WILL THE SHORTER BUSINESS CYCLE LEAD TO RECESSION IN 2012?
History may not be on the side of those calling for recession currently. According to recent data from Deutsche Bank the current expansion is still on the shorter end of the historical average length.
Since 1854 the average expansion has lasted 40 months. Since the great depression the average expansion has lasted 58 months. The last 7 expansion, however, have lasted almost 70 months on average. At month 27 the current expansion would be short by historical standards. Of course, if you’re following my balance sheet recession theory this is a relatively moot point, but if we’re going to following the standard NBER data points on recessions then this casts doubt on the odds of a technical recession occurring in the coming 12 months.
DB, on the other hand, says we could be in for recession in 2012 as we near that average point. They claim recent history has been an anomaly and not the norm:
“The “Shorter Business Cycle” theory has become the cornerstone to our macro thoughts over the last 18 months. The conclusion was that using evidence from history there was a very good chance that the next recession would start by 2012 especially once we concluded that the artificially long business cycles of the “Golden Era” were a thing of the past. Figure 76 shows the length in months of each completed expansion seen since 1854 with the current cycle added at the end for context.
We think that the three ‘super-cycles’ between 1982-2007 were the exception rather than the norm and existed largely because of a near 30 year secular global decline in inflation that transcended the business cycle. This was perhaps caused by Globalisation and the reduction in cost pressures that it facilitated. We think that the Western authorities ‘maxed out’ on the benefits of this inflationary decline by pumping monetary and fiscal stimulus into their economies whenever they had an economic problem. Given the lack of inflationary pressures they had a rare ability to do this without the normal subsequent price rises.”
Source: Deutsche Bank
Hello Cullen, this is actually a reply to your differentiation between a currency issuer (e.g USA) and a currency user (e.g. Greece).
You say “the USA can create its own currency out of thin air”.
However, one thing that confuses me with this is that its the US GOVT (fiscal policy) that borrows money whereas it is the Federal Reserve (monetary policy) that prints money.
Let’s say that Obama announced a new fiscal stimulus package and had to borrow another XXXbn amount of dollars, and that there was no demand from non-us investors for the ADDITIONAL amount of USTs so domestic savers and the federal reserve where the only remaining buyers. Let’s then assume that domestic savings where not sufficient to take down the extra supply of USTs and the Fed did not want to do another round of QE. So inevitably US rates would increase.
To sum up, in your assumption about a country like the US that issues in its own currency does not face solvency risk, are you assuming that IF there is no private sector demand for USTs, the govt can force the Fed to buy up the debt and thus create inflation?
many thanks – J
The current 10% deficit is no different than a $1.6 trillion stimulus package, so we can use the current budget situation as a real live example. So we take in $2.4T of taxes, 15% of GDP, and we spend $4T, or 25% of GDP. (a trade deficit is no different than a government surplus, but for the sake of simplicity, we’ll assume a $0 net trade balance)
The key to MMT is this – the government will FIRST spend $4T, then it will tax $2.4T. The government prints money when it spends because the dollars spent are created out of thin air, unlike Germany, France, or Italy, who are unable to create Euros out of thin air.
So now we have a private sector with a net worth $1.6T greater than before. If the USG ran this deficit ad infinitum, this would be highly inflationary because the private sector would be loaded up with more and more dollars to spend every year.
So now it is easy to see that the best way to control root cause of inflation, IE too much money chasing too few goods, is by TAXING the private sector since this is the only way to remove dollars from the private sector. If we were currently operating at full capacity and private sector debt loads were within historical norms, then the primary risk to the economy would be overheating. Under this scenario, running a deficit would be dangerous because the private sector would allocate that extra $1.6T toward spending versus DEBT PAYDOWN. Debt pay down is deflationary, thus it is appropriate for the USG to run a deficit in order to offset the deflationary forces.
Ok so we just went through all that without the need to issue one single US Treasury bond. As you can see, issuing USTs is merely a monetary operation that allows the Fed to control interest rates and mop up reserves. Issuing USTs happens AFTER everything else. The Fed auctions USTs off to primary dealers, which are set up to take down the ENTIRE auction. Yes there is an accounting entry at the USG level that days the US debt is now $1.6T higher than before, but the form of that debt is the issue at hand. Dollar bills and treasury bonds are the EXACT same thing – a liability of the US government – except the treasury bond pays interest. If the USG replaced all USTs with dollar bills this would not be money printing. Rather there would be no US risk free rate because the USG’s debt would now be interest free. This would do nothing to inflation because think about it – the USG already planted the seeds of inflation by running a deficit and adding to the private sector’s ability to spend due to having a greater net worth. So if the private sector is $1.6T richer with dollar bills or treasury bonds, it doesn’t matter – the ability to spend is greater due to a higher net worth.
Bottom line, spending comes first, taxation second, bond issuance third.
Will politicians ever increase taxes? Politicians love to spend more and hate raising taxes, even when the economy is over heating.
@ BJM- That was very well written.
Here is another way to look at it:
The US government is about to spend money into existence (deficit spend).
This means that deposits are going to rise in the banking system.
If that was the end of it, there will be downward pressure on interest rates (excess reserves in banking system). Currently, banks will earn 0.25% on the excess reserves.
So, Fed issues Treasuries to mop up the excess reserves created by the spending to manage interest rates. Treasuries pay more than 0.25%, someone will take that deal.
The money to buy the Treasuries comes from the government deficit spending.
No one has to find any extra dimes from their piggy banks.
It helps to stand on your head to study this.
Hi J,
You have to think of the entities differently. You’re working under the premise of what I would call the myth of the independent Fed. We are taught that the Fed is this independent entity, but when you study the ops you recognize that the Fed and Tsy are intricately intertwined. They are two pockets in the same pair of pants. This is ultimately what makes the US truly sovereign. The Fed is actually very much a part of the US govt even though there is this supposed political barrier. So, when Tsy issues debt the Fed isn’t buying debt in order to “fund” the USA’s spending. It is performing a reserve maintenance operation. You can actually see this in the Fed ops and the way they work with Tsy to forecast reserve and remove them as they target interest rates. If the Fed weren’t intricately connected in this manner then it would be the equivalent of a foreign central bank. Not unlike Europe.
Have you read my primer? This is all a bit too detailed to explain here and you won’t understand it without knowing the foundation of my position. http://pragcap.com/resources/understanding-modern-monetary-system
-Cullen
The “power to coin money and regulate the value thereof” is granted to Congress by the Constitution. Both the Fed and the Tsy are creations of Congress. If Congress wanted to, it could order the creation of x trillion $ for spending that doesn’t appear on the debt side of any balance sheet, as they did during the Civil War with the Greenbacks.
I was wondering who was the author of the DB report as I would love to read it.
many thanks
Jim Reid. Here is a little more;
http://ftalphaville.ft.com/blog/2011/12/16/803431/deutsches-reid-on-shorter-business-cycles/
Arrghhh. The comment above was a reply to Caroline.
I didn’t know you were a pirate….
The Middle East and Northern Africa have not yet finished boiling… the political/social temperature over there is actually rising.
We will likely see things come to a head over there. Expect oil well into the 100s and a subsequent recession soon after.
And then, there’s Europe….
I find the analysis above to be extremely sterile. These are different times. Globalization, peak oil, currency wars, etc… A multidisciplinary approach is warranted now.
Good to see you blogging again.
Hope the fish are biting (or getting speared!)
Thanks!
“History may not be on the side of those calling for recession currently.”
http://ftalphaville.ft.com/blog/2011/12/20/806221/
Thanks for explanation guys, I didnt realise the US Treasury could actually print money (i.e. spend cash that it has not yet collected from taxes or raised from debt issuance). Do you have a source for this claim (e.g. a link to the treasury’s or Fed’s website that goes through this), as I dont think it is widely known?
Thanks – J