Satyajit Das: Botox Economics – Part 2

By Satyajit Das, a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2010, FT-Prentice Hall).

From late 2008 onwards, Governments have spent aggressively, going into or increasing deficits, to increase demand within the economy to offset weak private sector consumption and investment.

Financing these initiatives presents significant challenges. In the five quarters ending 30 September, 2009, U.S. Treasury borrowing increased by $2.8 trillion, a rise of around three times from the level of previous years. The U.K. and European countries increased public debt by similar or higher amounts (in percentage terms).

In 2009, investors readily bought large new issues of government debt, despite relatively low interest rates. Rating agencies maintained sovereign debt ratings, especially for major countries despite deteriorating public finances.

Central bank purchases under ‘quantitative easing’(“QE”) (read printing money) programs helped the market absorb the volume of new issuance. According to estimates by Morgan Stanley, Fed purchases of assets, QE programs and other liquidity support programs reduced private sector net purchases of new Treasury issues to $200 billion in 2009. In 2010, in the absence of continued Fed support, private buyers will have to absorb $2,000 billion.

If buyers of sovereign debt pull back, Ireland, Greece and Spain provide an insight into the actions necessary. In order to restore fiscal stability, the Irish government introduced a special 7% pension levy and implemented the toughest budget in the country’s history. Public sector salaries were cut between 5-15%. Unemployment and welfare benefits were also cut. More recently Greece and Spain proposed a program of similar budgetary austerity.

Focus in the short run will be on the ‘PIGS’ (Portugal, Ireland, Greece, Spain) but in the longer term it will shift to major economies with high levels of government debt – the ‘FIBS’ (France, Italy, Britain, States). At least, Japan has its very large pool of domestic savings.

The need to maintain the confidence of rating agencies and investors as well as access to markets may ultimately force the required disciplines. As James Carville famously observed: “I want to come back as the bond market. You can intimidate everybody.” Politicians everywhere will learn the reality in Thatcher’s terms: “You can’t buck the markets.”

The need to reduce the overall level of debt in certain economies has not been fully addressed. Public debt has been substituted for private debt. As his friend Dink tells author Joe Bageant in Deer Hunting with Jesus: Despatches from America’s Class War: “Sounds like a piss-poor solution to me, cause they’re just throwing money we ain’t got at the big dogs who already got plenty. But hell what do I know?”

The last few decades have seen an economic experiment where increasing levels of debt have been used to promote high growth. This policy had the unintended consequence of increasing risk in the global economy, which was not fully understood by the individual entities taking this risk or regulators and governments. This experiment is now coming to an end.

The real risk is of long-term economic stagnation. A period of low growth, high unemployment or underemployment and over capacity is possible while individuals, firms and governments repair balance sheets.

Governments and central banks continue to inject liberal amounts of botox to cover up problems, at least, while supplies exist. In absence of any definite solutions, policymakers are deferring dealing with the problems, rolling them forward. In the words of David Bowers of Absolute Strategy Research: “It’s the last game of pass the parcel. When the tech bubble burst, balance sheet problems were passed to the household sector [through mortgages]. This time they are being passed to the public sector [through governments’ assumption of banks’ debts]. There’s nobody left to pass it to in the future.”

The summary of 2009 and the outlook for 2010 may be the logo on a black T-shirt worn by Lisbeth Salander, the heroine of Steig Larsson’s Girl with the Dragon Tattoo: “Armageddon was yesterday – Today we have a serious problem.”

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  1. Neil D

    We worry about stagnation, but wasn’t the demand of the last 10+ years fueled by household debt? It was artifical and unsustainable and there is nothing we can do about it. We have little savings and why would we want people to borrow more money to buy Chinese made junk?

    The mortgage deadbeats screwed up buying overpriced homes. Much of that loss will be absorbed over time by taxpayers. Raising taxes on the wealthy is the only thing we can do. They benefitted most from the debt fueled binge and will now have to give some back just like everyone else.

  2. DIY Investor

    I have never been a gold bug but I have to admit that I’m moving in that direction. Isn’t the problem, after all, the fact that money can be created out of thin air? Maybe all of this started in 1970.

    1. Bates

      Any purely fiat currency, the dollar for instance, is a promise to pay (deliverable goods and services to the dollar bearer) based on the assumption that the US economy will produce sufficient future goods and services to redeem all dollars. There is no guarantee of how many goods and services a dollar will purchase at some future time…The dollar is a Federal Reserve Note with zero maturity. The value of a dollar is based on a belief in future earnings, and is therefore dependent to some degree on ‘dollar faith’.

      Gold, on the other hand, is based on labor already expended and is in no way dependent on the future of any economy. Gold held currently represents past labor to find it, dig it up, refine it, and deliver it to market…all this effort was expended in the past…so that the gold coin you hold in your hand is not dependent on any future labor, taxes, economic results, treasury issues, ad infinum. ‘Gold is money and nothing else’ JP Morgan.

      Paper gold is little different than fiat currency…it is a promise to deliver in the future…But deliver what? Gold? Goods and services? A fiat currency? Approach paper gold with extreme caution and read the prospectus very carefully… Most companies offering paper gold have exempted themselves from just about everything under the sun.

  3. joebhed

    If not Botox, what?
    Pity that the great minds are incapable of seeing beyond these surface symptoms of players, politics and their surface-soothing strategies.
    The fact that we are living beyond our means is unrelated to the symptoms being portrayed here. It stems from the systemic flaws that go unmentioned, despite the fact that these flaws are causal and not the oft-discussed symptomatic effects.
    The most basic unmentionable flaw to go unrecognized is so simple as to usually engender a “so-what” response.
    It has two parts – the first is that ALL of our money is created as a debt, and we cannot have any money in existence without having more debts.
    The second is that when we create the money we need as debts, we create debt obligations (P+I) greater than the amount of the money in existence, the result being the escalating, impossible repayment of the existing debts, and no ability to create the money to repay those debts without FIRST creating more debts.
    So, QE comes naturally under such a flawed system.
    The flaws in the system are fatal.
    It is the debt-money system that controls our national circulating medium that is flawed to the point of being broke, broken and insolvent.
    The only solution is to reform the nation’s monetary system, and to replace the present system of private debt-money fractional-reserve banking with one of debt-free money of government issuance, coupled with full-reserve banking.
    The way to do this is all laid out by the pre-eminent economists of their day right here.

    It’s the monetary system itself that is flawed.
    Let’s stop criticizing its symptoms.
    The Money System Common

    1. Ignim Brites

      The other solution is to accept that the dynamic of capitalism is to persistent deflation. Once this is widely known and once governments cease to fight this, systemic debt problems will disappear forever.

      1. joebhed

        I think I get it.
        Either we agree and accept that private money creation, which you equate with capitalism, leads inevitably to an indebted people subject to poverty and suffering, because the bankers can, or we raise a pen and take back the sovereign money system, a right for which we already fought a war more than two hundred years ago.
        In his paper on How Debt Money Goes Broke, Steven Lachance pretty much agreed with that choice – the debt-money system is insolvent and either we need a new money system or the government abdicates our sovereign rights and gets out of the way of free capital marketeers.
        And I agree that this is the real choice that is before us.
        Either the private banker debt-industry makes the rules, or the people make the rules.
        It’s our pen.

  4. lambert strether

    The key graf:

    “It’s the last game of pass the parcel. When the tech bubble burst, balance sheet problems were passed to the household sector [through mortgages]. This time they are being passed to the public sector [through governments’ assumption of banks’ debts]. There’s nobody left to pass it to in the future.”

    “Nobody”? Really?

    It’s not my parcel and it’s not my game. Why not claw back everything possible from the people who own the parcel and played the game? Salaries, bonuses, ill-gotten gains, Swiss Bank Accounts, and the complete confiscation of inherited wealth?

    That’s what we’d do with drug dealers, and surely the banksters and rentiers have done far more damage, and killed far more many people, with their “game” of pass the parcel, than any drug lord ever has?

    1. Ignim Brites

      Once governments get their operating budgets in balance they can freely (somewhat) default on their debts.

  5. Bates

    I have never heard a good explanation of why the US economy became 60 – 70% dependent on consumption. Yet we often hear smart people say that it is so.

    Here is a little thought experiment; Real capitalism (without major government intervention) is a cyclical economic system of booms and busts. During the busts the weaker businesses and banks go bankrupt and are replaced by more efficient banks and businesses.

    The capitalist model worked pretty well in the days of Adam Smith (division of labor) and even up until the time of Marx (excess labor value)…but what is happening now when a ‘less efficient’ business is replaced in an economic downturn? The new business replacing the old is a factory full of digitally controlled robots…with a few people to maintain and service the robots. The guys painting the finished product are gone, the girls machining the parts are gone. Raw materials, and parts manufactured in other robotic factories, come in one end of the factory and finished product exits the other. If you don’t believe me go to any modern manufacturer and take the tour.

    BTW, these robotic factories are everywhere and are multiplying becaues capitalism requires that a business, to remain competitive, must adopt the latest technology.

    If you think that a typical fast food joint cannot replace there 20 person shift with a dozen robots and a couple of humans to interact with the customers…well, think again. It probably hasn’t happened yet because the workers at the fast food joint are cheaper than the robots…but that situation will change in time.

    So, what happens to 6 – 7 billion people that have been replaced, for the most part, with robots? How will capitalism, or any economic doctrine, address this little problem?

  6. Blurtman

    In this terminal stage, the Power Elites erect one facade and facsimile of reform after another, each one heralded as the “fix” the nation-state or Empire so desperately needs to return to “the good old days” of seemingly unlimited power and prosperity. All are shams, carefully designed and marketed simulacra of actual change.

    These monumental efforts at creating the illusion of reform have an immediate payoff: the Power Elites remain solidly in power, and their share of the nation’s income and wealth actually increases as the majority of citizens sink deeper into various stages of poverty.

    Eventually, of course, the system comes apart at the seams, because facades, illusions and sham reforms have not actually fixed any of the marginal returns or fundamental problems eroding the system/Empire. Eventually the State/Empire collapses.

    1. Doug Terpstra

      Great comment, and thanks for the link. CH Smith shares valuable, self-evident wisdom.

  7. Ida Tarball

    Isn’t QE functionally equivalent to debt free money? The Fed buys treasuries and returns the interest to the Treasury. Maybe we shouldn’t be so uptight about “monetizing the debt?”

    As far as the robot factory issue, it seems to me that the only way to deal with that is to spread the ownership of our capital stock among the general population. Some form of trust fund with a national inheritance or endowment that provided income to the people would be a great idea, though the politics would be problematic.

    The deep problem nobody wants to talk about is the pathologically skewed income distribution we’ve developed. A class of super rich, who can’t spend it all because they have so darn much, and a class of poor people who can’t spend because they don’t have it is a recipe for underconsumption aka overproduction. Anyone with a passing familiarity of the depression era knows we’ve seen this movie before, and it doesn’t have a happy ending.

    As for the reason we’ve become so consumption dependent, my theory is that it’s our reserve currency “exorbitant privilege” come back to bite us in the butt. It has given us an overvalued currency that has allowed us to run big trade deficits, which has allowed corp. America to outsource our manufacturing base. Investment in manufacturing has withered and only increasing debt has allowed us to maintain demand. It seemed to be a free lunch while it lasted, but now the waiter has put the bill on the table.

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