America’s Fiscal Train Wreck

Submitted by Edward Harrison of Credit Writedowns.

As you all know, Yves has been swamped writing her book, a work we all await with anticipation. So I have stepped into the breach to add my voice to hers on this site from time to time. This week I will also try to help pick up the slack for Leo as he is off stuffing his face and sunning in Greece (lucky devil). So I want use this opportunity to thank you all for your comments and suggestions since I started guest posting here. I hope you have enjoyed my contribution.

Below is a blurb I just wrote over at my own site. I wanted to run it by you here in order to motivate a discussion about the trade-off between short-term deficit spending and longer-term plans for deficit reduction. There has been a lot of talk about how reckless the U.S. has become with the deficit ballooning to unheard of proportions in the trillions. About this time last year I thought Bill Gross was crazy when he was already talking about trillion dollar deficits. But, he was quite prescient.

Here’s the question: can the U.S. run up a huge deficit now as long as it shows a credible plan to reduce it over the long-term? I have suggested that healthcare (and social security) be a main target of that longer-term deficit reduction plan. But, is this a trade-off that can actually work? Your comments are appreciated.

Here is the original post. Enjoy. (Note: I filed this post under the categories Health care and Banana Republic.)

I think a technical recovery will happen in the Q4 to Q1 timeframe. But this recovery is likely to be weak, if it happens at all. Downside risk remains. Unfortunately, the Obama administration has fired all its bullets, spending huge political capital bailing out the big banks and putting together a weak stimulus package we all knew was going to fail.

Now, Joe Biden is trying to save face, talking as if recovery is guaranteed and no further stimulus is necessary. Yet, on the eve of the G-8 summit, it takes Gordon Brown to remind us that the Great Depression II meme is still at play. If the United States wants to keep deflationary forces at bay, it will need to support the economy with fiscal stimulus.

The problem is the U.S. government budget deficit. In April, in a post called “The Cult of Zero Imbalances,” Marshall Auerback made the case for stimulus, aware of the downside risks for the dollar and bond prices because of that deficit. Yes, there are risks for America associated with deficit-inducing stimulus in the short-term, but they can be mitigated if the Obama Administration actually showed a plan to reduce the longer-term deficit. But, as David Leonhardt has argued, Obama’s team has no deficit reduction plan whatsoever.

So now we must contemplate America’s fiscal train wreck; and that is exactly what Richard Berner at Morgan Stanley is doing. Here is an excerpt of his research note published today.

America’s long-awaited fiscal train wreck is now underway. Depending on policy actions taken now and over the next few years, federal deficits will likely average as much as 6% of GDP through 2019, contributing to a jump in debt held by the public to as high as 82% of GDP by then – a doubling over the next decade. Worse, barring aggressive policy actions, deficits and debt will rise even more sharply thereafter as entitlement spending accelerates relative to GDP. Keeping entitlement promises would require unsustainable borrowing, taxes or both, severely testing the credibility of our policies and hurting our long-term ability to finance investment and sustain growth. And soaring debt will force up real interest rates, reducing capital and productivity and boosting debt service. Not only will those factors steadily lower our standard of living, but they will imperil economic and financial stability.

Later in his missive, Berner, rightly admits that economists warning about deficit spending in America have been singing this tune for quite some time. And, as with the boy who cried wolf, no one believes them any longer. No less than former U.S. Vice President Dick Cheney said “deficits don’t matter.”

Well, they do matter. Eventually, the day of reckoning will come. Berner puts it this way.

Some are concerned that our reckless fiscal policy will trigger a downgrade of the US sovereign debt rating, making the financing of our burgeoning deficits more difficult. While worries that the US will default on its debt are illogical, global investors and officials are concerned about the credibility and the sustainability of our fiscal policies. So am I. They fear that we will adopt policies that will undermine the dollar and the domestic value of dollar-denominated assets through a combination of risk premiums and inflation. I worry about that too, although such policies probably would be accidental rather than deliberate. As a result, interest rates may have to rise significantly to compensate investors, including reserve portfolio managers and sovereign wealth funds, for such dangers. While the dollar will for now retain its reserve-currency status, such concerns put it at risk.

Definitely read his piece which is linked below. He does an excellent job of demonstrating that healthcare is a large part of the problem and sounding the alarm for fixing it once and for all.


America’s Fiscal Train Wreck – Dick Berner, Morgan Stanley

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. Mike

    I personally think we have passed the event horizon for bringing the national debt back down to a serviceable level. I think fiscal discipline will have to be forced on the U.S. long before we voluntarily start deficit reduction and debt repayment.

  2. Expected Returns

    Governments throughout history have proven to choose expediency over sound policy. No matter how attractive the "sound plan" to reduce deficits our government proposes, spending will continue to increase unabated.

    Remember, all the bailouts in the last 30 some odd years were described as emergency measures that would not be repeated. Does anyone think if we grant the government carte blanche to spend that they will self-impose discipline when the time comes? Maybe I'm cynical, but I doubt it.

  3. shargash

    I think your question is moot. There will be no credible plan to reduce the deficit in the future. If such a plan were crafted, the first place to look to reduce spending should be the military. The US spends more than the rest of the world combined, and 10x what either Russia or China spends. As a starter, cut the military budget in half. As you point out, we also need healthcare price reform. The problem is that I'm not sure that cutting defense spending in half coupled with significant healthcare reforms are enough.

  4. Brick

    There are a number of different questions here which need to be broken down. Firstly there is the question of whether a further stimulus is appropriate and I might be tending towards agreeing it might be. The second question is whether it is appropriate to increase the deficit to pay for the stimulus and here I would suggest it might not be. This might be achieved by rebalancing the budget towards more labour intensive fields rather than low employment expensive items. I expect this to be ignored because of the political structure and lobbying that goes on in the US.

    The next question is whether the deficit is sustainable and I think a big mistake is being made in looking at the deficit purely as relative to GDP. What should be looked at is the size of the deficit relative to available investment. Where Italy may be able to look at available investment as an inexhaustible pool the same probably will not apply to the US. Having said that I don't expect the collapse of the dollar or treasuries in the next few months, but rather in a longer time frame as the deficit approaches 60 percent of GDP.

    The big question to be answered is whether taxes will be raised at the right point if at all. Most economies including those in Europe have a good record of raising taxes when the need arises, while the US has a very bad record with such policies likely to completely undermine the political structure there.

    I doubt whether healthcare reform will reduce deficit without some sort of price capping which will be fought tooth and nail by some very strong lobby groups. Bold steps are required and it all looks rather timid at the moment.

  5. ronald

    Of course deficit's matter but when the economic system has crashed the debate needs to be broader then what is framed by the financial sector press. The fact that American standard of living is in for a reduction is not news nor has it been for a number of years. The idea that average middle class workers can afford large homes, multiple auto's, ATV's and assorted hi-tech gear,cheap healthcare and large pensions makes good political slogans but has no reality.

  6. RTD

    If the stimulus is successful at jump starting the economy, it will at least partially pay for itself through higher tax revenues. In any case, I don't see any viable alternatives to fiscal stimulus, however imperfect it may be, right now. The laissez-faire, let them fail and "come what may, let the heavens fall" crowd is insane. Monetary policy has done just about all it can at this point. Short of a debt jubilee, which will never happen in the absence of a violent revolution, there aren't any other alternatives to fiscal stimulus. My biggest worry is a partial recovery later this year or early next year, followed by another leg down, in which case even a second stimulus will likely be too little too late.

    The reality is that the bursting of a credit bubble on this scale has only happened a few times in modern history – 1990's Japan, the Great Depression, and the 1873-1879 depression. While there are measures that can be taken to soften the blow, there are no quick fixes – this is the lesson we don't seem to want to learn. Bubbles MUST be prevented, Greenspan couldn't have been more wrong when he said it's easier to just clean up after the fact.


  7. David

    Edward, that would be "breach", as in "gap". Unless you really did mean "breech" … as in, you expect to get blasted. Good post! Cheers!

  8. Kelli K

    Good comments, especially Brick's.

    What is missing from the equation so far: growth. Where is growth going to come from? If we grow the economy, deficits shrink as a percentage.

    So, a short term stimulus should be ALL about rebuilding our crappy infrastructure. We're stuck in the 19th century. How about some investment we can see? That gives jobs?

    Second, the tax increases we know are coming need to hit the consumer class and favor the employer class (big and small). It's appalling that that is not the case. And, yes, I'm a consumer, so I know what I'm saying. But people will understand that someone's gotta pay, but it can't hurt the jobs machine or we're all dead. It's an easy case to make. Why isn't anyone making it???

  9. Economic Perspectives from Kansas City

    Increases in the federal deficit tend to decrease, rather than increase, interest rates. This is because deficit spending leads to a net injection of reserves into the banking system. (And big deficits imply big injections of reserves.) When the banking system is flush with reserves, the price of those reserves – in the U.S. the federal funds rate – is driven to zero (yes, zero!). Unless a zero-bid is consistent with Fed policy, the central bank will begin selling bonds in order to drain excess reserves. The bond sales continue until the fed funds rate falls within the Fed's target band. The Federal Reserve sets the key interest rate in the U.S., and it can always hit any nominal interest rate it chooses, regardless of the size of the budget deficit (or debt). And this isn't just true of the Fed. Just look at the Japanese experience…despite a debt-to-GDP ratio in excess of 100%, the Bank of Japan never lost the ability to set the key overnight interest rate, which has remained below 1% for about a decade. And, the debt didn't drive long-term rates higher either.

    Read more here:

  10. Mike

    I think the people supporting another stimulus are off in left field. We are going to run a ~$2.5 trillion deficit this year, and GDP is going to shrink anyway. We are to the point where there is essentially no added benefit from each additional dollar of debt. We could keep digging this hole forever and not get out of it. But let's pretend we issue more debt for a second stimulus. We will have to get growth greater than the 5% interest rate we will pay for the debt just to break even. We will never win this game. Additionally, a second stimulus will lead to more treasury issuance, sucking more money from the private sector that other private businesses are also seeking. The government is borrowing at the expense of private industry, and the government is a less efficient manager of capital. The U.S. needs to get its financial house back into balance, but that will only happen when the bond market says no more.

  11. hbl

    Worries about fiscal deficits driving up interest rates in the context of private sector deleveraging seem very overblown to me. Rates on government debt are likely to stay low or even decline when there are less other assets available for investment. Of course the ability for taxpayers to ever pay back the debt is an open question and that is a valid concern… though Japan's 180%+ government debt to GDP ratio has yet to cause any crisis in confidence there.

    Certainly though keeping entitlement promises at current levels could represent fiscal spending beyond the "hole" in demand opened up by the crisis, and I agree changes will probably be needed there.

  12. Edward Harrison


    the fact that the Fed controls short term rates and that Japan saw no increase in long-term nominal rates doesn't get at the heart of the issue for me. Berner shows that real rates in Japan did rise as its deficits rose. The same was also true in heavily indebted Eurozone countries like Belgium and Italy before convergence.

    Moreover, the Fed only controls short rates. To the degree an increase in deficit spending creates more reserves, this should be reflected in higher real long-term rates as the increase in the monetary base expands credit in the system.

    In short, I don't buy the fact that deficit spending lowers rates. It may over the short-term at the short-end of the curve. However, longer-term, the increase in reserves associated with deficit spending is inflationary and that means higher longer-term real yields.

  13. Edward Harrison


    in a deflationary, deleveraging environment, nominal yields are not going up substantially. But, there are two problems.

    One is the potential for burst of stagflation when reflation takes hold. This would crush bonds until a relapse occurs.

    The second is that it is real yields more than nominal yields that we care about.

  14. Thai

    Ed, the basic issue is obviously ROI. If society spends its money for a decent ROI, then deficits don't matter as the money will come back with interest.

    The problem centers around low ROI spending and this is where national dialogue needs changing and the biggest of these issues is health care.

    To illustrate a basic flaw in people's thinking, we tend to forget we are all going to die.

    Whatever health care we recieve today that puts off one illness, just replaces one cause of death today with another cause of death tomorrow and most end of life illnesses whether they are heart diseaser or cancer or something else are all equally expensive.

    To illustrate the dilemma:

    If I spend $100 for primary care visits every other year + $500/year in medication starting at birth and the result is I die at age 70 from an illness that costs $200,000 to treat before I die, then I will spend a total of $238,500 over the course of my life on health care.

    If I increase preventative care spending in order to live longer such that I spend $100 per primary care visit but I now sewe the doctor TWICE a year and I also increase preventative medication costs to $1000/year and the net effect is that I get to live to 85but still die of an different illness that costs $200,000 to treat, then I will have spent $284,000 over the course of my life.

    Preventative care INCREASES costs- ion this case from $238,500 to $284,000 or 17% (of course I live longer).

    This kind of spending increases can only work if I either give up something else, work a longer career, OR (like in the UK) I an 85year old only gets to spend (say) $154,500- of course I got to live 15 years longer.

    We obviously do not do this in America.

    If we can get this dialogue going and resolve this issue as a society, I do not fear our debt one bit. If we cannot, then I agree with your other commenters that we have already passed the event horizon.

  15. hbl

    Hi Ed,

    "One is the potential for burst of stagflation when reflation takes hold. This would crush bonds until a relapse occurs."

    There have been two debt deflations / balance sheet recessions / credit recessions (pick your term) in the last century. In the Great Depression, a massive deflation and debt liquidation cycle cleared a lot of debt, followed by a global war with massive military spending and destruction of productive capacity, so yes inflation jumped after a decade of depression. In Japan, a form of reflation "succeeded" in the sense that they lost 300% of GDP in asset wealth (equivalent to $42 trillion in the US today) without any significant decline in GDP or any sharp CPI deflation… but Japan has never come close to stagflation. So I guess I don't understand where this worry comes from when deleveraging has only just started.

    "The second is that it is real yields more than nominal yields that we care about."

    I agree and that is a good point, however suggesting nominal yields may not rise while real yields do rise implies a recognition of deflation taking hold… I guess I had the sense that most commentators worried about rising yields resulting from deficit spending aren't even acknowledging deflation, but perhaps that is an oversight on my part — I see now that Berner does make the distinction.

  16. Bill

    Health care is the issue. Social Security is fine (and if my parents got lower benefits, I'd just have to help them more anyway). The rest of the budget needs help too – last I checked, the military has a smaller trust fund (none, actually) than Social Security or Medicare.

  17. Anon1

    I think "showing a viable plan of debt reduction over time" is a waste of time and effort. Why? Because it is not binding. Look at what happened with the Clinton to Bush Administrations. Clinton left office with a budget in the black for the first time in a long time (with the barest beginnings of paying down the debt). Bush comes along and WHAM! Not only is the deficit spending reignited, it is lit off with an explosive vengeance: huge tax cuts AND two very expensive wars right on top of each other!

    If the Obama Admin came up with a "viable plan" to cut the deficit and even pay down the debt over 20 years AND if they actually held to that plan, it would immediately be tossed out the window with the next President (in 2012 or 2016) on whatever excuse that new President whipped up (War! Terrorists under the bed! Monsters! Must tax cut and spend or the enemy, terrorists, and monsters win!).

    A balanced budget amendment isn't an answer either because we MUST have the freedom to, at least occasionally, spend more than we take in. There are economic emergencies, war emergencies, natural disaster possibilities, pandemics, etc, that could come along that requires a burst of deficit spending.

    While it may be necessary to come up with a plan to mollify our financiers buying Treasuries, any such plan is transitory and in no way binding. Another Bush could all too easily come along…

  18. shargash

    "Shargash, here are the military stats you are looking for:"

    That site appears to only be counting DoD authorizations (based on the footnote). If so, it under counts spending. Nuclear weapons are funded out of DoE, some veterans spending is out of HHS, NASA performs military missions, and DHS is at least partly military in nature (and I'm not sure all National Guard expendentures are funded out of DoD). In any case, the numbers are gruesome enough when only DoD authorizations are counted.

  19. Stevie b.

    Ed – it's the first time i've seen you recognise & use the word "stagflation" and for me that's progress!

    hbl – whilst I have always immensely respected your views, I don't think we should be blind-sided by history. It'll be different the next time around – especially in a smaller, more interconnected world. I don't think many feel stagflation is round the corner, but it's lurking and with any eventual wee sign of global recovery and for the reasons I've put to Ed before, stagflation may not be far behind.

  20. Brick

    Couple of points to pick up on from the comments. Firstly Japan was borrowing in an environment where the rest of the globe was expanding and the size of the deficit was not as big as the US one (ignoring the ratio to GDP). It should also be noted that Japan has a history of being able to raise taxes when the need arises. So it is a dangerous game to compare Japan’s and the US deficit. The second point is about household savings which have been shown to have risen. This conveniently ignores the fact that a good percentage of that saving is actually paying off debt. Go look at the IMF figures for US saving which are calculated differently to the way it is done in the US and household saving remains unimpressive. Any assumption that the Federal reserve can set the nominal interest rate is based on the fact that the US dollar carry trade does not unwind and China does not have a hissy fit and stop buying treasuries. Ultimately the US is playing a dangerous game that investors from outside the US will not take fright. For the time being the dollar is seen as a safe haven, but there are a number of scenarios where this could become unstuck like a decoupling in a recovery. How many times do you feel the US should flip the coin on outside investors not changing their mind.

  21. hbl

    Stevie b.-

    "This time it's different" has always been a dangerous statement to make… you could very well be correct but personally I don't see the evidence to convince me.


    "Firstly Japan was borrowing in an environment where the rest of the globe was expanding and the size of the deficit was not as big as the US one (ignoring the ratio to GDP)."

    By traditional arguments if the rest of the globe was expanding it should have been even tougher for Japan to compete to finance its government bonds yet yields sank to global lows. And since the borrowing was in yen, it seems to me the deficit size primarily matters relative to the size of the Japanese economy (and equivalently w/ the US today).

    "This conveniently ignores the fact that a good percentage of that saving is actually paying off debt."

    If I pay off a non-bank loan, the lender now has cash assets in place of loan assets. Odds are they would look to invest in a new fixed-income asset of some type since that is what was on the books before — and if private debt on aggregate is contracting while public is expanding, guess which has the larger marginal supply available? Now if it was a bank loan and the money is "gone" after being paid back (though I'm shaky on the accounting), this doesn't hold… but bank credit is much smaller than total credit in the US, plus QE pushes out new money that could fill that sort of hole in bond demand. Detailed walkthrough here. If you think this is wrong, please say why.

  22. Stevie b.

    @ hbl ""This time it's different" has always been a dangerous statement to make…"

    I should have worded it differently and if you click on my name, you'll see that on this we are in complete agreement!

  23. MacroStrategy Edge

    Ed and all –

    If you stop to think about it, under current monetary arrangements, you will realize the source of the money used to pay taxes or buy debt is essentially three fold:

    1) The central bank can purchase more assets than it sells

    2) The federal government can spend more than it takes in with taxes

    3) Commercial banks can buy more assets than they sell, or make more new loans than they liquidate.

    If the commercial banks are too worried about future losses and collateral values (and sitting on $1tr of reserves earning 0.25% suggests that is still the case in the US, and was the case in Japan and post Great Depression US as well)to grow their balance sheets, then the money to pay taxes and buy government bonds comes from…the govenment deficit spending and/or the central bank expanding its balance sheet.

    What, then, is the limit to fiscal deficits and public debt?

    It comes down to investor ignorance or fear of these simple basic facts of the current monetary arrangement.

    The nonbank private sector – households and businesses – cannot create money. They have to acquire money before they pay taxes or buy Treasury bonds. To acquire money, they have to sell assets to the central bank or sell goods and services to the federal government (or successfully appeal for benefit payments).

    When you trace money back to its source, you realize talking about escalating fiscal deficits leading to federal government debt rating downgrades or even outright default is…well, on the verge of absurd.

    That doesn't mean large and rising fiscal deficits cannot provoke fears of "monetization" and inflation, although as the unemployment rate approaches 10% and capacity utilization hits post WWII lows, such fears may be a bit premature.

    That doesn't mean private portfolio preferences, both here and abroad, cannot shift away from US Treasury debt because risk adjusted returns look better in other asset classes or in other regions.

    But it seems our inability to grasp the essence of current monetary arrangements is clouding our ability to clearly assess the full range of policy options.

    The private nonbank sector cannot create the money needed to pay taxes and buy bonds. Think about where the money ultimately comes from, and you will realize the federal budget constraints are not the same as a household budget constraint.

  24. Carlosjii

    This reminds me of the long term British Foreign Service official – something to the effect “All the worriers and nay sayers came to me for fifty years decrying conditions and warning of war. I was only wrong twice.”

  25. Big Picture Trader

    MacroStrategy Edge,

    Yes, possibly, but then we would all live in a world where private citizens unable to gain access to the government dole suffer 15-20% unemployment and no prospects for any sort of social mobility, because the government has simply cornered every single dollar of productive capital in order to pay transfer payments.

    You reach a "limit" to this when the dollar loses confidence as a medium of exchange and interest rates sky rocket. Remember, these things don't happen in a vacuum.

    To Edward,

    We are past the point of no return, as many commentators have said. Fiscal discipline will be forced upon us. No politician can, or will, ever be elected telling the people the truth in a country where entitlements have become just that – entitlements.

    For all those advocating socialized health care, can you explain to me how this will reduce exponential costs (not just nominal costs, but rate of growth?) over the next 10 years?

  26. juan

    MacroStrategy Edge,

    while from demand-centered perspectives it may not be so, the limits to fiscal deficits and policy is exactly the inability to raise the long-run rate of profit. Without a sufficient purging of overaccumulated capital [and not just U.S.], we/others are left with pretenses of control over a capital system which, for decades now, has been tending towards stagnation.


    Well in times of social desperation, people need free medical services even more. But this is a major political decision and not a financial one. So,cut down a slice from military expenses and offer the American people free medical services at last and at least. What is the use of maintaining a worlwide expensive network of military installations and prescence when in the American inner cities people already cue up for soup rounds and food coupons? There is something very wrong here, as some do not seem to understand that the old "system" has already collapsed, that the systemic global financial damage is irreversible…

  28. Hugh

    Biden is an idiot. He hit us with his "no one could have predicted" shtik on the economy which must have come as a surprise to most of us around here who have been saying this stuff for months. He then follows this up with giving a green light to Israel to attack Iran. The man is a verbal menace. The joke is, of course, that he was brought on the Obama ticket to lend it foreign policy experience and gravitas. I suppose I should accept this as just another upside down aspect of the Obama Administration.

    I have to say too that I find it incongruous to have an economist from Morgan Stanley which did so much to create the fiscal train wreck is on expressing concern about it. It's a little like the kid who kills his parents and then pleads for mercy because he is an orphan. And of course in his eyes, it is not an out of control financial industry but entitlements that are at fault and need to be cut. In this article from Calculated Risk, the current estimate for government and Fed aid to the financial industry is up to $6.788 trillion. But the real problem is entitlements. Give me a break.

    I agree with the view that if there were a reasonable plan on the table to address the financial crisis it would be easier to justify large deficits but as it is the Obama Administration has a bunch of goofs running its economic policy so it is as lacking in ideas in how to deal with the meltdown and burst housing bubble as it is in how to deal with future deficits.

  29. MacroStrategy Edge

    Big Picture:

    I am describing how money is created in the economy we inhabit, not in an economy I desire or imagine.

    Tell me where the money you get to pay taxes and buy Treasury bonds is created from in the first place. Not how you earn the money -how does the money you earn get created?

    Government does not need to corner every dollar of productive capital as the fiscal deficit increases and government debt outstanding increases – government creates the money it collects in tax payments and in bond sales.

    Government does not need to make everyone a ward of the state. With a highly indebted private sector, if the trade balance and the fiscal balance do not adjust in such a fashion to meet the desired level of domestic private saving, nominal incomes will tend to collapse in a debt deflation spiral, and yes, then many people would be likely to end up on government benefits.

    Until people are willing to see the source of money creation in the economy we inhabit, they are missing a big part of the Big Picture.

    Governments without fixed exchange rates or convertible currencies (as in a gold standard) have to create the money they receive in tax payments and bond sales. They have been doing it for years. If such money creation fuels too much demand relative to supply, or if it creates inflation expectations among suppliers that have the bargaining power to push up final product prices, then you can get interest rates rising and exchange rates falling. But last I checked, the CPI was falling at a 1% year/year rate for the first time since April 1950, and private wage and salary income was falling at a -2.3% y/y rate for the first time in half a century, while import prices were down at a -17.6%
    y/y pace. Beyond a few commodity prices that can be easily manipulated by professional investors, such as we have seen with oil over the past year, deflation is clearly the issue staring us in the face, despite an already large fiscal deficit and a massive expansion of the Fed's balance sheet. That should tell bond investors and currency investors something.

  30. MacroStrategy Edge

    Juan – I do agree there has been serious misallocation of tangible capital. That after all is the residue of serial asset bubbles. But I doubt we have so much productive capital in place that we have exhausted the scarcity value of capital. Or at least a few aspiring citizens of developing nations might beg to differ with you.

    In the meantime, when the government spends more money than it receives in tax payments, the private sector must receive more money than it pays in taxes, right? Part of those money income flows are usually profit incomes, unless the household saving rate moves up in lockstep with the fiscal deficit, which is usually not the case.

    Fiscal deficits are in part received as profit incomes, and that is one reason why they can help pull economies out of recessions or subpar growth trajectories. Public investment can be especially useful in enhancing productivity of the productive resources of the business sector.

    Eliminating productive capacity to raise profit rates, which then encourage future investment driven growth strikes me as a two steps back, one step forward theory of economic progress. One would think one objective of an adequate economic system should be to reduce scarcity and minimize necessary labor time.

    Eliminating existing tangible capital gets you there only if it frees up productive resources that can be guided by market signals or policy toward more productive uses. That is usually easier said than done, as tangible capital is not putty or clay but rather designed for fairly specific uses, and it is an unfortunate property of durable asset markets, especially after sustained or serial asset bubbles, that lower prices are not the cur for low prices, as the existing holders of durable assets increase supply for sale from existing stocks of durable assets, and this can swamp the reduction of flow supplies of durable assets as new production is curtailed.

    Contrary to the stories told by conventional economics, the market of Chiquita bananas and the market for houses do not clear in quite the same fashion. In the latter case, the expectation of lower prices can lead existing owners to dump durable assets, so home prices still fall even if homebuilders are less active.

  31. joebhed

    Well, gee, deficit spending will cause inflation.
    To not, will cause deflation.
    What's the question?

    Macro hits on the FACT of the monetary system itself being a major factor, and possibly the major factor, in determining future directions for the economy.

    So we can either have inflation or deflation.
    What we cannot have is economic stability.
    The reason we cannot have economic stability is because there is TOO MUCH DEBT in our monetary system.(see Taleb's latest commentaries).

    The problem is NOT that there is too much debt in the banks or financial services.
    There is too much monetary system debt and this is a natural result of the scientific equation that says A plus B is greater than A.
    Since we only create the "principal" amount of EVERY loan that is used to create ALL the money that is existence, from where do we obtain the interest payment money?
    The Chicago Plan for Monetary Reform.
    Invest in that.

  32. MaxH707

    Unless the health delivery system voluntarily reorganizes, nothing else will ultimately matter–market realities will force reform on the model. As it is now, specialists sit alone in their dispersed offices, order too many duplicate tests as insurers are force those insured (a healthy family of 4) to pay an average of $10K/yr. out of pocket. (Most of these insureds never use the system.) Physicians don't want their skills to be viewed as a commodity, but unfortunately reorganizing the system will mean a glut of doctors on the market thereby driving down rates of reimbursement. (Ask dentists how they feel…already there's a dentist on every corner.)

  33. ravinenator

    The US fiscal situation will not be resolved until global imbalances are corrected. Current US deficit spending is merely the latest vehicle through which the trade deficits with China, Japan, oil producers and other net exporters are financed (after the shutdown of the financing pipeline that relied on structured finance products).

    Assuming the US pursues economic policy that it is in its own self-interest, there are only two ways to close those trade deficits:

    1. Via a currency revaluation on the exporting side (i.e. China, Japan, etc.).
    2. Via US inflation to force a real revaluation even though the nominal exchange rate is unchanged.

    After the tech bubble and the housing bubble, I think door #3 (magic productivity gains in the US economy make everything work out) is no longer credible.

    Bluntly, holders of (non-TIPS) US Treasuries that expect the US to agree to years or decades of below potential output merely to preserve the current real value of US Treasuries are making a startlingly foolish bet given past history and practical political realities.

  34. juan

    MacroStrategy Edge,

    'Scarcity value' is part of the neoclassical perspective, one which so far as I know has never had anything like an objective rate of profit theory so misses one of the system's primary determinants while, same time, overemphasizing the market and consumption, neither of which is productive of labor created surplus value even though both are required for its realization. Production and consumption form a contradictory unity.

    Coming from the old labor value perspective, it stands out that the total mass of capital rises relative to the mass of living labor employed and that as this extends over multiple cycles, will tend to depress capital's avg rate of profit. IOW, capital becomes overaccumulated relative to that which it depends on.

    Fiscal and monetary policies cannot prevent this , which does not mean – at least for a period – such policies were unable to mitigate but, particularly post-1970, at increasing cost.

    Every crisis stands as evidence of the capital system's inherent contradictions which for way too long have been pretended away in fantasies of equilibrium, rational actors and control.

  35. skippy

    @juan said…IOW, capital becomes over accumulated relative to that which it depends on…

    BINGO… IWO and expand, hence the never ending need for the shell game or ever changing pools of attraction in correlation with capital flows.

    Is this not why we have monopoly laws etc, too funny, financial success is the goal in a capitalistic endeavor until it becomes to large of an attractor of capital, there fore impeding/sucking dry capital flows to the rest of the economic farm, restricting diversity, allocation of risk or a mobius strip with holes and road blocks.

    Skippy…permision to use that structure with your name attached P.

  36. Francois

    The problem is not health care per se: It is health care as we have it in the USA.

    Single payer would reduce costs, and significantly so. Prove to me by facts and figures that HC insurance corporations are synonym with quality health care and the winner gets all my assets. Good luck!

  37. Big Picture Trader

    MacroStrategy Edge,

    Thank you very much for the clarification, and I agree with everything you say.

    If I'm to understand you correctly, you're a fan of Steven Keen's assertion that it's basically the banks who drive money creation/destruction. Over the last 30 years especially, the banks have responded to the "demand" for money from the private sector through various means, both including de-regulating their activities to give them a freer hand, and in the explosion of credit. I agree with this assertion, and believe that it's in fact the government that plays catchup following the banks as the banks respond to the private sector's demand for credit/money.

    Now, we have a situation where the banks are dramatically curtailing credit creation, in a perfectly logical response to the private sector's retrenchment and repudiation (at least today) of taking on any more debt, because they're saturated to the gills.

    It also sounds like you might be a fan of Hugh Hendry?

    Would be interested in hearing your additional thoughts.

    thanks for the response,

  38. Brick

    hbl –
    The point about Japan being in an expanding global economy is that the supply of global treasury debt was low while the demand was moderate. Yield does matter but the balance between supply and demand also matters and investor will not always shift from low yield assets to higher yield if the lower value is perceived as lower risk. Now we see ramped up supply from many economies whilst, demand is only moderately up due to risk aversion and the risk in holding treasuries is slightly increased. The problem is that demand will only hold up while risk aversion is still in place.
    On savings I partly agree, but wanted to distinguish between savings and debt repayment because they tend to end up with a different mixture of asset allocation. A good part of savings can end up in equities, treasuries, thus helping to support the deficit directly. Debt repayment can lead to more loans which would benefit the economy and work towards reducing the deficit, but I bet some goes towards balancing out losses in other areas at this point.

  39. Alan


    here are the military stats you are looking for:

    First, I do not uncritically accept Chinese government statistics on this subject. Strangely enough, one party dictatorships have been known to occasionally lie about such matters in the past.

    Second, superficial numbers like these are more misleading than informative unless one understands the costs of military power to any given society.

    The US Department of Defense spends over 50% of its budget on personnel. Operations and Maintenance accounts are the next largest category, followed by major equipment procurement and research, development, test and evaluation. For this money, $600 billion in 2004 on John Pike's ("Global Security") showing, it obtains about 2.3 million active duty troops in all services.

    According to Pike's same information China only spent 10% of this figure ($60 billion). Yet it also obtained at least 2.3 million active duty troops.

    We can extend this mismatch to other known areas of power potential. I'd key on annual steel production capacity as another important factor. China has in the neighborhood of 600 million tons. The USA produces 100 million tons and rapidly falling (all hail Global Warming remediation).

    Need China spend the same as the USA per ship hull?

    There are many qualitative factors beyond gross numerical comparisons like these. Assuming these area all in the USA's favor would not be correct.

    Anyone can look at events like Tianamen Square and ongoing massacres in Xinjiang. If with their eyes wide open they want to ignore this character because believing the regime will use its power benignly, fine. It greatly facilitates some people doing a highly profitable "business as usual".

    I don't Shargash's very tired political cant rises to the N-C level.

  40. John Doe

    When a government becomes over extended it is only health care that is cut. History as a guide indicates that the days of the US far flung military empire may be over. We will pull back from many of the over 100 overseas bases, drastically cut the $700 billion (or more when country all the black ops, secret weapons budgets etc) spending.

    The refocus on the US as a country of working stiffs not a world super power may be good for us.

  41. juan


    yes, increasing concentration [and centralization] is one of the phenomena associated with downwards pressure [and/or actual decline] in rate of profit. Firms try to offset a lower rate by increasing their mass — some of this can be seen in the long-run M&A activity and in disaggregated profit data but, as I think you imply, progressively greater concentration becomes a market negation, so adds to inherent tensions and, finally, uncontrollability.

    Speculative activity, socialization of costs, credit inflation, etc are other attempted offsets which, as we're beginning to see, also come to progressively undermine the system's ability to reproduce itself.

  42. Rebekah

    It is unfortunate that thinking about the question of the deficit is so myopic. There is no need for any deficit whatsoever, what is needed is a return to a constitutional monetary system as laid out in the constitution. The 100% privately owned Federal Reserve is an illegal entity whose sole purpose is to counterfeit American money and sell that worthless paper to the American people at interest. Debt money, backed by nothing, which the American people must work and produce real value to pay back. To end inflationary woes and to get rid of debt, deficits and the income tax forever simply follow the following steps.
    1. End the use of Federal Reserve debt money. Debt-free constitutional money should be used instead. The power to issue coin for the people belongs to the people, not a bunch of profiteering vultures contributing nothing to the economy and making debt slaves of us all. With no debt/deficit to service, the need for an income tax entirely disappears.
    2. End fractional reserve lending. When banks can lend 10-20 times the amount of money they actually have in reserves, it is again, the same as counterfeiting and the resulting inflation in the money supply causes 90% of all inflation. The full reserve lending system will make banks far more cautious how they lend their money and reduce inflation dramatically.
    3. Regulate the markets. Corporations are legal fictions with the same rights as human beings, but with incalculably more power. These entities and the financial markets must be strictly regulated to prohibit monopolies and oligopolies, the natural goal of these entities, to ensure that there is competition and a market at all. Consumers must come first.

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