2009: What a Difference One Word Might Make!

What is the difference between the and those? If you are Barack Obama, it may determine whether you have a successful presidency, and at the very least it defines how much maneuverability you will have in the financial markets. To give an example, suppose I said ”œDamn the deficit! Full speed ahead.” This is an altogether different statement than ”œDamn those deficits! We have enough debt.”

The first sentence is how the global bond market has approached the U.S. financial condition for the past fifteen years. The focus is short term and singular ”“ the market looks at the deficit racked up in the past fiscal year. Year by year goes by, and nobody notices how the annual deficit creeps higher and higher. When economic conditions worsen, the market says ”œI don’t give a damn about the deficit ”“ go ahead and borrow more.”

The second sentence was how the bond market used to approach the issue; the concern was on the cumulative deficits, or in other words, the total debt. In this second mode, the market penalizes each incremental borrowing because it expands the total debt and is seen as hurting investors.

Obviously the first approach is a very indulgent view of U.S. borrowing and has allowed for an enormous expansion of the federal deficit. How did we get into this situation? There are quite a number of biases that helped create this tolerance.

1. Reagan taught us that deficits don’t matter.

This is the operative fiscal philosophy of Dick Cheney, as related by former Treasury Secretary John W. Snow. Not that Ronald Reagan intended to teach this lesson. He came into office with an economic team that was composed of a new breed of economists ”“ supply-siders ”“ who felt that tax rates were so high they were stifling economic growth, and if you cut tax rates the subsequent growth in the economy would generate sufficient tax revenues to cover any deficits. There was a more sinister motivation as well, best expressed by anti-tax zealot Grover Norquist, who famously said he wanted to shrink the federal government so that it could eventually be drowned in a bathtub. As the deficit ballooned following massive cuts in the tax rates, the pressure would be so great to balance the budget that the federal government would be forced to shrink drastically. Et voila! No more New Deal or other ”œwasteful” social programs.

What went wrong with this theory is that Ronald Reagan never had the guts to cut federal spending. He just let the debt grow, and in a dramatic fashion. Dick Cheney somehow took from this experience the belief that you could grow the federal debt forever without consequences; the economy would flourish and things would miraculously work out in the end. Cheney was speaking for virtually all the Republican Party, because today’s Republicans would rather slay their first born child than ever raise anybody’s taxes or do anything about deficit spending.

The end result of this crackpot economic theory is that when the Republicans are in power, there is no check in the White House on deficit spending, and when they also control the Congress the door is wide open to pork barrel budgets and rampant growth in the national debt.

2. The Federal Reserve imposes no penalty on the administration or Congress when deficit spending is out of control.

We need to qualify this statement somewhat. The Federal Reserve from the 1980s to most of this decade has been under the helm of Alan Greenspan. He is a deficit hawk when Democrats run the White House or Congress, but he loses all fears about the national debt when Republicans are in power. We saw this during the Clinton administration. Greenspan kept interest rates high and said many times publicly that he was unable to lower them unless something was done to reduce annual deficits. He obligingly began lowering rates in the 1990s once Clinton introduced much stricter controls over spending, and Congress adopted a pay-as-you-go policy that required new revenues to be found for any proposed spending. When George W. Bush came to power, Greenspan had a miraculous change of heart. He kept interest rates low when Bush began giving away the budget surplus he inherited, and then he lowered them further when Bush moved into full-scale deficit spending, with a complicit Republican Congress helping him every step of the way. The effect of all this was that there was no independent check from the Federal Reserve on deficit spending when Republicans were in power, and in fact monetary policy abetted fiscal policy by goosing up the economy artificially with low interest rates and massive deficits.

3. The bond market itself exercised no discipline on the U.S., because two big purchasers of federal bonds arose to soak up much of the new paper being issued.

Quite conveniently, Japan and China came to the rescue of the U.S. just as George W. Bush was about to plunder the Treasury. Both of these countries are export powerhouses, China being the more recent arrival in this area, and both of them embraced a symbiotic relationship with the United States as the biggest consumer in the world. Japan and China would sell all they could of manufactured products to the U.S., but instead of being paid in goods or services of equivalent value, they were content to be paid in paper ”“ U.S. Treasury securities, and large amounts of ”œagency” paper issued by Fannie Mae and Freddie Mac.

By the autumn of this year, the federal debt had exceeded $10 trillion for the first time, and had more than doubled in the eight years of Bush’s administration (he has added more to the national debt than all other presidents combined, which includes the previous profligate spending of Ronald Reagan). If you subtract from the $10 trillion any Treasuries owned by agencies of the U.S. government itself (largely the trust fund for Social Security), you find that nearly 50% of all publicly held U.S. debt is owned by foreigners, mostly central banks, and mostly China and Japan, which hold a half trillion dollars each. These numbers do not include hundreds of billions of dollars of agency securities owned by these governments, which were betting correctly that these securities were really the full faith and credit of the U.S. government (they were proven correct when the U.S. government nationalized both Fannie Mae and Freddie Mac this year).

So instead of having a bond market that penalizes excessive spending by demanding higher interest rates, we had a distortion for at least a decade of two countries buying all the debt they could, just to keep their exporters in business selling to the very country issuing all this debt. The U.S. sat back and let its financial fate drift increasingly to two foreign powers, because as we all know, ”œdeficits don’t matter.”

4. Once the Democrats got into power, they abandoned fiscal discipline.

Pay-as-you-go never made a comeback even though the Democrats took over at least part of the Congress in 2006. This may have been because it wouldn’t have mattered anyway with Bush discovering the power of the veto, and the Republicans still able to derail any bills in the Senate. Still, the Democrats never displayed any concern about the national debt, and now that the U.S. economy is flirting with an economic depression, everyone is reaching into the FDR/Keynesian toolkit that requires large amounts of federal deficit spending to pull the economy out of a prolonged and serious economic slump. Whereas Congress has spent a decade arguing over the cost of national health care, which could run as much as $100 billion dollars, suddenly it is easy to spend $700 billion on a bank bailout, another $300 billion rescuing Citibank, about $100 billion taking over the commercial paper market, and in excess of $1 trillion nationalizing the two housing agencies. Some of these amounts are promises to pay in the future if necessary, but of the total, at least $1 trillion has been added to the national debt as the U.S. Treasury has had to issue new bonds worth at least that amount.

5. The Credit Crisis has created unexpected public demand for Treasuries.

One thing the Credit Crisis has taught the general public is that it pays to worry about getting your principal back, even from something as basic as a checking or money market account. The collapse of Lehman Brothers and Bear Stearns, along with the merger and disappearance of Washington Mutual, Merrill Lynch, and numerous hedge funds has shown how it is possible to lose all of your principal in a credit default. Even the rich are not immune, as evidenced by the Bernie Madoff scandal.

As a consequence of these fears, hundreds of billions of dollars has fled the banking system and been put into U.S. Treasuries, to the point now where the public is willing to pay interest on its own deposits (which is to say, buy Treasuries earning negative interest). This is the sort of fear one sees in depressions and deflations, and it has occurred conveniently when the United States is issuing enormous amounts of new debt.

When Will the Bond Market Change its Mind?

In the financial markets, it is true that the same situation can go on for a long time. The United States has enjoyed at least 15 years with no checks and balances on its fiscal excesses. The American government, the American consumer, the global bond market, and various central banks are all co-conspirators in this effort to allow consumption in the U.S. to be based entirely on borrowing as a means of payment.

Another economic truism is that nothing lasts forever. The financial markets can ”œturn on a dime”, especially when it comes to trillions of dollars at stake. The United States enjoys a halo of financial respectability built on many decades of economic growth, and based on its role as the linchpin of the global financial system (starting with the U.S. dollar itself as the world’s reserve currency of choice). One day, though, the world notices that the halo is gone, and then everything changes.

What does this mean in practical terms for the United States? It may mean that domestically a national deficit scold will appear on the scene, and like Ross Perot in the 1990s, change politics so that it becomes fashionable again to worry about the federal deficit. More likely, though, it means that our symbiotic friends Japan and China will reach their saturation limit for buying new Treasuries. What the United States asks of the world is not just that it hold on to the Treasuries it owns, but that it add $1 billion more a day, day after day, year after year. Japan and China may no longer be able to shell out $1 billion a day to buy our paper.

When Fannie Mae and Freddie Mac were in serious trouble earlier this year, Japan and China were quick to demand protection from the U.S. government. They wanted assurances that their agency paper would not default, and that the U.S. government would step in and take over responsibility for these debts if necessary. Not only did they get such assurances, but the U.S. Treasury now backstops agency debt, and owns and manages both of these companies under the nationalization program. Existing debt, therefore, is secure as far as these central banks are concerned.

But that says nothing about future debt. The appetite for taking on future debt is constrained by several events. For one, if the bond market starts to sell off U.S. Treasuries, yields will necessarily rise in order for the government to attract buyers for any new paper. This means the existing holdings are devalued ”“ if Japan or China were to sell existing debt, they would take a financial loss.

Which leads to the second point. Japan is fast slipping into a deflationary recession, which is beginning to look worse economically than the ”œlost decade” of deflationary stagnation in the 1990s. China is also facing a deteriorating situation, and has promised a $500 billion government spending program to buttress the economy. China can issue new debt to cover these promises, but China’s credit rating is not that good and its debt capacity is limited. Which means China, like Japan, will ultimately have to dig into its reserves and start selling some of its existing U.S. Treasuries. Because they hold such massive amounts of these securities, even a modest sale program would likely drive U.S. interest rates and borrowing costs higher.

So forget about anyone buying future debt, it is the sudden release of existing debt on the open market that is the bigger worry. Not only would bond prices tumble, and yields therefore rise, but to make things worse the bond market would have to deal with a third revelation, which is that the U.S. government itself cannot raise enough money to pay back its debt.

How could this happen? Any national government is financially only as strong as its ability to generate tax revenues from its citizens. Taxing power is the fundamental pledge that all modern governments make to anyone who holds on to the currency of issue, because currencies these days are ”œfiat money”, having no backing in anything tangible or tradable like gold or silver. What is already happening on the municipal and state level in the U.S. ”“ rapidly declining tax revenues ”“ is now creeping into the federal budget. The collapse of the stock market in September and October will severely deplete tax revenue from capital gains in 2009, and rising unemployment will lead to a reduction in take from income taxes. The true danger of this situation will suddenly reveal itself to the market sometime in 2009.

You will then have a perfect storm. The principal buyers of U.S. Treasuries will disappear because they have more urgent domestic needs for their reserves. They will even be selling their stockpile of existing Treasuries. The U.S. government will begin to have obvious problems raising tax revenue to continue to pay on its debt, and while it won’t default on its debt, its Aaa credit rating will be in jeopardy. The bond market will suddenly realize U.S. Treasuries are no longer risk free ”“ that in fact they are quite risky. Everyone will suddenly start worrying about those deficits, and as buyers disappear for U.S. paper, interest rates will head up. The Congress, the White House, and the Fed ”“ hitherto blissfully ignorant of any costs to federal deficits ”“ will have discipline forced upon them.

As this scenario plays out, President Obama will find his hands are tied. Every incremental bit of new debt issued to the market will have a cost in the form of higher interest rates, and probably a weaker U.S. dollar on the exchange markets. An economy already in depression will be in desperate need of fiscal stimulus (monetary stimulus in this situation is already useless ”“ interests rates are close to zero and are not spurring borrowing and lending). But Barack Obama will not be able to issue new debt in any substantial quantity, because it will drive interest rates higher, and the economy deeper into depression.

I suggest that this scenario will occur in 2009, but no one knows for sure. If President Obama is lucky, he can go on issuing debt year after year without much consequence except for future generations. There is a general impression that if things get really bad, Obama can turn himself into another FDR and spend his way to ameliorating people’s pain, if not reviving the economy right away. But FDR came into office with a relatively modest national debt compared to Obama, and he wasn’t fighting a major war at the cost of at least $100 billion a year.

Obama’s situation is in fact much more dire than he realizes, and much worse than FDR’s when he became president. My suspicion is that 2009 will be the year when the American halo disappears completely, and the desperate condition of the country will be fully revealed, at great cost to the U.S. stock market, to the economy in general, and to the well-being of all Americans. Politically, it is not clear that such a tragedy will somehow usher the Republican Party back into power. In fact, the dissolution and disappearance of the Republican Party, or at least its permanent confinement as a regional Southern party, is much more likely, because in the minds of the voters, any political party which has brought about two Great Depressions doesn’t deserve to exist.

But President Obama will not escape either. He will find his maneuverability restricted and the presidency very confining, to the point where the best he can do is become a national cheerleader bucking people up in the face of terrible economic deprivation. His historical epitaph might well be reserved to one observation: ”œAt least he was good at giving speeches.” This might not sound like much, but to the average American about to undergo the pain of this coming depression, any solace will be welcome.

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Numerian is a devoted author and poster on The Agonist, specializing in business, finance, the global economy, and politics. In real life he goes by the non-nom de plume of Garrett Glass and hides out in Oak Park, IL, where he spends time writing novels on early Christianity (and an occasional tract on God and religion). You can follow his writing career on his website, jehoshuathebook.com.

37 CommentsLeave a comment

  • This is an excellent diary, Numerian (despite being undercut by a rather weak title and opening paragraph).

    I agree that economic and political events will likely play out as you project, even though the timing, as you note, is uncertain.

    Add to this grim scenario the fact that fossil fuels are still depleting, although at a slightly reduced rate due to the economic downturn. Oil and gas prices will continue their wild fibrillation, of which last summer’s price runup and this winter’s collapse are the first signs. That will further pressure the real economy and greatly constrain politicians’ options.

    In terms of domestic U.S. politics, I expect the result of the crash of ’09 (or ’10) will be a rejection of both parties, much as Argentina saw in its recent collapse. New political groups will form from their ashes. That could play out a number of different ways, including regional/separatist blocs and, likely, some kind of authoritarian/imperialist/fascist group. That’s the one we should fear, and work to oppose.

  • … the economic history of the United States for the past quarter century, this is as good as it gets! I still wonder Numerian, if Obama has a trump card. The whole cesspool of “Off-Shore” wealth, from the Caymans to Switzerland to the Isle of Man. Didn’t the late Mrs. Helmsley quip that taxes are for the “little people”(at least she loved her dogs)? The ultra-rich consider a W-2 a mug’s game. Can Obama shine the light on secret off-shore accounts, as well as shelters and barely audited partnerships? Could we be talking about hundreds of billions of lost tax revenues? I’ll bet you that these are the same people who fund right-wing think tanks and lobbyists. Enemies of the People (as well as Obama).

    Happy New Year! JB

  • The electoral college militates against multiple political parties in the U.S. Third parties crop up now and then but have trouble building the permanent political base necessary to ensure 271 votes consistently.

    However, your scenario of replacing both political parties is certainly plausible. The Democrats are starting out poorly in 2009 with an administration formed of the intelligentsia from both parties that created this mess. If Obama fails, the blame may fall enough on both parties to cause a real house cleaning.

  • I’ve had a difficult time understanding why the t-bill market didn’t dry up as predicted after the Chinese and Japanese backed out.

  • Bernie Madoff! Authorities are looking into whether he used multiple accounts in places like the Cayman Islands to hide trades, and help clients evade US taxes. If so, the light of day will shine quite clearly on these practices, forcing the hand of the government to do something about Off-Shore account abuse.

    In some respects this is too bad, because at the same time US investors will want to shift some of their wealth out of the US. If things get bad enough here, the government could forbid capital outflows like Argentina and Brazil have done. There needs to be a way for investors to legally and safely transfer some of their assets elsewhere.

  • But his mind refuses to go to the conclusion. He talks about a 30-50% correction in GDP, and relates it to investment opportunities. I’d guess that’s going to mean a total collapse in the U.S., especially with the elites out to maintain their wealth at all costs like he suggests. He might better serve by expanding on future food opportunities rather than stocks.

  • Denninger doesn’t figure in the recognition of the dire economic consequences of climate change that will become apparent in 2009. As soon as the Obama administration replaces the Bush administration, science will replace ideology and propaganda at the Department of Energy and EPA, and the public is going to learn about the developing disaster. They will be shocked to learn what it is going to take to mitigate climate disaster, since it is already too late to avoid it. This is going to be very costly across the board and will require a thorough-going restructuring.

    This has to be combined with the required restructuring of the economy after three decades of neoliberalism. Massive deleveraging and debt destruction is mandating real change, but so far the Obama team has not surfaced that specifically, outside of Obama’s saying in a general way that the situation is very bad and still tanking.

    The only way to save this ship is to tell the passengers and crew that we’ve just hit an iceberg and will sink if we don’t all pitch in and work like mad to save it. Then they have to start wringing the bad debt out of the system and reverse direction on energy and the environment.

    People are still operating under the illusion that in a few months we’ll be back where we were. That’s just not going to happen. This is not the end of a boom-bust cycle. It’s the phase transition between eras, and it’s going to mean revising the rules, which is going to involve a wrenching change in the nation’s thinking.

    The ending of the debt-driven economy is going to means a decline in the velocity of money, because people will no longer be able to manage cash flow irresponsibly with debt, or have little appetite to do so. This is going to leave the country and world with massive overcapacity.

    The silver lining in this dark cloud is that new opportunities will arise out of the restructuring that is required, for we are all screwed until it kicks in. But trying to save the obsolete will just delay the necessary.

  • Nouriel Roubini has said if Obama gets it right, there’s a chance to avoid a depression. The recession is of course already here and Roubini says a deep recession is unavoidable. You (Numerian) seem to think a depression is a sure thing. Even though I’m permanently out of country; I hope your wrong, because then even I won’t escape it. Scary times ahead no matter which way it goes. Thoughts?

  • He doesn’t fully understand Peak natural resources (bet you thought I was going to say oil).

    Truth is, I’m more in the Taleb camp at the moment. The more complex and redundant the system, the less likely to fail, the more catastrophic the failure when it occurs.

    I did inhale.

  • He’s surrounded himself by competence before ideology or any type of radical thinking. That’s certainly a relief compared to the bungling kleptocracy of the Bush administration. But most of the people around him have a natural inclination to use what’s worked in the past, so we’ll continue to get wasteful bailouts until the bond market begins extracting a penalty for new debt.

    Just because the EPA may turn to science and begin issuing accurate reports regarding global warning doesn’t mean the administration is going to undergo a paradigm-shift in policy. There are so many competing demands on Obama’s attention – so many problems that have festered under Bush or been created by him – that it is not clear how Obama prioritizes, as he must. The priorities may be assigned to those problems which demand the most immediate attention, which suggests until there is some demonstrable, dramatic deterioration in the global climate, climate warming may not rise to the top of the list.

  • The link above provided by Don gives you Denninger’s predictions of what will occur in 2009, and depression is a common thread. In fact, he points out that this is a global economic problem and the situation is going to be much worse in Europe and China than in the US. Europe’s banks are more leveraged than ours, and China has both a massive overcapacity problem, and even more of a debt problem than the US.

    There are official definitions of depressions, and usually they require a 10% reduction in GDP. The fourth quarter just finished is estimate to have suffered a 5% decline in GDP, so economists don’t have enough evidence to say we are in a depression. This is reminiscent of this time last year. I noticed in October 2007 that suddenly a lot of local businesses and local governments were having revenue problems, and it reminded me exactly of the circumstances in 1974 and 1982 which kicked off those recessions. People were beginning to worry about the future and rein in spending. I said at the time the recession is here, even though we didn’t have any noticeable decline in GDP until a year later.

    The reason I say depression is here now is because several key elements are here. First, deflation, which began in housing values, is spreading rapidly to all asset classes, especially commodities, but also corporate bonds, stocks, and now prices in general (witness the price reductions this Christmas on consumer goods). Second, a depression is created by the disappearance of credit in an economy, as economic players start focusing on the debt overhang which must be eliminated before the economy can grow. Personally I am surprised at the extent to which credit has been destroyed. I did not predict the elimination of Wall Street investment banks altogether, much less the collapse of even the commercial paper market. This stuff is super, super dangerous for the economy and pretty much dooms us to a depression. Getting a loan – getting basic cash – is getting harder and harder, and this Credit Crisis is suffocating the economy like a boa constrictor.

    Finally, many people don’t realize that unemployment, measured the way we used to do it in the 1980s, is already at 12.5% and rising. This is worse than the peak in the 1982 recession, and will easily reach 15% or even 20%. Anybody with a job will be suffering from underemployment, if not outright wage compression. These are the circumstances we had in the 1930s.

    To me the depression is here, just not officially, and not yet completely in terms of human suffering. But it is rolling along nonetheless, and I think a year from now politicians and economists will all be using the word. As scary as that is, these are exciting times because something must be built on the ashes. As tj has pointed out above, it is an opportunity to completely rethink and reorder society in a less corrupt, more sensitive, and more efficient way, in which resource scarcity is taken into account and damage to the environment is penalized.

  • 5 Themes for 2009

    Before we get to 2009, first, think back to a year ago. Deflation was barely on the radar of mainstream economists and financial media. Most viewed it as an impossibility, focusing instead on what was supposed to be the resurrection of the commodities bull market.

    Even today, while paying deflation minor lip service here and there, the vast majority of economists and financial media are ill-prepared for just how severe this ongoing deflationary credit contraction and debt unwind is going to be.

    Consequently, if there is one theme that stands above all else in 2009, it will be this: The despair that unfolds as the point of recognition emphasizes the “de-” in deflation. The fat is in the fire.

  • You know I am a huge fan, and have been for years, but we are missing something.

    You are close, probably closer than most, but no prizes for almost clever enough. We need to survive the coming demogoguery/violence, so we need to aim high: as high as “good enough to muddle through.”

    We cannot see the past 30 years as a morality play of improvident attitudes. True, I am sure, but not mechanical enough to be helpful.

    I liked your posts on how private companies took over the creation of money supply — the whole parallel money supply thing. That was more helpful to me. It was a convincing discussion of the bureaucratic dynamic in the U.S.

    Anyway, I am struggling with ideas about how the international markets do work, and should work. How we got here; what we should aim for.

    Vaguely, the imbalances inherent in the payments for oil, and the need to recycle petro-dollars, and the planned imbalances of creating export economies in Japan, the young tigers, and China. The planned indifference to the third world in Africa and South America. (Not too smart if the carbon sink in the Amazon is destroyed.)

    What would a sustainable world economy look like? What should be our ultimate goals? What are the incentives that can be established to get there?

    I have few scruples about defaulting on certain huge debt-holders who spent the last 3 decades greating their wealth (and lending it out) by a cynical manipulation of institutions and propaganda. But once you blow up the world as you know it, then you have to have some sort of plan for what comes next. And you cannot expect a lot of help from the powerful that you just tried to dynamite.

    I have this nagging sense that what is good economic policy in normal times is not necessarily the best economic policy in an emergency. And if true, that is a difficult thing to explain in sound bites. “Rally heroically in the name of expediency” just doesn’t resonate that well — although if there is a fire, people will instinctively act that way.

    Well, obviously, I am rambling. Here are my questions.

    What is debt? Is it all the same?

    What is money? Does it have the same meaning internationally as domestically? I view money as a promise. In a country, the promise is governed by laws. Internationally, not so much.

    Picture this: for the next decade and beyond, people need to feed their kids, put clothes on them, keep them safe, and heal them when they are hurt. The answer from smart policy people cannot be: there is no way to get there from here.

    There will be an explosion. People will demand an answer. Many vile, unscrupulous people will identify scapegoats and lie that they have an answer. The radical right (and others) will be POPULAR AGAIN, Baby!

    So the answer is not just “reduce debt.” The answer is not “the Govt won’t be able to spend.”

    Whatever the rules of conventional law and finance may seem to be, they will dissolve when the conflagration starts.

    Trouble is, the rules may be broken in the name of one promise, and the authoritarians that come in may never provide relief to those who were ready to cheer the fire.

    We need a principled and moderate revolution. Some promises must be abandoned. New ones must be made that will inspire confidence.

    What, exactly, we should do, I don’t think you have figured out yet.

    It shouldn’t be your job. But I don’t see anyone else who I trust more to get the job done.

  • It seems to me based on his picks that Obama is going to bite the bullet and start preparing the public for the wrenching change that must take place. The first priority, however, is softening the shock from the fall since the economy has already been driven off the cliff and is in free-fall.

    This is a very delicate situation because you want to prepare people for what is coming without freaking them out and causing more panic than is necessary. I think that he has to sail between the radical right that wants the market to handle it, catastrophic consequences be damned, and radical left that wants to initiate progressive reforms across the board even though the country is not ready to go there yet. As a result, he has put a highly qualified but somewhat retro economic team on the job, to reassure the Street, the US public, and the rest of the world that everything is under control. Doing this has to be his first priority, or panic will gum up the works. His team is also in a position to mediate between the market fundamentalism that is moribund and the new economy that is being born.

    This is going to be tricky, because in a huge and highly complex economy like ours, there are not do-overs if mistakes are made. Just about anything could be the butterfly’s wing that initiates (metaphorically) a chaotic transformation instead of a controlled one. Obama has to do everything possible to maintain control, in an engineering sense here, instead of a political one, although maintaining political control will be important to maintaining engineering control. The opposition will try to sink the ship because if Obama is successful they are toast for many years to come. They won’t be forgetting FDR and the New Deal soon.

    IF this is handled very skillfully, Lincolnesque and FDR-style, we may be able to get though this debacle with minimum catastrophe. But there are going to be many factors tugging in opposing directions that will have to be reconciled, not the least of which is the complicated environmental and international situations.

    Obama recognizes the environmental situation as a possible economic plus if he can finesse it into new technologies and new jobs. This is possibly the next level of innovation beyond the digital revolution, and it could be very lucrative for the US and a great boon to the world, as well. So expect Obama to be focusing attention this way.

    The international situation will be difficult because the US is the center of the empire and wealth will be flowing here for safety, if not opportunity. The rest of the world is going to be crushed with debt destruction, and the US is going to have to step up to the plate to avoid disorder, even though it will be hard pressed at home.

    This will provide potential enemies with many opportunities to challenge US power and undermine American leadership, not only directly but also directly through allies and clients. I am concerned that Obama is taking his eye off this ball and letting the US militarists gain advantage. In addition, there is the temptation at this time to continue military Keynesianism.

    There is an old Chinese saying, “May you live in interesting times.” Happy New Year, sort of….

    On that note, interest groups will all be loudly active in tugging policy, strategy and tactics their way. Rather than just sitting by and offering Obama mindless support, progressives need to be actively pushing their agenda in competition with the other interest groups. The squeaky wheel gets the grease. Progressives will actually be helping Obama by doing this and also helping the nation and world.

    Two important books: George Soros, The New Paradigm for Financial Markets, which shows how the crisis evolved from the mindset of market fundamentalism and how to fix it with a new mindset, and George Lakoff, The Political Mind, which applies cognitive science to progressive political thinking and action. Both of these thinkers see the grave threat to democracy and they offer ideas on how to fix it. Progressives need to realize that the world is not rational and that they need to understand how mindsets work. So far, the Dems are coming across as wimps because they don’t. Unfortunately, Obama suffers somewhat from this problem, too. Vide his Rick Warren pick, as well as his “non-partisanship,” instead of laser-like focus on the interests he want to push hard for. Without creating a new frame of reference, this administration will be a retro one, by default.

    In my view, the constitutional issues are fundamental and of the highest priority. If that battle is lost, the rest of the game won’t matter. We will be headed for an authoritarian future.

  • De-nial = de-pression = de-flation.

    It was obvious one year ago that the crash in the property market was just the beginning of a economic crash. The tax code alone dictates that cause & effect.

    Loose a primary residence to the crash – some tax relief, BUT, second loans are recourse loans, and mess up the relief process by first lien-holders.

    Loose investment properties to the the crash – no loan relief, no forgiveness of the tax on the “lost value = virtual income” – bring on the bankruptcies.

    And there was no effective discussion or program to keep homeowners in homes, and little progress since. The loan modification programs are largely an illusion. And the banks? Continually badly behaved.

    The “authorities” were Pollyannas. What else could they be? When listening to public statements, one has to consider the source, and adjust the message based on the question “what else could that source say”. Any authority figure will have to place positive spin on any event, be they a President, or a CEO, or a spokesbot.

    On the bright side. When all are saying “the sky is falling, the sky is falling”, the sky has already fallen, and we are past the bottom. Hard to believe when all is gloomy…it is common.

  • I don’t know how often I have heard this over the years. At some point, the abandonment of the dollar and US paper is inevitable. But Denninger’s point is that the $ will appreciate simply because other countries will be relatively worse off. When US Treasuries actually sell off will remain a very difficult call. The inertial forces that have kept US paper as the dominant form of storage are still in play. So I guess what I am saying is that as the pain starts to really kick in worldwide, US gov bonds may still hold out as the safe haven. (Having said that, I own a lot of TBT and am in the black.)

    So what would change this worldwide game of chicken? From my point of view, there would have to be a viable alternative. The worldwide pool of capital is so huge that it is hard to see what could hold it with the kind of “safety” that the US debt instruments provide.

    Your post AND the comments are worth multiple re-reads. Thanks.

  • You ask: What is debt? What is money. Debt is essentially a promise to repay. Money is essentially a medium of exchange. Both are based on trust. Debt is based on the the lender trusting the borrower to repay the loan. Money is based on the trust people have that it will be accepted as a medium of exchange with a relatively stable value. When trust breaks down, so do credit and money.

    All debt is not the same. Different borrowers have not only different credit ratings but also different orders of credit rating, the most credit worthy at the moment being the US Treasury. Similarly, the strongest (most trusted currency) is the US dollar. This follows from the US being the center of the de facto global empire.

    The problem right now is that credit is drying up not for lack of liquidity but lack of trust. Lenders do not trust that most prospective borrowers will be able to repay. The problem emerging is that the US is diluting its money and may undermine trust in dollar stability. Dollar instability also affects trust in relation to debt. Creditors do not want to be repaid in devalued currency. This situation affects all lower orders of debt. But deflation is the worry at the moment and for the immediate future. Inflation could emerge from overreacting or if measures are not taken quickly once there is a turn around, but that is not likely very soon. The big problem is going to be recognizing the turnaround and not tightening too soon, which would set things back. dicey game. FDR made this mistake in 1937, for instance, and things got worse.

    Lower orders of debt are also adversely affect by economic contraction, which reduces ability to repay. This means increased interest demanded at successively lower levels, restricting borrowing capacity of less creditworthy borrowers. States are effectively being shut out of the market owing to decreasing revenues and have to go to the Feds now. Etc., etc.

    These are apparently straight up economic problems having economic solutions, but that is not the case. The problem is that economics does not exist in a vacuum. It is more correct to speak of socio-economics, which implies political economics.

    Market fundamentals want a market solution, but a market-based solution would be socially disastrous and is therefore ruled out politically. No leader want to be the next Herbert Hoover, and no party wants to be the GOP after the New Deal.

    Progressives want to go directly to the new era, bypassing go. That’s not going to happen either, since the frame of reference is not yet structured in the national mindset. The ground needs to be prepared after three decades of failed memes that are difficult to eradicate, since they have gone Pavlovian.

    As a result there will likely be a series of pillows put in place to cushion the fall, but that will be expensive and take funding from more productive uses. Ideally, there will be a balance between cushioning the blow by wasting funds just propping things up and actually preparing the ground for a new era by seeding positive change. But you can’t just let the financial system fail or Detroit go under, as some people advise. The consequences would be too wrenching and the country would spiral not only into economic depression but psychological depression as well, if not panic.

    Presently, the way the world has been working is the rest of the world lends the US money by buying Treasuries, which the US uses, first, to finances its empire, e.g., two active wars off budget and the largest military expenditure on record — which Obama is talking about increasing. The second place the money goes is into bank reserves that are made available for lending through fractional reserve banking. That credit was extend to business for expansion, but a lot of it went to LBO’s that just increased debt and enriched a few. It was a wealth extraction scheme. Credit also went to real estate, both residential and commercial. Both sectors produced bubbles when loans were made imprudently. Finally, a lot of credit was extended for consumer purchases, like autos and other products and services, again extended imprudently. Now the bill is coming due with the economy contracting and a lot of that debt will default or be negotiated. The upshot is that the debt-based economy is over for some time to come. This will involve financial write-downs and bankruptcies, and decreasing velocity, while trying to restructure the economy on a sounder basis. Juggling act.

    What should this restructuring be like. There are going to be a lot of people tugging for things to go their way. Progressives need to push for as much progressivism as the system can stand, because that is money well spent instead of being wasted supporting what is obsolete.

    What is happening at the moment is that financial authorities are losing ability to control of the economy through monetary measures, because the funds they are injecting are producing diminishing returns. As the rate of return is approaching zero, the “inflection point” is reached, where things spin out of control. Karl Denninger thinks that we are pretty much there.

    Moreover, the US is still strongly committed to military Keynesianism and there is no reason to think that this trend is going to change under the new administration, other than token measures. The military will have to give up some toys. But the savings will be spent on other things, like increasing manpower. Until progressives can reverse this trend significantly, there are going to be problems righting the economy. Military spending is unproductive.

    Most important is reforming lobbying and campaign finance. As long as special interests control the pols, they will get their way. Obama is not different. Wall Street is into him and the rest of the Dems very big right now, for example. But if progressive don’t force change here, other serious reforms will fail to materialize. The real problem is not know what to do, but being able to do it. Unless the deniers, the defenders of the status quo ante, and the saboteurs are checked, being right will make no difference, because they will be in a position to block change. Progressives need to reframe the debate and move the Overton window leftward as fast as possible. So keep the pressure on. There’s no time for a honeymoon.

  • …correct on the unemployment figures; something I didn’t factor in and Roubini speaks of 10% as coming soon, not in the present. So, exciting? yes, but only if, as you say, the opportunity is used to rethink and recognize past shortsightedness. Thanks for the further thoughts.

  • world economies will not recover in 2009—we’ve currently entered the beginning of a period of global stag-deflation Roubini forecasts 2010 as the earliest change from these economic conditions.

  • is that I agree that by the usual rules of the game, we are in trouble

    my sense is that some rules will be broken, but how to do it without ending up with no rules

    my sense from Numerian is that he has no confidence in a stimulus approach

    I have doubts that anything proposed so far will be effective, but I see no alternative but to try. political reasons as well as economic reasons

    as much as I distrust the tone of many peak oil doomsayers, I have a nagging feeling that we must move to a green economy not just to save the planet from climate change but also to develop an economy not reliant on massive annual capital flows out of the country

    good early step would be smart grid because it promotes small generation of electricity and conservation by individuals, but there are complicated computer standards that need to be set before smart grid can happen. basically, need the computer standards, and then a Fed buying program for meters conditioned upon state law regs that tie rates/utility profits to something other than volume consumed. Not impossible, but the outlook is currently very poor. If anyone in power understands the essential route forward, that person is successfully keeping a very low profile

    the military may need to take a haircut, but that will not happen first

    I have a small quibble with your campaign finance remark; that will never work. Public funding of campaigns or bust

    buy your freedom or live without it

  • OK almost unrelated — I heard a funny story about Roubini and his swank parties in NYC – weird artwork, hangin’ w the chicks. The person I heard this from had heard of Roubini as kind of a partying professor rather than an esteemed economic expert. Hedonics! 😀


  • Many are extrapolating from the 1930s Depression to determine what could happen next. Consequently we get assumptions such as:

    a) Politics will move leftward and the people will rise up against the monied classes. Social strife may well occur. The wealthy will form armies of thugs to protect their interests.

    b) A leader will arise – Obama most likely – to lead a New New Deal.

    c) The Fed should not make the same mistake and raise interest rates in order to fight budget deficits. Similarly, fiscal policy should this time be as loose as possible in order to avoid a depression.

    d) While extremely loose monetary and fiscal policy will help, ultimately the only way out of a depression is war.

    What is wrong with these sort of extrapolations from the past is that this time things are different and worse. The debt overhang affects all levels of society, even college students. U.S. debt permeates the global financial system, and the appetite for more debt is approaching a breaking point. The U.S. is already waging too wars. Energy is hardly cheap nor abundant as in the 30s. Global environmental catastrophe may well be the paramount issue to address but does mankind have the leadership to do so?

    We will inevitably be surprised at what will transpire. The disgust with financial capitalism may not come from the general public, but from the monied classes, many of whom could be wiped out. I’m thinking of prominent entrepreneurs like Steve Wynn, Sumner Redstone, and Rupert Murdoch, who may join Buffett and Gates in calling for an overhaul of the financial markets, greater protection for investors, higher taxes on wealth, and more money spent at home rather than abroad. What may concern them is that capitalism itself will be in question. Many of the countries that embraced free market capitalism, global trade, the hegemony of the dollar, and the multilateral infrastructure like the World Bank and IMF – the BRICS for example – will be looking for some other way to organize the world and their economies. The fight will be between those who want to retain the basic structure of free market capitalism, and are willing to give up many of their privileges to do so, and many others who will be looking for something completely different.

    It is not clear that any one nation, or any intellectual movement, can shape the outcome. What may be happening inevitably is a breakdown of capitalism into something we can call international feudalism. Nations will huddle for economic protection in groups as global trade breaks down, and neither the U.S. nor Europe have the means to enforce a new international structure. China and Japan will have common interests as exporters. Russia, Iran and other OPEC countries will have common interests as raw materials providers. The industrial countries like the U.S., France, Canada etc. will have a common interest in expanding nuclear power for themselves but keeping it out of the hands of other nations.

    We may be seeing the beginning of the end of the militarized state as represented by the U.S. It is increasingly uneconomic to maintain as massive a military presence as exists now, and the efficacy of this military machine in the face of insurgencies, guerrilla warfare, and asymmetric warfare is certainly doubtful. This is a process that is just beginning, and the U.S. will be forced to abandon its military economy, rather than do so voluntarily. It may not be Obama, but some president soon will have to “bite the bullet”.

    War may be fought with economic weapons and things like cyber-attacks, because it is too expensive, uncertain, and risky to resort to conventional warfare. Water and energy sources will also be used as weapons. Sometime in the next ten years the world may also be surprised by a global pandemic, which is long overdue.

    We can spend a lot of time formulating what the new world order is going to look like, but the system is too classically chaotic to do so, and what we are much more likely to see will be a new world disorder limping along for decades.

  • We can spend a lot of time formulating what the new world order is going to look like, but the system is too classically chaotic to do so, and what we are much more likely to see will be a new world disorder limping along for decades.

    There’s going to have to widespread recognition that the old order is finished before real restructuring can begin. That alone is going to be a messy process that is going to involve not only the US, UK, EU and Japan, but also China, Russia, India, Brazil, and the ME petro states at least, probably while several conflicts are in progress, too.

    Just as people aren’t going to see eye to eye on this in the US, there are going to be a number of factions jostling for position. And that’s before real work begins on a NWO. I agree that it’s likely to be a decades long process, and there are no guarantees how it’s going to turn out because it is going to involve a number of different power struggles.

    I do think that the market fundamentalism that underlies economic neoliberalism is finished though. Too many people got burned big time. The idea that unfettered markets seek equilibrium has been discredited because it is based on a fallacy. Soros does a pretty good job showing this in The New Paradigm for Financial Markets, but events have pretty much made arguments unnecessary. The facts are obvious, and even Alan Greenspan admits that he never thought for a moment that supposedly rational players would act irrationally, but was wrong. When self-interest becomes greed, it does funny things. Surprise, surprise. Oh, and did you hear, Madoff is rumored to be about to play the crazy card, about equal to the-devil-made-me-do-it defense.

  • you would be amazed at the flukey bs that drives history sometimes

    anyway, it is a matter of honor to try

    The comparison to the 1930s does not drive my fears about demogoguery. We have seen plenty of that in the last 50 years.

    Moreover, I quite agree that economic conditions are very different, but I think that they are not entirely worse. We have electricity everywhere. The public accepts the concepts of social security and labor unions.

    I think that the concept of money/debt is under strain today in a new and fundamental way. The 700 billion for TARP, and the hundreds of billions more for this and that, has not completely registered yet, but the idea that the public MUST bail out the system and the wealthy or perish is likely to morph into the idea that we might as well own the system — and that wealth is unfair.

    You simply cannot bail out multi-millionaires by the bushel and then tell the average consumer that she is on her own with the mortgage and credit card debt. No one will listen.

    The resentment may feed the left and may feed the right. It is very likely to feed both. And an angry, unemployed youth will inevitably include violent millenialists of many stripes.

    Suicide bombing is another invention since the 1930s.

    Violent frustration will be horrible in its own right, and won’t make things better. We need a moderate revolution before things come to that.

    Years ago, I predicted to you that when the crisis arrived, our conventional leaders would be astounded and completely without any idea about what to do. So it was an easy prediction. Still, the challenge remains the same.

    What should we do next?

  • Here’s a comment I just posted on another thread. It fits here too.

    During the Countercultural Revolution of the Sixties and Seventies, the Internet didn’t exist and communications among individuals and communities was dependent on word of mouth and the independent newspapers or “free press,” Now things are radically different, and progressivism is a global affair. I also regularly talk internationally for free on Skype, computer to computer. In addition, a lot of people are networking using Web 2, e.g. through Facebook, etc. It’s a different world.

    We may be way ahead of where we were decades ago, but there is still no substitute for a local network when things head south.

    The prevailing view of the Copuntercultural Revolution was that meaningful change had to come from the bottom up rather than top down. Top down change always favors the power elite and centralization of power. Bottom up change is organic, community-based, and decentralized. At this level true democracy can bloom. Moreover, it has to be based on spirituality (self-actualization) and the ideal of the tribe as a group of self-sufficient individuals voluntary cooperating for mutual benefit, rather than relying on religious or political ideology to impose norms externally.

    I’d say this remains true today.

  • your queries and questions always resonate with me. I understand more from you than from the financial analysts. Thank you.

    Tolerating prostitution is tolerating abuse and torture of women and children.

  • You have about 100 basis points in the position, then. Depending on your pain threshold, you may have to hold on to this through the low 30s or high 20s, and there is always the question of whether the market just wants to sit here for six months. Still, I think the odds are in your favor that some time in January the bond market will retrace this explosive move up. TBT has a gap leading to consolidation around 45, and yet other gaps all the way up to 55.

  • And risky to play with given the double-volatility structure of these ETFs. You’ve got to keep your positions small and monitor volume because you have to set stop loss levels that are actionable. Some of these ETFs have such low volume that you can’t rely on a stop loss. Also, because of recent volatility you have to accept a wide range of daily activity, and setting typical stops a few percentage points away from entry almost always guarantees you will take a loss. Hence the need to have wide latitude for your stop loss, and a small position because of this.

    I have to agree that these ultra short ETFs are adding volatility to the market. You can see it in the daily action. Cramer is already screaming about the need to outlaw these. I hope the SEC doesn’t make that mistake. Right now these ultra products are quite the rage, which means investors are going to learn the hard way how this leverage can hurt them. Once enough people get that message, the fervor will calm down and volume will grow more steadily.

    The other reason I hope Cramer doesn’t get his way is that these are the only tools available to legitimately go short in your IRA.

    I think, by the way, I am hijacking my own thread here by getting off topic from debt and the bond markets, but on the other hand the TBT and TLT are at the core of much current trading in the bond market derivatives.

  • Here’s the actual forcast from Roubini

    In the advanced economies, recession had brought back earlier in 2008 fears of 1970’s-style stagflation (a combination of economic stagnation and inflation). But, with aggregate demand falling below growing aggregate supply, slack goods markets will lead to lower inflation as firms’ pricing power is restrained.

  • Think of him as the Hervé Villechaize of economics, and it makes sense. Apparently Hervé was always the sexiest man in the room.

    “The Playboy reader invites a female acquaintance in for a quiet discussion of Picasso, Nietzsche, jazz, sex.” – Hugh Hefner

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