Alford: Structural Remedies Necessary to Tame Global Imbalances

By Richard Alford, a former economist at the New York Fed. Since then, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.

Calls for global rebalancing are back in vogue, while the debate about the appropriate stance of domestic policy heats up again. While there is disagreement about the exact role the global imbalances played in the run up to the financial crisis and the crisis itself, there is general agreement that a rebalancing of the global economy is necessary if we are to enjoy a return to sustainable growth. There is less than full agreement on the net benefits of further monetary and fiscal stimulus.

China is in the hot seat and the Yuan exchange rate remains the focus, even as the US is placing greater weight on continued Chinese fiscal stimulus. In addition, US-based macroeconomists and policymakers are now focusing on and criticizing proposed fiscal austerity in Europe. Their concern is not solely with European economic performance per se. Among their concerns is the perceived impact that European austerity would have on US economic performance. They view demand and income growth in Europe as the means by which the US will reduce its current account deficit. There is little or no mention of any need for the Euro, the Dollar, or any currency other than the Yuan to adjust to promote or support the rebalancing.

These positions reflect interesting wrinkles in US economists’ and policymakers’ mind sets. They are a variant on the old US policy position first espoused by the then Secretary of the Treasury John Connolly: It’s our currency, but it’s your problem. The current version is: It’s our current account deficit, but it’s your problem. Alternative wording of the revised up dated Connolly doctrine: If the rest of the world will just pursue expansionary fiscal monetary policies, then the US can avoid having to choose between austerity and unemployment on the one hand or further increasing unsustainable deficits on the other.

However, the idea that given global counter-cyclical stimulus and “Bob’s your uncle”, the US will return to sustainable noninflationary trend growth does not stand up to analysis. It is unlikely that counter-cyclical expansionary policy abroad will correct the US current account deficit or help restore trend growth. In fact, the idea that the solution to the current US economic woes lies in traditional counter-cyclical policy is being questioned. Recently, in the FT, Jeffrey Sachs wrote:

• Now, against a backdrop of a widening sovereign debt crisis we need to abandon short-term thinking in favour of the long-term investments needed for sustained recovery
• .. Certain countercyclical spending is vital on social grounds. But stimulus measures …reflected a hope that a temporary fiscal bridge could carry us back to consumption and housing led growth — a dubious proposition since the old “normal” had been this financially unsustainable.

Sachs offered a number of guidelines for economic policy consistent, in his view, with restoring sustainable trend growth. They included:

• government should work with a medium-term budget framework of five years and within a decade-long strategy on economic transformation.
• governments should steer their economies towards needed long-term structural transformation. External deficit countries such as the US and UK will need to promote exports over the next five years …
• we need, in sum, to reset our macro timetables. There are no short-term miracles, only the threat of more bubbles if we pursue economic illusions…

Sachs cites the need for the US to promote export growth and not simply expand domestic demand. The language suggests that he believes that the US external position reflects a structural problem that has to be addressed if the US is to achieve sustainable trend growth. Furthermore, Sachs is not alone in his beliefs that inappropriate economic policy can contribute to the growth of the economic imbalances. For example, Edwin Truman writes:

“Instead, the imbalances and the crisis were jointly caused by flaws in the design and implementation of macroeconomic policies and the resulting global credit boom.”

If a return to external balance or at least a trade deficit of a sustainable size is required for the US to achieve sustainable growth and avoid future crises, is it reasonable to assume that demand stimulus abroad alone would bring about the required structural transformation in the US economy? There are numerous reasons to believe that is not the case. Returning to Truman:

Current account balances are endogenous to the economics of the overall economic and financial system. A country’s recorded, ex-post current account position must simultaneously satisfy three relationships: the difference between net domestic savings and net domestic investment, the difference between domestic production (output) and domestic demand (often referred to as absorption), and the difference between the net change in the demand for domestic assets by the rest of the world and the supply of those assets…

It follows that external adjustments also require parallel domestic adjustments in order to succeed. Calling on our trading partners to increase demand and their imports from the US will not narrow the trade deficit unless there is a narrowing of “the difference between net domestic savings and net domestic investment…”, but US domestic economic policy is not supportive of the required domestic adjustment. Continued deficit financing of stimulus packages widens the difference between net savings and investment. Monetary policy is also geared towards increasing consumption and reducing private savings. To the extent that a significant fraction of the consumer basket is comprised of imported goods and the US income elasticity of demand for imports is high, stimulating consumer demand increases domestic demand (often referred to as “absorption”) relative to domestic output. In short, US domestic economic policy is inconsistent with an effort to achieve external balance and hence a return to sustainable growth. Back to Truman for a moment:

It also follows that a large country has the capacity through the application its own policies to achieve, within a reasonable range, is preferred current account position….

Given that US macroeconomic policy remains inconsistent with reducing the external deficit (in fact, it is just the opposite), our trading partners might very well ask why they should deviate from their chosen policy stances to help the US reduce its external deficit when it is unwilling to adjust its own domestic policies to achieve that end.

The relative downplaying of the importance of exchange rate adjustment in addressing the US trade imbalance is also troubling. If the US is to correct its external imbalance, resources (capital and labor) are going to have to be reallocated to the production of tradable goods and services. In the absence of Dollar exchange rate adjustments, it is difficult to see reasons why the US economic agents would move into the tradable sector. In recent years, if anything, US resources have been moving in the opposite direction. It is unlikely that economic agents in the US will return to the tradable goods and services sector solely on the basis of promises by our own policymakers or other policymakers that demand for US exports will increase.

While exchange rate adjustments will not alone correct the imbalance, it is difficult to see a solution without some exchange rate adjustment. It is virtually impossible to see it given the absence of exchange rate adjustment coupled with fiscal and monetary policies which are inconsistent with a narrowing of the imbalance.

Returning to the principle point, the US faces structural and not just cyclical economic problems. The structural problems are reflected in mutually determined unsustainable current account and fiscal deficits, as well as depressed saving rates. It is easy to see evidence of structural problems in economic performance, All one has to do is look at recent economic performance (e.g. growth rates, growth in real wages, the number of workers who have joined the long-term unemployed etc.) relative to earlier periods and recognize that those less than satisfactory outcomes were only achieved with virtually constant economic policy stimulus (e.g. the cyclically adjusted Federal fiscal deficit) and asset-price-bubble-induced unsustainable increases in consumption relative to income. (See Brenner for evidence of the structural dimension of the current crisis.)

Once one recognizes that the US is contending with structural as well as cyclical problems, then it is clear that a move to sustainable trend growth requires something other than the standard countercyclical stimulus. In order to achieve balanced sustainable growth the US will have to increase savings (relative to income and consumption), increase investment relative to income, and increase the production of tradable goods versus nontradable goods. However current US policy has consisted of efforts to stimulate private consumption (decrease savings), increase public dis-saving, subsidize consumption of nontradable goods (housing) all coupled with perfunctory calls for exports to double.

Unfortunately, the US does not face a simple choice between lower fiscal deficits and idle resources on the one hand, and temporarily higher deficits and trend growth with full employment on the other. Or, as Sachs put it: “There are no short-term miracles…” The US also faces a choice between addressing the causes of structural imbalances now, perhaps at the expense of idle resources, or addressing the same problems in the future when the costs of adjustment will undoubtedly be higher. The costs of addressing the global imbalances now are higher than they would have been had they been addressed in 1996 or 2001.

Economic stimulus, which is not accompanied by steps to address the underlying structural problems, is a pernicious palliative. It will mask the costs of the structural problems; reduce any incentive politicians and policymakers have to pursue short-term costly, but longer-term higher payoff policies; and at the same time allow for the costs to resolve imbalances to fester.

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  1. Greg

    It’s been 3 years. There hasn’t been a substantial policy change anywhere. There won’t be. It’s all in.

    1. alex black

      That would seem to be the case. We’re going all in. With a pair of deuces. And a printing press.

  2. alex black

    Just curious – if the solution to our structural crisis and chronic trade deficit is for the US to produce tradable goods (presumably to be bought by consumers in countries with huge trade surpluses – oh excuse, me, I mean country with huge trade surplus – cough, China, cough), what the hell can we make that the Chinese can’t make themselves at far less than our cost? They’ve got a billion people they need to keep working, and who are happy to work for far less than what US workers have come to expect and demand (for the Chinese workers, it’s a huge upgrade for them to work at current manufacturing wages – beats starving in a rural mud-floor hut.)

    Seems like there’s nothing we can produce that we can trade to the Chinese consumer. Maybe the Chinese government? What, better arms? A giant fleet of state-of-the-art drones? Not sure that’s a great idea…. Commodities? Yeah, they need oil, we’ll trade all our surplus oil. Oops. We don’t run a surplus with oil…. Other commodities? They’re already locking them down everywhere else in the world, and we don’t have any anyway.

    I’m at a loss here. The only thing I can think of is that with China’s one-child birth policy and their preference for boys, they have a couple of hundred million boys growing up who won’t be able to find girlfriends or wives. Maybe we should start teaching our daughters how to speak Chinese, and be really deferential and all that. If we can pry off their Ipods for a minute, and get them out of the mall.

    What exactly do we have to trade?

    1. ndk

      China has long complained that we don’t export enough high-tech goods to them, and I think there’s some validity to that. I believe even Germany and Japan run trade deficits with China, but more generally, there’s also some validity to the idea that moving up on the value and quality ladder is a viable approach to trade. There are some options.

      But yeah. For most of us working stiffs, this is a race to the bottom, and I for one am, along with my field, well on my way. Wait for the field to level through 30 years of gradual impoverishment, and go from there.

      The far greater threat to all of us serfs in the medium- and long-term is automation. There will always be jobs that humans are best for, but retraining is getting harder and harder.

      1. alex black

        I suspect that wage arbitrage will take far less than 30 years to complete. The grind will be much quicker.

    2. Tom Crowl

      You hit the nail on the head!

      Apparently the Rubin, Summers, et al “Genius Club” figured we could export “Magic Paper” forever. Somehow they assumed the world would be enamored of our financial acumen and then we could all become stock brokers and investment bankers…

      and then live happily ever after… forever.

      Oh well. Oops!

      Of course you can’t ignore the careful attention that the American people have given to their democratic processes. They’ve allowed this to happen. They stood by and beggared their own children by ignoring this idiocy in exchange for Hummers and 3000 square foot houses that they’ll never own!

  3. ndk

    “Given that US macroeconomic policy remains inconsistent with reducing the external deficit (in fact, it is just the opposite), our trading partners might very well ask why they should deviate from their chosen policy stances to help the US reduce its external deficit when it is unwilling to adjust its own domestic policies to achieve that end.”

    Brilliantly worded, Richard. Thanks for this.

    I agree that a revaluation might help somewhat, but only at a cost to the Chinese. I can’t imagine they move quickly enough that the PBOC needs a rescue, though, and am frankly gobsmacked they’ve done anything at all. And it’s no more than a part of any solution. As we saw from ’05-’07, it wasn’t enough — things actually got markedly worse.

    Essentially, this is China confessing that part of the blame for imbalances is on their shoulders.

    I wonder if there is a quid pro quo in place similar to what you describe. Geithner, before his apotheosis to Treasury, used to worry a lot about our low domestic savings. I’ll eat my hat if the man has the courage to pump up domestic real interest rates to increase savings at a time of ~17% underemployment. Maybe there’s just a promise to act as soon as possible. Or maybe Fisher was really signaling something.

    And if nothing else, a sense that the USD is losing one of its struts should lead to some capital and some slightly higher real interest rates. That fall in the currency might be enough to get enough inflation to counteract the deflationary force of the higher real interest rates, but the tandem effect on long bonds — owch. Guess we’ll see.

    But I still honestly don’t get why China would budge at all. It’s so against their interests it hurts. Where has my thinking gone wrong?

    1. alex black

      The other problem with raising interest rates is that that would gobsmack the already teetering housing values, making the solvent banks insolvent, and the insolvent banks even more insolvent, and most homeownes with equity (which is often their main retirement savings) – equityless.

      There are a lot of homes with adjustable mortgages – up the short-term interest rate and those instantly become foreclosures.

      At this point, I’m wondering if the only quid pro quo we have to offer China is “How many trillions of dollars that we owe yo will you forgive us if we look the other way while you take Taiwan?”

      Trade war or tariffs? All the prices at Wal-mart suddenly double and we have rioting shoppers who NEED that $39 vacuum because their shrinking budget can’t afford an $80 one anymore.

  4. attempter

    Economic stimulus, which is not accompanied by steps to address the underlying structural problems, is a pernicious palliative.

    True, although nowhere near as pernicious as bailouts and corporate welfare (including “military stimulus”).

    Of course, the only structural reform worthy of the name would involve ending all corporate welfare, eradicating all rackets, purging all rents, and redistribuing land on a food production stewardship basis, since America needs millions more small and medium-size farmers. That’s both a post-oil physical imperative and a democratic imperative as well.

    In general, since we’re bound to undergo transformation to the post-fossil fuel world anyway, structural reform by definition would be focused on a rational policy for this transition.

    And by now we’ve learned that representative pseudo-democracy didn’t work. Everywhere it was hijacked and turned pernicious. So anyone who doesn’t want the post-oil political and economic order to retrogress to all the worst aspects of medieval feudalism must fight for a new, decentralized federalism, with a much, much lower center of gravity (political relocalization), which would constitute a true participatory democracy.

    That’s the stuff I think of when I think of structural remedies.

    But those still hypnotized by oxymorons of faith like “sustainable growth” (a contradiction in terms) will never start finding their way out of the trap, since they’re only searching for ways to remain inside it.

    1. i on the ball patriot

      Attempter, you consistently get it, and you keep the focus where it belongs. Kudos to you!

      A nit pick/question here … I am not sure though that “sustainable growth” is a contradiction in terms unless you have bought the Orwellian meaning change in the word growth itself through its co-option so many times as a mask for greedy privatization. We here the ‘growth is good’ sloganeering associated with the gangster slime greed grabs so often that many of us now, through that disingenuous association, consider growth as bad and unsustainable. But there is a good and normal balanced growth or development that is achievable with the greedy pigs out of the way. I would hope that that balanced growth is achievable and ‘sustainable’.

      Deception is the strongest political force on the planet.

      1. attempter

        Thanks for the kind words, i ball.

        The reason growth is not sustainable is thermodynamics. EROEI. Exponential growth requires exponential increases in energy production and use. But with Peal Oil and soon Peak Coal it won’t be possible to sustain anything close to the current level of energy consumption, let alone keep increasing it.

        The world’s economies never really grew in the thousands of years prior to the Industrial Revolution. Nor did population, which kept running up against Malthusian limits; the only reason Malthus was “wrong” was because he didn’t take the one-off fossil fuel drawdown into account.

        And that drawdown, which was nothing but spending the principal which was kept under a mattress, was the only thing which enabled the Industrial Revolution and the “growth”/debt economy itself.

        I suppose in theory it might have been possible to use the surplus afforded by fossil fuels to build out a renewable energy infrastructure which could have been largely self-sustaining. This couldn’t have been a “growth” economy, but it maybe could have maintained a steady state considerably above the level where we’re headed.

        But instead mankind chose to use the fossil fuel inheritance for wars, luxury binges, and keeping gangsters. Very expensive, destructive, worthless pursuits. And now it’s too late, and the great struggle of the Peak Oil age will be to get rid of those gangsters instead of letting them reinstate medieval feudalism. We’ll be lucky if we’re not all slaves, let alone still have some significant level of energy to work with.

        The fossil fuel age was just an ahistorical blip. With the fossil fuel peak and energy descent in this century, civilization and its economy/economies will return to the normal historical track.

        1. RagingDebate

          What we will actually be lucky is if the world avoids war as the alternative of reinvesting in a sustainable model. Mankind centralizes and decentralizes. Those with the gold aren’t going to give it back or reinvest it until the bottom of this downturn has been reached. I expect full blown war to be raging before that time.

        2. i on the ball patriot

          “I suppose in theory it might have been possible to use the surplus afforded by fossil fuels to build out a renewable energy infrastructure which could have been largely self-sustaining. This couldn’t have been a “growth” economy, but it maybe could have maintained a steady state considerably above the level where we’re headed.”

          I would consider; “a renewable energy infrastructure which could have been largely self-sustaining” as “sustainable growth” and not only NOT an oxymoron but a laudable goal. Yes, continued exponential growth is out of the question, but a very throttled back growth based on reasonable and sustainable growth is possible I believe.

          I think I might be more optimistic than you are in terms of reversing the big fossil fuel pig out that we have been on and are still in. I see it more — to use the diet metaphor again — as humanity has been on fossil fuel roids for a while, got pumped up, and now, realizing the gross error, must get off the fossil fuel roids and get consumption to a more sustainable level by bringing on alternative (foods) technologies. We have developed some pretty big technology muscles in the roid stage that can be applied to the problems. I know it won’t be painless, as much damage has been done, and the gangsters are still firmly in control, but I like to keep the hope alive so as to urge as many as possible to decentralize and move in that self sustainable direction.

          Knocking off the parasites and gangsters is job one though and the work done in moving towards that sustainable goal has to be balanced with much more political involvement by everyone.

          Deception is the strongest political force on the planet.

  5. lark

    Reading this article was a waste of time. I thought he was going to suggest structural remedies – which ones, for example. All he is saying is that we need them. Well, duh.

  6. don

    The author sites Brenner, who as a Marxist economic historian would, I suspect, and this is based on having read much of his work, that global uneven development (a term more in vogue with Marxists, but meaning essentially the same as structural imbalances), contains internal structural contradictions that are essentially irresolvable within the logic of global capitalism.

    I would add that any notion that these structural imbalances can be addressed by US policy makers is naive at best. Furthermore, any correction of structural imbalances in the US presumes the resolution of those balances globally, which would imply that policy makers on a global scale work in coordination to bring about that resolution. That seems highly unlikely to me.

    Having said all this, the author brings to the surface several compelling arguments that seems to escape those who debate greater stimulus vs. reducing deficits.

    1. purple

      Most Marxists would say ‘global imbalances’ are unresolvable within the nation-state system, with some debate about whether capitalism is logically attached to the nation state system.

      Keynes saw this and proposed his Bancor currency, which was shot down by the dominant nation-state at the time, the U.S.

      Capitalism without a dominant nation state has a very bad history, and a break-up of the US military umbrella in Asia would reveal that in short order. Another question is whether imposing its global order will ultimately bankrupt the U.S.

  7. Jackrabbit

    If you’ve followed Alford’s postings, a least since the beginning of the year, you may have the sense that he is aligned with Wall Street (as I have). He dresses up his Wall Street agenda with an academic writing style.

    When you strip away the BS, he’s basically saying that we should take the austerity road, with some (unspecified) targeted long-term investments. Naturally, Wall Street and the wealthy would prefer austerity over the alternative: higher taxes.

    The home ATM is shut down. The Government Credit Card has been canceled. But there is still a need for funds to get this stalled economy moving again.

    1. alex black

      I’m not well-versed in economics, but do you have any examples of when higher taxes got a stalled economy moving again?

      1. Jackrabbit

        My comment did not recommend raising taxes. I simply pointed out that 1) the economy needs more help, 2) we can get there by austerity or raising taxes, and 3) Wall Street and the wealthy do not want the possibility of a tax increase to even be an option.

        We have one of the most regressive tax systems in the developed world. We have one of the highest disparates of income and wealth.

        I actually believe that some combination of government spending cuts and taxes are appropriate and its difficult for me to see a political solution that doesn’t include both.

  8. michel

    “Naturally, Wall Street and the wealthy would prefer austerity over the alternative: higher taxes.”

    This is commonly said, and commonly said on this blog, but it is total nonsense. The underlying logic is that we have two and only two choices. One is something called ‘austerity’ which allegedly will result, on most accounts, in making a recession into depression, or at least worsening it. The second is to raise taxes.

    To see what is really going on and what should really be done, and what the alternatives really are, you have to look at particular cases. Take the UK, it is going through a well publicized budget process at the moment.

    It has a deficit of 11% of GDP. The left opposition and the state sector unions all agree that to lower this deficit by making any spending reductions will be disastrous. But just ask yourself what is this spending going on? Its going on total idiocy. Stuff like, paying the rich, and one means by this in the UK people earning about double the average wage, an allowance for every child they have. Why is this either necessary or desirable? Its about paying civil servants the only inflation adjusted final salary pension schemes the country has. Why is this such a great idea? With an unfunded pension scheme at that? Its about huge levels of local government spending on completely ridiculous projects which no local government should even be thinking of doing. Its about paying people not to work, and conniving at them making supplemental money in the black economy.

    It is also about participating in America’s wars, but that is another story.

    The bottom line of this is what is happening in policy terms is to to tax anyone stupid enough to work, and divert their money to those who are not, who may actually be better off than them. If you talk to most people in the UK, they have people in their acquaintance who are working the system, and are better off than them who are paying the taxes that fund this.

    If you listen to the two people who have made the most sustained study of this stuff in the UK, they are Frank Field and Ian Duncan Smith. Field, for instance, cites the work of an anthropologist who spent 18 months in an allegedly deprived area of a Northern City, and found that family incomes according to the official stats were around £4k a year, but in fact, on the ground, more like £17k.

    If you raise taxes to continue this crazy spending, all that happens is a massive transfer of resources not from rich to poor, but from worse off working people to the well off working state sector unions, and to the welfare constituency.

    We should be cutting spending, not because it is important to lower the deficits in the OECD countries, though it is, but because there is no usefulness in the astronomical wastes of money involved in the current spending, and because it is wrecking our societies too. Its producing a culture of state paid pregnancy as a profession, absent fathers, areas of cities in which the main commitment is to joblessness, a culture of drunkenness as social recreation, domestic violence, substance abuse, the whole works. This spills over into the schools, which would normally be the way out for children, but they have been so infected by the prevailing culture that they have become arenas in which learning is actively prevented.

    We should not raise taxes to keep on doing this, because it is not something we should do anyway. We should cut taxes and cut the spending, because it is deeply unfair to the working population to keep funding this stuff. We should stop doing it because it is wicked abuse of the recipients themselves. Work, jobs, stable families, these are actually good for people, more than that, essential, and the current pattern is bringing about exactly the reverse.

    So we have a situation in the UK in which there is this 11% deficit, mostly caused by spending which is neither necessary, desirable nor productive, and we have howls of rage from the beneficiaries of it when we talk about retrenching.

    Consider how fast, at 11% of GDP, total debt will rise. There is a limit of just under 100% of GDP. Go over this, you are going to have to balance the budget anyway because you will not be able to borrow. When you get there, your situation will be worse than it is now, because you’ll have had another couple of years of spending on things that actually make the situation worse. And you will have the debt as well.

    The bottom line is not to stop borrowing, though we should do that. The bottom line is to stop destructive state spending. The left keeps arguing for more spending, more borrowing. The argument usually centers on this. What it should center on is stopping the destruction. Its like saying to an obese person, eat less. Yes, do eat less, but what you really need to do is totally stop eating doughnuts, fries, milkshakes, cheesecake. Change the diet, and also, eat less.

    1. Yves Smith Post author

      I hate to sound like a pedant, but your obesity example is more apt than you realize, and it does not support your argument.

      I happen to know a simply frightening amount about weight loss as a result of being a horribly fat child. I will not bore you with all the details, but that plus a bad knee injury has led me to spend a lot of time with people who are arguably among the world’s top experts in weight loss, sports conditioning, and rehab for athletes (one of my contacts has trained more Olympic medalists than anyone, and also gets sent actors who need to get in shape for movies because he can do in 33 days what it takes anyone else three months to do).

      Basically, simple dieting does not work. While you will meet a lot of obese people who overeat, there are ALSO obese people who diet and take very little weight off. They lose maybe 5-10 lbs, then it stops. And they are not cheating.

      Why does this happen? The human body is an adaptation machine. If you cut calories, it thinks you are starving and downregulates your metabolism. The human body is VERY GOOD at adapting to starvation, given that it has been common in human history until recently.

      Same thing happens with economies. You cut spending to try to lower the fiscal deficit as a % of GDP. But GDP falls. Look at Ireland, its debt as a % of GDP is MUCH worse than it was preausterity because its GDP has shrunk nearly 19% nominal (and the debt is in nominal terms). How good a job would you be able to do in reducing your indebtedness if your income fell 19%?

      The trick with humans, BTW, is you need to engage in quite a few tricks to keep your metabolism from downregulating. Simple dieting is typically not very successful after the initial few pounds (when your body has not yet caught on to the idea that you are starving it). Those people you see in the ads who brag about weight loss are often on stimulants like ephedra, which works but is a cousin to meth.

      1. i on the ball patriot

        You match a nutritious balanced diet to a balanced activity level fitting the condition of the individual.

        The condition of the individual has been damaged by being forced fed and now force starved (bubbled and now troubled) and the individual has lost control of his diet.

        Calling on those who intentionally created the force feeding, and now the starvation, to make remedial measures is folly.

        To regain control of the diet you need to eliminate those who have unreasonably and in gangster fashion corrupted the food supply.

        This post is just another Vanilla Greed lament. The Vanilla Greed vs Pernicious Greed dynamic is now being played as a good cop, bad cop, energy dissipating, divisive ploy by the ruling elite. You are being snookered!

        No balls! No brains! No freedom!

        Deception is the strongest political force on the planet.

      2. Jackrabbit

        Yes, Yves, I agree. We need a balanced approach. I wonder if a political solution doesn’t include BOTH new taxes and government spending cuts is even possible.

        We have one of the greatest disparates between rich and poor. Yet the rich do not want their taxes to rise in the least bit. In fact, I’d bet there’ll soon be plenty of calls to LOWER taxes (to stimulate the economy!)

  9. Avg John

    Hate to be a doomsayer, but the fact is we are saddled with archaic social, economic, and political institutions, that just don’t work. We are hopelessly mired in gridlock. Yes, there is a way out of this mess but it will require an entirely new way seeing and defining ourselves, a new way we organize our societies, and it will have to be shoved down our throats. Necessity is the mother of invention.

    As an example consider the underlying reality of an automobile. It is a glob of atoms assembled in such a way so that it can quickly move us from point a to point b. But ask yourself how society defines an automobile? Of course, it defines our status, whether we are smarter and more worthy than our neighbor.

    How efficient and cost effective would it be if we designed and built say five basic models of cars, all identical in appearance but perhaps diverging slightly in function, all highly engineered for durability, quality, safety and fuel efficiency, AND society placed a premium value on the fact that producing and owning such models was gentle on the earth’s limited resources (a value) and was an act of a virtuous citizen (a value)?

    How about a free market system organized similar to the Amish society. Competing 21st century “Tribes” of people or communities, with wide distribution of ownership and democratic rule. Pretending that the office of President of the U.S or congressional representation is something other than an elected king and his court is nothing more than a lie. Same institutions, different label and faces.

    I don’t know what society is going to look like in the future but I know what we have now ain’t going to work. In my opinion, a bunch of brilliant economists and political scientists wrestling with the question of “should we reduce the deficit or increase the deficit” or arguments about managing exchange rates is silly and a waste of time, and we should be thinking about what we need to do to survive the 21st century. We got bigger fish to fry.

    We need an open public forum with as much public input as possible. By the way, start with the crazy “little” people, because they probably will have the best ideas. Not that they are smarter, just that they aren’t afraid to think outside the box and state their ideas publicly. Too many established smart people, with good ideas (and carefully guarded egos), are terrified that “THEY” will ridicule them.

    But I have little hope we can face the truth and adapt in time to save a lot of horror and pain. But change is on its way, for sure.

  10. michel

    Yves, maybe analogies are not helpful. The central question is, why should we continue to borrow huge amounts we cannot repay, to spend money on doing things that are bad for society, are even bad for the people on whom we are spending?

    You say “You cut spending to try to lower the fiscal deficit as a % of GDP. But GDP falls. Look at Ireland, its debt as a % of GDP is MUCH worse than it was preausterity because its GDP has shrunk nearly 19% nominal (and the debt is in nominal terms). How good a job would you be able to do in reducing your indebtedness if your income fell 19%?”

    Yes, this could be. However, your solution is to keep on borrowing so as to spend on things that make the problem worse. The fact is, Ireland is not going to pay back that debt. The debtors are not going to collect, unless they collect the underlying assets if there are any.

    So you must not argue that continuing to borrow and spend is going to make the debtors any better. What you are arguing for is default.

    It may be that default is the only way out – in fact, my argument suggests it is not simply the only way out, it is what is going to happen, whether its a way out or not. But default by itself is not the answer either. You have to do two things, and you have to do both of them. The first is default. The second is, stop spending state money on things that are not only useless, but actually are positively bad for society and are making the problem worse. They are doing this because they are diverting resources to unproductive activities.

    In the UK as Field has pointed out, the effect is to both tighten the labor market and deter people from useful employment, and the social consequences of having a large proportion of the population devoting their energies and lives to the avoidance of paid work are truly frightful. Not least for them.

    There are two things wrong with your approach. One thing is the assumption that all this deficit spending is useful. It is not, it is mostly positively harmful. The second assumption is that continuing to borrow and spend like this will avoid default. It will not. It will postpone the appearance of default, but when default finally happens, it will make it much, much worse.

    Just confront the two key facts: (1) We have to stop spending on things which make the problem worse. This means lowering spending in real terms, lowering borrowing. (2) We have to get the defaults over with, because they are going to happen. There’s no way around it.

    When the UK is on a deficit of 11% and total debt of 100% of GDP, interest rates on Sterling have risen to 20%, they cannot get their Gilt auctions away, and this has happened once in living memory, what will your prescription be then?

    Prescriptions to solve a problem must have some demonstrable way in which they do actually solve it. The prescription of borrow and spend and don’t worry does not do this.

    You can make the same criticism of prescriptions to lower spending, lower GDP, engage in deflation, and also pay back the debt. This is not consequent either. It is the opposite side of the mistaken prescription you and Rob P advocate, and it fails for the same reason. The debt is toast. This has to be acknowledged. No proposed solution which assumes all that can be paid back is going to work. Not yours, not the Irish approach. The only thing that will work is write it off and then get back to responsible fiscal policies for another couple of generations.

    1. Yves Smith Post author

      A sovereign that issues its own currency does not need to default. It does not need to issue bonds to fund any deficit. Its constraint is inflation, not default. Since inflation in the US is low (so low we may be at risk of deflation), deficit reduction should not be the top economic priority right now.

      The ONLY sovereign defaults in the modern era have been:

      1. Gold standard countries. They don’t control their currency

      2. Countries that dollarized, like Argentina, that effectively did not control their currency

      3. Countries with large banking sectors that racked up huge foreign currency debts they could not backstop. That’s Iceland, and could be the UK.

      The ONLY exception is the Russian default of 1998, which was bizarre and elective (as in their debt to GDP was low below 20%, so they had debt issuance capacity plus they controlled their currency, hence no need to rely on debt issuance). They appear to have gotten some bad advice.

      Since the eurozone countries don’t control their currencies, they may well default.

      1. RagingDebate

        Whom did the Russians take advice from? I wager you already know the answer :) The path chosen will yield similar results. Have tradeables for the growing black market and the means to defend yourself from violent crime.

      2. michel

        Yves, what you are advocating is default. Default by inflation, which is the modern analogue of debasing the currency, but its still default.

        I am not particularly opposing default. If you cannot repay the debts, default is what will happen, one way or the other. The thing I am opposing is your other prescription – which is to keep spending government borrowed money on all kinds of programs which are inimical to social well being and the welfare of the supposed benficiaries.

        You keep talking about deficit spending and government spending and not reducing them as if it made no difference what the money was used for. But it does! What we are doing with all this spending is the equivalent of ripping huge chunks out of the freeway system, and forcing people to hand carry their truckloads around the voids. It is not just useless, it is positively and perversely harmful.

        Whether or not we default, we must stop doing that, and that means dramatically reducing government spending. It may be that doing that will increase the likelihood of defaults. It doesn’t matter. We should do it anyway. We need to stop shooting ourselves in the foot. Whether we then enter a marathon is a different question.

        1. D. Warbucks

          As long as we can agree to the stipulation that only entitlement programs such as medicare and social security will be cut, then I am all for reducing government spending.

          1. michel

            If you look at the UK, the truly damaging stuff is definitely not health spending or social security (pensions). These are relatively sound – though it has to be admitted that the result of throwing money at health care in the last ten years has been proliferation of staff rather than workers. The number of ‘managers’ has increased enormously, not so nurses.

            The problem is with stuff like payments to everyone for having children, the ID card scheme, the NHS database scheme, unfunded public sector pensions which get ever more generous at every salary negotiation with the public sector unions. Its a sort of crazed mission creep, the state seemingly wanting to take all the money, and then more than what there is, and then take a huge cut, and start giving it back in counterproductive ways.

            They are now apparently proposing to pay operators of windmills not to deliver their electricity to the grid, on some crazed grounds or other. They are also proposing to pay people who put up windmills or solar panels something between 4 and 10 times the going rate for electricity if they do pass their electricity to the grid. They are spending astronomical amounts of money on education, all of which goes on implementing methods of teaching reading and numeracy which are known and proven to result in kids leaving school unable to read or to figure. Of course, they are all vastly expensive and require all kinds of computer aids to administer.

            The thing that Yves will not face is that this stuff is not contributing to economic growth. It is complete madness, its activities that must be stopped. Of course, once stopped, we will save expenses. But that is almost secondary, we have to stop the madness! And alas, the only way to stop the madness is to stop funding it.

            We will end up stopping funding, because this is the only way to close down these idiotic activities. And people like Yves will keep telling us this will hurt economic growth and bring about a second great depression.

            No it won’t. It will actually lay the foundation for renewed growth. This stuff is the main obstacle to it.

          2. Jackrabbit

            michael says:

            The thing that Yves will not face is that this stuff is not contributing to economic growth.

            So when has Yves advocated or supported inefficient and wasteful spending?
            I think there is a misunderstanding here, or you are just twisting her words.

            And for the record, I too am against wasteful spending and the insanity of “unsustainable” spending or borrowing. The fact is, the US has one of the highest level of wealth and income disparity so asking the poor and needy to suffer through an austerity program while the wealthy live it up just seems, to me, to be politically unfeasible (or it should be). Yes there may be efficiencies to be found and pork to cut, but that alone seems unlikely to be enough.

            And the US is not the UK. There may be some similarities (we speak the same language, I think) but there are important differences (energy policy, the NHS, military scope, etc.) that make it difficult to draw any hard and fast conclusions about spending priorities and tax changes.

          3. Jackrabbit


            Having more carefully read your comments:

            1. As Yves explained, default is very unlikely.
            2. SOME of the debt may be inflated away. That doesn’t necessarily require the “default” of hyper inflation.

            We are truly in a bind due to years of over consumption and investment in nonproductive and unnecessary assets (housing, etc.) and a mountain of debt. We clearly need a national strategy that recognizes this and doesn’t “extend and pretend” or attempt to return us to 2006.

        2. Jackrabbit

          First, inflation is not default. We’ve had inflation for decades. Have we therefore “defaulted” on the amount that was paid back in inflated dollars? In a similar fashion, is paying debt from savings from productivity gains constitute a default? (No.)

          More importantly, why does everyone assume that the choice is either/or? The best (and most politically viable) policy is probably a combination of government cut backs, increased taxes, inflation, etc. Especially when you consider that the US has one of the highest wealth and income disparities.

          1. michel

            JR, you’re making the same mistake as Yves. You speak of ‘austerity’, which seems to have become short hand for lowering government spending, as hurting the poor. This might be true if the cuts in government spending were to be of useful transfer payments which benefited the poor and only the poor.

            But the opponents of ‘austerity’ are typically talking about Greece, the UK, Spain etc. These are cases in which what the money is going on is public sector salaries and pensions, or, as Field has persuasively and compassionately argued about the UK, completely destructive kinds of entitlement transfer payments. These do not benefit the poor at all.

            My quarrel with Yves position is that she opposes cuts in government spending for these countries, but she never addresses the question of what it is useful for the governments to spend the money on. So she never explains why continuing the spending is going to be useful or the foundation for economic growth. This seems to be a given, but it is not. Many of these state programs are as destructive as paying people to tear up highways would be.

            What we’ve seen in many of these countries has been public sector looting of the economy on a grand scale, financed out of debt. It has sometimes, as Field argues, been destructive of those its intended to benefit. And sometimes it has simply enriched an elite union minority at the expense of everyone else. And sometimes it has acted as a sort of bribery, paying the welfare constituency out of taxes so as to keep their votes.

            Yes, the UK and the US are different, as are the US and Spain and Greece. The opponents of what they call ‘austerity’ apply their comments more to Europe than the US, and it is for those countries that I am objecting to it.

          2. michel

            By the way, a deliberate policy of inflation to lower the real value of debt repayments certainly is default. Debasing the currency was not default either, in name, but that is what it was in reality.

            In the end, and this is so obvious that it is hard to see why people keep denying this, if you continue to borrow at the UK current rate of 11% of GDP, you will raise interest rates and decrease government spending on anything but interest payments.

            The UK debate on this subject deserves careful attention. The sharp remark of Clegg, the Deputy Prime Minister in the UK was that paying more in interest than you do on education or health is not progressive.

            That is where continuing deficits of this level lead to.

            Why anyone thinks that the economics of this situation are changed if you do or do not run your own currency is a complete mystery. Fundamentally if you finance spending out of borrowing, at some point you will run out of borrowing power and also out of taxing power, and you will default. It is only the how of it that matters. You can print money and pay people back in devalued currency which now is worth 50% of the old money. That is a default. Or you can pay them back at 50c on the dollar in the same currency you have now. That also is default. What happens is the same, the lender takes a 50% haircut.

          3. Jackrabbit

            As for inflation and default, there are degrees and it can get technical and legal. You suggest that “default” be linked to intention (to inflate). Then any amount of inflation is a default as long as it was a policy choice. I think this definition is too severe and consistent with the law or practice, though it would be a “moral” default.

        3. Ming

          I suppose you prefer self interested private sector spending? Let’s see… how has the private sector performed in both advancing the the global economy and improving the future of mankind? In the US, in the space of merely 7 years, private debt has exploded from approximately 6 trillion to 12 trillion. And what did they invest in? New tv’s, new furniture, big cars with shitty gas mileage, and of course that really productive asset that is
          called housing. What about private corporations in the US? Debt
          of private corporations has doubled by almost 12 trillion. Not excluding their profitable investments in subprime mortgages and low- cost blowout preventers, and paying out approx 990 bilion in debt financed dividends, I am hard pressed to find an investment, that was solely intiated and financed by private industry that will bring meaningful longterm benefits for society. ( all of the investments into renewable energy either have direct government support or can count on government mandated incentives. Environmental only occurs when a government is able to enforce compliance on all players. Drug industry relies on an enormous amount of fundamental research which is in some way supported by the public either through taxes or tuitions as well as government cultivation via the potent system and the Fda drug approval system. ) and let’s not forget about the investments made into derivative contracts and CDO’shatShat I am trying to say is this…..private sector spending can be just as wasteful as inept government spending. However, government spending when accompanied with the intention for fostering th common good, with a lucid vision of what needs to be achieved, and approached pragmatically, is a very useful and benign

          1. Jackrabbit

            Good points Ming.

            We need an effective and responsible government if we are going to emerge out of this world-wide economic calamity in reasonably good shape. Private industry is not up to the task, and has their own problems.

            Unfortunately, the government that we have is hobbled by partisanship and special interests.

    2. gerold k.b. weber

      An important major global imbalance which can’t be rebalanced with more and more household or government debt is an increasingly skewed income and wealth distribution which doesn’t allow the households to clear the consumer markets.

      In the past global consumer markets were cleared, as middle and lower class households as well as governments piled on more and more debt.

      This global game seems to be over.

      One radical solution along the lines of Michael Hudson, Marshall Auerback et al. certainly is a debt jubilee (reboot capitalism 1.0). A slower but potentially more sustainable solution is to repair the skewed income and wealth distributions in a way that consumer markets are cleared under (near) full employment.

      Always wondering why nearly nobody has the guts to discuss solutions along this simple considerations …

  11. dr

    Only economic theorist and politicians are espousing the export option for alleviating US financial woes. US multi-national corporations aren’t joining the pitch for they know that it is cheaper to manufacture in the designed country that to export the same product from the high cost US.

    Exports won’t save the US.

  12. ray l love

    Some very good conversation here today. But gerold is correct in pointing out that not enough is being said about wealth-distribution.

    The way out of our shared mess must be in the direction of more investment in the poor countries. Billions of people have genuine needs and yet the advanced nations are well short of reaching their productive capacity. The advanced nations also have investment flows that are excessive (bubbles), while poor nations have far too little in development funds. Simple.

    The global investment-class has too much political influence and that is allowing capital allocations that are based on the protection of wealth, as opposed to long-term sustainability. There is simply not enough upward mobility at a global level. The World Bank standard of $1.25 a day equates to 16 cents per hour based on a 40 hour work-week…; in 1929, before the Crash, 71% of the US population was living below poverty, now the global economy has a very similar problem: excessive and misguided investment-flows and a lack of purchasing-power among the masses.

  13. Jerry

    Two comments…..China has many people to feed and we have great agriculture so we have one strong export….and we all need to start thinking about how our lives are going to change…it’s going to be like 1940’s-50’s (you know one car, smaller houses or shared living spaces, saving to purchase an items rather than charging it (layaway is acceptable…goods kept at the store for you until you pay monthly to pay in full), and it might mean fewer hours (hello who wouldn’t more time to spend with their families rather than making our fellow employees our families)…

  14. Hugh

    This post might have been more useful if it had had more specifics and less verbiage, or perhaps not. I think everyone understands that our accounts balance is not cyclical. There is a structural component to accounts deficits simply from having the dollar as the world’s reserve currency for the last 60 years or so. Of course, it has gone far beyond that. There has been a policy of de-industrialization over the last 30 years which tracks with the construction of the paper economy. This was predicated on the fantasy that we could trade “services” for real goods. The housing bubble burst and the meltdown should have shown how empty that services oriented paradigm was.

    Now Alford comes along and says we need to get back to producing goods. Unfortunately, he thinks these should be tradable goods. The problem is selling such goods into a deflationary Europe or a protectionist China or to developing economies that may also be trying to export and where we would have to compete against both Europe, China, and Asia in general. In other words, this sounds like an admonition to put water on your house when it is on fire, except there is no water. I would argue that our resources would be better used re-industrializing the country along sustainable lines. This would not only improve the country, employ people here, but, in so doing, stimulate domestic markets and demand. Rather than produce goods for foreign markets nobody wants or can afford to buy, doesn’t it make more sense to produce goods domestically for domestic use?

    1. michel

      The word ‘sustainable’ should be banned. What on earth does it mean? How do we test for whether something is sustainable?

      Or does it just mean, I like it?

  15. AntiOutsourcing

    Why don’t we start penalizing the export of existing JOBS? How about better incentives for large firms to employ Americans?
    During the Obama era, firms in the Hartford CT area have been laying off employees and outsourcing insurance underwriting jobs to Asia.
    These newly unemployed people held semi-skilled service jobs involved in evaluating American insurance policies.

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