Richard Koo’s latest note contains a chart that regular readers have seen before.  Similar to my recent analysis, Koo attempts to forecast the de-leveraging of US households using broader trends (via Business Insider):

It’s easy to look at this chart and conclude that the US economy will remain in the garbage can until 2020 or so.  I don’t think that’s an accurate reflection of the current environment though.  First of all, Japan is the proper comparison.  Greece and the bankrupt Euro nations exist in a monetary system that is not comparable to that of the USA. Although both Europe and the USA are suffering balance sheet recessions, one is an autonomous current issuer.  The other is a single currency monetary system in which each nation is a currency user.  Therefore, the whole solvency debate in the USA should be disregarded (unlike Greece).  Second, we are Japan, but slightly different.  As I stated late last year we are Japan on fast forward:

“The bad news is, we are Japan, but the good news is we are Japan on “fast forward”.  As I described in mid-2009everything in the USA’s balance sheet recession appears to be occurring much more quickly than it occurred in Japan.   So, the good news is that we won’t need government aid as long as the Japanese needed it.  In the meantime we must remember that stimulus is not self sustaining recovery.  Ultimately, the USA will not be out of the woods until the private sector begins to meaningfully expand, contribute to closing the output gap and help reduce the 9.8% unemployment rate.  Based on many macro trends I have said this could be occur as early as 2012, however, any number of exogenous risks could set us back by months or years.  Thus far, there are some relatively positive signs coming from the private sector, however, we are still a long ways from sustained private sector recovery.

For now an accommodative Fed, a $1.3T deficit, a general lack of austerity and a tepid private sector recovery is likely enough to sustain economic growth, but not enough to meaningfully close the output gap.  This all continues to point to a period of very high unemployment, tepid economic growth and a recovery that feels like a recession.  As I said in early 2010 we might be in a technical recovery, but it still very much feels like a recession with a 9.8% unemployment rate.  The good news is we’re not talking ourselves off the edge of the cliff.  The bad news is the recovery remains tepid and highly susceptible to exogenous risks.”

In June 2009 I posted this chart (via Nomura) comparing the Japanese and US credit crises.  You’ll notice that it took Japan 10 years to accomplish what the USA did in about 2 years:

This is important because the US government and private sector have been much faster to respond to the balance sheet recession than the Japanese were.  Most importantly, we’ve run large and continual budget deficits throughout the current malaise.  The Japanese were notorious for their start and stop stimulus which created a bumpy de-leveraging process.  The USA has not succumbed to the persistent fear mongering campaigns of those trying to convince us that we are Greece.

As I mentioned the other day, I think a private sector recovery can become self sustaining in 2013 or so given the current trends in incomes and debt levels.  Unfortunately, the overall de-leveraging should continue until we see some sort of mean reversion that Richard Koo highlights.  This assumes the current (meager) recovery and government aid continues though.  That might be a lot to ask given recent rhetoric out of Washington.

In sum, (if current trends hold and the Fed, Europe or China do not derail the recovery) the overall de-leveraging should continue until we see some sort of mean reversion that Richard Koo highlights.  That doesn’t mean the economy is going to be weak until 2020 though.  Remember, improvement is improvement.  As these trends improve investors will view them positively.  More likely, it means the US economy will remain weak, but getting healthier at a slow rate with a private sector that is no longer government dependent after 2013.  At that point, cash flows should be sufficient to slow the de-leveraging to the point where some level of private sector re-leveraging actually contributes meaningfully to overall growth (we are seeing some signs of this in various loan data already).  And if the recovery surprises to the upside (which could very well happen if the Euro crisis is dealt with by 2013) we could see a pretty decent economy some time beginning in the 2013 range.

So yes, we are Japan.  We are destined for slow growth and a generally depressing economic environment in the next few years, but don’t go bury yourself in a bunker somewhere with a bag of rocks you bought at the local pawn shop. The real recovery is coming, the world is not ending and if you plan properly now you might just be prepared to ride the back of the next great period of economic growth.



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

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • DanH

    Cullen, thanks for all your work. You’ve taken an extremely complex situation and dumbed it down to the point where anyone on the planet can understand it.

    If I read you right I think you’re saying that private sector debt:income levels should be about in-line by 2013 so that means the de-leveraging can stop on a broad scale. At that point the private sector no longer needs to feed at the government teet, right?

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

    Basically right. The upside risk is stronger growth. The downside is more idiocy from the Fed, Europe or Chinese. I’ll re-evaluate by quarter. This isnt a predictable environment by any means…

  • Thomas

    The downside is a 50%+ cut in asset prices. There is no upside risk of stronger growth.

    You sound like a lot of investment advisors out there who, even though they seem to understand the problem, continue to have an undiscriminate bias towards the optimistic view that things will turn the corner soon.

    Much like Japan and the great depression, asset prices will reflect long-term growth prospects under a disinflationary/deflationary environment. At 0-2% GDP growth rates, there is zero chance we stay at these levels on the SP500.

    Your article compares us to Japan and fails to conclude that after 10 years (or 20 in their case) our stock market can be down 75%, much like theirs.

  • Willy2

    Yes, the US is going down the same path as Japan. And yes, at a much faster rate. But there’s a major difference between Japan and the US. When the japanese real estate bubble developed in the 1980s Japan had a current account surplus and was therefore not dependent on the kindness of foreigners like the US was from 1965 up to now.

    Personally I am looking for (at least) a 60% decline in US GDP in the next say, 5 to 10 years. And that’s something different than our mr. Roche thinks will happen. And the final straw on the back on the camel will – IMO – be (sharply) rising interest rates.

    Mrs./Ms. Stephanie Kohn wrote two excellent articles (published here at this website) and I am confounded that TPC doesn’t draws the right conclusions from those articles.

  • Willy2

    But even that 60% decline in US GDP offers some EXTREME opportunities to be taken advantage of in the next 5 to 10 years.

  • boatman

    it will take your views on what they should do to the TBTF banks and your ‘swedish model’ at least to ensure the beginning of the next secular bull and real economic expansion instead of another cyclical bull bubble.at may DOW bounce only 1300 below koolaid drunk-foolish credit expansion 2007 high we are already in that bubble.

    and it will take china bust or eur fail or iran vs. isreal(or vice versa) or some world contagion(not going to take much in this house of cards) to bring force to bare to that end…..and DOW 4000.

    to date we have changed little and faced nothing.

    otherwise, we are just japan……not FFWD

  • Rich

    Willy2, a 60% decline in GDP? Are you serious? That’s truly pessimistic.

    In a situation like that there will be no opportunities to be taken advantage of. U3 will be 50 to 75%, U6 100%. Most of the S and P will be nationalized long before we reach that point. Private land holdings will be confiscated. Guns and food stockpiles will be useless. The revolutions in China and Russia come to mind. Sell everything and emigrate, not to the developed world (say Canada or Norway), because they will also be affected, but to someplace like Africa, which is almost entirely disconnected from the global economy.

  • goodfriend

    Having read Koo’s book (“holy grail”..recomended !) thanks to prag cap, i have in mind what happened in early 2000’s in Japan: too early fiscal tightening that negatively impacted GDP…this risk is present in USA…but also in the fast forward fashion since it IS happening. I feel it is of importance in trying to measure time to get down to acceptable leverage for private sector.

    Additionnally i do not think it recoup with your recent post about high links between balance sheet recession and housing prices (and also the “other day” paper you refer to). The deleveraging/indebtness measures are using average, i think it is problematic since in essence those measures do not capture the fact that a bulk of household are simply dead from a financial perspective i.e. will not be growth engine before long time. Housing crisis also creates frictions in labour markets that will not help recovery (selling your house and moving away is probably not that simple due to losses to be taken).

    Moreover i feel that pressure is being put on wages either indirectly due to high unemployment or indirectly through govt social program cut. But i’m not going to digress by repeating what Mr Reich said in his “2 minutes video”.

    Going back to Japan analogy, Japan was also a huge exporter…a positive element that is not that much present in US economy i believe.

    My interpretation in terms of equity trading is that we are on for “trading range” markets for next few years…if we put aside euro crisis and china hard landing scenarios.

  • El Viejo

    Those New York squatters are getting outa debt real fast. Why pay exorbitent rent when you can still find properties owned by real people and negotiate with them for less. (that is if you don’t have the guts to squat)

    When I was a student at a state university back a while ago a couple of friends of mine and I found a condemned house. Well, we contacted the caretaker of the estate (her son) by phone and arranged to fix the place up for free rent. A little paint and some plumbing and carpentry and voila free rent for almost 4 years and then minimal rent after that so we sub let and continued to make money. One day a city inspector came by and said, “I thought this house was condemned.” I shrugged and said, “Beats me.” He turned and left. Boy scout up and improvise.

  • Peter D

    Going back to Japan analogy, Japan was also a huge exporter…a positive element that is not that much present in US economy i believe.
    What is “positive” about it in your view? True, exports are demand injections but in the US those could be easily substituted by govt deficits (if only we weren’t afraid of those). Otherwise, exports are real costs and imports are real benefits.

  • KB


    I completely agree with you on your main statement that we are Japan on fast-forward. The other part, though, where you discuss that we might be better off, is quite controversial.
    How should we measure success? By S&P vs. Nikkei performance? I doubt it. I’d rather look at PPP and quality of life. Judging by these, Japanese did pretty well last 20 years, and a lot of other countries would dream of such performance…. But the most important question is how this ends. I hope you would not argue that big japanese qe experiment has not ended yet, and we can only guess the final outcome. Would it be, like you said, something like self-sustaining recovery? With the total debt levels at current level or probably higher? I doubt it. If you have a case of such recovery, it would be the most valuable piece to be published on your site.
    So, let’s say we do not know. We have not seen the Japanese end, and we do not know what would happen in America. It would be nice for us if Japan gets there first, so we can prepare. And I do expect Japan to be there first. But there is no guarantee to that as USA is catching up pretty quickly.
    Again, I see your case of “a (US) private sector recovery can become self sustaining in 2013 or so given the current trends in incomes and debt levels.” to be unfounded. If you have some arguments to prove it, I would love to see them.

  • Geoff

    The Nomura table comparing Japan to the US is awesome. The Koo debt chart not so much. Debt alone doesn’t mean squat. It needs a comparison, like income, assets or GDP. Something!

  • JH

    You have conveniently skipped the whole issue of mountain of toxic derivatives that are going to; at some point create another economic crisis.
    The shell game of shuffling and hiding those toxic time bombs cannot, and will not last forever. When the day comes that they once again take their rightful place on the stage as the most important player in this economic calamity, panic and collapse will once again be the rule of the day.
    This is what Brooksley Born warned us of in 1996 and since then the problem has grown to enormous proportions, it has even grown larger since the crash.
    While I believe at some point in the future, growth is possible again, it will not be until first we pay the unpaid bill that is still on the table.

  • haris07

    Yes, we are Japan and fast forward, but we WON’T have a sustainable recovery in 2013. If it was soooo simple, lets just run up $$$ more of fiscal deficit RIGHT now and fast forward the recovery to Jan 2012. Your thesis on just ignoring the fiscal deficit (and yes, despite you and others arguing that you are not ignoring it, you all are) is incomplete at best and nonsense at worst. NO, even a monopoly printer of its own money in its own currency CANNOT run up deficits forever….the basic fact being that running up deficits does NOT create wealth aor value. I don’t know when or how this breaks down, but break down it will.

  • Calvin

    I am laughing at the comments today because Cullen can’t win. On some days he is criticized as being too pessimistic, on other days he is way too optimistic. It’s tough being a blogger. :-)

  • Pete

    I felt long before that we are following the Japanese, ever since we passed the stimulus plan and lower the rate to zero. the whole essence of Japan is to inflate the asset price artificially to avoid the pain. It might not be feasible for the court system to handle large number of bankruptcies, if we let the chips fall. But more importantly the system, designed by the interest group, will be the ones affected most. in another word, the rich and powerful will be the ones suffering in the bankruptcy court. That cannot happen in this country, or any country. so what’s left is one way, and one way only, the Japanese way.

  • Pete

    debt is a bitch. you either default or you pay. they don’t want either. so they create another way to deal with it, inflate away it. they can maintain the nominal steady, but still inflate it away gradually. that’s exactly what they are doing.

  • CybrWeez

    Heh, I was thinking the same thing.

  • Peter D

    His thesis is that we should ignore deficits now when there is huge resource and capacity under-utilization. Deficits numbers by themselves don’t tell you anything. The adverse consequences of deficits mostly happen in the form of inflation at full capacity, which is nothing like what we’re experiencing.
    Also, something I’ve been saying:

    Debt/deficit numbers in themselves are only a reflection of some underlying economic realities. As such, targeting certain debt- or deficit-to-GDP ratios should not be the goal of economic policy. As Abba Lerner’s rules for Functional Finance state:
    1. The government shall maintain a reasonable level of demand at all times. […]
    2. […] the government shall maintain that rate of interest that induces the optimum amount of investment.
    3. If either of the first two rules conflicts with the principles of ‘sound finance’ or of balancing the budget, or of limiting the national debt, so much the worse for these principles.

    That said, a very large deficit most probably means something is wrong with the economy – the real culprits could be large unemployment, low productivity, big spending on nonproductive activities such as wars etc. Therefore targeting a certain deficit number is akin to treating a symptom instead of the underlying disease and is quite likely to be futile or even counterproductive. For example, a huge chunk of our projected debt growth is due to growing costs of Medicare and Medicaid. Trying to reduce the deficit by simply cutting those programs will do little (or nothing) to control the growth of medical costs in the economy and will not achieve anything beyond driving households into more debt and most likely higher deficits due to transfer payments and falling tax revenues (the automatic stabilizers). Similarly, saying that we should stop fighting wars because “they cost too much” is a funny rationale for what in most cases is a good goal. Seen this way, the deficit should be left alone and if the right policies are pursued the improvement of the underlying economy will deliver deficit reduction on its own.

  • http://www.thoughtofferings.com/ hbl

    I agree with most of this post. I think it’s worth noting that Japan was a SUCCESS story with respect to keeping GDP growth near potential and avoiding significant unemployment after their bubbles burst in 1990. Their primary failure seems to have been the ill advised 1997-1998 austerity.

    (Whether they did the right thing with their banking system etc is a separate debate).

    The current US problem of insufficient aggregate demand is much larger than anything Japan experienced between 1990 and 2007. The key questions are how quickly aggregate demand can grow “organically” now and whether congress will choose to help or hurt the situation.

    Cullen’s timeline chart is interesting and you can see the positive impact of government stimulus on growth in 1992-1995 and 1999 by looking at the first chart here:


    Also, Japan’s two “lost decades” are not what most people think. Real per capita GDP growth in Japan has been essentially the same as in the US since 1980 other than a temporary deviation from the late 1980s to the late 1990s. So demographics aren’t just one factor in Japan’s “slow” growth, they are the dominant factor. See two graphs here:


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

    Japan’s balance sheet recession was corporate based. Ours is not. If you’re going to understand the current malaise you need to recognize this fact. Our corporations are actually pretty healthy (aside from our banks).

    I am not super optimistic so I don’t know where that comes from. I am just trying to shed some light on the picture with an honest assessment. Yes, things stink, but it’s not the end of the world that so many forecast. We’ll get through this. And some pain will occur. And yes, if some exogenous risk were to derail everything then my marginally optimistic scenario could be thrown down the tubes….This is a fluid situation. For now, it doesn’t look like the end of the world to me….

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

    I think we’re a more robust and dynamic economy than Japan. Add in the fact that we’ve responded much more quickly and consistently and I think there’s a legitimate case for being in a better position than Japan.

    My 2013 estimate is based mainly on the debt:income ratios. I think these trends become largely sustainable when this trend rights itself again. If people have the cash flows to meet their debt payments then the de-leveraging should stop en masse. That could set the table for some level of self sustained organic pvt sector growth.

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

    True, our banks are still bankrupt. And I certainly wouldn’t underestimate their ability to derail this whole thing. But it looks contained for now….a major decline in housing or a sovereign default would bring the banking issue back to the forefront.

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

    Will there be repercussions? Yes, if we are running a 10% deficit in 2013 when the pvt sector is getting back to normal then we should expect inflation to kick in big time (along with economic growth). Could that get out of control. Sure. But I expect automatic stabilizers and fiscal austerity to take care of that before 2013.

  • Thomas

    I disagree. The fact that the corporate sector was worse off in Japan doesn’t make our situation better. Our household sector is in worst shape, our financial sector is in worse shape. Japanese households didn’t increase their leverage or their spending in the 90s. Even though exports were growing in the 90s, Japan’s GDP growth rates stalled because of the consumer retrenchment.

    Their stock market tanked and never recovered because retail sales never recovered, not even to this day. Demographics didn’t help. Same situation here in the US, unfortunately.

    In the US financial obbligation ratios are not at extreme levels, only because the interest rates are currently subsidized. If they were at normal levels, FOR ratios would be almost twice the historic average. the consumer will greatly deleverage from $13T in liabilities to less than $10 trillion in the next few years, even if the banks don’t want to recognize it.

    MMT has nothing to do with this dynamic. In my view the stock market is toast once we realize that max 2% GDP growth is all you can get in a balance sheet deleveraging environment.

  • Adam

    No educated MMT’er would ever say ignore the deficit. That said we’d tell you that the deficit alone tells you nothing of importance, its just a number. It only become relevant when taken into account all of the components of aggregate demand – both injections and leakages – as well as the operational capacity of the economy and where it is in relation to full capacity. When you review all of those components then you are in a place to understand if the deficit is creating a danger to the economy, namely demand driven inflation.

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

    The Japanese are also savers. Americans are spenders. So the psychology is very different. You could actually argue that the Japanese are more susceptible to deflation due to their psychology. I think that’s an important element here. Is the US domestic economy going to remain in the dumps for the next few years? Yes. Are the exogenous risks high because of this? Yes. Does it mean we are destined to become Japan 2.0 and suffer a 20 year lost period? I don’t think so.

    I think your argument that asset prices should tank is spurious. House prices are nearing their inflation adjusted average (10% more downside maybe?). US corporations on the whole are incredibly strong. Our international reach and strong global footprint is the envy of the world. Japan had a handful of big tech names. I think you’re downplaying the strength of corporate America. Margins could contract in the coming years and the market will do what the market does (gyrate – and I hope to trade it accordingly as previously explained). But on the whole, I think it’s silly to get excessively bearish about corporate America.

    Don’t get me wrong – there are huge risks out there. If housing turns further down, China craters, European debt crisis, etc then my somewhat optimistic thinking gets thrown down the tubes and I hope I’ll respond accordingly. For now, I am not convinced that we are going to suffer another lost decade. It might be tough sledding for a few more years, but it’s not the end of the world in my opinion.

  • nottpc

    Interesting timing considering cyclical recessions of late have been around 6-7 yrs apart. Considering the last recession was 2007/2008oish that would dovetail nicely to 2013, just when ur recovery hits. That said most recessions have been due to a hawkish fed tightening and this fed looks like it wont tighten until the 2020s.

    Another point is the huge jobs hole we will still be in in 2013. Without a housing rebound of significant ilk its hard to put back a few million jobs.

    Last point, many who are delevering are enjoying rent free status as they live in homes for 2 yrs+ as banks drag their feet on foreclosure. That is 7M american households able to spend and pay down credit card debt. In 2013 most of those people will be forced to actually pay for the roof over their head which will be a new headwind. Espeically with the job prospects so weak.

    Anyhow we will see. If there is any true govt cutbacks coming in mid decade the US will be in trouble

  • haris07

    And I have argued that government spending NEVER goes down, it always goes up. In any case, it is also channeled in large part to speculative activity and not for productive purposes. I think you guys live in a dream world….wait until this destructs, either we go nowhere like Japan or it destructs under the weight of high unproductive deficits leading to speculation. Self sustaining recovery – it will NOT be. Not until the deleveraging has gone on for substantially more.

    In a theoretical world, govt deficits will be run up in bad times for PRODUCTIVE use and will be curtailed in good times. Forget that happening…not as long as Obama and Bernanke take the easy way out (and oh! yes, the Republicans too).

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

    Can’t disagree there.

  • José

    All that’s great and everything, but what are all the unemployed people and their families going to live on for two more years, air? We need a real stimulus now, even if it comes from another payroll tax holiday, especially if it’s only on the first 20K of income or so, because God knows that we can only pass things in this climate that count as “tax cuts” (we can’t pass any major infrastructure repair/improvement packages, no matter how sensible for shorter term employment and longer-term sustainability, God forbid).

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

    I am certainly in favor of another payroll tax holiday!

  • Peter D

    And I have argued that government spending NEVER goes down, it always goes up

    But that’s empirically wrong. We had higher debt in the wake of WWII and it went down. Also, a huge part of the current deficit is due to transfer payments that have been kicked in due to the recession. When unemployment falls, so do the unemployment payments, while tax revenue picks up. Haris, you are shooting from the hip. Yours is not a rational argument.

  • Peter D

    And if anything, my only hope for larger deficits – which is what we need right now – is that a Republican that is not totally batshit crazy, like Romney (although I loath the guy) is elected in 2012. Obama showed that he has no conviction/courage/ability to do the right thing. Too bad. I can’t believe I am half-heartedly rooting for a Republican in 2012, but seems to me this will be better for the economy if only because the sociopathic Republican obstruction will cease.

  • gf

    Peter if you are all right with having a bannana republic by all means support the republicans. But the marginal gain from the lack of obstruction on economics will be out weighed buy outright regressive policies on every other front.

  • goodfriend

    “if only we weren’t afraid of those”: that’s unfortunately the point…additionally I view that Japanese situation as positive since they were more in a position were private sector (here foreign) can handle growth

  • Thomas

    Good points, as usual. I do think that the household sector is the determinant factor here, not corporations. They pull the cart. If they re-leverage, it’s game on. But looking at the hard numbers, comparing them to the US in 1929 and Japan 1990, it’s very hard to be objective & optimistic.

    Let’s face it, the middle 3 quintiles of our population (the engine, if you will) is in all essence bankrupt at 150% debt to income. Whatever scheme is generated by the FED to allow the top quintile to try to make up this difference is futile. The perceived financial wealth of this quintile is in its vast majority financial, not tangible. It’s the function of 20 years of borrowing from future growth. As this future growth doesn’t materialize, it has to be destroyed. If it were cashed in, it would be destroyed too.

    In my view, at some point soon we will be looking at reported earnings of $60 for the SP500, not the $100+ of operating earnings that are forecasted. Slap a multiple compatible w/ GDP growth of 2% or less and you are looking at new 10 year lows for the SP500. I don’t think that scenario can be discarded.

  • goodfriend

    Did you run up scenario were fiscal austerity kicks in ?

  • JH

    I read a couple of weeks ago that they were contemplating putting lithium in the water supply to cut the depression and suicide rates. From reading some of the comments here, I believe they may be already putting something a little more powerful in there already.
    The Japanese were able to pull off what they did because they have a hard working, self-sacrificing, money saving population.
    We on the other hand have a lazy, non-productive, self-indulging, spend thrift, hopelessly in debt population.
    Yea, this is going to work… just keep kicking the can.
    Can just one person here explain what is going to be the engine behind this fantasy recovery that is being predicted for 2013?
    We have had no organic growth that was not artificially manufactured from a debt driven bubble in decades.

  • Peter D

    You’re right. I don’t believe I will ever vote Republican. Just throwing some hypothetical around. Although I am still very unhappy with Obama on civil liberties front, where he’s been at time more reactionary than even Bush.

  • Coolidge Low

    Anything is possible. In a recent Q&A, Scott Mather from PIMCO said it best. “I suggest putting aside any typical cyclical model that may have been useful in the past. Over the secular horizon, say the next three to five years, we argue that market behavior may be vastly different than the models would predict”.


    Keynes……. The Economic Consequences of the Peace, published in 1919. Keynes wrote it to object to the punitive reparations payments imposed on Germany by the Allied countries after World War I. The amounts demanded by the Allies were so large, he wrote, that a Germany that tried to pay them would stay perpetually poor and, therefore, politically unstable. We now know that Keynes was right. Is history repeating? Greece will default very soon or the Fed will have to lose another 6.6 billion in Iraq………

  • Willy2

    There’re still enough opportunities to make a buck in the coming financial storm:
    1. Go short.
    2. Buy gold, silver both stocks and bullion. Although currently I am looking for an opportunity to go short gold, silver, gold and/or silver stocks.

    That drop is based on the fact that the US needs to import about 60% of its energy needs. So, when the US military breaks down, interest rates will through the roof and the US is no longer able to afford its energy imports. Hence the 60% drop in GDP.

  • Ben W

    There’s a very interesting CNBC interview with bond manager Jeff Gundlach from a few months ago. Gundlach sees a large deflationary threat in the form of bad mortgage debt, still on the bank books. Definitely worth a quick view, imo; it’s about 10 minutes long (starts at ~2:30).


    Gundlach says the banks’ balance sheets are still extremely inflated, because the recovery rate from bad mortgage loans is dropping. This has two causes: dropping housing prices, and increasing liquidation times. The longer it takes to foreclose and liquidate out the loan, the less is recovered: the house detiorates while in foreclosure and so its value drops further, and meanwhile the servicers forward the principal and interest until the time they deem the loan non-recoverable.

    I’m unclear how this affects the sensitivity to shocks – i.e., it may or may not mean another credit crisis. But I do think it means more pain in the future: either another shock, or another long, drawn-out period of pain.

    What are some catalysts that could cause another credit crisis?
    – European sovereign debt crisis
    – US austerity package
    – Slowdown/recession/housing drop

    But, hey – the mortgage crisis is “contained” now, right? =)

  • Ben W

    Silver did not perform favorably during the last credit crisis – and it looks as if another credit crisis is indeed a risk. Silver is a “risk on” asset.

  • haris07

    Sorry, you are talking theoretical mumbo jumbo and WWII stuff, I am talking reality and more recent stuff. Deficits will keep going up, Bernanke will keep printing $ (that doesn’t make it into the economy at all but he still wants to keep doing it anyway), and a significant portion of this will be channeled into inefficient speculative activity…until there is an even bigger collapse which forces evertone’s hands.

  • Willy2

    Precisely, silver WILL get hit AGAIN. But in the long run its purchasing power WILL increase although it may correct. and that’s why I am looking to go short gold and especially silver.

  • Wulfram

    I think these are good points. One of the encouraging things about reading corporation balance sheets and cashflow statements is that our corporations are very healthy.

    I’m conflicted on debt:income ratios reverting back to the trendline. I think even the historical levels are slightly too high. If we just re leverage like we have been for the last three recessions, it’s only going to lead to a less stable economy in the future. If you look at the deleveraging that has occurred so far, it’s clear that debt to income ratios are still way too high given the increasingly volatile nature of household cashflow.

    There are important structural elements such as demographic changes, technological improvements, and a culture shift taking place that are making long term employment in any company more rare than in the past. It used to be uncommon that you would change jobs more than once every five years. Now, I would say switching jobs every one or two years is the norm.

    This creates the effect where it becomes harder to sustain even moderate DTI ratios. The recovery is and will leave behind a large portion of the bottom of the pyramid as many jobs such as manufacturing and sales are stuck in large downward trends. We’ve also got a huge retirement problem; many seniors have 20%) levels of deleveraging puts us in the position where the slightest shock creates another recession.

    Personally, I would like to see the government encourage and help out with the deleveraging process.

    There should be a minimum of 10% down payments on FHA/Fannie/Freddie loans to help stabilize long term loans. I know this is a pipe dream, considering that we’re fighting tooth and nail for a measly 5% downpayment requirement.

    I also like the partly government subsidized temporary work program in Germany where corporations can employ workers on a part time basis with the government picking up the full time – part time hours. This helps eliminate the incentive to collect unemployment, and makes it less risky for corporations to start hiring again.

    A simpler tax system with the elimination of most if not all tax breaks (including the onerous mortgage interest deducation) coupled with bumping the income brackets much higher so that the lower and middle classes would see their tax levels remain mostly unchanged with the benefit that former homeowners, renters, and our younger generations would not be at a tax disadvantage. I’m sure people love their $8,000 tax credit for buying Chevy Volts, but I don’t really see it as a cost effective stimulus program.

    I would also like to see the government increase retooling/training programs for jobs that will see future growth. Despite the high unemployment rates, there is a shortage of engineers, nurses, therapists, accountants, analysts at the moment. The problem is employers are reluctant to invest in the training for these jobs given the cost, unsure demand, and high “mobility” in the workplace. It’d be helpful to see the government step in.

  • Peter D

    Care to provide any evidence for your assertion?

  • KB

    Tricky assumption – Japan was very robust in 80x-90x with all their jitoha and cars/electronics….. On the other side, looking at our current structural dis-balance and financial sector, one might argue that we lost some of our robustness.
    Regarding income/debt ratios, i am not sure that going from super extra high to just very high would be enough. Also, you might have to model in some increases in future saving rate and non-discretionary spending. The remaining disposable income for the ratio would be much smaller….

  • dr

    You forget that this is the decade of boomer retirement. Boomers, along with their 90s higher salary income will be leaving the work force only to be replace by cheaper/outsourced/temp workers. Without strong income growth for the echo/GenXers you can kiss a recovery good-bye.

    Japan is a telling example of such a future.

  • jeffc

    A look at what happened to Iceland and its economy after the government did not bail out the banks, but let them default on debts (and nationalized them). Iceland never defaulted on sovereign debt, but they took the pain early and now are rebuilding the economy.


  • Ben W

    Derp. I misread your 1st post, my apologies.

    I agree with you, although I think the case for silver/gold depends on the Fed/gov’t’s actions. Do they favor inflation, or deflation? Mostly it depends on Congress; if they get serious about austerity, silver could go back down to 10, and the economy would be in the crapper.

    I don’t think the argument regarding energy and -60% GDP is correct. We still have massive natural resources in this country; if energy prices go up, more of these will come online. And we have a *ton* of room for energy conservation – home insulation, carpooling, public transit, CFL lighting, etc. Did you know that the average US passenger car mileage is about 23 mpg?

  • Dan Dell

    OTC derivatives will be regulated, but they will have to do it piecemeal. That’s why they delayed OTC rule-making for another nine months. They did this for two reasons: 1) bc they are extremely complex (in variety, structure, and lack of uniformity) and therefore require ample time to understand the proper way to put them on exchanges and 2) bc the margin requirements for banks will amount to trillions once they decide how to put OTCs on exchanges, and banks are, like Cullen said, insolvent an therefore too weak for thoughtless regulatory oversight

  • Dan Dell

    The baby boomers won’t leave the workforce bc they will realize that they can’t retire financially. I am absolutely amazed at the amount of boomers who think that their couple hundred $K in their IRA will be sufficient

  • Michael McGillicutty

    I think this is indeed one of the most under discussed, yet most important factors we are facing. There will be a vacuum in employment, spending/consumption, a huge push for more secure asset classes….the permutations are many, and not very well understood.

  • Chaos

    Growth is a myth, here some insights why it is:
    – Demographics.
    – Resources.
    – Not enough consumption.

    The three factors are connected via feedback loops and influence each other, THIS is the real economy, and not the financial accounting and magics that goes on the system, which is just a shadow of the underlying factors.

    But that’s not bad itself, you can get growth until you achieve decent employment levels and capacity utilization, and then a stagnant aggregate growth but a steady-state dynamic system. There will be trouble with zombi banking system and need for continual support from the public to soften the rough edges of the system, but I think the natural conclusion is going to be forever extremely low-interest rates and very low growth and inflation (if at all), with some fiscal policies to keep money circulating adequately without causing social unrest.

    It will be hard for the idiots in power to learn the lessons, and we will have a few years of political and social convulsion. But I hope the situation can be stabilized.

  • Chaos

    Again, how can the US be Japan in fast fordward? Japan situation development took in a very different environment (expansionary), contrary to the current situation, which is mostly global deleverage (and developing countries can’t and won’t get into deficit to help with growth).

    Not only that but there is trouble with costs inflation, which can stop any foresight of continued and solid growth, and then the US has its own structural problems: an chronic trade deficit, if the economy expands then the trade deficits increase, and not the contrary. Until these are fixed there is no way we can talk about real recovery and problems will keep coming back again and again.

  • Vick

    The Japanese tried to hide/ignore their problems to save face. We make movies about our problems. We are not Japan. I like the analogy – Japan on fast forward.

  • haris07

    Resetting things here.
    Simply put, I agree with Cullen and you on a lot of things (MMT and even agree that this is hardly the time to cut deficits IF…). Where we part is that fiscal deficit spending is somehow seen as panacea (or close to it) by you rose colored galsses folks. IF it was efficiently done, yes. BUT, it is hijacked along the way into non-productive speculative purposes and it doesn’t create actual wealth. Evidence – see the last 10 years. On top of this, the idea that the govt will spend its way out of trouble has actually encouraged businesses AND Americans to fritter away work ethic and rely on asset bubbles to spend beyond their means. Weak political and even weaker Fed leadership has led to this and I see no reason (or action) to believe that things are changing. This is causing the American society to lose values (even now, I see evidence all around me of people somehow believing that “things will be Ok” and continuing to spend away w/o trying to understand that things are broken – I personally know of more than a few people who are behaving like idiots w/o changing – can’t blame ‘em fully I suppose, if the govt has instilled in them a false sense of security based on rhetroci like “America is great”, “housing prices will never fall” and the like, I guess they just play along and max out credit cards).

    Where I don’t agree is that deficit spending can create “wealth” or “value” – it can if used productively, but that is more fantasy than reality.

    So, as much as I would like to think that deficit spending can indeed be used to remedy the problems, it won’t happen because people will never learn the lesson until they are shocked into some disaster.

    So, forget this fantasy of growing sustainably in 2013, there needs to be strong political leadership and a Fed that understands what to do, neither of which is happening. And Koo (and to a certain extend you all) have somehow bought into the hypothesis that becoming Japan is such a good thing (Koo keeps saying that is the best that they could have done and complians about deficit spending being cut back), but I would argue that some forced deleveraging would actually be a good thing. People need to realize that borrowing for unproductive causes cannot work and that is how capitalism works. So, I would actually do a little bit of Austrian cleansing (but support it from becoming a panic by deficit spending to keep things from falling apart – automatic stabilizers and the like).

    Long story short (and I will shut up after this), forget the fantasy that a slow deleveraging with deficit spending to the moon will work. It would work IF the deficit spending was productive, but it won’t. And so the only way to instill some sense into society and restore values is to deliver another shock to the system.

  • Peter D

    I just love this purification by fire mindset. I just met a guy yesterday who lives in Newark, where they just fired more than a 100 policemen and the usual street gang violence is back to what it used to be some 10-15 years ago where they have people killed every day. This austerity la la land you are talking about is not some benign “learn to live within the means” fantasy. It is actually killing people, destroying families and communities and robs us of our future.
    How the hell do you know deficit spending will be unproductive? This is such a huge assumption to make and I think it is mostly a convenient article of faith not supported by much evidence. And last time we had huge deficits it actually ushered in several decades of unprecedented prosperity growth.
    Yes, there is a segment of population that tried to leverage too much – pretty sure it was NOT because they assumed the govt will bail them out, as you seem to think, but whatever. However, it is now mostly totally innocent folks who are suffering because of financial crisis that they had no role in bringing about. The idea that somehow this will heal itself with some austerity makes just about as much sense to me as all those Jehova Witnesses and such that refuse medical treatment, leaving it to God to heal them.

  • http://joofie.com yourejammingmeup

    This analysis is forgetting quite a few points. From a purely statistical financial model view based on averages and projections taken alone, yes, 2012-2014 would be a good start to a real economic recovery after household debt levels get more under control. However, this recovery will not occur, and the reason is the increased rate of outsourcing we have seen over the past decade will not abate (with skilled labor in India and China), and it will continue to eliminate useless private American jobs and especially well-paying private American jobs. With everyone in America struggling to get a job that pays minimum wage or work for the government, and a lack of both startup capital and innovation, this country will never, ever get back to a healthy employment rate, standard of living, and household debt level without some sort of profound change in corporate culture or major war that changes the rules. Couple this with permanently high energy prices (for one reason or another), changing demographics, and a leeching military industrial complex that has completely taken over politics, and I just can’t see any sort of meaningful recovery for this country anytime soon. I’m buying a copy of Rosetta Stone now…

  • Desmond

    I think that anyone who thinks we are going to “recover” is hopelessly sentimentalist. The political reality is that the kleptocracy aims for global destabilization while it concentrates all wealth in its hands–i.e. “privatization.” Destabilization is the precondition for their eventual “solution,” which people will practically beg for and be willing to pay any price.

  • Ralph

    From Mosler:

    It’s all unfolding like a slow motion train wreck.
    The underlying deflationary forces were temporarily masked when QE2, under the misconception that it was somehow inflationary, caused global portfolio managers to exit the dollar, both directly and indirectly.

    But now that psychology is fading, as the global lack of aggregate demand revealing the actual spending power just isn’t there to support things at the prices managers paid to place their bets.
    And the next ‘really big shoe’ (as Ed Sullivan used to say) to fall could be China, as they move into their traditionally weaker second half.

    Which looks to be closely followed by the US as some kind of austerity is passed by Congress, further supported by continuing austerity in the UK and the euro zone, and the setback in Japan and much of the rest of the world from the earthquake, and not to mention Brazil and India attempting to fight inflation.

  • Hmmmmm

    Oh what the hell…. I read another piece of your garbage… listen buddy… you are clueless how people think, make decision and behave. All you central planning types are simply sychophantic about your currency regimes as if currency expansion is some panacea.

    You people live in a total “fantasy land” that Modern Monetary Theoy creates…. You have no concern over creating a MORAL, RATIONAL AND CONSTITUTIONAL monetary system as described by the Austrian School as compared to this banking cabal manipulated mess of a system in creating since 1971 (by the way, I do not advocate a commodity backed currency or gold standard, that is equally a bad idea due to the ease at which gold can be cornered and manipulated as well). The proper currency system would be public issued fiat in direct, algorithmic relation to population / production growth. There has to be some currency elasticity, we have seen what happens when there is not (true disinflation / deflation).

    Some points ALL MMT arguments fail to grasp is just basically the duration of their currency regime is not a long enough timeline to determine the efficiency and sustainability of this current Bretton Woods II currency cabal. You act as if post 1971 has been smooth sailing thanks to the stewardship of government spenders and central banks. Clearly it is falling apart and the idea of a “monopoly currency” will soon go the way of the Dodo. Again, I point you to the rise of super-national currencies and the talk of global currency. I guess global currency just means global police state and global tyranny. You sure love a system where demand is created through the threat of priosn. Well, that is just swell. This school of thought that that “deficits don’t matter because the government can just create money” is insane an historically observable all its failing. It leads to the very social rot and decay you are currently seeing. These modern monetary theorists also just kind of make magic little statements about inflation. To them, inflation only exists if government get “reckless” with their spending. HELLO! What the hell do you think happens when government are given the blank check of the magic money tree? Something about absolute power corrupting absolutely.

    To people like you, your only concern is how much their stocks go up thanks to asset inflation and what the yield curve looks like. YOU REFUSE to see the connection to YOUR monetary theory and world events in general and the chaos and DEPRESSION (get a clue, this is not a recession if you use actual metrics). YOU REFUSE to understand the misallocations that occur in capital markets due to YOUR manipulation of prices. YOU REFUSE to understand that freedom and liberty are directly connected to the amount of money the government spends, and steals from you in the form of taxation (to which, MMT says is only to create currency demand). As I pointed out to Cullen the MMT rube, is that taxes is not all that puts currency in demand… coincidence of wants do. Yes, true, some observations of MMT are correct, but not the explanations or the underlying morality. MMT is simply a new form of fascist monetarism. People who want to run your life through price manipulation.


    End of story.

    You and your school of though is a major problem in the world today and if you had an ounce of decency and sanity, you would amend your thinking and join me in the real world.

  • Peter D

    Cullen, it is quite amazing how these people sometimes totally conflate MMTers and the neoliberals! As if MMT is not some marginalized view that is hardly understood or espoused by anybody outside of a small (albeit, hopefully, growing!) group of people, but rather the current orthodoxy that got as in the trouble in the first place! As far as I can tell, these are usually Austrians, with their own inferiority complex and what not (credit to Bob Murphy for not doing that…)

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

    This guy’s been going off the rails now for a few hours on another thread. He’s really disturbed by the website. He started off by claiming that my analysis is dead wrong because I posted Bob Doll’s bullish outlook earlier this year, then went on to claim that I have never been right about anything, then claimed I am a monetarist, and now claims I am a fascist. So, you can see that he pretty much has me pinned down in all regards :-)

    I’m pretty sure he’s just here to vent and feels like it’s okay for grown men to go on the internet and kick and scream about things.

  • Peter D

    Saw that :)

  • Willy2

    It’s a pity Japan was able to survive in the 1990s and the 2000s because then we could have seen what could become of the US in the near/distant future. Although comparing the US with Japan is comparing apples to oranges because 1) Japan still is running a Current Account Surplus, 2) the Yen is not the world’s reserve currency. In that regard it’s better to compare the US of today with the Britain from say 1880 up to say 1945. And then we see much more similarities. Both countrries had (very) large armies and were in the latter part of their empires up to their eyeballs in debt/drowning in debt as a result of all those military adventures. And we all know what happened to the british empire, don’t we ?

    Just imagine Japan going down the drain as well. Then they will sell all their US T-bonds because they then can reduce their currency reserves.

  • Peter D

    Don’t be ridiculous. The British Empire fell apart because of their debt!?
    How about comparing us to the British Empire from the lat 18th and early 19th Century? They had debt-to-GDP of at times more than 200%!
    And “The most important event in the history of humanity since the domestication of animals and plants” happened in a country with Debt to GDP greater than 150%”

  • rhp

    “Yes, there is a segment of population that tried to leverage too much – pretty sure it was NOT because they assumed the govt will bail them out, as you seem to think,”

    Actually, I think the segment of the population that DID assume was led by Hank Paulson…………….

  • http://joofie.com yourejammingmeup

    Let me say this website made clear for me MMT, which is awesome and I’m very grateful to Cullen for this. Not so awesome are the dolts responsible for things like this that threaten said real recovery at the worst time:


  • Piccola Economista

    Murphy at least has a practical sense of humour. Unfortunately, the Austrian “scholars” and neophytes lack it. I should know, I was one of them long ago. Just look at the literature and the videos they produce, and you see the psychology of pessimism promoted.
    Perhaps part of the problem is the aversion to mathematics, and the over-emphasis of the “a priori” reasoning they use? Or stated another way, they fail to “adopt and adapt” to empirical fact, for the most part (there are always exceptions).
    As well, the narrow view of history creates some manner of hindsight bias. I’ve been reading Zarlenga’s “Lost Science of Money” (I’m at chap 11) and am amazed at all the various monetary experiments (proto-MMT, if you will) that have occurred in history, that no one else seems to discuss or acknowledge.

    Even though I am still trying to critically analyze and grasp MMT’s finer tenets, I keep finding my attempts at error-finding corrected (to my benefit), and it truly leads one to a conclusion that things aren’t, nor have to be, as bad as “they” try to make it out to be.
    So here’s to the stalwarts of MMT that promote “rational and progressive solutions” instead of “emotional and anachronistic criticism”.
    CIN-CIN… Salute !

  • Roger Ingalls


    That is a very good site.

    Thanks for the link.

  • Andrew P

    All true. But the exogenous risks are much greater today than with Japan because the problem today is global. Japan’s bubble burst in isolation. Ours did not, and there are more bubble bursts to come around the world.

    In my view, the biggest exogenous risks are geopolitical. Economic turmoil brings radicals to power, and radicals start global conflagrations that take on a life of their own. I see the our current position analogous to the era before Hitler assumed power in Germany.

  • Andrew P

    The only thing that could drop GDP by 60% or more is a full on nuclear war with Russia or China, or an alien invasion. Even in a full scale deflationary depression triggered by a full collapse of the EU and China, a full scale Pakistan-India nuke war, a 9.0 quake in California, and a full Muslim oil embargo all at the same time, GDP isn’t likely to drop more than 20-25%.

  • Andrew P

    The only way out of the toxic derivatives mess is to stop issuing new derivatives and kick the can until most of the old ones expire. Most of these things do have expiration dates, don’t they??

  • Andrew P

    We are already constrained by the need to import so much energy. Any inflationary stimulus created by the Fed and Treasury simply leaks out the back door to oil exporters, negating the stimulus.

  • Andrew P

    History tells us that economic turmoil brings radicals to power and results in major world wars, eventually. That is why the governments of the world are so desperate to kick the can. WW III will take place before 2030 at the latest. It will probably even start before 2020.

  • Andrew P

    The British Empire was weakened by WW I and destroyed by WW II. WW I also destroyed the Ottoman Empire.

    The UK’s financial decline surely weakened the Empire and contributed to its inability to perform better in those wars, but did not cause the loss of empire per se.

    Empires are ALWAYS destroyed by war, even if they are weakened by other causes first.

  • Peter D
  • Willy2

    The british empire was effectively broke on the eve on WW I. Only with the help of the US they were able to fight WW I and WW II. And that indebtedness to the US was used by the US to finally break the back of the british empire. In the era of the british empire pound sterling was the senior currency and that allowed the british “”to push it””. Like the US now can “”push it”” because now the USD is the world’s reserve currency. And boy, did the US push it. But somewhere in the near future the US will find out that they have been “”pushing their luck”” too far.
    The US was already in a death spiral on the eve of the year 2001. And to avoid bankruptcy the US was FORCED to invade Iraq in march 2003. The US was able to survive becasue the chinese were willing to absorb all those USDs in the time frame 2000-2003. Otherwise the US would have gone belly up already much earlier. In fact, the US could have gone belly up already in the late 1960s, early 1970s.

    To understand that one needs to read up on US monetary/financial/foreign policy and how these three things are related/intertwined. Much too complicated to explain that in this limited space on this blog/in this thread. Two guys that are in the know are is mr. Michael Hudson (www.michael-hudson.com) and F. William Engdahl.