Wednesday, August 11, 2010

The long train wreck

Trouble with you is the trouble with me,
Got two good eyes but WE still don't see.
Come round the bend, you know it's the end,
The fireman screams and the engine just gleams...

Driving that train, high on cocaine,
Casey Jones YOU BETTER, watch your speed.
Trouble ahead, trouble behind,
And you know that notion just crossed my mind.

-- Casey Jones, by the Grateful Dead

The Great Depression was not all for naught. At least not yet. The social safety nets put in place in the aftermath of that Great Ruction have kept unemployment at half the rates seen then. And the unprecedented bail out of bankers in the last couple of years have kept them in fine fettle, caviar and Housewifes.

It has all conspired to conjure a complacency that is as unwarranted as it is fanciful.

But David Stockman has his hand on the train whistle as the Great Depression redux continues picking up speed. Just a couple of weeks ago he did an Op-Ed for the NYT:

Four Deformations of the Apocalypse
The nation’s public debt — if honestly reckoned to include municipal bonds and the $7 trillion of new deficits baked into the cake through 2015 — will soon reach $18 trillion. That’s a Greece-scale 120 percent of gross domestic product, and fairly screams out for austerity and sacrifice.

In 1970 it was just 40 percent of gross domestic product, or about $425 billion. When it reaches $18 trillion, it will be 40 times greater than in 1970. This debt explosion has resulted not from big spending by the Democrats, but instead the Republican Party’s embrace, about three decades ago, of the insidious doctrine that deficits don’t matter if they result from tax cuts.

After a short intermission, he's back for round two with more op-ed.

Beware the light at the end of the tunnel (Commentary: It's a debt train about to collide with federal obligations)
The federal deficit is no longer an abstract long-term problem; it's a financially critical freight train hurtling down the track at alarming speed.

Here's a dramatic way to look at it: Nominal GDP is only $100 billion higher than it was back in the third quarter of 2008. That means it has been growing at only $4 billion per month, while new federal debt has been accumulating at around $100 billion per month.

Yes, this period represents the worst of the so-called Great Recession, but never in history has the federal debt grown at a rate of 25 times GDP for two years running!

the federal debt still has grown at two times the rate of GDP during what looks to be the strongest phase of the recovery.

at $52 trillion, credit-market debt today is 3.6 times that of GDP, compared with 1.6 times that of GDP when the original argument of supply-side versus Keynesians opened up back in 1980.

Moreover, this 1980 total economy "leverage ratio" hadn't fluctuated appreciably for 110 years going back to 1870. So I call it the "golden constant," and note that had the total economy-leverage ratio not gone parabolic after 1980, credit-market debt today would be $22 trillion at the 1.6 times ratio.

In short, the economy is freighted down with $30 trillion in excess debt. The process of liquidating the household and business portion of this -- about $24 trillion -- will swamp the normal cyclical recovery mechanisms for years to come. And it's insane to keep adding the mushrooming public-sector portion of the debt or order to artificially juice the GDP numbers for a few more quarters.

Further, if we're in a period of sustained debt deflation, it's extremely likely the GDP deflator will shrink toward zero and real growth will struggle to make 2-3%. Hence, nominal GDP growth is almost certain to be even slower in the quarters ahead

At the same time, there's virtually no chance unemployment will drop much below 10% in the context of a deflationary "recovery," meaning that budget costs for unemployment, food stamps, etc. will remain elevated, not come down by hundreds of billions as currently projected

So we have baked into the cake a rather frightening scenario: monthly federal debt growth upwards of $125 billion, or three times the likely nominal GDP growth of $40 billion per month -- as far as the eye can see.

At least once a day someone on CNBC talks about the $1.5 trillion in corporate cash on the sidelines and how healthy business-sector balance sheets are.

That's pure baloney. If you peruse the flow of funds, and you'll see that corporate-sector cash assets have increased by $279 billion since the December 2007 peak, and now total $1.72 trillion. According to the same data, non-financial, corporate-sector debt has increased by $480 billion and now stands at $7.2 trillion. Corporate debt net of cash has actually increased by $200 billion during the Great Recession.

Stated differently, corporate debt net of cash was $5.3 trillion or 36.7% of GDP at December 2007 and is now $5.5 trillion or 37.6% of GDP. There's been no de-leveraging in the business sector either -- especially when its noted that tangible assets have also declined by 20% on a market basis and are flat on a book basis during the same period.

Every reason of prudence says not to tempt the financial gods of the global bond and currency markets with this freight-train scenario: Do something big to close the deficit, and do it now.

Also, there's no possibility in either this world or the next of obtaining the needed $700 billion to $1 trillion in structural deficit reduction by spending cuts alone. We've had a rolling referendum since the first Reagan budget plan in 1981, and progressively over these three decades the Republican party has exempted every material component of the budget from cuts, including middle-class entitlements, defense, veterans, education, housing, farm subsidies and even Amtrak!

Like Casey, the GOP has been in the anti-spending batter's box for 30 years, and has never stopped whiffing the ball. The final proof is that the one GOP spending cut plan with any integrity -- the "roadmap" of Congressman Paul Ryan -- has the grand sum of 13 co-sponsors, and I dare say half would call in sick if it ever came to a vote. Therefore, tax increases are now needed because it's too late and too urgent for anything else.

That should be a call to arms, fiscally and monetarily. But this is an election year (isn't every year, these days?) and no elected doctor will be prescribing caster oil for the ailing economy. Or, should they, they will add a bucket full of sugar to make it go down -- and out -- before any prophylactic effect.

And what's the Fed to do? Well today, they said this:
Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months.

Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.

inflation is likely to be subdued for some time.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

As Rex Nutting summed it up,
The Federal Open Market Committee announced it would reinvest the proceeds of its investments in mortgage-backed securities as they mature into Treasurys.

As economic stimulus goes, this is pretty thin gruel.

What has the Fed accomplished? It avoided a second Great Depression, but large sectors of the economy are still struggling. It's not clear what easier credit conditions can do to ease that suffering.

Trouble ahead, Lady in red,
Take my advice you'd be better off dead.
Switchman's sleeping, train hundred and two is
On the wrong track and headed for you.

Driving that train, high on cocaine,
Casey Jones YOU BETTER, watch your speed.
Trouble ahead, YOU KNOW, trouble behind,
And you know that notion just crossed my mind.

-- id.

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