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How does the greatest bull run of all times end?

by Jerome a Paris Thu Jun 11th, 2009 at 07:56:40 AM EST

Contrary to what the general public thinks, the most remarkable bull market in our times has not been that of that stocks, or even of real estate, but rather that of bonds. The chart below (via Yahoo) shows yields on 10-year Treasuries, the most traditional, safest long term bond. Yields are the net interest you'd get from buying such a bond on the secondary market today and holding it: they go down when bond prices go up:

Bonds price have been going up for more than 25 years, with a remarkable spike in recent months, which is now being retraced. The increase in yields from record lows of 2.07% in December to a recent high 3.99% in the most recent auction is much commented and seen either as (along with the recent increase in oil prices) a sign that financial markets are getting worried about inflation and the massive increase in public debt, or as a welcome return to normality as panic buying of government bonds recedes and money starts flowing again to other productive uses.

The debate is not only amongst academics or on ET itself, but has taken a political angle with Merkel speaking publicly about it recently.

As the graph above shows, we're still at a point where both interpretations (a jump in inflation worries, or a return to pre-panic levels) are justified, and only time will tell us whether interest rates continue to shoot up, ie markets do worry about inflation as too much government paper floods the system, or to stabilise, as government spending allows the economy not to crash too badly.

My position is simple: this bond bull market is a gigantic bubble, fed by the combination of stagnant incomes and ever rising levels of debt (and thus asset prices) to sustain otherwise-constrained consumption. The virtuous circle of low "inflation" (ie stable income costs) and increasing asset prices (not seen as inflation, for some reason) has created a systemic shift in the relative remuneration of labor and capital, and a massive transfer of wealth from the middle classes to the very rich. As long as house prices went up, that was fairly invisible and tolerable for the unsuspecting public, but ultimately, the financial markets pushed their logic too far and started to "create" wealth by depleting the economy rather than just distributing to its profit the fruits of everybody's work. In other words, they captured so much that it did not leave enough to the rest of the system to be sustained, which required capturing an ever bigger share of a now shrinking pie - to the inevitable endgame of a crash.

Or: you cannot live above your means forever. The economy is going to have to come back to its real value creation level, and is likely to look worse for a long while as it needs to pay down the accumulated debt. This will happen either by way of deflation and a long recession, or by way of inflation and a long recession. This is a fight between various finance players who are invested in inflation-protected assets or not and, ultimately, it matters little to the rest of us: all we'll see is the recession and sharply falling spending.

The problem was consumption funded by debt; the solution is not on the demand side, but on the income side. Thus, governments' plans to increase spending are useless per se, unless that spending goes (i) to increasing incomes (social spending, redistribution) and (ii) to investment in collectively useful infrastructure that makes it possible for more value to be created and distributed.

So far, governments have spent lots of money to prop up banks, ie replacing a private asset bubble by a public debt bubble. It will burst, by default or inflation. The only way out is for governments to spend their way out of the recession smartly; the question is whether financial markets will allow that way out (by financing it at reasonable rates, ie betting that smart spending will allow to avoid default in the end) or whether it will be imposed on them in indirect (inflation) or direct (a take-over of finance by the State, which is always possible and unthinkable to day for ideological reasons and not for practical reasons) ways.

Unfortunately, the markets are unlikely to willingly accept to see their share of the pie reduced, so I expect inflation hawks to prevail and prevent socially useful spending by governments: we'll get higher interest rates AND no meaningful redistribution, until banks, even propped by trillions of public money, crash again (something I actually expect to happen fairly quickly).

I guess that makes me a "Doctor of Doom" - but I actually think that those economies where the households have not gone into a debt binge (ie most of continental Europe) will do a lot better, ultimately, even if everybody suffered from last autumn's financial "heart attack."

  • how can you have inflation when you have massive under-use of the economy's capacity?;

  • how can we reconcile a massive recession with increasing oil prices (if it is a pure inflation play, how sustainable is it? and if it is a sign of recovery of sorts, how does that chime in with the recessionary outlook?);

  • how can banks look healthy when the economy is crashing so badly? (that's an easy one: they're hiding the losses behind the massive liquidity provided to them by the Fed et al)? How long can that contradiction last? (that's the big question)

I can't help think that financial markets are acting against their own interest, by trying to prevent income increases, public spending on the public rather than on the banks - and yet they're supposed to be the smartest people around...

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Jun 11th, 2009 at 06:01:57 AM EST
1. Because inflation is based on abstract fears for the future defined by monetarist ideology - and really, it might as well be called Ideological Inflation.

What's likely to happen is deflation for most of the population (shrinking income, falling RPI) combined with inflation (rising interest rates and commodity prices) on the markets.

This is possible because the real and the financial economies are now frighteningly disconnected. The expectation of future inflation in the Common Wisdom is enough to create inflationary effects in the financial markets, even when the real economy is somewhere between wounded and in a death spiral.

Eventually the inflation will work down in the form of higher RPI and domestic interest rates, and then everyone will be screwed - again - because real spending will shrink even further.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Jun 11th, 2009 at 07:00:37 AM EST
[ Parent ]
Great Expectations | LabourList.org
A piece of research by Goldman Sachs which I came across in the Financial Times Alphaville "walled garden" today had much to say on the subject of consumers' fear of inflation and discussed whether or not this could itself drive inflation. One assumption was:

"Suppose every firm and consumer in the economy woke up one morning to expect 5% inflation"

and one conclusion was:

"A shift up in household inflation expectations could ignite a broad-based surge in inflation, but we see no sign that this is under way".

This reminded me of my long standing conviction - from my admittedly untutored perspective of Coarse Economics - that such inflationary expectations are yet another example of an assumption which is complete bollocks but which  conveniently justifies the otherwise unjustifiable.

Now one of the key reasons for the property bubble was the completely pervasive view that house prices can only ever go up. So it has demonstrably been the case  that the average punter has inflationary expectations in respect of land prices (since buildings depreciate).  By definition, inflationary expectations underpin all asset bubbles, which have with few, if any, exceptions been driven since John Law's Mississippi Bubble by excessive creation of credit by credit intermediaries aka banks.

But retail prices are another matter altogether.  The people who inhabit the real world outside neoclassical economics do not tend to think:

"Hmmm.....I expect that retail prices will rise by 5% in the next year, therefore I will ask for a 5% pay increase plus a bit."

They think

"Bloody hell, prices have gone up 5% and I need a pay rise to keep pace, plus a bit".

In other words, if prices do not rise much - or even fall, and of course deflation would be a wonderful thing if only our money did not consist of interest-bearing debt - then there would be little or no pressure for much more than modest wage increases. But we have drummed into us that employees/consumers do not think this way.  

The inflationary expectations of employees could lead to inflationary wage increases, and must therefore be beaten out of them at all costs.

But then on Planet Neoclassical there is never a good time for wages to increase. In a growing economy, wage increases may choke off growth; in a level economy, wage increases will prevent growth; and in a recession of course, wage increases are unthinkable, because they will make the recession worse.

Bollocks again. Capitalists like Henry Ford knew that if he paid his workers poorly then they could never afford his cars. That piece of economic common sense appears to have been forgotten.

I have never understood why it is that to increase wage costs is inflationary; whereas to increase interest rates   from 2% to 3% (which is a 50% increase in a financial cost) is not only not inflationary of retail prices but  is in fact, the Voodoo Economics cure for such inflation.

It gets worse, though.

If a manufacturer raises prices either because he has the "pricing power" to do so (through a monopoly or cartel) - or simply because he is able to maintain an arbitrary profit margin - then such price increases are by definition inflationary. Well, actually in the fantasy world of Neoclassical Economics such  maintenance or increase of the return to Capital is apparently not inflationary, although increasing the return to Labour is.

Strange, that.

In case you hadn't gathered, conventional Economics has nothing whatever to do with the real world we inhabit and everything to do with justifying an outcome convenient for the owners of financial capital.

As JK Galbraith memorably put it:

"Modern conservatives engage in one of man's oldest exercises in moral philosophy: the search for a superior moral justification for selfishness".

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Thu Jun 11th, 2009 at 10:04:59 AM EST
[ Parent ]
Glad to see you getting pieces like this into Labor List, Chris.  What signs, other than your being able to continue publishing such articles, are there that this is sinking into the minds of that audience?

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Jun 11th, 2009 at 12:47:56 PM EST
[ Parent ]
Well, I got asked to contribute to a dialogue with Duncan Weldon (reasonably well-known Left-leaning economist) which I did today


and we got along famously offline as well.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Thu Jun 11th, 2009 at 02:47:19 PM EST
[ Parent ]
Just read it.  Great!  How large is the readership of Labor List?

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Jun 11th, 2009 at 03:50:30 PM EST
[ Parent ]
"how can you have inflation when you have massive under-use of the economy's capacity?;"

Yes indeed. In financial assets there is a fixed supply, but in production and real economy? There the supply should increase. Unless it is stagflation.

by kjr63 on Thu Jun 11th, 2009 at 10:55:34 AM EST
[ Parent ]
  1. I don't know about Europe, but I submit that the US has lit its economy on FIRE (financial/insurance/real estate).  We've been steadily transferring our capacity into those areas for 30 years, to the detriment of all other sectors.  That capacity doesn't transfer well back to other sectors.  If you aren't building a residential subdivision, there isn't much to be done with that capacity.
  2. The same way we reconcile falling oil prices with rising prices at the pump: Acknowledge that oil is a game that's rigged in cartoonish fashion and ruled by fear.  There is less reason in the oil market than there is in gold.
  3. I think this is the key to the inflation vs. deflation debate: How do the central banks play the next hand?  Do they crank up the printing presses, or do they throw it in and let things contract?  The recent TARP repayments indicate the latter, but the real test will be how the Fed treats the players that flunked the stress test.  Bail or No Bail?
by rifek on Thu Jun 11th, 2009 at 01:45:17 PM EST
[ Parent ]
OK, my takes (also drives my personal trading):

  • real global inflation is impossible if we do not close the price loop at the wages "missing link". Which means, a labor shortage. Which is globally impossible with free trade doctrines and China in the game.

  • markets are irrationnal may fear of inflation for a long time although nobody sees it, or they may be undecided about the winners of the race to the bottom in currency thrashing.

Yield curve implications: ever more steepening, from 1% overnight to 6-10% 30Y.

Actually, the high long yield must also pay for the higher risk of default in nominal terms, since the cash flow of states will not inflate along their liabilities.

Banks will be all right as long as there is a gov policy of rolling all of their outstanding debt, or repo'ing all their assets. But they will have no other business than clearing of payments and deleveraging, no lending.

- Oil is going up because everybody (that is mainly, China, US) is building up the strategic reserves, OPEC took several mb/d out of the market, the rest of the world is depleting, and we have exhausted the pool of "easy" demand destruction. However, in 2008 dollars, oil cannot be higher than 100$/b except for brief spikes (Deffeyes computed the ratio of oil bill to world GDP, and that tells you the story). Yet, OPEC will try to get as much as they can because they need the cash flows to maintain domestic stability.

Price implications: I expect oil has entered a trading band of 60-120 in 2008 USD. I may briefly spike above, but no more (otherwise, painful demand destruction comes quickly). Oil-related inflation will abate soon.

The only thing I remain undecided about is the USD/EUR parity. I believe it is possible that the dollar tanks (and the oil trading band would apply in euros), yet the US still experience a domestic deflation (total destruction of their foreign trade, yet no demand for domestic substitutes of foreign products, very low velocity of money, etc...)


by Pierre on Fri Jun 12th, 2009 at 11:24:26 AM EST
[ Parent ]
Question 1:

You can't have inflation everywhere, but you can have inflation somewhere, if a currency breaks down.

However, contra RatEx theory, you can have a widepspread anticipation of broad based inflation in conditions where broad based inflation are impossible if the anticipations are based on a simplistic model of inflation that is counter to available evidence, such as a Monetarism based on a minority subset of money, and that model predicts a broad based rather than currency specific inflation.

Question 2:

Oil overshot low, and much of the price increase is the recovery to a more sustainable long term supply price for current demand conditions. Some of the price increase may be actual hedge/speculative purchase, if (AFAIU) inventories are up. The prospective downside risk is modest, maybe 10% or 20%, and the prospective upside gain is massive, for either the oil price shock scenario or the currency break down scenario.

Question 3:

By lying. Abandoning mark to market is responsible for a healthy slice of reported bank profits. The question is, of course, whether there will be a strong enough recovery to turn a substantial portion of those present lies into future truths. I am dubious that there will be without policy changes.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Jun 12th, 2009 at 06:19:47 PM EST
[ Parent ]
I am not sure that I understand your first bullet. Could I persuade you to spell it out?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Jun 13th, 2009 at 08:52:04 AM EST
[ Parent ]
As long as enough participants in financial markets believe that "massive increase" in the "monetary base" translates mechanically into a greater money supply ... (despite the obvious fact that it in fact an increase in the monetary base in the face of what would otherwise be a shrinking money supply) ... then there will be substantial expectation of inflation.

Irrespective of whether inflation is feasible in the real world, financial markets are not time-telescopes. They do not read from the future, but only from present anticipations of the future. So if a flawed model is prevalent, it will show up as inflationary expectations.

IOW, when there's smoke, there's fire ... but sometimes its not smoke, its just a dust cloud.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Sun Jun 14th, 2009 at 11:04:53 AM EST
[ Parent ]
by Jerome a Paris (etg@eurotrib.com) on Thu Jun 11th, 2009 at 06:49:42 AM EST
Ah, you would post as I was already on my bike to get to work, on a day with a four hour morning class and a four hour night class. By the time I saw this today, it was already past the dKos time clock deadline.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Fri Jun 12th, 2009 at 06:20:57 PM EST
[ Parent ]
Arthur Laffer (yes, that Laffer) sides on the "inflation beckons" side:

Get Ready for Inflation and Higher Interest Rates
The unprecedented expansion of the money supply could make the '70s look benign.

Rahm Emanuel was only giving voice to widespread political wisdom when he said that a crisis should never be "wasted." Crises enable vastly accelerated political agendas and initiatives scarcely conceivable under calmer circumstances. So it goes now.

Here we stand more than a year into a grave economic crisis with a projected budget deficit of 13% of GDP. That's more than twice the size of the next largest deficit since World War II. And this projected deficit is the culmination of a year when the federal government, at taxpayers' expense, acquired enormous stakes in the banking, auto, mortgage, health-care and insurance industries.

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs -- such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid -- are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Jun 11th, 2009 at 06:52:45 AM EST
Jerome a Paris:
the unfunded liabilities of federal programs -- such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid
Don't ya just love that malicious shovelful of misdirection?

These are/were not unfunded plans...the money was stolen to pay for the Viet Nam War, and every other dalliance of soft-imperialism since, shoveled into the pockets of Boeing and Ratheon and The Carlyle Group and GE and Blackwater, and Halliburton and their intermediary bankers and every other conniving group who was able profit on fear and war by buying congresscritters and vice-presidents.

Corrupting the system that we mutually rely upon is treason.

Never underestimate their intelligence, always underestimate their knowledge.

Frank Delaney ~ Ireland

by siegestate (siegestate or beyondwarispeace.com) on Thu Jun 11th, 2009 at 07:37:43 AM EST
[ Parent ]
He assumes that the government won't just say "you know what? Fuck that. This guy, this guy, that guy and these three guys don't get their money."

In other words, he's assuming that a sovereign default cannot politically decide to discriminate between politically and economically important creditors (pensioners, medical services, infrastructure) and robber barons.

The obvious solution is to tell the robber barons to take a hike. Preferably off a short pier.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Jun 11th, 2009 at 08:27:52 AM EST
[ Parent ]
correct. There is a play between future payments and real, actual payments. Military spending is real, immediate. Future liabilities are something else. There will be default (as Jake implies)
It's easy for the USA to balance the books. Just rise indirect taxes. But it's easier to get the money from China, and it's just fine with China, busy boiling slowly the American frog through deindustrialization...

Patrice Ayme Patriceayme.com Patriceayme.wordpress.com http://tyranosopher.blogspot.com/
by Patrice Ayme on Thu Jun 11th, 2009 at 02:07:43 PM EST
[ Parent ]
Or.. how does a 25-year debt binge end?

The brainless should not be in banking. — Willem Buiter
by Migeru (migeru at eurotrib dot com) on Thu Jun 11th, 2009 at 07:16:16 AM EST
Binges end with hangovers.  The only question now, since the finance types are using hair of the dog, is whether the rest of us will die from it.
by tjbuff (timhess@adelphia.net) on Thu Jun 11th, 2009 at 10:00:17 AM EST
[ Parent ]
I'd worry about the quantityt of vomit on my doorstep.
by Nomad on Thu Jun 11th, 2009 at 10:07:46 AM EST
[ Parent ]
Speaking of vomit, DoDo has given us a nice description of the various kinds...

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Jun 11th, 2009 at 10:22:53 AM EST
[ Parent ]
It will end with default, except if it is smoothed out into an industrial policy, as I pointed in my latest diary (June 10), where Laffer was quoted (although he said nothing really new, but it was Laffer, so I exerted reverence, or, as some at the ET would say, reference).

Patrice Ayme Patriceayme.com Patriceayme.wordpress.com http://tyranosopher.blogspot.com/
by Patrice Ayme on Thu Jun 11th, 2009 at 02:30:10 PM EST
Why would there be any default?

Sovereign defaults normally entail debt obligations denominated in foreign currencies. The US has not had to resort to that to any substantial degree, as of yet, so the preconditions for a default are not in place.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Jun 12th, 2009 at 06:22:44 PM EST
[ Parent ]
Sovereign default can take many forms. I would personally argue that reneging upon pension obligations and deliberately devaluing/greatly inflating your currency to dispose of debt to foreign creditors that is denominated in your own currency would also constitute a form of sovereign default. I see no reason that legitimate creditors should be treated differently based solely on whether their debt is denominated in the debtor's currency or not. Pretending that they should strikes me as an exercise in making it harder to default on obligations owed to Wall Street, Frankfurt and London than on obligations owed to your own citizens.

Of course there are some practical and technical differences, but on the level of public discourse, those differences are much smaller than the similarities.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Jun 13th, 2009 at 08:37:34 AM EST
[ Parent ]
... meanings for existing terms.

This scenario:

deliberately devaluing/greatly inflating your currency to dispose of debt to foreign creditors that is denominated in your own currency
... is not common in the history of financial crises.

While decisions to default on obligations to creditors have been happening time and again, in Europe since the Middle Ages, deliberately deciding to wreck your economy as a way to slip out from under your debt burden is much less common. What more typically happens is that there is a structural imbalance that drives the hyperinflation.

In some cases, it is the effort to meet international obligations that cannot be met that drive the hyperinflation, as in Weimer Germany facing reparations payments when WWI had crippled the economies of its primary pre-WWI export markets. In others, as in the Confederate States hyperinflation, there is a structural imbalance on the current accounts side. The hyperinflationary risk looming over the horizon for the US$ would be more similar to that one.

If meeting the interests of Wall Street takes first billing, and the opportunity to pursue a brawny recovery is not taken because it involves a reversal of the fight against income growth for 90% of the US population, then prolonged stagnation punctuated by recession seems the more likely outcome.

Social insurance schemes always involve at their heart the sharing of the national income of that year, and if real national income drops, the standard of living that goes with that share will normally drop.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Sat Jun 13th, 2009 at 12:06:47 PM EST
[ Parent ]
On the meaning of "sovereign default":
Pointing to a non-negligible risk of sovereign default in the US and the UK  does not, I fear, qualify me as a madman.  The last time things got serious, during the Great Depression of the 1930s, both the US and the UK defaulted de facto, and possibly even de jure, on their sovereign debt.

In the case of the US, the sovereign default took the form of the abrogation of the gold clause when the US went off the gold standard (except for foreign exchange) in 1933. In 1933, Congress passed a joint resolution canceling all gold clauses in public and private contracts (including existing contracts).  The Gold Reserve Act of 1934 abrogated the gold clause in government and private contracts and changed the value of the dollar in gold from $20.67 to $35 per ounce.  These actions were upheld (by a 5 to 4 majority) by the Supreme Court in 1935.

In the case of the UK, the de facto sovereign default took the form of the conversion in  1932 of Britain's 5% War Loan Bonds  (callable 1929-1947) into new 3½ % bonds (callable from 1952) on terms that were unambiguously unfavourable to the bond holders.  Out of a total of £2,086,000,000 outstanding, £1,500,000,000, or something over 70%, was converted voluntarily by the end of 1932, thanks both to the government's ability to appeal to patriotism and joint burden sharing in the face of economic adversity and to ferocious arm-twisting and `moral suasion'.

(Willem Buiter)

The brainless should not be in banking. — Willem Buiter
by Migeru (migeru at eurotrib dot com) on Sat Jun 13th, 2009 at 12:13:56 PM EST
[ Parent ]
André Lara Resende, in a recent guest blog on Wm. Buiter's Mavecon, places the current situation in an informative context. It is not a short post.

There are two currents of interpretation of the present crisis. The first emphasizes a deficiency of the regulatory framework. It argues that it was such deficiency that ultimately led to the excess of leverage in the financial system. The explosion of ingenuity that followed the development of contingent contracts, the so called "derivatives", and the securitization of credits transformed the financial system from a relationship oriented system into a market transaction oriented system. It should have been more and better regulated in order to avoid the resulting excesses. The second current emphasizes the presence of large international macroeconomic imbalances. Obviously both interpretations are at least partially correct, but they are above all complementary. The macroeconomic imbalance would not have been so deep and persistent without the extraordinary development of the financial market. Indebtedness and leverage would not have reached such extremes in the world without the international macroeconomic imbalance. To accept that both interpretations are complementary does not necessarily lead to the conclusion that to redesign the regulatory framework is as important as to find a way to reverse the international macroeconomic imbalance.

He notes, as has Bruce, that much of the reason for that imbalance was the withdrawal of capital from the BRICs in previous crises, and the insistence of the IMF on restrictive monetary policies in these countries to "restore confidence" of their soundness in the eyes of the international capital markets.  The BRICs concluded that they could only participate in the international markets provided they accumulated large holdings of reserve currencies and forewent stimulative economic policies in their own countries, though it meant that critical social infrastructure needs went unfulfilled.  This prevented them from engaging in needed stimulative spending and still tends to hold down such spending.  But as commenters noted, their relative size, anyway, would limit the impact of their spending on the world economy.  

There is a major difference between the present conditions and those prevailing at the time Keynes elaborated his theses. The General Theory is of 1936. Before that, from 1932 on, sketches of the argument could be found in his essays.[3]  In 1932, the economy was still in profound depression, but - as known today - due in a large extent to the errors of monetary policy, the excess of debt of the private sector had been eliminated by the collapse of the financial system. The generalized bankruptcy of banks and firms solved the problem of excessive indebtedness. Banks, enterprises and households were broken, but with no debts. The costs were dramatic, but the excess of debt disappeared. The fact that the mistakes of 1929 have not been repeated, lead to circumstances far different from those of 1932. Financial collapse was avoided and despite the severity of the recession, we are still far from the thorough disorganization of the economy and massive unemployment -close to 30% of the labor force - of the Great Depression. The economy, however, almost two years after the beginning of the crisis, continues to be overwhelmed by unredeemable debts. As long as households and firms continue to bear the brunt of excessive debt, they will try to reduce expenditures and increase savings. Until debt is reduced to levels which are perceived as reasonable, the private sector expenditure will be exceptionally low. After the Great Depression, in the early thirties, there was a lack of demand because there was no economic activity and no income. Today, the lack of demand is the result of the exceptionally high rate of savings required to bring back private debt to reasonable levels.  These are very different situations.


It was not Keynes, but Irving Fisher, the American economist who lived between 1867 and 1947, who did the most insightful analysis of economies in deflation, paralyzed by excess debt. Keynes' analysis dealt with how to reactivate an economy where debts had been decimated by the depression. Keynes, at least the one of the General Theory, is the economist of the post-depression period. Fischer is the great analyst of depressive periods in themselves, when the question of excessive debt and deflation prevails.[4]   Fischer studied the depressions of 1837 and 1873, as well as the one from 1929 to 1933. He argued that neither monetary policy nor fiscal policy is able to stimulate the economy while excessive debt remains present. An idea of the relative dimensions of the current debt problem can be grasped by the fact that, in 1929, the total of American debt was 300% of GDP; it reached almost 360% of GDP at the end of 2008, after staying between 130% and 160% from the beginning of the fifties to the end of the eighties. Ben Bernanke, the Fed chairman and an academic with relevant contribution to the understanding of depression periods, is well aware of the difficulties to escape from the deflation trap. When visiting Japan some years ago, he remarked that the best way to get out of deflation is not to get into it.

I, of course, have no idea as to what kind of new international financial system could give China, for instance, the confidence to spend down some of the reserves they have accumulated, how that could be done without having destabilizing effects and even if they would do so if they could.  I can see that were they to spend it to purchase MRI equipment, etc. from the USA it would help our economy, and thus theirs.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Jun 11th, 2009 at 02:56:02 PM EST

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