2009 October 31 Saturday
Economy Switching To New Debt Addiction

Richard Cookson, global head of asset allocation at HSBC, gets to the heart of the matter: Federal Reserve and Executive Branch policy amounts to switching the economy from its private debt addiction to a substitute public debt addiction. Be sure to read the Waldman link too.

"The way to think of it is this: It's not a recovering economy, it's a cross-addicted economy," he told CNBC.

"In other words, all you've done is you've taken the private sector debt and you've bunged it into the public sector. That's all you've done. Now that's not a recovering economy, as it were in addictive parlance, but it's simply the fact that you've got a huge amount of money being whacked into economy."

If I thought they were doing this as a temporary measure to gradually wean the economy off its addiction to spiraling credit card, mortgage, and other private debt I wouldn't object. But Timothy Geither, Ben Bernanke, and company seem so focused on the short term that they are doing reckless things.

If Bill Gross is correct how do we adjust the economy to the end of the asset price inflation (he says appreciation) of recent decades? Again, keep reading down to the Waldman link.

Let me start out by summarizing a long-standing PIMCO thesis: The U.S. and most other G-7 economies have been significantly and artificially influenced by asset price appreciation for decades. Stock and home prices went up – then consumers liquefied and spent the capital gains either by borrowing against them or selling outright. Growth, in other words, was influenced on the upside by leverage, securitization, and the belief that wealth creation was a function of asset appreciation as opposed to the production of goods and services. American and other similarly addicted global citizens long ago learned to focus on markets as opposed to the economic foundation behind them. How many TV shots have you seen of people on the Times Square Jumbotron applauding the announcement of the latest GDP growth numbers or job creation? None, of course, but we see daily opening and closing market crescendos of jubilant capitalists on the NYSE and NASDAQ cheering the movement of markets – either up or down. My point: Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don’t go up – economies don’t do well, and when they go down, the economy can be horrid.

Now, you might wonder why this asset price inflation of recent decades. Steve Randy Waldman has a compelling explanation: The big asset price inflation was due to increasing inequality and the propensity of wealthy people to save and buy assets. Click thru and read this full article. Then tell me in the comments what do you think of his reasoning. Seems sound to me.

Whether an economy generates asset price inflation or consumer price inflation depends on the details of to whom cash flows. In particular, cash flows to the relatively wealthy lead to asset price inflation, while cash-flows to the relatively poor lead to consumer price inflation.

Why? In Keynesian terms, poorer people have a higher marginal propensity to consume. The relatively poor include people who are cash-flow constrained — that is they cannot purchase what they wish to purchase for lack of green, so their marginal dollar gets immediately applied to the shopping list. Also, poorer people may be different, there may be a correlation between poverty and disorganization, lack of impulse control, inability to defer gratification etc. Think of Greg Mankiw's Spenders/Savers model.

Less of economic growth was paid as wages. So more went to wealthier people and they used that increased income to buy assets such as stocks and property. Asset prices soared to the extent that monetary policy was expansive.

The wage share of GDP decreased significantly over the 1970s and 80s. Compensation did not decrease as much, but much of nonwage compensation is retirement savings that is saved rather than consumed.

The people who run the US Federal Reserve and other central bankers didn't see a problem since they only worry about consumer price inflation. They fail to recognize that inflation of housing, commercial buildings, and other assets is as important as inflation in the prices of consumer goods.

Why the blind spot when it comes to asset price inflation? When this happens people feel richer. When the cost of consumer goods goes up people feel poorer. Now, unless the real production of goods and services goes up as fast as asset prices the asset price increase is just an unsustainable inflation. The bubble will burst. The results (some of which we are seeing now) are not pretty.

Update: Meta Finance makes a very similar argument:

If the flood of liquidity provided by central bankers does not go into the labor market, then where does it go? Into asset markets. It is also no coincidence that the last few recessions and jobless recoveries have been followed by asset market bubbles, first in technology stocks, then in housing.

Thus the conventional wisdom, that China ‘exports deflation’ to the world, is only partly true. Over the last twenty-odd years, China has indeed exported deflation, but this has been concentrated in very specific segments of the economy: in the prices of retail goods, and in worker salaries. It so happens that these segments are precisely the ones captured in standard measures of consumer inflation. Central bankers, lulled by this quiescence in measured inflation, have time and again erred on the side of loose monetary policy, leading directly to the asset price bubbles that have done so much harm in recent years.

Right now Fed monetary policy is very expansionist. Unemployment is still dropping but the stock market has soared.

Share |      By Randall Parker at 2009 October 31 10:06 AM  Economics Business Cycle

Rob Black said at October 31, 2009 10:27 AM:

This is the ultimate apotheosis of the 'liberal' free-market paradigm pushed by Thatcher, Reagan, the WSJ. THe Economist magazine, and thusly became the prevailing economic orthodoxy of the past 30 years.
Basically, due to ideological fixation with 'free-trade', indusutrial production shifted to the far-east.Likewise uncontrolled mass third world immigration was lauded as'enriching'.
The middle and working clas were well and truly ass-raped by these policies - there incomes stagnated or declined, whilst the capitalist class (who have government in their pocket) thrived in inverse proportion.
- Blame those silly White, blue-collar cunts (baseball cap wearing, hunting and fishing types who take christianity seriously) who voted for that mega-cunt Reagan.
All Reagan did for them is to put up their daughters on the porn-stages of LA to be dick-stuffed big-time by multiple black mega-dicks in all orifices whilst baldy, impotent microphallic mega-rich bankers and lawyers called Morty salivate and insufflate (vampire fashion) at the sight of white flesh getting dick-torn.

DrAwkward said at October 31, 2009 12:53 PM:

Does the above comment meet the civility standards for this blog? Just a question...

Randall Parker said at October 31, 2009 1:24 PM:


I rarely delete comments, excepting spam with links to products and scams. I haven't come up with good rules for what to delete. Part of me wants the world to see what other people think. So for example, you can find lots of jihadists commenting in my old posts about Muslims. The people who get deleted out of conversations still exist. One argument I have with myself is that having such people interact with others might help correct erroneous thoughts. But I'm ambivalent about this.

I'm most tempted to delete comments that aren't even on topic. Occasionally someone shows up to rant on something unrelated to the post topic and I'll delete the comment.

Rob Black,

I am confused whether you think the white blue collar workers are contemptible or are being wronged. Or both? Or some are disgusting?

Your phallic imagery does not make your argument more persuasive. Plus, your argument isn't clear anyway. So even if someone was ready to be persuaded to which viewpoints are you trying to persuade them? That the blue collar workers can't be trusted with the vote? That even the middle class is voting against its interests?

Since low barriers to imports was promoted just as much by prominent Democrats such as Bill Clinton, Robert Rubin, Larry Summers, et. al. I think it is disproportionate to name just Reagan among the American political figure.

Mega-rich bankers: Are you quite sure they are poorly endowed?

Clarium said at October 31, 2009 1:38 PM:


Paul Craig Roberts does post about income inequality, and as a person who advocated supply side economics, he never did regret supporting the Reagan tax cuts in his writings. As a result, I put less blame on Reagan for the current predicament and blame it on neo-liberalism. One could argue that the Reagan tax cuts were the right perscription for the economy at that time, and argue that tax cuts were no longer needed during the Bush years. However, the internation pressure for low-taxes beyond the Reagan years are still there due to international competition for capital, while the Reagan tax cuts were motativated mainly be domestic considerations.

Well, one could make the argument that the post-Reagan democrats contributed more damage to the living standards of the working class than Reagan.

According to Larry Bartels, the middle class does vote against its interests. He makes the case with the issue of the Bush tax cuts; you can make a case on it regarding immigration. Regarding immigration, I do not think the working class "votes" against its own interests. As Bartels argue, the wealthy have a disportionate influence on politics so they can get immigration despite what the working class thinks.

Mthson said at October 31, 2009 3:29 PM:

"Part of me wants the world to see what other people think."

I find that interesting. One of the things I like about the internet is it makes more apparent just how unreasonable most humans are. Even if we tried to create a paradise that keeps out the crazies, a portion of our children would just be new crazies, or would exhibit regression toward the mean in other respects, like all the lazy children of driven people.

I think the only way out is neurotechnology and genetic technology to give the many the advantages of the few.

Clarium said at October 31, 2009 4:01 PM:

Randall, at least you said that a left-wing theory made sense as you cited in income inequality argument for boom-busts. Rarely Austrians (right-wing) acknowledge it, although it isn't mutually exclusive. I suppose embracing the left-wing model is a good idea for investment (as it gives one a contrarian perspective) since the right-wing Austrian model is now "consensus" among investors (just look at the comments on Seeking Alpha and Mish's site proudly proclaims its 29 million hits.)

As you know, one reason I call myself "Clarium" was to honor Peter Thiel's anti-immigration stance. Like Thiel, I do not like immigration. (Thiel is anti-immigration, not anti-immigrant as Gawker stated.)

Mercer said at October 31, 2009 6:42 PM:

Gross says at the start of his piece that growth based only on rising asset prices are an illusion - I agree. Then he says that they are "the actual growth rate of our economy" - I do not agree.

"Whether an economy generates asset price inflation or consumer price inflation depends on the details of to whom cash flows. In particular, cash flows to the relatively wealthy lead to asset price inflation, while cash-flows to the relatively poor lead to consumer price inflation."

I agree that poor people don't buy many stocks. I don't agree that people with income below the median don't buy many houses.

In the past decade production of consumer goods has shifted to China which has lower wages and no OSHA or EPA rules. Production of houses has stayed in the US with no reduction in EPA, OSHA or zoning regulations. China has also helped keep long term interest rate lows by buying massive amounts of treasury and agency bonds and this helped fuel rising home prices.

"Why the blind spot when it comes to asset price inflation?"

Greenspan screwed up. They were certainly economists like Robert Shiller who warned him.

I think that the political class has been promoting home ownership the wrong way. If they want promote it they should be trying to make homes cheaper not increase the amount of debt that people can get.

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