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“It is a general popular error to suppose the loudest complainers for the public to be the most anxious for its welfare.”
                              Edmund Burke

Commentary & Analysis
Going around the horn of plenty … circa 2009

I was looking through a Summer 2009 edition of The International Economy magazine (I found it while I was reorganizing my office.) The cover reads:

An American “Lost Decade” of Stagnant Growth?

The cover story was basically a one-question poll of some of the world’s most popular, and dare I say respected, economic and financial minds. With the exception of a few details, the questions and answers still apply today.

The respondents each provided several paragraphs. But I’ll pick out some key details to share. Let’s go around the horn [my emphasis]:

Tadashi Nakamae
President, Nakamae International Economic Research

Policymakers should cut excess supply capacity, including labor. This is not a popular solution, especially for politicians who have constituents to answer to. Nonetheless, the more politically palatable alternative, to raise demand through monetary easing or fiscal spending, is not a sustainable long-term solution. Trying to raise demand to bubble-era levels is futile. People were spending based on an illusion of wealth: how do you recreate something that never existed in the first place?

Meanwhile, bailouts will continue, while other desperate economic measures will probably be taken in the form of even lower interest rates. For Japan watchers this should sound all too familiar. America’s debt-to-GDP is likely to top that of Japan. The Federal Reserve will probably have to apply Japan’s unsuccessful experiment with quantitative easing. The United States gave Japan some jolly good advice about cutting losses and moving on in the 1990s. Now it needs to take its own advice.

Martin Wolf
Chief Economics Commentator, Financial Times

An alternative view is that Japanese monetary and fiscal policy was insufficiently proactive. Again, because the U.S. collapse has been bigger, its fiscal and monetary policy has been more aggressive, sooner. But the Japanese public has also shown itself willing to buy enormous quantities of Japanese bonds, at low rates of interest. That may well not hold for the United States.

In short, the United States will not experience a lost decade. The outcome will either be much better or substantially worse than Japan’s. Either the United States will secure a strong private sector-led recovery or it will run out of fiscal and monetary room for manoeuver.

Barry Eichengreen
Professor of Economics and Political Science, University of California, Berkeley

It is implausible that U.S. growth in the 2010s will average only 1.5 percent per year as was the case in Japan in the 1990s. The American electorate would not stand for this. American voters would be quicker than Japanese voters in the 1990s to demand new policies–and new policymakers–if U.S. growth were that disappointing. Hopefully those new policies would include a more growth-friendly policy mix, a more robustly capitalized banking system, and auto (and other) companies left to float on their own bottoms.

Louis Moore Bacon
Founder, Chairman, Chief Executive Officer, and Principal Investment Manager, Moore Capital Management

The U.S. economy will probably grow more slowly over the next ten years than over any prior postwar decade but should avoid the worst aspects of Japan’s deflation.

The U.S. authorities have responded more quickly and aggressively than the Japanese authorities did. It took Japan fifty-six months to achieve what the Fed managed in twelve months on official interest rates. Fiscal support packages have been bigger, too, in the United States compared with those implemented at the early stages of the Japanese cycle.

Ok, that’s enough from them for now.

Now let’s look to a truly brilliant mind – me – to see what was written in Currency Currents in August 2009:

The government, in all their society-stimulating ways, has played a large role in damping investor concerns. You know the story: stimulus spending, propping up banks, bailing out autos, etc. They tell us they’re making sure they fix this problem that so nastily shook us senseless last year. But how long do we believe them? How far can their promises take us?

After my Tuesday column a reader pointed out the lingering idea that deficits will ultimately wreak havoc on the US economy and dollar:

In the short term, an anticipated decline in the stock markets from a vastly over bought position may send the U.S.$ higher against its counterparts. However, those trillion $ deficits are frightening, especially to foreigners like myself who hold so many U.S. dollars. Until the U.S. can begin to get its financial house in order, those trillion dollar deficits certainly do not bode well for the U.S. dollar in the intermediate or longer term and threaten the future well-being of the entire country. Pardon my abruptness but in my lifetime I have seen the U.S. go from a wealthy creditor nation to an impoverished debtor ironically relying on its former enemy, communist China to bankroll it. Some would say that more prudent fiscal management must await a clear end to this Great Recession. However, with foreigners pulling the strings, the U.S. may not have the luxury of waiting that long.

All is not lost and some major market-induced transformations may be in the works despite outside efforts that seem counterproductive. Still, it’s hard to ignore the need for more prudent fiscal management when any additional efforts seem almost destined to create more problems than they solve.

Is it possible to rein in the seemingly out-of-control spending and cash dump that’s leaving heaping piles of liability all over our balance sheet? Yes, but it will be tough. A cut in spending just may mean a cut in government. Though Americans may be a little less confident in and thankful for the government when spirits become deflated and the real pace of recovery becomes evident.

Back to now … the latest US third-quarter GDP report released yesterday (downward revision from 2.5% to 2%) and the commotion surrounding the Super-Committee’s “failure” have inspired this look back (and forward) at potential US stagnation.

More than two years have passed without a definitive resolution to the question: An American “Lost Decade” of Stagnant Growth?

Since the financial collapse and recession prompted aggressive action from policymakers, we’ve been harping on ideas like:

  • Demand-targeting is not the solution.
  • The “recovery” through 2009 and 2010 was very much the smoke-and-mirrors of fiscal and monetary policies’ impact on financial markets.
  • The market ultimately wins; policymakers merely determine the ease or difficulty with which it does.
  • Stubbornly high unemployment, depressed asset values, and an end to public stimulus add up to a stagnant economy.

US consumers can sustain current reduced levels of demand, at best; but even this will not be enough of a driver to restore acceptable levels of growth in the US (and abroad.)

Per the above excerpts from The International Economy, Martin Wolf said:

But the Japanese public has also shown itself willing to buy enormous quantities of Japanese bonds, at low rates of interest. That may well not hold for the United States.

He was implying that high interest rates would drag down the US recovery. But I bet he didn’t imagine a chart of US 30-yr bonds would look anything like this two years later:

Or 10-yr Treasuries:

It may not be entirely the American public that has driven bond prices higher (yields lower). But it has happened. Yet it’s tough to really notice whether these low interest rates have had an impact. At best, I suppose you could argue it helps mitigate the burden of public sector debt repayment; but the benefit of lower yields hasn’t exactly made their way into the private sector.

Low interest rates seem just a means for our fiscal paymasters to buy time and hope the economy gets going again. But time is running out; and all they’ve done is perpetuated the illusion of a stable economy. It has the potential to get real ugly real fast.

If you’re wondering what this means for the US dollar and/or financial assets, consider this:

Nov. 21 (Bloomberg) — Foreign bank deposits at the Federal Reserve have more than doubled to $715 billion from $350 billion since the end of 2010 amid Europe’s debt turmoil, buttressing the dollar’s status as the world’s reserve currency.

Forty-seven non-U.S. banks held balances of more than $1 billion at the New York Fed as of Sept. 30, up from 22 at the end of 2010, according to a survey of 80 financial institutions by ICAP Plc, the world’s largest inter-dealer broker. The dollar has appreciated 7.2 percent since Standard & Poor’s cut the nation’s AAA credit rating Aug. 5, the second-best performance after the yen among developed-nation peers, according to Bloomberg Correlation-Weighted Currency Indexes.

With Europe on the brink of collapse and China facing a confluence of headwinds, we cannot call this a perverse trend of capital flow into the US; it is simply a relative game. Investors, banks and governments don’t feel comfortable parking any large amount of money anywhere else in the world; and the financial markets aren’t so appealing anymore.

Stagnation may be relatively better than recession, but it’s no cakewalk.