Is It a V?

Yesterday, at the Peterson Institute for International Economics, Mike Mussa and I discussed - and debated - the likely shape of the US and global economic recovery.  Mike has great experience and an outstanding track record as an economic forecaster.  His view is that the entire post-war experience of the US indicates there will be a sharp rebound.  Victor Zarnowitz apparently stressed to Mike, a long time ago, “deep recessions are almost always followed by steep recoveries.”

I completely accept the idea that a slow or L-shaped recovery for the US and at the global level would be something outside the realm of experience over the past 50 years.  I would also suggest that the financial crisis in fall 2008, the speed of decline in the US, and the synchronicity of the slowndown around the world over the past 6 months has also surprised everyone (including most officials) who think that we are always destined to re-run some version of the post-1945 data.

I argued that the nature of our economy has changed profoundly over the past 30 years, and we are only now beginning to understand the consequences.  There has been some pushback against the main argument of our Atlantic piece, which is that a (very modern) financial oligarchy has taken disproportionate economic and political power in the US (aside: “we’re just stupid” is not much of a defense; the people involved are very smart, so how exactly did they get to create stupid organizations with the power to blow up the entire economy?)  But no one is seriously disputing (1) the financial sector has become very large, (2) it was able to take on risks that were massive relative to the system, (3) these risks were not well managed, to say the least.  We have experienced the financial equivalent of Three Mile Island; you will never look at finance again in the same way.

What does this imply for shorter-run macroeconomic dynamics?  Do conventional US-based macro models still apply in the same way?  Can finance drive growth in the same way as it has over the past 20+ years?  How easy is it to switch people and capital into new sectors, for example so growth can be more driven by non-financial technology development?  To the extent that banking survives the waves of contagion that are apparently still with us (look at the CDS spreads for major US banks over the past few weeks; during the rally!), won’t bankers hunker down for a while and refuse to take risk – until the next bubble, of course?

I agree with Mike that fixing the financial system is often not necessary (or actually sufficient) for a rapid economic recovery, although in today’s situation I worry about the disruptive effects of current bank bailout plans in many countries.  A fast recovery, particularly if combined with moderate inflation, would probably improve the banks’ balance sheets considerably.  To me, fixing the banks – i.e., greatly reducing their economic and political power – is essential for all our futures, irrespective of when and how the economy recovers.  We cannot allow the same kind of potentially system-breaking risks to be taken again, and we cannot assume that the solutions that failed in the past (e.g., tweaking regulatory powers) will work in the future.  Next time, the banks won’t just be Too Big To Fail, they’ll be Too Big To Rescue – the fiscal costs if we let this happen again would likely be huge; where is it written that the U.S. will for all time have fiscal credibility and provide the world’s leading reserve currency?

The main short-term issue for the shape of our recovery is surely that balance sheets are perceived as damaged all around the world.  Plenty of creditworthy consumers think they need to be more careful.  Firms with sensible investment projects are worried about the future availability of credit.  Governments have only a limited ability to engage in fiscal stimulus; almost no one ran a sufficiently counter-cyclical surplus during the boom.  And policy responses in most of the G20 remain inadequate.

If we have created a more unstable financial structure, perhaps we have stepped back in time to the US in the 19th century, when downswings could take considerably longer (or recoveries were more likely to be L-shaped; look at the NBER’s data) than in the post-1945 period?  Or have we become more like an emerging market not just in terms of the excessive power of finance and the ability of one overexpanded sector to bring us down, but also in terms of our broader macroeconomic dynamics?

Emerging markets do, it is true, often recover quickly from steep declines.  But they usually achieve this through managing a large real exchange rate depreciation (i.e., the nominal exchange rate falls by more than prices increase), which produces an export boom.  At the level of world economy, we cannot export our way out of this recession.

By Simon Johnson

The PIIE event audio is available already.  It was also recorded by C-SPAN; when I learn the broadcast details, I’ll add them here and also put on Twitter.

65 responses to “Is It a V?

  1. For what it’s worth my view is that it will be like a “W” shape but where the last stroke on the right upwards has been rotated downwards to the baseline.
    So we have good news ahead and even more bad news ahead -something to please both bulls and bears.

  2. Wow. Go get ‘em, Simon.

    I wish I disagreed.

    I worked in the technological innovation that drove a good portion of the economy in the 70′s and 80′s. I have no doubt that Wall Street’s, “what have you done for me this quarter”, focus is part of the reason we aren’t the technological innovators we used to be. I know it played a part in my decision to stop trying to do real work.

    Short term focus raped most American companies some time ago. Now they are a mere shell of what they were or could have been. The financial structure dominance looked at short term gains and produced bigger profits on that meme for a while.

    Ant grasshopper. The story is still valid, but on a large scale it takes more than a year.

    I think you are right that the old story of our economy has been rewritten over decades and now we reap what has been sowed. The new old ideas are being bumped by the older old ideas. I hope we have enough real economy left to make something happen in a year or two.

    Financial shuffling and short term magic can work for a while, but it can fail massively too. Especially after it has eaten away the original foundations.

    They killed the economy. Those termite bastards!

  3. Mr. Johnson: I agree with your assigning “emerging” nation status to the U.S.in global markets and your assertion that the world can’t recover by exporting. The U.S. is doubly at risk with our own diminished industrial strength.Other nations will redouble their efforts to export, and we’re not in a good position to compete here or as an exporter. This argues for the L- shaped, slow recovery you are suggesting. We are in trouble both financially and in our reduced industrial strength.
    Ken Davis

  4. Regarding the rise in CDS spreads: Is it possible that it is related not to new information about the banks’ financials themselves, but a reaction to the government’s dealings with the auto companies?

    It seems to me that those expecting the government to protect bondholders’ equity have a bit more to fear now.

  5. What does this imply for shorter-run macroeconomic dynamics? Do conventional US-based macro models still apply in the same way? Can finance drive growth in the same way as it has over the past 20+ years? How easy is it to switch people and capital into new sectors, for example so growth can be more driven by non-financial technology development?

    I confess to be at a loss as to what exactly the prognosticators of “recovery” and back to business-as-usual think is going to be the basis of restored growth and exponential debt, now that on front after front (oil, arable land, fresh water, and soon natural gas, coal, most metals) we’re facing terminal resource depletion.

    I can’t find a straight answer anywhere; rather, it would seem leprechauns or whatever will provide. “Technology will save us”; some undefined deus ex machina is just expected on faith.

  6. Anyone who says it’s going to be a “V” shape recession/recovery is failing to remember that correlation does not prove causality. Just because the past 10 or 12 recessions have been V shaped does not mean all recessions are V shaped by nature. If you look at all of the issues causing or occuring right now, few have easy short term fixes.

  7. Paris Biltong

    The Reagan-through-Bush years, during which income and wealth disparity increased at an unprecedented pace, also marked the gradual polarization and decline of consensus politics in the United States. In that, the US now resembles many emerging countries a lot more than it used to in the sixties and seventies. Recovery from the current disaster cannot just be willed by the government but requires broad popular support. The current measures seem inadequate at best, grossly unfair at worst. Nothing short of radical reform will help.

  8. we_are_toast

    There are no other downturns that resemble this one. There is no correlation with other recessions. It’s new ground. New difficulties with a growing and aging population, along with diminishing resources, will make sure this L lasts a very long time.

  9. Simon,

    Sorry to be dense, I looked at the chart for the CDS spread – is this supposed to represent an exposure for the banks listed?

  10. …experienced the financial equivalent of Three Mile Island;

    Right: 1. Nobody died (or was even injured) 2. We turned our back on a clean, efficient energy source for 30 years as a result (is securitization today’s equivalent of nuclear energy?)

  11. On the V-shaped recovery and the issue of sunk capital (physical, human, and institutional)…

    Brad DeLong made an interesting comment about misallocated human capital and economic transitions costs – noting that if there’s enough demand pressure these do not really hinder a recovery.

    Tyler Cowen took the opposite opinion – the Federal Stimulus package won’t help the use restructure.

    http://moneywatch.bnet.com/economic-news/blog/blog-war/?tag=content;col1

    I happen to agree with Brad in this regard, and would point to some historical examples:

    Notably, the post-WWII restructuring. The US had MASSIVE debt, and still managed to invest and restructure. GI Bill, among other things.

    To execute successfully, the Govt. will need to actually make some choices on where to allocate resources (aka, a real industrial policy, a real energy policy, and a real public health policy). And it will need to make the right choices.

    The fundamental obstacle to this are those individuals who believe the government can never do anything right, and who have done their best to prove this by making govt. fail (aka, George Bush & team – “look ma, the govt. has been a disaster for the last 8 years, that proves that govt. is always a disaster!”)

    ————

    Separately, it looks like the more conservative monetarists are starting to finally receive a challenge on the velocity issue (aka, the idea of taxing excess reserves, proposed by Scott Summers at the Money Illusion and now being taken up in an article in The Economist’s Voice), and some respected economists are starting to float the idea that maybe… just maybe… we don’t need no fancy sophistimucated financial system for the economy to work sort of OK.

    http://www.bepress.com/ev/

    Honestly, I am encouraged by one simple fact – we finally have some economists writing stuff that matters.

    Now, if only I can convince them to take up the call for coordinated global quantitative easing (“printing money) in concert with a worldwide phased increase in capital-asset ratios. Advantages: – kick start demand, give governments the one-time-only ability to invest massive resources in renewable energy and infrastructure, prevent an inflationary rebound, and create greater future financial stability.

    The main obstacles seem to be the entrenched financial interests (SJ’s oligarchs), and the Friedmanomic religious establishment.

  12. Paris Biltong

    Chernobyl?

  13. middle world guy

    To have a V-shaped recovery, wouldn’t one have to look at our capital allocations over the proceding years and explain how they will spur economic growth and productivity in the upcoming years? It’s one thing when investment simply moves ahead of reasonable short term demand – say for example when Global Crossing wrapped the world in excess fiber optics; but it’s quite another when capital alloactions have little or negative value in the future.

    Where did all that capital go in the early-to-mid 2000′s? Housing projects that made little economic sense, short-term consumables, a disasterous Iraq war, overpriced prescrpition drugs, etc. The list is long indeed. In other words, the Googles were overwelmed by the Countrywides in terms of the amount of total capital allocated. Even Hedge Funds seemed to be more interested in commodity speculation than any thing else – how was that useful in terms of a future economic recovery?

    With so much bad “investment”, I find it impossible to believe that the cost of all this has really been priced in. The U.S. built a pretty impressive economic motor that hummed along well in the decades after WWII. That motor is now nearly dead or at the very least in serious trouble. Few are ready to accept that reality.

  14. Bad design: Chernobyl’s RBMK reactor, however, used solid graphite as a neutron moderator to slow down the neutrons, and neutron-absorbing light water to cool the core…This makes the RBMK design very unstable at low power levels, and prone to suddenly increasing energy production to dangerous level if the temperature rises.

    U.S. AEC has never sanctioned graphite reactors for commercial power production, and likely never will.

  15. I do not believe we will see a sharp recovery in the near future. As an outsider to economic theory, I have been astonished at the collapse of the American economy as a whole – not just the financial sector. I wonder just what has happened to the American business environment that makes it near impossible to thrive as a business.

    Newspapers, airlines, auto industry, construction, mortgage brokers, commercial real estate, banks, other financial institutions, retail – all on the brink of collapse. This morning, I heard a report that the insurance industry is now asking for a bailout.

    Is anything working? (Other than WalMart?)

    As the businesses have failed, executive compensation has reached absurd levels. When you have someone like a John Thain (who got a $15 million signing bonus when he joined Merrill in 2007) – whose company lost $15 billion in the 4Q alone, spending a chunk of his time renovating his office and negotiating his next bonus, that’s time taken away from building his business – or, in the case of Merrill Lynch, helping his business recover from catastrophic losses.

    You can talk about “broader macroeconomic dynamics” all you want, but people screwed up in a big way – and the ones who screwed up most catastrophically are taking away the biggest salaries too.

    Rick Wagoner spent nearly two decades in the C-Suite at GM (COO, CFO and CEO). His company exists today thanks to taxpayers – and he’s walking away from his bankrupt company with a $20 million retirement package.

    That’s absurd. He’s a failure in business – but even so, he’s built tremendous generational wealth for his family most Americans can’t even imagine.

    In your post, you say: “To me, fixing the banks – i.e., greatly reducing their economic and political power – is essential for all our futures, irrespective of when and how the economy recovers.”

    I couldn’t agree more – but wonder if we have the talent in this country who can devise a regulatory foundation that will protect us.

    What can a regulatory agency do to protect the economy from business leaders who don’t take the time to fully understand the tools they’re buying and selling – allowing their business to pile up trillions of dollars in debt? TRILLIONS of dollars in debt. How does that happen?

    Do we have the capacity or understanding needed to create a new structure that will prevent a crisis of this magnitude from happening again? That remains to be seen.

  16. ““we’re just stupid” is not much of a defense; the people involved are very smart, so how exactly did they get to create stupid organizations with the power to blow up the entire economy?)”

    Smart people can do stupid things; especially if they lack important knowledge or experience. Anyone who has been around the housing industry for a couple of decades or more knows that it is cyclicle, what goes up will go down and vice versa. Maybe people were blinded by the brilliance of their computer models.

  17. “I agree with Mike that fixing the financial system is often not necessary (or actually sufficient) for a rapid economic recovery, although in today’s situation I worry about the disruptive effects of current bank bailout plans in many countries.” – Simon

    What?! Simon, what is the data point that lead you to this view? The baselinescenario has consistently argued that unless we clean up the banks quickly the recovery will be slow. Is that not the case now?

    This is why I’ve kept asking for numbers to back up qualitative descriptions. Otherwise, we could end up focusing on what we think is the problem instead of the real problem.

  18. Paris Biltong

    “Notably, the post-WWII restructuring.”
    The conventional wisdom is that there was a great deal of pent-up demand at the end of the war, which is hardly the case now. The return of troops from Iraq is unlikely to provide must oc a boost. Spending on infrastructure and in the areas that have been neglected (broadly speaking the public sector) could pehaps do the trick but it remains to be seen whether this is politically feasible.

  19. What would a V shaped, rapid recovery do to Fed rates? It seems to me that type of recovery could be counter productive and lead to another leg down.

  20. Good point, but I think the conventional view understates govt. action, and mistates timing:

    If you look at the data, there was a massive drawdown immediately after WWII. The pickup occurs later, after the govt. re-engages an active policy. If you recall, Truman _almost_ lost the ’48 election due to the post-war recession. The Martial Plan, which amounted to a massive subsidy of US exports, wasn’t passed until 47 and didn’t kick in till a little later.

  21. Clean? No one has yet found a satisfactory solution to the disposal of vast quantities of highly dangerous radioactive waste. This seems like a beautiful example of optimistic theory overlooking troublesome reality, which is the last thing we need in any arena.

  22. >No one has yet found a satisfactory solution to the >disposal of vast quantities of highly dangerous >radioactive waste.

    I guess when you kill off the program desigend to do just that, you’re right! :-)

    This is real off topic, but that was the purpose behind the new reactor designs that used waste from old reactors to power them and produce waste you can hold safely in your hand. These reactors can be colocated with old reactors to keep the old waste on site and reprocessed into the new reactor.

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

    The design started under Carter, continued under Reagan, Bush, and then in what I can only assume was a complete misunderstanding of the technology by the Clinton admin, was killed as nuclear proliferation. Other countries are moving on with this work, we can buy the gear from them I guess.

    David

  23. middle world guy

    Exactly. Since rates are at zero now, they would have notch up the discount rate at an unprecidented clip to clamp down on inflation, thereby killing new business investment before it really had a chance.

    The Fed used up all their firepower when they printed all that money. If they are primarily going to defend against devaluation (ie out-of-control inflation), I don’t see much room to give new investment a chance. The choice is pretty basic – either take the pain now and let all the junk work its way through the system, or remain in denial and gamble on run-away inflation. In real terms, its L-shaped either way, just that later drags things out even longer.

  24. It could also be a simple matter of supply and demand. Companies that wrote CDS have lost a lot money or simply collapsed (e.g. AIG). Also CDS require collateral from the companies that sold them as the bond price drops. The companies that are still around are very like to have much of their capitol tied up in CDS related collaterals. How many CDS sellers are still around and how much selling can they still do?

    On the other hand, I don’t have any number to back this up. Perhaps others more knowledgeable can share some data points here?

    Lastly, it is very easy to come up with reasonable sounding narratives. However, how does one choose which narrative is likely correct without data?

  25. The theory is:

    The Fed has plenty of firepower left; the Fed Funds rate (the darling of the 90s) is not the only implement.

    Currently, the Fed is using directly-injected liquidity. The hope is they can directly suck it out at a later time.

    One can argue about whether QE and TALF and other programs are good and/or will work, but one cannot say the Fed is powerless. At the very least, so long as govt. is running a deficit the Fed can continue to finance it. Nor can one say that raising rates is the only solution to stopping inflation.

    Many people acknowledge the Fed’s current tools are rather blunt when it comes to impacting velocity. (AKA, the “pushing on a string” analogy). But let’s not overstate the case.

  26. I meant the following to be a critic of baselinescenario and not a critic of Adam’s comment.

    “Lastly, it is very easy to come up with reasonable sounding narratives. However, how does one choose which narrative is likely correct without data?”

    This is an area that baseline scenario can do better at. For example, baseline scenarios support the idea of limiting bank size to reduce systemic risk. However, is that really true?

    Imagine the following 2 dominoes sets scenarios.

    1. One dominoes set have a million little dominoes.
    2. One dominoes set have a thousand big dominoes.

    These dominoes set are not setup in 1 straight line. The dominoes are set up in a 2D fashion where a particular domino can be knock over by multiple neighboring dominoes.

    Questions:

    Of of these 2 dominoes set, which one is easier to prevent a total collapse?

    Today, our financial system is a domino set rig for collapse because of
    a) lapse in regulation
    b) lack of proper isolation mechanisms between financial institutions. For example, the stock market is a great isolation mechanism between seller and buyer of stocks. Unfortunately, many derivatives are not sold in regulated markets. This resulted in unmanaged interdependency risk.

    Bank size is a secondary issue at best, a big red herring and distraction for fixing the real problem at worst.

    Anyway, that is my narrative…

    Without data how should one choose which narrative is right?!

  27. The problem for nuclear energy is there are too many ideologs.

    For a while, I was glad that the oil price was $140. This forced the ideologs to pause and more rationally reassess all the energy options.

  28. During Japan’s lost decade, they tighten up their monetary policy prematurely. They ended up choking off a recovery that was under way by 1995.

    I think the Fed is very aware of this threat. In addition, it is always politically painful to turn off the spigot. Most likely the Govt will not have the political will to do so early either.

    With both of the above factors, I think we are more likely to be slightly late in dialing back than being too early. Will we be so late as to cause inflation? No idea.

  29. BrentEubanks

    I have to agree with the commenter that suggested that the recovery, if not an L, will look like a W.

    I know that in the energy arena, the price crash and the difficulty of getting credit have mothballed many projects. If we experience a rapid recovery, it will be followed (or possibly slightly preceded) by a rapid runup of energy prices. A fast recovery could easily put us back in the $150/bbl range for oil. It seems very likely that in those circumstances, the high cost of energy would quickly deflate the (likely fragile) recovery.

    On another note, I read the article you linked as “pushback” to your oligarchy-of-greed theory. I don’t disagree with either you, or that David Brooks. What I don’t understand is why anyone thinks that the explanation has to be EITHER greed OR stupidity. Why not both?

    The people in finance are very smart, but very smart people can blind themselves to seemingly obvious truths if they have a (e.g. financial) incentive to do so. In my experience, smart people are often better at this than average people, because they can construct ever-more-convoluted models to justify doing what they want to do anyway. (Gaussian copula function, anyone?).

    Posit the cause as greed-induced blindness, and then both of you are correct. The solution, as both of you note, is to reduce the size of the banks. Brooks suggests that the difference between the greed model and the stupidity model informs the approach to the solution. I disagree. The major failure of the system, regardless of cause, is a failure of resilience. The response to this is to get past the liberal/conservative or capitalist/socialist dichotomy, and focus on cultivating resilience in the system even at the cost of some “efficiency”.

    I recommend this article for a good, brief perspective on what that might look like, and on the false dichotomy currently being pursued:

    http://tinyurl.com/dz4b2e

  30. Financial TMI? That was LTCM. I’d compare today’s mess with Chernobyl.

  31. Apologize for going Porter (we need mroe edcation spending), but the one thing no one talks about is the collapse of competitive adantage windows. This is critical to understanding the new economy. Technological diffusion makes the liklihood of the US capturing any kind of post WWII rents a certain no. Plus the US destroyed the rest of the world capacity. The only argument making any sense is the world hums along and the EM grows and absorbs more and more from the new periphery, Malthus notwithstanding.

  32. Clarke Robinson

    “On another note, I read the article you linked as ‘pushback’ to your oligarchy-of-greed theory. I don’t disagree with either you, or that David Brooks. What I don’t understand is why anyone thinks that the explanation has to be EITHER greed OR stupidity. Why not both?”

    Yeah…I didn’t see what Brooks was “pushing back” against. The article he cites as representative of the opposing “stupid” perspective:

    http://american.com/archive/2009/our-epistemological-depression

    …is hardly in disagreement with Johnson’s Atlantic article. Both speak of transparency/opacity, the need to restructure the banks, and greed. It looks more like Brooks is trying to create controversy where there is none.

  33. “Next time, the banks won’t just be Too Big To Fail, they’ll be Too Big To Rescue” — HUH?

    What bank has been rescued? The big banks who played in the game are insolvent, despite what the powers that be would like you to believe.

  34. If this is a “V”: (1) We haven’t reached the bottom of the left side, and (2) It will be a very wide “V” – spanning 5 years or more.

  35. Simon, we have taken risks “…that were massive relative to the system…:” We have not managed these risks well. We may not be able to export our way out of this one, but we have to try. We cannot dismantle our financial institutions and quit. We are Americans.

    The lesson of this financial crisis is not to contain risk or limit it. The lesson is to price risk properly and put it in hands that can tolerate loss. If I understand you (you are very vague on details) regulating by “…greatly reducing their economic and political power…” (banks) will not work in the US. This would make our financial system, inasmuch as it is built on banking, subject to government oversight, which simply will not happen. Period.

    You have identified the single greatest reason for our present mess: running chronic trade deficits with a trade partner that locks us out of his capital account. How are US banks responsible for that? Can banks be blamed for the assumption by rating agencies that real estate values would escalate at two percent a year indefinitely? European bankers accepted ratings by US ratings agencies of US securities. How can this be characterized as an exertion of political power by US banks?

    Further, limiting the “economic power” of US banks is another way of saying you propose to limit the credit generating capacity of US banks. This is dangerous, particularly now. The US is in the throes of making a multi-trillion dollar bet. We are borrowing the money for this bet. A large part of it is being spent to rescue, repair and reform our financial system. If we restrict our banks in their capacity to generate credit now we may place the means of repaying the debt we have incurred beyond our reach.

    Maybe one day all nations will happily balance their trade accounts through the IMF. They may even use SDRs to buy bread and beer. That’s the time to talk about a global credit supervisor. Today, however, the world (just as much as the US) needs the US banking system to be put back in good order, so it functions reliably, so credit (big credit) can flow into international development which will lead to a resumption of trade (big trade.)

    To limit the size of US banks now would be to force us to work off our debt internally. It’s a big debt which means a reduced standard of living for a long time.

  36. Bill Bradbrooke

    Simon, we have taken risks “…that were massive relative to the system….” We have not managed these risks well. We may not be able to export our way out of this one, but we have to try. We cannot dismantle our financial institutions and quit. We are Americans.

    The lesson of this financial crisis is not to contain risk or limit it. The lesson is to price risk properly and put it in hands that can tolerate loss. If I understand you (you provide few details), you propose “…greatly reducing their economic and political power…” (banks.) If by this you are suggesting permanent nationalization of banking, this won’t happen in the US.

    There are many reasons for our financial crisis. You have identified the single most important one: running chronic trade deficits with a trade partner that locks us out of his capital account. How are US banks responsible for that? Can banks be blamed for the assumption by rating agencies that real estate values would escalate at two percent a year indefinitely? European bankers accepted ratings by US ratings agencies of US securities. How can this be characterized as an exertion of political power by US banks?

    Further, limiting the “economic power” of US banks is another way of saying you propose to limit the credit generating capacity of US banks. This is dangerous, particularly now. The US is in the throes of making a multi-trillion dollar bet. We are borrowing the money for this bet. A large part of it is being spent to rescue, repair and reform our financial system. If we restrict our banks in their capacity to generate credit today we may place the means of repaying the debt we have incurred beyond our reach.

    Maybe one day all nations will happily balance their trade accounts through the IMF. They may even use SDRs to buy bread and beer. That’s the time to talk about a global credit supervisor. Today, however, the world (just as much as the US) needs the US banking system to be put back in good order, so it functions reliably, so credit (big credit) can flow into international development which will lead to a resumption of trade (big trade.)

    To limit the size of US banks now would be to force the work-off internally. It’s a big debt which means a reduced standard of living for a long time.

  37. If they notch up Fed rates quickly, how will the US govt. pay off their debt at 4-10% at the long end when at 2.85% the numbers don’t allow that to happen?

  38. “Next time, the banks won’t just be Too Big To Fail, they’ll be Too Big To Rescue”

    Ahem. Is that not the case already? 4 trillion dollars? Paid for by taxes, cuts in services, losses in 401(k), pension funds, IRAs?

    Buiter thinks that the jury is still out on whether the US and the UK can afford the “rescue” they have embarked on. To me, the whole re-bubble re-leverage re-indebt campaign is looks more and more like the government and banks are adrift in the middle of an ocean, and the former is trying to find a life belt made from solid gold to throw it to the banks, all of them standing on the shoulders of the drowning survivors from the lower decks.

  39. What is the right size for consumer spending and investment in a deleveraged world?

    PCE was only 7 trillion in 2001 versus 10 trillion in 2008. If we believe most of this 3 trillion increase from 2001-2008 increase was driven by excesses, what should a sustainable PCE be? Even if we put a 50% hair cut, we’re looking at a 1.5 trillion decline in PCE, which is a 15% decline on a 10 trillion base. Yet, I don’t see anyone even discussing this level of PCE compression. Why is this critical element of GDP not part of the discussion regarding shape of the recovery? In other words, can someone explain why PCE shouldn’t compress dramatically, driven by fear of job losses, shutdown of the home ATM and reduction of credit lines.

  40. A-hem; back on point.

    Or do we all suffer from ADHD?

  41. adios amigos

    Anne,
    Your country strayed from the basics of the business fundamentals that are an integral part of success. 1. Honesty: if you don’t have honesty as a core principle going forward, your going to be doomed to ever repeat the current misery you are suffering. 2. Integrity: (see #1) 3. Moral compass: “screw everyone” is not now, nor will it ever be, a recipe for long term success. 4. Good Products, Good prices: without it, your toast. Stop paying assemblers $60 per hour, their simply not worth that, period. Tell the Unions to face reality. Just ask GM how that worked out, long term. 5. Honest government: this is probably your biggest (and toughest) problem. A good place to start? OUTLAW LOBBYING. I would also pass an ironclad balanced budget amendment to the US Constitution. It stops the institutionalized stealing dead in it’s tracks. 6. Motivate the citizens: this too, is tough in America. No harm in admitting that. But unless you all get together and DEMAND change, the thieves will continue to run you over as a society. Start small. YOU go to a town council meeting and raise hell. No harm in that, is there? Find out where your Congressman’s office is, and demand to see him….in person, preferably right now. Organize. Demand change. Your voice is probably a lot louder than you think.
    AA

  42. adios amigos

    Anon,
    And, working off your debt internally, would be bad, why? It’s probably the best thing you could do for yourselves, rather than clawing back future earnings AGAIN. Have you noticed, that never has a happy ending? Food for thought.
    AA

  43. Speaking of THree mile Island, I loved this from Taleb yesterday:
    “4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.”
    Nassim Taleb

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  45. silly things

    Did folks listen or read the debate between Simon Johnson and Michael Mussa?

    The link is in the first sentence but here again for convenience.

    http://www.petersoninstitute.org/events/event_detail.cfm?EventID=109

    Reading the comments, it is clear most people have only read Simon’s view expressed above. So much conviction in various comments, yet also so clear that most only knows how to regurgitate but not to think critically!

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  47. “At the level of world economy, we cannot export our way out of this recession.”

    Come now, Simon, think outside the box–now is the perfect time to start selling to Mars!

  48. Notch up the fed funds rate while simultaneously allowing the Fed to directly refinance T-bills at below market rates.

    The more concerning question is what happens to indebted private sector actors who don’t have access to direct Fed financing.

  49. Sorry, but I’m not sure how we can predict the shape of the eventual recovery, when the country is still losing over 600,000 jobs every month. Of course, moderate rises in unemployment would be a normal thing to expect in the early stages of a “typical” post-1945 recovery. But “quantity changes quality”; with unemployment rising so rapidly, it’s not clear that any sort of recovery is even beginning to get underway.

  50. I’m not an economist. This is a good thing. I am, however, fairly old, and have been through a few of these. I am also intuitive, so I can see what’s happening. You may laugh, but here’s my non-quant analysis (I went to Bronx Science, but then ended up with a Phd in English): people have gotten tired of the recession. they’ve made some adjustments, and those who can have begun tentatively spending again. This may be a V, or a U, but it’s not an L to the consumer. The consumer has to get on with life. He has paid down some debt, walked from his mortgage, and found another job. He puts one foot in front of the other and soldiers on. I feel the change in mood in my own community, the web geeks. They aren’t after money as an end in itself anyway, and they’ve come to realize they’re still alive and therefore should be living. Myself included.

    Keep up the great blog. I really enjoy it. I just look at it from a different perspective.

  51. No doubt a V.

    But this time is different right? Yes and No. Of course 2009 is a different time in history. But a fascinating paper by the economics department at Harvard, reveals that a significant number of factors are the same now as compared to other financial crises that have occurred for 800 years!

    http://mast-economy.blogspot.com/2009/03/remember-1979-is-this-time-different.html

    Given the assumption that this recent bear is no different, have a look at the charts for the past 12 bear markets:

    http://mast-economy.blogspot.com/2009/02/bull-market-move-swift-and-steep.html

    This current move will continue to be swift and steep leaving many in the dust.

  52. If you look at the history of the Dow, using non logarithm charts, using a regression line the Dow should be at about 2000-3000.

    Derivatives, out sourcing creating developing market growth, and other leverage must have something to do with the disconnect. And, maybe this disconnect is here to stay. But maybe it is unsustainable.

    I am afraid all of the thievery that has taken place in the “official” games (not the Olympics, the game of picking and chosing which bank will or wont survive to receive the free money from AIG and TARP “backstops” ) that our country will suffer from this almost 200Billion dollars to AIG and 400plus billion that has been given to Citi. This is a heavy burden–the country was bitching about the 700billion dollar stimulus but an equivalent amount has been passed out to save failed entities– but even a bankrupt organization might be saved with 600billion dollars of free money plus the ability to borrow at a half of a percent and lend at 5-30% when you consider commercial lending and credit card lending.

    Are AIG and Citi national treasures worth 600billion dollars? It is such a sad story.

  53. The “L” with a horizontal component trailing downward into a depression is staring you right in the face.

    Look around. People have produced and bought too much stuff. Lots and lots of stuff. 5 or 10 years of production and demand pulled forward by EZ-credit and cheap oil. And then… burp.

    Most businesses and banks projected that accelerated increase in demand and productively way into the future. They financed expansions, built more houses. All this securitized and backed by bonds with leveraged CDO’s on top. Mal-investment and over-production squared.

    So now what are we going to do? Force families to buy more TV’s and cars? Maybe extra financial products? Tulips?

    It’s over. O-V-E-R. The consumer has crashed. There is nothing to inflate. We have to wait a long, long while for a massive oversupply in housing, durable goods and container-ships full of junk to decay.

    While we’re all enjoying the fruits of that future production, businesses have realized if there is no demand then there is no need to produce. Now businesses overcorrect, if only to survive. Now we unwind 5-10 years of over-employment, and then some.

    Sure this is an over-generalization. People still need to eat, be clothed, and be merry under a roof. We still need production, we still need services and businesses to provide them.

    But for most things, there is only deflation and liquidation as far as the eye can see.

    That is, deflation and liquidation of your assets, not the elites’.

  54. we are screwed

  55. Anonymous,

    Some excellent points.

    Question: Are you distinguishing between “US banks” and the small number of very large banks? I don’t see a forced choice between limiting the size of banks and helping most banks in our system work.

    Am I missing something?

  56. My question of those who believe we’re in a rather typical recession (post-WWII) and that the economy will enjoy a sustainable rebound soon:

    What are you assuming about how the $4 trillion or so will be worked out and what that impact will or won’t be?

    I’m not arguing; I’d just like to understand your thinking on this.

  57. For a post with more than 55 comments already, I think a much higher percentage of these comments are helpful than is usually the case. I’m really enjoying this.

    Comments that I consider “not helpful” are mainly those rants that we’ve often seen from people trying to demonize whomever they disagree with.

    This is a cool change.

  58. A wise old Greek once said it is a sin to get angry, but more of a sin to not get angry about some things…

    …as for the rants, it seems to me that a better way to categorize ‘these’ posts would be passionate anger over extremely important issues…and as such, i wonder what percentage of the people participating on this blog believe that passionate anger is not valid or useful in the discussions going on in this forum?

    Some people are just more passionate than others.

  59. Excellent point beergut!

    (and by the way, nice round belly)

  60. How is it possible to spend more with our national deficit growing to almost 4X what it was prior to the presidential election–and on top of that, we teeter-totter on the edge of the world wondering about the chances of the US Treasury defaulting? With the aging of our country’s infrastructure it would have been so wonderful if our government hadn’t allowed 185Billion dollars to be given to AIG, and another 400 billion to backstop Citi, and instead a 600billion dollar infrastructure strengthening project had been put in place.
    Unfortunately, the horse has left the barn and chances for this being corrected look grim.

  61. Based on what I’ve seen, anger usually plays the same role here as it does with the thinking process in other parts of life. When we’re angry, we feel righteous indignation and assume that we know far more than we actually do. I’ve never seen evidence that being anger generally helps the thought process. Here and otherwise, I’ve seen the reverse.

    I understand that feeling strong anger can make one more likely to post. Exactly how does being angry help the thought processes of the angry people?

  62. P.S. An example of how anger usually impairs the thought process is the post I was responding to.

    That post missed what I’d actually said. I’d not said anger was in any way “wrong.” What I said was unhelpful was exactly this: “rants that we’ve often seen from people trying to demonize whomever they disagree with.”

    Being passionate and demonizing those who disagree with us are two entirely different things. I wrote specifically about the latter.

  63. Phil, please forgive my misunderstanding of what you said earlier. Clearly, what you say is true.

  64. Given some of Professor Johnson’s remarks about the nature of the financial sector, and its role in the economy I have a question about the question he raises above: “Can finance drive growth in the same way as it has over the past 20+ years?”

    Is the presumption behind this question correct, or another way of asking the question, under what definition of growth is the presumption correct?

    For instance, some economic indicators haven’t grown, like real wages for lower income earners. And in the several decades after WWII, wasn’t there comparably better rates of growth, although the financial sector was regulated and controlled differently?

    The presumption doesn’t seem obviously right to me, at all.

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