Obama: Debt could cause a double dip recession

By Edward Harrison of Credit Writedowns

Barack Obama has now come clean about his thinking on why his administration has decided to focus first on reducing the deficit and next on jobs. He fears a double-dip recession will occur if foreigners lose confidence in the U.S. dollar, causing interest rates to spike. 

This is nonsense and it demonstrates how much at odds Obama’s economic thinking is with reality. This is the clearest indication that the Obama Administration doesn’t understand how modern money works. In fact, by focusing on deficit reduction, he has increased the chances of a double dip instead of decreasing them.

If he wants to reduce deficits, knowing it will precipitate a double dip and would decrease malinvestment. Fine. That’s not my solution, but it is accurate view of the economics.

What Obama actually said

At issue is whether the federal government’s enormous debt burden in the U.S. could cause investors to lose confidence in the U.S. government and shun its debt.

In an interview on Fox News today, the President said the following:

I think it is important though to recognize that. If we keep on adding to the — Even in the midst of this recovery that at some point. People could lose confidence in the US economy in a way that could actually lead to a double dip recession.

Is this really true though?

How deficits really work

Think of an economy this way: the people in any economy buy goods and services from one another and from the outside. In any given time period, one person, one company or one group/sector might use credit in order to buy more goods and services than it makes in income. It’s like spending future income by using credit. This puts that individual, company or group/sector in deficit i.e. they have spent more money than they have earned. Now obviously, if one sector is in deficit in a given period (i.e. they have spent more capital than they have earned), then the other sectors are in net surplus (i.e. they have received more cash than they have earned).

Let’s give these groups/sectors of the economy names: the private sector, the public sector and the foreign sector.  Giving the groups names makes it plain that if the public sector is in deficit, the combined foreign and private sectors must be in surplus.  Simply put, if you look at all of the households and businesses that make up the private sector and aggregate them together, you can determine if the private sector has a net surplus or a net deficit in any individual time period. And if the private sector has a net surplus, the combined foreign sector and public sector must have a deficit for that time period. The sector financial balances move in concert.

What this means for today is that a government which reduces its deficit in a given time period is forcing an equal reduction in surplus in the private and foreign sectors. So that means, in aggregate, the private sector and the foreign sector will reduce the surplus cash it is taking in over what it spends.

Scott Fullwiler has a good graph depicting how the private sector surplus/deficit moves in concert with the public sector deficit/surplus, the difference being the current account deficit:

We can look historically at how these sector financial balances have moved over time. Figure 2 shows how closely the private sector surplus and the government sector deficit have moved historically, which isn’t surprising given they are nearly the opposing sides of an accounting identity. The difference between them, more visible starting in the 1980s, is the current account balance.

Figure 2: Historical Behavior of Private Sector Surplus and Government Sector Deficit as a percent of GDP



Below, I am now providing figure three from Fullwiler’s post at reader request, as it shows the current account deficit as the missing link since the 1980s.


Unless the increasing current account deficit switches direction violently, this can only mean that reducing the government’s deficit reduces the private sector’s surplus. Net-net, the government’s decreased deficit spending will decrease savings in the private sector. And no deleveraging can occur if savings in the private sector are reduced.

Is that what we want? Reduced private savings means continued high private sector leverage. In the U.S., the private sector has much greater debt burdens relative to the size of the economy than the federal government does. You would think we want the private sector to reduce leverage more than the public sector.

Long-term deficit reduction

What I have suggested is long-term deficit reduction.  If the President is concerned about deficits as far as the eye can see, he might want to look at retiree healthcare costs.  In June I said:

Yesterday, I argued that the United States faced a policy dilemma in avoiding debt deflationary forces while maintaining fiscal prudence.  The reality is that President Obama faces political constraints in Washington right now in regards to budget deficits.  He is not likely to get another stimulus package through the Congress unless he can credibly demonstrate a longer-term deficit reduction outlook.  In my view, this necessarily means changes to Social Security and/or Medicare.

But, of course, President Obama is not going to do that because this would mean cutting Medicare benefits, a political loser.

This looks like Hoover more every day

The President just doesn’t seem to understand how the economy works frankly. Reducing deficits by cutting spending or raising taxes decreases aggregate demand. And it is a decrease in aggregate demand which would induce a double-dip recession. So, the President’s logic just doesn’t work.

But what about a strike on U.S. government debt?  As you probably surmised from the above, if the U.S. private sector is increasing its savings, there is automatically a greater domestic bid for U.S. treasury securities.  So, it is a misnomer to say the U.S. is dependent on foreigners, thinking that this must continue. If the private sector saves more, a larger percentage of government bonds will be bought with domestic savings. In Japan, interest rates did not spike when the government increased deficit spending for this very reason.

The only question we have to ask ourselves is whether we want to reduce debt by:

  1. The Liquidation Scenario. decreasing aggregate demand and precipitating a major depression in order to liquidate zombie companies and malinvestment. This would cause a massive wave of defaults and decrease debt burdens significantly through bankruptcy and debt repudiation. or;
  2. The Glide Path Solution. increasing aggregate demand by maintaining government spending while trying to liquidate zombie companies and malinvestment. This would allow the private sector to decrease debt burdens significantly over time through increased savings. It also has the benefit of reducing dependency on foreign sources of capital. The downside is a major increase in government debt, the spectre of big government and a long muddle through.

As I have said previously, the Obama Administration is doing neither of the above. It has opted for a third Herbert Hoover solution:

  • The Hoover Status Quo. decreasing aggregate demand and precipitating a double dip recession in order to reduce government deficits. This would cause a wave of defaults and decrease debt burdens through bankruptcy and debt repudiation. Meanwhile they will try to prop up zombie companies and maintain malinvestment. This would simultaneously prevent the private sector from decreasing debt burdens through increased savings and maintain dependency on foreign sources of capital – all without ending the spectre of big government.

I have advocated the glide path solution. But I see the liquidation scenario as much better than the present path – especially since, with the present course, we are witnessing crony capitalism on a massive scale. The problem with the liquidation scenario is a lower standard of living and the prospect of geopolitical tension, social unrest, poverty, and war.

The Herbert Hoover solution we are now using leads to a Japanese outcome at best or a Great Depression outcome at worst.

Obama: Debt Could Fuel ‘Double-Dip Recession’ – FOXNews.com

Update: I have already addressed the potential for added stimulus in a previous post, “I am now moving from multi-year recovery to a double dip baseline“. I see this as a non-starter because it would mean ‘tax and spend,’ which would jeopardize moderate Democrats who this deficit reduction policy is looking to protect.

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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 http://www.creditwritedowns.com


  1. WPEconomy

    This author is totally off-base. The analysis would be good (well-written for sure), if only its underlying assumption – that Obama is going to cut the deficit to avoid recession – were accurate at all. The author took one little snippet from an entire interview (FoxNews nonetheless – where you have to know Obama is going to say something different to appease right-wingers a little) where Obama said he worried about the deficit possibly causing another recession because of fears about the dollar.

    Did the author not read the rest of the article? Obama proceeded to talk about tax incentives for businesses and other stimulus-like measures. Obama has done ANYTHING BUT decrease aggregate demand. Remember, we had a several billion dollar stimulus earlier this year (albeit, it was a little smaller than I think was needed). And, if the author was paying attention to the news, rather than basing his or her entire analysis on a snippet, the author would know that a new jobs bill is likely around Christmas time or early next year. Obama, Harry Reid, and House Democrats started discourse on the jobs bill LAST WEEK. So, I just find this post uninformed and mostly irrelevant, however insightful and fruitful it would be if the assumptions were accurate.

    More here on jobs bill by Christmas at my blog: http://www.wpeconomy.com/2009/11/jobs-bill-legislation-by-christmas.html

    1. Edward Harrison Post author

      I have read the rest of the article. I had already written about the spending increases that could come (I stress could because I think Congress will veto them):

      The only way to both add stimulus and reduce the deficit is to increase taxes – on whom is the only question. Obviously, adding stimulus while increasing taxes sounds a lot like ‘tax and spend’ and opens the door to all manner of attacks from the right. This is a huge tactical error that will be both politically damaging and unlikely to actually stimulate the economy. I see this as a potentially catastrophic outcome for Democrats. It is all too predictable although Obama is rushing ahead with this even earlier than I suspected he would.


      1. CLiu


        The only way to both add stimulus and reduce the deficit is to cut the tax and reduce the size government.

        Get real!

        1. DJBrown

          Agree totally with you. Keynesians drive me nuts and, yes, the poster is using a Keynesian analysis. Okay, Keynesians, aggregate demand is C+I+G. We have a lot of G going on here, but what make you think you can separate an increase in G from a decrease in I? The Glide Path assumes government policy as a scalpel, when it is really a hedgeslammer. Even using the most straightforward tool available to Keynesians, the interest rate mechanism, the Government almost always overshoots. Thus, the Fed blow bubbles without creating any real incentive for private savings and investment, or they induce recessions. Ah, but the Keynesians say look at the 30’s, we released the “animal spirits” through government expenditure. Of course, we were in a one-off then because we were a creditor nation with a very small G, no Social Security etc. Not now, and Keynesians of course ignore the 70’s counter-example. There is no glide path because businesses know G will not be reduced once we’re out of the woods, and who will determine when we are we out of the woods, anyway? The politicians. Instead of using fiscal policy to “guide” the economy, we should just use more generous automatic stablizers like the Germans. Higher unemployment, retraining subsidies, etc. The only long-term solution to our macroeconomic quandary is to ignore macroeconomics entirely. Instead, remove the dollar as a reserve currency and let all currencies float, cut our deficit, and cut taxes to the bone. Interest rates will rise, providing natural incentives for savings and investment. G will lower as a percentage of aggregate demand (using absurd Keynesian jargon), and I, which is by its nature more productive, will rise.

          1. DJBrown

            I re-read your analysis. The references to malinvestment and long-term deficit reduction certainly echo of Austrian thinking, but the concept that you can prop up agregate demand through fiscal expenditure is classic Keynesianism, the valid counterpoint to which is that such expenditures will simply crowd-out private investment and lead to inflation over the medium to long term (though, given the level of unemployment now such appears to already be the case). The Scott Fullwither graph is a classic case of “correlation does not equate to causation.” The reference to chartalism aside, debt-driven consumption has been the driver of most recent growth until recently, if you buy the aggregate demand model. I don’t buy the model, because it doesn’t accurately define an economy’s capacity for wealth creation. An Austrian, or at least the Chicago School variant of monetarism, would argue that interest rate policy should be tied mechanically to the inflation rate, and we should focus on production and not consumption. There must be real, market-based incentives to saving and investment. Therefore, exchange and interest rates should float as the economic situation dictates. In my opinion, the economic path is self-evident. Sooner or later we must follow the liquidation path or face a monetary crisis. Its the politics that make it appear difficult.

            P.S. I love the blog

          2. Edward Harrison Post author


            I’ll grant you I am using ‘Keynesian thinking.’ The Chicago School Monetarist Milton Friedman is a neo-classisist who believes in the rationality of economic actors and self-equilibrating markets. The Austrian School and the Monetarists are different, especially in regards to the central role debt takes in the Austrian view. But in its extreme forms the Austrian view also has these two flaws in their world view.

            Economic history demonstrates that in extremes (like today), markets do not always return to equilibrium. Moreover, people are not rational. In cases of economic disruption, you get things like the German Revolution of 1848, the End of Reconstruction and the beginning of Jim Crow post-1873, the rise of Mussolini post-1921 and the rise of Hitler post-1929. These are just a few examples, but history is littered with them. The fact is economic collapse and war, poverty, despotism, and destruction go hand in hand.

            Can it be avoided, and, if so, how? My view has evolved, but here is how I presented it last year:


            The goal is to return to a healthier economic state with a minimum of economic loss. We are all still in disagreement about how best to get there. I respect but disagree with the view that the best choice is to just let the chips fall where they may. It assumes too much about human rationality and market equilibrium.

            As to the lack of equilibrium, the graphs in this post, also from last year, get to the point:


            Make no bones about it: the debt overhang is large. But, the private sector is far more heavily indebted than the public sector and, in a fiat currency system, there are important differences between sovereign government debtors and private debtors.

            There aren’t a lot of options here. One way or another, we are going to see some serious debt deflation in the coming years.

  2. MyLessThanPrimeBeef

    Which solution does exporting countries prefer? That’s the one we should avoid.

    For me, it’s the Cultural Revolution that wiped out China for a while that enables China to have 10% growth these days.

    I would think the Liquidation scenario would give us the best chance to spring a trap on those countries with too much manufacturing capacity currently. It’s like a battle. Once that happens, you will have a tremendous advantage re-starting your own manufacturing base.

  3. selise

    Edward Harrison – a small suggestion for your post. imo scott fullwiler’s fig 3 (from the same link you are using) is even more helpful to your point than fig 2 because fig 3 shows how private net savings and public deficit move together until the current account balance deviates from near zero.

    p.s. disagree with you though about economic “dependency on foreign sources of capital.” we are now dependent on some things, oil for example, but capital is not one of them. rather leave those issues to marshall, randy, rob et al. though since they are the experts and i am not.

  4. marcf999


    what stinkin taxes? just spend baby! spend! Functional finance under fiat money systems has been a staple of every government since Carter. Reagan did it, Clinton did it, Bush 1&2 did it.

    The right wingers may wince but they coined “deficits don’t matter” and the left certainly isn’t going to slow down a good spending program nowadays. Functional finance transcend politics. Everyone loves free money.

    This is excitement for the excitables, aka FOXNews.

  5. mikkel

    “So, it is a misnomer to say the U.S. is dependent on foreigners, thinking that this must continue. If the private sector saves more, a larger percentage of government bonds will be bought with domestic savings. In Japan, interest rates did not spike when the government increased deficit spending for this very reason.”

    While that’s true, Japan was always a net creditor nation. We are a net debtor nation, so there is a no way that our government debt can rise without relying on *net* increase in foreign demand (unless China/Japan start having massive export increases to the rest of the world). This is something that Michael Pettis has pointed out repeatedly. It is also why I am primarily a liquidationist — with massive government demand after the liquidation phase — instead of thinking we can glide through it.

    I also agree that it is impossible to know what Obama is proposing. Timelines and sectors are very important. In fact he even says “Obama told Fox News his administration faces a delicate balance of trying to boost the economy and spur job creation while putting the economy on a path toward long-term deficit reduction.”

    If long-term deficit reduction means increased spending in energy/health infrastructure that will lower costs over the coming decades then that’s totally different than turning off the spigot now.

  6. mmckinl

    Obama is exactly half right …

    Debt is the problem … but not government debt. The problem is the bad debt that isn’t being reconciled by banks, specifically Wall Street Banks.

    Naked Capitalism has covered this topic continuously for well over a year, calling for de-leveraging of bad debt in the private sector.

    It is this unreconciled bad debt that will pull the economy down by sucking good capital into the black holes their accounting tricks call balance sheets.

    Obama has truly been captured by the banksters thinking and it will spell Japan style economic misery-stagnation for a decade or more, ballooning the US, state andd local deficits because of the drop in tax revenue and business activity.

    I see no way out unless we get radical change in the way we do business and government … But the big money is pressing Congress and the White House to do what is in the best interest of the very criminals that got us here.

    1. Anon

      This is pretty much right. We should double the deficit tomorrow by writing a check for everyone to pay off the first 150k in mortgage debt, 100k in student loan debt, and 40k in consumer debt.

      Take the debt out of the private sector and let the economy reboot and rebound.

      BTW, this is not tongue in cheek.

      1. CLiu

        Yeap, you just crashing the dollar tomorrow. So those irresponsible who bought the houses beyong their means now come debt free and those responsibles who saved are now pennyless.

        what a wonderful idea.

  7. Ed

    Someone here or on another blog pointed out that a factor usually missing in these articles is that the US ran large deficits and had a large amount of government debt BEFORE the recession or depression. This is quite different from the scenario during the 1930s when Keynes was writing, and changes things significantly.

    People look to the history of US policy during the Great Depression, but the US was the world’s creditor at the time. The country that is in a similar situation to the 1930s US is now China. The current US situation approximates that of 1930s Britain. But then 1930s Britain didn’t try to outspend the other countries in the world combined on defense.

  8. Sigmaseek

    The difference between private and public credit is that typically private credit has to be secured by something tangible and public credit is secured by claims on private assets and the future productivity of taxpayers. Adding public domestic credit on top of private domestic credit just runs up the credit on what are already leveraged private domestic assets. There is a limit on interest paying capacity of assets as we are now seeing. The government has been capitalizing interest since Bush took office and it has only gotten worse with Obama. If the government were private it would have had its credit cut off long ago, but since tax levies are senior to any bank credit it gets the ok to crowd out private credit. As your equation goes, Foreign sources of capital is the only source of credit as the private assets and thus the private credit is getting market to market. The foreign claims on public/private assets are therefore declining in value. Public debt repudiation or default are the only answer to any sustainable recovery despite the financial engineering the Fed is undertaking. So it’s clear to me that you obviously have no idea how our credit system works. Someone’s gotta pay until they can’t or there’s nothing backing the credit.

    1. pebird

      “If the government were private it would have had its credit cut off long ago …”

      by whom, that other government (the banks)?

      Public debt is used for interest rate and exchange rate maintenance and political reasons – that’s it. There is NO future claim on taxpayers or the unborn. The only constraint is the real capacity of the economy to produce goods in demand.

      If foreigners don’t have the dollars, they can’t buy the debt – it’s just a way to sop up excess dollars – it is NOT a financing mechanism at all.

      With what do you think China buys US debt? Yuan? No, they have excess dollars and they want to maintain a currency peg. They could spend the dollars (which would be great for the US but would blow their peg), or they can buy Treasuries and use them as collateral and get some leverage when they borrow to purchase raw materials and goods, and still maintain the peg.

      What happens when the Treasuries mature? – we rip up the bond and give them back their dollars with some interest. Big deal, they will probably roll over to new Treasuries anyway.

      So the world population has increased by almost a billion people in the last 10 years. World GDP has increased from 30.5 trillion 1999 to 60.5 trillion USD in 2008. And everyone is upset that the world’s reserve currency government debt has gone up from 5.7 trillion in 1999 to 12 trillion USD today during a financial crisis. Why? Are we going to run out of numbers? Ooooooh, scary.

      So there is going to be a run in the dollar? To what? The Euro? The RMB? Yen? Gold? Are countries going to start trading in physical gold instead of electronic account balances?

      The TOTAL money (government and banking) in the system has been drastically reduced over the last year. Everyone looks at the “big” government spending but doesn’t complain about the bigger private banking non-spending.

      This debt hysteria is out of control – it’s a political attempt to keep the Administration hamstrung and to NOT engineer a recovery – the banks would rather foreclose on real property than be paid back – remember the loans they made were garbage – and they were fully aware they were toxic. To be paid back with real property (real estate, commercial buildings, businesses) at “pennies” on the toxic debt dollar is the steal of the century.

      1. Mike S

        I agree completely. When I look at companies, I look at two different major ideas, cash flow vs. debt, and assets vs. debt.

        If you do any debt/assets ratio for the U.S. we are golden. I’ve seen estimates as high as $200 Trillion for total U.S. assets, and we are nowhere near that for debt.

    2. joebhed

      Sorry for being at the base level here, but all US dollar-denominated debts are secured by the full faith and credit of the American people.
      It makes no difference if it is created by the government or private commercial money creators.
      The asset and collateral only secure the loan to complete a transaction. They have nothing to do with the money that is created.
      The new money that is created to secure a derivative or SIV instruments has an asset or collateral of a piece of paper, but it creates a future claim on the American taxpayers for the “stream-of-payments” that are coming due.
      Same is true for a mortgage.
      And if the government created money by direct issuance and payment, it would also need to be balanced against goods and services.
      But without the debt-service, stream-of-payments.

  9. Valissa

    Been studying up on propaganda and related economic and political history.. So here’s a couple of points…

    (1) “Obama’s economic thinking”… I think the key thing to recognize ehre is that you are not nreally talking about Obama’s thinking because Obama has no backgound (degrees in economics or learned from experience), so his so-called economic thinking comes from his key economic advisors. Which of his advisors is actually behind his current statements? I think that would be useful to know.

    (2) focussing on reducing the deficit (Groundhog’s Day)
    Flashback to Bill Clinton’s election. After campaigning on “no new taxes”, once he gets elected his Wall Street advisors press on him to be concerned about the deficit… so Clinton raises taxes and then comes the Republican Revolution of 1994 and Dems lose control of the Congress. Go back even further to Jimmy carter, another populist Dem who gets elected and immediately befriended by Wall Street.

    Wall Street does not care which party is in power (because the “financial elites” control the levers of power in both parties), and are happy to give the masses an illusion of change by letting the other party be in charge for a while. So the masses keep playing “throw the bums out” while the banksters continue to loot. Long live the Kleptocracy!

    1. erichwwk

      Valissa says:

      “Wall Street does not care which party is in power (because the “financial elites” control the levers of power in both parties), and are happy to give the masses an illusion of change by letting the other party be in charge for a while. So the masses keep playing “throw the bums out” while the banksters continue to loot. Long live the Kleptocracy!”

      Can’t say it better.

      I look at the last three years correlation between financial sector profits and financial sector compensation should forever burst the illusion that the sector “earned” its income. A better model is the “toll-road” or “warlord” economy, whereby the financial sector merely taxes/skims (transaction fees) a percentage of what is “really” produced, akin to what the Mafia does when selling “protection”.

      And politicians of BOTH parties, with a few minor exceptions, are party to this kleptocracy, whose main purpose is to give banksters a diversion, by agreeing to play the “bad cop” for a healthy share of the proceeds.

    2. erichwwk

      Valissa asks:

      “…has no backgound (degrees in economics or learned from experience), so his so-called economic thinking comes from his key economic advisors. Which of his advisors is actually behind his current statements? I think that would be useful to know.”

      Bingo. Best I can Obama relied on David Furman, a Yale Law Review colleague, to advise him re economic advisers. Remember that the economy did NOT become an issue until late in the campaign. Also know that economists are split, between the rational market expectations, tops down, central planner types who hide under a “free market mantel” while essentially advocating the opposite, represented by the Goldman Sachs types, who have traditionally managed Treasury as their private preserve. These are represented by Robert Rubin, Larry Summers, Henry Paulson, Tim Geithner, etc. The other half of economists see wealth creation as common property, and a bottoms up process by which NOONE ever sees the big, entire picture. These are represented by Joe Stiglitz, Paul Krugman, Robert Reich, Robert Kuttner, David Korten, James Galbraith, Simon Johnson, etc.

      The rift between Larry Summers and Joe Stiglitz is legendary. Unfortunately, Obama went with the Wall Street elitists (also check out the extent to which Wall Street contributed to Obama- as well as to his chief of staff, Rahm Emmanuel.)

      So I find your conclusion of electoral politics being a diversion, to direct attention away from the banksters, quite on target. BTW, there have been many prominent politicians, in particular Manur Olson who have written extensively on government as a “stationary bandit” vs a collective decision making institution. As far as wealth creation as a common, rather than a private individual process, I recommend Gar Asperovitz and Lew Daly’s “Unjust Deserts- How the Rich are taking Our Common Inheritance and Why We Should take it Back”. http://www.unjustdeserts.com/

      Also try “rent seeking” at wikipedia for a basic discussion and references, which starts out as:

      “In economics, rent seeking occurs when an individual, organization or firm seeks to earn income by capturing economic rent through manipulation or exploitation of the economic environment, rather than by earning profits through economic transactions and the production of added wealth.”

      The fact that wealth can be obtained by cooperation (ala Adam Smith) or by taking from others (ala theft, whether overt via a visible army, or covert through financial manipulation) is a very old phenomena.

      1. erichwwk

        mea culpa. I meant ECONOMISTS rather than politicans, when I mentioned Mancur Olson and the public choice / neo institutional movement in economics.


        Also remember that Obama taught constitutional law at the University of Chicago, which was greatly (but not totally) transformed by Milton Friedman (and Rose w/ “Free to Choose”), and the University’s (and UCLA) association with the RAND corporation.

        Try Kim Phillips-Fein for one perspective of GE’s involvement with the transformation.

        “Invisible Hands-The making of the Conservative Movement from the New Deal to Reagan.”


  10. Ben

    “by focusing on deficit reduction, he has increased the chances of a double dip instead of decreasing them”

    This is exactly what I thought when I read Obama’s quote:

    “It is important though to recognize if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the U.S. economy in a way that could actually lead to a double-dip recession.”

    If we stop adding to the debt now, we’ll repeat the 1930s – as Krugman points out on a daily basis.

    1. eric anderson

      Ben, if we don’t stop adding to the debt now, it’s Zimbabwe time. I would prefer the Great Depression scenario, thank you very much. Have you been to Zimbabwe lately?

  11. lark

    Obama at times seems like the “mainstream media” in giving equal time to right and left approaches, even though we tacked right for decades and we are exactly here, right now, with Obama as president, because the right wing ideas have failed.

    Thus we get tax cuts as stimulus. “Strong dollar” rhetoric. No aggressive pro-jobs policy. Bailouts for Wall Street insiders. No action on making it easier to unionize. Weak action to help homeowners facing foreclosure.

    Now, in the midst of a collapse in demand and soaring unemployment, he tells us he’s worried about the deficit. Thanks, buddy.

    It’s always time for takeaways for the working folk and giveaways to the rich in this country. I am sick of it.

    This weak gruel is Reagan lite. Not what I voted for.

  12. DownSouth

    Thank you Edward Harrison!

    This is an absolutely superb post and one that, when you say “liquidate zombie companies and malinvestment,” addresses some of the issues raised by jdmckay, which in my way of thinking are very salient.

    I must confess that trying to get my mind around all this just makes my head spin. I agree the route Team Obama has taken is the worst of all worlds.

    So that leaves the “liquidation scenario” and the “glide path solution” as to what we ought to do. Like yourself, my preference is also for the glide path solution.

    Libertarians seem to embrace the liquidation scenario, and for myriad reasons. For the more principled libertarians, I believe their reason to be that they believe human nature precludes the glide path solution. The glide path solution may be attempted, but it is bound to failure because human nature makes the Hoover Status Quo the inevitable outcome.

    I’m a little more optimistic about human nature than this and don’t believe the Hoover Status Quo to be inevitable. However, there are no guarantees, the situation being fluid as described here by Gintis et al:

    We argue that altruistic punishment is critically important to both the health of egalitarian systems, as well as to their demise. On the one hand, a small fraction of altruistic punishers can induce self-interested individuals to cooperate, on threat of being punished for defecting. On the other hand, when the frequency of free riding is too high, altruistic punishers will withdraw their participation, thereby exacerbating the problem of low participation rates, leading to the complete unraveling of social cooperation.

    or here by Peter Turchin:

    Another important mechanism for suppressing within-group variation in fitness is moralistic punishment (Fehr and Gächter 2002, Henrich 2008). Unconditional cooperators (altruists) are vulnerable to exploitation by self-regarding free riders. Moralistic punishers (or moralists, for short), unlike altruists, attempt to ensure that others also contribute by punishing free riders. If, despite their efforts, the majority fails to contribute to the common pot, moralists stop contributing themselves (thus, they are conditional cooperators). A moralist, thus, is a second-order cooperator because it creates public good (ensuring that all cooperate) while bearing some fitness costs (because punishment is costly). Mathematical models and experiments with real people show that when public good games are played by mixtures of altruistic, selfish, and moralistic strategies the outcome tends to one of two extremes. Either the moralists succeed in forcing free riders to contribute to the common pot, or moralists fail to do so, and then nobody contributes (except for unconditional altruists, if any are present). In other words, either the group achieves a cooperative equilibrium, or succumbs to the “tragedy of the commons.”

  13. i on the ball patriot

    Edward Harrison said;

    “Barack Obama has now come clean about his thinking on why his administration has decided to focus first on reducing the deficit and next on jobs. He fears a double-dip recession will occur if foreigners lose confidence in the U.S. dollar, causing interest rates to spike.

    This is nonsense and it demonstrates how much at odds Obama’s economic thinking is with reality. This is the clearest indication that the Obama Administration doesn’t understand how modern money works. In fact, by focusing on deficit reduction, he has increased the chances of a double dip instead of decreasing them. ”

    I think the Obama Administration understands very well how modern money works — and they don’t give a rat’s ass about a double-dip recession as it will be just another part of a well crafted (and well executed thus far) program to decimate the global middle class so as to reduce global consumption and consolidate power into a two tier ruler and ruled world. Obama is simply the current flunky con man actor in the decoy illusion that masks the machinations. Breaking past promises made for social programs and reneging on those obligations; pensions, social security, medicare, etc., is well under way and is a very obvious incremental component of the overall plan. You are getting the liquidation scenario, but it is the middle class that will be liquidated.

    Addressing this problem in the very limited framework of economics, that includes only the “private sector, the public sector and the foreign sector”, without looking at the far more pivotally important — and now all pervasive — “corruption sector” as the driving force of societal direction is a distraction and a disservice to your readers. This disservice is especially so when you consider that whatever course you ‘advocate’ is a fantasy that will never be implemented because you have a totally ‘non responsive to the will of the people government’.

    We need a path advocated to responsive government.

    Deception is the strongest political force on the planet.

    1. Valissa

      Well said… hear! Hear! Normally I don’t bother doing this, but this comment deserves the extra attention. Glad to see someone is keeping an eye on the ball ;)

      1. erichwwk

        Ditto! But enough of whining. What is needed now are thoughts on how to return entitlement or purchasing rights to those that create it, and share with those physically unable to contribute their share.

        Under our current monetary system, with the various tools available to the Treasury and FRS to force bankruptcy,as the IMF and World Bank does on the global level, even the tools of private or slow money have only limited impact. Other options?

  14. Marshall Auerback

    Nice piece Ed. I realise that every time one advocates government deficit spending, the distorters come out in force and claim that we are simply taking the country in the direction of Zimbabwe, so let’s be clear. The government should spend UNTIL we get inflation. The inflation would be from too much aggregate demand and a too small output gap.

    That would mean that fatefull day would be an economy with maybe 4% unemployment and 90%+ capacity utilization and an overheating economy in general.

    Sounds like that’s the goal of deficit spending to me- so in fact you are indirectly confirming that deficit spending does work.

    And if we do need to raise taxes to cool things down some day, we can start with a tax on interest income if we want to cut payments to bond holders or a financial transactions tax on the “polluter pays” principle.

    Regarding the supposed default alternative to inflation, in the full employment and high capacity utilization scenario that might call for a tax increase to cool it down, I don’t see how default fits in or why it would even be considered. So again, I’m confused by the concept of fiscal insolvency, which would only seem to apply if there was an external constraint, such as a currency board, or large quantities of foreign debt.

    In fact, with our counter-cyclical tax structure, strong growth that follows deficits automatically drives down the deficit, and can even drive it into surplus, as happened in the 1990’s. In that case one must be quick to reverse the growth constraining surplus should the economy fall apart as happened shortly after Clinton ran budget surpluses for 3 straight years.

    1. DownSouth

      ►”The government should spend UNTIL we get inflation.”◄

      To put that in biblical terms:

      To everything there is a season, and a time to every purpose under heaven.

      A time to be born, and a time to die; a time to plant, and a time to reap that which is planted.

      A time to kill, and a time to heal; a time to break down, and a time to build up;

      A time to weep, and a time to laugh; a time to mourn, and a time to dance.

      A time to cast away stones, and a time to gather stones together; a time to embrace and a time to refrain from embracing.

      A time to get and a time to lose; a time to keep, and a time to cast away;

      A time to rend, and a time to sew; a time to keep silence and a time to speak;

      A time to love, and a time to hate; a time of war, and a time of peace.

      Ecclesiastes 3:1

      I suppose wisdom comes from knowing which action is appropriate for which time time.

  15. Ankit

    “Now obviously, if one sector is in deficit in a given period (i.e. they have spent more capital than they have earned), then the other sectors are in net surplus (i.e. they have received more cash than they have earned).”

    I am confused at this identity. Deficit of US government are funded by the savings of investors and not “more cash received than earned”. Something is not right here. Can someone explain this to me. Thanks.

    1. pebird

      Your right, something is not right, and that is that the US government deficit is NOT funded by anyone.

      Start a new country in your head and figure out how to get a currency started up. You could wait for people to save up the currency, but wait, you haven’t issued it yet. Hmmmmm, a problem, what do I do?

      Maybe the government issues the currency by spending it first, and requires taxes to be paid in that currency. People realize the currency has some use (to pay taxes) and so they start using it, becoming busy beavers and producing and exchanging things they need.

      Of course, the government can’t just issue currency without controls, it needs to understand how the economy is functioning and uses a complex network of private actors (finance) and markets to determine how much money supply is needed to support a given economic output.

      Banks can only issue money with a corresponding offset (liability and asset). So, if you get money privately, you get a loan. If you pay it off and the source you earn that income from only received its money from a loan, there cannot be any net gain in financial assets. The ONLY way to have money “free and clear”, is for the public to issue it. The money issued by the government/public should correspond to the net financial free wealth of the country – the financial value of assets that are not encumbered by private debt.

      The government does not collect savings (or taxes) from people to fund their spending – they just spend. They tax to reduce aggregate demand (reduce inflation pressures) and do some redistribution. In my view, they don’t spend enough – look at our highways and schools.

      But, but, the money can’t just come from nowhere, can it? Just like value comes from nowhere but emerges from our own abstract, invisible work.

  16. RSDallas

    Obama probably got more than an earful from his new Chinese buddies who more than likely TOLD him what he HAD to do or suffer the aftermath of the first failed treasury auction. Henceforth his reckless spending days are over. Result: The US economy still falls off the cliff.

    Obama’s cronies have probably woken up and realized that you can’t re-inflate the consumer who has been demolished by this scandal either by the fact that they no longer have a job or that they are up to their eyeballs in debt and can’t seems to get approved for that “special offer” credit card or low interest rate home loan. Or maybe the consumer has finally woken up from their fairy land dream and they realize that having to much debt can be a bad thing and produce painful experiences.

    This is a DEBT issue (Corporate & Personal). Plain and Simple. The debt has to be wiped out or paid back. It can’t just be kicked further and further down the road like it has been for the last 20 years. It will NOT go away. It will be a painful situation for all of us.

    We probably will have a double dip recession (Maybe Depression) sometime soon. The patient (weak US Companies and the Consumer) can’t live without life support until they pay back their debts. Obama and his cronies have to blame it on something other than themselves. This statement on Fox is an inside look at what’s to come.

      1. SidFinster

        This is closer to the truth, but remember: Obama is a politician, not an economist, and he is in Asia now.

        Right now there are a lot of Asian creditors who are very nervous that their dollar-denominated holdings will lose value because the Obama Administration is spending like drunken sailors handed platinum cards.

        Obama has to reassure these creditors in order to keep them buying dollar assets.

        At the same time, Obama knows that he has to sell any package to the voters back home.

        Stimulus aside, the average frustrated registered voter is not exactly seeing a return to The Good Old Days of 2005 and he is not patient. At the same time, an increasing segment of the electorate suffers “bailout fatigue” and grows ever more nervous about uncontrolled deficit spending. Vid. the recent elections in VA and NJ.

        By crafting this seemingly nonsensical statement about deficit spending causing double-dips, Obama can send a signal to all of his constituencies at once, telling everybody what they want to hear.

        If Obama is good at one thing only, it is that.

        But now for the real beef: regardless what he says, Obama cannot practice fiscal discipline and fight depression at the same time. He cannot simultaneously keep Asian savers and American spenders and deficit hawks happy.

        So will Obama cut the Asians (and American deficit hawks) or will he cut the masses clamoring for pork loose?

        My suspicion is that Obama will make a lot of noise about a strong dollar while his actions will devalue it. After all, Asia has continued to buy dollar assets, no matter how much the dollar is abused.

  17. craazyman

    I very much appreciate Ed’s posts and Yves and Marshall’s and everyones here. Very informative and entertaining stuff, and it keeps me sane to feel the communal outrate at the banksters.

    But the logic here doesn’t make sense to me either. I am not an economist, and I am a bit of a dimwit, admittedly, or at least a blockhead. I drink beer and lift weights and keep my body primed for the beach. Yes, I do. I studied higher mathematics once, but forgot all of it. Whatever I learned in my study of economics was instantly forgotten.

    But even so, I can’t figure out the notion that a government can willingly “reduce its deficit in a given time period”. That is out of its control. It can choose to reduce spending, but it can’t control how much revenue it receives, which is the other half of the deficit or surplus.

    It can estimate this revenue and can change tax rates, but it can’t “reduce the deficit” by fiat, that relies on fate and whatever economic growth occurs. It seems to me that the government deficit is reduced because of an increase in the private/foreign surplus. I may be wrong, I admit. But it seems the chicken and the egg is a problem here.

    Also a government’s books are very different than those of the private sector. Everyone knows that, no doubt Ed does too I am sure. But even so, a government only has revenues and expenses. The private sector has “profits” and “retained earnings”.

    I wonder if this is not an example of Einstein’s admonition to physicists to make things “as simple as possible, but not simpler.” I wonder if all this is “simpler”.

    I still have a bias that economics is 16 equations and 19 unknowns. And that 2 of the 3 unknowns are “Nature” and “Imagination”, which together (plus the third unknown) = Profit. I think the third unknown is “Fate” — like if an asteroid hits the earth and the whole economy disappears and with it all of Imagination. I suppose Fate is a subset of Nature. But I prefer to give it its own category. It seems more elegant to me that way. And theoretical elegance is very intoxicating.

    -D. M. Witt, PhD, MA, BA, GED, MTA, NFL

  18. Gary

    You should present your glide path solution to to the Japanese. They could use a good laugh right now after 20 years of glide path depressionomics. Excess debt needs to be liquidated – period.

    1. mannfm11

      It is government that allows for the frauds that are Enron, Goldman and City. Fractional reserve banking is fraud. What people don’t seem to understand is they went to no reserve banking, which is why what the Fed has been doing is meaningless. The reserves are in the matresses of foreign countries.

  19. kievite

    Down South: Helping people to preserve job and some level of income in times of economic collapse is a worthy goal. If that means heavy, confiscating level of taxation for super rich so be it, they just should not became permanent and should be gradually reduced as the crisis passes.

    As economic collapse undermines good, innovative companies turning them into zombies along with junk companies ( negative cash stream, living of a borrowed time) killing zombies is not such an attractive idea. I think that will lead to the preservation of financial sector at the expense of manufacturing as a result (survival of the greediest ;-). Is this what you want?

    I think that US-minted libertarian (anarchic capitalism) ideas are pretty destructive in he current environment, especially if applied by stupid enthusiasts or greedy opportunists (the latter is more common). This is a kind of Wall Street bolshevism (including Ann Rand style, detached from reality poetization of the law of jungles). Actually those ideas became part and parcel of the current republican ideology that got us into this mess. Less government fairy tale by Reagan turn into fairly dangerous reality of out-of-control Enron, GS, City and like.

    As ideology is sticky, it tend to capture nations and held them hostage even after most realize that it is absurd (bolshevism was dead after the WWII, it took another 50 years to bury it), is not clear what will come out of the current mess and whether the US has enough healthy political forces to prevent “really hard landing”.

  20. Ronald

    Ed, what Obama actually said was that “recent poll data indicate that independent voters believe I am over spending and need to act like I care about the Federal Debt at least until after the next election cycle”

  21. mannfm11

    As I study this more, this is nonsense. History doesn’t say what Hoover did, which was most of what FDR did, which led to a 20 year depression. What they should do is the opposite of what they have been doing. Cut spending, raise the interest rate, raise taxes on unearned income inexcess of $300K a year and boost the tax on earned income in excess of $500,000 to 50%. The payment of government debt would put money back into the system. I would wipe out the equity in the banks and wipe out Wall Street and call the guarnatees on government debt. We would have one hell of a depression for 9 months and a recovery. As it is, we are going right down the Japanese path without an American economy to support us. The debt needs to be wiped out, not supported and increased. I am being somewhat facitious here, but what is being done is disaster and what I recommend couldn’t make it worse.

    1. mannfm11

      In any case, there won’t be a double dip recession because the recovery is a cruel hoax so Wall Street can loot more money. A recovery won’t occur until unemployment claims drop to under 400K a week.

  22. Michael Fiorillo

    Obama may also be setting the stage for attacks against, and the eventual privatization of, Social Security, in the name of “fiscal responsibility.” This has been the wet dream of his banker pals and campaign funders, and their dads and granddads, for decades. Only a Democrat might be able to get away with it, in the ultimate “Nixon goes to China” scenario.

    He is already moving fast to privatize public education by using stimulus money to jam desperate states and localities that can no longer adequately fund the schools into accelerating the opening of charter schools, the Trojan horse of school privatization. While urban public schools are being starved of resources becasue of budget cutbacks, charters are metastasizing, supported by a heavily capitalized corporate/Wall Street/philanthropic/academic/media complex.

    By privatizing Social Security and public education, the commodification of public goods is complete: privatized health care, privatized infrastructure, privatized armies, privatized prisons, privatized schools and retirement systems.

    The Microsoft, er, Gates Foundation now only needs to figure out how to charge you for the air you breathe.

    1. kievite

      I agree that this might be a dream of Obama handlers but politically conditions right now are less favorable then when Bush tried. Also Social security remains so far a small island of stability in the whole retirement mess (401K conversion into 201K). I hope Obama is not suicidal and still entertain some hopes for reelection.

  23. mannfm11

    Aggregate demand has nothing to do with this. Bankruptcy is where we are. Aggregate demand can be solved by taking the losses and starting over. Everything is for sale for something, just not what the bankers need to sell it for.

  24. reader

    I don’t disagree with the authors points, however, they miss the point and the main reason for concern by foreign holders/purchasers of USG debt, that is, that the growth rate of the deficit and the current level of debt, take the country in the short term, 2-3 year, to near-insolvency and the point at which the interest payments overcome the taxing ability of the nation. The taxing power of the Federal Govt has limits – and these are being fast approached. This is the problem. So relative situations with private v. public and how and when and which to de-leverage become irrelavant. If we don’t get the deficity and the unfunded liabilities under control – the outcome will be assured and the only bet will when default will happen and if it will be soft (defacto deflate away over time 10% per year or there abouts) or hard (default or hyperinflation). This is not comlex math – it is simple arithmatic.

  25. Hugh

    All of these net surpluses and deficits are relative to each other within the given paradigm. In a deflationary spiral they could all being going south together.

    I think you haven’t been paying attention to Obama and his policy moves. In fact, he with Orszag at the behest of Pete Peterson already tried to take one swipe at Social Security. That didn’t work out so well. Peterson even got disinvited to the conference he had pretty much put together. And one of the biggest and least talked about areas for cost cutting in the current healthcare debate is Medicare. It is all in the name of reducing waste, increasing efficiency, but isn’t it always?

    Yes, absolutely Obama is replaying Hoover and yes, he doesn’t understand money or economics at all.

    Personally, I think stimulus and debt repudiation are both needed to get out of this mess, but Democratic and Republican leadership on economic issues is so pathetic and lamebrained that it will take fullblown depression and probably even a certain amount of time in one before the public dumps the current hopeless, clueless, totally captured elites for a few common sense problem solvers.

  26. E-con-man

    Aggregate demand, blah…blah.

    Can you explain your point in a simple non-Keneysian language, Ed? After all, your type of economic analysis couldn’t see all these coming anyway. What is the guarantee that it will take us out of the hole?

    1. Hugh

      Actually there are quite a few of us out here who did see all of this coming. And most of us who did see Keynes as one component, but an important one, in how we get out of this mess.

    2. Edward Harrison Post author

      E-con, I am not a Keynesian nor is this a Keynesian analysis. What I am saying is fairly simple:

      1. recession is the result of supply of goods and services exceeding demand.
      2. cutting the deficit means either raising taxes or lowering spending or both. Both of these measures lower demand.
      3. Therefore, the President is wrong when he says cutting the deficit will avoid a double-dip recession because it is likely to precipitate it.

      If the Obama Administration wants to cut the deficit (for whatever reason he puts forward), the time to do so would be when employment and capacity utilization is high. If he wants to cut discretionary spending, he should focus on military spending. If he wants to cut the deficit, the way to do it is to focus on the long-term deficit not on the short-term. So, all around this is bad policy.

      And I actually have seen this coming for a long while:

      The issue is debt. As I indicated in terms of solutions. There are two ways to deal with it:

      1. take your lumps and suffer a sharp decline hoping it will be short (but because the economy is not self-equilibrating, this leads to a deflationary spiral and deadweight economic loss and may not be short)

      2. mitigate the downside, aware that this risks are malinvestment and a long muddle through.

      Given the debt load, there aren’t many other realistic options.

      1. Richard Kline

        So Ed, broadly I agree with what you say here, especially in this concise summation in comments. And I’m supportive of the larger points you advance behind this post, those being a) Obama’s approach (more accurately the Summers-Emmanuel Program for Re-election) is wrongheaded, and b) there are few present _realistic) options to near-term government deficits. That said, I disagree with some of the starker parts of this argument, not that you are alone in advancing them. To me, the differences here are important.

        EH: “[R]ecession is the result of supply of goods and services exceeding demand.” Well, that is one cause of recessions. But there are others, and this one is only part of the cause of our borderline depression of the present int he US.

        Another cause of recession is the collapse of credit provision, i.e. a failure of intermediation. We were very near that as a national financial system a year ago. Now, credit provision to speculators is restored; to the larger parts of the economy it is halting; to small business it is still arrested. Small businesses struggle to get credit even for existing business, and have no opportunity to expand _demand notwithstanding_. This is a significant contributory cause to the continuing economic problems in the US. The Federal Government could use some of that deficit spending to set up a Small Business Loan Administration, an appropriate way to address this issue which would particularly support employment gains and so bolster demand, but we se NOTHING of the sort from the Congress or the Executive.

        Yet another cause of recession is the artificial supression of demand by existing debt. That is, demand and supply are well matched, and indeed actual demand may exceed supply. But debt prevents the action of demand, or either alternatively or in addition makes the demandor a poor risk if paying other than cash. We very much see debt supression of demand in this depressionary environment, which is NOT a cause of excess supply. We see NO MEANINGFUL ACTION on this issue from the Congress, just a lot of hand-wringing regarding mortgage workouts with no follow-through, and what follow-through there is of the crank sort. We see no engagement by the Executive at all (because the debt _holders_ are the most important constituents of the political class, and they will permit no debate or intervention), just a drawing of the covers over the soft little heads of our nominal leaders on this one.

        Yet another cause of recession is demand diversion. That is, instead of buying all those shiny new automobiles made in the Rust Belt US citizens are paying war taxes to support colonial adventures and ransom payments to the health insurance [sic] industry. The costs in both cases are significantly discretionary at the government level (wars could be built down and insurance ghouls regulated, but no). The guns or butter argument, made more broadly. In essence, this is malinvestment at the government level, but it is a fundamentally artificial distortion of demand and supply alignment which again is NOT a function of excess supply. The powers that be are presently flubbing this test big time too, I may say, refusing to contain significantly discretionary, primary costs at the expense of domestic demand.

        Another cause for recessions are if somebody bombs your productive capital sector or distribution system back into, say, the Stone Age, whereby supply falls short of demand but that’s the least of your immediate problems. We don’t presently have this issue in the US as a contributory cause—but we’re big on ‘exporting it’ to others, together with the parasitical private contractors meant to paste said others back together on a cost plus plus basis.

        My larger point here is that ‘demand’ and ‘supply’ are neither uniform entities nor the only functions in an economic system. Economists often formulate the issue this way, and this leads to a certain reification (abstracted thing-ness) of the concepts which distorts. Most large scale actions have aggregate causes, even where the causes are broadly similar (for example demand declines, but from different stresses or problems not a single one). Not all demand is the of univorm function, and different kinds of demand disruptions require different, _specific_ interventions. The specifics really do matter. We have too much lumping of different specific problems under common rubrics like ‘the deficit,’ ‘stimulus,’ ‘interest rates,’ and the like. This is one reason why we often hear these days vehement but completely wrongheaded arguments either advocating or opposing some of these ‘things’ when really something quite different is happening. It is particularly in examining the _specifics_ of present government actions that those actions are most especially found wanting. Egregiously expensive first home buyers’ subsidies which merely shifted demand forward rather than stimulated. Mass credit provision to bankrupt speculators while the real economic activity which might stimulate employment goes begging for funding. Health insurance ‘expansion’ which is a massive windfall for the insurance industry which has presently taken our health care hostage. In almost all cases when one looks at the specifics of present government, what we have is huge subsidy and rescue of profit making, rent-seeking, incompetent, politically connected crony corporations. The minimum demand stimulus bang for the maximum bucks expended.

        EH: “Net-net, the government’s decreased deficit spending will decrease savings in the private sector. And no deleveraging can occur if savings in the private sector are reduced.” Broadly this is true, but again too limiting. The private sector can also increase savings the old fashioned way, by turning a profit on economic activity.

        Perhaps by alternative, some of those stuck off the sugar tit of government money provision might have to engage in come productive activity which stimulates demand. Consider those banks earning riskless returns on their reserves at the Fed, they might have to actually, um, lend some money to earn a profit.

        This isn’t an argument here that we don’t need stimulus but we should just liquidate and let the bastards earn a living, dammit; the welfare queen diatribe, just applied to corporate welfare queens. There are too many dislocations and too much debt, stimulus is warranted in the short-term. But the _manner_ in which stimulus is being applied gets very little short-term return will introducting ever greater long-term costs and structural distortions. Intended or not, if government spending crowds out actual economic activity because the government money is *cough* free to those well enough connected to gorge on it, _that_ kind of government spending is a cancer. We have in this, too, the issue of ‘military stimulus spending’ which has recently been discussed in posts on NC. There is evidence that this kind of spending actually _supresses_ the domestic economy in the long term.

        Again, ‘fiscial policy’ or even ‘deficit spending’ aren’t uniform entities which can be taken ceteris paribus into economic formulae to produce *voila* a ‘right answer or wrong answer’ (sic). I know that you understand this, Ed, but the rhetorical fine points really matter. There are multiple vectors to fiscal policy. Some are useful; some are questionable but necessary; some are useless; some are pernicious. Too many facets of the fiscal policy of the present Administration vacilate between useless and pernicious. I take that as your larger point; certainly, it is mine.

        1. Edward Harrison Post author


          thanks for adding that. We definitely agree on some of the finer points that I couldn’t address in the post. If I understand what you’re getting at, you’re talking about the difference between proximate and ultimate causes, recession and depression.

          The proximate cause of this downturn is supply of goods and services exceeding demand. The ultimate causes are a credit crunch caused by too much debt used to perpetuate unsustainable and misallocated consumption.

          For a generation now, private sector debt levels have been building in the U.S. to foster growth of the financial sector and, at varying times, the technology, telecom and housing sector. There has been a tremendous overbuilding and misallocation of resources which can’t be captured in GDP statistics.

          With this credit crisis, we have reached a point where the debt levels cannot be pushed much higher. So while we may be in a statistical recovery, depression is the longer-term result.

          The problem I have with the economics of the Administration is they deny this. We can debate how best to achieve an unwind in a fair and efficient way and whether a debt unwind can be controlled. But,the Administration does not seem interested in accepting this. They appear to be trying to perpetuate an asset-based economy as if it were sustainable – by using stimulus to prop up rickety enterprises and to keep the financial sector abnormally large. In so doing, they are making the eventual unwind that much more painful.

  27. Vi ny G.

    This resembles the crash of the Titanic and the iceberg.
    The question is this: is America the Titanic, or is it the iceberg?

    Vinny G.

  28. Mark


    I can’t help but reiterate how much I think of what you have to say — it is amazingly lucid and illuminating IMHO.

    On topic, it seems that there is something to what Obama is saying if you believe, as I do, that inflation and rising interest rates are a genuine risk if the monetary base and deficit spending increase (even with 10% unemployment). Inflation and higher interest rates could be especially destabilizing because they could cause real estate values to collapse in real terms while other prices increase.

    Interest rates and inflation seem like a real conundrum. In my view, the “fake” recovery and rapid increases in debt and equity values in the face of very weak underlying economics over the past six months illustrate how quickly and easily quantitative easing can create bubbles.

    If foreigners are concerned about our balance sheet, they will be reluctant to finance our deficits. If foreigners will not finance our deficits, the Fed will need to, and this will likely inflate more bubbles and create inflationa.

  29. rootless cosmopolitan


    Although I agree with you on that reducing the public deficit increases the probability of a recession, I have a problem with your argumentative logic.

    You write with respect to the source of credit:

    “This puts that individual, company or group/sector in deficit i.e. they have spent more money than they have earned. Now obviously, if one sector is in deficit in a given period (i.e. they have spent more capital than they have earned), then the other sectors are in net surplus (i.e. they have received more cash than they have earned).”

    Correct me, if I misunderstand you, here you say that the source of someone’s debt was the fraction of someone else’s income, which wasn’t spent, i.e, “saved” (BTW: What is “they have received more cash than they have earned” supposed to mean, anyway?). But, aren’t you missing here totally that banks create loans, i.e., credit money out of thin air? Banks don’t need any current savings/income to do this, although they expect future cash flow from it. And I think credit created by banks is a major (or the major?) source of debt in modern world economy.

    But if banks create credit out of thin air, then your conclusion,

    “Unless the increasing current account deficit switches direction violently, this can only mean that reducing the government’s deficit reduces the private sector’s surplus. Net-net, the government’s decreased deficit spending will decrease savings in the private sector. And no deleveraging can occur if savings in the private sector are reduced.”

    for this portion of debt in the economy, the source of which isn’t someone else’s income, doesn’t follow anymore.

    Secondly, even if saved income of the domestic private sector was the source for 100% of the public debt, I see yet another flaw in your argument. You imply higher net private saving is the same as deleveraging, or lower net private saving is the same as reduced deleveraging. You ignore 1. that net private saving is the difference between saving and investment (S-I) in the accounting identity and 2. that debt isn’t equally distributed over the whole private sector. Instead, there are net debtors and net creditors. Deleveraging means that net debtors reduce the amount of their debt, but the term I needs to only grow faster than S to reduce the difference S-I, compensating for a reduced public debt in the accounting identity. The increase in the term I could come from the net creditors. If the net debtors in the private sector pay off their debt (assuming they still can, which is doubtful for a large fraction) to the net creditors in the private sector, then there is deleveraging in the private sector. And for this, net creditors only would have to reduce their fraction of S with the same rate, with which net debtors increase their fraction, in turn. There even isn’t any necessary relationship to the amount of public debt here.

    Nevertheless, reducing the public deficit would increase the chance of a recession, assuming total demand (i.e., GDP) in the economy is the sum of total income and total debt change (i.e., the first derivative of the total debt amount). Thus, a decrease in debt change in a time period (i.e., the second derivate of total debt is negative), even if the debt change itself is still positive, would provide a negative contribution to the GDP change. The same would be true for a decrease in the debt change of private debt, though. Decreasing private debt change, e.g. due to accelerating deleveraging, if the debt change is already negative, also increases the chance of a recession.

    All of this is quite abstract. I don’t really believe that the trajectory of the economy or the deleveraging process in a totally over-debted economy, once the debt bubble bursts and more and more debtors default on their debt, can be actually controlled.


  30. a

    “At issue is whether the federal government’s enormous debt burden in the U.S. could cause investors to lose confidence in the U.S. government and shun its debt. ”

    Yes; and since Obama has just been to the Far East and talked with the Japanese and Chinese, who are the biggest holders of said debt, maybe he knows WTF he is talking about.

  31. Mickey, Akron, Ohio

    Of the three options – liquidation, the glide path, and Hooverian – the first and third are DOA non-starters. From the moment Paulson pushed TARP onto policy-makers Obama’s hands were tied. Politically, nationalization and the writedown of shareholder equity were not in the cards. And doing so now would be bad timing… and ensure a double dip, if not a free fall over the cliff. The collateral damage to the global economy would be considerable and not without consequences. So, LIQUIDATION is not in the cards.

    The Hooverian option is more for Chinese/Japanese ears than it is for domestic consumption. If the economy double dips Obama’s electoral fortunes in 2012 will double out. Hence, talking tough about deficits is only that right now. It is a warning shot though that at some point after 2012 AUSTERITY measures of some sort to address the deficit will be on the table. If I had to bet, looking at federal outlays – Defense, Social Security, and Medicare – the latter two will likely be targeted for “reform”. Defense is “off limits” even though I suspect it could be cut by a $100 billion without any appreciable loss in security. But it ain’t gonna happen… Whether Democrats wield the cleaver or not after 2012, once Social Security and Medicare are “reformed” the true meaning of “change we can believe in” will be revealed.

    Our creditors have been assured that nothing radical or sudden will be done to upset their apple cart full of our apples. CONTINUITY will be the rule for now. The “glide path” is the only real course to follow at this point, however incoherent and frustrating it may be. Muddling through if you will… And I think Ed knows that.

  32. jdmckay

    I read your stuff regularly, both here on on your blog, and both appreciate & value much of what you say.

    But, I (respectfully) think much you assume is incorrect… these are different times with vastly different conditions. You say:

    Simply put, if you look at all of the households and businesses that make up the private sector and aggregate them together, you can determine if the private sector has a net surplus or a net deficit in any individual time period.

    That statement implies (IMO assumes) there are reliable figures to add up. I’ve looked hard, and (despite what some “experts” say) I don’t think that’s so.

    The fed’s toxic asset valuations are guesswork at best, not to mention added complication of Fed’s assumption of all those junk (mostly) CDOs co mingles public/private assets. Beyond that, we have another big round of VRM up-ticks coming next year, w/a dwindling Joe Q Citizen income base already strung out and holding on. Much of that “holding on” is sourced by tapping savings, 401k’s (etc).

    Beyond that, US accounting practices have been largely left uncorrected since Enron.

    I’m a techie… programmer, network guy, I have just about every Micro$soft certification there is. My retirement has been 401k exclusively, mostly built up since early 90’s.

    Through early 2000’s, I had professional investment managers handling this, w/fairly close oversight on my part… but no level of understanding nuts & bolts of things like I do now… not even close.

    Since Enron, I began spending hours… tons of hours, investigating markets/companies/currencies/regulations… all of it. I’ve managed to not only avoid losses, but profit since ’03.

    I can tell you, unequivocally… I know a lot of these proffesionals here in Albuquerque, a lot. I’ve had substantive discussions w/most of ’em in advance of every major market event since ’03, and I was right on all of ’em for precisely the reasons that moved things.

    Not one of these “pros” got it right. Virtually all were knowledgeable only of the data/product pitch their respective institution was marketing. Even the CPA firms here were advising to stay “in the market” as late as 3/09, saying we were “only experiencing a correction.”

    In our state (and from what I see, all across the country) appointed managers of public funds (state/local retirement & benefits) had virtually no understanding of the securities to which they committed themselves. Here, they were various flavors of derivatives, built layer upon layer, that when traced back to their orgins were valued upon… you guessed it, mortgage bonds.

    I can also tell you that there is no home value rebound on the horizon here. I can also tell you that Albuquerque… a town w/steadily growing, healty tech sector just 4 yrs ago, has lost all that. There is very little left… a lot of bankruptcies. Office space vacancies are higher than published data reflects.

    There is not much $$’s available to get it going again. Beyond that, the income needed from these tech startups, given cost of operation here, is increasingly problematic because much of what they would offer is just not competative w/similar foriegn enterprises… it’s just not.

    Situation is much worse in Silicon Valley (where I spent 15 yrs through ’05).

    And we haven’t even started talking about hazards in commercial real estate…

    And if the private sector has a net surplus, the combined foreign sector and public sector must have a deficit for that time period. The sector financial balances move in concert.

    By my accounting of things, none of this can be anywhere close to accurately accounted for by available accounting data. To my eye, however, what is more indicative of public/private balance sheets is the productive activity I see. And what I see is not encouraging. In fact, at best, there’s huge volumes of capable workers hanging out in a holding pattern, w/fingers crosse, hoping “things will turn around.”

    So, returning to your assertion re: calculations of public/private debt & equity… I just don’t think it prudent, myself, to buy that given current conditions. As I’ve said recently in a few other posts here, there is very little focus on just what kind of economic activities are going on (or more importantly, not going on).

    Where’s all these “stimulus” $$ going? Are they jumpstarting needed initiatives… planting seeds that can fuel necessary and self-sustaining economic engines? I don’t see it.

    I’m very dismayed listening/reading these discussions about size of stimulus… do we need more or less, and is deficit too big/sustainable… whatever. From where I sit, the near total exclusion of just what the hell is being invested in, what we (society) needs, and what it will take to get us there… it’s all obscured through macro economic jargon that illuminates little that matters.

    I think these discussions, as you’ve proffered here, are several times removed from what matters. There’s been too much erosion of underlying material value which, when it’s all said and done, is what determines whether $USD has any real value at all. The levels of obfuscation that have accumulated, especially this decade, suggest to me that if accurate value of just what we have as a nation is to be determined, we’re going to have to roll up our collective sleeves and do a serious housecleaning. We’re going to have to assess what we have, from the bottom up, rather than continuing assumptions promulgated from the top down, based on foundatiohns that no lonhger exist.

  33. g kaiser

    He might have said it, but he is only regurgitating what he has been told to say. Goldman et al are running the show and will demand service for their ilk. To hell with the rest.

    We are approaching the edge, faster than many may realize, and it is most likely too late to make any attempts to steer or brake. So, the cliff it will be.

    What will fall fastest, Obama’s popularity or the economy of the US is anybody’s guess.

    He is dead right on one account though, foreigners increasingly do not trust the US or the leadership of the country, which are the banksters.

    Splat, splat.

    1. Siggy

      The private sector needs to delever. The Federal sector needs to delever. That debt that cannot be serviced needs to extinguished. All of the foregoing leads to a reduced level of demand. Given the relative fixed position of supply, there needs to be a substantial reduction in all prices.

      We need to embrace deflation. We need to restore to the currency its function as a store of value. The preservation of purchasing power should be the sole function of the Federal Reserve.

      The regulation of the financial markets needs to be reconstituted; and critically the natural penalties for failure need to be reconstituted. More than moral hazard is accomplished when we bailout some bank because it happens to be a ‘primary dealer’ bank. We abrogate the most important aspect of the force of the market as an insturment of control. If there is no penalty for a foul, there will be fouls!

      I say, lets have the depression.

      1. jdmckay

        We need to restore to the currency its function as a store of value.

        Bingo… then respond to what that tells us.

        1. Siggy

          That we are a bankrupt banana republic on the path to becoming some form of a have and have not society with too many nuclear weapons.

      2. rootless cosmopolitan

        “We need to restore to the currency its function as a store of value.”

        I don’t even know what it is supposed to mean, when you say “store of value”. What is “value”? How can “value” be “stored”? And what was different, compared to today, when currency was supposedly a “store of value”?


        1. Siggy

          The meaning is the presevartion of purchasing power. If purchasing power is continuosly diminished, improvements in productivity are illusory. Similarly, you cannot borrow your way to prosperity whereas, you can save your way to prosperity only if the purchasing power of your currency remains constant.

          Government stimulus funds are derived from increased tax revenue. Effectively, what the government hands out the government takes away.

          If you don’t understand the continuous loss in purchasing power of the money then you are probably unaware that coffee once sold in one pound tins, today the typical tin is 12 ounces. Or, 40 years ago you could buy a very nice car for $6,000, today a comparable car will cost upwards of $24,000.

  34. MPatin

    Good piece. Put another way, the Fed and Treasury have painted themselves into a corner and they can only hope the paint will dry enough for them to tiptoe out carefully without destroying the floor. The problem is I don’t think anyone knows how feasible it may be to even “glide” out slowly as you suggest. The amount of credit deflation (paint drying) that may be required will only put additional stress on production and raise the probability of another leg(s) down. If mass opinion sees this happening, the shift in psychology could bring us back to a depressionary mess of historical proportions, and the Fed and Treasury will have shot their wad. Banks who are wary or downright incapable of lending now will be driven much further into that mindset. The smart guys over at Elliott Wave advisory have pretty much bet their farm on that “inevitability.” Leave it to say, it’s scary our there.

  35. par4

    Everyone needs to QUIT thinking the government works for them. That’s pre-Reagan thinking. Both Dems and Repugs serve the oligarchs first then the plutocrats. They aren’t going to give it up, you’re going to have to take it from them.

  36. Blindweb

    They all seem to fail to realize that THERE IS NO WAY OUT. The U.S. economy overextended. It will return to a lower state no matter which policy is chosen. The only question is the path it will take. The majority will be losers, a small percentage will be winners depending on the policies.

  37. Alex Sebastian

    Maybe I missed something, but I feel like there is discontinuity in your arguments. You said that the private sector has more leverage relative to the size of the economy than the government (a comparison which I do not feel proves anything – but I digress), and as a result you would prefer for the private sector to pay down their debt vs having the public sector do so. Fair enough. Then you go on to say that the private sector’s increased savings will automatically create a bid for Treasuries. If in fact they are deleveraging though, by definition, they will be paying down their debt, rather than buying assets (Treasuries) with their savings. So the question is: Who does the private sector owe money to? I’m going to go out on a limb here and say that the vast majority of it is neither domestic consumers (anyone remember negative savings rates?) nor the government (when was the last time you saw any government buying Corporate securities?)…. leaving foreigners. So if foreigners do in fact lose faith in the USD, with the private sector net saving, these savings are very far from automatically translating into a bid for Treasuries. With governments globally issuing like no tomorrow (and corporations to boot – $7T in bank debt maturing in the next 3 years), there will be a whole lot more global competition for those dollars than usual – likely leading to the spike in the cost of debt that Obama was referring to.

  38. debt

    I think as the dollar is falling, US exports will become more cost-competitive: And with that, imports will also be more expensive. This will help to stabilize the dollar, at some point the balance of trade will be restored. However, America will need to rebuild some of its old export-oriented industries. And Americans will need to become accustomed to a lower standard of living, both in relative and absolute terms. The change will be less visible and create less political stress, if it is delivered through erosion of the dolla

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