Just to follow up, from a purely U.S.-centric perspective, if non-financial profits have been high, that, in the first place, is because of astonishingly low interest rates, which allowed for the replacement of accumulated debt at much lower cost, and, of course, lowered the cost of any new investment. However, low interest rates didn’t stimulate any remarkable increase in cap-ex, ex construction, which has been low to mediocre this cycle, because, on the one hand, wage stagnation has led to soft demand conditions, ex MEW, such that cost cutting has been the only way to maintain profits, absent market pricing-power, which means off-shoring, not just for large MNCs, with long-range strategic planning and operating capabilities, but for a lot of smaller firms needing to compete in such an environment. Hence, though profits are high as % of GDP, cap-ex is low as % of GDP, and the vacuum is filled by debt-financed PCE as % of GDP. And insofar as profits have not simply been returned through the likes of stock buy-backs, I’d guess they’ve been parked for “high” financial returns. There simply hasn’t been enough domestic demand to warrant cap-ex expenditures, even though the interest cost has been low, especialy in the aftermath of IT overinvestment, and what investment is warranted can be better accomodated overseas.

As for LBOs, there’s an inherent contradiction at work. Either equity markets are notably inefficient, so as to tolerate poorly performing company managements, who under-utilize and misallocate capital stocks, so that taking a company private allows for long-range reinvestment, which inhances productive performance, which promises long-range equity returns,- in which case the “efficient markets hypothesis” is wrong and the financial system superintending capital allocations is seriously deficient; or they are a product of an over-financialized approach to productive business, in which a combination of cash-rich businesses, low interest rates (and easy credit liquidity), and lagging equity “values”, (which, measured in terms of inflation and the trade-adjusted $, have never returned to prior levels, even nearly, and that with the stock buy-back and LBO craze), resulting in temporarily attractive deals, based on current financial accounting, without consideration for longer-range effects. Needless to say, given my cynical, outsider status, I tend toward the latter hypothesis: namely, that LBOs mostly amount to a form of rent-seeking based on the stripping of “intangible assets” and “business goodwill” from business organizations. This is based upon my uninformed hunch that real productive businesses in the real economy, especially when there is large, relatively long-term, and illiquid real capital investment involved, require sector-specific know-hows to manage their capital stocks and organization under variable market and macro-economic conditions, which is not the sort of thing that is obvious from reading quarterly financial statements, even in terms of sector specific comparisons, (since one company might be up and another down in any given period, but each is intensely aware of its market and its competition). An easy example of the destruction of “goodwill” would be Circuit City’s firing of its experienced sales staff to cut costs early last year. But that sort of ham-fisted decision-making might be multiplied in any number of ways across any number of business sectors. Even aside from rising interest rate spreads and tightening credit standards, I suspect that’s precisely the sort of thing that might doom the long-run results of LBO deals. The only question is whether the legal structures have been deft enough for the head honchos to escape the consequences.

As someone who is now considerably removed from Japan, I am glad to hear you confirm my impression, that the horrors of the lost decade are overstated. The Japanese had a simply massive overhang after the bubble years. I don’t see how they could have avoided socializing at least some of the losses.

I have also wondered whether the wreckage is more a money than a real economy phenomenon (at least in recent years). What if the deflation is worse than the authorities say, perhaps -2%? The two drivers for growth are demographic growth and productivity gains. Japan has horrific demographics, but what if the zero nominal growth means 2ish% real growth due to deflation? I hate to sound dense, but I don’t know of any economist (at least one published in the West) who has worked through a scenario like that. Everyone halts at “Oh, deflation is terrible, you’ve just emasculated the monetary authorities.”

Your point about it not feeling like a depression: you are right, we won’t have such a benign outcome here. First, the overleverage was in the corporate/commercial real estate sector. Companies were borrowing 100% against inflated real estate values. So individuals weren’t directly exposed, while here, the leverage has been in the consumer sector. And Japan as a matter of policy gave priority to preserving employment and keeping the income distribution from getting too skewed. Here it is devil take the hindmost.

Dr Roubini has suggested that the pessimism may be at or near it most climactic. He long ago earned my maximum respect for gutsy consistent call and not fluttering like a weatherwane with the vicissitudes of the market – to deliver a near-perfect foretelling of the chain of events that would lead us to where we sit today. Bravo. He was, of course a year early, which is a dogs-life in markets. And before anyone punch the “buy-basket-button” on their Portfolio Trading software, reminisce for a moment about the number of snuffed rallies, aborted bulls, and near-suicidal swoons between the 1991 lows in Japan, and the ultimate lows more-than-a-decade later in 2002. The sheer number of Fiscal Stimulus packages, end-of-bear calls, and bullish headfakes are worthy of some careful study for those believing that it is within the authorities power to legislate away the unwinding of a decade-long binge which has fundamentally changed the nature of the American economy…and not for the better.

Japan never felt like a depression, and rarely felt as if it were in deep recession, whilst relatively, in real terms it gave up 30%. Maybe their society’s idiosyncratic social structure needed a decade of adjustment to maintain peace and order. But can you imagine the outcome of another decade in the USA of increasing inequality, declining real wages for a large share of the people, even if unemployment or inflation ever reaches 70s levels??

I’ve no answers, only questions, though I’ve always preferred to pull the band-aid quickly and painfully off of a wound, rather suffer a more-drawn-out but only slightly-less excruciating pain. It may not, in actual fact be better for the wound, but psychologically, I reckon its better to hit bottom faster and deeper, for almost everything thereafter can be seen as improvement, and THAT I believe, does wonders for optimism, investment and the Public Inerest as a whole.

-Cassandra-

Pretty much all the post save the intro is Buiter, including the sunny outlook.

Consumer consumption is >70% of the economy. Much of that consumption has been by means of credit. Banks are now severely tightening consumer credit of all kinds, and will continue to do over the next several years. The only potential upside is manufacturing (iff the $ keeps tanking), and I don’t see us bringing that kind of additional capacity online until long after the credit monster has eaten our lunch.

I think your writing is very good, and dead-on for the most part. Suffice it to say, my jaw hit the floor at your sunny outlook. I hope you’re right, but I don’t see how you can be.

I am with you on the outlook. Businesses have shown high profits by clamping down on expenditures of all kinds. That has led to them shunning investments (investments lead to increased costs as well as requiring a capital outlay). They have become neurotically fixated on short-term bottom line, thanks to Wall Street.

The lack of investment says to me that the earnings growth has been due in large measure to cost cutting. That means companies have really been disinvesting. That will catch up with them eventually, independent of the macro outlook.

And Buiter misses the leverage story. Public companies don’t have too much debt, but the average rating is just a hair above junk due to all the highly geared big LBOs.