Saturday, February 20, 2010

Question: Obama worries me more than Greece or anything else so far. Let me know if I should change my viewpoint on the guy...

Don't discount Greece yet. It may be a small country, but the domino effect could be severe (remember subprime? it was a tiny portion of the US mortgage market). Obama unfortunately, has no understanding of economics and has been relying on a financial intelligentsia (Bernanke, Geithner, etc.), who were instrumental in getting us into this mess, to get us out of it. The result is that the U.S. is following the footsteps of Japan and its "zombie banks" and dire fiscal situation (not to mention the fantastic moral hazard risk brought on by bailing out bank bondholders). To me the only good news since Obama took office is that Volcker seems to be getting a bigger and bigger voice in this administration. I hope this is a sustainable trend.


  1. Numerous countries will be de-leveraging over the next 4 to 6 years. There is no way of avoiding this ... it's a necessary step to economic recovery. In some countries, the government can take up the slack of aggregate demand as the private sector de-leverages. In other countries, the total debt/GDP is too large for that to occur. Spain has a larger GDP than Greece and has a total debt (private + public) of about 350% of GDP. Italy is about %315. UK has a staggering 480% total debt to GDP, right up there with Japan (all figures as of Q2/2009).

    The worrisome bit about the UK is their "unexpected" increase in inflation recently. The Bank of London said the inflation was due to the lower VAT rate and that this should be corrected with the recent increase in VAT. This seems very fishy to me that the central bank is attributing inflation to fiscal tax policy rather than the usual definition of too much money chasing too few goods. Excess capacity is not declining in the UK, nor is unemployment ... so it does seem worrisome that the UK is heading toward monetary induced inflation and that their intent is to monetize the debt.

    The total US debt is approaching 300% and as little of 1/3 of the stimulus was spent, which means 2/3 is left to borrow in addition to the fiscal deficits we have now. I can only guess that the other 2/3 is being held back to juice the economy prior to the 2012 election. If the economy does not improve on its own by then (without stimulus) then I fear the same outcome for the US as Japan (which is a best-case scenario).

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  3. That McKinsey report is a must-read, as is the Rogoff and Reinhart book. I'm afraid however that each financial crisis (and post-crisis environment) is different.

    Notably, this one started and affected the "core" countries of the world economy (US, UK, Europe and Japan), as opposed to the periphery as was the case in a large part of the sample studied by McKinsey and R&R.

    The closest precedent is the 1930's, although the differences are still quite important: first regarding the policy response. Second, with the fact that the largest economy, in which the crisis erupted, was already a net international debtor and borrower with a not so good fiscal outlook.

  4. [...] the largest economy, in which the crisis erupted, was already a net international debtor and borrower with a not so good fiscal outlook.

    The most recent crisis (a bursting real-estate bubble followed by a balance sheet recession) arguably erupted in Japan first. Richard Koo's book - The Holy Grail of Macro Economics - paints a stark parallel between the present-day U.S. crisis and Japan's lost decade. There are significant differences, of course, but their are stark similarities to U.S. fiscal and monetary policy.

  5. I have heard good things from The Balance Sheet Recession, by Richard Koo as well.

    The US and Japan (as of the early 1990's) are extremely different: Japan was a net lender and a net creditor, and it wasn't the global engine of growth and consumer of last resort.

    As I said, each crisis is different, and this one doesn't escape the rule.

  6. There are differences, no denial there, but read the book before you dismiss the uncanny similarities. Koo is able to explain aspects of the US 1930's depression that Bernanke - as a student of that era - couldn't explain, thus causing him to proclaim such answers as "the holy grail of economics" (the title of Koo's book).

    Ironically, Bernanke is pursuing a nearly identical approach as the Bank of Japan during the lost decade, with some alarming differences. For example, the Fed (rather than the Treasury) is buying real-estate paper. Bernanke is quick to say that the paper is guaranteed by the Treasury, but the Treasury is broke (haven't you heard?). Do you want your Federal Reserve Note backed by toxic mortgage paper and mounds of Treasury notes on the Fed's non-transparent balance sheet? Not a good plan.

    Anyway, to the point of your blog entry, I think the UK is near the front of the sovereign debt crisis line (perhaps just ahead of Japan). The U.S. is only a few spots behind the U.K. (if we continue on the present course).