Reports that the USA government’s total financial commitments from the financial crisis now top US$5 trillion raise the obvious question “Can they afford it?”.
The answer isn’t obvious. Some economists, from a range of schools of economic thought, argue that the government sector (lumping the Treasury and the Federal Reserve together) has a limitless capacity to pay debt as a consequence of its status (especially since the US dollar is still the world’s reserve currency).
I don’t dispute the capacity of the government sector to issue debt. But if it is to service that debt then there are financial issues for both the government and taxpayers if the debt it takes on is huge.
The bailout may amount to swapping a small amount of private debt for a larger amount of public debt in the future. This certainly seems to be the history of Japan’s attempts to “pump prime” its way out of the collapse of its Bubble Economy.
I’ve recently managed to find official Japanese data on debt levels and long term US debt data (with some problems about series breaks, which are obvious in the following charts). Japan has followed a traditional “Keynesian” approach to its crisis–running government deficits and on one occasion (2002) drastically increasing base money (by over 30 percent in one year). It is still mired in a long-running low-level Depression; inflation did start to pick up in the last year, but the economy has once again fallen into recesssion.
When its Bubble Economy burst at the end of 1990, aggregate Japanese debt was equivalent to 162% of GDP–consisting of a 108% private debt to GDP ratio and a 54% government ratio. In 2008, aggregate debt was 259% of GDP–made up of a slightly smaller private ratio of 94% and a much larger government ratio of 165%.
On this empirical record, the portents to the USA to be able to get out of this crisis by debt-financed government spending and direct financial sector bailouts–which effectively swap private debt for government debt–are not good. The latest Flow of Funds data records the aggregate US Debt to GDP ratio as 381% of GDP (with the private sector’s share of that being 290%). This is more than twice the level that the Japanese economy started with when it entered its Lost (Two?) Decade(s).
November 29th, 2008 at 10:20 am
When public debt is 150% of GDP, if we assume that if the economy was doing reasonably well then they would pay say 5% interest this equals 7.5% of GDP. Ouch. As you expect the Japanese economy slows down as soon as interest rates get anything much above zero and never gets anywhere near 5%.
The clear message from the Japanese experience is that you can’t just fiddle with interest rates and borrow money. Unless the other characteristics of the economy are changed debt will build up and whenever interest rates are increased the economy will stop.
November 29th, 2008 at 11:01 am
Very interesting. They can’t grow their way out, that is more or less given, but spending seems like the most likely outcome to me.
On this page you will see more details on the 4-5 trillions:
http://www.nowandfutures.com/key_stats.html
I think there are several reasons:
1. the yen was never a reserve currency, and undervalued to creating huge distortions and problems getting out of deflation. The Japanese stock market traded like a “growth story”, all the way back to 1965 when the nikkei was at 1300, and the dow at 1000. In 1989 the dow was around 3000 and the nikkei at around 40000. I don’t think the growth in Japan was that great.
I have made a small graph of this relationship between the nikkei and the dow (please don’t laugh:) : http://i305.photobucket.com/albums/nn240/carseller_02/nikkeidow.jpg
A very interesting thing is that the Nikkei, track the 10 year US treasuries.
http://finance.yahoo.com/echarts?s=%5EN225#chart14:symbol=^n225;range=19881101,20081104;compare=^dji+^ixic+^tnx;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined
Just put the date to 1988 – 2008 and you will see that there is a perfect relationship between the 10 year US treasury notes and the Nikkei index. If the treasury notes were to fall in value now, it’s 100 % sure that the nikkei will rise. The Dow have not followed this ratio the same way the nikkei have done before the last years, but I think that is because the US have managed a bull market in both stocks and treasuries much longer, because they never had the super bubble of japan. Japan’s stock market fell off in 1989. I think the best bet against treasuries are hard assets.
2. The US stock market bubble is not larger now by market cap than in 1974. There is also an inflationary/ hard asset trend lasting since 1974, as the big shots like George Soros and Warren Buffet are going for the hard assets, Soros even buying a mine in Australia last month. Japan never had an inflationary trend going for them. They had their deflation while the world was in a paper asset trend, not a hard asset trend like the current one.
3. The reserve currency status, and commodities being a hedge against any weaker dollar seems likely to help the US boost inflation much more effective than Japan ever could with a weak Yen.
I really think the stock markets are at the bottom now. In 2003 stocks bottomed out some times before treasury yields on the 10 year. As treasuries bottom out, I think the inflationary trend will go on.
If the treasury bull trend were to go on, then some kind of 0 % boom would likely result as long as they managed to keep the stock market alive. However I think a repeat of the time from 2003, only with a more push towards stagflation is likely.
November 29th, 2008 at 11:08 am
Let me add that Japan barely have inflation, money growth and GDP growth measured in dollar terms, in the broader measures since 1989, compared to the US, as shown in the other link that show the US money growth. That probably makes the dow bubble even less than my graph show. My idea is that the nikkei slowly have deflated to finally match the dow jones in size around now.
November 29th, 2008 at 5:40 pm
Interesting, the charts suggest the Japanese post 1990 boom debt trend is very different to the US post 1929 boom. The US post 1929 shows total aggregate debt steadily declining until 1950 (from around 300% to 120% of GDP) even with the increase in government debt spending. The US 1890 boom peak had a similar downward trend in total debt levels; Japan post 1990 shows total debt continuing to increase from a lower base 150% to now 300% of GDP. It would be interesting to know if the US had the same level of private to public debt transfer in its two cases compared to Japan or what the differences were? Could give support to the case for letting the market sort itself out and putting public spending to directly protecting the public interests; so the public is protected from systemic financial failure, and kept well fed, well sheltered, and well educated to participate in new productive growth with public spending also directly funding or re-acquiring critical services (via government programs and loans) and reining in spending like excessive salaries and service cost disparities; this rather than burdening the public by the transfer of financial private speculative debt for eons to come. Bottom line would seem, whatever Japan did, don’t do it.
November 29th, 2008 at 5:52 pm
No.
I quote Bob Moriaty,
‘To restore confidence in the system, you have to use gold. Let me give you an idea of how out-of-control the system is today. If you took the 80 tons of gold that the U.S. supposedly has on deposit in Fort Knox and West Point, that would be $200 billion worth. The USA created $3.2 trillion in paper money, 16 times as much, in just the last month. That means it might take a gold price of $50,000 to $250,000 an ounce to actually clear the system, but we do have to clear the system. We have to go back to honest money. If you’ve ever played poker, and somebody sits down and pulls out a Sears credit card, he’ll bet on every card because he isn’t playing with real money’.
November 29th, 2008 at 9:05 pm
So the “Japanese disease” can be described as a failure to resolve excessive private debt levels, instead converting private debt into public? If so, the parallels with the US are striking. We should expect the same result, with the only alternative being hyperinflation and sovereign default.
But what is the mechanism by which this is so damaging? Is it the cost of servicing the debt, or the inability to keep growing the bubble? And what are the consequences for the rest of the world? These are tough questions.
November 29th, 2008 at 10:03 pm
You might be able to control the system with some form of “Digital Gold” that was controlled by a currency board, instead of shipping around the actual metal.
- Ernie.
November 30th, 2008 at 1:38 am
It don’t have to be hyperinflation, or deflation.
i think it’s possible to have something in between. When thinking of the obligations of the US, to pensions, medicare, china, etc, I just can’t see how deflation can succeed in the longer run.
November 30th, 2008 at 2:02 am
I think that this post may offend some. Not intentional, just my views. Though radical to be sure. Apologies if it does.
Some might like to skip this one.
I think you know the answer to your question in the second para Steve and you reluctantly come to that unstated conclusion in the end. The US simply can not afford the new debt.
US public debt has been rising since 1974 although the ratio to GDP has not increased much thanks to GDP’s growth but due to all of the bail outs (with more to come car company rescue comes about) this is now shot to bits.
And how are the bail outs supposed to pay the US Goverment back? As of 24/10/08 AIG has gone through USD 90B of the USD 123B US Goverment loan. Even in their best profit year of 2006 it would take 6 years of profits to pay that back! Citigroup would need about two years of its best profits to pay back USD 45B ignoring the preferential shares that require payment of 10% per annum.
The cold and I know ruthless answer is to let the companies fail. Where gaps are left in business circles the Government can and should step in by creating properly and conservatively run statutory authorities.
And, yes, this inevtiably leads to depression but depression must now occur. If not now later. The bail outs merely put off that day of reckoning and this putting off that day has been occurring for some time now and will become more expensive and harder when it does occur.
Further Governments should socialise/nationalise certain industries(yes a dirty word that but Governments should always have retained control of certain nationally critical industries such as communications, utilities, public transport to name a few instead of fobbing off those responsibilties onto private industry).
And Governments should take the depression as an opportunity to retrain and reskill the population.
And declare a debt moritoria if necessary.
November 30th, 2008 at 2:10 am
Correction, Steve’s question to which I refer is actually at the end of the first para
November 30th, 2008 at 2:53 am
This graph tells a lot:
http://finance.yahoo.com/echarts?s=%5ETNX#chart34:symbol=^tnx;range=my;compare=d+^n225;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=off;source=undefined
Put it on max. it shows the dow , a utility company, vs 10 years treasuries. vs the nikkei 225
It tells a story. that words can’t describe.
If someone wants to try put the graphs into words I am interested in hearing about it.
The lower the yields on US goverment bonds, the bigger “the bubble”.
November 30th, 2008 at 2:59 am
http://finance.yahoo.com/echarts?s=%5ETNX#chart34:symbol=^tnx;range=my;compare=d+^n225;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=off;source=undefined
put at max.
Look at this graph. It’s like the nikkei fell off the bandwagon, while the US just kept growing debt. As shown on this utility company.
I don’t know, it’s confusing to really know if the US stock market is a 800 % bubble as this graph suggest, in comparison to the nikkei.
November 30th, 2008 at 6:56 am
I’ll provide some alternative logic on why things will not devenlop as in Japan, and what could happen if they do.
One thing I can add is that I have found is a perfect relationship between the US treasury note and the Nikkei index going back to 1981.
This relationship is around 2,7
That is, the theoretical value of the nikkei index in thousand is 2,7 times the yield on the 10 year US
treasury note. Yield 15,5 %, nikkei should trade at 42000. This is a ratio that have hold from 1981-2008 more than 90 % of the time. In 1981, the nikkei should had been at right above 40000, but were trading below the potential of the 2,7 rule, whenever that have happened it goes back up to the earlier potential when the yield drops, later since 1988 however this ratio have more or less hold true 100 % of the time, meaning that the nikkei will never bottom out before the bullmarket in US treasuries permanently end. To me it appears that this bullmarket ended back in 1999, because of the low commodity prices at that point. I don’t think the trend in rising commodity prices and the CRB since 1999 is compatible with a bullmarket in US treasuries.
http://i305.photobucket.com/albums/nn240/carseller_02/bottom.jpg
This is an old graph, but it shows the trend, that I think is in work. The best buys right now, I think are in silver mining shares.
The only way there is a chance for the bullmarket in US treasuries not having ended as I see if is if oil and other commodities set a new low, lower than the 1998 now, meaning oil prices need to drop another 80 %. If they don’t, then I think that means that there is a bubble in US treasuries simply because it’s not logical for treasuries to increase in worth if the most important commodity don’t decrease in worth, it does not make sense at all, as it is impossible to print oil, what you print simply cannot be worth more if oil increase in price, impossible. I think the bubble, probably helped by China and other foreign holders means 10 year yields should had been much higher. Some research done by the fed shows that yields should had been 1 % higher if it were not for China, but I think the figure is much higher.
If the 10 year treasuries head towards even a lower level in the coming 10 years, maybe 1,5 % like in Japan. That in turn would mean that the nikkei would reach 4000 because of the 2,7 relationship that have held up perfect since 1988, since the nikkei is already trading at around book value, that would cause the nikkei to drop to 0,5 times book value. I think that is highly unlikely, and another reason why the bullmarket in treasuries is not only over in 1998-1999, but have been in a bubble for the last 10 years.
If so, then there is very likely this bubble in US treasuries is going to pop, once the US start printing lots of money now. Then yields on treasuries will head higher, inflation will go up, the dollar will go down, and there will be a boom like the one from 2003, only stronger, much like a mix of the recovery from the 73-74 bear market, with the inflation coming when jimmy carter took over from around 1977-1978.
Then, the question arise to what could be a good investment if US treasuries are in a bubble.
Then, could investments would be hard assets, emerging market, BRIC shares, mining, precious metal shares, oil related stocks, oil drilling. Very much of the same from 2003. I think Chinese shares will perform very similar to Japanese shares from the early seventies. Whenever the US treasuries start to weaken, and yields go up, I think the shanghai stock index, fertilizer stocks, anything that gives leverage away from treasuries will start to rise again. This is when the music starts to play, and stagflation come back to hit us in the face.
I think the Chinese stock market, as it like the Japanese should move inversely to treasuries probably will start to develop into a bubble like the nikkei did, what the shanghai index did, was not a big bubble, just a short period of speculation, if they get a multi year bubble in China, the stock market will become a monster, like nikkei, with Chinese companies taking over the world. I have read some posts from the 1980. It was incredible how optimistic things were for Japan in that age.
November 30th, 2008 at 9:52 am
CAN SOMEONE PLEASE! COMMENT ON THE THREAT OF U.S. ‘CREDIT DEFAULT SWAPS’ and will this be the next ‘cliff’??
November 30th, 2008 at 10:52 am
Hi Steve,
This recent blog entry from Paul Krugman is pertinent (the graphs he added did not copy):
November 28, 2008, 1:47 pm
Was the Great Depression a monetary phenomenon?
Has anyone else noticed that the current crisis sheds light on one of the great controversies of economic history?
A central theme of Keynes’s General Theory was the impotence of monetary policy in depression-type conditions. But Milton Friedman and Anna Schwartz, in their magisterial monetary history of the United States, claimed that the Fed could have prevented the Great Depression — a claim that in later, popular writings, including those of Friedman himself, was transmuted into the claim that the Fed caused the Depression.
Now, what the Fed really controlled was the monetary base — currency plus bank reserves. As the figure shows, the base actually rose during the great slump, which is why it’s hard to make the case that the Fed caused the Depression. But arguably the Depression could have been prevented if the Fed had done more — if it had expanded the monetary base faster and done more to rescue banks in trouble.
So here we are, facing a new crisis reminiscent of the 1930s. And this time the Fed has been spectacularly aggressive about expanding the monetary base:
Ben goes for broke (refers to chart that did not copy).
And guess what — it doesn’t seem to be working.
I think the thesis of the Monetary History has just taken a hit.
November 30th, 2008 at 12:28 pm
The endgame of all this is that most people will have their wealth wiped out due to hyperinflation.
The USA had hyperinflation during the War of Independance when they printed ‘The Continental’.
It’s value went to zero and hence the famous phrase ‘Not worth a Continental’.
The tragedy of the situation we find ourselves now in is the world’s reserve currency will soon go the way of the Continental and all fiat currencies.
All this has happened before and will continue to as long as money is backed by nothing.
The con the US pulled on the world in 1971 to disconnect the US dollar to Gold was huge. It is now going to blow up in everyones face.
The Quadrillion derivative mess hasn’t even started to blow up!
Oh Jesus!
See you in 2012….let me know has things are going then….
November 30th, 2008 at 1:08 pm
The Continental and the railroad boom, at the same time, maybe that’s Warren Buffet have been loading up on railroad stocks. History have a way of repeating itself, in an interview he said the dollar is going to become worthless, later corrected to worth less:)
November 30th, 2008 at 2:16 pm
Here is another picture, other than the primitive one I made, that show the dow vs the nikkei, in a true relationship.
Lucky for the US they don’t have a stock market bubble the way japan did. The US stock market now, is like the the market in Japan, after 20 years of deflation.
http://www.sharelynx.com/chartsfixed/NikkeiDow.gif
(they was at around the same level in 1963
November 30th, 2008 at 4:29 pm
I’m curious where you found this data on Japan. My very crude approximation sent to another blogger earlier this year was 250% total debt-to-GDP in Japan in 1990, though I suspect your numbers are more trustworthy.
December 1st, 2008 at 6:00 am
Steve-
Where did you get your debt-to-GDP data on Japan? When I did some digging a few months ago the best crude estimate I could come up with for 1990 (combining multiple sources) was 250% — see paragraph 5 of a post from another blogger:
http://www.nakedcapitalism.com/2008/07/has-deleveraging-even-begun-not-for.html
I suspect your data is likely to be more accurate but am curious why they differ so much.
December 1st, 2008 at 7:43 am
[...] Read the rest of this great post here [...]
December 1st, 2008 at 10:11 am
I think that if history really is repeating, and this Chart tells the story: http://www.debtdeflation.com/blogs/wp-content/uploads/2008/11/IMG0014_4969953.PNG
Then this would be similar to 1938, and not 1929, the reflation phase already happened in 2003-2008. However could really the dollar take it this time around, and not collapse? What about WW2? WW3? A big war would be the natural progression from here on.
December 2nd, 2008 at 10:27 am
I think it’s very interesting what will happen if japan return to it’s quantitative easing program, with the US to joining in.
Even if japans easing program did not do that much for Japan other than suppressing the Yen, boosting exports, and causing bubbles, and inflation everywhere through the carry trade, I think there is real danger for the “carry trade bubble economy” going on, if the US joins japan, and they hit the pedal to the floor at the same time.
December 2nd, 2008 at 11:51 am
Good morning Steve,
The bailout/thievery commitments that the financial institutions have so far managed to get the U.S. government to go along with, now total something on the order of $8.5 trillion, according to Bloomberg News.
To get some idea of what that adds up to, in doing research for his “Bailout Nation” book, Barry Ritholz calculated, using inflation adjusted figures, that it is greater than the cost of the Marshall Plan, the Louisiana Purchase, the race to the Moon, the S&L Crisis, the Korean War, the New Deal, the invasion of Iraq, the Vietnam War, and NASA — combined.
Combined, those total just under $4 trillion.
The only American historical event that comes anywhere near the bailout commitments was World War II, at $3.6 trillion.
Still less than half of the current thievery.
December 9th, 2008 at 2:43 am
[...] Kuvio 3: Yksityinen ja julkinen velka suhteessa bruttokansantuotteeseen Japanissa 1985-2010 (Steve Keen) [...]
December 17th, 2008 at 9:19 pm
Can anybody translate the Finnish?