Fri Oct 22nd, 2010 at 05:28:56 PM EST
While many have complained about the limitations of Mainstream Economics others have worked to provide alternatives. One of those is Steve Keene, who has now come up with a simple but powerful change that incorporates the role of debt into our understanding of economic cycles in a way that can easily be added, at least by those not resolutely obtuse, onto existing formulations:
Deleveraging, Deceleration and the Double Dip October 19th, 2010
For a long time I've focused on the contribution that the change in debt makes to aggregate demand, in the relation that "aggregate demand equals the sum of GDP plus the change in debt". An obvious extension of that was that "change in aggregate demand equals change in GDP plus acceleration in the level of debt"--which would imply that change in unemployment is driven by changes in the rate of growth of debt.
Though I was aware of this implication of my analysis, I held off from testing it because I was concerned that this was pushing the data one step too far.
A physical system with a similar relationship between velocity (the rate of change of one variable) and acceleration (whether the velocity of another variable is increasing or decreasing) would generate a large volume of sufficiently detailed data that the relationship could be empirically tested.
But the economic system, with the large time lags in data collection, survey methods rather than direct measurement, and the dodgy practices statisticians are forced into by politicians and economic bureaucrats who often don't want raw information to be available? I just thought that the relationship, even though it made sense, wouldn't be discernible from published statistics. So I held off.
It turns out that I shouldn't have been so cautious: the data well and truly supports this, on the surface, weird causal relation: the change in employment is strongly affected by the acceleration or deceleration of debt. This can give the paradoxical result that the level of employment can rise, even when the economy is deleveraging, if the rate of deleveraging slows. This phenomenon has driven the apparent stabilisation of the US unemployment rate (though of course the more meaningful U-6 measure has risen to 17 percent, and Shadowstats puts the actual unemployment level at 22.5 percent-well and truly in Depression territory), and it is highly unlikely that it will last.
My uncharacteristic timidity means that I have to doff my cap in the direction of the three economists who first published on this topic: Biggs, Mayer and Pick. They first showed the correlation between what they called "the credit impulse"--the rate of change of the rate of change of debt, divided by GDP--and both GDP and employment (for those who have access to research from Deutsche Securities, they have a simpler explanation of their analysis in Global Macro Issues for December 17 2009: "The myth of the credit-less recovery").
The chart below shows my confirmation of the relationship with the data on the annual change in unemployment in the USA and the annual rate of acceleration of private debt since 1955. The correlation is -0.67: a staggering correlation of a first and a second order variable over such a period, and across both booms and busts.
The two dotted red lines labelled "S" and "E" show when the NBER thinks this recession started and ended, and they neatly coincide with turning points in the credit impulse--an indicator that the NBER is not even aware of, let alone one that it considers when attempting to date recessions.
Note that the red line represents CHANGE in unemployment, which had only returned to the significant level at which it had been when NBER called the start of a recession. And the upward turn in the blue credit impulse line partly reflects the arrival of the 2009 Stimulus money into the real economy, as that stimulus was, after all, the occasion for new net borrowing by the government sector, however necessary and beneficial it was or remains to plugging the hole in demand created by cratering investment by the private sector.
But what about the NBER calling the end of the recession. Steve notes that the contraction in credit in 2008-2009 was over three times greater than the previous worst case example, that of 1974-1976, and that "ultimately all three factors--the level of debt (compared to GDP), its rate of change, and whether that rate of change is increasing or decreasing--must be taken into account." By way of analogy, he notes that the current journey back from peak debt is more like a drive from Los Angeles to New York and back, while the journey in 1976 was more like a journey from LA to Utah and back. We have only started to deleverage the economy. And it gets worse:
The rate of change of debt (with respect to GDP) is like your speed of travel--the faster you drive, the sooner you'll get there--but there's a twist. On the way up, increasing debt makes the journey more pleasant--the additional spending increases aggregate demand--and this experience is what fooled neoclassical economists (who ignore the role of debt) into believing in "the Great Moderation". But it increases the distance you have to travel when you want to reduce debt, which is what the USA is now doing. So it's great when you're driving from LA East (increasing debt), but lousy when you want to head home again (and reduce debt).
With that far to travel back home, you might be tempted to accelerate--which is akin to increasing the rate of change of the rate of change of debt (it's a measure of the g-forces, so to speak, when they can be generated by either rapid acceleration or rapid deceleration). Acceleration in the debt level when it was rising again felt great on the way out: booms in the Ponzi Economy the US has become were driven by accelerations in the rate of growth of debt. Equally, acceleration in the opposite direction feels dreadful: as the rate of decline of debt increases, aggregate demand collapses and unemployment explodes.
What actually feels better in the reverse direction is deceleration--reducing the rate at which debt is falling--and that's what's been happening in the last year.
But here's the problem: too much deceleration and you actually reverse direction: you start heading East again, rather than returning home. That wouldn't be a problem if all you'd done was drive to Utah, but instead you've hit New York instead: drive any further, and you're in the Atlantic.
With the level of debt the USA has accumulated, the prospect that any sector of it (apart from the government) can be enticed to go back into accumulating debt once again is remote. So the deceleration in the rate of reduction of debt that is occurring right now will ultimately give way to at best a constant rate of decline of debt, and at worst another acceleration--and the dreaded "double dip".