WHEN WILL THE BALANCE SHEET RECESSION END?
Despite the seemingly strong activity in the economy in recent months there is trouble lurking beneath the surface. Don’t get me wrong – we have a real recovery on our hands (see here), however, it remains fragile and largely driven by government intervention. Beneath the surface the balance sheet recession lurks.
As the housing bubble grew the US economy experienced an unprecedented growth in debt. This generated an imbalance as debt levels far outstripped disposable income. This environment was sustainable as long as asset prices continued to climb, however, once prices deteriorated debtors were left with an imbalance. As a result, a balance sheet recession ensued as demand collapsed under the weight of households who preferred to pay down debts rather than spend. The impact is magnified by corporations that cut costs (read, fire workers) as demand collapses and they attempt to protect margins. Real sustainable recovery cannot ensue until the indebted sector of the economy returns their balance sheet to a state of normalcy.
The government’s response to the crisis was massive and far more effective than most presumed. But it was not a cure. It was merely a temporary fix. The following updated sectoral financial balances diagram shows what has occurred over the last 15 years. It’s undeniable that the government response via huge deficits is having a positive impact on the private sector balance sheet:
(Figure 1)
The bright side is that things could have been much worse. Even better, we haven’t fallen for the fear mongering from the hyperinflation/USA is bankrupt crowd who are helping to cause so much destruction in the nations of Austeria. The problem is that this government intervention is not a cure. Aggregate household debt levels are still too high as evidenced by the debt:disposable income levels (see figure 2). This means we could still be several years from sustained private sector growth. As I like to say, the public sector is not yet ready to pass the baton to the private sector.
(Figure 2)
At the current trajectory it’s not unreasonable to assume that the balance sheet recession will last well into 2012 and potentially longer. While a 1:1 ratio is “sustainable” by my estimates, it would be comforting to see levels closer to the historical levels in the 80% range. If that is the case we could see the impact of the balance sheet recession persist far longer than anyone believes. The obvious upside risk is a dramatic improvement in the labor market. On the other hand, our government is now explicitly encouraging fiscal imprudence in an attempt to “keep asset prices higher than they otherwise would be”. This sort of policy has the very real potential to increase instability and turn recovery into bubble. Other exogenous risks (Europe, China, housing prices, etc) also pose substantial risks to the downside. For now, I think it’s safe to assume that the recovery will remain fairly fragile well into 2012, but given the size of the deficit and potential for labor market improvement we could see continued economic strength.
In sum, it’s clear that government intervention has been sufficient to defer the negative effects of the balance sheet recession. In the near-term, that is a net positive, however, the risks are substantial. If the balance sheet recession persists into 2013 or longer then the obvious risk is a substantial decline in the deficit. Austerity would almost certainly expose an overly indebted household sector and send the economy back into a tailspin. With the deficit projected to be $1.5T this year it’s comforting to know that we are not repeating the mistakes of Japan, however, it’s important that we not get too complacent as the balance sheet recession lurks underneath a seemingly rosy surface.
Great thoughts. Thanks.
Nice!
Is there any way to know which people are reducing their debt:income ratio? Is it fair to say that given the unbalanced nature of the recovery, the de-leveraging could also be unbalanced? It is quite possible that high income households (that haven’t faced reduced income) have largely reduced their debt, perhaps by selling the holiday home for example, whilst the majority of the population are still in trouble. Given the approximately 15% underemployment rate, many households have faced reduced income over the last few years, and many others would be facing wage freezes.
Could an unbalanced de-leveraging process delay private sector growth further than expected?
Good questions. This chart(bottom of the link page) is a bit old but it breaks down household leverage by income bracket. It shows different leverage paths: 1) The highest income bracket barely strayed from its historical debt to income levels 2) Middle income households went from debt to income levels of sub 100% to plus 150% levels. 3) the Lowest income bracket went thru a period of super leverage in the past decade to crazy levels(plus 200%)
Since the chart is old so it doesnt so how far households have deleveraged in the past 3 years. But the distribution of leverage is also consistent with the skew of unemployment towards lower income brackets as well.
The take away is that we are in a three speed economy, not two as some have suggested.
http://www.businessinsider.com/jonathan-wilmott-the-overleveraged-us-consumer-is-a-mytn-2009-12
Great post. It is good to see a balanced view as opposed to “US is dead, Buy Gold” type of comment.
Care to share the source of the data for Figure 2?
Thanks
Good analysis, so long as you take a sterile view of the world. But we don’t live in such a world.
We have integrated into the global economy a few billion people whose wages in my view, represent an extreme deflationary force on wages for workers in the West. And as US policymakers’ solution is to devalue the dollar by using the opposite of austerity policies, two worrisome trends emerge:
1)The developing world’s workers whose food costs are a large part of their wages increasingly feel squeezed, which will result in political instability.
2)The US Middle Class that relied on housing as a source of wealth will continue to see the value of things they own decrease, while the value of things they consume, increase, as their wages, well,. the ones lucky enough to find work, decrease. This too will result in political instability.
The FIRE Economy, a perversion of some sort of “full employment policy” instituted in many post-industrial economies with the aid of expansive fiat, was the one thing that policymakers tried to save. Can’t blame them, as it was the easiest to save. No factories to build, or ditches to dig, only keyboard strokes were required. But make no mistake about it. The FIRE Economy is extractive, not productive, and it too will end as all Ponzis end. And it will take the economy down with it.
Which will leave us with what? An already decimated manufacturing base, and a collapsed FIRE Economy.
It used to be that one nation traded one good for another, guns for spices, for example. What barbaric times. Today, one only needs a functioning Ponzi system of debt driven ever increasing asset valuations that create paper which is used to buy real things like oil.
But what do I know? Maybe we finally figured it out, and all’s well.
What is funny is almost all deleveraging thus far has been via default, not Americans finding Jesus and purposefully changing behavior. Multiple pieces in wsj the past year showing default of debt is main driver even of the tiny delevering. The only people who seem to have changed their behavior are those who had no choice in the matter and have had credit cut off. So we are solving little and more importantly learned nothing. Even worse our drug dealer in chief is back handing out 0% down fha loans with fico scores greater than 520 while losses continue to accrue to taxpayer.
While that’s a valid philosophical point, from a practical standpoint I’m not convinced it matters in the short or medium term.
Debt levels are down in households and corporations despite the behavor you (perhaps rightly) object to. Those 0% loans you refer to don’t seem to be increasing overall debt ratios, probably in large part because they serve to increase demand for products that are currently in surplus, which in turn prevents the private sector from continuing to cut production (read as: jobs) in the short-term. That salvages one part of the economy immediately in exchange for what I freely admit could be serious long-term issues.
With the free market currently placing human resources as inefficiently as it is, maybe it’s a choice of the lesser of evils. There are definitely long-term issues to be concerned about with household debt behavior, but I think almost anything would be better than having a large percentage of the population destitute and unproductive right now. That leads to social unrest and economic instability in every timeframe. There are lots of other issues that need to be resolved, but can anything really be changed, anything at all, without first fixing the labor market?
nottpc
“Even worse our drug dealer in chief is back handing out 0% down fha loans with fico scores greater than 520 while losses continue to accrue to taxpayer”
Are you a loan originator? I am (yeah, I know, we’re lower than used car salesmen).
I can assure you that the loan you described is not available.
FHA loans (with very few exceptions) require a minimum of 3.5% down. There isn’t a lender in the country that will do 3.5% FHA down with a 520 FICO score. You MIGHT be able to get a loan with a 580, but you have to remember, FHA loans require full documentation of income, and they are not so easy on debts. For the most part, a minimum of 620 is needed to get an FHA loan. Typically, someone with a 620 FICO has had some recent payment problems, too much credit card debt, or a serious problem (bankruptcy) from several years back, or some combination of the 3.
While FHA loan performance is a bit poorer than conventional loans, the FHA borrower pays for a good portion of that differential. There is a 1% funding fee, and ,0.90% annual mortgage insurance fee that is included in the payment. Private mortgage insurance (typically for loans between 80 and 95% LTV) does not have a funding fee, but annual rates for the higher LTV’s are similar to FHA’s.
Re “drug dealer in chief”, Obama has made mistakes, and he will make more, but to casually call him a drug dealer is ridiculous and offensive. Enabler in chief, maybe.
If yiu are a mortgage broker you would admit that fha did not even have a credit score minimum up until about 5 months ago, So yes they are drug dealers in chief. Further all these 3.5% down put people upside down if homes fall 5% and here we go again to the strategic default era. Plus many sellers are offering givebacks to push through sales. Plus states like CA had$ 10K home credits up to 12/31/10 not to mention the federal rebates which many states allowed to be used in lieu of down payment effectively allowing someone to buy a home up to$ 170K for nothing down. Child please.
nottpc:
Why would you question whether I am a loan originator? It’s easy enough to look that up at the NMLS, since we are all licensed.
http://www.nmlsconsumeraccess.org/
It is true that FHA did not have a minimum FICO score, however, FHA never makes loans, banks do (FHA sets the guidelines, and provides insurance to the banks, with the premium paid by the FHA borrower). I could not find a bank even a year ago that would do a FHA loan with a 520 FICO. Maybe there were some in 2007 or early 2008.
What evidence do you have that borrowers that went from 3% equity to owing 5% more than the home was worth are defaulting in droves? From the evidence that I’ve seen, it generally takes negative equity of greater than 25% to push people into strategically defaulting. The primary cause for ordinary defaults are the same as they have always been: loss of job, divorce, illness.
It is true that FHA loans default at a higher rate than conventional loans. That should be expected, considering only borrowers that could not qualify for the better terms in conventional make up the pool. However, they are not the train wreck many make them out to be. The default rate has stayed about the same since 2008.
As far as California…I don’t lend there. More than enough to do in my own state of Washington. We could not use any federal rebates toward the down payment. The DPA’s ceased over 2 years ago (down payment assistance from non-profit groups that funneled down payment money from sellers to buyers via a back channel). Seller assistance with closing costs are limited to 3%.
There ARE a few zero down options: RDA loans, which can only be used in rural areas; some state specific programs which often offer a small 2nd mortgage as a down payment; VA loans, which require a significant time invested in serving our country, and FHA homes that are HUD owned (they require $100 down, which I see as effectively zero).
These all have significant hoops to jump thru.
Another massive decline in home values will cause an ever more rapid rate of default, both strategic and ordinary, in all loan types. Limiting the eligible pool of buyers further than what exists now only makes the liklihood of home values crashing even greater.
…basically think, the view about a sustainable US economic recovery is a view through rose colored glasses. In reality, the US situation is grim, beyond repair. In the current global environment, it does not pay to be patriotic.
Remember the Obama appointed Deficit Commission (populated by US banking interests) reporting December 2010.
Along with the press, the media, and most of the political punditry, the Deficit Commission appears far more worried about government debt (deficit) than depression. As a result, their report includes a two-way strategy:
1. change the tax system in order to shift the cost function -taxes- for Wall Street and Corporations off finance, off industry, onto labor
1.a. cut social spending
This ensures as much of the government spending power as possible is available to bail out the inevitable collapse when it comes financially and to give subsidies to companies.
1.a. cut cost function -labor- lower wages by 20 percent by creating a depression (remember your concern about the potential, deflationary effect of the QE strategy)
Reason:
-to make the economy more competitive
-the economy can earn its way out of debts
-make more profits, pay more bonuses_stock options
Remember: the financial sector has a long history of ‘Pump’n Dump’ and its happening now. Most of the $600 billion government bail-out is reported to have gone abroad, into the BRIC countries–Brazil, Russia, India, China, Third World countries, Malaysia.
Game Over – The rats jumping ship – Shrinking the US economy – setting up shop in BRIC-VILLE -
USD_EURO kaputt – BRIC currencies on fire
Kind Regards
Agree. Much of the stimulus money ended up in emerging markets and created bubbles there, dirving commodities higher. But most people in the US couldn’t care less about instability in the emerging markets, they only care about what happens in the US. They are only now strting to object since food is becoming too expensive. Of course, if emerging markets blow up US will also go right back into the recession. But it might or might not happen. And I am sure financial firms will find a way to capitalize on that. For financial indyustry volatility ( boom and bust) is good, this is when they can make the most money. Stable environment is boring and non-profitable for them.
That commission however also pointed out and discussed one glaring issue that you ommitted, as do many who bring up the same concerns and ideas you are. The costs of health care for an aging population is the two-ton gorilla in the corner, both for the private and public sector. No matter how the cost of health care is distributed, as it stands right now that cost will be too high for anyone to pay.
I can’t imagine a useful discussion of solutions to any long-term government spending or the greater long-term economic issues without discussing that. You have to include a solution for providing health care in the US economy or quite simply nothing will be enough.
Wow, I am sorry- reading your comment a second time I see that I completely misinterpreted it on my first look. I first read it as you summarizing those recommendations and promoting them or proposing them and now I realize you’re critiquing them as incomplete just as I am!
That’ll show me to read fast- please accept my apologies.
1:1 ratio is sustainable only if:
wages growth = interest on debt outstanding.
(haven’t seen anything like that probably… ever). Otherwise deleveraging has a much longer way to go.
And if by chance wages reduction happens – it’ll blow this ratio again.
Declining prices could help offset a lack of wage growth for some time. It wasn’t long ago that an entry level computer cost £2,000 and now you can get one for £350. Of course, prices cant go to zero…
In a “flows model”, such as MMT, the federal deficit is necessary to increase the net financial assets of the domestic private sector. However, the problem is this ignores the “stocks” of the economy, represented by assets, liabilities, and the productive value therein. The problem is that the Ponzi build-up in the private sector has not been restructured/deflated, only supported by the deficit, i.e. transferred to the public sector.
The deficit works in a cyclical way, but it does not deal with the structural/secular problems that will work to inhibit economic growth in the future. At some point, the total debt burden is too high to support with the income receipts (nominal GDP approximately) of the domestic economy.
MMT is absolutely not a “flows model.” The sector balances are flows, but sector balances are a small subset of MMT. MMT is all about stock-flow consistency.
Chad – your comment only applies to countries with fixed exchange rates, such as Euro countries. In the US, the ‘debt burden’ will always be supported, since the issuance of debt is nothing more than a monetary operation, and funds exactly nothing. The US should stop issuing debt immediately so the deficit hawks will sit in silence over this not so well known reality.
But Chad is correct that the deficit just allows the private debt Ponzi scheme to continue. So the private debt will for sure not be supportable at some point.
Investor X
You could even argue that they’re encouraging fiscal imprudence. It’s a no consequences world….
Steve
I am referring to the aggregate debt burden, not the federal debt, and particularly the private debt currently serviced by the private national income and collateralized (mostly) by the private sector balance sheet.
Borrowing money to fund unproductive activities is not condusive to long term economic vitality. Eventually those activities fail to promote enough growth to justify the liabilities associated with them, and the credit deflation ensues. Here is where I make no distinction between private or public, because it eventually boils down to an asset allocation decision. Federal government is not immune to this, regardless if they are the monopoly supplier of the currency in a floating exchange rate system.
Cullen, Would you please comment on this blog posted by Jim Jubak. I believe he has this wrong, but I am still struggling to understand your approach.
“Last week a newcomer moved to the top of the rankings for the world’s leading holder of U.S. Treasuries.
Used to be Japan, once upon a time. But Japan with holdings of $877 billion in U.S. Treasuries is now No. 3.
For a while China was the biggest holder of U.S. government debt. But now with $896 billion China has slipped to No. 2.
As of last week, the leader of the pack is—the envelope, please–the New York Fed, which holds the Federal Reserve’s Treasury bills, notes, bonds, and TIPs. (TIPS are Treasury Inflation Protected Securities.) As of last week the Fed’s System Open Market Account held $1,108 billion in U.S. government debt. (That’s $1.108 trillion if you prefer.)
And the Federal Reserve isn’t done building that portfolio. It’s still buying Treasury debt—about two-thirds notes with four-year to 10-year maturities—as part of the second program of quantitative easing and it is also buying about $30 billion a month to reinvest the interest from its portfolio.
By June, when the current program of quantitative easing is due to end, the Federal Reserve will hold about $1.6 trillion in U.S. government debt, or about as much as China and Japan hold now combined.
Which is kind of scary when you remember that the Federal Reserve will have to shrink its balance sheet one day. That will mean managing the sale of some part of the world’s largest portfolio of Treasuries without sending interest rates shooting up (and the U.S. dollar shooting down) as buyers demand higher yields if they’re going to swallow all that debt.
That sale should be especially tricky since there’s no evidence that the other big holders of Treasury debt—China, for instance—are eager to add to their already large portfolio holdings.”
Tags: debt | Federal Reserve | U.S. debt crisis
The debt sales by the govt are not a financing tool. Jubak clearly believes they are. Rates will only “surge” if the US govt raises short interest rates or inflation goes much higher (which would likely be due to a stronger economy). Funding is never an issue so any chatter of bonds being dumped for fear of solvency is nonsense.
Isn’t the better question why would the Fed have to sell treasuries? Why can’t they hold until maturitity?
The fact the Fed holds so many treasuries is just evidence treasury securities fund exactly nothing, and serve as a monetary operation, not a funding source.
Since they’re paying interest on reserves there is nothing stopping them from holding to maturity. They can tighten policy without selling the portfolio. So, my guess is they won’t and they’ll just let the portfolio shrink naturally….
IF they weren’t paying interest on reserves, what would stop them from holding to maturity ?
Bigger question, what happens at maturity ? UST has to pay the principal back on the bond, where does UST get the funds to payout at maturity ? If they issue more bonds to rollover then how does this shrink the FED balance sheet ?
If they weren’t paying IOER they’d have to unload the portfolio because the excess reserves would put downward pressure on rates.
The UST gets the money from nowhere. They are effectively paying the interest on the tsys to themselves….
Modern Money = Incestuous financing.
The way this recovery is unfolding is a farce. Crooks loot the treasury and go unpunished while the ‘taxpayer’ burdened with a drag on future income to pay the bill.
Wasn’t the Federal Reserve created to smooth out economic cycles? Instead what we’ve created is increased volatility within the real economy while putting savings of Americans up for grabs.
The fed has merely transferred the individual credit card balances of households and corporations onto a giant credit card held by the US government as the quasi-government mortgage institutions lift the debt off of the banks balance sheets while the government asks little in the way of reform in the behavior of those responsible.
Americans have lost the discipline to manage their finances. Expect more volatility and more losses.
What happens if certain assets the Fed has purchased (e.g. mortgage backed securities) don’t perform as expected? Will the Fed hold these non-performing assets to maturity even when these assets might not even return their principal, let alone the interest they were supposed to generate? If the percentage of non-performing assets that the Fed holds is significant, would the longer term effect be inflationary or deflationary?
RH
P.S. Is there any public record of the assets the Fed has purchased thus far, and if so, if there a way to determine the percentage which are non-performing or under-performing? Thanks.
The government would eat the losses. But I am pretty sure they’re making money on the balance sheet. There have been several articles talking about how profitable the Fed has been in recent years.
UST pays interest to FED on the bonds held on the balance sheet, which are then returned (minus the rent) to UST.
For the MBS toxic crap that the FED bought from the bannks, sure the cash flow from the performing loans (mostly interest) is profits to the FED which is returned to the UST (minus the rent) – but don’t confuse these profits from a solvent balance sheet in these assets – only the FED as buyer of last resort can prop these assets up on the backs of the taxpayer. If you believe that these are profitable assets then why didn’t the banks continue to hold them. All of the non-performing and defaulting assets are losses that have completed the accounting of the wealth transfer from the taxpayer to the banks by these back door bailouts.
By government you would mean the US taxpayer.
It’s already happening, the capital injections into FNM and FRE are covering the debt guarantees on the agency MBS the Fed bought.
Fannie and Freddie is lifting the rotting mortgages off of the banks balance sheets, the Fed is making sure that banks have earnings.
“Since they’re paying interest on reserves there is nothing stopping them from holding to maturity. They can tighten policy without selling the portfolio. So, my guess is they won’t and they’ll just let the portfolio shrink naturally….”
Bingo.
you are such a one trick pony. the fed can issue money to infinity and it doesn’t matter. the government can run deficits to infinity and it doesn’t matter. this is such hogwash. the reality is the american economy has been hollowed out by the exodus of our manufacturing base. no economy is sustainable longterm with the huge trade balance deficit we have been running in this country. the only answer is to begin rebuilding our manufacturing base and the only way to do that is implement tariffs on china to force them to float their currency and remove their barriers to trade.
One trick? That’s all? Surely I know more than one trick….
In all seriousness though Jake – you clearly haven’t taken the time to actually understand my commentary. I HAVE NEVER SAID THAT THE GOVERNMENT CAN SPEND AND IT DOESN’T MATTER. I HAVE NEVER SAID THE GOVERNMENT CAN RUN DEFICITS TO INFINITY WITHOUT CONSEQUENCE.
I am going to repeat this so people get it because this sort of comment occurs far too often:
I HAVE NEVER SAID THAT THE GOVERNMENT CAN SPEND AND IT DOESN’T MATTER. I HAVE NEVER SAID THE GOVERNMENT CAN RUN DEFICITS TO INFINITY WITHOUT CONSEQUENCE.
The key is inflation. And with very low inflation we can be fairly certain that the high deficit will not translate into serious economic concerns. Please see the article on understanding the modern monetary system. I am honestly trying to help people understand this stuff better, but I can’t learn it for you. You have to actually take some time to try to learn it on your own.
Thanks,
Cullen
Ah yes, so what do we do, we lie about the inflation. inflation today is in excess of 5% and yet the government tells us it is 1%. they have been lying to us for years and using all kinds of tricks to understate inflation. the problem with your focus on inflation is by the time the government can no longer hide the true rate of inflation the currency will be well on its way to destruction. yet all you want to focus on is printing more money and telling us how it doesn’t matter. do you secretly work for the fed?
Jake,
I have a question for you. Not surprisingly, disposable income and CPI have a VERY high correlation. So, your accusation that the govt lies about inflation would also mean that they are lying about how much money we all make. Do you see the inherent conflict there? According to you the govt is telling us we’re poor so that they can lie about inflation….Something doesn’t compute with your conspiracy theory.
If you look at the weights in the basket of goods, it does not reflect what a retiree consumes.
On top of that, there are all kinds of costs that are not being measured. For example, I don’t think the deductible on my insurance is going in. Here in Canada, I am also being nickle and dimed like crazy for governement services and I’m pretty sure my muni taxes aren’t in the basket.
The Cdn dollar has gone from 63 cents to par yet the cost of my products is still going up. Adjusting for the currency, this would bring the number over 10% inflation on an annual basis since 2005. Of course our government is saying 2%.
The list goes on.
“The key is inflation”.
With all due respect. Inflation is not the key it will be the end result of “The key men” Chairman Bernanke and his comrades that will again be behind the curve.
Notice the talk is shifting gradually from coming Deflation, to De-inflation,to a little bit of inflation and soon the serious inflation will come as all the heavenly money from no where start to show up in the money supply.
I wonder if they’ll use the word contained.
Yes. Like asking a pyromaniac to contain a fire.
So TPC, here are two questions:
1. Why is UK experiencing inflation and no growth (stagflation). They also issue their own currency and likely were impacted a lot by the credit crisis?
2. Why is it so correct to exclude food/energy in measuring inflation? Granted, rising costs are unlikely to be passed on to consumers in large part, but does that mean inflation is low?
I would suggest that prices paid component of the ISM indices are flashing at least a yellow if not a red on inflation (cutting thru the nonsense of core CPI and ignoring food and energy!)….so notwithstanding slack in labor and capital, we are either on the verge of higher inflation or a collapse in margins or both. So much for MMT…it is an elegant theoretical exercise with little to no practical implications (other than what is obvious – US will not explicitly default on its debt and hyper inflation is unlikely, bothof which I have always agreed with you and the MMT’ers on). MMT does NOT address the misallocation of capital…it just says that government deficits are always good in a downturn w/o addressing the fact that the govt debt is funneled into mostly inopportune and inefficient projects that do little to nothing for the economy!
MMT doesn’t say deficits are always good in a downturn and that we don’t have to worry about efficient allocation of capital. But that is the knee-jerk reaction MMT-resisters commonly have. Cullen has stated numerous times that ANY system won’t work well given inefficient allocation of capital and corruption.
This turns into a discussion of policy implementation, and applies to any economic regime, whereas MMT is mostly just a description of the operations in monetary system such as the US’s.
1. I am no expert on the breakdown of the UK economy, but from what I know they have actually experienced a decent recovery. In addition, they have a higher sensitivity to petrol prices so inflation has been higher.
2. I have never said it’s “correct” to exclude food and energy. But it does help create a smoother picture.
I have never said that deficits are always good during a downturn. I have said they are good during a downturn in which there is very low inflation.
As for misallocation of capital – I have done quite a bit of work on the way the govt misallocates funds, spends inefficiently and helps promote fiscal imprudence.
The UK and US are most likely experiencing very similar inflation. The difference is what is measured. UK inflation covers 700 items. But not owners equivalent rent. Which just so happens to be the largest component of US inflation. If you threw out OER in US inflation the figure would jump and Ben would be forced to admit there is inflation. Since there is not we can live in a fantasy world of no inflation.
I am actually amazed at some of the comments on the board the past few days…no less than 5 business owners have said they are seeing surging prices and a few seem to indicate it is threatening their business. The only response to them is surging input costs is not inflation and if you can’t pass along your not inflation it sounds like your business will fold and so goes your employees. Not inflation is super cool…causes business failure but does not exist.
Thank you for pointing that out. I was one of those business owners that posted over the last few days and I have to admit I thought it was ridiculous for people to make those commments. At some point, these costs will have to be passed on to consumers. A number of food and clothing companies have come out over the last few months saying that higher commodity prices will force them to raise prices this year.
Also, has anyone noticed that when you go the grocery store food prices are not rises but almost all food container sizes are getting smaller? I wonder if the gov’t takes that into consideration when calculating inflation. I highly doubt it.
Yes, rising input costs that squeeze margins and thereby cause businesses to fail are not good. But if final goods and services prices don’t go up, it isn’t inflation. It’s not a value judgment. It’s just how inflation is actually defined.
I do agree regarding OER, though, in that it is not completely consistent with a measure of final goods and prices inflation. But it’s a difficult question since pure housing prices aren’t exactly what you want to include in a price index for final goods and services either. Note that Cullen’s measure of inflation excludes OER and includes housing prices and is still not rising much more than official measures.
Why is it so correct to exclude food/energy in measuring inflation?
Because spot prices are affected by futures prices, and futures prices can be be volatile, and are at times impacted by excessive trading and speculation.
Since the exchange mechanism isn’t stable, the resulting prices aren’t good measures of overall consumer prices. A good wheat crop isn’t inherently deflationary, and a virus that kills off pigs isn’t necessarily inflationary, especially when there are available substitutes.
I think you are very correct in saying that the last few years could have been worse. Had the so-called “Minsky moment” not been followed by a (unfortunately too short) “Keynes momemt”, we’d probably not be talking about a recovery at this point.
Also, I find the type of graph used in figure 1 is very well suited for depicting sectoral balances. (Just one question: Shouldn’t the title of that graph read 1995 rather than 1952?)
Good catch. Thanks.
No one mentioned that the Fed gives much of the interest collected on their portfolio back to the Treasury. When the bonds mature they can give that money back as well. So my kids do not have to obsess over the “growing” national debt. I would suggest, that along with not collecting data on M3, we should also quit collecting data on the so called “national debt” right? It would be good to keep track of the treasuries owned outside the US government, but the rest is figment since that part of the debt has been, in effect, cancelled and written off. In the end QE2 is helping to ameliorate the public’s balance sheet recession since we will not have to pay back this debt with our taxes.
The bonds that the FED have on the balance sheet represent money that has been created and spent by the gov’t. When the bond matures where does the UST get the money to pay off the principal on the bond.
1. they can have the FED create it (new FED FRN liability), deposit into the UST account. The UST pays/cancels the bond; then the FED returns the money back to the UST; then the UST pays the FED back for the initial account funding to cancel the FED liability of creating the new money. OR skip the process and just cancel the bond. BUT the original money that was put into the system is still there, resulting in monetary inflation – which already happened at the time the bond was monetized.
You’re right, and I understand that this QE2 is no different from Uncle Sam printing money. But trillions of dollars were lost from our economy in 2008. This QE2 is an important way to get some of that money back into the economy. The public and the world needs more dollars. Over 60% of the money in the world is US dollars. The lack of money is central to what is happening in Egypt today. You are thinking too small.
I understand that this QE2 is no different from Uncle Sam printing money.
This is false. Quantitative easing involves very little increase in the M1 money supply.
“Quantitative easing” is simply the term used to describe the bond purchases made by a central bank once its overnight rate has hit the zero bound. It is a rate setting mechanism (or at least attempts to be.)
QE is almost identical to the type of operations that central banks undertake whenever they attempt to reduce interest rates, regardless of what the rate is. When central banks lower rates, they do so by buying bonds. The only controversy comes from those who don’t understand how central banks operate.
“In this manner, by creating ourselves our own paper money, we control its purchasing power, and we have no interest to pay, to anyone. You see, a legitimate government can both spend and lend money into circulation, while banks can only lend significant amounts of their promissory bank notes, for they can neither give away nor spend but a tiny fraction of the money the people need. Thus, when your bankers here in England place money in circulation, there is always a debt principal to be returned and usury to be paid. The result is that you have always too little credit in circulation to give the workers full employment. You do not have too many workers, you have too little money in circulation, and that which circulates, all bears the endless burden of unpayable debt and usury.” -Benjamin Franklin explaining to directors of the Bank of England government issued money (link)
Sorry, Here is the link
http://www.webofdebt.com/articles/qe2.php
There is a solution that is simple, yet difficult and the FED Head has vowed to not let it happen…DEFLATION. We have tried fiscal and monetary solutions which have simply masked the problems at hand. While it would be extremely painful in the short to intermediate terms…a Great Depression 2.0 would lead to psychological changes in financial habits that could be beneficial for years to come….or until the extreme levels of greed overtakes the masses again.
“Balance Sheet Recessions” end only when the “balance sheet” is a full accounting and a resolution of the debt” and the assets”. That is the only way. All the rest is just BS.
Southerner, deflation is bad, and the powers that be will do anything to prevent it. Lessons learned? Memories are short.
How long did it take Japan to get out of its balance sheet recession? Hard to believe the U.S. could do it in only a few years.
The US economy under Ben Bernanke follows the Alan Greenspan recipie of ‘bubble economics’, featuring a total disregard for the debt side of a balance sheet. Instead, they focus exclusively on the asset side to be bid up for gains.
The idea in the long term is to recycle any gains out of the debt service, financial profits and government bailout grants into new loans to a point where debt service ends up absorbing the entire economic surplus.
The result:
-no new capital investment left for the corporate sector
-no revenue left for infrastructure and social spending
-families unable to afford education or retirement
As the bottom 90% is increasingly driven into debt to the wealthiest 10% by loading more and more property and income streams down with debt, the economy collapses
Under ‘debt leveraging’, there is no end to a balance sheet recession in the long term
Kind Regards
What sort of recovery is it when you have 43 million on food stamps, unemployment at 9% plus, and everyone apart from the uber-wealthy suffering from squeezed income and higher costs?
A stock market that is forced higher by the Fed’s funny money, and the big banks making billions each week by churning T-bonds back to the Fed at a higher price.
Welcome to America, where mass delusion is the key to ‘recovery’, and our blogging host has bought it hook line and sinker.
What is funny is almost all deleveraging thus far has been via default, not Americans finding Jesus and purposefully changing behavior.
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Households are deleveraging by paying down or defaulting but in aggregate this deleveraging is not happening. The Fed is loaded with worthless paper and banks are still using mark-to-make-believe. So the write downs still need to happen and if they don’t, we need inflation to deflate that debt. And I’m talking about the type of inflation that shows up in the top line and GDP. And as long as we don’t get one or the other we have a balance sheet problem.
Everyone keeps on saying that corporate debt levels are low but maybe we are looking at it the wrong way. Maybe there are too many companies per sector, thus too much debt in aggregate for the future of some industries.
IMO, we are nearing the end of the interest rate cycle. Rates and spreads can not go any lower. In the last 2 years, companies got the opportunity to refi one last time. That,s why the economy recovered but that game is finished once and for all. Next time, when the economy slows, corporations won’t be getting any respite. They’ll be facing bankruptcy and M&A. The big will get bigger. We saw it with the baks and we’ll see it in other sectors. And when this M&A peaks, it will mark the true end of our 3 decade cycle of financial engineering.
I understand that this QE2 is no different from Uncle Sam printing money.
This is false. Quantitative easing involves very little increase in the M1 money supply
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1. Pimp & Co. has 1 trillion in bad MBS that should be written off or down.
2. Fed says no no, they’re good. Give us the MBS and here’s 1 trillion $.
3. Pimp & Co. says thank you and makes 1 trillion dollar purchase of treasuries.
4. Treasury says thank you for your support Pimp & Co.
5. Obama says, let’s spend the 1 trillion on health care and other stuff.
So how is this not printing money if someone out there is getting the money and buying goods and services with it? Had they not used QE, do you really think GDP would still be at 14 trillion?
#5 I believe is the key to what you’re asking, right? The idea that that 1 trillion is being spent from the pool of money that comes from the 1 trillion purchase of treasuries?
That is a completely different issue. Federal spending does not have to be correlated to tax revenue or bond sales, so it is a totally different issue. Tax revenue is “destroyed” money and spent money is “created” out of thin air. QE has nothing to do with that.
QE is 100% intended to be a tool to achieve target interest rates through an asset swap, nothing more. Whether or not it can achieve that is really the only point of disagreement, I think, QE. Calling it the creation of money is pretty much just political rhetoric that works because it’s easy to imagine bonds as being how deficit spending is finance- but that just isn’t the case in a fiat currency system.
I’m don’t assume that it’s JUST to keep rates low. That’s too simple.
For a hole set of reasons, they need to keep asset prices up (pensions, bank capital ratios…) so they can’t write down debt.
The problem is that MBSs are still toxic and they need to get them off the private market’s books stealthily and that is what QE is doing.
If they manage to do this without writing anything major off, inflation is going to hit. Government did not let corporate America implode, instead they are squeezing out private business gradually.
I know the Bank of Canada is working with the Fed in ways to spot inject inflation in the most efficent ways. Universities are working on this. They need GDP to go up to shrink the Debt to GDP ratio. Now use your logic to determine which sectors can be best used to stealthily inject inflation… health care maybe?
whole and not hole
I know that you’re trying to be clever, but this is woefully inaccurate that it’s laughable. You clearly don’t understand open market operations or how the Fed conducts them.
You’re the one missing the forest.
You’ve presented a pile of dung, and confused it with a tree.
MBS’s and the federal budget have nothing to do with QE. It just makes you look ignorant to believe that they are.
You need to type less and read more. You’re so off base and clearly lacking knowledge of this subject that it’s laughable.
In the following he talks about health care spending:
http://www.pimco.com/Pages/Rocking-Horse%20Winner%20April%202010%20IO.aspx
“Replacing corporate and mortgage debt with a government checkbook is initially beneficial because the sovereign is assumed to be more creditworthy than its private market serfs”
http://www.pimco.com/Pages/Investment%20Outlook%20March%202010%20Bill%20Gross%20Dont%20Care.aspx
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I can’t remember which month it was, but Gross in one of his investment outlooks, specifically stated that he sold his MBSs and replaced them with treasuries.
I also remember seeing his name, on the Fed’s website, in the committee that was set up for the bailouts.
You’re making an assumption that all of the MBS was bad. 95% of Americans pay their mortgage on time. So yes, there is a chunk of bad paper out there that can’t be serviced, however, things were not nearly as bad as the markets had priced in March 2009. The Fed, as lender of last resort, rightfully stepped in and helped make a market in this bad paper. And the ensuing correction to the upside is reality. You can call it distortion, but one could easily make the argument that the market was distorted on the downside as well due to irrational behavior.
If you go here. You will see that more than 10% of loans are delinquent so your 95% is off.
http://www.federalreserve.gov/releases/chargeoff/delallnsa.htm
Secondly, let’s not forget that those MBSs and CDOs were not priced for zirp when issued. They may not be o but they are less valuable than you infer.
I can’t remember which month it was, but Gross in one of his investment outlooks, specifically stated that he sold his MBSs and replaced them with treasuries.
PIMCO reallocated its portfolio by selling MBS’s and using the proceeds of that sale to buy bonds.
The Fed didn’t buy any of PIMCO’s MBS’s. The Fed had nothing to do with that transaction.
If I sell Starbucks’ stock and use the proceeds to buy bonds, that transaction had nothing to do with the Fed, Ben Bernanke or the process of quantitative easing. I simply made the decision to get out of one risky asset and move the money into a different, less risky one.
Your PIMCO example is irrelevant to QE. In the US, QE involves treasury bond purchases as a rate setting mechanism. The Fed is not allowed to and does not buy MBS’s.
You have taken a few separate concepts (open market operations, portfolio allocation, the federal budget) and completely confused and jumbled them together.
The Fed did buy MBS. http://www.clevelandfed.org/research/trends/2010/1010/01monpol-2.gif
MBS’s and the federal budget have nothing to do with QE
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Ya right…
http://www.federalreserve.gov/monetarypolicy/files/monthlyclbsreport201101.pdf
Table 2. Domestic SOMA securities holdings
Billions of dollars, as of December 29, 2010
Security type Total par value
U.S. Treasury bills 18
U.S. Treasury notes and bonds, nominal 943
U.S. Treasury notes and bonds, inflation-indexed1 54
Federal agency debt securities2 147
MBS3 992
Total SOMA securities holdings 2,156
Stop issuing those bonds and we’ll see how long your consumeristic ways will last.
I would be quite happy with that. Stop issuing bonds. Buy the outstanding back. Merge Fed and Tsy. End the Fed’s interest rate setting. Set the overnight rate at 0%. I would absolutely love to see an end to the govt bond market. That would be fantastic. Then maybe we’d all stop whining about whether or not we have money and we wouldn’t have a Fed that helps misallocate capital.
With no QE, pension funds would have had to take huge haircuts. That means pensions would be even more underfunded.
If pensions were even more underfunded, governments across the country would be cutting even faster.
I don’t care what you call it, it ends up being funding.
Not true. When the USA spends they simply credit bank accounts. The money comes from nowhere. Not taxes, not bonds. There is no such thing as a funding shortfall. There is the potential for inflation, but there is not such thing as the USA not being able to fund itself. That is a myth.
I understand all this but my point is that all these tricks do impact the level of funding that is decided and the allocation of this funding.
MaybeI should not call it funding and call it spending.
How is that not monetization of the debt???
How do you monetize the debt when the debt doesn’t even fund your spending? This is a term that remains from the gold standard days when govt’s used to literally buy gold and issue new gold certificates. Today, it is impossible to monetize the debt. The Fed could purchase up every outstanding tsy bond in existence and it wouldn’t matter at all to how much money the govt can or cant spend. It’s a fear mongering term and when you read someone use it they are trying to scare you or they have no idea what they’re talking about. Usually (actually always) the latter.
Money printing is always done by tsy. And it is done in the form of deficit spending. This is independent of the Fed open market operations.
Moneta – in your step 3, the 1 trillion that was “created” is destroyed again when it is given back to the government for the bonds, isn’t it?
No it was not. Fed buys MBS. Pimp & Co. gets cash for stinky MBS. With cash buys treasuries. With cash from Pimp & Co. government gets to keep on spending… that’s the deficit.
All in all, Fed gave government to spend.
And their trick of using the investment banks to keep people in the dark is working like a charm… most people obviously still refuse to believe that they are monetizing the debt.
The GDP would not be 14 trillion is the government did not do QE.
the balance sheet recession will end after the pop of the now forming paper bubble in…in…in….EVERYTHING ….but western currencies maybe….probly brought on by some political convulsion.
Eur peripheral defaults bringing down paris n hamburg banks….china awash in empty buildings bust.
i am sorry this isn’t over….i really am.
US n Eur shoulda took that swedish bank model in ’08.
the can runs out of road.
I also believe the US can print all the money it can, thus has no funding problem. But this also has consequences such as misallocation of capitial, shrinking productivity and a general lack of trust leading to a decline in living standards.
From the bottom up I look at debt/gdp. When you include all debt and entitlements, the ratio is huge. This ratio needs to contract so either debt drops or GDP rises.
I believe debt will be maintained at all costs (to prop up assets) but entitlements will get cut and GDP will rise quickly though inflation mostly. CPI won’t reflect the true cost of inflation.
When this ratio gets back in line, that’s when the balance sheet problem will be resolved.
Agreed. That’s what my original article was all about!
…junk economics based on a bankers view of equilibrium in an economy
Kind Regards
From the bottom up
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Top down.
Well, since the US is NOT making the mistakes of Japan,
And -
Since this time IS different,
The balance sheet recession MUST be over!
When the US spends they simply credit bank accounts and where does that go ?
As reserve and then if it use as QE its called a swap by the Fed and its no longer increasing the money supply.
I don’t care how it’s called, Changing money for Toxic Assets is simply shortchanging the public. IF I take a blood bath in the market there is no QE to bail me out.
Any new T bills purchases above what the fed could not purchase if the money was convertible will end up as devaluation sooner or later
Cullen
“Today, it is impossible to monetize the debt. The Fed could purchase up every outstanding tsy bond in existence and it wouldn’t matter at all to how much money the govt can or cant spend…..
“Money printing is always done by tsy. And it is done in the form of deficit spending. This is independent of the Fed open market operations.”
I think I’m finally getting my head around this. The money is created by deficit spending. The Treasury may choose/or not to cover some this by issuing treasuries. These are put on the market, but these days that market is weak. So the Fed takes some of these out of the market and puts them on their books (QE2). Interest on these is given back to the Treasury. So when people add this up its seems like the Fed is printing money. But I see how it’s difficult to argue that the Fed is not printing money because the Fed and Uncle Sam have a husband/wife like relationship. It actually doesn’t make any difference who is doing the printing in a practical sense. It all started with the deficit spending. Is the diluting the amount of US dollar/reserved currency in the world? Is this deficit spending like a fire hose in a pool or rain in the ocean?