My opinion is that the oncoming U.S. recession and banking crisis is not caused by resource limitation. Rather, its the result of overleverage on virtually every asset in the country. When debt servicing costs exceed profits, there’s going to be blood in the streets. Last year, approximately 31% of business profits were reported by the financial sector. It doesn’t take a rocket scientist to conclude that this degree of burden by an essentially unproductive sector of the economy is unsustainable.

Ultimately, I believe that human ingenuity (creativity and technology) will provide rapid adaptation to declining natural resources… We no longer use whale oil for lighting… Were the US economy to seriously commit to the development of renewable energy infrastructure, as well as maintenance and repair of existing public infrastructure, we would be well on the way to correcting the current account inbalance. These activities would also provide the political/financial stimulous needed to make the economy productive.

I will admit however, that the US debt burden, and the Iraq fiasco has undermined most of the international support for the US Petrodollar system… As the dollar depriciates, so does the collateral for all the financial leveraging.

“Dr. Summers has long argued that even if easy credit causes crises, restricting the flow of credit in the midst of a crisis doesn’t actually help things — he generally thought that liquidity crises in emerging market economies could be solved with more liquidity … . His current policy suggestions are consistent with that thinking –”

That’s also Krugman’s thinking. In “The Return of Depression Economics” he says something to the extent that “Recessions are caused by people chasing too little scrip instead of real goods and services, and the solution is to print more scrip.” That thinking was valid *while* the world was still on the way up to Hubbert’s Peak, i.e. when recessions were caused by failures in aggregate demand. But now the world is bumping against the physical “limits to growth” (most notably, but not exclusively, in oil production), and the foreseeable stagnation and subsequent fall in economic output (until stabilizing at some lower sustainable level) will not be the consequence of insufficient demand but of physical constraints imposed by Nature. In this new scenario, stimulating aggregate demand with monetary policy is no longer able to increase output at all. It only raises the price of the critical limiting resource/s.

Think of a pub. When there’s plenty of beer, turning heating on to make customers thirsty so that they drink more will increase sales (demand is the limiting factor). When beer is running out, it won’t (supply is the limiting factor).

Thoughtful comments. Greenspan was particularly culpable for being a “new economy” cheerleader on the upside – very reckless.

http://www.business-standard.com/opinionanalysis/storypage.php?tab=r&autono=305290&subLeft=2&leftnm=4

Good points.

First, even if monetary policy has no real long run effect on real activity, economic activity has declining marginal utility, so, assuming that monetary policy can at least have a short-run effect on activity, the wisest use of it is to smooth the cycle. That implies that monetary policy must be used as much to restrain as to stimulate. Unfortunately, the fantasy mandate that the Fed is given, and their weakness in the face of hectoring from people like Barney Frank, mean that the application of monetary policy has been biased, and now has a restraint deficit. Using monetary policy to smooth the cycle also requires honesty about distinguishing between cyclic and secular variations in activity, which I think has been lacking in the US (eg upturns are a “new paradigm” whereas downturns are caused by temporary “headwinds”).

Second, while I did not articulate it, I would of course not dispute that monetary policy can have a lasting effect on real activity if abused badly enough. For example, even continuous easing will eventually cause economic damage by high inflation. Maybe the US has suffered from some of this, but it is not recognised because it has been confined to asset prices.

Third, I did not mean monetary policy only. Fiscal policy mistakes have also been made, both strategic by blowing the surplus while the baby boomers worked, and tactical, such as maintaing mortgage tax relief despite low long term interest rates and a booming housing market, and low gasoline tax, despite geopolitical and environmental concerns. Regulatory policy (eg on sub-prime lending and SIVs) may have also played a part.

GS Alpha lost 60 percent of its assets as investors bailed, but that is different from a -60% return. Assuming that GS Alpha had performance characteristics that are similar to other quant hedge funds, it is likely that it ended up the month of August with positive returns, and will end up this year in the black.

The big losses for the quant hedge funds all occurred on three days. 8/6/2007 to 8/9/2007. On 8/10/2007, they rebounded after GS very loudly said that they were putting their own money into Alpha, and that stopped the panic.

Here is a test. Suppose I’m a hedge fund manager and I made a whole bunch of money betting against subprimes. What am I going to say? The banking system is wonderful, I want people to invest so that the price of securities goes up and I lose money!!!!! Or you are all DOOMED DOOMED DOOMED, SELL SELL SELL so that I can make money off my short positions!!!!

Also, GS’s story is that it made mega-bucks doing what the hedge funds did.

Something I find odd is your selective skepticism. You seem over fixed on conspiracies and secret conflicts of interests, yet you ignore the pretty obvious conflicts that are right in front of you.

I don’t think it will make much difference, and I’m inclined against one. The reason for the summer rate cuts was to stop a panic, and no one is panicking now.

An interest rate cut is going to have minimum impact on subprimes. Subprime borrowers are not influenced much by interest rates. The problem is that a lot of them can’t afford the non-teaser rates and were planning on refinancing, and without a supply of lenders, no one is going to be able to refinance.

The two shocks that are going to come ahead are…..

In about a month when European banks start announcing results. US banks report results three months late, but European banks report results six months late, and we are about to see their exposures.

In about six months to one year, the teaser rates for the 2006 loans are going to expire, and there is likely going to be another round of defaults. What will make this really interesting is that this is going to come right in the middle of election season.

The pricing for BBB CDO’s is very interesting. Everyone knows that they will default, but they are still be traded at deep discounts because the question that people have is *when* will they default. If you can squeeze out one or two more payments before someone goes under, that’s still money.