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More to worry about … the US downturn looks to be getting worse when it should be getting better

by Brad Setser
February 6, 2009

Paul Swartz, my colleague at the Council’s Center for Geoecononomic Studies, continues to track how the current recession compares to past recessions. The United States fiscal deficit is now rising faster than in past cases. The biggest previous change was in 2000-2001 recession, when W’s tax cuts combined with a big cyclical fall in tax revenue to produce a large swing in the United State fiscal position. A modest surplus quickly turned into a large deficit. The swing in the United States fiscal position this time around is likely to be even larger. Counter-cyclical fiscal policy is back.

As Dr. Krugman notes, though, the case for a large policy response is simple: the economy is declining at a rapid pace. The US actually started to slow back in 2006, when residential investment tailed off. The recession formally started in late 2007 or early 2008. For a while it was possible to hope that the recession might prove to be fairly shallow. Exports were doing well, and the contribution of growth from net exports helped offset the fall in residential investment. And the American consumer seemed quite willing to keep spending.

But, well, things have changed. Rather than getting better, things are still getting worse. Exports are poised to fall sharply, as the world not just the US has slowed. And the fall in US industrial production has accelerated. The following graph comes from Paul’s chart book. The fall in industrial production in the current cycle is already worse than the fall in an average post World War 2 recession.

To help put this fall in context, Paul compared the current fall not just to the average but to the best and worst trajectories in the past data.

Unfortunately, the fall in US industrial production is approaching the worst falls in the post-World War 2 data set. Some recessions in the past produced a sharper initial fall. But in an average post-World War 2 recession, the economy would be recovering by now — not getting worse. If things don’t improve, the current fall may match the biggest fall in the post war data. And remember, industrial production wasn’t exactly booming during the boom years of this cycle; it took an awful long time for industrial production to top its 2000 levels

That is why — despite the risks — I support a large stimulus. The United States debt levels suggest that it still has room to use the public sector’s balance sheet to try smooth the economic cycle. And there is nothing moderate about the current cycle.

It would certainly be nice though if other countries joined in, especially those with large current account surpluses. Low oil prices are bringing the US external deficit — and the United States need for external financing — down even as the US government borrows more. This combination won’t last forever. The US government can help support US and global demand, but it would be best if it didn’t do so alone. The more countries like China do to help put their legions of newly unemployed to work at home, the better.

173 Comments

  • Posted by Stefan

    To Cedric Regula
    It is not necessary to dilute savers, only to show that it is possible. China could buy half of the whole world at today’s prices. If they want to continue being a black whole absorbing money, the rest of the world will have to print money.

  • Posted by Stefan

    So far the Fed has FAILED to show that it is capable of printing money.

  • Posted by Cedric Regula

    I think the Jack Cooks and Steve Keen posts are exactly right as far as the economic backdrop and mechanics of a debt based economy. And if we break that, then we have a pure fiat currency based economy with all the historical examples of how that works.

    Also I think Brad’s analysis of the details in his post here are all on target. So if we topple over to the hyper-inflation side and need to form the AARP Liberation Army, I’ll recommend that we give Brad a pardon.

    But that still leaves the question of what to try in order to thread the needle between a severe deflationary outcome or hyper-inflationary outcome, which may be in fact may the same thing….collapse.

    So I think the mindset needs to be to assume the economy has to downsize to a sustainable level, and any policy actions have to be designed to achieve a controlled downsizing, and that is the best we should expect. Any thoughts of re-flating housing or GDP back to where it was in the foreseeable future should be abandoned.

    So that was a simple paragraph to type, but would make a great subject for a new book. But not today.

    Some quick suggestions:

    Start retiring baby boomers early and employ echo boomers.

    Come to the realization that the US can’t afford its global political-military footprint. England finally did fifty or so years ago.

    Pay more than lip service to energy independence. It is possible. It would make Brad very happy about the CA deficit as well.

    Keep Ben away from the printing press. Massive QE is the beginning of the end. Pay higher long term interest rates. That is financially stable. Congress has already fixed new F&F loans for real estate at 4.5%. That is enough of a stabilizer for real estate. (hope its temporary). Let long treasury rates rise so Americans want to buy them. Again, Brad says that’s more stable.

    So now I’m tired of typing, but that would be the general idea as far as I think.

  • Posted by Kafka

    I just don’t get the math especially if one believes savings will increase which necessarily will result in decreased consumption and GDP (including manufacturing). How is the stimulus supposed to work anyways? I just don’t get it. Government, Health Care (basically government) and Education (government) comprise over 50% of the economy. More government is the answer? Manufacturing comprises about 10% of the work force and as a percent of GDP is on the decline (and can only decline more rapidly as savings increases). This is a liquidity trap and more debt is never the answer in a liquidity trap. Long run borrowed stimulus will only exacerbate the problem. How much more can the government spend? In 08 the fiscal conservatives doubled government spending from 01 to $3.6 Trillion with tax revenues of $2.6 Trillion. The rich and the corps paid about 80% of the tax revenues but they aint gonna be for long and tax revenues will decline by at least $600 Billion while the bloated government spending likely increases by about $1 Trillion. This is the recipe to fix the economy? What about the $70 Trillion or so present value of unfunded social costs? In the last 8 years total U.S. debt has gone from $20 Trillion to $52 Trillion and now the answer is more debt, the consumers are tapped out and have not had a real wage increase in 10 years. Fischer knew that of which he spoke but no one listens because it is not politically expedient. Thus, we are about to witness the greatest wealth transfer in history by increased taxation to fund the deficits or inflation which of course hurts the worst those who can afford it the least.

  • Posted by Twofish

    Kafka: I just don’t get the math especially if one believes savings will increase which necessarily will result in decreased consumption and GDP (including manufacturing).

    One has to distinguish between demand and consumption. If you increase savings, those savings won’t just sit there like gold bricks. Something will be done with it, like investment in factories or restaurants.

    Kafka: I just don’t get it. Government, Health Care (basically government) and Education (government) comprise over 50% of the economy. More government is the answer?

    If it means that I get to have the same salary as physics professor rather than as an investment banker then I won’t complain.

    Kafka: Manufacturing comprises about 10% of the work force and as a percent of GDP is on the decline (and can only decline more rapidly as savings increases).

    And this is a good thing. Just imagine a world in which robots did all of the work, and the people employed in manufacturing goes to zero. You press a button and whatever you want gets made by robots. What would that world look like?

    Marx was convinced that as factories became more efficient, things would fall apart, and a lot of the 20th century was devoted to trying to figure out how to get around the paradox of overproduction. The answer of the last ten years was to have everyone be real estate brokers, and that didn’t work.

    Kafka: The rich and the corps paid about 80% of the tax revenues but they aint gonna be for long and tax revenues will decline by at least $600 Billion while the bloated government spending likely increases by about $1 Trillion.

    My proposal is that you get the economy fixed so that people are making multi million dollar bonuses creating value and then tax the hell out of this. The problem is that if you don’t get the economy out of a downward spiral, things will get worse and worse financially speaking.

    Kafka: This is the recipe to fix the economy? What about the $70 Trillion or so present value of unfunded social costs?

    Simple. Raise taxes and cut benefits. You don’t have to do it now. If Obama gets the economy working again, he’ll have enough political capital to raise taxes on the rich to whatever he wants them to be.

    Kafka: In the last 8 years total U.S. debt has gone from $20 Trillion to $52 Trillion and now the answer is more debt,

    That’s a semi-bogus number since bank deposits constitute debt. When you deposit money in a bank that increases the amount of debt in the world, since the bank owes you money.

    What matters is who owes what to whom, and the numbers don’t look bad.

    Kafka: the consumers are tapped out and have not had a real wage increase in 10 years.

    So tax the rich, and set up a health care system and good schools. One problem with the health care and school system right now is that it impedes economic flexibility. People can’t start their own businesses because of health care, and people are forced to live in high priced housing areas if they want decent schools.

    Kafka: Fischer knew that of which he spoke but no one listens because it is not politically expedient.

    And therefore what he says is useless. Telling people that they have to be unemployed for years and they are must be economically miserable is just unacceptable.

    Fischer: Thus, we are about to witness the greatest wealth transfer in history by increased taxation to fund the deficits or inflation which of course hurts the worst those who can afford it the least.

    I don’t think it will. Inflation hurts the poor. People in the US have opposed taxes on the rich, because they have believed that that taxes on the rich will hurt them. However, those arguments are dead.

    The funny thing I’ve found is that most really rich people I know, don’t mind paying higher taxes (which is why Wall Street gave more money to Obama than McCain) It’s the wannabe rich that care, and the wannabe rich don’t believe the “taxes are bad for you” arguments any more.

  • Posted by Twofish

    bseter: But i would refer back to my earlier point that the US economy is transitioning from a world of no household savings to a world of maybe 5-10% household savings. that means consumption will fall relative to GDP.

    And long term what should happen is that those savings get invested which means that you end up with the same amount of spending as before, only it will be spending on different things.

    The problem is that right now the extra savings is going into a broken financial system that has nothing better to do with the money than to put it into Treasuries. So part of the purpose of the stimulus is to “free the money” and get the money that is flooding into the government doing something useful.

  • Posted by Stefan

    When is fiscal stimulus efficient?

    1) When there are available real resources
    2) When there is low inflationary pressure
    3) When the private sector is down due to fear (i.e not real lack of demand)

  • Posted by Stefan

    …to elaborate

    A wants to buy from B and B wants to buy from A, but nobody buys because he fears the other one wont buy.

    That is the governmental kick-start opportunity.

  • Posted by Twofish

    eb: The current mess doesn’t look that different from the dot com bust: both were massive wealth transferences rather than wealth creation periods and resulted in the gross misallocation of capital. Can we learn anything from this?

    I disagree with this characterization of the dot-com period. It turns out that looking ten years out that vast amounts of real wealth was created by the dot-coms, and the new wealth created by companies that did survive far outweigh the wealth destroyed by the companies that didn’t.

    You could argue that the craziness of the dot-com era was in fact the most efficient way of allocating capital. You give vast sums of money to 1000 companies doing crazy things. 975 of the them go bust. The remaining 25 or so end up creating enough wealth to make up for the 975 that go bust.

    This is the problem that I see with the latest boom-bust cycle. I don’t see much if anything that was created long term.

    This opens up some fundamental questions about resource allocations. One fundamental question, which I don’t know the answer to, is whether I would generate more social value working as a physics researcher than I would working as a investment banker. If the answer is yes, then we have a problem if investment bankers are making three to five times the salary as physics researchers, working less, and (even with the downturn) finding it easier to get jobs.

    Your typical Wall Street investment bank has a staff of about 150 or so physicists and mathematicians, and Wall Street is the only major employer of physicists to do physics work with money that isn’t (or at least wasn’t) coming from the government.

  • Posted by Stefan

    Today’s “dotcom-sector” should be the development of electric vehicles.

    The welfare gain that is about to be made is immense.

    And it will be easier for capitalists to “lock in” profits, as this industry/infrastructure will be far more capital intensive.

  • Posted by Cedric Regula

    stephan:

    There is a little room for everything. I’ll guess I’ll have to report here on my economy activity of last night.

    Went to the local nightclub. A few months ago they changed ownership and after an extensive remodel re-opened with a $10 cover charge and Guinness on tap for $4.50 a pint. I went back then and the place was nearly empty.

    Last night I was pleased to find out they lowered the cover charge to $7 and Guinness was on tap for $2 !!!!!!!!

    The place was packed and no one looked depressed at all !

    So that got me thinking of supply-demand-price curves of course. And the potential for stimulus checks is enormous here.

    But before I firm up any conclusions, I’ve decided to go back a few more times to get some more data points and make sure last night was not just a fluke.

  • Posted by Kafka

    Two fish, interesting but I don’t buy it. The only reason for the GDP increase was the faux debt increase in the last 8 years and bank deposits are a small component of the aggregate increase. Some estimate it now takes about $5 of debt to create $1 if GDP and after interest costs, that aint profitable. Equating campaign contributions by Wall Street to the rich not minding if taxes go up is a bit disingenuous since the campaign contributions are nothing more than bribes (called something else). If you think the rich don’t mind paying taxes why do they devote so much time and expense to avoiding them? Maybe you think Laffer was wrong but there is a threshold where it becomes pointless to work. Of course Buffet and Gates don’t mind paying taxes since a substantial portion of their worth and earnings have been contributed to non taxable private foundations where only a small percent has to be paid to charity each year and everything else accumulates tax free after costs (costs include salaries to your family and friends). At the end of the day what you advocate is something that sounds an awful lot like socialism, which is fine, I love Europe where most are the same, but guarantee you, me and my kind (and many more) will go to places like Monaco (I know good riddance). Fischer and Schumpter were right that is the point and if you truly want to fix the problem as opposed to going socialist, you gotta fix the problem not perpetuate it. If you wanna go full fledge socialist fine (me and mine will leave) but don’t have what exists today, social fascism (privatization of profit and losses absorbed by the public). For that matter why should I work 120 hrs per week if Uncle Sam is gonna take my dough and give to my neighbor who works 8 hrs/4 days a week (and is likely sleeping with my wife while I am hard at work). And lastly, if you think the switch to a services based economy as opposed to production based economy under a fractional reserve fiat based money financial system controlled by Politicos is the answer, name one time it has ever worked, I can name a bunch where it hasn’t?

  • Posted by bsetser

    indian exporter — you are right that central banks hold dollars to cover BoP outflows from the capital account not just because they want a claim on future us exports. but ultimately us dollars held abroad are a claim on future us production; investors only want dollars as long as they are convinced those dollars hold value. and their ultimate value is a claim on future us production.

  • Posted by david_in_ct

    stefan:
    You are going to be very very right.

    twofish:
    I have often had similar thoughts to yours about societal worth in terms of what I can earn doing quant type things in finance vs. what I might earn writing real-time operating systems, automating medical testing or working in a physics lab, all things I’ve had occasion to do. In the end I come to the conclusion that the payment schedules are not that far off. At least in what I do in the financial world I am very much paid as an entrepreneur. If things work out there is a nice payoff. If not, very little or negative. The same is definitely true in the other professions. I think the confusion comes in because the comparison is often made between the virtually risk free life of a professor and the apparently fairly large risk undertaking of a ‘trader’.
    Another thought along the same lines is why did an apparently very smart lot of people make what turned out to be horrendous capital allocations. I think the answer to that question is undoubtedly because they could and in each of their own personal calculations it made perfect sense to make the bets. Understanding it from this point of view leads one back to the idea that the system itself is fatally flawed if from a rational game playing perspective the aggregate behavior of the players can bring down the house.
    I would be interested in Brad’s or anyone else’s opinion on disentangling money creation from private banking. I believe that if the power of dollar creation was vested totally with the government and not with the private banking system then what we have witnessed could never have transpired. Bubbles would quickly run into horrendous capital costs as they sucked in more and more of a relatively fixed monetary base. Without fractional reserve banking and the fed policy of limiting the price of credit instead of its amount bubbles could never get any real traction.

  • Posted by Cedric Regula

    Regarding electric cars and CA deficit reduction.

    Here is S. Africa’s electric car they just unveiled at the Paris auto show. Detroit tells us they need $50B from the taxpayer to get started on these.

    These go best with a complement of nuclear power plants. A great public infrastructure program in my opinion. I think $50B buys something like 20 nuke plants.

    http://blog.wired.com/cars/2008/10/south-african-e.html

  • Posted by Cedric Regula

    Coal-to-Liquid(CTL) and CA deficit reduction

    CTL without greenhouse gas reduction (carbon sequestering) was price competitive with $55 oil.

    A new study was done with GHG sequestering added and that took the cost up to $86 oil. Another opportunity for a public works program.

    This does make clean diesel fuel and diesel engines are 35% efficient compared to 25% for gas engines. Electric beats all at 80%.

    So the fuel price is not as bad as it may seem.

    ==========================================
    NETL Report Concludes CTL Plus Carbon Capture Results in Fuel with 5-12% Less Lifecycle GHG Than Petroleum Diesel; Modest Biomass Additions Lower GHG Further
    7 February 2009
    Tarka1

    A new report from the US Department of Energy (DOE) National Energy Technology Laboratory (NETL) concludes that coupling a Coal to Liquids (CTL) process with carbon capture and sequestration (CCS) yields a fuel with 5-12% less lifecycle greenhouse gas (GHG) emissions compared to the average emissions profile of petroleum-derived diesel, based on the US national average in 2005. These synthetic fuels are economically competitive with petro-diesel when the crude oil price (COP) is at or above $86 per barrel (based on a 20% rate of return, in January 2008 dollars, with a carbon price of zero).

    Adding biomass to the coal in the CTL process (Coal and Biomass to Liquids, CBTL) can reduce the GHG emissions further, according to the study. A mixture of 8% (by weight) biomass and 92% coal can produce fuels which have 20% lower life cycle GHG emissions than petroleum-derived diesel and which are economically competitive when crude prices are equal to or above $93/bbl.

  • Posted by adiemuso

    we are already in a depression of somesort. call me a pessimist but i think realistically we are already one step in the sinking ship.
    China is not looking good now. Guangzhou which is one of the main industrial ‘park’ of China is slowing down to almost a stop. And freight rates from China to Europe cost you almost nothing except for some charges and bunkering fees. I do hope things get better and are what the pessimists here believe. Sadly its not.
    Be it the US or anywhere else, government stimuli plans require funding. these funding comes from borrowing, be it from citizens or foreigners, this increase in Sovereign debt amidst the current situation of massive asset deflation is worrying. Of course, by driving up domestic savings rate, the improvement in the current account balance, can hopefully offset the increase of the Government Borrowings/Spending. But, if everyone else is doing that, who then is left to spend? who then is left to buy these debts? do we revert back to the old credit boom, but this time on a larger grander national scale amongst nations in the world? if so, it will be a clash of debts, national debts. and that is very very scary.

  • Posted by locococo

    Yes, the nonsense at “the depths of an economic bust, correspond to the gross excesses of a credit bubble driven economic boom” being that they can easily overshoot on the downside also.

    In order not to perhaps (tho not excluding)
    – to follow djc s advice on making credit bubble »unissued« through
    – to address some of the albion s points there, banning the naked shorts and adding those bond and cdo holders in for the ride while keeping them out of the good bank and from their former deposits
    – diminish confusion on what constitutes a »reserve« generally and what in particular plus how did we get here in the first place. It is here where the final solution will or will not come from.
    – and for those here of keynesian views spending focus on manipulating real estate drop to a stand still preferably routed through municipal level using also the conservatorships to their…. points? Here you get PR and Gs in sufficient quants and diminish the removed from market marked part of the equation further some

    all might be advised

    Not sure about the triggering the Ponzistop tho. That may indeed require rethinking approach to the real zero interest and combining it with the newer reserve deal

    The other argument I have with Austrians is that base of the currency needs to be a sound tangible. In absence a sound reason might help also. In a time race here the hedge becomes a sound tangible regardless of exchanges supposed to be traded on and of its denominator. That enemy actually helps. I d name the long yied – the judge, don t know about you.

    By now there s a 4 months lagg behind the curve plus a total blunder of the biggest manipulation ever to add on no focus of wrong people and nonsense policy proposals. Remember Schwartz? And japan?

    It s the finest of tuning of major proportions not major tune of the two details. Anyway, don t look like you re up to it?

  • Posted by Twofish

    Kafka: The only reason for the GDP increase was the faux debt increase in the last 8 years and bank deposits are a small component of the aggregate increase.

    I don’t think so. In the last eight years, we’ve seen a explosion in technology that has generated real value and real wealth. Think of what computers were like eight years ago versus what they are like now, and the entire industries that have been created.

    The US does not have a problem with wealth creation. It has a serious problem with wealth distribution.

    Kafka: If you think the rich don’t mind paying taxes why do they devote so much time and expense to avoiding them?

    They don’t really. It’s the wannabe rich “Joe the Plumber” types that care about taxes. The really rich people have so much money that they don’t care about taxes. As long as you could convince the wannabe rich that they will become rich, you could get their support, but that era is gone.

    Kafka: At the end of the day what you advocate is something that sounds an awful lot like socialism, which is fine, I love Europe where most are the same, but guarantee you, me and my kind (and many more) will go to places like Monaco (I know good riddance).

    I don’t care what you call it. If I was running for office, I’d care not to be labelled “socialist” or “Marxist” but since I’m not, you can label me whatever you want. If you want to call me a socialist or communist, fine, then I’m a socialist and/or communist.

    Kafka: For that matter why should I work 120 hrs per week if Uncle Sam is gonna take my dough and give to my neighbor who works 8 hrs/4 days a week (and is likely sleeping with my wife while I am hard at work).

    Because you may will find yourself out on the street tomorrow, and the 120 hours per week may not be generating any real wealth or value for society.

    Kafka: . And lastly, if you think the switch to a services based economy as opposed to production based economy under a fractional reserve fiat based money financial system controlled by Politicos is the answer, name one time it has ever worked, I can name a bunch where it hasn’t?

    The US economy works quite well. There are a lot of flaws and things that can be fixed, but it fundamentally works. It’s not perfect, no system is, but it’s amazing how well it does work.

    Just to give you an example. People got fed up with the old set of officials, voted them out, and now we have a new set of officials. No riots. No blood in the streets. No coup. We even had a nice ceremony and party to celebrate. People are screaming at each other in committee rooms to figure out what to do. It looks messy, but no one is shooting each other.

    Compare that to how most countries handle economic crises, this is amazing. Absolutely amazing.

    Ultimately, I think we’ll get through this thing, because I have faith in the American economic and political systems to self-correct. I have no idea whether the stimulus plan will work. If it does, great!!! If it doesn’t, we’ll try something else. If that doesn’t work, we’ll try something else. We’ll just keep trying things until we end up with something that works.

  • Posted by Twofish

    dave_in_ct: I think the confusion comes in because the comparison is often made between the virtually risk free life of a professor and the apparently fairly large risk undertaking of a ‘trader’.

    The trouble here is that this is an apple to oranges comparison. Tenured faculty have jobs that are relatively “risk-free” but to get to that point, you have to be a slave for about a decade, and there is no assurance that you will get to that position. For the same amount of risk/effort that it takes to be a tenured physics professor, you can end up being a IB managing director.

    Kafka: I would be interested in Brad’s or anyone else’s opinion on disentangling money creation from private banking. I believe that if the power of dollar creation was vested totally with the government and not with the private banking system then what we have witnessed could never have transpired.

    How money gets created is a very interesting topic, but I don’t see how you can prevent private creation of money. If I write you an IOU and people start trusting my IOU’s, then I’ve just created money. It so happens that people trust US Government IOU’s more than they trust my IOU’s, but if you restruct government issued IOU’s then you end up with lots of private people issuing their IOU’s.

    Very little of what people think of as “money” is government created. There are only about $900 billion dollars in Federal Reserve Notes out there. Most of what we consider “cash” (i.e. checks that people write to each other) is not “government created money.”

    Kafka: Without fractional reserve banking and the fed policy of limiting the price of credit instead of its amount bubbles could never get any real traction

    I don’t see how you can have a world without fractional reserve banking. Fractional reserve banking has existed since the 16th century, and if you try to get rid of it, it just pops up in some other form. To get rid of fractional reserve banking, you basically have to get rid of all debt, because the moment someone can write an IOU, it will be very quick before it becomes a bank.

  • Posted by Twofish

    BTW, I think that hedge funds and Wall Street are going to end up making a huge amount of money off of Geithner’s plan. Probably much. much more money than they would have made under Paulson’s plan.

    What is likely to happen is that private investors are going to be buying mortgage securities at current market rates, once it becomes clear that the world isn’t going to end, the value of these securities is going to go up by a huge amount, leaving lots of hedge fund people very wealthy.

    Before anyone complains about a secret government bailout…. Let me explain why this is happening….

    1) The government has to pump money into the banks. If the US government walks away, people’s checking accounts become worthless. That’s not going to happen.

    2) Banks need cash now. They would like to hold on to the securities, but that need cash now to loan out.

    3) If the government pays any money for the mortgage securities, people are going to be screaming “bailout”. This is especially the case of the government pays more than current market rates for them.

    4) You can’t force people to sign something that they think won’t be good for them. If the government forces private investors to take losses, then you won’t find any private investors. You can try to mix the gains and losses, but after Merrill-Lynch, no one is going to do that.

    So what is going to happen is that Treasury puts money into the banking system to keep it from collapsing. It gets private investors to purchase mortgage backed securities. It will be presented (truthfully) as a way of saving taxpayer money.

    What I want people to do is to accept some responsibility for their decisions, and not to get too upset when people start making huge amounts of money from what is now worthless junk. You had the chance to have Treasury buy the assets under Paulson’s plan, passed it up, so if someone else makes huge amounts of money from it, they deserve it, and don’t complain about any back room deals, because everything here was above board.

    This also goes for people that think the US economy is doomed. If someone bets that the economy is not, and then two to three years from now they make heaping large amounts of money from that bet, you shouldn’t complain about that. Personally, I think it is a sucker bet.

    You can tax capital gains heavily to get some of the money back.

    One final thing. I could be lying or wrong. It could be that the assets that I claim will be valuable in two years are really worthless, and being the evil investment banker that I am, I’m trying to off load junk on the taxpayer. Or I could be sincere and just wrong. Maybe it is a good thing that you off load junk to private investors.

    Or maybe not…..

  • Posted by cdr

    About the fiscal policy
    1. Envelopes show that the sum, that’s currently under consideration, will in effect cause the stick for the gap jump to shorten by half (for the purpose of doing the job).
    2. The direction and timing of spending currently aims to replacing the missing C with a G (intended for winning the 2010 – buy American – election). The original preaching labels such a plan as “misdirection”.

  • Posted by david_in_ct

    Twofish: How money gets created is a very interesting topic, but I don’t see how you can prevent private creation of money. If I write you an IOU and people start trusting my IOU’s, then I’ve just created money. It so happens that people trust US Government IOU’s more than they trust my IOU’s, but if you restrict government issued IOU’s then you end up with lots of private people issuing their IOU’s.

    You could not nor would you want to prevent private creation of credit. The BIG difference would be that private parties could not create the unit of account. While there would certainly be a price and an exchange rate for private credit this is vastly different from the issuance of new legal tender. I think from an analytical standpoint (and a fair banking system) it is far cleaner to disentangle federal reserve notes from any and all calls upon them.

    The quantity of Twofish notes would be unlimited but their only conversion to legal tender would be a market based one. Now it is largely up to a bank credit officer to decide whether a checkable deposit magically appears. There are a complex web of restraints placed on the bank in the current system which attempt to manage this process but we have just witnessed their spectacular failure mainly because of the inherent conflict of interest which resided within the banking system. The more money banks lend the bigger the call option they are generating for themselves. Since they can create vastly more credit exposure for themselves than their capital base, beyond a certain tipping point it makes perfect economic sense for them to lever up to the moon. Which is exactly what happened.

    By splitting the two pieces there would be investment banks, and for lack of a better term vault banks. Vault banks would simply hold your units of account and provide checking services. Investment banks would take your federal reserve notes and invest them in other things. While they were invested you would not have access to them. No different than a hedge fund.

  • Posted by Twofish

    david_in_ct: You could not nor would you want to prevent private creation of credit. The BIG difference would be that private parties could not create the unit of account. While there would certainly be a price and an exchange rate for private credit this is vastly different from the issuance of new legal tender

    I don’t see how this would be a big difference. Except for very small transactions, people rarely use legal tender to make economic exchanges. If you show up to a buy a car with a suitcase full of cash, rather than a check, then people will look at you very strangely.

    Unless you actually using the physical green stuff, you are not using government created money or legal tender.

    david_in_ct: . Since they can create vastly more credit exposure for themselves than their capital base, beyond a certain tipping point it makes perfect economic sense for them to lever up to the moon. Which is exactly what happened.

    Which is why banks need to be heavily regulated, and bad things happen when they are not.

    david_in_ct: Vault banks would simply hold your units of account and provide checking services. Investment banks would take your federal reserve notes and invest them in other things. While they were invested you would not have access to them. No different than a hedge fund.

    What’s in the vault? One problem you have is that most checks, savings accounts and money market accounts are not backed by paper dollars, and you are going to have to massively contract the money supply if you want anything to fit inside the vault.

    The trouble with this is that pretty soon you would end up with a “shadow banking system” in which people started making direct exchanges of IOU’s. At which point you end up pretty much where we are now.

  • Posted by david_in_ct

    Twofish: I don’t see how this would be a big difference. Except for very small transactions, people rarely use legal tender to make economic exchanges. If you show up to a buy a car with a suitcase full of cash, rather than a check, then people will look at you very strangely.

    Unless you actually using the physical green stuff, you are not using government created money or legal tender.

    david: This is just not correct. When you show up to a car dealer ship to buy car even if you use a check you are using legal tender irrespective of whether the frn were created by the Fed or by the bank. Every checkable dollar in the system is exchangeable for foldable green on demand.
    The only way that checkable deposits come into being are either because the money is first printed by the fed and used to monetize some treasury debt, OR and this is the big one, the bank loans it into existence in your checking account. When a bank does this they do not remove the money from someone else’s checking account, it just gets created from nothing.

    Twofish:What’s in the vault? One problem you have is that most checks, savings accounts and money market accounts are not backed by paper dollars, and you are going to have to massively contract the money supply if you want anything to fit inside the vault.

    The trouble with this is that pretty soon you would end up with a “shadow banking system” in which people started making direct exchanges of IOU’s. At which point you end up pretty much where we are now.

    David: There is a big difference between a money market fund and a checkable deposit and there should be. One is pure cash which is convertible on demand to green the other is an investment in short term debt which needs to be sold to someone with cash. Cash should have no return but also no risk.

    It would exactly be what was needed if people made more direct exchanges of IOU’s. I suspect that you would think for more than an instant before exchanging your labor for david_in_ct redbacks. This is a good thing.

    As it stands now, once the Fed has had their bimonthly meeting, the banks then make virtually all the decisions with regards to whether or not the base money supply will grow. Again, base money (cash and checking accounts which represent cash) grows as a function of Fed printing FRN’s and monetizing treasury debt (bill passes) or loan origination at a bank. When loans are made where a bank is not a counterparty there is no change in the base money supply. This difference in crucial.

  • Posted by df

    I sure don’t see anything surprising. The global debt bubble as exploded.
    There s no demande for debt, hence money growth can not happen any more through new loans.
    Everything is happening as explained 60 years ago by K. Polanyi.
    If you let markets rule money creation, they create bubbles and bust. We are in a bust. One like 1929, but worse since Debt/GDP ratio is worse.

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