“Money we don’t have”

Good NYT article on deficit hysteria, with an especially illustrative quote from Rep. Cooper (D, TN):

“We have to stop spending money we don’t have,” said Representative Jim Cooper, a Tennessee Democrat who voted against the bill. “I hope deficit reduction fever is catching.”

The U.S. is in the midst of a balance sheet recession, with demographic ratios shifting an an unfavorable economic direction for several more years.  Under those conditions, deficit reduction fever will lead directly to the dreaded Japanese Disease —  another decade of stagnation, underemployment, and opportunity costs, all of which will impose greater burdens on future generations than expanded federal deficits would.

And policymakers — not to mention most members of the electorate, including analysts and the media — continue to commit two fundamental errors regarding fiscal policy:

1. They believe that all deficit spending must be financed with interest bearing debt, thus competing with the private sector for scarce financial resources.  However, judging by current Treasury rates, there’s still plenty of room for expanded federal borrowing.  And there’s a symbiosis between federal deficits and repair of balance sheets in the financial sector, as evidenced by the perfect quarters turned in by several major investment banks recently.  Politically, that relationship is almost nauseating, as it’s doing very little to relieve distressed households — but it nevertheless makes apparent the  dynamic between public sector fiscal deficits and private sector balance sheet relief.
2. They also believe implicitly that the U.S. is on a gold or similar standard, where fiscal and monetary policies are constrained by the supply of some exogenous factor, and governments can thus literally “run out of money.”  Governments can’t run out of money, as it is ’created’ by nothing more than digital ledger entries.  In other words, government (today, via operations of the quasi-private Fed) is the sole creator and supplier of high powered money.  Thus, the only constraint on money creation is inflation and a loss of confidence in the currency, and at the moment, those forces are emphatically not in play.  This too is symptomatic of Japanese Disease.

The fears of incumbent politicians like Cooper are certainly understandable.  But they’re borne of either ignorance about how these things work, or self-preservation.  Either way, it smacks of lousy political leadership. 

And given that Republicans are likely to benefit in November, we’d expect the trend towards fiscal conservatism to intensify.  Even President Obama, in a speech yesterday, promised the following:

• A three year freeze on all non-discretionary federal spending beginning in 2011
• Expiration of tax cuts via sunset provisions
• Elimination of 120 federal programs
• Reinstatement of PAYGO
• Higher fees on banks that are expected to lower federal deficits by $90B over ten years

He promised all of this as a way to force the public sector to budget in the same way that families and businesses do.  Again, this is wrong, and is borne of either ignorance or pandering.  And as with Congress, it smacks of crummy political leadership either way. 

The administration’s jawboning is also reminiscent of budget austerity measures touted by the Carter administration in the 1970s in reaction to the “tax revolt” — austerity measures that contributed to its eventual demise, even though they may have been more appropriate to the conditions prevailing at the time (e.g., baby boomers entering adulthood, global trade and financial integration, etc).   Today, austerity is far less appropriate, but even more vigorously pursued.  That almost certainly spells trouble for Obama in 2012 – assuming the GOP can field a worthy candidate and avoid blowing all of its political capital in the intervening years. 

You also have to wonder, were he to experience a change of heart, whether there’s any credible way for him to backtrack from his neo-liberal rhetoric.  The DLC, Brookings, Peterson, and all the other usual suspects have painted the guy into one hell of a corner.

In the meantime, assuming that reality will align with rhetoric, the political climate continues to be favorable to the USD and Treasuries, and rather risky to gold.  A contrarian call? You bet.  But it’s based on what we think is a well-grounded and – just as importantly – non-ideological assessment of the facts. 

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a state registered investment adviser in the Commonwealth of Pennsylvania. The views expressed by the author are as of the publication date, and are subject to change based on market and other conditions. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy or a solicitation to sell any security, or to engage in any investment strategy. Investors should not use this information as a basis for any investment decisions without first consulting their own financial adviser. SCM is an Amazon.com associate, and earns a commission on sales generated through links from our website. Some clients of the firm are long GLL and/or long TLT.  At the time of writing, neither the firm nor its principals owned any securities mentioned. PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.

URLs:

http://www.nytimes.com/2010/05/29/us/politics/29deficit.html

http://www.japanreview.net/review_bsr.htm

http://www.miraeasset.com/ourmarket/outlookView.do?board_id=1125&group_id=1&pageNo=2

http://www.investmentnews.com/article/20100602/FREE/100609973

http://seekingalpha.com/article/208174-how-deficit-hawks-will-keep-cutting-spending-until-we-re-all-on-food-stamps

Reflections & reading

Here’s our current take on the state of markets and political economy – plenty of fodder for anyone seeking reading material for Memorial Day weekend! 

REFLECTIONS ON MEMORIAL DAY

It’s easy to forget that this three day weekend is more than just a respite from a busy and uncertain world, but also an opportunity to reflect on the public sacrifices of so many, and what they mean to us.  Part of that is obvious, part of it less so.  As Oliver Wendell Holmes observed of Memorial Day in 1884 (emphasis added):

…to the indifferent inquirer who asks why Memorial Day is still kept up we may answer, it celebrates and solemnly reaffirms from year to year a national act of enthusiasm and faith. It embodies in the most impressive form our belief that to act with enthusiam and faith is the condition of acting greatly. To fight out a war, you must believe something and want something with all your might. So must you do to carry anything else to an end worth reaching. More than that, you must be willing to commit yourself to a course, perhaps a long and hard one, without being able to foresee exactly where you will come out. All that is required of you is that you should go somewhither as hard as ever you can. The rest belongs to fate. One may fall-at the beginning of the charge or at the top of the earthworks; but in no other way can he reach the rewards of victory.

We’ll be thinking of all servicemen and women, past and present, and hope you will too.  We’ll also be thinking of ’the Captain’ — we miss having him on the bridge with us. 

GEITHNER RALLIES EUROPE

Markets have had a nice little relief bounce this week, thanks in part to Treasury Secretary Geithner’s solidarity promoting visit to Europe.  Interbank funding markets, though somewhat improved, continue to show signs of stress.  This shouldn’t be surprising, as Geithner’s message is that the current EMU-IMF rescue plan is a good one, and just needs coordinated implementation:

“The European leaders have put together a very strong programme of reforms on the fiscal side and a very strong commitment on the financial side,” he said at a news conference alongside new British finance minister George Osborne.

“I think it’s got the right elements and again I see a very strong political commitment — you see that not just in Germany but across Europe — to make it work. I think what Europe should do is implement the program they’ve laid out.”

As we’ve pointed out, we think that assessment is just dead wrong.  Unless the ECB is somehow surreptitiously monetizing Greek debt, then the current plan virtually assures its eventual default.  And as with the once supposedly “contained” subprime crisis, it’s extremely unlikely that Greek debt can be ring fenced in a way that will prevent global financial contagion and damage to the real global economy.  The euro’s continued descent (like the flight to the USD and U.S. Treasuries) implies as much.  As long as “fiscal austerity” is given primacy the world over, then the bullish USD and UST trade should continue, and gold should look increasingly precarious. 

THE AUSTERITY BAND PLAYS ON

We commented yesterday on the OECD’s double barreled assault on recovery.  Larry Elliott of The Guardian also penned a good counter point:

…the risks of tightening too quickly are probably greater than tightening too slowly. Why? Because in the US and in the European Union (although not in the UK) deflation is now a threat. Should the global economy tip back into recession, policymakers would have no ammunition left to fire. Interest rates are at rock-bottom levels already, budget deficits have exploded, new money has been created electronically, central banks are awash with the bad debts they have scooped up from financial institutions.The best (or least bad) outcome would be for policymakers to hold their nerve, keeping pro-growth policies in place until there is evidence both of recovery becoming embedded and of the reforms necessary to prevent a second financial crisis. Unfortunately, the European sovereign debt crisis has muddied the waters, making governments – and institutions like the OECD – nervous. The voices urging austerity are currently more powerful than those urging the need for job creation. After a brief flirtation with unconventional economic policies, the old orthodoxy is making a comeback.

There’s also a good video piece on the Peter G. Peterson Foundation’s most recent fiscal scarefest, er, summit, with some pointed jabs at the man himself.  The scariest part of the video, to us, is when deficit reduction commission co-chairs Erskine Bowles and Alan Simpson offer their intensely hawkish views, as we expect them to have the President’s ear when it comes time to enact fiscal consolidation. 

INFLATIONISTAS EXPOUND

In a NYT op-ed, David Einhorn, a hedge fund manager who’s one of the best balance sheet analysts alive, tried his hand at macroeconomic analysis, with mixed results.  One particular aspect is especially curious — Einhorn derides credit rating agencies (and “modern Keynesianism”, whatever he means by that):

Modern Keynesianism works great until it doesn’t. No one really knows where the line is. One obvious lesson from the economic crisis is that we should get rid of the official credit ratings that inspire false confidence and, worse, are pro-cyclical, aggravating slowdowns and inflating booms. Congress has a rare opportunity in the current regulatory reform effort to eliminate the rating system. For now, it does not appear interested in taking sufficiently aggressive action.

Yet only a few paragraphs later, Einhorn sounds just like those same rating agencies – the ones that have gotten Japan so remarkably and consistently wrong over twenty years — when discussing the risk of sovereign debt default:

I don’t believe a United States debt default is inevitable. On the other hand, I don’t see the political will to steer the country away from crisis. If we wait until the markets force action, as they have in Greece, we might find ourselves negotiating austerity programs with foreign creditors.

Some believe this could be avoided by printing money. Despite the promises by the Federal Reserve chairman, Ben Bernanke, not to print money or “monetize” the debt, when push comes to shove, there is a good chance the Fed will do so, at least to the point where significant inflation shows up even in government statistics.

That the recent round of money printing has not led to headline inflation may give central bankers the confidence that they can pursue this course without inflationary consequences. However, printing money can go only so far without creating inflation.

The Pragmatic Capitalist penned a good rebuttal to Einhorn’s piece:

First, the government doesn’t actually print money (at least not in terms of money creation). They simply press a button on a computer that changes accounts up and down. It’s not like they find a gold miner and print up a note and “monetize” anything. Most importantly though, the government never actually has nor doesn’t have dollars. They simply change accounts up and down as they tax and spend. So what does the Fed do? They target the Fed Funds Rate via monetary operations with the belief that they are the grand wizard behind the whole operation. The Fed’s interest rate mandate or target of “price stability” actually means they can’t monetize the debt. In a Q&A session last year Mr. Bernanke admitted as much…

Now, this is generally the point in the conversation where the inflationistas begin talking about the “effective default” of the USA via dollar devaluation. The problem is, each time the crisis flares up the price action in markets makes it abundantly clear that there is no inflation, but rather continuing deflationary fears.

…The inflationistas have made the same error that Mr. Bernanke made when he supposedly “saved the world” in 2008. Mr. Bernanke assumed that banks were reserve constrained while Mr. Einhorn assumes that adding to reserves is inherently inflationary.

But as we see very low levels of borrowing (due to the private sector’s lack of debt demand – caused by the continuing balance sheet recession and de-leveraging) we also see zero signs of inflation.

Einhorn is not the only smart hedgie manager who’s worried about inflation — Seth Klarman is too:

The concern that the dollars he earns for his clients will lose their purchasing power is always on hedge fund manager Seth Klarman’s mind.   The possibility that the government will continue to print money to solve our economic problems has left him more worried than at any time in his career.

“There are not enough dollars in the world to do that, unless we greatly debase them,” he said.

Our take is that Klarman isn’t thinking deeply enough about stocks, flows, and multipliers in making such a statement.  Monetization should be sufficient to stem deflationary pressures long before it approaches 100% of outstanding debt.  And as we noted recently, in a deflationary balance sheet recession, there is a period of ”disdeflation” that must unfold before we can arrive at actual inflation:

Deflation implies a shortage of money.  If that shortage persists, eventually all or most prices will come down, even if relative prices (e.g., the number of eggs exchanged for a quart of milk or a certain amount of gold or silver) do not move. And because most debt contracts are priced in nominal rather than real terms, this causes carnage in credit markets, e.g., waves of default, bankruptcies, and restructuring…

Under fiat monetary systems, precious metals are nothing more than a barometer of inflation (rising) and deflation (falling), and like any other prices, they are subject at times to human error and herding.  And today, with everything on the planet flashing deflation ahead, there is simply no fundamental reason for gold prices to increase.

So why has gold been rising? It’s most likely due to the fear that policymakers will use inflation to involuntarily “restructure” public sector debt…

Here’s the thing though – if there’s outright deflation, then monetizing debt, be it sovereign or private, cannot be inflationary until deflationary pressures have been completely extinguished. This idea simply mirrors the concept of ”disinflation” that has held currency with economists from the 1980s into the 2000s — similar to how today’s environment is an inverse reflection of the episodes that have people like [Einhorn and Klarman] wringing their hands about inflation, and gold bugs screaming that the sky’s the limit.  

Is it disdeflation? Whatever we choose to call it, it is not a “door” or a magical threshold that is instantly crossed as soon as central banks monetize interest bearing debt, or treasuries credit accounts with new units of money. It’s more like a long passage, with plenty of room between here (deflation) and there (inflation). Most importantly, there are places along that passage that offer a sounder economic and financial footing than what we’re currently on.    

Most importantly, if the world’s governments continue hurtling towards austerity as currently promised, at least part of his statement will prove true: “There [will not be] enough dollars in the world…”

THE INTERGENERATIONAL DEBATE

On the “sounder footing” point above, given how the intergenerational “mountain of debt” meme continues to run wild, we can’t over emphasize this: debt is not the only thing that one generation leaves to another!!!  There are also tangible and intangible assets — not only financial wealth, but also public and private resources, knowledge, security, technology, arts and culture, peace, health, etc.  Poorly timed austerity measures will mean that FEWER of those assets are available to future generations, due to Wicksell’s ‘residue of social maladjustment’; they will also require even further expansions in public sector outlays, due to poor economic performance, thus raising the dreaded debt-to-GDP levels that they’re aimed at lowering (Japan, anyone?). 

Alan Simpson acknowledges as much in the Real News video, though he seemed to be deeming it necessary, perhaps laboring under the prevailing dogma that government deficits always work against private sector economic growth.  For a competing take, we recommend Richard Koo’s take on Japan, the U.S., and balance sheet recessions. 

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Some clients of the firm hold positions that are expected to move inversely to gold prices.

URLs:

http://www.usmemorialday.org/observe.htm

http://people.virginia.edu/~mmd5f/memorial.htm

http://www.reuters.com/article/idUSLDE64P12320100526

http://654advisors.com/index.php/blog/2010/05/oecds-double-barrel/

http://www.guardian.co.uk/business/2010/may/27/larry-elliott-deficits-austerity

http://www.pgpf.org/newsroom/press/Top-Leaders-to-Meet-in-Washington/

http://www.nytimes.com/2010/05/27/opinion/27einhorn.html?ref=opinion&pagewanted=all

http://654advisors.com/index.php/blog/2010/05/japan-not-greece-black-widow-ii/

http://seekingalpha.com/article/207443-talking-ourselves-off-the-edge-of-the-cliff

http://www.advisorperspectives.com/newsletters10/Seth_Klarman_is_More_Worried_than_at_Any_Time_in_his_Career.php

http://seekingalpha.com/article/206104-disdeflation-an-important-and-not-entirely-new-concept

http://654advisors.com/index.php/blog/2010/05/a-brief-now-what/

http://654advisors.com/index.php/blog/2010/05/fiscal-reform-will-fail/

He likes it! Hey Nicky!

At the moment, Mr. Market looks pretty satisfied with the EMU’s surprisingly large rescue plan – European stock bourses are up over 5%, France’s CAC40 over 8%, while U.S. equity futures are up over 4%.  Vienna’s ATX and the Madrid General, with their home countries also heavily exposed to troubled sovereign debt (Spain doubly so), are up over 9% and 12% respectively:

Of course, following a week when indices were down 7 to 11%, these kinds of gains still leave markets roughly 3% shy of last week’s highs.

It’s not clear how much of this consists of short covering, and how much reflects renewed belief in fundamentals.  European officials still sound as if they are strongly committed to austerity — perhaps the sizeable rescue package reflects nothing more than a desire to spread the pain to bearish traders as well?

And globally, a handful of analysts have noted that many cyclical asset prices have optimistically decoupled from leading indicators such as Chinese property markets (see this rather cautious piece by former uber bull Ajay Kapur, for example: http://www.miraeasset.com/ourmarket/outlookView.do?board_id=1350&group_id=1&pageNo=1).

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Symmetry Capital Management, LLC is an Amazon.com associate, and earns a commission on sales generated through links from our website. At the time of writing, the firm, its principals, and its clients did not own any securities mentioned, or any securities issued by entities mentioned.

“An absolute general mobilization” in Euroland

Wow…the EU may, may, have finally put together a mammoth, TARP sized plan to prevent or at least mitigate a 2008-style meltdown on the continent. As described in an article by Ambrose Evans-Pritchard of The Telegraph (UK):

“It is an absolute general mobilization: we have decided to give the eurozone a veritable economic government,” said French president Nicolas Sarkozy, once again basking as Europe’s action man. “Today we have an attack on the whole of the eurozone. This is a systemic crisis: the response must be systemic. When the markets open on Monday morning we will be ready to defend the euro.”

Great caution is in order. German Chancellor Angela Merkel has so far said little. The descriptions of the deal agreed by EU leaders in the early hours of Saturday are coming from the French bloc and EU bureaucrats. How many times during the Greek saga of the last four months have we heard claims from Brussels that turned out to be a distortion of what Germany had actually agreed, causing each relief rally to falter within days? They had better get it right this time.

Perhaps it shouldn’t be surprising that the French bloc is pushing such a description, given their relative exposure to Greece and their immense exposure to Italy:

Image by Bill Marsh/The New York Times

Evans-Pritchard continues, noting what a seminal event this is for the EMU and the euro:

…if the early reports are near true, the accord profoundly alters the character of the European Union…The creation of an EU rescue mechanism with powers to issue bonds with Europe’s AAA rating to help eurozone states in trouble — apparently €60bn, with a separate facility that may be able to lever up to €600bn — is to go far beyond the Lisbon Treaty. This new agency is an EU Treasury in all but name, managing an EU fiscal union where liabilities become shared. A European state is being created before our eyes.No EMU country will be allowed to default, whatever the moral hazard. Mrs Merkel seems to have bowed to extreme pressure as contagion spread to Portugal, Ireland, and — the two clinchers — Spain and Italy. “We have a serious situation, not just in one country but in several,” she said.

The euro’s founding fathers have for now won their strategic bet that monetary union would one day force EU states to create the machinery needed to make it work, or put another way that Germany would go along rather than squander its half-century investment in Europe’s power-war [sic] order.

According to Evans-Pritchard, a key problem with the present accord, beyond German inflation phobia, is that its key components still include severe austerity measures:

The answer to this — if the objective is to save EMU — is for Germany to boost its growth and tolerate higher `relative’ inflation. This would allow the South to close the gap without tipping into a 1930s Fisherite death spiral. Yet Europe will have none of it. The weekend deal demands yet more belt-tightening from the South. Portugal is to shelve its public works projects. Spain has pledged further cuts. As for Germany, it is preparing fiscal tightening to comply with the new balanced budget amendment in its Grundgesetz.

In other words, while Germany may have surrendered significant ground on the matter of closer fiscal integration, it has apparently not given up on its demands for severe austerity measures in other EMU nations. Note that even Sarkozy’s quote closes with the somewhat cryptic statement that “on Monday morning we will be ready to defend the euro.” Does that mean that a stronger euro will be pursued by policymakers, or that stabilization measures will be taken that, in the long run, should ensure the euro’s continued existence? The former would only exacerbate the sense of crisis and panic, so it’s tempting to assume that Sarkozy and other European leaders are committed to the second. However, Evans-Pritchard closes with two disconcerting historical references that should give pause:

While each component makes sense in its own narrow terms, the EU policy as a whole is madness for a currency union. Stephen Lewis from Monument Securities says Europe’s leaders have forgotten the lesson of the “Gold Bloc” in the second phase of the Great Depression, when a reactionary and over-proud Continent ground itself into slump by clinging to deflationary totemism long after the circumstances had rendered this policy suicidal. We all know how it ended.

We should see a good deal of dislocation (relocation?) and continuing volatility in markets tomorrow, with credit markets being key ones to watch. If European leaders can manage to soften the austerity demands, quell their inflation paranoia, and execute on a meaningful stabilization program, then things should settle down in reasonably short order.  If they can’t, then keep your seat belts fastened.

Another critical issue is whether the backstop provided by a new facility is large enough relative to the debt levels at the center of the crisis. According to data in a recent Spiegel article, it might be, all told. In 2012, there’s E370B of debt maturing in the PIIGS nations, E328B in 2011, and 276B in 2012. And something that has been completely overlooked in this crisis is that, according to Ajay Kapur’s research, most of the PIIGS countries are on the cusp of favorable turns in demographic composition, at least as it relates to financial sector performance. That certainly adds an interesting wrinkle to the story.

TOH to Zero Hedge for links to the Telegraph and Spiegel articles.

UPDATE 5/9/2010 — The ECB has announced that its bond market operations will be sterilized, which means it intends to offset the creation of new euros resulting from its planned bond market purchases. The net effect is to undo any actual debt monetization. This indicates to us that current plans to ‘protect the euro’ are indeed likely to have a deflationary bias. It will be interesting to see how forex markets react — do they think it can be done (stronger euro), or will they bet on inevitable ECB easing (weaker euro)?  This does nothing to undermine Stephen Lewis’ warning above about “deflationary totemism”.  

URLs:

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/7702335/Europe-prepares-nuclear-response-to-save-monetary-union.html

http://learning.blogs.nytimes.com/2010/05/04/its-all-greek-to-me-understanding-the-debt-crisis-in-europe/

http://www.miraeasset.com/ourmarket/outlookView.do?board_id=1125&group_id=1

http://www.businessweek.com/news/2010-05-09/ecb-intervenes-in-bond-market-as-part-of-eu-debt-crisis-plan.html 

A brief “Now what?!?”

Equity markets and indices are down over 2% today on worries about what most pundits refer to as the “Greek bailout,” which took its (supposedly) final shape over the weekend, with details to follow from the IMF and other parties. The terms, as currently laid out, are brutal, a fact reflected by the intense street protests in Greece and the government’s loss of union support. The theories and practices underlying them are highly questionable and pitifully anachronistic as well, which make it all the more frustrating.   

There’s no doubt that Greece has made some mistakes, that the lack of accurate fiscal disclosures by its previous government was extremely unethical, and that labor market reforms may be in order. But there are humane ways to approach and work through the entire imbroglio. Unfortunately, neither the IMF nor major eurozone countries seem to be giving that much thought. And as Marshall Auerback has pointed out, Germany’s longstanding inflation paranoia has it behaving as if it’s 1921 all over again; when to us, reality appears to be much closer to the deflationary late 1920s and 1930s.   

We referred to the Greek plan as pitifully anachronistic because it embodies what we might call gold standard era thinking, when the supply of new money was a function of mining output and demand for gold ownership in the private sector. At the turn of the 20th century, economist Knut Wicksell pointed out the need for a “rational monetary system“, while highlighting intellectual obstacles to it:   

It is no exaggeration to say that even to-day many of the most distinguished economists lack any real, logically worked out theory of money, a circumstance which has not, of course, been particularly conducive to the success of modern discussions in this field.   

Wicksell’s sentiments are still relevant today, and (in our view) have been powerfully echoed and expanded upon by proponents of neo-chartalism, also known as Modern Monetary Theory. Bill Mitchell, an occasionally acerbic but ever prolific member of the MMT club, recently posted the following diagram on his website:   

The essential point of the diagram is to illuminate that, under a fiat currency system, the government (whether through its treasury or via a quasi-public central bank) is the sole provider of money. And one of the resulting takeaways of this fact is that under certain conditions, fiscal austerity in the public sector will impose significant costs on the private sector. In turn, that will tend to raise the value of money, all else equal, which is the essence of deflation. And as Wicksell pointed out over a hundred years ago, deflation, like inflation, comes at a cost (emphasis added):   

…when a rise or fall occurs in the money prices of all, or of most, commodities…[a]djustment can no longer proceed through changes in demand or through a movement of factors of production from one branch of production to another. Its progress is much slower, being accomplished under continual difficulties, and it is never complete; so that a residue, either temporary or permanent, of social maladjustment is always left over.   

By linking the inflation boogeyman to public sector debt levels, prevailing economic theory sometimes leads to poor policy prescriptions and outcomes, as we are now seeing in Greece. It also fails utterly to explain the experience of Japan over the last two decades, and it looks set to fail in both the Eurozone and the U.S. in the coming decade.  So far, our contrarian calls for a strengthening USD and a dovish view of long term U.S. Treasury yields has lent support to this thesis.   

As with our recent “What Happened?!?” piece, we also think it’s important to tie the Greek “rescue” package to the current U.S. policy outlook. Today, speaking to the Business Council, President Obama once again invoked our “unsustainable fiscal deficit” and argued for immediate reimplementation of PAYGO. Looked at in terms of Mitchell’s diagram above, that implies that at best, the federal government is unlikely to add to the supply of vertical money.  It’s also important to realize that a concept like PAYGO essentially restricts the vertical money supply function to the central bank. And yet, according to recent testimony from Fed Chairman Bernanke, the Fed is targeting roughly a 50% contraction in its balance sheet, which also implies a contraction in narrow or vertical money supply (though rising velocity could give the Fed some room to work with).  Similarly, it was over tightening in both the fiscal and monetary spheres that led to the 1937 recession after several years of economic recovery.

The upshot of all this is that leaders in the public sectors of both the U.S. and the Eurozone are clearly signalling their intentions to “crowd out” private sector saving and, potentially, income. And unfortunately, electoratal majorities in key countries seem to support this direction. Normally, we expect electoral outcomes to approach optimal, but in this particular case, we suspect that the historic lack of economic and financial education might steer us wrong. Then again, voters with incomes might be making some rational inferences about deficits, austerity, and taxes. If so, the burden of adjustment could rest even more heavily on the on the un- and under- employed (believe it or not, that’s something that a handful of policy pundits have advocated, and that at least one senator briefly pursued).   

Either way, deflation will be the inescapable result of excessive restriction or contraction in vertical money.  We’re currently getting slight whiffs of it from credit markets and price indices (although the latter are still positive); cooling measures in China are also likely to help it along. As noted in our “What Happened?!?” piece, we don’t expect it to manifest in an economic downturn until 2012 or 2013, but it could show up in market prices before that. We’ll be watching commodity markets closely, as a broad decline in those prices would provide an especially powerful confirming signal.  Stay tuned…   

URLs:   

http://www.newdeal20.org/2010/03/30/greece-and-the-eurozone-angie-aint-it-time-to-say-goodbye-9235/   

http://www.newdeal20.org/2010/04/12/the-piigs-problem-maginot-line-economics-9697/   

http://en.wikipedia.org/wiki/Inflation_in_the_Weimar_Republic   

http://en.wikipedia.org/wiki/File:GDP_depression.svg   

http://mises.org/books/interestprices.pdf   

http://bilbo.economicoutlook.net/blog/?p=7864  

http://www.econlib.org/library/Essays/wcksInt1.html   

http://654advisors.com/index.php/blog/2010/04/a-brief-what-happened/ 

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy.

A brief “What happened?!”

It was a tough day in major equity indices yesterday, with the S&P 500 down over 2%.

We don’t think it had much to do with the Senate’s lengthy grilling of Goldman Sachs executives. Rather, it was mostly about the continuing sovereign crisis in Europe, especially Greece and Portgual. We think it might also have been helped along by President Obama’s remarks on deficit reduction earlier in the day, though that’s a much more controversial assertion. 

On top of Germany’s continuing hard line on support for Greece, S & P substantially lowered its ratings yesterday on the sovereign debt of Greece and Portgugal. Such actions lower the price that buyers are willing to pay for their debt in the market place. The resulting price adjustments are often exacerbated by rules governing institutional portfolio holdings and bank capital, as multiple large sellers head for the exits simultaneously. Momentum driven speculators might play a role as well. 

In turn, lower bond prices mean higher bond yields. For example, if a bond with a $100 face value pays an annual coupon of $5, its stated yield is 5%. But if the best price the bond can fetch is $50, then the yield rises to 10%, or $5 divided by $50. The yield to maturity on such a bond is even higher, since the holder eventually receives the $100 face value at maturity. 

This is trouble for Greece because a large slug of its sovereign debt matures this year, meaning that it will have to pay an exorbitantly high price (in terms of interest rates) on its new debt. If those rates are high enough that default or insolvency become inescapable, then current bond holders may not be able to recover the full face value of the bonds they own. There’s been a good deal of talk about debt restructuring, which is basically a process aimed at helping a debtor avoid a worst case outcome while containing the total damage done to creditors.

Importantly, the price adjustments did not just hit Greek and Portuguese debt, but also that of Ireland, Italy, and Spain. It’s more than a little ironic that dithering by the same governments that want banks and nations to shore up their balance sheets is having the exact opposite effect. And if that dithering continues long enough for full blown contagion effects to take hold, then the threat of the euro payments system locking up will become too large to ignore. That’s the very thing that the USD payments system faced in the wake of Lehman’s collapse and AIG’s near collapse in 2008, and which U.S. policymakers took such drastic measures to avert. Could Greece prove to be the eurozone’s Lehman, or at least its Bear Stearns? [Update 4/28/10 - We just noticed that Marshall Auerback asked a similar question on April 12th]

Ironically, Germany’s Angela Merkel has claimed that the primary motive for her country’s intransigence is to preserve the eurozone. And yet the current EMU is essentially what they’ve anted up in the high stakes game they are playing with Greece and other eurozone governments.

While we’re not huge fans of the credit rating agencies, especially given their track records during the mortgage crisis and during the twenty year bull market in Japanese government bonds, yesterday’s announcement might actually have some value when all is said and done, as long as the markets’ severe reactions act as a wake up call to European leaders. The news flow today seems to support that thesis, though only time will tell.

Meanwhile, President Obama’s remarks reminded us that the threat of premature fiscal tightening in the U.S. is still in play. We think that his call to cast a critical eye upon all federal expenditures and carefully address longer term structural deficits is absolutely appropriate (just as we think it’s fair for the German electorate to raise similar questions about Greece). However, we’re concerned that he might be a victim of the same budget surplus fetishism that has gripped many Democrats since the 1990s.

For example, he repeated, as erroneously as ever, that the federal government’s budget is like that of any family. But in fact, the federal government’s budget is more properly thought of as a complement to family and private sector budgets in the U.S. For example, if the private sector desires to increase it savings, the public sector should run larger deficits, all else equal. And if the public sector does not fully accomodate this desire, one likely result is higher private sector leverage (debt). We’re careful to point out that this dynamic is complicated by global effects — but it should still sound familiar to anyone who was awake during the past decade or two.

Amazingly, the same budget fetishists who continue to decry ”crowding out” effects in borrowing ignore those same effects when it comes to saving. 

Until the President and policymakers demonstrate a better grasp of this, our call for long term USD strengthening remains on the table. And if stringent fiscal reforms are accompanied by a Fed tightening cycle, watch out. This isn’t likely to unfold until 2012-2013 (late 2011 at the earliest). However, it’s important to point out that underlying demographic cycles have the potential to make things all the worse, perhaps along the lines of a 1937 redux.  

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Symmetry Capital Management, LLC is an Amazon.com associate, and earns a commission on sales generated through links from our website. At the time of writing, some of the firm’s clients own shares of Alpha Bank (ALBKY), National Bank of Greece (NBG), and Currencyshares Euro Trust (FXE). One of the firm’s principals owns shares of Goldman Sachs (GS). The firm, its clients, and its principals do not hold any positions in Lehman Brothers, AIG, or the debt of any sovereign issuers mentioned.

URLs:

http://preview.bloomberg.com/news/2010-04-27/greece-s-junk-contagion-pressures-eu-to-broaden-bailout-after-market-rout.html

http://www.newdeal20.org/2010/04/12/the-piigs-problem-maginot-line-economics-9697/

http://seekingalpha.com/article/200708-greece-will-have-the-last-laugh

http://www.newdeal20.org/2010/03/30/greece-and-the-eurozone-angie-aint-it-time-to-say-goodbye-9235/

http://www.cnbc.com/id/15840232?video=1478940638&play=1

http://www.whitehouse.gov/omb/blog/10/04/27/Laying-the-Path-to-Fiscal-Responsibility/

Days of reckoning for state pensions?

Northwestern professor Joshua Rauh has published a paper in which he estimates that (1) state pension funds will run out of money in an average of 10 to 20 years and (2) the current gap between state pension assets and liabilities is equivalent to 25% of outstanding federal debt.

Rauh points out that actuarial practices understate the gap, and that with 8% annual return on pension assets [optimistic in our view], annual contributions to pension funds would have to double over the next ten years to close the gap. That’s a heck of a tax increase and/or shift in social spending at the state level. And given the contractual nature of defined retirement benefits, the fact that they are not indexed to nominal asset values in any way, and the importance they are afforded in most state constitutions, it seems unlikely that any ground can be made up on the benefits side of the equation.

States potentially have the option of scrip’ting away part of the problem by issuing their own currency (a more permanent version of California’s IOUs). The problem there is that many pension beneficiaries may live outside of the state they worked for, and that such measures might run afoul of pension guarantees.

Thus, it seems inevitable that the federal government will become more deeply involved in this issue in coming years. And while a great deal has been made of a ‘Keynesian revival’ in economic policy over the past few years, the pension crisis, like demographic cycles, actually seems to call for a revival of Abba Lerner’s ‘functional finance’, and the neo-chartalist school in general.

Essentially, if tax related or other burdens associated with pension fund solvency would impose deflation and/or penalties on real output, then the sanest way to resolve the crisis would be to employ the federal government’s capacity to issue interest and non-interest bearing debt (Treasury bills/notes/bonds and U.S. dollars, respectively), as we did with the financial system.

While straightforward in theory and operation, functional finance could prove a bit messier in its outcomes, given that U.S. dollars are still the global reserve currency. As we’ve pointed our previously, goods subject to the Law of One Price, primarily commodities, could very well ”inflate” in price, even if core U.S. price indices are relatively tame. That combination can have a regressive impact on households, and asymmetric impacts by industry.

If mishandled, it would mean that we’re shifting some of the adjustment costs in state pension assets to people outside and inside our borders who had nothing to do with the problem, while others would benefit unduly. Messy stuff.

URLs:

http://kelloggfinance.wordpress.com/2010/03/22/the-day-of-reckoning-for-state-pension-plans/

http://www.kellogg.northwestern.edu/faculty/rauh/research/RauhASPSSUSC2010.pdf

http://www.sscommonsense.org/page04.html

http://www.cfeps.org/pubs/wp-pdf/WP10-Wray.pdf

http://www.ucm.es/info/ec/ecocri/cas/Febrero.pdf

Crisis, regulation, vigilance & cynicism

A cynical take on Sen. Dodd’s financial regulatory reform bill by Matt Koppenheffer for Motley Fool:

We can probably point to plenty of regulatory failures in the lead-up to the financial crisis. But I hardly think that they’re regulatory failures stemming from lack of regulators. As Valukas noted in his report, regulators were swarming on Lehman well before its collapse…

It seems to me that the issue never was whether there were people trying to address the problem, but rather that they were trying to regulate on a fuzzy mandate of not letting something bad happen within the bounds of a very permissive system. For the same reason that we have speed limit signs posted in our residential neighborhoods, we need to give regulators a clearer, tougher set of standards that they can impose on financial companies.

First and foremost, those standards need to address the lunatic business model that Lehman Brothers — and, really, most of the big financial companies — was operating on at the time of its demise.

Specifically, Lehman was increasingly building up large, illiquid, proprietary investments while primarily financing itself through very short-term agreements. What it became was a massive, teetering Jenga game right smack in the middle of our financial system that could be toppled in the blink of an eye if it lost the confidence of major counterparties…

That last paragraph echoes a beautiful turn of phrase by Bill Bernstein in the most recent Financial Analysts Journal, in which he refers to ”leveraging so unstable that it could not survive the slightest of economic breezes, let alone a 100-year storm.”

Koppenheffer continues:

…the bill includes the Volcker Rule the way Cocoa Puffs include well-balanced nutrition. Little actually gets implemented in the text of the bill. Rather, specific regulations are supposed to come from a study on the rule’s potential impact. Not only is this likely to maximize the squishiness of the eventual rules, but it also gives lobbyists plenty of time to work their magic.

In the end, I don’t see the Fed folks as a bunch of incompetent bumblers. But when it comes to smothering the next Lehman, Fannie Mae…or AIG…I do think they’ll fail miserably because they’re being given a butter knife to regulate with when what they need is a buzzsaw.

A tangential riff: If we aren’t going to impose a hard, fast cap on leverage and other risky behaviors, then perhaps the power of network effects and private sector vigilance (vigilantism?) can help fill the gaps in our financial regulatory structure. For example, it seems reasonable to expect (OK, hope) that the next Harry Markopolos will be taken more seriously.

But when the issue is not fraud by a single market participant, but rather systemic levels of leverage and risk, then it seems unlikely that any kind of enforcement powers could be brought to bear if regulatory bodies haven’t purposefully enlisted private sector assistance beforehand. 

I suppose we’re a bit cynical too.  

URLs:

http://www.fool.com/investing/general/2010/03/24/why-the-fed-will-fail.aspx

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1553816

http://en.wikipedia.org/wiki/Internet_vigilantism

http://en.wikipedia.org/wiki/Harry_Markopolos

Paul Ryan’s floor speech

As most of the country knows, the House of Representatives passed its latest version of healthcare reform yesterday, and emotions are running high on all sides as a result. Rep. Paul Ryan, a Republican from Wisconsin whom we sincerely admire, seemed to best embody his party’s core philosophical objections to the bill. Unfortunately, too many of the GOP’s arguments are stubbornly anachronistic and overly narrow. They don’t fully reflect the realities of healthcare, and they conveniently overlook the fact that we have had ‘socialized’ medicine in this country for quite some time – since Medicare and Medicaid became laws, and since the tax code and other regulations began to favor group insurance plans.

Our intent isn’t to cheer or take shots at either side. Instead, it’s to raise the level of discourse, something that neither party nor the press has done very well. With an issue as complicated and important as this one, political maturity is a must, and truth telling from leadership is absolutely vital.  Unfortunately, Ryan’s speech was riddled with shallow thinking and empty slogans. Perhaps that suited its purpose, but it does little to move the debate or the electorate in constructive directions.

At 1:45 of the video:  “Our founders got it right, when they wrote in the Declaration of Independence that our rights come from nature and nature’s God, not from government.”

For tens, perhaps hundreds of thousands of years, and in almost every part of the world, invoking divinity is how the powerful have justified their position (they still do in some parts of the world). So Jefferson may simply have been speaking the English monarchy’s language when he wrote that in the DOI.

More seriously, in today’s world, rational people ought to be able to agree that political rights are absolutely defined and managed by governments. The classical liberal principle of doing no harm to others is a great starting point, but the philosophical or religious beliefs that inform one’s political philosophy are not in and of themselves “rights”.

In fact, in a society of diverse religious and philosophical views, it’s absolutely vital that a government does just that.

1:57 “Should we now subscribe to an ideology where government creates rights, is solely responsible for delivering these artificial rights, and then systematically rations these rights?”

Government does indeed create rights. It defined and allocated them in the Constitution without any mention of God as a source. And it has amended and reallocated them many times since. Calling them “artificial”, as in man made, is no more meaningful than the typical PETA slogan, or the idea that human creations, good and bad, are somehow ‘unnatural’.

And political institutions absolutely ration individual rights. They always have, all the way back to our hunting and gathering days, so it’s an idea that we really ought to be used to by now. The challenge is to hold governments accountable for doing it in a way that approaches some social optimum. That’s what the Constitution has done rather well over two centuries, and it’s something that modern political institutions have tended to become more adept at over time.

2:09 “Do we believe that the goal of government is to promote equal opportunity for all Americans to make the most of their lives? Or do we now believe that government’s role is to equalize the results of people’s lives?”

Long ago, the federal government enacted some stupid ideas on how to finance health care coverage. For generations, those ideas have benefitted employees of large corporations, unions, and public sector employees. They have been subsidized, either through higher premiums, greater personal risk, or less health care, by the self-employed and entrepreneurs (which may be why politicians always try to kiss their rear ends), as well as those who do not qualify for private insurance coverage, Medicare, or Medicaid. From the get go, these ideas have promoted INEQUALITY.

Healthcare reform is aimed, in part, at finally addressing this situation, a situation that has stood in stark contrast to the principle of equal opportunity. Over the years, the GOP has developed some good ideas on this issue, but in session after session, they utterly failed to do anything about it. They punted repeatedly until the situation got bad enough that the Dems were finally able to run the ball down their throat. Tua culpa, GOP.

Furthermore, this legislation can’t be said to seek equal outcomes, and Ryan surely most know that. It does seek to extend the social safety net, i.e., to redefine the acceptable minimum outcome in personal health care coverage. It also seeks to impose responsibility, in that everyone must chip in in some way. Personally, I don’t care for that kind of thing, and I know I’m not alone in that. Compulsory anything tends to rub Americans the wrong way.

Unfortunately, as long as there is Medicaid, and as long as health care costs of the uninsured are borne socially (via welfare or higher costs for others), it doesn’t make any sense to avoid a minimum level of buy in. It’s similar to having to carry liability coverage on your automobile, except that we are all physical bodies, and thus all have to participate.

If that really rubs you the wrong way, you have a few options:

• Start working on the technology that will provide the bodily equivalent of mass transit and other alternative modes of transport.
• Work to repeal Medicaid (why not Medicare while you’re at it?).
• Move.

2:24 “The philosophy advanced on this floor by this majority today is so paternalistic, and so arrogant. It’s condescending. And it tramples upon the principles that have made America so exceptional.”

Both parties have been guilty of arrogant, condescending paternalism throughout their history. I’m not sure what makes this bill so special. And if we look at the trajectory of American greatness, it’s hard to say that it’s based solely on founding principles (though they’ve certainly made it possible, along with plenty of luck).

Did the U.S. become more exceptional or less after the Progressive movement, the New Deal, and the Great Society? My point is not to sing the usual lefty praises for those episodes, but to point out that they do not seem to have undermined American exceptionalism at all.

3:18 “As we march towards this tipping point of dependency, we are also accelerating toward a debt crisis, a debt crisis that is the result of politicians of the past making promises we simply cannot afford to keep. Deja vu all over again…It’s unconscionable what we are leaving the next generation.”

First I’ll note my love for Yogi Berra quotes. Then I’ll reiterate that there is no U.S. debt crisis.

We do have entitlement and dependency issues to face as a society. But the federal budget is unlike any other budget in our country. It’s not like personal, household, business, or state and local government budgets. In the world, the only budgets that operate in a truly similar fashion are Japan’s and the United Kingdom’s (and in a far more constrained fashion, the European Monetary Union’s). Japan is about ten years ahead of us on the demographic curve, and its net public debt has reached levels that all the deficit hawks in the U.S. now shudder about. What happened? Nothing – no debt crisis, no threat of default, no crowding out. Nothing but a handful of downgrades from the credit rating agencies, and trading floors littered with the bodies of almost two decades worth of misguided hedge fund managers.

And the worst debt to GDP projections, even if we overlook the uncertainty involved in forecasting a decade or more, don’t reach any kind of level that justifies the prevailing deficit anxieties — not for a large modern economy with monopoly power over issuance of the currency used to pay interest on and retire its debts. Until people no longer want to accept dollars (and it’s easy enough for anyone to test out that hypothesis), the government can create more of them. In other words, unlike the rest of us, the only budget constraint faced by the federal government is the socially acceptable level of inflation.

Finally, without proper context, the ‘debt on the backs of our grandchildren’ meme is so much claptrap. If more debt now means better economic outcomes overall, then we are imposing severe opportunity costs on future generations if we do not run larger deficits.

That said, it may be true that health care reform does not represent a social investment with positive ROI. It may also be true that simply rectifying distortions and making the system fairer could have been accomplished with far less than what this bill contains. The electorate has a little over seven months to reflect on it before rendering its judgement in November, and as we’ve noted here and here, this issue deserves a lot more philosophical honesty than it’s been getting. It’s difficult, complicated stuff, with no right or wrong answers – only some as-yet-unknown social optimum, which our sometimes messy political processes are helping us grope our way towards.

URLs:

http://www.youtube.com/watch?v=lwk1aHU-pms

http://www.newdeal20.org/2010/02/10/the-federal-budget-is-not-like-a-household-budget-heres-why-8230/

http://654advisors.com/index.php/blog/2009/07/should-health-care-be-a-right/

http://654advisors.com/index.php/blog/2009/07/ryan-what-does-it-look-like-in-september/

Stiglitz: The Dangers of Deficit Reduction

A timely column from Nobel economist Joe Stiglitz (emphasis added):

A wave of fiscal austerity is rushing over Europe and America…But despite protests by the yesterday’s proponents of deregulation, who would like the government to remain passive, most economists believe that government spending has made a difference, helping to avert another Great Depression.

…even deficit hawks acknowledge that we should be focusing not on today’s deficit, but on the long-term national debt. Spending, especially on investments in education, technology, and infrastructure, can actually lead to lower long-term deficits. Banks’ short-sightedness helped create the crisis; we cannot let government short-sightedness – prodded by the financial sector – prolong it.

Faster growth and returns on public investment yield higher tax revenues, and a 5 to 6% return is more than enough to offset temporary increases in the national debt. A social cost-benefit analysis (taking into account impacts other than on the budget) makes such expenditures, even when debt-financed, even more attractive.

In those last two paragraphs, Stiglitz is pointing out that if the returns on public spending are greater than the cost of financing them, then the future debt level will actually be lower. The government’s current cost of financing is simply the yield on Treasury debt. As of Friday, the ten year Treasury note yields 3.7%, while thirty year Treasury bonds yield about 4.6%. If publicly financed investments can be expected to return more than those figures, then undertaking them — and adding to current deficits and debt levels — is a no-brainer.

And as long as the yields on the securities of private sector issuers aren’t abnormally higher than those on Treasuries, the argument that the federal government is going to ‘crowd out’ the private sector is without merit.

Of course, it’s debatable (1) whether public expenditures are likely to produce returns of that magnitude and (2) whether future Congresses, Administrations, and Treasury Departments will manage the federal balance sheet appropriately. Unfortunately, no one’s openly debating these points. Instead, we’re treated to pithy but nonstop dogma from both sides, and a peculiar obfuscation by those in the middle, which in all cases overlook the basic financial calculus that Stiglitz reminds us of in his column.

Most importantly for debt and deficit hawks and those who fear higher taxes (those whom econo-nerds would refer to as ‘Ricardian equivalence’ subscribers), when the financial calculus is positive, then the debt service associated with marginal federal spending can be financed organically, via higher growth, rather than through higher taxes.

In short, people on all sides of the deficit issue should be able to agree, at least on financial and economic grounds, that investments yielding more than their cost of financing, when they do not crowd out private sector borrowing or resource demand, should absolutely be carried out.

—

Unfortunately, Stiglitz overlooks his own argument when he writes the following, which make us wonder if he doubts his 5 to 6% return figures, or if he’s just offering a gratuitous slap at the financial sector (emphasis added):

As the global economy returns to growth, governments should, of course, have plans on the drawing board to raise taxes and cut expenditures…

Continuing with his love of taxes:

The financial sector has imposed huge externalities on the rest of society. America’s financial industry polluted the world with toxic mortgages, and, in line with the well established “polluter pays” principle, taxes should be imposed on it. Besides, well-designed taxes on the financial sector might help alleviate problems caused by excessive leverage and banks that are too big to fail. Taxes on speculative activity might encourage banks to focus greater attention on performing their key societal role of providing credit.

As we’ve pointed out elsewhere, the domestic financial sector is going to shrink even without  punitive measures, as demographic composition shifts away from the saving and investing age groups. Well-designed regulation might be a better approach than taxes to constraining financial sector activities to socially beneficial ones (we admit that a ‘Tobin tax’ can be the most efficient approach to regulation under certain conditions, but aren’t convinced that it’s optimal for the financial sector).

And it would be profoundly unjust for the federal government, which so strongly encouraged and underwrote the expansion of mortgage financing (Stiglitz’ “pollution”), to retroactively punish the financial sector, its employees, and its current and future clients for simply following the government’s orders.

Stiglitz also takes a step back from his underlying thesis with this sentence:

Over the longer term, most economists agree that governments, especially in advanced industrial countries with aging populations, should be concerned about the sustainability of their policies.

From a technical standpoint, this isn’t as iron clad as so many of us reflexively believe. First, we have no idea whether an aging population is bound to be a drag on an economy, whether it depends on particular conditions, or anything else. There simply isn’t much historical data available to test such a proposition. Second, if we assume that it is a significant drag, then policies that are seen as unsustainable under “normal” conditions might very well be the most sustainable under those novel conditions. This could include expanded deficit spending and public debt, and/or expansion of money supply.

[To be fair, Stiglitz is almost certainly referring to entitlement spending obligations in that passage, which might be a bird of a different feather. We're just using it as an opportunity to critique some of the conventional wisdom around demographics.]

—

Despite Sitglitz’ inability to break out of his New Keynesian box, or part ways with his passion for higher taxes, we agree wholeheartedly with his essential argument:

…even with large deficits, economic growth in the US and Europe is anemic, and forecasts of private-sector growth suggest that in the absence of continued government support, there is risk of continued stagnation – of growth too weak to return unemployment to normal levels anytime soon.

The risks are asymmetric: if these forecasts are wrong, and there is a more robust recovery, then, of course, expenditures can be cut back and/or taxes increased. But if these forecasts are right, then a premature “exit” from deficit spending risks pushing the economy back into recession. This is one of the lessons we should have learned from America’s experience in the Great Depression; it is also one of the lessons to emerge from Japan’s experience in the late 1990’s.

…we must be wary of deficit fetishism…high-return public investments that more than pay for themselves can actually improve the well-being of future generations, and it would be doubly foolish to burden them with debts from unproductive spending and then cut back on productive investments.

These are questions for a later day – at least in many countries, prospects of a robust recovery are, at best, a year or two away. For now, the economics is clear: reducing government spending is a risk not worth taking. 

URLs:

http://www.project-syndicate.org/commentary/stiglitz123/English

http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml