The United States has run massive budget deficits every year the Bush administration has been in office. The latest budget projections from the White House show annual deficits in the $250 billion range for the rest of the president’s term, at which point nearly $3 trillion will have been added to the national debt.

And thereby added to aggregate demand, non-government income, and ‘savings’ of financial assets.

In fact, George W. Bush has presided over the biggest fiscal deterioration in American history a sorry legacy considering his predecessor left him a healthy budget surplus projected to be $5 trillion over 10 years.

The budget surplus drained the savings of net financial assets of the non-government sectors, and thereby ended the recovery triggered by the large deficits of the early 1990s.

The Bush fiscal reversal helped restore aggregate demand, growth, and employment

Austan Goolsbee is a senior economist for PPI and the Democratic Leadership Council. This did not happen by accident. WhiteHouse officials have repudiated the Clinton administration’s view that fiscal responsibility lays the groundwork for sustained economic growth.

And rightly so.

Government deficit = Non-government ‘surplus’ (savings of financial assets) as a matter of accounting, not theory.

Often identified with former Treasury Secretary Robert Rubin, this view held that by running massive deficits.

Adding to aggregate demand.

and borrowing heavily.

‘Borrowing’ only ‘offsets operating factors’ to give non-interest bearing deposits created by deficit spending an interest bearing alternative in order to keep the Fed Funds rate at the FOMC’s target level.

the federal government drove up the cost of capital.

The Fed votes on the interest rate, and the cost of capital includes a risk adjustment as well.

NOTE: A few years ago, Japan had a debt of 150% of GDP, annual deficits of 7%, and 10-year interest rates under 1%.

By cutting the deficit, it could bring interest rates down.

Only if it causes a slowdown that causes the Fed to cut rates.

and thereby stimulate new waves of private investment.

No, a slowdown does not encourage private investment.

The economic boom of the 1990s seemed to prove Rubinomics right.

No. The high deficits of the early 1990s triggered the expansion, and the surplus of the late 1990s ended it.

But Republicans have nonetheless rejected that approach. Glenn Hubbard, formerly President Bush’s top economic adviser, said in a December 2002 speech: “One can hope that the discussion will move away from the current fixation with linking budget deficits with interest rates.” When pressed on the point, he responded: “That’s Rubinomics, and we think it’s completely wrong.”

Hubbard is right on that point, but he still favors lower deficits; so, he’s ultimately wrong as well.

More recently, in an editorial marking the 25th anniversary of Ronald Reagan’s inauguration, the conservative Wall Street Journal opined that Rubinomics was a failure, and argued that history had vindicated the supply-side line that tax cuts are the most important policy that government can undertake.

They think tax cuts are good because through growth they ‘raise more revenue than they cost’ and bring down the deficit that way.

Their goal is the same: to bring down deficits.

Meanwhile, the Bush White House has pointed to higher-than-expected tax revenues in the last two years as further proof that we do not need to worry about fiscal responsibility in the near future.

Right, both believe lower deficits are ‘better’; both miss the point.

Times have changed since 1992, and the economic case for fiscal discipline has changed, too. But it remains strong.

Wrong.

It is true that the globalization of capital markets in the last 15 years means that America no longer displaces an inordinate percentage of the world’s capital when it borrows heavily from abroad.

We have no imperative to borrow from abroad. He has it all backwards, as does most everyone else. In fact, US domestic credit funds foreign savings.

Therefore, the interest rates that the U.S. government has to pay for its massive borrowing are not as high as they might be.

The Fed sets the rates by voting on them.

The left and the right have gone far astray from the economic fundamentals.

otherwise. In addition, governments and central banks have helped our situation. Lending countries such as China and the world’s oil exporting nations seemingly have been willing to hold U.S. debt even though higher returns might be available elsewhere.

Yes, to support their exports. But now that Paulson and Bush have ‘successfully’ caused them to change policy by calling them currency manipulators and outlaws, they no longer are accumulating USD financial assets at previous rates.

This has caused the USD to begin falling to the levels that coincide with rising US exports and falling imports.

It won’t stop until the US trade gap gets to levels that equate it with desired USD accumulation levels of foreigners. Could be near zero.

Of course, it is nice to be able to borrow money without having to worry much about the impact on interest rates.

That’s what all governments with non-convertible currency and floating fx do in the normal course of business.

But if globalization has made borrowing from abroad easier, it also exacts new penalties for fiscal profligacy. In fact, there are three big reasons why Americans should still be concerned with big budget deficits: (1) they have unfair distributional consequences between generations.

No, this is inapplicable.

When our children build twenty million cars in 2030, will they have to send them back to 2008 to pay off their debt?

Are we sending goods and services back to 1945 to pay for WWII?

No, each generation gets to consume whatever it produces, and it also can decide the distribution of its consumption.

(2) they make it harder for our government to respond to fiscal crises.

No, government can buy whatever is offered for sale to it. Government spending is not constrained by revenue.

and (3) they subject America’s economic well-being to the potential whims of foreign governments and central banks.

Only to the extent that we might lose the benefits of high real imports.

Imports are real benefits; exports are real costs.

Before looking at each of these, however, it is important to address the administration’s claim that our current fiscal position is basically healthy.

‘Healthy’ is undefined and inapplicable.

The recently released budgets of the Congressional Budget Office (CBO) and of the president show the government going back into surplus by 2012, which makes it sound as though the problem has been solved.

No, sounds like a recession would quickly follow if they press those results.

A closer look at the numbers, however, reveals that the positive news is overstated.

Thank goodness – might continue to muddle through and avoid recession after all!

The CBO’s projections, for example, assume that all the Bush tax cuts will expire; that the Alternative Minimum Tax (AMT) will affect a growing fraction of people earning between $75,000 and $100,000 over the next five years; that federal spending will grow only with inflation, rather than with population or GDP growth; and, most importantly, that the federal government will go on raiding the Social Security trust fund “lock-box.” The president, by requesting hundreds of billions of dollars in further tax cuts, has painted himself into such a tight corner that he cannot produce a fiscally responsible budget without leaning heavily on such dubious assumptions.

Hoping he doesn’t succeed!.

A more realistic analysis shows very significant deficits for at least the next several years, after which the baby boomers’ exploding health and retirement costs will make the fiscal picture dramatically worse.

He means ‘better’ but doesn’t realize yet.

Make no mistake: Deficits still matter. A balanced budget may be less central to economic growth today than in the 1990s. But deficit reduction now functions as a crucial insurance policy against global financial shocks and over-reliance on foreign lenders.

There is no reliance on foreign lenders. Government is best thought of as spending first, then borrowing to support interest rates.

as well as national emergencies such as Hurricane Katrina’s devastation of the Gulf Coast.

Government can spend however much it wants at any time it wants, unconstrained by revenues.

The constraint is inflation, not revenues, but the author never even mentions inflation.

It should not be a goal in and of itself pain for pain’s sake. Fiscal responsibility should be our goal because it remains an important foundation of economic justice and growth.

Justice???

Here is a closer look at the adverse social and economic consequences of the Bush administration’s irresponsible fiscal policies.

Although fiscal policy is seldom viewed through the lens of economic fairness, the first and biggest problem with fiscal irresponsibility is distributional. When we borrow money without paying it back, we are leaving our children and grandchildren a legacy of much higher tax rates and much lower public benefits than we enjoy, because they will have to foot our bill..

As above, they will get to consume whatever they produce, debt or no debt.

Real wealth is not the issue.

And government can distribute current year output any way it wants.

Economists use what is known as “generational accounting” to calculate how much of the nation’s debt burden will need to be borne by later generations compared to ours and previous generations as a function of today’s large fiscal imbalances. The results are stark.

And totally inapplicable.

As a share of their income, future generations will have to pay about twice the taxes as today’s workers have paid or else they will receive around one-half the public spending.

The living will still get all the output, no matter what tax rate they elect to charge themselves.

The money we spend beyond our means today takes away the money our children will have for Social Security benefits, Medicare, Medicaid, and every other spending priority.

And who gets the money that is ‘taken away’ – dead people of the past???

Is he that dense or is this blatant propaganda? Both???

The interest payments on the country’s growing debt already accounting for approximately 10 percent of the federal budget, pushing $300 billion dollars will ultimately become the government’s biggest budget item. The payments for the spending of the past will increasingly crowd out the spending priorities of the present.

Crowd out – figured he’d slip that in our of left field.

The country is in for a double disappointment because all these new deficits have not been used for investments. It is one thing to run deficits to invest in activities that might improve productivity or standards of living for future generations. This, after all, is what FDR did to pull America out of the Great Depression and win World War II. A bigger economy would allow us to soften the distributional blow of deficit financing. But that is not what the Bush administration has done. It borrowed to finance huge tax cuts for a fortunate few, and most of the money went straight into consumer spending with little lasting impact on the kids who will one day have to pay the bills for this splurge.

Savings is the accounting record of investment.

In general, investment is a function of demand – nothing like a backlog of orders to spur expansion of output.

Also, technology and cost savings drives investment..

And the point of investment is future output and future consumption.

The whole point of economics is to maximize consumption in the general sense.

The second major problem with running big deficits is that it diminishes the government’s ability to respond to crises.

Not. As above.

It eats up the rainy day fund, if you will.

No such thing. Inapplicable. Government spends by crediting accounts.

This is not constrained by revenues.

To that point, if you pay your taxes in cash, the government tosses the cash into a shredder. Clearly it has no use for revenue per se.

When the government operates without the fiscal cushion that budget surpluses provided in the late 1990s, it is hard-pressed to respond to emergencies, such as Hurricane Katrina, or even fulfill more basic commitments.

Only if it’s ignorant of monetary operations and the working of the payment system. (So, maybe he’s right???)

It is especially troubling today that despite an economy in full-blown recovery, record-smashing corporate profits, low interest rates, and strong productivity growth, the country’s budget deficits have still been in the $250 to $400 billion range.

The rising deficit is what’s supporting GDP above recession levels currently.

On top of that, the true size of the fiscal mess is masked by the fact that we are dipping into the Social Security surplus to finance current consumption. Since 2001, we have effectively borrowed almost $1 trillion from the trust fund, and the CBO forecasts another $200 billion or so every year for the foreseeable future. Our true annual deficits have been in the $400 billion to $600 billion range and are forecast to continue in that range for the rest of the Bush term.

Point? Social Security payments are operationally not revenue constrained, just like the rest of government spending.

It’s about inflation, not solvency, but he never mentions that.

What are we going to do in the event of another recession, a decrease in corporate profits, another Hurricane Katrina, a collapse of the Pension Benefit Guarantee Corporation, or another major war? And how will we finance future Social Security and Medicare benefits? The probable answer is, we’ll borrow more but this will only postpone the day of reckoning and make it more severe.

The government can always ‘write the check’ with any size deficit or surplus. Doesn’t matter, apart from inflationary consequences.

The United States has a strategic petroleum reserve to guard against unforeseen disruptions in our oil supply. It is not a long-term solution. It is crisis insurance. Similarly, cutting the deficit would give us a strategic fiscal reserve.

Inapplicable concept with a non-convertible currency and floating fx.

Should bowling allies carry a reserve of ‘score’ to make sure you get your score if you knock the pins down???

Without it, the country must either raise taxes to deal with a crisis or else significantly increase the federal debt burden, which already totals almost $80,000 for every household in America.

So???

The third risk of today’s fiscal irresponsibility is the negative impact it has on our international position both economic and, potentially, geopolitical. Our economic position is seriously undermined by a low savings rate and the deficit is like an anchor that drags our national savings rate down.

Not the ‘national savings’ rhetoric again!!!

That’s a gold standard construct. Back then, when the US went into debt, it was obligated to repay in gold certificates and ultimately gold itself.

Borrowing was getting short gold and/or depleting our gold reserves.

Our national savings was defined as our gold reserves.

This is ALL no longer applicable and no longer presents a fiscal constraint.

We need to get our low savings rate up.

Inapplicable.

One of the stated goals of the big tax cuts the president pushed through a compliant GOP Congress including dividend tax cuts, capital gains tax cuts, estate tax cuts, and top-bracket income tax cuts was to increase incentives for high-income people to save. On the most practical level imaginable, this policy call it Supply Side 101 has failed. The savings of high-income people have not increased dramatically, certainly not enough to offset the plunge in the national savings rate that the big Bush deficits represent (because a nation’s savings rate combines personal, corporate, and government savings). For a country to maintain investment by entrepreneurs and companies when there is not enough domestic capital to be had.

Savings is not ‘domestic capital to be had’

He is shamelessly mixing metaphors.

Loans create deposits. Capital grows endogenously. He should know that.

it must by necessity borrow from abroad.

Wrong. Loans create deposits. Not the reverse as he implies.

It is a good sign for the economy that our investment rate the part of GDP spent on machinery, capital, buildings, factories, and the like has finally recovered from the recession of the early 2000s.

Due to the $700 billion fiscal shift from surplus to deficit.

But because that investment has been coupled with low national savings, the United States has had to borrow an astounding amount of money from foreign countries.

He has the causation backwards.

Domestic credit creation funds foreign savings, not vice versa.

Treasuries alone increased $1.2 trillion dollars in the first five years of the Bush administration, after falling more than $200 billion in the last two and a half years of the Clinton administration. Most often it is foreign governments and central banks that own our debt. That is what raises the potential threat to America’s geopolitical position.

How??? The risk is theirs, not ours!

It is certainly less concrete than the impact on the savings rate, but the impact of borrowing on America’s geopolitical posture might be important in the event of a crisis. Because America has had to borrow from abroad,

It doesn’t ‘have to’ at all. There is no such thing, as above.

it has ended up owing a great deal of money to governments whose interests do not always mesh with our own. Our government owes China some $350 billion, for example, and we owe oil exporting countries such as Saudi Arabia, Libya, Algeria, Venezuela, and Qatar a combined $100 billion more.

That’s their problem, not ours. We already got the real goods and services from them. They are holding undefined ‘paper’.

Most of the time, it does not matter who holds a country’s debt. Investors around the world, no matter who they are, simply respond to market forces. But in times of crisis, if investors happen to be the governments and central banks of other countries as is predominantly the case today with U.S. debt then lenders can have inordinate influence over a borrower’s international policies.

Hard pressed to find an example if he uses this one:

Take one example from our own history: the Suez crisis of 1956. Britain which was heavily indebted to the United States joined with France and Israel in an invasion of Egypt after Egypt’s president, Gamel Abdel Nasser, nationalized the Suez canal. The Eisenhower administration, which had lambasted the Soviet Union’s invasion of Hungary that same year, was determined to keep its anti-colonial credentials intact by opposing the British-French venture. The United States refused to float its World War II ally further loans to support their currency and even threatened to dump its holdings to precipitate a currency crisis. The British, desperate to avoid a devaluation of the pound.

There’s the rub – they had a fixed exchange rate they wanted to support.

With floating fx, this isn’t the case:

caved in, and the Suez misadventure heralded the end of European colonialism in the Arab world. Could other countries exercise the same kind of economic leverage over the United States? Hopefully, we are a long way from having that sort of situation in reverse where our foreign policy goals are stymied because of financial pressures from our debt holders but it is not inconceivable that we would be forced to choose between our geopolitical goals and financing the debt we owe foreign countries.

It should be inconceivable because it is inapplicable with floating fx.

This debt is primarily owned by governments with political motives, not just economic ones. If these governments decided to dump U.S. treasuries, we could plunge into crisis mode. Since there is not enough domestic savings to cover our investment, either our investment rate would need to fall, or interest rates might need to shoot up in order to attract capital from somewhere else.

There is no imperative to ‘attract foreign capital’.This is just plain wrong..Maybe for inflation, but he never goes there.

This is just plain wrong.

Either way, it would be bad news for the U.S. economy.

Maybe for inflation, but he never goes there.

Further, as the risks associated with our accumulating debt grow, oil exporting countries will be tempted to sign their contracts in euros or yen rather than dollars, as they do now.

Doesn’t matter; it’s just a numeraire.

If that happens, then anything that devalues the dollar including policy initiatives designed to reduce the trade deficit will directly increase the price of energy rather markedly.

Saudis are price setters in crude for other reasons – that’s the source of crude price hikes.

Given the hazards of continuing down the current path of fiscal excess, Congress should act soon to get things under control. That does not mean immediately balancing the budget by draconian cuts to necessary investments. Small deficits say on the order of 1 percent of will not run the economy into the ground and occasional big expenses on emergencies like Hurricane Katrina are a fact of modern life.

Too small to sustain aggregate demand. Probably need around 5% deficits from the evidence of the last twenty years.

But we know that entitlement spending will grow dramatically in the next 20 years and we need to make space in the trunk for a few very large suitcases, as it were. We should not be filling up the space before those bags even arrive.

Inapplicable.

The debt our generation accumulates becomes part of the legacy we leave to the next generation. The “greatest generation” that fought WWII sacrificed a great deal for the next generation for us, their children and grandchildren. Not only did some give their lives, but over the next 20 years they largely paid off all of the massive debt they had to accumulate during the war.

We’ve averaged 3-5% deficits for a long time which have supported growth and employment, and avoided a depression.

At the end of the war, America’s debt exceeded its entire GDP. By the Kennedy administration, the ratio was back down to the same level it was before the war.

But the nominal amount continued to grow, and when it didn’t, the economy suffered.

Opportunity, not debt, was the legacy our grandparents wanted to leave behind....

Warren Mosler, from a talk in Chianciano, Italy, on January 11, 2014 entitled Oltre L’Euro: La Sinistra. La Crisi. L’Alternativa.

I just want to say a quick word about what a good economy is because it’s been so long since we’ve had a good economy. You’ve got to be at least as old as I am to remember it. In a good economy business competes for people. There is a shortage of people to work for business. Everybody wants to hire you. They’ll train you, whatever it takes. They hire students before they get out of school. You can change jobs if you want to because other companies are always trying to hire you. That’s the way the economy is supposed to be but that’s all turned around. For one reason, which I’ll keep coming back to, the budget deficit is too small. As soon as they started tightening up on budget deficits many years ago, we transformed from a good economy where the people were the most important thing to what I call this ‘crime against humanity’ that we have today…….

So what you do is you target full employment, because that’s the kind of economy everybody wants to live in. And the right size deficit is whatever deficit corresponds to full employment….

US Macro Update

So looks to me like it’s all gone bad since the oil price crash, exactly as feared, and the Atlanta Fed most recently lowered it’s Q1 GDP estimate to 0.

First, a quick review of the accounting.

GDP = spending = sales = income

An increase in spending = an increase in sales = an increase in income.

And, on a look back, as a point of logic, is this critical, fundamental understanding:

For every agent that spent less than his income (aka demand leakages) another must have spent more than his income (aka deficit spending/spending from savings) or that much output would not have been sold.

And this also means that to sustain last year’s rate of GDP growth, all the sectors on average need to grow at least at the same rate as last year, and higher if GDP growth is to increase.

Next, in that context, a quick look back at the last few years.

When stocks fell after the 2012 Obama reelection I called it a buying opportunity, as I saw sufficient total deficit spending along with sufficient income growth for additional private sector deficit spending that I thought would support maybe 4% GDP growth.

But that changed when we were allowed to at least partially go over what was called ‘the fiscal cliff’ with the expiration of my (another story) FICA tax cut and some of the Bush tax cuts amounting to what was then estimated to be a $180 billion tax hike- the largest in US history. And the sequesters about 4 months later cut about 70 billion in spending. That all lowered my GDP estimate by that much and more, and I began referring to a macro constraint that would keep an ever declining lid on GDP.

The fundamental problem was that govt, the agent that was spending more than its income to offset the demand leakages, had suddenly removed that support, and I didn’t see any other agent stepping up to the plate or even capable of stepping up to the plate to increase his deficit spending to replace it. Historically it would be housing and cars, but with the income cuts from the decrease in govt net spending I didn’t see those sectors sufficiently increasing private sector deficit spending.

So GDP growth was lower than expected in 2013, and even what we had towards the end of the year looked bogus to me, including the mainstream claiming the rise in inventories this time was a good thing, not to be followed by reduced production, as it meant there were high sales forecasts and it all would be self sustaining. I thought otherwise and wrote about heading to negative growth by year end.

And in fact Q1 2014, originally forecast to grow at about 2%, was first released as positive before being subsequently revised down to less than -2%, with maybe 1% of that drop due to cold weather. At that point I continued to not see any source of deficit spending to offset the demand leakages that were dragging down the economy.

However, what I completely missed in early 2014 was the increase in deficit spending underway in the energy sector as new investment chased $90 crude prices. I knew crude production was expanding, and likely to grow by maybe a million barrels/day or so, but I didn’t realize the magnitude of the rate of growth of that capital expenditure until after prices collapsed several months ago and economists started estimating how much capex might be lost with lower prices.

It was then I realized that the energy sector had been the mystery source of the growth of deficit spending that had been offsetting the drop in govt deficit spending, and thereby supporting the positive GDP prints that otherwise might have gone negative much sooner, and that the end of that support was also the end of positive GDP growth.

So here we are, with Q1 GDP forecasts all being revised down after Q4 was also revised down, as all the charts are pointing south, and all are in denial that it is anything more than a random blip down as happened last year in Q1, along with the pictures of houses and cars covered in snow, as forecasts for Q2 and beyond remain well north of 2%.

But without some agent stepping up to the plate to replace the lost growth in energy CAPEX that replaced the lost govt deficit spending, all I can see is the automatic fiscal stabilizers- falling tax revenues and rising unemployment comp- as the next source of deficit spending that eventually reverses the decline.

FX Update:

The euro short/underweight looks to me to be the largest short of any kind in the history of the world. The latest reports confirmed large scale global central bank portfolio shifting out of euro both through historically massive active selling, as well as passively as valuations changed relative weightings. And at the same time, the speculation and portfolio shifting that drove the euro down resulted in the real global economy selling local currencies to buy euro to use to purchase real goods and services from the EU. In other words, the falling euro has supported a growing EU current account surplus that’s removing net euro financial assets from the global economy.

The portfolio shifting has been driven by fundamental misconceptions that include the belief that

1. The old belief that lower rates from the ECB are an inflationary bias and therefore euro unfriendly.

2. The old belief that QE is an inflationary bias and therefore euro unfriendly:

3. The belief that Greek default is euro unfriendly.

4. The new belief that the EU current account surplus creates a domestic savings glut that is euro unfriendly.

The operational facts are the opposite:

1. Lower rates paid by govt reduce net euro financial assets in the economy while net govt spending is not allowed to increase, the net of which functionally is a tax on the economy and euro friendly.

2. QE merely shifts the composition of euro deposits at the ECB while (modestly) reducing interest income earned by the economy and increasing ECB profits that get returned to members to contribute to deficit reduction efforts and not get spent, the net of which is functionally a tax on the economy and euro friendly.

3. Greek bonds are euro deposits at the ECB that are reduced by default, thereby acting as a tax on the economy and euro friendly.

4. The EU current account surplus is driving by non residents buying real goods and services from the EU which entails selling their their currencies and buying euro used to make their purchases, which is euro friendly.

So it now looks to me like the portfolio shifting has run its course as the EU current account surplus continues to remove euro from the global economy now caught short. This means the euro is likely to appreciate to the point where the current account surplus reverses, and since the current account surplus is not entirely a function of the level of the euro, that could be a very long way off. Not to mention that as EU exports soften additional measures will likely be taken domestically to lower costs to enhance competitiveness, which will only drive the euro that much higher.

Introduction

I reject the belief that economy is strong and operating anywhere near full employment. I also reject the belief that a zero-rate policy is inflationary, supports aggregate demand, or weakens the currency, or that higher rates slow the economy and reduce inflation. Additionally, I reject the mainstream view that employment is materially improving, the output gap is closing, and inflation is rising and returning to the Fed’s targets.

What I am asserting is that the Fed and the mainstream have it backwards with regard to how interest rates interact with the economy. They have it backwards with regard to both the current health of the economy and inflation, and, therefore, their discussion of appropriate monetary policy is entirely confused and inapplicable.

Furthermore, while I recognize that raising rates supports both aggregate demand and inflation, I am categorically against raising rates for that purpose. Instead, I propose making the zero-rate policy permanent and supporting demand with a full FICA tax suspension. And for a stronger price anchor than today’s unemployment policy, I propose a federally funded transition job for anyone willing and able to work to facilitate the transition from unemployment to private sector employment. Together these proposals support far higher levels of employment and price stability.

So when is the appropriate time to raise rates? I say never. Instead, leave the fed funds rate at zero, permanently, by law, and use fiscal adjustments to sustain full employment.

Analysis

My first point of contention with the mainstream is their presumption that low rates are supportive of aggregate demand and inflation through a variety of channels, including credit, expectations, and foreign exchange channels.

The problem with the mainstream credit channel is that it relies on the assumption that lower rates encourage borrowing to spend. At a micro level this seems plausible- people will borrow more to buy houses and cars, and business will borrow more to invest. But it breaks down at the macro level. For every dollar borrowed there is a dollar saved, so any reduction in interest costs for borrowers corresponds to an identical reduction for savers. The only way a rate cut would result in increased borrowing to spend would be if the propensity to spend of borrowers exceeded that of savers. The economy, however, is a large net saver, as government is an equally large net payer of interest on its outstanding debt. Therefore, rate cuts directly reduce government spending and the economy’s private sector’s net interest income. And looking at over two decades of zero-rates and QE in Japan, 6 years in the US, and 5 years of zero and now negative rates in the EU, the data is also telling me that lowering rates does not support demand, output, employment, or inflation. In fact, the only arguments that they do are counter factual- the economy would have been worse without it- or that it just needs more time. By logical extension, zero-rates and QE have also kept us from being overrun by elephants (not withstanding that they lurk in every room).

The second channel is the inflation expectations channel. This presumes that inflation is caused by inflation expectations, with those expecting higher prices to both accelerate purchases and demanding higher wages, and that lower rates will increase inflation expectations.

I don’t agree. First, with the currency itself a simple public monopoly, as a point of logic the price level is necessarily a function of prices paid by government when it spends (and/or collateral demanded when it lends), and not inflation expectations. And the income lost to the economy from reduced government interest payments works to reduce spending, regardless of expectations. Nor is there evidence of the collective effort required for higher expected prices to translate into higher wages. At best, organized demands for higher wages develop only well after the wage share of GDP falls.

Lower rates are further presumed to be supportive through the foreign exchange channel, causing currency depreciation that enhances ‘competitiveness’ via lower real wage costs for exporters along with an increase in inflation expectations from consumers facing higher prices for imports.

In addition to rejecting the inflation expectations channel, I also reject the presumption that lower rates cause currency depreciation and inflation, as does most empirical research. For example, after two decades of 0 rate policies the yen remained problematically strong and inflation problematically low. And the same holds for the euro and $US after many years of near zero-rate policies. In fact, theory and evidence points to the reverse- higher rates tend to weaken a currency and support higher levels of inflation.

There is another aspect to the foreign exchange channel, interest rates, and inflation. The spot and forward price for a non perishable commodity imply all storage costs, including interest expense. Therefore, with a permanent zero-rate policy, and assuming no other storage costs, the spot price of a commodity and its price for delivery any time in the future is the same. However, if rates were, say, 10%, the price of those commodities for delivery in the future would be 10% (annualized) higher. That is, a 10% rate implies a 10% continuous increase in prices, which is the textbook definition of inflation! It is the term structure of risk free rates itself that mirrors a term structure of prices which feeds into both the costs of production as well as the ability to pre-sell at higher prices, thereby establishing, by definition, inflation.

Finally, I see the output gap as being a lot higher than the mainstream does. While the total number of people reported to be working has increased, so has the population. To adjust for that look at the percentage of the population that’s employed, and it’s pretty much gone sideways since 2009, while in every prior recovery it went up at a pretty good clip once things got going:

The mainstream says this drop is all largely structural, meaning people got older or otherwise decided they didn’t want to work and dropped out of the labor force. The data clearly shows that in a good economy this doesn’t happen, and certainly not to this extreme degree. Instead what we are facing is a massive shortage of aggregate demand.

Conclusion

There is no right time for the Fed to raise rates. The economy continues to fail us, and monetary policy is not capable of fixing it. Instead the fed funds rate should be permanently set at zero (further implying the Treasury sell only 3 month t bills), leaving it to Congress to employ fiscal adjustments to meet their employment and price stability mandates.

The Fed did not raise rates because the FOMC concluded this was not the time to remove accommodation.

I agree this is not the time to remove accommodation. But I do not agree lower rates and QE are accommodative.

Changing rates shifts income between borrowers and savers, and with the federal debt just over 100% of GDP, the state is a large net payer of interest to the economy. So lowering rates reduces interest income paid by the state to the economy. Therefore that aspect of lowering rates imparts a contractionary bias and, yes, raising rates would impart an expansionary bias. In other words, the Fed has the ‘easing’ and ‘tightening’ thing backwards, and if it wants to impart an expansionary and inflationary bias a rate increase would be in order.

Paying more interest, however, does have distributional consequences, as the additional income paid to the economy goes to those holding government securities. Alternatively, a fiscal adjustment (tax cut and spending increase) directs additional spending power to other constituencies. So the remedies for a weak, deflationary outlook come down to some combination of rate hikes, tax cuts, or spending increases.

And given those choices, I think most of us would vote to leave rates at 0 and either cut taxes or increase public spending.

Additionally, the rate selected by the Fed translates into the term structure of prices presented to the economy, as forward pricing is necessarily a function of Fed rate policy. So in that sense, the term structure of rates put in place by Fed policy *is* the rate of inflation presented to the economy at any point in time.

Let me also add that setting a range for fed funds rather than a single interest rate gives the appearance of ignorance. A combination of paying interest on reserves and a few (reverse) repurchase agreements to pay interest on any residual funds not subject to interest on reserves would both do the trick and improve the optics.

And as for QE, the Fed buying secs is functionally identical to the tsy never having issued them, and instead letting tsy payments remain as reserve balances. That is, QE shifts duration but not quantity, and there is little to no evidence that shifting duration has a material effect on aggregate demand, inflation, or employment.

So while QE is just a placebo, like any placebo, it does impact the decisions of portfolio managers, corporations, central bankers, etc. who believe otherwise.

STAFF ANALYSIS OF THE CONGRESSIONAL BUDGET OFFICE’S BUDGET AND ECONOMIC OUTLOOK, 2015–2025 “Political differences shouldn’t prevent us from taking bold, decisive action to address America’s dire financial outlook.

Yes, there is an acute shortage of available desired savings as indicated by the slack in the labor market.

Republicans and Democrats agree that being $18 trillion in debt today and facing the prospect of spending more than $800 billion a year on interest payments alone does not lend itself to a prosperous future for our country.

We don’t agree. A prosperous future is not a function of said forecast interest payments.

CBO’s numbers only reinforce this notion.

To the contrary, the inflation forecast and growth forecast together indicate the deficit forecast is far too low-given current institutional structure- to accommodate the nations savings desires, and as a consequence aggregate demand falls short of full employment levels.

The longer we postpone reforms and put off making tough decisions, the deeper the hole we have to climb out of. Let’s not miss the opportunity before us to start down a new path and address our problems head on.”

I agree, the problem of inadequate aggregate demand should be addressed head on, immediately, and decisively with an immediate fiscal expansion- tax cuts and/or spending increases. There is no time to waste as we are sacrificing yet another generation of young Americans on the alter of failed austerity.

– Chairman Mike Enzi “America remains on a financially unsustainable path that threatens the future stability, security, and prosperity of our economy.

The idea of financial sustainability with a non convertible currency, floating exchange rate policy is entirely inapplicable.

What is threatening the future is a deficit that’s far too small to accommodate our savings desires, as evidenced by the low inflation forecast and the low participation rates.

Interest on the debt alone will consume $5.6 trillion of federal spending over the next decade.

This interest is paid routinely by the Fed by simply crediting the appropriate member bank’s reserve account at the Fed.

There are no grandchildren or taxpayers in sight when this routine accounting entry take place.

We have a duty to prevent a clear and present danger, and that means we must take steps now to balance the budget.” – Sen. Jeff Sessions “The new projections released by the CBO should serve as a stark reminder that our country is on an unsustainable economic path. The longer we wait to act, the more difficult it will become to put in place real reforms to control spending and reduce our over $18 trillion national debt.

It is a fact, not theory, that those $18 trillion of net financial assets held by the global economy as ‘savings’ is far less than the desired net savings as evidenced by the unemployment rates and labor participation rates, and an immediate fiscal expansion- lower taxes and/or higher spending- is in order.

This dangerous level of debt remains a drag on the economy and job growth and will only worsen over time if Washington continues to irresponsibly add to the credit card.” – Sen. Mike Crapo “This latest CBO report indicates that we’re headed down an unsustainable path that will put a damper on economic growth and hurt American workers.

Nothing could be further from the truth. When govt cuts taxes and/or increases spending every professional economic forecaster paid to be right increases his GDP estimate and lowers his unemployment forecast.

When a nonpartisan organization like the CBO says that Americans will pay more taxes yet our deficits will rise, something needs to be done.

Yes, we need an immediate tax cut and/or spending increase.

It’s crucial that we get our spending and deficits under control so we can grow our economy and give job creators the certainty they need to expand and hire more workers.” – Sen. Rob Portman “With $18 trillion in debt and the growth of entitlement programs skyrocketing, it is clear the federal government’s current fiscal path is unsustainable. A sluggish economy makes the problem even worse. CBO has warned that this situation could persist if no action is taken.

True! Without an immediate tax cut and/or spending increase the economy will continue to under employ and under pay the American people.

Controlling debt requires making smart choices on spending as well as enacting policies that encourage stronger economic growth.” – Sen. Roger Wicker “I didn’t come to Washington to sit idly by as lawmakers in both parties pretend the deficit is shrinking and that our national debt is not a concern.

True, he came to Washington with no clue as to the functioning of today’s monetary system.

We have a genuine fiscal crisis on our hands. We’re already handing our kids and grandkids a national debt of over $18 trillion and tens of trillions of dollars of unfunded liabilities for entitlement programs. The latest CBO report shows that the deck is stacked to get even worse.

No, in fact their 2% long term inflation forecast is evidence that the built in spending is insufficient to keep the US running at anywhere near full capacity.

We need a sense of urgency to seriously tackle our national debt because of the threat it poses to our economy and national security. As a member of the Budget Committee, I look forward to working with Senate Budget Chairman Mike Enzi and House Budget Chairman Tom Price in the pursuit of a budget that reflects the tough decisions necessary to eliminate wasteful spending, prioritize our resources, and grow the economy.” – Sen. David PerdueSummary CBO projects that the government will collect $3.2 trillion in revenue and spend $3.7 trillion this year, resulting in a deficit of $468 billion in FY 2015 ($15 billion less than recorded in the prior year). Based on current law, CBO projects that the country’s fiscal situation will remain relatively stable for the next few years. After FY 2019, however, CBO projects steadily increasing levels of deficits, debt, and interest payments. By the last year of the budget window, FY 2025, deficits will again surpass the $1 trillion mark, debt held by the public will reach $21.6 trillion, and a single year’s interest payments will total $827 billion.

And the inflation and employment forecasts show that isn’t nearly enough to be adding to savings to support our economy at full employment levels.

According to CBO, federal outlays will total $3.7 trillion in FY 2015, or 20.3 percent of GDP— slightly higher than the 20.1 percent 50-year historical average. Federal outlays are expected to grow to reach $6.1 trillion, or 22.3 percent of GDP by FY 2025, while revenues are expected to remain steady at about 18 percent of GDP. Spending is projected to increase by 2 percentage points of GDP over the budget window. Mandatory spending (primarily Social Security and health care spending) will account for 1.7 percentage points of the increase; net interest costs will contribute another 1.7 percentage points; and discretionary spending will account for a reduction of 1.4 percentage points. CBO projects federal revenues will total $3.2 trillion in FY 2015, or 17.7 percent of GDP—slightly above the 50-year historical average of 17.4 percent. Under current law, total revenues will rise significantly in 2016 to $3.5 billion (18.4 percent of GDP) due mainly to the expiration of business tax provisions that were allowed to lapse at the end of calendar year 2014. After FY 2016, revenue collections will remain steady at approximately 18.1 percent of GDP throughout the duration of the forecast period. In total, over the 10-year budget horizon (FY 2016–2025), CBO expects the federal government will collect $41.7 trillion in revenue. Deficits Over the period FY 2016–2025, annual spending will outpace tax collections by a cumulative total of $7.6 trillion.For the budget year (FY 2016), CBO projects a deficit of $467 billion. Spending will total $3.9 trillion, while revenues total $3.5 trillion. Deficits will begin to climb after FY 2016, reaching $1.1 trillion by FY 2025. Deficits will remain relatively flat at around 2.5 percent of GDP from FY 2015 through FY 2018 (slightly below the 50-year average of 2.7 percent of GDP), then rise steadily to 4 percent of GDP by FY 2025. Debt And Interest CBO projects that debt held by the public will follow a similar path as deficits, remaining relatively stable at about 74 percent of GDP in the near term and then rapidly growing to nearly 79 percent of GDP by FY 2025. In dollar terms, debt held by the public would increase from $13.4 trillion in FY 2015 to $21.6 trillion in FY 2025, a nearly 62 percent increase. CBO notes that while the federal debt increase over the projected window seems modest, it is already high by historical standards—with debt remaining greater relative to GDP than at any other time since the years immediately following World War II.Gross debt, which includes Treasury securities held by federal trust funds, will also continue to rise according to CBO. By the end of FY 2015, CBO projects a gross debt of $18.5 trillion. This number will grow to $27.3 trillion by the end of FY 2025, an increase of 47.7 percent. Gross debt grows less rapidly than public debt because Social Security begins redeeming bonds at a rapid rate toward the end of the projection period.

Yes, and the 2% inflation forecast indicates all of this fall short of providing the savings needed for our economy to sustain full employment.

According to CBO, carrying these high levels of debt has negative consequences for the federal budget and the U.S. economy, including increased government borrowing crowding out private borrowing and leading to increased costs of borrowing for businesses

That applies only to fixed exchange rate regimes. It is entirely inapplicable to the US with our floating exchange rate policy, as history has clearly demonstrated.

limits to the ability of the government to respond to crises with tax and spending policies,

Any such limit is by political decision, and not an operational constraint with todays floating exchange rate policy.

and increased interest payments.

Yes, which are simply a credit to a member bank account by the Fed.

The federal government is expected to spend $227 billion on interest payments in FY 2015, or about 1.3 percent of GDP. These interest payments will increase to $827 billion (3 percent of GDP) by FY 2025, an increase of 264 percent. These interest costs, a product of continuing to carry such a high debt burden, will put a strain on federal resources and begin to crowd out other priorities.

Interest payments are a matter of the Fed crediting a member bank account. The notion of a strain on federal resources’ is entirely inapplicable. And, in fact, even with those interest payments inflation is forecast at only 2% indicating there is no forecast of excess spending per se.

Enough???

Question: What do the president, the party leaders, all members of Congress, all the headline economists (both hawks and doves), the entire Federal Open Market Committee, and just about everyone else apart from Modern Monetary Theory (MMT) proponents agree on?

Answer: They all agree the U.S. has a long-term deficit problem. Therefore they all agreed to let the FICA tax holiday expire at the end of last year without any discussion, just as they let the sequester go into effect March 1 with no serious discussion.

Together these fiscal adjustments reduce the U.S. economy's income and savings by about $5 billion per week, reducing sales, output, and employment accordingly from where it would have been otherwise, which also increases the risk of aborting a fledgling private sector credit expansion, which would further hurt the economy.

And what have they gained by the pain inflicted by this proactive deficit reduction policy? Absolutely nothing of value. The 'national debt' is nothing more than a bunch of dollars balances in savings accounts' at the Federal Reserve Bank better known as 'Treasury securities.' These 'securities accounts,' as insiders call them, along with checking accounts at the same Federal Bank (called 'reserve accounts') and the actual cash in circulation constitute the total net dollar savings of the global economy, to the very penny. When the U.S. government spends more than it taxes, those extra dollars it spent first go into our checking accounts, and then some gets exchanged for actual cash as needed, and some goes into those savings accounts at the Fed called Treasury securities.

So how is 'all that debt' paid off? When Treasury securities are due, the Fed simply shifts the dollars from those savings accounts at the Fed to checking accounts at the Fed. That's all! And this is done for tens of billions every month. The debt is paid off by a simple debit and credit on the Fed's books. There are no grandchildren or taxpayers in sight -- they would only be getting in the way. There is no such thing as leaving our debt to our grandchildren!

What if no one buys 'the debt'? In other words, what if no one wants to shift their dollars from checking accounts to savings accounts at the Fed? Who cares! The dollars can just sit in the checking accounts (and earn a little less interest).

What about interest rates? The Fed meets and votes on the interest rates it wants the government to pay on those extra dollars it created and put into checking and savings accounts by deficit spending. 'Market forces' don't grab Chairman Bernanke's arm and raise it to vote for higher rates. The level of rates paid by our government is entirely a political decision. The Fed has the tools to set both short- and long-term rates at any level it votes to implement.

Think of it this way. Congress has appointed the Fed as scorekeeper for the dollar. And just like any other scorekeeper it neither has nor doesn't have any dollars. It just has a 'scorecard' -- a giant spreadsheet -- with all of our bank accounts tied to it. It spends by changing numbers in our bank's accounts to higher numbers, and it taxes by changing numbers in our bank's accounts to lower numbers. Notice that the federal government therefore doesn't actually 'get' anything when it taxes or 'use up' anything when it spends.

Think of federal spending as printing dollars, and taxing as 'unprinting' dollars, which means there is no such thing as the federal government running out of dollars. And it means we can't 'become Greece' the way a U.S. state, corporation, or individual that doesn't spend by 'printing' can 'become Greece' and go broke. So if the U.S. can't run out of dollars, it is not leaving debt to the grandchildren, and it can never become Greece.

So you may ask, "Why not just go and spend like crazy and not tax at all?" In other words, what is the actual risk of too much deficit spending? How do we know if we have a long-term deficit problem or not?

The good news is the world is chock full of credible, professional inflation forecasters who are paid to be right (not the fear mongering sensationalists shamelessly making wild, unsupported claims with no need to be right) and do a pretty good job of getting it right. And what were they saying about inflation before deficit reduction? The Fed had a 2 percent long-term inflation forecast and most all the others were pretty close to that. And the longer term U.S. Treasury inflation indexed securities also were presuming very low rates of inflation.

This means, even before any deficit reduction measures were taken, there was no long-term deficit problem!

And there still is no long-term deficit problem!

And wouldn't you think that at a minimum, before cutting the military, Social Security, and Medicare, the burden of proof would be on those claiming a long-term deficit problem?

But no, even without a long-term inflation problem, paradoxically, the burden of proof is on those claiming there is no long-term deficit problem, as we continue to destroy our economy and our civilization.

The graph below by Professor Stephanie Kelton sums it up. It shows that for the U.S. domestic private sector to carry a positive balance, the government must in effect carry a negative balance. A balanced budget, such as achieved by President Clinton, simply does not work. With Congress taking this budget cutting, balanced budget path, the one with one eye in the land of the blind becomes king.

Saudis remain price setter:

Main theme: deflationary biases

Greece is a deflationary event, as EU aggregate demand is further restricted, with no sign of any possibility of fiscal relaxation.

Oil fell as Saudis increased discounts, further reducing global capex and related asset prices.

US oil production that gets sold counts as GDP, and for Q3 both production and prices look to be lower. Yes, the lower price also reduces the deflator, but the fall in the price of oil relative to other prices reduces GDP.

The decline in oil prices has also directly lowered income earned from oil sales, royalties, etc. plus ‘multipliers’ as that lost income would have been ‘respent’ etc. This loss has been at least 1% of GDP and completely ignored by analysts who have been over forecasting growth by several % since oil prices declined.

And the more than 50% decline in drilling due to the lower prices = declining production as oil (and gas) output from existing wells declines over time. This means both less GDP and higher imports, a negative bias for the dollar.

Trade flows remain euro friendly and are taking over the price action, and trade will continue to put upward pressure on the euro until the trade surplus is reversed.

The stronger euro vs the dollar initially helps US stock psychology via earnings translations, etc. but hurts euro zone stocks, exports, GDP, etc. reversing this year’s growth forecasts. And a weaker euro zone economy is also a negative for the US.

Oil capex is down and not coming back until prices rise, and the US budget deficit is down further as well, and I see nothing else stepping up to replace the reduced private and public deficit spending that was offsetting the demand leakages (unspent income) inherent in the institutional structure that grows continuously. So unlike last year, when oil capex did the heaving lifting, I expect any bounce in Q2 gdp from Q1 to be modest and transitory.

The Fed may raise rates some not because of the state of the economy, but due to fears that current policy somehow risks some kind of financial instability. No discussion, of course, that Japan has had a 0 rate policy for over 20 years with perhaps the highest level of financial stability in the history of the world, perhaps indicating that a 0 rate policy promotes financial stability…

Employment seems to have begun to decelerate as well, with fewer new jobs each month and claims beginning to rise.

Unlike the last recovery that ended suddenly with a financial crisis that cut off credit, this one is ending with a fall off in aggregate demand from oil capex due to the Saudis cutting oil prices, so the sequence of events has not been the same. But, as always, it’s just a simple unspent income story.

At the beginning of 2013 the US let the FICA tax reduction and some of the Bush tax cuts expire and then in April the sequesters kicked totally some $250 billion of proactive deficit reduction. This cut 2013 growth from what might have been 4% to just over half that, peaking in Q3 and then declining to negative growth in Q1, due to the extremely cold winter. Forecasts were for higher growth in 2014 as the ‘fiscal headwinds’ subsided. GDP did resume after the weather improved, though not enough for 2014 to look much different from 2013. And with the fall in the price of oil in Q4 2014, forecasts for Q1 2015 were raised to about 4% based on the ‘boost to consumers’ from the lower oil prices. Instead, Q1 GDP was -.7%. The winter was on the cold side and the consumer had been saving instead of spending the savings from lower gas prices. And the forecasts for Q2 were for about 4% growth based on a bounce back and consumers now spending their gas savings. Most recently Q2 forecasts have been reduced with the release of Q2 data.

My narrative is that we learned the extent of capex chasing $90 in Q4 after the price fell in half. It seemed to me then that it had been that capex that kept 2013 growth as high as it was and was responsible for the bounce from Q1 2014 as well as the continued positive growth during 2014 up to the time the price of oil dropped and the high priced oil related capex came to a sudden end.

By identity if any agent spend less than his income another must have spent more than his income or the output would not have been sold. So for 2012 the output was sold with govt deficit spending where it had been, and when it was cut by some $250 billion in 2013 some other agent had to increase it’s ‘deficit spending’ (which can be via new debt or via depleting savings) or the output would have been reduced by that amount. Turns out the increase in oil capex was maybe $150 billion for 2013 and again in 2014, best I can tell, and this was sufficient to keep the modest growth going while it lasted. And when it ended in Q4 that spending (plus multipliers) ended as well, as evidenced by the sudden decline in GDP growth. And so far the Q2 numbers don’t look like they’ve increased much, if any, since Q1. And to do so will take an increase in ‘borrowing to spend’ that I can’t detect. Of course, I missed the surge in oil capex last year, so there could be something this year I’m missing as well.

When oil prices dropped I pointed out three things-

1. Income saved by buyers of oil equaled income lost by sellers, so the benefit to total spending was likely to be small and could be negative, depending on propensities to save and to spend on imports. And yes, some of the sellers of oil were ‘non residents’, but that was likely to reduce US exports, and cuts in global capex could reduce US exports as well.

2. Lost capex was a direct loss of GDP, plus multipliers, both domestically and globally.

3. Deflation in general is highly problematic for lenders, and tends to reduce private sector credit expansion in general.

To me this meant the drop in oil prices was an unambiguous negative. And in the face of universal expectations (including the Fed) that it was a positive, which can be further problematic.

Euro Zone

Forecasts are for modestly improving growth largely due to the weak euro driving exports. However, the euro is down from massive foreign CB selling, probably due to fears of ECB policy and the Greek saga. This technical selling drove the euro down and the euro area 19 member current account surplus up, absorbing the euro the portfolios were selling. Once the portfolio selling subsides- which it will as euro reserves are depleted and short positions reach maximums- the trade flows continue, which then drives the euro up until those trade flows reverse. In other words, the euro appreciates until net exports decline and the anticipated GDP growth fades. And there is nothing the ECB can do to stop it, as rate cuts and QE works only to the extent it frightens portfolio managers into selling, etc.

Also, ironically, a Greek default would fundamentally strengthen the euro as Greek bonds are nothing more than euro balances in the ECB system, and a default is a de facto ‘tax’ that reduces the holdings of euro net financial assets in the economy, making euro that much ‘harder to get’ etc.

Back in November my forecast for 2013 was 4%, which at the time was by far the highest around. The govt was spending more than its income by about 6% of GDP, which was about $900 billion if I recall correctly. But then it cut back, first with the year end FICA hike along with other expiring tax cuts, and then with the sequesters that began in April.

Consequently, the govt spent only about $680 billion more than its income, which lowered growth by maybe 2%. And today mainstream economists are saying much the same- growth would have been maybe 2% higher without the ‘fiscal drag’ of the tax hikes and spending cuts.

So far our narratives are the same.

But here’s where they begin to differ.

They say the GDP/private sector would have grown by 4% if the fiscal drag hadn’t taken away 2%, and so without the govt again taking away 2%, the private sector will resume its ‘underlying’ 4% rate of growth.

I say the GDP/private sector would have grown by 4% that included the 6%/$900 billion net spending contribution by govt, if govt hadn’t cut back that contribution to $600 billion.

That is, they say the govt ‘took away’ from the ‘underlying’ 4% growth rate, and I say the govt ‘failed to add’ to the ‘underlying’ 2% growth rate that still included a 4% contribution by net govt spending.

And, in fact, I say that if the govt had cut its deficit another 4% to 0, GDP growth might have been -2% (multipliers aside for purposes of this discussion), which is the actual ‘underlying’ private sector growth rate. And that’s due to the ‘unspent income’ of some agents not being sufficiently offset by other agents ‘spending more than their income’.

Furthermore, I say that unless the ‘borrowing to spend’ of the ‘non govt’ sectors steps up to the plate to ‘replace’ the reduced govt contribution, the output won’t get sold, as evidenced by unsold inventory and declining sales in general, throwing GDP growth into reverse, etc.

So because we have different narratives, we read the same data differently.

They see the 1.7% Q3 inventory build as anticipation of future sales, while I see it as evidence of a lack of demand.

They see the Chicago PMI’s large spike followed by 2 months of decline as a strong 3 month period, while I see it as a sharp fall off after the inventory build.

They see the fall off in mortgage purchase apps as a temporary pause, while I see it as a disturbing fall off in the critical ‘borrowing to spend’ growth maths.

They see October’s shut down limited 15.2 million rate of car sales followed by November’s spike to 16.4 million as a return of growth, while I see the two month average a sign that growth has flattened in this critical ‘borrowing to spend’ dynamic.

And likewise with the weakness in the Pending Home Sales, Credit Manager’s Index, Architectural billings, down then up durable goods releases, new home sales, the slowing rate of growth of corporate profits, personal income, etc. etc.

And they see positive survey responses as signs of improvement, while I see them as signs they all believe the mainstream forecasts..

;)

And not to forget they see the increase in jobs as evidence of solid growth given the rapidly growing % of sloths, and I see it flat as a % of the population.

;)

Happy New Year/ La Shona Tova to all!!!

The budget deficit is now looking too small to sustain growth, as evidenced by the incoming data over the last 6 months. The problem is, as always, unspent income- aka demand leakages- must be offset by agents spending more than their incomes or the output goes unsold. And collapsing GDP growth and rising inventory ratios are telling me that’s it’s been happening ever since the price of oil collapsed, ending the shale related capex, with nothing yet stepping up to fill that spending gap.

At the same time, the Federal govt is going the other way as, reducing the amount that it’s spending in excess of taxation. Additionally, with the current tax structure, if there is any pick up in growth from private sector credit expansion it will cause the federal deficit to further decline, which will require that much more private sector deficit spending to support growth. That’s why the tax structure and transfer payment structure are called ‘automatic fiscal stabilizers’. And, of course, if the economy does stall, the Fed will get the blame for ending QE and more recently allowing longer term rates to rise….