I Love Larry Kotlikoff(Partly Because He Can't Stand Krugman)

[FinanceDude]

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Originally Posted by urn2bfree Ir we can kick start the economy there WILL be increased demand- as I pointed out with the demographic facts....some of the lack of demand for housing right now is that 57 year olds and 21 year olds do not buy houses. They don't. The Baby Boomers peak was around 1957. The Echo boom peaked in 1990-guess what happened when the Baby Boomer peak turned 21...economic slump. Then they got older and they did what people have been doing for centuries- they married, had kids, bought houses, cars, baby clothes, schools had to be built, etc..it will happen no matter what, slowly and surely with more pain if we do the wrong stuff or we can have an economy booming and ready for them if we kick start it. the only power strong enough to kick start it is BIG Deep pocketed government.

How much kick-starting? $3 trillion, $5 trillion, $15 trillion? So far, there has been little to no effect. Maybe we have slowed down the next Depression but 9% unemplyment isnt going to pay the bills for very long. Infrastructure spending will give some TEMPORARY jobs, but after the project is done and the federal money is gone, then what?

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This is not what the govt haters want to believe, it unfortunately is true. Funny how the same people want to talk about the government having to balance its books like any household- thinking the government is just like the rest of us... but somehow the government is not like the rest of us when it spends. Even though it can spend HUGE amounts as a customer- why would that not be part of demand like the rest of us....either it is just like us or it is isn't (I dont think it is) but their arguments are all based on half baked notions that it is and ignore the full implications of the comparison.

VERY FEW governments run surpluses for any length of time. However, we are in a place we have not been as far as in debt since World War II. What is the catalyst NOW that will bring the next wave of prosperity and productivity to the US? It sure doesn't seem to be in manufacturing, DW has been in manfacturing for 25 years and she says this is the worst she's ever seen it............

[M Paquette]

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Originally Posted by urn2bfree Ir we can kick start the economy there WILL be increased demand

I don't think you'll be able to 'kick start' the economy just yet. Remember, this is a balance sheet recession and recovery. We'll still be in recovery mode until all those consumer and commercial balance sheets get back to reasonably sustainable long term levels. That point is years out.

What the government can do is lessen the severity of the impact of The Great Unwinding, trying to keep the economy moving until the private sector is strong enough to carry the load.

To give folks some idea of where we are at, for the 'little people' living off of a salary or hourly wages, the current debt to income ratio is around 154% as of Q4 2010, down by 7.5% from the pre-recession peak at almost 162% The long term level for 1960-1980 was below 80%.

For the rest of us, including our interest and dividend income, bonuses, CEO salaries and whatnot, the debt to income measure is about 100%, still high, but below the pre-recession peak of 112%. [1]

All those consumers are deleveraging, paying down debt, or falling into various forms of default and having the debt written off. It's a slow process, though. Household income levels are down, with today's Census Bureau report showing median household income at $49,445, down 7.1% from the 1999 peak.

We are looking at several more years before consumer demand for goods, 70% of our economy, will be able to pick up. All that cash flow that would normally be rippling through shops, businesses, and contractors, to wholesalers and materials suppliers is instead paying down pre-existing debt, going back into capital reserves of overextended lenders trying to get their house in order.

It'll be a while yet. The August 2011 Blue Chip Consensus Forecast extended with March 2011 Blue Chip long-run survey of 50 private sector forecasts has real GDP chugging along at around 2.6-3.1% til 2021 (it doesn't go past that...), and unemployment over 6% til 2017.


1. "From Keeping Up with the Joneses to Keeping Above Water: The Status of the US Consumer.", BlackRock Investment Institute

[urn2bfree]

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Originally Posted by M Paquette We are looking at several more years before consumer demand for goods, 70% of our economy, will be able to pick up.

Yes it will be around the time a critical mass of the Echo Boom children reach age 30- ie 2014- new household formation jumps up rapidly around age 25, few people can stand to live with their parents after that and it jumps again at 30- these are facts of human behaviour- the necessity of getting the heck out of mom and dad's house will be the mother of invention. It worked with the last boom of babies, I am betting on this next generation to behave in largely the same way.

[devans0]

The liquidity trap and flight to quality makes sense. Demographics throughout the industrial world had produced a boomer generation that are now hitting retirement age. If I were predict what drives current consumption, I would have to say downsizing McMansion housing for seniors turning those super houses over to echo-boomers. The Boomers needs will lead to increased demand for condos or retirement cottages or the equivalent, and a quest for a simpler life. Super saving in such a world would sponge up excess money as pre retirement people hoards money. (seem familiar?, we are just ahead of the curve.) Inflation stays low. Consumption drops. Everyone wants to save, no one wants to buy. Japan's renowned saving rate led to stagnation there, We have the same dynamics here. I suspect that demographics will overwhelm any gov't interventions.

What will China do with their two adults producing one child policy? Their aged will really suffer. Our problems are dwarfed by what they face. Catholic countries and emerging nations will have the worker populations.

The other interesting areas will be the guns-into-plowshares effect as the new hardware and robotic advances move to peacetime production. Stealth car paint and ground based predator technology running lawnmowers and picking up the laundry...from Bangladesh..and geriatric (quest for fountain of youth) health care. No one can predict, but it will be interesting.

When will it change? The current boomers have to move out of jobs, and start spending down. I am in the middle boom cohort and would expect to reach normal retirement age in seven years. The middle boom cohort seems likely, so I call it in six to eight years. Then growth and inflation as the pent up savings starts to finally spend.

To look for specifics in economics isn't done, but I am curious to see how others see the future. Who comes out ahead? Who loses?

[Gone4Good]

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Originally Posted by M Paquette Remember, this is a balance sheet recession and recovery. We'll still be in recovery mode until all those consumer and commercial balance sheets get back to reasonably sustainable long term levels. . . . To give folks some idea of where we are at, for the 'little people' living off of a salary or hourly wages, the current debt to income ratio is around 154% as of Q4 2010, down by 7.5% from the pre-recession peak at almost 162% The long term level for 1960-1980 was below 80%. . . . . Household income levels are down, with today's Census Bureau report showing median household income at $49,445, down 7.1% from the 1999 peak.

More evidence of the problem's nature.

Consider the ratio - Debt / Income. It's high, as pointed out above. But now consider the last statement "Household income levels are down . . ." Even as folks try to deleverage they can't because income falls. They may make some head way reducing the numerator, but it's little help when the denominator also falls. So debt burdens stay high despite attempts to save, despite default and restructuring.

Rewind a couple of posts . . .

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Originally Posted by Gone4Good Because we can't lower interst rates below zero, the market can't clear. In that environment, attempts to increase savings lower income at the macro level. The lower income frustrates attempts to increase savings and the process continues.

The problem is that we can't deleverage unless someone else steps up to "dis-save." The mechanisim that normally governs this (interest rates) is stuck out of equilibrium. Even with zero interest rates the price offered to savers is too high, so no one is willing to dis-save.

The solution to the problem is to find another way to allow folks to deleverage - inflation (if it can be manufactured), forced loan modification with bank recapitalization if necessary, etc.

[Gone4Good]

Laziness has prevented me from walking through a full-blown example of what I’m talking about, so I suspect much of what I’ve been saying sounds like gobbledy-gook (queue snide remarks from the usual characters). But here goes, for those who have the patience for it:

At the macro level the world is a closed system. Inputs equal outputs. The simplest way to see this is that for every borrower, there is a lender. One person’s debt is another person’s asset. At the macro level, we don’t act in isolation. Your Yin is my Yang.

With that in mind, consider a world with only two people Brad and Sarah. This world has only two products, Widgets and Gazzoos. Brad produces Widgets, Sarah produces Gazzoos and they trade with each other. In this world, GDP equals the total amount of Widgets and Gazzoos produced. Brad uses his Widgets to trade for Gazzoos and vice versa. The more Widgets he produces, the wealthier he is. This is the basis of “Classical” economics, and the underlying rationale to focus on the economy’s “Supply side.”

Now add money and an interest paying bond for savings. Suppose Brad doesn’t want to use all of his income to buy Widgets and Gazzoos? In that case, he can make his extra income available to Sarah, who wants to consume more. Sarah borrows from Brad, and consumes the production Brad doesn’t want. The interest rate charged reflects the balance between how much consumption Brad is willing to forego, and how much extra consumption Sarah wants. Let’s say 5% is the equilibrium rate.

If Sarah decides she’s borrowed too much, she starts consuming less and repaying Brad’s loan. Brad isn’t interested in consuming more when he can lend at 5%, but Sarah wants to consume less if she’s got to borrow at 5%. So the interest rate declines. At 4% Sarah is still willing to borrow and consume, but less than she did before. At 4% Brad is still willing to lend and save, but less than he was before. Output of Widgets and Gazzoos remain unchanged.

Now let’s assume something dramatic scares Brad & Sarah (space aliens?) to the point where Sarah wants to repay her loan but Brad doesn’t want to decrease his savings. Sarah starts trying to repay her loan but Brad wants to keep lending, so interest rates decline further . . . from 4%, to 3%, 2%, 1% and finally down to 0%.

Even when Sarah can borrow at 0% she feels she already has too much debt and wants to pay Brad back. Those space aliens are really scary. But Brad is also scared and wants to maintain his savings. But now he has an alternative. With loans only paying 0% interest, Brad is indifferent between loaning to Sarah and simply sitting on cash. So that is what he does, he hoards cash.

But Sarah is trying to save too. She cuts the amount she buys from Brad to repay her loan. The cash Brad receives from loan repayment he sits on, he doesn’t buy any extra Gazzoos from Sarah nor does he loan that money to her. But now Brad’s income has declined (Sarah is buying less of his Widgets). If Brad doesn’t want to reduce his savings, he must also cut his purchases from Sarah, so her income declines too.

Sarah’s debt ratio doesn’t meaningfully change as both the numerator (her debt) and denominator (her income) declines. The only way for Sarah to fix her balance sheet is if Brad is willing to spend some of his savings, allowing her to maintain income. But he’s comfortable sitting on cash at 0%. What he requires to spend more (save less) is a negative interest rate on his money, but the market can’t provide that.

So Brad & Sarah find themselves stuck in the liquidity trap.

What would help them get out of the trap? Inflation, because it creates a negative return on Brad's money and also depreciates the value of Sarah's debts. A third party who was willing to increase their spending on Gazzoos and Widgets would also do the trick, because it would allow Sarah to repay Brad while keeping overall production (income) unchanged. Cutting taxes would be beneficial by allowing Brad to consume more and Sarah to save more. More directly, a third party who was willing to pay Brad to reduce Sarah's loan would work.

What wouldn't work? Higher interest rates and a third party also trying to increase their savings (e.g. government austerity). Deregulating Brad's widget production wouldn't do any good either because Sarah doesn't want to buy any more of his widgets.

[Texas Proud]

Gone4Good...

Nice example...

...but are the products produced the basics such as food and gas etc. Or are they extras such as big screen TVs

Because if they are basics, then there is a level of consumption that will occur no matter what... IOW, Sarah has to eat... and at some point if her income gets to low she will raise her price to get more income so she can eat...

Brad has no choice but to pay the higher price because he can not produce what Sarah produces and also needs the basics.... yes, this is inflation... but it will create an equilibrium after awhile...


OR, Sarah can just say "Brad, I will not pay you back as I do not have any money except for basics"... Brad has to write off the loan and they are now back to the beginning where there were no loans... IMO, this is what is happening now... banks have been writing down real estate and will continue to do so.... also CC debt and other loans have been written down over the last few years.... eventually, we will get back to an equilibrium and things will start to pick up....


We already have tried the 'third party to pay off Sarah's loan' with the mortgage modifications.... that did not work so well... not sure how much it cost us either....

[Gone4Good]

If we want to see how "Flight to Quality" fits in with the above example, we need to add more elements. Simple is better for illustrative purposes, but you can make this as complicated as you want.

But lets just say that the interest rate mentioned above isn't the rate at which Brad & Sarah lend and borrow from each other, but the risk free rate. And lets assume that it isn't "space aliens" that have everyone scared, but Sarah's solvency. The basic story stays the same except now we can say interest rates are driven to zero by a "flight to quality."

The overall thesis still holds.

[Gone4Good]

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Originally Posted by Texas Proud ..but are the products produced the basics such as food and gas etc. Or are they extras such as big screen TVs Because if they are basics, then there is a level of consumption that will occur no matter what...

The products reflect everything that is produced.

And yes, eventually you reach some kind of equilibrium, but what does that mean?

Basically it means that income will fall until indebted agents reach a point where they either can't, or have stopped trying to, cut spending anymore. Those agents are still constrained by debt meaning growth is slow and fragile, production is well below potential (unemployment is high and capacity utilization is low) but we've stopped falling.

Sound familar?

FWIW, I don't think we hit the point in the economy where the indebted can't cut spending. I think what we've done is broken the panic that caused everyone to rush to the exits at the same time. We did that with bank bailouts, and a whole host of currently unpopular government intervention. That doesn't mean we can't have another panic and another nasty leg down. We're in a precarious spot right now.

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Originally Posted by Texas Proud We already have tried the 'third party to pay off Sarah's loan' with the mortgage modifications.... that did not work so well... not sure how much it cost us either....

We actually haven't in any meaningful way. Yes, there is a program, but the actual modifications number in the low hundreds of thousands. Not a very big program. And it's also not one that reduces principal balances. Cutting interest rates isn't enough. There are good ideas floating around that involve cutting loan balances in exchange for home appreciation rights. I'd rather see money spent doing that on a very large scale then on most of the other things being suggested.

[Texas Proud]

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Originally Posted by Gone4Good The products reflect everything that is produced. And yes, eventually you reach some kind of equilibrium, but what does that mean? Basically it means that income will fall until indebted agents reach a point where they either can't, or have stopped trying to, cut spending anymore. Those agents are still constrained by debt meaning growth is slow and fragile, production is well below potential (unemployment is high and capacity utilization is low) but we've stopped falling. Sound familar?

I guess you missed where I said Sarah was not going to pay back Brad... so no more debt constraint...

But I do agree that you can get into this lower equilibrium... I would suggest that is where Japan has been for over 20 years... I would also suggest that the spending their gvmt did did not fix the problem... their debt to GDP ratio is way over 200% and approaching 300%... and their interest rates continue to be zero....

If gvmt spending did work, Japan would not be in the situation they continue to be in... it would have fixed the problem many years ago.... but they probably are still in a debt constraint (not sure, just remembering what I have read)....

I would also suggest that we can not get back to the production 'potential' that we had before.... it was a false production based on excessive debt... workers now produce more than before... heck, we might be getting to a point where we will not have everybody with a job...

[Texas Proud]

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Originally Posted by Gone4Good We actually haven't in any meaningful way. Yes, there is a program, but the actual modifications number in the low hundreds of thousands. Not a very big program. And it's also not one that reduces principal balances. Cutting interest rates isn't enough. There are good ideas floating around that involve cutting loan balances in exchange for home appreciation rights. I'd rather see money spent doing that on a very large scale then on most of the other things being suggested.

I can agree with that... but how much money would you suggest If we were spending tax dollars, I would want the appreciation to go toward paying back the taxpayer and not the bank. Or at least a share of the appreciation...

[Texas Proud]

Another problem is that this is a worldwide slowdown... this tends to show that the causes are not just the US mortgage problems...


I did see an clip that showed a number of teachers taking jobs overseas... to me, that is also a way that will help fix things... migration... but since there are very few 'hot spots' of jobs, that is not a great solution right now.... however, gvmt support makes it easier to not move to a place where there are jobs, or a job that you qualify for...

I just did a search on Monster and there are over 300 jobs for accountants listed... not a huge number, but jobs are out there... I also looked in NY and there are about 300 there... there were over 1,000 engineer jobs....

[Gone4Good]

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Originally Posted by Texas Proud I guess you missed where I said Sarah was not going to pay back Brad... so no more debt constraint...

I did see it. You had two valid scenarios and I chose to comment on just one.

But what happens when Sarah defaults? Brad loses an asset - some of his savings. If he's trying to maintain savings, which is our sceanrio, he cuts spending further to try to rebuild his pile. The downward spiral continues. The only way to avoid this is if Brad agrees to "dis-save" which is what we've been saying all along.

Taken to the extreme, you get back to the point you sugget - no more debt. But think about the implications of a cash only economy. What's the value of the average home if there is no borrowing? $40K? Less? Consider how much further down we have to go to get to that equilibrium.

[Gone4Good]

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Originally Posted by Texas Proud I can agree with that... but how much money would you suggest If we were spending tax dollars, I would want the appreciation to go toward paying back the taxpayer and not the bank. Or at least a share of the appreciation...

I don't have a number in mind. Large enough to meaningfully move consumer leverage statistics, so we're talking about principal reductions in the many hundreds of billions or more. Some of that would be offset by the value of the home appreciation rights, so it's hard to take a swag without some serious number crunching.

Principal reduction would show up as losses to lenders, but then we have the same problem we had with Brad writing down his loan to Sarah. The bulk of those losses would need to be shouldered by the government, or it's probably a pointless exercise.

[haha]

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Originally Posted by devans0 What will China do with their two adults producing one child policy? Their aged will really suffer. Our problems are dwarfed by what they face. Catholic countries and emerging nations will have the worker populations.

Emerging nations maybe, but Catholic countries have some of the planet's lowest birth rates.

Ha

[FinanceDude]

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Originally Posted by Gone4Good The solution to the problem is to find another way to allow folks to deleverage - inflation (if it can be manufactured), forced loan modification with bank recapitalization if necessary, etc.

So, why again do you chide people like me that suggest inflation is a way to get out of this mess

[Gone4Good]

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Originally Posted by FinanceDude So, why again do you chide people like me that suggest inflation is a way to get out of this mess

Please link to a quote where I've done any such thing. I'm confident you won't find one. You probably have mistaken me for someone else.

[M Paquette]

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Originally Posted by FinanceDude So, why again do you chide people like me that suggest inflation is a way to get out of this mess

I'm not entirely sure that inflation would cover the whole situation. We could inflate the costs of goods sold, by pushing more money into circulation. (Cash tucked in mattresses or Treasury bills doesn't help, as it's not chasing goods in the marketplace.) The econo-speak for this would be increasing the velocity of money.

The gotcha here is that wages that consumers are paid won't automatically rise to match. There's not a shortage of workers, not by a long shot, so there is no real reason for employers to offer more pay to workers. There's not even enough demand for labor to significantly restore hours to part time workers lost since the 2007 peak. (Just restoring part time worker hours to the 2007 peak would be the equivalent to adding 950,000 new full time workers.)

I suppose we could make some sort of Nixonian fiat to alter this. Somehow I don't think that would get very far.

Inflation gets us a higher cost of goods, to be paid by workers with a fixed debt load and effectively fixed income. Workers who have been able to pay debts up til now must choose between feeding and clothing their family and defaulting on loans.

Now, a modest level of inflation, combined with real growth in the gross domestic product could reduce government debt relative to GDP over a sufficiently long period of time, but that's not the debt that is causing this particular balance sheet recession. Consumers drive 70% of our economy, and it's their high debt level relative to income that has throttled their spending and reduced their access to easy credit.

[Gone4Good]

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Originally Posted by M Paquette Inflation gets us a higher cost of goods, to be paid by workers with a fixed debt load and effectively fixed income. Workers who have been able to pay debts up til now must choose between feeding and clothing their family and defaulting on loans.

Absolutely true.

The working assumption many of us have is that we can't get a generalized inflation without also having wage inflation. Too many dollars chase all things, including workers.

Recently we have experienced an issue of commodity price inflation. I think that is largely due to international growth and is not reflective of U.S. monetary policy (except to the extent that some countries - namely China, but others as well - have outsourced their monetary policy to the Fed). But inflation at both headline and core levels have been running hotter than I would have thought given the other cool economic readings.

Unless wages also inflate, this other inflation adds to the problem rather than addresses it.

But I have a problem reconciling goods inflation with a lack of wage inflation and credit creation. In this environment, won't higher prices just cause demand destruction, forcing prices down? Seems unsustainable.

[MichaelB]

Inflation does not solve a debt overhang problem for an economy, it just determines who will end up footing the bill.