and expensive).
Although I do agree the debt Jubilee would be bad as it would be moral bankruptcy, I got caught up in the philosophy and forgot about the actual topic at hand.
Debt jubilee have been done quite often in history, most often when there is so much debt that economic activity stops. As for the moral aspect, many religious or philosphical thought systems view debt itself as a form of slavery.
What is the ‘morality’ of saddling a young person with $50k of debt so he can obtain a degree to earn $15 an hour? Inedentured servitude was a better deal than that — work seven years for a colonist in Virginia and then get free land and a clean slate.
What is the ‘morality’ of tieing our children to a $16 trillion debt (unless you acknowledge that it won’t be paid back .. say, isn’t printing a form of debt jubilee?)?
Our current deleveraging *is* a form jubilee, except we’ve decided to forgive the debts on some people and not others. How moral is that?
Debt is a two-way street. When the lender makes a bad loan, he deserves to take a loss and not foist his loss on another man via economic threats.
By the way, San Bernadino, California declared bankruptcy this week, the third such filing by a California city this year.
From a philosophical standpoint I agree that default is not immoral, and I agree that the current form of delevaraging is a moral hazard. My problem with the debt jubilee is that I don’t feel it’s warranted at this point. There’s still plenty of much less drastic options that could be enacted to fix the problem.
I 100% agree that student loans should be entirely revamped, and in general the government should get out of the business of lending, or guaranteeing loans.
I agree lenders should suffer losses when making a bad loan, I addressed much of this in my longer post above.
One Cullen Roche says: “”The government must run large deficits in order to lt the private sector can heal its balance sheet”".
Has one C.R. become a follower of Paul Krugman ? He basically proposes the same.
I’ve been saying that line for 4 years. I honestly wonder if you actually read the articles or not….
I noticed that for four years. But Krugman’s view is imcompatible with the notion that banks create credit out of thin air and borrow money later to have reserves.
And Steve Keen had a – IMO – good story why this is incompatible.
See Mish’s website:
http://globaleconomicanalysis.blogspot.com/2012/07/steve-keen-goes-off-deep-end-with-debt.html
And by the way: Keen is advocates a debt jubilee of sorts.
Clearly, he does not.
1. The bankruptcy of the US is actually not out of the question. When (not IF) taxrevenues are dwindling then a number of states will look at what they’re paying the federal government (in federal taxes) and what they get in return from the federal government. When they pay more into the system than they receive then it’s – IMO – simply a matter of time when those states (e.g. Texas, Alaska) will leave the union.
2. Reducing the reliance on oil requires the US to shrink by say 5%, 10%, 20 or even more.
A question for everyone:
Is it better for government to be revenue restrained (as in Europe), so that they do not have the capacity to deliberately devalue the currency, with the risk of eventual collapse in the currency.
Or is it better for the government to be able to borrow with no limit, and when the markets stop buying your debt, your central bank steps in and buys it for you?
As a saver, I wish I lived in the Eurosytem, as the currency is protected.
Any savers in the US agree with me?
Just finished reading 5,000 Year of Debt. Well worth the time to read, love to hear from others on site that have read it.
I haven’t read it, but I just bough it… hope to get to it soon, thanks for the recommendation!