This is going to be a quick hit. But I thought I should put this out there now that the Platinum Coin idea has been rejected, something that makes this downside scenario more likely. The idea here is that we are in an interregnum period similar to the 1933-1937 period that will unfortunately come to an end. I’m going to spell this out briefly because it highlights my guiding macro thesis for the past few years on the US.
John Carney at CNBC has written a good column today detailing the Obama Administration’s negotiating position in the debt ceiling crisis. President Obama does not want to use ‘The Coin’ or the 14th Amendment or any other tricks to keep this from spiralling out of control. The thinking here is that by just playing this straight, it will put pressure on Republicans to eventually cave – as they did when they raised income and payroll taxes at the beginning of the year, something they said they would never do.
John thinks that taking this approach is dangerous because it could make default a real possibility. I agree. Nonetheless, this is where we are. To be sure, true fiscal conservatives who back the debt ceiling standoff like Senator Rand Paul don’t want default. Senator Paul has devised a strategy to avoid default by prioritizing spending in a way that puts the onus back on the President, taking default off the table. And, we do still have the sequester cuts to think about. Those items have only been put on ice; they have not been taken care of. More recently, Obama has apparently taken default off the table, just as Paul wanted – and so now the President is backed into a corner. The net-net of this brinkmanship is that additional cuts of some sort are coming – and in conjunction with the existing tax increases, this will probably put the US into recession.
That brings me to my macro thesis. I wrote a post in October 2009 entitled, “The recession is over but the depression has just begun“. Here are the most salient points from that post:
When debt is the real issue underlying an economic downturn, the result is a period of stagnation and short business cycles as we have seen in Japan over the last two decades. This is what a modern-day depression looks like – a series of W’s where uneven economic growth is punctuated by fits of recession…
So where are we, then? We have left the fake recovery and are entering a new era of growth that could last as long as three or four years or could peter out very quickly in a double dip recession…
As for the recent asset-based economic reflation, be under no illusion that these measures ‘solve’ the problem. The toxic assets are still impaired and banks are still under-capitalized. But the increased asset value and the end of huge writedowns has underpinned the banks and led to a rise in the broader market in a feedback loop that has been far greater than I could have imagined at this stage in the economic cycle.
The double dip or the economic boom?
So what’s next? A lot of the economic cycle is self-reinforcing (the change in inventories is one example). So it is not completely out of the question that we see a multi-year economic boom. Higher asset prices, lower inventories, fewer writedowns all lead to higher lending capacity, higher cyclical output, more employment opportunities and greater business and consumer confidence. If employment turns up appreciably before these cyclical agents lose steam, you have the makings of a multi-year recovery. This is how every economic cycle develops. This one is no different in this regard.
However, longer-term things depend entirely on government because we are in a balance sheet recession.
Get ready because the second dip will occur. It will be nasty: unemployment will be higher and stocks will go lower than in 2009. I am convinced that it is politically unacceptable to have the government propping up the economy…
So to recap:
- A depression was borne out of high levels of private sector debt, the unsustainability of which became apparent after a financial crisis.
- The effects of this depression have been lessened by economic stimulus and government support.
- Government intervention led to a reduction in asset price declines, which led to stock market increases, which led to asset price stabilization and more stock market increases and eventually to asset price increases. This has led to a false sense that green shoots are leading to a sustainable recovery.
- In reality, the problems of high debt levels in the private sector and an undercapitalized financial system are still lurking, waiting for the government to withdraw its economic support to become realized
- Because large scale government deficit spending is politically impossible, expect a second economic dip within three to four years at the latest.
What is now playing out in Congress is very much in line with what I said a little over three years ago in October 2009. Deficit fatigue has become too large to resist. Austerity is coming to the US. The crux here is to remember that this has been a crisis brought on by high private debt – not public debt or deficits. The government has been effective in preventing a private sector debt deflation by providing economic stimulus, permitting large-scale deficit spending and bailing out the banks. This has added a huge slug of net financial assets to the private sector and supported asset prices and private sector balance sheets. When these government deficits get cut, there will be serious pain in the private sector because balance sheets are still stressed and the result will be a relapse into economic depression.
Personally, I would like to be proved wrong. I don’t want a depressionary relapse. But right now, it looks like we are headed in this direction.