Total global credit rose from $80 trillion in 2000 to $210 trillion today

Unemployment and deleveraging
The great debate

Oct 28th 2011, 13:34 by Buttonwood ECONOMIST

JUST off the plane from the Buttonwood conference in New York and, as always, it was great to have the chance to hear so many important thinkers speak on a wide variety of issues.

The speech that stuck in my mind was a passionate defence of the US jobs act from Gene Sperling, director of the National Economic Council in the Obama administration. Maybe the reason it caught my attention was that all the passion in this debate tends to come from the deficit-cutting side, but Mr Sperling made a very convincing case that long-term unemployment is a huge crisis.

The current mean period for workers to be unemployed is 40.5 weeks; in the early 1980s recession, it was 21. The longer a worker is unemployed, the harder it is for he or she to get a job; some companies even state that the unemployed need not apply for jobs. This can be terrible news for those at both ends of the age spectrum. Those in their 20s can find that a long spell of unemployment leaves a permanent dent in their lifetime income; those over 55 may find it impossible ever to get work again.

That, argues Mr Sperling, is why some kind of stimulus is needed. Doing nothing is not an option. To those who say that the 2009 stimulus plan failed, he had a convincing rebuttal; when President Obama was elected in November 2008, forecasters were projecting a decline in GDP over two quarters of 1.6%. The actual decline was 7.8%; the economy was in freefall. That output was growing again by late 2009 surely owed something to fiscal stimulus (although monetary policy must have had an impact too).

But what about tackling the deficit? Here Mr Sperling had a key fact which demonstrated why reduction cannot be achieved by spending alone. In 2000, 45 million people were getting social security; by 2020, that figure will be 70 million. Medicare has a similar uplift. Given that background, it is implausible to state that spending can be locked in at 2000 levels; one cannot repeal ageing, as Mr Sperling said. Even if adjustments are made to those programmes (increasing the retirement age, controlling drugs costs), politicians can, at best, slow the rate of spending increase. Taxes will have to be raised.

Typically, however, the other striking speech came from Kyle Bass, the investor, which illustrated the other side of the problem. He pointed out that total global credit rose from $80 trillion in 2000 to $210 trillion today. In many nations, debt is three to four times GDP. These figures have normally been seen only in the course of major wars (i.e 1914-1918 and 1939-1945) when the result was a complete wipeout for creditors of the losing states.

Dealing with this debt is a kind of deadweight on the economy. Yes, every debt is also someone else's asset. But the burden of repaying debt will affect the decisions of consumers, companies and governments while uncertainty over whether they will get repaid will weigh on investors. The euro crisis (which hadn't been solved by this week's deal) illustrates the point.

So that's the key issue. How to deal with an age of deleveraging without blighting the lives of millions of people though long-term unemployment. I am not sure that the conference provided the answer but it did make me think that one should not be too ideological about the issue; to recognise, for example, that America might have more flexibility to deal with the problem (because of its reserve currency status) than Britain or Greece.

US interest rates at zero are 7% too high!

The Fed's impending blunder

By Ambrose Evans-Pritchard Economics Last updated: October 27th, 2010
http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100008351/the-feds-impending-blunder/

OK, I’ve calmed down after a week of Jamon Iberico and Rioja in Granada’s Albaycin, so I will try to be polite about the US Federal Reserve. Try, that is, not necessarily succeed.

For a good insight into the thinking of the New Keynesian priesthood that rules our money and our lives, it is worth reading “QE2: How Much is Needed?” by Jan Hatzius from Goldman Sachs.

His argument – crudely – is that US interest rates at zero are 7pc too high given the Taylor Rule on output gaps, et cetera (not that Professor Taylor himself happens to agree, but let us not quibble).

Since rates cannot be minus 7pc, the Fed would need to launch a $4 trillion blitz of fresh bond purchases to fully compensate, such is the mess that America’s leadership has inflicted on the Great Republic. I have over-simplified: Goldman Sachs relies on a “policy gap” concept, which factors in fiscal tightening et al.

This would push the Fed balance sheet to $6.3 trillion, above the $5 trillion pencilled in as the upper limit during the Great Crash.

Mr Hatzius is not saying the Fed will do this, or should do this. His forecast is that the Fed will start off with baby steps of $500bn spread over six months or so, rising over time to meet the bank’s “dual mandate of low inflation and sustainable employment”.

(Actually the Fed’s mandate is “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Stable prices are not the same as low inflation. It takes Ben Bernanke’s maniacal obsession with the doctrine of inflation targeting to twist this into a mandate for printing large sums of money at a time when the Dallas Fed’s `trimmed mean’ measure of annual inflation has jumped from 0.5pc in May, to 0.8pc in July, and 1.5pc in August. But again, let us not quibble).

Mr Hatzius said the Fed sees “tail-risks” in using QE to the full, but may nevertheless do another $2 trillion in the end.

I have no doubt that this report reflects thinking at the Fed Board in Washington, and among Bernanke allies at the San Francisco Fed and Boston Fed – though not of course at the Dallas Fed where Richard Fisher confesses: “In my darkest moments I have begun to wonder if the monetary accommodation we have already engineered might even be working in the wrong places.”

What we have is a glimpse into the Sanctum Sanctorum of money creation, a glimpse of Jesuitical fanaticism.

Now, I put my hand up and confess to having supported QE when the financial system was imploding in late 2008 and early 2009, and I continued to do so as the M3 money supply collapsed at 1930s rates earlier this year. I persist stubbornly in thinking that it was the right thing to do, AT THAT TIME.

But we are no longer in a systemic financial crisis, and the Fed’s motives have become subtly corrupted. Having argued during the boom that it was not the business of central banks to stop asset bubbles – and specifically that any fall-out could “safely” be cleaned up later – Bernanke now seems to determined to validate this absurd doctrine, bending all the sinews of the US economic and financial system to this end. One error leads to the next.

In a sense QE has worked all too well. M3 has stabilized. The M2 gauge used by the Fed – which was still contracting in May – has been growing annual rate of 8.4pc over the four weeks to mid-October. The pace has been accelerating for months.

OK, 8.4pc is not Weimar, but it is not imminent deflation either.

And what about velocity, the other part of the monetary cocktail? It is coming back from the dead as you can see below?

Simon Ward from Henderson Global Investors said his measure of velocity is rising at a robust rate of 8.7pc. “QE1 was justified during the crisis because monetary velocity was collapsing at that time. But now that velocity is recovering further QE is not needed. In fact it is potentially very dangerous,” he said.

Exactly.

This is the theme of Chapter 17 entitled “Velocity” in Jens O’ Parsson’s book Dying of Money, the cult text of our brave new world.

If I may recycle a passage from a column I wrote about the book in July: “Each big inflation – whether the early 1920s in Germany, or the Korean and Vietnam wars in the US – starts with a passive expansion of the quantity money. This sits inert for a surprisingly long time. The effect is much like lighter fuel on a camp fire before the match is struck.

People’s willingness to hold money can change suddenly for a “psychological and spontaneous reason” , causing a spike in the velocity of money. It can occur at lightning speed, over a few weeks. The shift invariably catches economists by surprise. They wait too long to drain the excess money.”

“Velocity took an almost right-angle turn upward in the summer of 1922,” said Mr O Parsson. Reichsbank officials were baffled. They could not fathom why the German people had started to behave differently almost two years after the bank had already boosted the money supply. He contends that public patience snapped abruptly once people lost trust and began to “smell a government rat”.

Hmm!

No doubt the Bernanke Fed views monetarism with contempt, despite paying lip service to Milton Friedman. This is a grave error. Surging M3 gave forewarning of the credit bubble from 2005-2007, and then rang alarm bells before the banking crash in late 2008. Ignore money and velocity at your peril.

The immediate effect of the Fed’s QE2 rhetoric has been to drive up commodity prices, negating much of the benefit. “How this possibly helps out the moribund US economy is anyone’s guess,” said David Rosenberg from Gluskin Sheff.

“If there is an `imbalance’, it is in the US pretending it can solve structural headwinds, overextended balance sheets, chronic unemployment and a massive housing inventory backlog with untested Fed policy tools,” he said.

Nor is it clear that Bernanke’s aim of driving down interest rates serves any useful purpose at this stage. As GMO’s Jeremy Grantham argues, this policy is reducing pensioners to penury. “Lower rates always transfer wealth from retirees (debt owners) to corporations (debt for expansion, theoretically) and the financial industry. This time, there are more retirees and the pain is greater, and corporations are notably avoiding capital spending and, therefore, the benefits are reduced. It is likely that there is no net benefit to artificially low rates.”

If you crunch everything in the mixer you can perhaps claim that QE2 will be a net plus of sorts. But is it really wise policy to embark on such a contentious adventure at a time of deep misgivings among the public and in Congress, and in the face of blistering criticism from China, Germany, Russia, as well as a lot of Western economists?

I hate to cite Alan Greenspan but he is right this time to warn that the Fed is playing a “dangerous game”, whatever the claims of New Keynesian economic theory. Politics matter.

Yes, the Fed is right to worry that protracted deflation would be lethal in an economy with total debt at 350pc of GDP. Those who call for a liquidationist policy of mass bankruptcy and default are an even greater danger to political stability than the Bernanke Fed. That policy was enacted from 1930-1932, with observable results.
But I suspect that something else is happening at the Fed. Bernanke is refusing to accept that the US must go through the slow painful cure of debt-deleveraging. He is trying to air-brush away the consequences of 20 years of debt creation and Fed error.

The proper role for the Fed from now on is to steer a narrow course between the Scylla of deflation and the Charybdis of inflation, for year after, for as long as it takes, until America is properly purged. AND THEN NEVER COMMIT SAME IDIOTIC MISTAKE AGAIN.

US foreign indebtedness increased 62% in 2008

Back to the future?

As bad as that sounds, and it is, the situation is far worse for our significant others:

15. United States - 95.09%
External debt (as % of GDP): 95.09%
External debt per capita: $44,358

Gross external debt: $13.627 trillion (2008 Q3)
2008 GDP: $14.330 trillion

14. Norway - 114%
External debt (as % of GDP): 114%
External debt per capita: $118,353

Gross external debt: $551.59 billion
2008 GDP: $481.1 billion

13. Finland - 116%
External debt (as % of GDP): 116%
External debt per capita: $62,579

Gross external debt: $328.56 billion (Q4 2008)
2008 GDP: $281.2 billion

12. Sweden - 129%
External debt (as % of GDP): 129%
External debt per capita: $73,245

Gross external debt: $663.58 billion (Q4 2008)*
2008 GDP: $512.9 billion

T-10. Spain - 137.5%
External debt (as % of GDP): 137.5%
External debt per capita: $57,091

Gross external debt: $2.313 trillion (Q4 2008)
2008 GDP: $1.683 trillion

T-10. Germany - 137.5%
External debt (as % of GDP): 137.5%
External debt per capita: $63,767

Gross external debt: $5.25 trillion (Q4 2008)
2008 GDP: $3.818 trillion

9. Denmark - 159%
External debt (as % of GDP): 159%
External debt per capita: $107,026

Gross external debt: $588.7 billion (Q3 2008)
2008 GDP: $369.6 billion

8. France - 168%
External debt (as % of GDP): 168%
External debt per capita: $78,070

Gross external debt: $5.001 trillion
2008 GDP: $2.978 trillion

7. Austria - 191%
External debt (as % of GDP): 191%
External debt per capita: $100,787

Gross external debt: $827.49 billion (Q4 2008)
2008 GDP: $432.4 billion

6. Switzerland - 264%
External debt (as % of GDP): 264%
External debt per capita: $171,478

Gross external debt: $1.304 trillion (Q4 2008)
2008 GDP: $492.6 billion

5. Netherlands - 268%
External debt (as % of GDP): 268%
External debt per capita: $145,959

Gross external debt: $2.439 trillion (Q4 2008)
2008 GDP: $909.5 billion

4. Hong Kong - 295%
External debt (as % of GDP): 295%
External debt per capita: $93,539

Gross external debt: $659.93 billion (Q4 2008)
2008 GDP: $223.8 billion

3. Belgium - 327%
External Debt (as % of GDP): 327%
External debt per capita: $155,362

Gross External Debt: $1.618 trillion (Q4 2008)
2008 GDP: $495.4 billion

2. United Kingdom - 336%
External debt (as % of GDP): 336%
External debt per capita: $153,616

Gross external debt: $9.388 trillion (Q4 2008)
2008 GDP: $2.787 trillion

1. Ireland - 811%
External debt (as % of GDP): 811%
External debt per capita: $549,819

Gross external debt: $2.311 trillion (Q4 2008)
2008 GDP: $285 billion

Source CNBC

U.S.'s debtor status worsens dramatically

Foreigners hold 50 percent

By David M. Dickson Washington Times | Saturday, June 27, 2009

In the midst of the longest, and probably deepest, postwar recession last year, the U.S. investment position with the rest of the world sharply deteriorated.

At the end of 2008, America's net international investment position was minus $3.47 trillion, the Commerce Department reported Friday. That represents the difference between the value of U.S. assets owned by foreigners ($23.36 trillion) and the value of foreign assets owned by Americans ($19.89 trillion).

At the end of 2007, the U.S. net international investment position was minus $2.14 trillion. Thus, America's net indebtedness with the rest of the world increased by $1.33 trillion, or 62 percent, during 2008. It was by far the biggest annual increase in data that go back to 1976.

Foreigners now hold nearly 50 percent of the federal government's publicly held debt. If foreign investors significantly reduce their purchase of future U.S. Treasury debt securities, without even dumping their current holdings, U.S. interest rates could soar and the dollar could collapse, analysts fear.

At minus $3.47 trillion, America's net debtor status with foreigners represents nearly 25 percent of U.S. gross domestic product, the highest level in history.

"Three decades of massive [trade] deficits have converted the United States from the world's banker - able to 'pay any price and bear any burden in the cause of freedom' - to the world's largest debtor, utterly dependent on China and other foreign interests," said Charles McMillion, chief economist of Washington-based MBG Information Services.

Essentially, America's net international investment position is driven by what the United States borrows from the rest of the world to finance its ongoing trade deficit, said Brad Setser, a fellow for geoeconomics at the Council on Foreign Relations.

Over the 2003-07 period, however, foreign equity markets outperformed the U.S. stock market, and the dollar steadily depreciated. These two factors reduced the annual deterioration in America's investment position that otherwise would have been dictated by massive U.S. trade deficits during this period.

"Both of those factors reversed themselves last year," Mr. Setser said. The dollar appreciated, and foreign stock markets suffered bigger declines than America's. As a result, America's net debtor status worsened significantly more during 2008 than its nearly $700 billion trade deficit would have dictated, Mr. Setser explained.

Over the years, America's status as a creditor or debtor has changed enormously. In the early 1980s, America's net international investment position averaged $350 billion, or 11 percent of GDP, making the United States the world's largest creditor. Today, it is the world's largest debtor - by far.

As recently as 1996, America's net debtor status was minus $456 billion. Since 1996, it has increased by more than $3 trillion, or 660 percent, as America's 12-year cumulative trade deficit soared by $5.7 trillion.

Foreign governments have taken notice - in particular, China, which now holds more U.S. Treasury debt than any other country. In the 12 months through April, China's portfolio of Treasury debt securities has soared by more than a quarter of a trillion dollars to nearly $800 billion.

In its annual financial stability report issued on Friday, China's central bank once again declared there were serious problems with the global monetary system's reliance on a single dominant currency - the dollar. An estimated 65 percent to 70 percent of China's $2 trillion in foreign exchange reserves, the world's largest stockpile, is held in dollar-denominated assets.

The People's Bank of China also warned the United States on Friday about its very expansionary monetary and fiscal policies.

"We are so deeply in debt and this money is so liquid that it hamstrings our monetary, fiscal and trade policies," Mr. McMillion said. "We've really mortgaged our financial future."