Technology Investment Dot Info

Without a major economic stimulus plan, “the shortfall in the nation’s output relative to its potential would be the largest — in terms of both length and depth — since the Depression of the 1930s,” said new CBO Director Douglas Elmendorf in testimony prepared for the House Budget Committee.

“Very simplistically, it is a choice between Zimbabwe and Japan.” – Niels Jensen, Absolute Return Partners

I don’t think I’ve ever had so many people ask me which way I thought the economy was going as in the last week. The simple answer is: first deflation, then inflation. But as to when and how much? At this point, no one has the answers; but at least Cassandra and her eclectic group of readers are exploring the questions. The discussion is US-centric, but all developed countries are confronted with the same problem to some degree.

• Do the US Fed and Treasury (and central banks and governments world-wide) really have the fire power (and political will) to stave off a de-leveraging driven deflation with whatever it takes?
• Would they attempt to, and have the practical and political capacity to, withdraw this quantitative stimulus (ie. newly printed money) at the first hint of growth (and a resumption in inflation)?
• Will they instead inflate the debt away at the great expense of creditors, liquidating a long-term reputation that has provided the benefit of a strong currency and low rates since the last US treasury default in 1933?
• Can real growth resume before the residual over-capacity and over-indebtedness is removed?
• Can the US government even finance its existing expenditure and debt committments long term?

This is inherently a political-economy battle, which leaves the pure economist’s talking at cross-purposes – about what is in theory possible or ideal rather than what is politically likely. The empirical economists are at even more of loss, with a single data point and nothing else equal.

On the deflation/liquidation (do nothing) side are ranged the creditors (China, Japan, Saudi…) and the mega-wealthy (which, last time I checked includes just about everyone in the US Senate). On the reflation/inflation (do SOMETHING) side are leveraged intermediaries, corporates and the poor US taxpayer who will end up with the debt service.

The US treasury bill appears to have become the most credible financial instrument, and the US taxpayer backing this appears to have become the guarantor of last resort. But the Bush years have cost future US taxpayers about $10 trillion (estimates Stiglitz) and in the near-term Obama will write some very large checks as well. Who will these future US taxpayers be? If spread across the upper 25% of income earners (as it must inevitably be) the burden will be on the order of $200k each plus interest. Want to step up? The super-rich may just write a check (or walk if they’re chased for more than a nominal share), but for what would have been the middle class this tax burden is the difference between remaining high-income poor and retiring with some personal capital.

Any delay at this point is a win for deflation, at least until supply cut-backs begin to bite (as Moldbug says “The prices we see now are the interaction of 2009 demand with 2007’s plans for 2009 supply.”). When US rates rise and/or the dollar drops the creditors are abandoning the field, but where will they go?

Cassandra is a “deflationist overshooter”, as am I for the moment:

[This view] reckons that: the weight of de-flation (de-leveraging, de-risking, precipitously de-clining core asset prices, de-capacitating financial system distress, de-employment shocks, secular de-consumption (savings) ratios, even demographics) trumps any triage, stitching or even bionic limb replacement conjured by central banks and Keynesian stimuli, by a large magnitude. And, this view conjectures, that by the time even the most interventionist authorities comprehend this, it will be too late for the inflationist “V” [referring to MV = PT] to ripen. AFTER that (two years?!? three?!?) when the majority of purging may be complete, and only then (year prior to re-election year 2012?) will the drastic measures be taken, which will be overkill and could very well/will lead to above trend inflation. Not hyperinflation. Above-trend inflation. [This view] understands, as Jeremy Grantham suggested last weekend, that solutions will – like reducing greenhouse gases – likely require multiple types of adjustment including falls and write-downs in asset prices (particularly debt); debt-for-equity swaps, coupled with some rise in nominal incomes and price indices. But like the deflationists, this view is predicated upon tinder being too wet to combust… and authorities – in this new paradigm – having the impetus and fortitude to “do the right thing” in the heat of the moment…

Perhaps we just need another boondoggle:

Just look around and you will see boondoggles sprouting up everywhere, in every field of endeavor: we have military boondoggles like Iraq, financial boondoggles like the doomed retirement system, medical boondoggles like private health insurance and legal boondoggles like the intellectual property system. At some point, creating another boondoggle becomes the preferred course of action: since the outcome can be predicted with complete accuracy, there is little risk.