Saturday, September 27, 2008

The Bailout and the Deficit Recycling Loop

I’ve been thinking mostly about the global portion of the loop—how the dollars we send abroad on the current account (and now, just a bit, on net private capital outflows) are returned to us—and its operation under the Paulson plan. The Fed/Treasury team is proposing to allow this recycling to proceed under an asset cleansing program: the Fed removes the bad assets from our creditors’ portfolios while the Treasury replaces them with nice, reliable T-bills. (Metaphor: TARP as a giant mollusk in the sea of finance.) So far so good.

But this is only part of the picture. The other part is the domestic sector. Our current account deficit says that, as a country, we consume about 6% more than we produce, where “consume” in this context means total demand and not just the household piece of it. So the recycling process has to actually get the money into the hands of those who will spend it. This means credit expansion of some form. To be more specific, capital spending is very weak at present, and households are now holding up the tent. They have been borrowing against largely fictitious real estate equity and, to a lesser extent, running up credit cards and drawing down savings. If the popping of the housing bubble and the retrenchment of consumer credit mean that these channels are no longer available, how do we keep the engines running?

Basically, there are two channels still open: fiscal deficits and further drawdowns of savings. In the case of the former, it is important to be able to identify how the deficits will enter the spending stream. I worry that much of the eleven-figure disbursement will simply keep financial institutions, now highly risk-averse, afloat. This maintains existing wealth for the small minority that holds most of it, but it doesn’t translate into effective demand. And eating up savings can go only so far. Say what you want, the asset bubble(s) promulgated by earlier rounds of recycling at least propped up domestic spending. I worry that, even if the bailout keeps the global loop in operation, it will not be able to reconnect it to the domestic loop. The result will be a monster recession.

4 comments:

Myrtle Blackwood said...

"I worry that, even if the bailout keeps the global loop in operation, it will not be able to reconnect it to the domestic loop. The result will be a monster recession.

A prolonged recession with ongoing dependence on malfunctioning and irresponsible global corporations will not be an acceptable option.
That's where I think the ideas of Sandwichman will be very helpful. Limit the amount of time in the workforce but distribute the availability of paid work as evenly as is possible. This then frees up time and opportunity for households to be far more self-sufficient.

Provide government programs to create employment in the installation of passive solar technology to homes. Restructure agriculture to organic. Install public transport infrastructure etc. There's no shortage of rewarding and sustainable work.

Eleanor said...

(a) A monster recession is a depression.

(b) Savings? Whose savings? Do working Americans have a net worth at this point?

(c) How about we end both wars, cut military spending, tax the rich and invest in programs like the WPA, the CCC and the Apollo Alliance? (See Brenda above.)

(d) Given how insolvent the financial sector is, won't it be necessary to seize it at some point? I mean, it looks to me as if gazillions in fake wealth is going to have be bled out.

Anonymous said...

Or, the biggest 150 US-based corps can pony up some of the $500 billion in cash they're sitting on and hire people to grow their businesses. It's about time corporations had some skin in the game. Everybody else does.

Anonymous said...

You say the move "means credit expansion of some short". This is wrong. On the one hand you have private sector credit being deflated as consumers go into "balance sheet repair" mode and actually pay down debt rather than taking on more. Further, with consumer is no mode to spend, corporations also have no reason to borrow more and invest, because what is the point of investing when there the future outlook for your customer's spending is bleak. Then businesses start firing people as things get worse. More unemployed means less aggregate pvt income and people get more scared, hence they intensify their debt repayment and spend even less. In a few words, there is massive and continuous credit contraction going on, from the private sector. This suppresses the money supply and, if the government doesnt step in and replace the lost pvt sector demand for funds, by borrowing and spending itself, there is bound to be a massive drop in GDP and US standard of living. If, however, the government borrows and spends as much and for as long as the pvt sector pays down debt, then there is no credit expansion. And while this will no caus the economy to grow again, it WILL avert a massive collapse a-la 1930s.

Look at Japan after their RE and then equities bubble burrst. The Jpn government has been borrowing and spending for 15 years, turning japan from the worlds biggest creditor to one of the world's biggest debtor nations. Yet Japanese inflation has remained non-exhistent and credit expansion did not happen. Why? Because all this gverment borrowing and spending was barely enough to replace the losses from the provate sector side. Without this, the Japanese would have experienced a tremendous collapse