The U.S. Is Losing the Economic Cold War 18 comments
Lawrence York
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There is an economic WAR going on and the way SB sees it the US is losing it primarily because of the shortsightedness of Congress to do the right thing. Almost like a scratched record stuck in a rut left unattended at a radio station, the US Congress is playing the same verse over and over and getting nowhere with the people’s business. Before long, listeners, not in the US but overseas, will tire of the scratched groove and change to a different station.
US leadership must develop a strategic plan and stop focusing on tactics. Assuming Congress eventually fixes the banks and restores lending, the question is where will the US be then, and how will we be positioned vis a vis the competition? Better question, how long do we have?
Let’s put on our strategic hats and look down the road. Currently the US has an estimated $11 trillion dollar deficit. The Fed has expanded its balance sheet to $8.5 trillion and the Congress is looking to spend another couple trillion on a stimulus package. Conservatively estimating realized losses on mortgage-backed securities at another $2 trillion and estimating realized losses on the Fed’s toxic collateral means that the US will at best emerge from the financial crisis with a $15 trillion deficit with a $7.0 trillion dollar Gross Domestic Product–remember the GDP was goosed to $14-$15 trillion using 40 times leverage. Cutting leverage by half would ordinarily at a minimum reduce GDP to one-half, but the math of losses has an exponential impact. When you lose half (50%) a 100% gain is required to get back even! This, just to say a $7 trillion dollar GDP will doom us to years and years of recovery.
Indeed, the US Government can be expected to crowd out businesses for loans to finance the deficit (as banks are now hoarding cash to shore up capital). The US Achilles heel is both that we will have twice as much debt as GDP, but also that we will be vulnerable to inflation and potential increases in interest rates–when, not if, rates rise from their historically low levels to five or six percent. Such an increase will make servicing the debt a big problem. And what if they rise to 7-8%?
Keeping with the scratched record metaphor, the Economic war, now a cold war, comes when the competition changes the station and decides to move on trading amongst themselves. Think BRIC countries–Brazil, Russia, India and China–they have the consumption base and resources. All they need is a foray into consumer installment loans, and if they work together and get their economies growing. When that happens they will demand interest rates to finance US deficits greater than the growth rates they can earn at home, and may just place an additional risk premium on US borrowing for its lower credit.
The scratched record metaphor is a good one but a tiresome one to keep on hearing. The US Government is focused on the tactical problem of fixing the banks and have failed to think strategically. Growth is the ONLY answer to the US's woes. Bureaucracy is by definition counter-productive. The US needs to boost productivity. Banks will continue, like the government, to have poor fortune so long as their customers continue to have no confidence and trust in a system that rewards failure and fraud.
To kick start US commercial activity Congress must lend directly to small business and incite them with compelling loans like they gave the banks. Perhaps in addition to providing streamlined SBA loans, Congress can provide offsets in the 25-50 percent range for each long term payroll created. Sure, this will mean short term deficits, but it will ignite the engine of growth by those who have demonstrated an ability to do it, not bloat up government.
Look at it this way: there are two solutions 1) Grow your way out or 2) inflate and default. Assuming default is out of the quesition–a big if–ignoring the demand side of the equation and continuing with trickle-down stimulative policies is akin to staying in a scratched rut. The real price of failure is high and the US’s very future hangs in the balance of what we do now. If we do not take the right bipartisan actions to harness the power of US business, the US will ironically find itself being the ‘freedom loving nation of the world’ who desires uncertainty, chaos and war over growth, prosperity, and peace. Why? Because the former allows us to finance our deficits and the latter puts us in bankruptcy because we can’t finance our debt.
The implifications for investors is huge. First, the track we seem to be on means greater debt and a long duration of uncertainty and low returns. Should Congress not get their act together and pass the right stimulus plan, the directive will be for investors to abandon the stock market in favor of commodities a healthy margin of cash, and wait for the dust to settle. Eventually it will, and bargains will be everywhere.
If Congress wisely stimulates business instead of banks and municipalities, then the theme remains get paid while you wait favoring low debt, high cash flow, export oriented companies.
Regardless of which track is ultimately taken by the US, the debt to be repaid is large and real. The world has an estimated $50 trillion more of derivatives to work through. Leverage is still high and losses have not all been realized. In the Great Depression, excess speculation and leverage in the stock market (100%) brought the financial system down. The Securities Acts of 33 & 34, the FDIC, and the Glass Stegall Act were all implemented to prevent fraud and the excesses from happening again.
We disregarded the need for regulatory oversight. We repealed Glass Stegall Act permitting speculation with insured deposits. And we permitted 40x leverage--this time in the bond market.
Against the backdrop uncertainty will dominate for the foreseeable future and the US will underperform most all other countries. The only wild card to change the inevitable dismal US outcome is if US temperament permits greater foreign ownership of US assets giving creditors something other than devalued treasuries to own. In that scenario, foreign investment will diminish the upward push on interest rates, bide time for the US to pay down its debt, and give our creditors vested interest not to forelcose.
Disclosure: Long EEM, XLE, SPY, BND, Short TBT, RWM, DOG.
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This article has 18 comments:
"Currently the US has an estimated $11 trillion dollar deficit."
Debt, not deficit.
"The Fed has expanded its balance sheet to $8.5 trillion..."
Nonsense. Take a look at the Fed's balance sheet (www.federalreserve.gov.../), which has grown from $979B to $1.85T over the last year.
"...and the Congress is looking to spend another couple trillion on a stimulus package."
It's funny, but I haven't seen anybody taking about a $2 trillion stimulus. Surely you can cite something, right?
"...the US will at best emerge from the financial crisis with a $15 trillion deficit (sic) with a $7.0 trillion dollar Gross Domestic Product."
You really think this? Did you know that you have to go back to 1984 to get to the point where GDP, adjusted for inflation, was half of what it was at Q3 2007? (EROP table B2) Your assertion is patently absurd.
"...remember the GDP was goosed to $14-$15 trillion using 40 times leverage."
You're saying all of the growth of the past 25 years was illusory. You are massively overstating things.
"Cutting leverage by half would ordinarily at a minimum reduce GDP to one-half..."
No. First off, you seem to be saying that the average leverage of everything in the economy was 40x, which is absurd. But let's assume that the economy is levered and that contributes to growth. Cutting leverage in half doesn't cut GDP in half. Much closer to a logical answer is that it cuts the GROWTH RATE in half.
"...but the math of losses has an exponential impact. When you lose half (50%) a 100% gain is required to get back even!"
This is not exponential. It's an inverse relationship.
"Indeed, the US Government can be expected to crowd out businesses for loans to finance the deficit (as banks are now hoarding cash to shore up capital)."
Your parenthetical is unrelated to your sentence.
"Such an [interest rate] increase will make servicing the debt a big problem."
Not so much. Government payments on existing debt do not change with interest rates - government debt does not have a variable interest rate. Only new debt is subject to current interest rates.
"...the Economic war... comes when the competition... decides to move on trading amongst themselves. Think BRIC countries–they have the consumption base and resources.... if they work together and get their economies growing."
Um, you think that you've named some of the currently fastest-growing economies? But more importantly, you don't seem to understand the relationship between the current account deficit and foreign purchasing of US Debt.
"When that happens they will demand interest rates to finance US deficits greater than the growth rates they can earn at home, and may just place an additional risk premium on US borrowing for its lower credit."
Your first statement is dependent on the second being true. US debt is seen as the safest place for cash, and all other instruments trade at a premium to it.
"The US Government is focused on the tactical problem of fixing the banks and have failed to think strategically. Growth is the ONLY answer to the US's woes."
Nonsense on the first sentence. The banking system is integral to the free flow of money. Without the banking system, commerce grinds to a halt. Look what happened to the commercial paper market for an example.
"The US needs to boost productivity."
I believe productivity gains in the US have been quite good for years.
"Look at it this way: there are two solutions 1) Grow your way out or 2) inflate and default."
Why would "inflate" and "default" BOTH happen? If the currency is inflated, doesn't the reduce the real cost of the debt?
"Assuming default is out of the quesition–a big if–ignoring the demand side of the equation and continuing with trickle-down stimulative policies is akin to staying in a scratched rut."
I can't think of anything in the stimulus that can accurately be described as "trickle-down."
"The real price of failure is high and the US’s very future hangs in the balance of what we do now. If we do not take the right bipartisan actions to harness the power of US business, the US will ironically find itself being the ‘freedom loving nation of the world’ who desires uncertainty, chaos and war over growth, prosperity, and peace. Why? Because the former allows us to finance our deficits and the latter puts us in bankruptcy because we can’t finance our debt."
What a load of hooey.
"The implifications (sic) for investors is huge..."
"Against the backdrop uncertainty will dominate for the foreseeable future and the US will underperform most all other countries."
Complete, utter, alarmist nonsense. I'd love to bet with you on this.
And then, the grand finale:
"The only wild card to change the inevitable dismal US outcome..."
Personally, I love changing the inevitable.
"...is if US temperament permits greater foreign ownership of US assets giving creditors something other than devalued treasuries to own."
Apparently you have no idea how much equity is available for sale in the US to any buyer, regardless of any limitations imposed by the government. InBev bought Anheuser-Busch. In most cases, there are no significant impediments to foreign ownership of US assets.
"In that scenario, foreign investment will diminish the upward push on interest rates, bide time for the US to pay down its debt, and give our creditors vested interest not to forelcose (sic)."
Again, so little knowledge of the relationship between trade and capital flows. And I love the last line. Who is going to foreclose on what? You think the Chinese, the largest foreign owner of US debt at about 6% of the total, is going to kick us out of America?
This is perhaps the worst article I've read here.
WRONG. Get the government OUT of business. Loans from the government only serve as interference, not as stimulus. Witness the CRA and subprime lending via government-sponsored Fannie and Freddie!!
Yeah, I wondered that too. It's gotta be a typo.
Unsubstantiated alarmist crap
And by the way, working through 50 trillion in derivatives because of excessive leverage sounds looney-tune to me. If I had heard that when I was teaching international finance I wouldn't have waited for a break to reach for the aspirin. Try thinking in terms of notional values.
It seems to me that one conclusion is reasonably clear: the human species has not yet discovered how to create a culture and a socioeconomic infrastructure that is productive, humane and stable. So, in the present difficulties (largely created by believers in minimally regulated capitalism) we are offered the choice of massive debt, followed by inflation or default or else, at the very best, to recreate an economic collapse and human misery to rival the great depression.
Naturally, it is not time to completely replace a leaky roof in rainy weather if a patch or a tarp will suffice. However, when times are relatively good, the voices of privilege and complacency are loudest and dissidents are treated like lepers.
The fundamental flaw in our thinking, besides the normal human quota of greed, fear, and intellectual bombast, is the massive allegiance to restrictive ideologies. Sooner, rather than later, people will have to start thinking outside of their ideological boxes. Sometimes, this is referred to as "pragmatism" but it needs to be big picture pragmatism not clever patches.
Need I add that the economy would be better regulated by a well designed computer program than by the Congress of the United States? There are only a few salient parameters in question: money supply, interest rates, government spending, and tax rates. Remove these from the arena of political bullcrap and watch our garden grow. Why? Well, a few things can be discerned.
Our political class will have less opportunity to extort money from the corporate class.
The corporate class will be less motivated to buy favors from the political class.
Mathematical methods are much more reliable than bullcrap when regulating a complex quantitative system. That is why airplanes can fly but our economy frequently crashes.
The government needs to focus on jobs. You don't create jobs by throwing money at random people. The government does not have to directly create the millions of jobs lost, instead it needs to create demand for goods that might directly employ a smidgen of people, but will indirectly keep the supply chains and their much larger employee base in business. i.e. just STEM the rate at which jobs are being lost. That means infrastructure spending, both direct and indirect via state and local government. There are several hundred billion in such projects shovel-ready right now.
I hate the current stimulus package. It is short-sided and stupid. If I had any say in the matter I would spend half the money on infrastructure (mostly by doling it out to the states and earmarking it from infrastructure only... let the states pay administrative costs), and instead of giving people tax breaks I would give people the option of deferring half their 2008-2010 taxes to 2011-2016. The other half of the money in the bill would make up the deferred taxes and get paid back in the next 5 years.
So, for example, someone who lost their job in late 2008 or early 2009 and owes taxes for 2008 could pay less to the IRS and declare the remainder of the income in small chunks over the next few years. Anyone would be allowed to do this, but only people who actually wind up in a lower tax bracket (i.e. who actually lost their jobs or had to downgrade to half-time) would benefit from it. Small businesses would be allowed to do this too. It's nearly perfectly targets the people who need the help the most.
-Matt
Yes Virginia, we are bankrupt and this is a Modern Depression, however, we will recover much more quickly than anyone is anticipating and stay atop the globe, for now. Isn't it obvious that decoupling has not occurred, even though international trade is at its zenith? We remain the shining model of 21st century capitalism, somewhat different than the 20th century version.
Now that model will be amended and (hopefully only temporariy) the government will measure aggregate risk and compensation via a forced seat on the board of major employers. That is a consequence of allowing the market to be a bit too free.
Look around and see that capitalism is spreading to fill the void of chaos and Communism. That is the real dividend of the Cold War Ronald Reagan won. We have survived this visit to the abyss for precisely that reason.
We are committed to dillute our currency to reflate the overextension and a fallinig dollar should be axiomatic, right? Global support for our dollar confirms that we have indeed won and, despite the obvious dillution, we remain the model that the world aspires to.
That said, let us try laying out a case for the theme that USA is headed for some deep trouble in the next few years.
First, the USA will need financing of the order of 3 to 4 trillions in the next couple of years. That money has to come from borrowing since:
1) our Federal Govt. revenues will shrink due the boomer retirement,
2) long wait for those now unemployed to get jobs and pay taxes,
3) many corporations in general will have so much net operating loss that they won't have any meaningful tax burdens for several years
Fed Govt expenditure will increase multifold because:
1) those roughly 4 millions unemployed now and the million(s) more to be added to the unemployed rolls over the next year will be collecting unemployment for the maximum time allowed,
2) Our interest service cost will increase rapidly due to the current 10 Trillion debt on the book and its rollover most likely at higher interest rates
3) New interest service cost to be added by the 3-4 trillions to fund all the losses and stimulii programs
3) New debt service cost to be added by financing our continued trade deficit though may not be at the heady levels of 65 plus billions a month of the past few years, will never the less be deficit only, pehaps at 30-40 billion a month clip because we don't manufacture many of the things we need for our daily lives
4) Our deficit financing needs will also rise by the expected continually increasing boomer retirements to come and their medicare and medicaid costs and Social Security payments. Recall our SS trust is filled only with IOUs from the Fed Gov that is to be repaid with Tax revenues
Need I go on, I am we all get the picture! Just put the numbers for these things. Then it is easy to see why the USA as we know it cannot ever exist in the future. Our children and and grand children deserve better, but I am not sure anything can done now in this regard. Shame on our generation of prolific consumers who did not know when enough is enough.
The only way economic growth can help is if some miracle hormone is injected into our economy that can produce goods and services the rest of the world needs and can afford. I think this can only happen in our dreams. While I continue to remain optimistic that if not us, the next generation will right this sinking ship, I cannot hide my skepticism.
On Feb 07 08:47 PM Delojozafado wrote:
> Well I don't know if this guy is a Kook. I know the price of silver
> has increased by 27% since Christmas. I know that my second largest
> equity holding is in Loonies, 2500 of GLHIF. I know my hedges in
> AGQ, DGP and TBT have been holding up my bond funds and bonds nicely.
> I know that my recently acquired positions in MLP CEFs (seekingalpha.com/symbo...
> other nat resource plays (BCF & BGR) are kicking butt. I went
> long 400 shares of ADM_PRA last week after ADM reported. This 9.2%
> yielder is up sharply by the weeks end. Any energy or nat resource
> dividend yielding theme going for ward will work. No matter how
> low the market or the US dollar go their "Stuff" will be worth something.
> ADM warned so their stock and convert tanked. These opportunities
> will continue to assert themselves in FCX-M. CHK-D, AES-C, HCN-G
> and even the non-convert REP-A. Anything not an insurance or financial
> should be working. With the exception perhaps of VTA. They are
> the buyers to the desperately leveraged and faced with forced margin
> calls. They are not very generous. Sort of like Louis selling his
> $10,000 watch in "Trading Places". There junk really is another
> investor's trash. At least that is what the chart says!
The truth of the matter is that we need lending and it is not necessary to save the too big to fail banks.The Fed and Treasury have already begun cirucumventing them with their 'quantitative easing' policies that have racked up $8.5 trillion in security purchases (note I don't use the words 'asset purchases'). My statement is that the US is likely to end up with a $15 trillion dollar deficit-or debt-but the choice of deficit is best because constantly rolling the debt, will have the burden on-going deficit spending as the debt must be serviced. My major point though is that policy makers must look a little futher down the road and think strategically instead of tactically--just fixing the problem of day. That would lead them to seeing that denial and tactical spending is aimless and will ultimately indenture the US beyond its capacity. SB argues instead for Growth, agreeing that foreclosure is not the answer. With policies consistently focused on tactical needs, policy makers have ingored the demand side of the equation exacerbating the problem causing job losses. Now handing out tax cuts, money to cities and spending on infrastructure, instead of empowering growth via small businesses that create jobs, is another example of a policy designed to keep what you had and it is a policy that will do more to run up deficits and debt than one to solve the problem.
US GDP was indeed goosed and balooned by the use of securitization iand leverage. The math of losses applies. The paradyme of chucking original research and credit analysis for statistical modeling is dead because most everyone outside the US will not soon be fooled again.
US GDP will slow massively then, because we will not be able to package and sell crap securities and leverage in any case will be curtailed. The risk of denial is the risk that others act and the US experiences a lost decade. Japan finally emerged from their ruins by exporting their electronics and auto expertise. Unfortunately the US has long ago sold its crown jewel exports. Now SB uses the word 'Growth' to convey new technologies and invention. SB argues that it is only by Growth and far-sighted policies empowering businesses that we can pay the enormous tab--a tab conservatively estimated to sum to $15 trillion. No Way. My friend, go through the arithmatic. We officially acknowledged the Recession at $10 trillion. The Government has nationalized Fannie Mae and Freddie Mac, bailed out the 'too big to fail' banks and AIG while keeping quiet on Ginnie Mae. The $12 trillion in mortgages held in these government entities have inflated principal values by and large and represent sub-prime and moderate income loans. The Fed has bought or holds as collateral, $8.5 trillion in securities, some percentage of which are not worth their principal value and no one but the government will buy them without a discount in their price. The Obama administration is fast at work getting a $820 billion stimulus program launched and has forecast that the US will run double or back to back (oct 2008-Oct-2010) trillion dollar deficits. Since the Treasury is outsourcing management (disposal) of the securities it is purchasing via TARP and TALF for a fee and these are held at real, inflated values, since China, Russia, the UK, etc. are demanding being made whole on the fraudulent securities they bought, since it is not unreasonable to estimate that the Treasury will ultimately lose 15-20 percent in the final accounting (if we get one) when housing prices will average that or more, then settling out at the 7/15 GDP/Deficit ratio is not KOOK forecasting. Moreover, it will be the rate of change in recovery and the years to get back even that will punish the US. And that is why I reaffirm that 'Growth' is the only answer.