Where Are We Now? Five Point Summary

1. Financial markets have stabilized – largely because people believe that the government will not allow Citigroup to fail.  We have effectively nationalized any banking system losses, but we’ll let bank executives enjoy the full benefits of the upside.  How much shareholders participate remains to be seen; there will be no effective reining in of insider compensation (my version; Joe Nocera’s view).  For more on how we got here, see the Frontline documentary that airs on Tuesday and Paul Solman’s explainer wrap up.

2. The real economy begins to bottom out, although unemployment will not peak for a while and could stay high for several years.  Longer term growth prospects remain uncertain – has consumer behavior really changed; if finance doesn’t drive growth, what will; is the budget deficit under control or not (note: most of the guarantees extended to banks and other financial institutions are not scored in the budget)?

3.  More broadly, there is sophisticated window dressing in the pipeline but no real reform on any issue central to (a) how the banking system operates, or (b) more broadly, how hubris in finance led us into this crisis.  The financial sector lobbies appear stronger than ever.  The administration ducked the early fights that set the tone (credit cards, bankruptcy, even cap and trade); it’s hard to see them making much progress on anything – with the possible exception of healthcare.

4. The consensus from conventional macroeconomics is that there can’t be significant inflation with unemployment so high, and the Fed will not tighten before late 2010.  The financial markets beg to differ – presumably worrying, in part, about easy credit leading to dollar depreciation, higher import prices, and potential commodity price inflation worldwide.  In all recent showdowns with standard macro models recently, the markets’ view of reality has prevailed.  My advice: pay close attention to oil prices. 

5. Emerging markets are increasingly viewed as having “decoupled” from the US/European malaise.  This idea was wrong in early 2008, when it gained consensus status; this time around, it is probably setting us up for a new bubble – based on a “carry trade” that now runs out of the US.  The “appetite for risk” among investors is up sharply.  The G7/G8/G20 is back to being irrelevant or merely cheerleaders for the financial sector.

Comments welcome.

By Simon Johnson

101 responses to “Where Are We Now? Five Point Summary

  1. Yesterday I heard arguments that it is sounder for the government to inject money into the economy by printing it to pay for public works than by having the Fed create it by lending, because the interest on the Fed loans requires future nominal growth, unless eventually there are defaults or hyperinflation. This pertains to your point #4. Is there anything to those arguments? Thanks. :)

  2. strike three


    It is a slow day in the East Texas town of Madisonville . It is raining, and the little town looks totally deserted. Times are tough, everybody is in debt and everybody lives on credit.

    On this particular day a rich tourist from the East is driving through town. He enters the only hotel in the sleepy town and lays a hundred dollar bill on the desk stating he wants to inspect the rooms upstairs in order to pick one to spend the night.

    As soon as the man walks up the stairs, the hotel proprietor takes the hundred dollar bill and runs next door to pay his debt to the butcher.

    The butcher takes the $100 and runs down the street to pay his debt to the pig farmer.

    The pig farmer then takes the $100 and heads off to pay his debt to the supplier of feed and fuel.

    The guy at the Farmer’s Co-op takes the $100 and runs to pay his debt to the local prostitute who has also been facing hard times and has lately had to offer her “services” on credit.

    The hooker runs to the hotel and pays off her debt with the $100 to the hotel proprietor paying for the rooms that she had rented when she brought clients to that establishment.

    The hotel proprietor then lays the $100 bill back on the counter so the rich traveler will not suspect anything.

    At that moment the traveler from the East walks back down the stairs after inspecting the rooms. He picks up the $100 bill and states that the rooms are not satisfactory. Pockets the money and walks out the door and leaves town.

    No one earned anything.

    However the whole town is now out of debt, and looks to the future with a lot of optimism.

    That ladies and gentlemen is how the United States Government is conducting business today.

  3. bungalowbill

    Nice parable, but it could be improved to reflect reality more accurately.

    First, the town owes some money to the rich tourist himself.

    Second, the town must be divided between rich and poor folks. The rich are waiting for a hand-out from the poor before settling business between themselves.

  4. strike three

    yes, I know the parable is simplistic and moronic, as most of these floating internet parables are…. but it is illustrative of basically what has been devolving in America over the last 20 years. We are creating less and less personal wealth from genuine productivity. There are a whole lot of rather meaningless, superficial “jobs” that we take and go through the motions with, meanwhile hoping that our financial assests generate an above average compounded rate of return and that our piggy bank homes double in value under the Rule of 7’s. Waiting for the time that we can sell this ditrious to the next sucker in line. Who is that going to be, a Mexican family hoping for their piece of the American Dream? That is the only growing demographic group left. We better hope they develop strong economic muscles….. This is called living in a bubble. Like lifting the rock off the dirt and exposing the 100’s of shocked and exposed bugs crawling around underneath.

  5. strike three

    yes, I know the parable is simplistic, as are most of these floating internet parables …. but it is illustrative of basically what has been devolving in America over the last 20 years. We are creating less and less personal wealth from genuine productivity. There are a whole lot of rather meaningless, superficial “jobs” that we take and go through the motions with, meanwhile hoping that our financial assests generate an above average compounded rate of return and that our piggy bank homes double in value under the Rule of 7’s. Waiting for the time that we can sell this ditrious to the next social ascendent in line. Who is that going to be, a hispanic family hoping for their piece of the American Dream? That is the only growing demographic group left. We better hope they develop strong economic muscles….. This is called living in a bubble. Like lifting the rock off the ground and exposing the 100’s of shocked and exposed bugs crawling around underneath.

    {edited – hoping to pass the comment moderation filter – thanks!}

  6. Oops, where do all our “friends in the REAL east” fit into this (China/Japan/Russia)? How much cheap credit has been generated by their excess savings/low consumption? I’m afraid your money go round is accurate in some respects, unfortunately it doesn’t quite go round in a circle, its like one of those optical illusions! Far east (& Germany) makes things, US and some others buy them, value moves from WEST to EAST. EAST has money sat doing nothing so they buy US Treasuries and other US debt such as mortgages (helps keep down their export costs as it suports the dollar and anyway where is their money gona go otherwise). Those purchases help free up credit in the WEST and lower interest rates (disinflation of the past 15 years). That encourages more purchases from the EAST by consumers in the WEST. And so it goes on … until something gives! Where does that leave things? WEST with big debts and difficulty earning themselves out of it. EAST with dodgy debts and no one to sell to anything to any more!

  7. Alan McConnell

    Re the cute parable about Madisonville, the
    traveler from the East . .: it should be noted that
    no one in the town(mentioned in the story) had any
    net debt to begin with. Each owed $100, each was
    owed $100, so they could all have exchanged their
    notes and wound up without dept, without “Eastern
    intervention”. And any one of these individuals
    could have done this unilaterally. E.g. the hooker
    could have said to the hotel keeper: “I owe you
    $100 for the rooms, but here is a $100 note from
    the Farmer’s Coop guy. I’m sure you’ll agree that
    he is a more solid citizen than I, and hence his
    IOU is better than mine”

    I also don’t see who the U.S. gov’t is supposed to
    represent in this parable. Is it represented by
    the rich Easterner, who does nothing? or is it
    the hotel keeper? if so, who is the rich Easterner?

    Anyway, it is a cute story.

    Best wishes,

    Alan McConnell

  8. This is of course an illustration of a self-extinguishing letter of credit.

  9. That cascading debt payoff email has been traveling around the internet for months. It assumes that everybody’s debits and credits cancel out and the only thing the town needed was a whiff of liquidity. What percentage of the populace do you think is owed the same amount that they owe? It’s cute but flawed.

  10. So…you’re suggesting that we wipe out all the debt and start over?

  11. strike three

    …. SORRY, I meant Simon…..

    Charles C.

  12. There are several dangers in the attempt at some kind of recovery .

    First is trying (as the banks and administration seem to be doing) to get back to a credit driven economy. remember that finance had become 20% or more of the GDP and 40% of all profit. this was (and still is) a way of transferring wealth upward.

    Second is that we reconstitute a dynamic economy, but with fewer participants, as workers, or owners. One way of looking at this whole episode is that it got rid of costly workers, and a rebound is likely to be at the GDP level but not at the employment level.

    The core idea of a society is it is an agreement among all about how to proceed, and that means institutions must work for common good. Payoff to elites is probably an essential part of that, but there is a difference when representative democracy shifts toward oligopoly and oligopoly to kleptocracy.

  13. I think 1,2,3,5 describe the simple status quo which the powers that be are determined to prop up zombie fashion for as long as they can.

    The only sentence which seems to acknowledge the existence of actual “people” is the one which admits that unemployment is getting kind of bad.

    And yet people are still tolerating the existence of a system which does nothing but render more and more of them economically useless.

    Why? Isn’t the potential wealth still there, if we redistributed land on a small-farmer basis? Wouldn’t that, for the first time in history, afford a society where it really was true that your intelligence and hard work defined your success?

    Point 4 emphasizes oil prices. Not just oil prices but Peak Oil itself will define and enforce the end of exponential debt when demand tries to exceed supply. This was imminent, but the financial crisis intervened, imposing “demand destruction” (which simply means rationing by wealth, and an ever more generalized suffering).

    Conventional oil production has peaked. It did so in July at 75 million barrels per day. Even under a continued economic boom it could hardly have gone higher. The usually unspoken notion was that liquid fuels (and, stemming from that, “growth”) would in the future come from “alternatives”, “unconventional” production like the Canadian tar sands, heavy oil from Venezuala, deep offshore drilling off Brazil, and the new Arctic Great Game, and agrofuels like ethanol and biodiesel.

    But the effect of the credit crunch on fossil fuel exploration and agrofuel production has been that many of these projects have been postponed or cancelled. But even the diminished fossil fuel consumption in the meantime has continued to deplete the already-depleting existing fields.

    What this means is that in a few years, if the money-printers and debt-incurrers can manage to prop up zombie growth for a few more years, and this manages to bring on resumed high oil consumption, this artifically stimulated growth will hit its head on an oil supply ceiling, and that’ll be the end of exponential “growth” once and for all.

    The most sanguine prognostications, e.g. those of the IEA or, place this end of growth, this Peak Oil event, in 2013.

    So that’s the physical limit on this deranged economic system. (If you click on my name, my most recent blog post tried to describe what’s going on.)

  14. “Wouldn’t that, for the first time in history, afford a society where it really was true that your intelligence and hard work defined your success?”

    I cannot envision any society where intelligence and hard work are sufficient conditions for success. Redistributing land in small parcels is not going to change that, unless we all decide to agree to redefine success as working hard and being intelligent.

    And with all due respect, I’m not sure how we can predict that the world economy will cease growth because of a decline in oil production. This ignores the possibility of humans finding a way to use less oil. These are wild guesses, forcefully stated and dressed up as certainties.

  15. My own sense is that, although we feel a bottoming out, because of the severity of unemployment and its likely increase, we face the possibility of a double dip. As Doug notes, credit has played a huge role in growth of GDP over the recent years and with the contraction of credit, we are not going to get the degree of stimulation that can pull us out. Also, recent changes in law will make consumer credit less available.

    I further suspect that we will see a generational shift in spending habits that will also suppress recovery.

    I share a lot of Russ’s sentiment that more radical change in the system is needed and that the administration so far is “window dressing.” For the past thirty years the economy has overcompensated at the top and undercompensated at the middle and working levels of society. The current crisis was largely created by this pattern and will not resolve until the wealth created flows more evenly throughout society.

  16. Why? Isn’t the potential wealth still there, if we redistributed land on a small-farmer basis? Wouldn’t that, for the first time in history, afford a society where it really was true that your intelligence and hard work defined your success?

    Is your goal here to create farmers or feed people? Our society feeds (I would say over-feeds) more people more efficiently than any in history.

  17. A good analysis. The market always prevails.

    We are entering uncharted waters with numerous shoals ahead under heavy seas. Those in power have successfully undermined the foundations of Pax America post war boom. Look out for unforeseen attacks that further weaken our financial system. The financial protections so blithely thrown under the bus, no longer protect us. We are exposed and vulnerable and the sharks are circling. The permutations/combinations of things that could go wrong are too numerous to count. The usual suspects that lead us out of recessions, the housing industry, the auto industry and hi tech start ups have been wiped out. The programs now being initiated, particularly cap and trade, and Universal Health Care, will only cause more financial destruction. These clowns now at the helm are either incredibly stupid or are purposely running us aground.

  18. http://www.youtube.com/watch?v=H5Jc3A3ZNEc&feature

    it would be well worth anyone’s time to see the infowars.com movie, here is the link to the one and onehalf hour movie:

    And, anyone interested in hearing the truth needs to watch wallstreetpro on youtube.com. He may sound rough, with tough language and a whole lot of anger, but he is a truth teller. I wish he could have his own show to spread his simple, and unsullied truth.

    Here is a link: http://www.youtube.com/watch?v=H5Jc3A3ZNEc&feature

    The clowns are not stupid, but they are “banking” on we the people being stupid and they are so far, right on the money.

  19. The carry trade will come into action for sure and I think that will prevent the dollar from collapsing, come what may. Status quo for a few more years?

  20. Depends what you mean by collapsing… If people are borrowing dollars to buy other currencies to pay for foreign hard assets, this will _accelerate_ the devaluation of the dollar.

    Unfortunately, markets tend to overshoot. Hence the bubble fears (which might result in a rush back into dollars after the pop) as investors unload those foreign hard assets and try to find a safe harbor.

    My primary problem with this is that the US govt. is massively subsidizing this affair. It’s borrowing money at 4% (by selling Tbills), loaning it out to banks at 0.25%… It is therefore using its control over the money supply to PAY banks to loan money to institutions and entities that are (effectively) short selling the US dollar. (It is also allowing banks to “earn their way out” of their current balance sheet hole by holding a wide margin spread, thereby sucking part of the monetary stimulus into a black hole and transfering billions in lost-seignorage to banks.)

    If that isn’t messed up, I don’t know what is.

    Think about this – for over 10 years, SOMEONE subsidized the Yen carry trade. WHO?

    The answer, if you do the math, is the Japanese taxpayer. Rather than expanding their own currency to help pay their expenses (which is what govts are supposed to do as economies grow), the Japanese govt effectively allowed Japanese banks to print currency (by borrowing it freely and loaning it out at higher rates) and use it to buy foreign currencies (thus depressing the value of the Yen for a long time).

    In the meantime, to sustain the economy, the Japanese government borrowed a vast amount of money (which it owes the interest on). That burden is now owed by taxpayers. This is one of the causes of the Japanese lost decade. If the Fed subsidizes a vast carry trade AGAINST the US dollar we are in for a bad time.

    The problem with both fiscal and monetary stimulus in a globalized economy with pathetic capital controls is that no one can internalize the benefits of the stimulus. Fiscal stimulus leaks through imports, and monetary stimulus leaks through dynamics like the carry trade. That is why coordination (or effective capital/trade controls) is important, or alternatively a mechanism so that countries don’t feel a need to store up large amounts of foreign currency (thus making net debtors of other countries in order to ensure their own financial security – a point SJ has covered well in the past).

    Right now, the entire global financial market is the Wild Wild West. The technical term for this is “messed up”.

  21. I like Joe Nocera’s article very much. I was planning to put the link in my post but Mr. Johnson beat me to it. There’s also a very good article by Weisman in the June 13 WSJ where Larry Summers outlines some of the PLANNED changes. Although it seems so far they are taking “baby steps” as far as changing bank regulation is concerned, at least they seem to be headed in the right direction. I especially like the 3rd principle of the 5 principles Summers mentions: REGULATED ENTITIES MUST NOT BE ABLE TO CHOOSE THEIR REGULATORS. I would think that would have been OBVIOUS back in 1999 when they repealed the Glass-Steagall Act. Whose genius idea was that??? Phil Gramm’s???
    I think unemployment is going to remain high for at least the next 18 months (probably longer). I don’t see inflation as a problem in those 18 months either. Here is the link to Weisman’s article in WSJ.

  22. What happens when the whole system fails, which it will? Dramatic inflation?

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  24. Jeffrey Yasskin

    On #4, consensus economists may make the shaky inference from high unemployment to low inflation, but that’s not the only way to infer low inflation. Scott Sumner wrote “10 reasons not to fear high inflation” (http://blogsandwikis.bentley.edu/themoneyillusion/?p=1164) at the beginning of May, which takes a market-based approach to predicting low inflation. AFAIU, while TIPS spreads have increased since then, they still predict low or normal inflation. Why should we worry about high inflation when the market isn’t yet worried about it?

    Also, why oil prices? It’s the commodity for which we should most expect increasing prices relative to everything else (because of peak oil), so it doesn’t seem like a sensible thing to infer inflation from.

  25. Why worry about inflation? Inflation fears have already caused a rapid jump in 10Y Treasury yields, and as I understand it, real estate borrowing follows this rate. As a result of the sudden increase in rates, a large number of real estate deals and refis in the pipeline are now dead.

    So even a little inflation (or merely fear of it) can kill what is left of a real estate market that barely has a pulse left. And why the fear over inflation? What part of 400% total debt-to-GDP ratio (which we’re approaching) do people not understand?

  26. I’m not sure I’ve seen many people mention one of BB’s favored tactics, to announce a ceiling for Treasury yields.

    From the speech:
    “A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.”

    If he tries this, it will crash the dollar. Sadly, it does look like that might be the only way out, but be prepared for a very very rough ride, when the price of a Honda Civic rises to $50k, even if you could afford the gas to put in it.

  27. Hmmm…with great trepidation I find myself disagreeing with Simon Johnson as follows:

    Simon wrote: “In all recent showdowns with standard macro models recently, the markets’ view of reality has prevailed.” I don’t see how Japan’s recent history fits the “market’s view of reality”. See Paul Krugman’s recent blog post: http://krugman.blogs.nytimes.com/2009/06/13/way-off-base/

    Simon also wrote: “Emerging markets are increasingly viewed as having ‘decoupled’…This idea was wrong in early 2008…it is probably setting us up for a new bubble” I don’t see how a new bubble in anything can be blown up with the shadow banking and “sunlight” banking system so impaired. My take is that it is setting us up for the next “shock” a la the failure of Creditanstalt in 1931. Could the Creditanstalt type catalyst of this cycle come out of Latvia? Ukraine? California?

  28. The US is broke and will not be able to sell its bonds at the municipal or Federal level without continued monetization-the only buyers of consequence being foreign central banks.

    The real economy will continue to slow-there is simply too much debt-reread that Simon it can all be summed up in 4 words…

    “Simply too much debt”

    Add that to the growing mistrust of the monetary masters and one comes to one conclusion-the ponzi scheme which can never be repaid has reached its endpoint and the 37 year break with the datum of gold has been an anomaly-bot he norm as history clearly shows.

    Better to run it on gold-the real gold-not the never audited, nested subcustodianed, likely encumbered ETF’s.

    John Doe

  29. Re point 5, CLSA’s Christopher Wood predicted quite a while ago (at least a year) that the West would suffer it’s big crash, and then we would see a super-bubble in emerging markets. It was never clear to me what timing he foresaw. It seemed hard to believe at the time, but this could be what he meant. Russell Napier sees a liquidity induced stabilization for a year or two and then things collapsing completely when the Treasury bond hits 6%.

    Those forecasts seem to jive with what’s happening now. It seems hard to believe this could go on for a year, but then who predicted $150 oil?

  30. Yeah, I don’t detect any whiff of revolution in the air, or even an appetite for real change. At least not yet. Given their druthers, most still would rather turn the clock back to to 2006 or so. So, the last clear chance to reform the existing institutions will be missed, and they’ll eventually be replaced by something else, after a great deal of trial and tribulaton.

    But I agree that there is a whiff of bubble in the air–in the emerging markets, at least in the big LatAm and Asian economies with large internal markets and potentially strong internal demand. Not nearly enough to save the rest of the world, but more than enough to save themselves.

    Give it time. And make sure you’re watching from a distance.

  31. Another interpretation of this month’s activity in the bond markets–consistent with the deflationist view–is that Treasuries have started to price in the risk of sovereign default. Commodity bubbles can burst very quickly, so absent inflationary expectations, markets will eventually vaporize newly-created credit. Regardless of the cause, the backup in yields will result in further asset deflation, raise corporate borrowing costs, and with a little luck, cause our policy makers to take a whiff of the fact that we’re close to Peak Credit.

  32. I am intrigued and not encouraged by the fact that the discussion seems almost wholly decoupled from the lives of the vast majority of Americans. They get a token acknowledgment in references to unemployment and consumer behavior, but it is almost as if high unemployment, continuing high rates of foreclosure and increasing homelessness, not to mention skyrocketing health care costs and the probable failure of Congress to do anything substantive in that field, are irrelevant to your expectations. That is unsettling, because from my perspective some of the roots of the recent crisis lay in the notion that what happened to ordinary people was irrelevant. So what if they can’t pay their bills? Well, so a lot of things.

  33. Kath, you are missing the fundamental problem. For centuries, the USA has had such generous natural resources that nearly everybody has been at least prosperous, if not rich. As a result of lots of extravagance, the wealth is nearly spent, & everybody will be poorer for a considerable time.
    The government has tried to hide the problem by helping crooks inflate the value of shares, housing, etc. so that people think they are much richer than they are.
    One area I know a fair bit about is retirement pensions – I worked in the area for years. Some big companies have either defaulted on their pensions, gone bankrupt to avoid paying, or used various loopholes in the plans to pay much less than their workers expected. Many more have put so little money aside to pay those now working that they will do the same thing in the next few years. This means, that workers who have been with a firm for thirty years, & expect to be supported in their old age, will get much less than they expect. This is not accidental, but because for thirty years the firm has been spending the money needed for the retirement, and been encouraged to do so by the government because it made everybody feel more prosperous than they were.

  34. Marie Antoinette

    I see your point, but think the gist of this post is to look at the macro, not micro picture.

    That said, it is very clear that ordinary people are paying attention to what is going on these days. It’s a far cry from the usual pattern of wake up, vote, fall asleep for 3 1/2 years.

    I was just at a town hall meeting with our US congressman on health care–standing room only, people shouting things out. These are (usually) restrained middle and upper middle class midwesterners here. I was stunned.

    Everyone is on edge. However, I think it’s true what some bloggers have noted lately (based on just released public opinion polls) that the working class and lower middle class is not overly worried by the “crisis” right now, largely because they have been in it for some time. It’s the upper-middle and even some rich folk that are being touched for the first time who are freaking out. As a lower- mid girl who only recently made it up a couple of notches (only to fall back 2-3 steps and be close to foreclosure) I am more than a bit schizophrenic. Most of the time I tell myself it doesn’t matter, I’m still young enough and flexible enough to start over; other times I just can’t stand the “new reality” and want to wake up and find it’s 2005 again. I had fewer hairs then too. Oh well.

  35. “I see your point, but think the gist of this post is to look at the macro, not micro picture.”

    Right, but my concern is precisely the apparent lack of connection. I don’t buy it. In the real world, as distinct from the textbook, things are connected. The housing bubble was not an abstraction but grew one inflated price and one stupid mortgage at a time, with spectacular macro consequences. The diversity, severity, and interaction of present micro problems could, in a worst case, bring down the whole house of cards. They might not, and we’d all better hope not, but perversely I would feel better with an analysis that recognized what I see as the fundamental instability of the system.

  36. Marie, did you mean heirs?? That last sentence has me confounded. Either that or you got hair implants…..and why not…you were moving up in the world.

  37. Gray hairs, prhaps?

  38. Sorry, perhaps.

  39. I’m continually amazed that business is being conducted as if everything is OK. There is no longer any economic logic behind the working of the financial markets, the only thing keeping everything working is inertia. No real change has occurred, no new system, guidelines or regulations to improve a broken system. Psychology is a funny thing, somehow the people are made to believe that everything will be fine, so it is, even though the ground under their feet is constantly shifting. When will hyperinflation come? Maybe never, probably soon, but what will be the event that triggers it? As mentioned, oil’s as good a bet as any.

  40. As long as 1 percent of the population keep taking home more and more (now 21 percent) of this countries income we will never work ourselves out of this recession. This is a flat out fact! Obama MAY hopfully get the first step toward single payer health care in place (the “public” program) which will eventually knock out the greedy insurance companies but the only hard stance I’ve seen so far is with auto manufacturers. I’m not holding my breath that he will do anything right however. This saddens me.

  41. Consumer sentiment is up a fraction on two auto bankruptcies? So bankruptcy makes people feel better than a lingering potential catastrophe I assume. Would anyone guess that would be a relatively low volatility market event? But everything is OK because now some banks want to pay the TARP money back (after the accounting rules changed) right? Truly bizarre behavior. The real question is how to position for the obvious oncoming freight trains of “flation.” Choosing which type prevails can only be a guess but what has the best odds for either scenario? Strange times indeed.

  42. Since GDP is 70% consumer spending that means with continued unemployment, continued foreclosures, GDP is going to keep on plummeting???
    Doesn’t it mean that continuing loss in assets in banks continuing purchase of that by Uncle Sam?
    What about state and local governments losing revenues; services going from less to worse?

  43. Obama is an unmentioned wild card in this 1,2,3,4,5 scenario. At every opportunity in his short, steep career the guy has swung for the bleachers. He did it when he first ran for state senate, again when he chose to run for President and again in his race speech in Philadelphia. I find it difficult to believe that this guy is going to be content to preside over the subjugation of America’s middle class by the banking class. I think it is more likely that at some carefully calculated point, he will put it all on the line and try to make radical changes in the economic structure of the country. I’ll cheer him on, I just hope at that point i am fully out of the stock market.

  44. Robby, my new way of expressing the Obama effect is to say that basically:


    people forget that on the day that Obama with all his powers as Messiah in the eyes of the people ( i was too, hoping that he wouldn’t sell out ) he anointed the paulson/bernake plan and as such, sold out to the real powers that be” the federal reserve with all their shills.

    If Obama was not corrupted by the powers of the fed, he would have decried the paulson/bernake plan and called for a REAL and IMMEDIATE evaluation and investigation of the lehman, aig, banks turning into holding companies, TARP, and secret treasury meeting SCAM.

    So, until there is a disconnect between Obama the savior and recognition of Obama as the man who anointed the biggest bank heist of all time aka bailout, and all many of the acronyms especially TARP but also, the AIG scandal, we are doomed to be stuck, and in danger from living in a country with a corrupt government.

  45. Pingback: links for 2009-06-13 at DeStructUred Blog

  46. I don’t know if you read Joseph Stiglitz article in the new Vanity Fair, but it actually plays a good counterpoint to your framing of the present situation and your general view of the handbasket that is transporting us to fiscal hell.

    I think that to call anything that we are likely to see in the next 18 to 24 months “recovery” is to redefine the word as it is commonly understood as a part of our economics jargon. For me, the financial oligarchs are in control, and the unfortunate thing is that what is going on here is (a) holding the world back from recovery of any kind, and (b) really causing a second stage of this country’s image deterioration internationally. I am going to be so anxious to see what the next G20 is like, and how this administration will handle the opportunity (if it actually is such).

    If Stiglitz is right about the international financial and cultural fabric, we won’t have to worry, we are screwed.

  47. Apparently in Bible times, the god Baal and his female consort Ashura were worshiped for their ability to produce rain and fertility. In a largely agrarian culture, fertility is more or less equivalent to prosperity.

    For some decades, we have arguably worshiped at the shrine of easy credit, made possible in part by the marriage of the central government and central bank, the two of which get in bed to exchange the IOU’s of Treasury bonds for green cash created from nothing as only a god or goddess can do.

    Of course, this is simplistic, not least because we do business with our neighbor, and for the present, cash is better than, say, gold, because we are trying to dump our things on a glutted market in exchange for cash in order to use our cash to pay down our debt.

    Only when collectively we lose sufficient faith in the power of Baal and his consort (partly via the sacrifice of our taxes) to postpone the day of IOU reckoning will things like gold start to function as surrogate currency. At least for a time.

    (Remember that the central bank holds Treasury bond IOUs as assets.)

    I think the cult continues for now. We can see no better alternative. But our faith is weakening. So is our faith in our neighbor.

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  49. Tippy Golden

    In a previous comment, I said Americans should take back their democracy. But I need to correct myself. There is no golden past to recover. Rather, democracy is an dynamic and evolving social contract. Consider the deeply-felt, and hard-fought battles for the enfranchisement of Black Americans and women, to name just two examples.

    A neighbour once said to me — we do not have a democracy — rather we are in a process of acquiring more democracy, and he is right.

    So the battle underway is to reduce the power of the oligarchy, a narrow elite, who have captured government and may even consolidate their wealth and power in a time of financial crisis.

    The way to dislodge them is through a political process.

    Robert Reich says “morale outrage” is counter productive unless it is directed at the right targets. In other words, “moral outrage” which is entirely justified and there is plenty to go around, is not enough. There needs to be an understanding of the causes of this outrage, and to channel the energy from this outrage, into action in the right way.

  50. It appears that given the strong correlation between the movement in equities with a 4-6 week lag in consumer confidence over the past 30 years that there has been a concerted effort to boost the “hopes & dreams” discussion with “green shoots in the developing second derivative” in an effort to resolve the crisis in liquidity as perceived by the political chattering elites by sustaining the green arrows on the TV concept of economic stability. Now that we have learned over the past 10 trading sessions that a >1% down movement in US equities will be covered with 250 million in closing orders cannot but give greater weight to the concept of equities that support consumer confidence that revive the consumer of 2006 thesis of macro economic recovery.

    Be it unemployment, FX spreads (esp. Australian-US spreads), emerging market equities, commodities in general or oil specifically, the % of US sovereign debt being purchased by central banks or corporate default rates in comparison to historical norms we may well find ourselves in a situation where, at least in the US there is an equities market supported by central bank liquidity, primary asset deflation and sovereign debt deflation coexistent within an inflationary commodities environment. This while leaving aside the movements in the junk/lower investment grade markets and perhaps more importantly, the action in the ratings arena with the making of S&P’s downgrades of CMBS irrelevant and its impact on the whole window dressing discussion.

    Just reflecting upon the concept that over a three month period I would witness a 30%-50% jump in equities, 100% jump in oil while 10 year treasuries yields moved from 2% to 4% contained within an ongoing 30%+ cumulative drop in housing with 10%-30% more to go and I cannot but consider that the business of creating window dressing as a proxy for resolving the underlying issues, as has been the norm in the past may well fail in the short & medium term his time around.

    We’ll see. However, I cannot but think that we may well find ourselves in the situation by this time next year that on the macro level the great Narod of American society along with businesses of all sizes will have come to the conclusion that confidence without trust is just a game.

  51. To much debt is right, and it is still going up, just who is incurring it is changing. As herb Stein said “if something can not be sustained, it will stop”. Total debt now 375% of GDP, how much more of an increase can be sustained?


  52. One day much of the macro community will come to appreciate what structural engineers have for centuries. That is a structure/system, be it a physical or an economic one cannot carry more weight than the sum total of the carrying capacity of those encompassed by the system/structure. In a macro sense this simply means that any system cannot bear more that the total economic output of everyone in the system.

    Fact of life. Gravity, like magnetism will eventually exert its force.

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  54. Good list, but you might consider two more items that weigh heavily on where we are and where we are going: 1) debt burdens are still crushing households, most of which have diminished assets and diminished access to credit, and 2) No one has offered a credible story for the next engine of growth — an inventory bounce is not a recovery, and the stimulus is too small and only dribbling out.

  55. Why add the conclusion that, in fact, the sun did rise this morning? That is even if it takes a few folks a couple of quarters to figure it out.

  56. some guy in a cube

    Nice synthesis, Simon. Thanks.

    It’ll be interesting to see what chaos ensues when oil blows past its 2008 highs.

  57. Let alone the chaos when it subsequently plummets…

  58. some guy in a cube


  59. On the carry trade, as I’ve argued here (http://baselinescenario.com/2009/06/04/bernanke-didnt-go-far-enough/), the central challenge is that Bernanke is over-using blunt instruments like discount rate in an attempt to limit overall govt. involvement in the finance sector (due to a belief that targeted govt activity = badness). This broad policy rate allows financial players to cheaply lever up on dollars and buy foreign assets – and, indeed, _subsidizes_ that behavior. In other words, the Fed is subsidizing investors who are _short-selling_ the US dollar by moving to non-dollar hard assets. In November, the Fed needed a sledge hammer. They didn’t use it till late February (sadly), even though many people were screaming in frustration (myself included). Now, they need a scalpel… how long till they realize it and make the change?

    HOWEVER, I disagree slightly that “In all recent showdowns with standard macro models recently, the markets’ view of reality has prevailed.” In most cases, this is true.

    But NOT in oil. In August 2008, the markets said oil was worth 147 dollars. In January, they said it was worth 30 dollars. Now it’s worth 70 dollars.

    Recall that the 147 oil price resulted from dollar flight and the belief in decoupling (as championed by “experts” like Peter Schiff). The current oil run is partly due to this, but partly has some “fundamentals” underneath it – OPEC tightening. But the market has already proven how badly it can get things wrong; there is a significant risk that the move to non-dollar assets reflates those assets, retriggers a post-restocking decline in demand/output, and this then triggers a second mini-collapse in commodity prices. So much of the market movement is determined by vast amounts of money being sloshed around, running in fear or greed or some combination of the two… which itself creates phenomena that otherwise would not have happened.

  60. STATSGUY – ANYONE – could you write a post that clearly explains how the cost of gasoline is determined? Why does it inevitably go up in the summer (when people schedule vacations that might require cars?)

    Why was it $4+ a gallon last summer? What made the price fall by more than half after the economy crashed? Seems fuzzy, to me and any knowledgeable explanation of how a gallon of gas is priced would be great.

  61. It’s a great question Anne. The price doesn’t seem to be very rational sometimes. A lot of paranoia and conspiracy theories surround that question. Some of it justified. I know at one time there was some collusion and price fixing in the world soybean market and I’m sure economic historians could give you other examples I don’t know about. There’s so many variables it’s really hard to say, but a lot of it has to to with the OPEC (or OAPEC). OPEC is a group of Middle East or Arab countries. They have meetings and determine how much oil they want to produce/SUPPLY over a given time period. You can look on Wikipedia of course. But that has a lot to do with the price. And you might kind of consider Saudi Arabia as the “big daddy” of OAPEC. That’s why so many western countries kiss up to Saudi Arabia (including the USA).

  62. Another key item is peak oil. While I know this is a controversial topic because we don’t know when total world oil production will peak, we do know the most important type of oil has peak – light sweet crude. Most other oil prices are priced off of what light sweet crude trades at in the market and yet light sweet crude peak several years ago. It’s also the most highly demanded type of oil because it’s the simplest to process into refined product – especial low sulfur diesel. Most of the world’s refineries can’t process heavier grades of oil (without billions in new investment) so when demand for fuel goes up they have limited options to buy because light sweet crude is declining in availability. This helps drive all oil prices up. Throw in OPEC’s ability to throttle supply and some market speculation and you’ve got a perfect recipe for price spikes.

  63. Also Anne, I might add, if you’re looking for a nice equation/formula x+y-z=the market price of oil, it doesn’t exist. If you could figure that out, you’d be richer than George Soros.

  64. And while you’re on the subject of Soros (probably the greatest living speculator) as oil climbed toward $147 a barrel he said that he suspected speculation had something to do with it. Paul Krugman and others spent some ink explaining why this couldn’t be true because of the way the futures market operates. So you can decide, bet with the economist (theory) or the speculator (practice).

  65. Others have covered this much better than I could, though perhaps a while ago.


    I would add refinery capacity to their other explanations (crude oil prices, summer reformulation to more expensive blends, and demand). There’s limited refinery capacity, and demand is inelastic enough that when even a small portion of that capacity goes offline (due to unscheduled events like fires/accidents, or possibly due to collusion – although this is tough to prove) gas prices rise even in the absence of crude price increases.

    There’s also this… http://auto.howstuffworks.com/fuel-efficiency/fuel-consumption/gas-price.htm

    But the larger question about overall global crude demand is just how inelastic it really is in the long term. The dip we observed when gas prices skyrocketted may have resulted from temporary reduction that is limited in scope (and ultimately loses out to long term trends like population growth and industrialization of developing countries). Alternatively, it’s possible that it set into motion a chain of events that could result in a long term reduction in gas demand (substitution to more fuel efficient cars, technology investments, or substitution to alternative fuels like electricity/coal).

  66. Brett in Manhattan

    I don’t see any way around a lost decade. We have a structural flawed growth economy predicated on consumers living beyond their means and paying 15% plus for the priviledge. This can work for awhile, but, eventually the debt servicing will overwhelm the borrowers.

  67. Jonathan Cole

    Supporting the oligarchs and kleptocrats is simply corruption which has destroyed the normal functioning of the economic system. There is always some corruption in any system, but in this case, the Bush/Cheney ideologues have delivered the nation to the elite criminal syndicate. The destruction of productive capacity will lead to poverty and massive shortages which will be coupled with dramatically rising prices. Sooner or later you need the new refrig. When inventory is a small fraction of normal lifecycle demand, the prices will go through the roof. Perhaps this should not be called inflation. More like a runaway train with hyper-criminals controlling the engine. Because the population has been systematically dumbed down,they do not even realize what is happening to them and seem to be willing to quietly simmer as the temperature rises. The proverbial frog in the almost boiling water. Could this be a crisis of biblical proportion?

  68. Old Lady in Red

    Oh…. Pshaw, as Grandmamma would say.

    …You bore me.

    We need a New Bank with smart lovely young men (with
    MBA’s) not Harvard….I have been there….sigh.

    ..who Take Care of Money, Assets.

    Sadly, the public is coming to understand the morass of “investment sharks” and well…. smile.

    The world is ripe for a New Thing.

    Controlling The Old Thing is, well, an old thing…

  69. Well, maybe we could start with some stylized facts.

    Just consider the banking rescue. Bloomberg reported (June 11) that “The U.S. government and the Federal Reserve had spent, lent or committed $12.8 trillion, an amount that approaches the value of everything produced in the country last year, as of March 31”, whereas “European governments have approved $5.3 trillion of aid, more than the annual gross domestic product of Germany, to support banks during the credit crunch, according to a European Union document.”

    And all that money spent, lent or committed for the banking rescue. To get the total amount of taxpayers´ money spent, lent or committed we must add all those stimulus packages etc., to keep the economies alive. And what has been the outcome?

    There are two evidence-based summaries available that are both very illuminating. As it happens, both of these summaries/scenarios were updated almost simultaneously:

    “Quarterly Update: The Recession in Historical Context” by Paul Swartz


    and “A Tale of Two Depressions – The world economy is tracking or doing worse than during the Great Depression (update)” by Barry Eichengreen and  Kevin H. O’Rourke


    In fact, despite the appearance of having two rival scenarios, they do not contradict each other, because the summary/scenario of Swartz is based on U.S. data, while that of Eichengreen and Rourke is based on global data.

    Moreover, both strongly suggest that there is one, immensely important, difference between the Great Depression path and the present Great Recession / Second Depression path: the public response to the crisis. It has saved us from a complete collapse of the global economy.

    But the more enlightened public response cannot change the nature of the crisis and the underlying necessities. This is a crisis of financial capitalism whose seeming vitality has been based on creating huge asset bubbles. Conversely, overcoming the crisis will inevitably include a huge deleveraging process.

    If the public policy had been as short-sighted as in early 1930s, we would have already been overwhelmed by the massive tidal forces of Fisherian debt-deflation. These massive tidal forces have been contained by public action, but they will continue to exert their force for many years. Turning the tide will take time and the process will be painful.

    In my opinion, there are only two ways out of this crisis. Both involve massive deleveraging processes. The first way would be, from my perspective, a much more rational and just way: Chapter 11 for global economy, a publicly guided process of deleveraging combined with a fundamental reform of the global financial architecture.

    The other way is what we are witnessing now. It is ersatz socialism for the benefit of the financial oligarchy, nationalizing their gambling debts while saving their privileges.

    No wonder we have all these relief rallies in the financial markets: some investors seem to believe that gambles for resurrection mean a realistic prospect for reviving the old and moribund system.

    Of course, we could end up having a depressingly familiar version of the financial system, but I do not think that the old system can be revived this time, at least without first having a lengthy and difficult period of deleveraging.

    To be sure, already during the gloomy days of September and October 2008, some cartoonists were making sarcastic jokes about the Masters of Universe busily planning for the next bubble – while standing on the ashes of the present bubble. The bursting of the tech bubble was papered over by creating a much bigger bubble. But I do not see a realistic possibility for repeating that now.

    The inevitable deleveraging cannot be conjured away by a mere show of animal spirits, and continuing the policy of ersatz socialism will create serious problems of its own.

    The essential question, for me at least, is whether we, after the inevitable deleveraging process is over, want to revive the casino, or whether we want to replace it with a new financial architecture.

    We need a financial architecture that can allocate resources and risks in a way that is consonant with sustainable development, not a casino with new gambling chips.

  70. your analysis is one of the best I have ever seen Thank u

  71. Tippy Golden

    This is a good post. And yes, let us talk about sustainable development to create a new engine for industry.

    Check out this documentary film.


    This is the first time I’ve heard of German Scheer — and economist — turned politician.

    “Scheer, an economist by training, was instrumental in passing perhaps the world’s most effective law promoting renewable energy, Germany’s Renewable Energy Sources Act (EEG). The law forces electric utilities to connect and then buy energy from suppliers of renewable energy. Those suppliers might include private homes fitted with solar panels, or communities relying on wind turbines, or farmers who turn manure into biofuels.

    Although ratepayers bear the cost for subsidizing renewable energy, the EEG remains popular in Germany, not least because it has created jobs: — a quarter of a million Germans — now work in “green collar” jobs, constructing windmills, solar panels, biodigestors and other components necessary for producing renewable energy.”

    I like the idea of creating “green jobs” for laid off auto workers. How about in the production of photo voltaic panels. Solar panel production created a new industry for laid off East German factory workers after the collapase of Communism.

    As for bio fuels. I’m sure the Americans invented industrial-scale beef and dairy farming. Check out what the Germans are doing with the manure !

  72. Tippy Golden

    I can’t resist quipping:

    Turn that BS on Wall Street into biofuel to drive the world economy.

    Steven Chu, I trust you know about Hermann Scheer, bring on the technocrats.

  73. We need bankers more than we need unionized labor… they work 50hrs a week

  74. compensate or die

  75. “Where we have seen improvements, they are the result of the unprecedented scope and intensity of policy actions to support demand and financial repair,” Mr. Geithner said in a statement.

    Is this someone who failed to accomplish anything meaningful while at the Fed for the last 5 years claiming he has fixed the financial crisis in 6 months?

    How can he know this hasn’t been the result of the Lehman bankruptcy & the resulting normal market correction? And how many trillions of our money has he spent to bailout these failed banks? How many of these trillions could we have saved if he hadn’t been a complete failure in his prior job at the Fed? How can someone who was an abject failure (and tax cheat) at the Fed for the last 5 years all of a sudden become so smart?

    And we paid this brain dead pseudo-intellectual a big salary for those 5 years while he was at the Fed to prevent a financial crisis, like this from happening? That was his job at the Fed for those 5 years & he was too dumb to prevent the collapse. And now all of a sudden, over night he becomes the brilliant one who is going to fix it? How can that be? Did he take some smart pills or something? I seem to be missing something.

  76. Found this on Treasury web site –

    “Before his nomination to the Treasury, Secretary Geithner served as the ninth president and chief executive officer of the Federal Reserve Bank of New York, where he began on November 17, 2003. In that capacity, he served as the vice chairman and a permanent member of the Federal Open Market Committee, the group responsible for formulating the nation’s monetary policy.”

    He was sitting right in the middle of the collapse on Wall St. for 5 years, with a lot of power, but was either too dumb or too lazy or both to prevent it? Would someone please tell me what Geithner’s accomplishments are, given all the power he had, that qualifies him to lead our economic recovery.

    And what does Geithner’s pick say about Obama? He’s a good speech reader. Not much else.

  77. Stabilized? your joking right? On the surface it apears to have stabilized. But thats only because of the market manipulation that’s going on behind Obamas Socialist Curtain. If you really think we are flattening out and ready to turn a corner, you are only fooling yourself and others. I’m in Texas, we are just now starting to see the crap the rest of the country has been going through. This is only the calm before the next storm.


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  80. imapopulistnow

    I don’t buy the “super bubble in the emerging economies” theory. Here is why:

    Globally we have a significant imbalance between supply and demand. Going forward, the USA and old Europe will continue to consume less and less. Demographics (old people do not buy stuff) and in the case of the USA, repayment of massive debt loads, higher taxes and higher import & commodity costs as the dollar devalues.

    We are not in a bubble as much as we are in an adjustment phase where the established economies consume less and the emerging economies consume more.

    Inflation yes, but hyper-inflation will not be a problem. Personal discretionary income will evaporate.

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  82. Spengler sums it up pretty well in Obama’s economic maneuvering room -already exhausted?:


    The wild lending by the Fed and drunken sailor spending by Buraq have put us in doozy of a fix. The 10 yr treasurys are already rising way too fast and we’re just starting to borrow to fund the deficit. Mortgage rates are rising right along with the 10 yr, too. Those green shoots are wilting and turning yellow.
    Spengler is right- there is not much room to operate now.

  83. Please explain why you are focused on the price of oil? How is this the key to where we are headed in the USA? The oil companies have been managing to make out like bandits all through this recession no matter what the price of oil has been by the barrel.

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  89. David Martin

    George Osborne, who is the Shadow Chancellor of the Exchequer in the UK, and may be in power by next June, wrote an article in today’s Times in which he pledged to carry out vigorous spending cuts, and mentioned that Canada’s cuts in the 90’s gave him inspiration:

    Perhaps he could also be persuaded to follow Canada’s example in pledging to regulate banks properly, as at present the UK is vying with the US in trying to sweep all the problems under the carpet, and instead of real reform limiting the Bank’s ability to take on dodgy loans for multiples of the UK’s GNP and to indulge in huge leveraging, are just assuring us that the regulators will not make mistakes in future, in spite of their horrendous record.

    In the UK at least the administration is likely to change before that in the US, and so new figures not committed to the present series of mistakes will be in power.

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  94. What will drive the recovery and what drives all significant economic expansion is the growth of at least one major new market — something new that emerges from Schumpeterian competition. That is why the real purpose of the Waxman-Markey environment bill is to overbuild the existing carbon-based electricity market with a clean energy market, at a total investment cost of about one trillion over 20 years. And the essential mechanism for this goal is the combination of a national renewable electricity standard (stimulating demand) and a non profit wholesale green bank (providing a satisfactory return to equity).

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  98. Pingback: Global Crisis Orientation « The Baseline Scenario

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