|Obama's permanent depression
President Barack Obama may be remembered for permanent depression, the way that
Leon Trotsky's name is linked with permanent revolution. Fiscal stimulus
combined with near-zero interest rates have proven to be a toxic cocktail for
the United States, the macroeconomic equivalent of barbiturates and alcohol.
Keynesian spending creates a deficit that sucks all the available capital out
of the grassroots economy and transfers it to the Treasury market. Easy funding
terms from the Federal Reserve allow financial institutions to make money in
government bonds while shutting off credit to the rest of the economy. It's
classic crowding out, in which the government's misguided effort to spend its
way out of recession pushes the productive economy deeper into the hole.
Panic is starting to take hold at the Obama White House over the
relentless deterioration of the job market. US jobs in September declined by
about 263,000 jobs, worse than the 175,000 drop expected by Wall Street
economists. To the 15.1 million on the official unemployment count, add 9.2
million "involuntary part-time workers" and 2.2 million who were dropped from
the tally because they had not sought work in the past month, and the
unemployment rate would rise to 17.1 million.
That doesn't include another three million long-term discouraged workers -
those who want to work but who have long since stopped looking. That would take
the number up to 20%. In past recoveries, a number of economists observed, all
the job growth came from small business, but small business is lagging in the
present crisis. The financial crisis crushed the entrepreneurs, as surely as
Joseph Stalin crushed the kulaks, the relatively affluent peasants.
Obama inherited a crisis, to be sure, but he has made it much worse. America is
in the kind of trap into which Japan fell during the "lost decade" of the
1990s, whence it never really emerged. In the Keynesian world of Larry Summers,
director of the White House's National Economic Council, and the Obama
economics team, the problem is that Americans save too much and spend too
little. To restart the economy, the government has to spend money for them -
hence the US$800 billion stimulus package.
There are two things terribly wrong with this notion. The first is that it is
simply a matter of what John Maynard Keynes called the "marginal propensity to
consume". Americans have saved almost nothing during the past 10 years, relying
instead on home equity that now has vaporized. The proportion of Americans over
60 will jump to 25% from 19% during the next 10 years, an unprecedented shift.
Americans must save to compensate for past profligacy, from a lower starting
point after the destruction of so much wealth, and with lower prospective
returns. The demand for savings is bottomless.
The second problem is that even if the government borrows money, the money has
to come from somewhere. Right now it's coming from households who choose to
save rather than borrow, and from the balance sheet of the Federal Reserve or
the banks, as well as foreign investors.
A quick walk through the numbers puts the problem in context.
Lenders to the US federal government, first half 2009.
|All Federal borrowing
(annualized, in $US billions)
|Rest of the world
|Fed balance sheet
Obama's government borrowed $1.7 trillion at an annual rate, or about 12% of
gross domestic product (GDP). Households coughed up less than half of that as
they shifted from spending to savings. Foreigners bought $545 billion, a bit
less than a third of the total. The Federal Reserve and the banks bought $400
billion worth, or about a quarter of the total.
Household purchases of Treasuries kept spending low and the economy
contracting. Even with this massive shift, though, the central bank still had
to print money. Most alarming is that the Federal Reserve's rate of purchase of
Treasuries is accelerating:
Federal Reserve monetization of government debt, 2009
|Fed purchases of treasuries
(annualized, in $US billions)
|Third quarter est
The rest of the world doesn't want an additional half-trillion dollars worth of
Treasury securities each year; it doesn't want the Treasuries it now has to
own. Households can't continue to put a trillion dollars worth of Treasuries
away per year - that's 8% of all personal income.
That leaves the Fed and the banking system. The central bank bought Treasuries
during the third quarter at an annual rate of nearly $700 billion, and provided
nearly zero-interest money to banks and broker-dealers, who bought a good deal
more. The Fed is buying much more than Treasury securities, to be sure; during
2009, it bought a remarkable $700 billion of mortgage-backed securities in a
fruitless attempt to stimulate the housing market.
Federal Reserve total securities holdings
Despite the unprecedented largesse of the Federal Reserve, banks are reducing
risk and cutting off the small-business sector in particular. During the third
quarter, US commercial banks added Treasury securities to their balance sheets
at a $350 billion annual rate. But they cut loans to business at a $300 billion
annual rate. Extremely cheap funding makes it possible for a bank to finance
the purchase of a two-year Treasury note paying 0.86%, or a two-year AAA
municipal note yielding 0.75%, with overnight money costing 0.25%. Cheap money
turns the commercial banks into an extension of the balance sheet of the
The near-zero interest rate allows banks to shift their balance sheets towards
nearly riskless assets, and reduce risky commercial and industrial loans.
US commercial banks' holdings of Treasury securities
vs commercial and industrial loans, past 12 months
Cheap money has crushed the dollar, and the sinking dollar has buoyed equity
prices, perversely enough.
Trade-weighted US dollar vs S&P 500 Equity
Index, 2009 to date
American assets are cheaper to foreign investors, and as the dollar fell
against other major currencies, foreign investors bought more American stocks:
In short, the rise in US stock prices has less to do with economic recovery
than with the drop in the global price of American assets. The dollar can only
fall so far, however, because other currencies can only rise so far before a
rising currency parity damages competitiveness. This game seems to be played
out for the moment.
This outcome was perfectly foreseeable a year ago; in fact, I forecast just
this result last November (see
Who will finance America's deficit?, Asia Times Online, November 13,
2008). I reviewed the difficulties attendant on financing America's deficit and
Monetization of debt remains a possibility, and to some
extent would only continue the current trend. Total Federal Reserve Bank credit
outstanding has more than doubled in the year to November 6, 2008, rising by
$1.2 trillion to $2.06 trillion. This reflects loans, securities purchases, and
related actions by the Fed to bail out the financial system. If the deflation
persists, the Federal Reserve may be compelled to purchase US government debt
The parallels between America in 2009 and Japan
in 1989 are uncanny. An asset price bubble has collapsed, just before a tsunami
of prospective retirements that the asset bubble was supposed to fund. Demand
for savings is bottomless, and the government satisfies demands for savings by
running a huge deficit and issuing debt. The crippled banking system borrows at
an interest rate of zero and buys government securities. And the economy
shrivels up and dies.
The point of lowering the risk-free rate is to push investors towards riskier
assets. In a normal business cycle, falling output leads to lower yields on
low-risk bonds, which in turn encourages investors to add risk to their
portfolios by investing in businesses. If the safest of all investments, namely
US Treasuries, suddenly offer much higher real yields, comparable to the boom
years of the late 1990s, why should investors take risk? ... If the Treasury
tries to spend its way out of recession, the results are likely to be very
Japan, though, had one advantage: it knew how to export. There is only one way
to drastically increase savings while maintaining full employment, and that is
to export. America has neither the export capacity nor the customers. It could
get them, but that is a different story. Francesco Sisci and I told it here
US's road to recovery runs through Beijing (Asia Times Online, November
Spengler is channeled by David P Goldman, Associate Editor of First
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