commissioner.org
| Source | ListMeister |
| Date | 04/01/08/01:38 |
| Tuesday, January 06, 2004
Thinking about the next slowdown http://itstheeconomy.blogspot.com/ There I go again, thinking ahead. We survived 2003 thanks to the continuation and expansion of the greatest credit bubble in history. By the end of 2003, the ratio of debt to GDP should be 3.1 to 1. In 1982, it was 1.7 to 1. In 1990, it was 2.3 to 1. In the last four quarters, we've added $5 of debt for every $1 of GDP. The new Z-1 tables will be out on January 8th, and I don't anticipate they will be good news. Japan, China and the rest of East Asia are lending us about $1 trillion a year just to keep our currency from depreciating too quickly. Private investors bailed out last year, so the central banks had to step in. It hasn't helped much. The Euro is up to a record high of $1.27 today. The Yen is up to 106 to the dollar. If China were to revalue the Yuan, we would see a very quick uptick in inflation. We're already seeing a jump in raw materials prices because the Chinese are starting to buy them instead of our debt securities. Either we get inflation, companies sacrifice profits, or we borrow even more, inflating our debt instead of our CPI. And at some point, there will be limits to how much we can borrow. The ratio of debt to income will eventually backtrack to more sustainable levels, someday. Foreign central banks are clearly nervous, and there are scattered voices among economic commentators that maybe, this time, the dollar reserve monetary system may be ending once and for all. China is considering repegging the Yuan to a basket of currencies, for one. If there is such an adjustment, there are two ways that debt to income levels can return to normal. The first is a debt-deflation that reduces debt levels through default. This will also crush asset prices. We should hope we don't go that way. A more likely candidate is a resurgence of inflation, which boosts nominal GDP relative to debt levels. The Federal Reserve is certainly hoping for the latter outcome. The only difficulty is that if official inflation picks up, then there will be upward pressure on interest rates as well. In an economy living and dying by monthly payments and refinancing, and growing numbers of people converting to adjustable-rate mortgages, a rising interest rate environment contains its own corrective mechanism. If we can no longer reduce monthly payments (or if they increase), we can no longer spend and the economy slows down again. And we used a big chunk of the leeway we had just to get through the year. Thanks to the tax cut, the federal budget deficit is expected to be around $500 billion or almost 5% of GDP. The Federal Funds rate remains at a 50-year low at 1%. Thanks to the largesse of our foreign creditors and money market funds yielding nothing, we were able to fund any bond issue that dollar borrowers needed to float, particularly if it was corporate and high yielding, and yield spreads fell to levels not seen since the bubble years. Everything went right, and there is little room for improvement. If the economy were to slow down, there simply aren't a lot of resources left. During periods of economic growth, we should see a gradual reduction in borrowing, particularly by the government. We should see a resurgence of employment - 300,000 jobs a month, not 100,000. We should see the Fed boosting interest rates, not keeping them at obnoxiously low levels. That we are not seeing this taking place belies the daily blathering of a strong, recovering economy. Things are not right at all. Current policy is contradicting decades of economic thinking. NAIRU and Taylor's rule are out the window. Doesn't that seem odd? So what happens as the economy gradually slows down? Economists certainly don't believe we can keep 8% up forever. Paul Kasriel is predicting a 3.7% growth rate for the fourth quarter. After that, what if we don't get 4% GDP growth as far as the eye can see? Will employers want to hire? Will the government be able to engineer another tax cut? Will the Fed lower interest rates, and will anyone care? Will states be able to stay solvent? Will housing prices go up another 10%? Will the falling dollar finally increase CPI inflation, or will we just be able to inflate our asset prices and debt levels for another year? Things certainly look shaky at present. We've been seeing one good piece of economic news followed by one bad piece. Again, not the stuff that sustainable recoveries are made of. I think the most likely scenario is that a slowdown in the U.S. will impact other nations first. South Korea has a significant consumer credit bubble. Mexico would be immediately impacted by a decline in U.S. imports. Japan and Europe are already tottering on the edge of recession. At that point, they will have to decide whether to keep financing our borrowing binge or start redlining us. The next six months are going to be key to whether Bush gets re-elected. If things start to slow down abruptly, he is going to be toast. posted by Teddy |
Copyright (c) 1998, Joongpil Cho