The L shaped recovery and a Bogus Debt Crisis

Our economy continues to scuttle across a bottom set by the huge drop in performance during the Great Recession. This economist was not surprised by the lackluster GDP report released today.  No one has used the correct fiscal policy prescription in this country since 1999.  The current batch of Washington nimrods are going to set us at a new low shortly.  We’ll be lucky to see nasty numbers like these a year from now.  It’s as if tanking the economy is job 1 now.

Gross domestic product climbed at a 1.3 percent annual rate following a 0.4 percent gain in the prior quarter that was less than earlier estimated, Commerce Department figures showed today in Washington. The median forecast of economists surveyed by Bloomberg News called for a 1.8 percent increase. Household purchases, about 70 percent of the economy, rose 0.1 percent.

Treasuries rose as the report dimmed prospects for faster growth in the rest of 2011. The faltering economy may get another blow from spending cuts being negotiated in Congress, keeping pressure on Federal Reserve Chairman Ben S. Bernanke to hold interest rates near zero.

“The second-half rebound is melting away,” said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts, the only forecaster polled to correctly estimate the gain in GDP. “It’s a very, very difficult situation for policy makers. The Fed could give a pretty strong signal that they are not likely to move on interest rates for a very long time.”

The yield on the benchmark 10-year note decreased to 2.85 percent at 1:22 p.m. in New York from 2.95 percent late yesterday. Stocks pared earlier losses on signs that House Speaker John Boehner’s plan to raise the debt ceiling was gaining support. The Standard & Poor’s 500 Index fell 0.3 percent to 1,296.42 after falling as much as 1.4 percent.

Former Labor Secretary Robert Reich tells it like it is in a post that might as well be entitled “It’s the jobs, stupid”.  Too bad he’s not up for the Treasury position now occupied by Secretary Slave to Investment Banks.  There’s a false equivalency being spread about raising the debt ceiling and increasing the deficit that’s really hampering policy discourse right now.  The two things aren’t the same.  The debt is the amount we owe and it builds each year when there is a deficit or when interest accumulates.  The deficit is a shortage in one year’s budget.  The only real crisis we have right now is a jobs crisis and a complete lack of demand. Again, no business person in their right mind is going to create anything if there’s no customers. Oh, there’s also a confederacy of dunces in the US House of Representatives.  But, I won’t go there right now.

Get it? We’re really in a “jobs and growth” crisis – not a budget crisis.

And the best way to get jobs and growth back is for the federal government to spend more right now, not less – for example, by exempting the first $20,000 of income from payroll taxes this year and next, recreating a WPA and Civilian Conservation Corps, creating an infrastructure bank, providing tax incentives for small businesses to hire, expanding the Earned Income Tax Credit, and so on.

But what happens next week if Congress can’t or won’t deliver the President a bill to raise the debt ceiling? Remember: This is all politics, mixed in with legal technicalities. Economics has nothing to do with it.

One possibility, therefore, is for the Treasury to keep paying the nation’s bills regardless. It would continue to issue Treasury bills, which are our nation’s IOUs. When those IOUs are cashed at the Federal Reserve Board, the Fed would do what it has always done: Honor them.

How long could this go on without the debt ceiling being lifted? That’s a legal question. Republicans in Congress could mount a legal challenge, but no court in its right mind would stop the Fed from honoring the full faith and credit of the United States.

One of the biggest right wing memes that drives me crazy is that the economy is bad because we have too much taxes still and that the President’s stimulus didn’t work because it was worthless spending.  I knew it wouldn’t do much to stimulate the economy simply because it didn’t take advantage of the government spending multiplier in key areas and wasn’t  big enough.  Also, it was the Biggest Tax Cut Ever which rarely works as efficiently as direct government spending to get consumption going again.  So why are so many idiots arguing that more of the same tax cuts are going to improve the economy and cutting all levels of government spending is considered confidence building when the government spending multiplier will just push recessionary momentum?  You got me.  It’s insanity.

So, what happens if these debt ceilings talk fail?  Well, first, every single financial asset, liability, and contract will reprice all over the world.  Most of them will reprice in a bad way that will hamper economies every where.  Every business project will be evaluated using a risk free rate that will now be higher and will not be considered risk free any more. That means many projects will now be rejected so expansions, new jobs, or anything like that will be rejected.  Remember, this is not because we can’t pay those bills, it’s because a few idiots refuse to pay them. Second, the world will continue to step away from the dollar. Third, there will be strong recessionary pressures. It’s not good, folks. As these recent GDP figures show, we’re far from out of the impact of the last financial shock.

But what if all those options failed? What would be the consequence of even a notional default? The IMF has talked of a global recession if there was a loss of confidence in US solvency although it’s not clear that a failure to roll over debt for a few days would qualify for that description.

Having seen what happened with Lehman’s default, the main worry would be a freeze in the markets. Take the finances of banks, for example. Many use Treasury bonds as the risk-free asset for capital purposes. As Capital Economics points out

“Government debt is only automatically 0% risk-weighted for banks under Basel II if it is rated AA- or higher (although regulators can make exceptions for domestic government debt issued in local currency). In principle, therefore, financial institutions would face significantly higher capital charges in the event of a US government default.In practice, it seems likely that the regulators would move quickly to waive the rules. But there might be a few hairy moments while they did. And what about money-market funds? Having been burned by the credit crunch, many have opted for the safe haven of US Treasury bills. Perhaps they could roll over those bills into some form of IOU from the government. But if investors demanded their money back at a time when Treasury bills were illiquid, money-market funds might be forced to suspend resumptions or “break the buck”. Then there is the repo market, widely used by financial institutions to raise money; Treasury securities are used as collateral for such borrowing.”

Standard & Poor’s has considered this scenario and suggests that

“Failure to pay off maturing debt or missing interest payments (approximately $62 billion of interest is payable on Aug. 15) would constitute a selective default pursuant to our criteria, and Standard & Poor’s expects it would lower the sovereign rating to ‘SD’. Even if the Fed and other central banks managed to keep the financial system functioning, we expect that markets around the world would be severely damaged. In such a hypothetical scenario, we expect that equity markets would generally plunge, borrowing costs and interbank lending rates would soar, and corporate credit markets would be closed to all but the highest quality issuers. We envisage that consumers and businesses would likely stop spending on all but essential items, and the value of the dollar would drop by 10% or more against other major currencies. With the dollar heading lower, investors would likely look for hard assets like oil and other commodities, driving prices higher.Given the fragility of the economic recovery, this is an incredible risk to contemplate. It is also worth noting that, even a freeze on government spending that stopped short of a default, would have a significant impact on demand.”

I still can’t believe that a few people are willing to tank the economy for failed economic hypotheses. It’s as if everything we’ve learned over the past 70 years has been completely thrown to the wind and we’re being run by the myth of Reagan’s ghost.  I say myth because what they’re going on didn’t even happen on his watch. He was responsible for the biggest single tax increase in history and was responsible for a lot of the debt they’re whining about today. Speaking of Reagan, one of his economists–Bruce Bartlett–has an excellent analytical piece up on how the Debt Crisis is being Fueled by Obama’s weak negotiations.  It’s worth a read.

Unfortunately, Obama is really too young to have the kind of experience that previous presidents like Reagan brought to the White House in terms of understanding intransigent enemies and how to deal with them. Consequently, Obama has really been caught flat-footed by the Tea Party era Republican Party. He believed it would respond positively if he offered it half a loaf on just about every issue.

For example, some 40 percent of the 2009 stimulus legislation consisted of tax cuts even though his economic advisers knew that they would have almost no stimulative effect. But Obama viewed them as an important concession to Republicans. Yet despite total rejection of his stimulus package by the GOP, Obama kept the tax cuts rather than reprogramming the money into more effective programs such as state aid or public works.

Nevertheless, Obama offered Republicans another half-loaf  by putting forward a health reform plan almost identical to those that they and conservative groups such as the Heritage Foundation had proposedin the 1990s. Obama’s offer was summarily rejected and Republicans suddenly decided that the individual mandate, which previously had been at the core of their own health reform plans, was unconstitutional.

Now we are in the midst of a debt crisis that stems largely from Obama’s inability to accept the intransigence of his political opponents. Last December, he caved in to Republicans by supporting extension of the Bush tax cuts even though there is no evidence that they have done anything other than increase the deficit. There were those who told Obama that he ought to include an increase in the debt limit, but he rejected that idea, believing that Republicans would behave like responsible adults and raise the debt limit just as they did routinely when their party held the White House.

I join Bartlett, former President Clinton, and others in begging the President to invoke the 14th amendment.  Then, he should find some economics advisers who know what they are doing and listen to them for a change.

20 Comments on “The L shaped recovery and a Bogus Debt Crisis”

  1. propertius says:

    Sure the GDP is in the tank, life expectancy and wages are down, and un- and underemployment are through the roof, and layoffs continue apace, but:

    1) corporate profits are up
    2) CEO compensation is up.

    That’s what’s really important, after all. I’m sure that “golden shower” will trickle down upon our unworthy heads any day now.

  2. propertius says:

    I strongly disagree that Obama is a “weak negotiator”. He’s getting exactly what he wants (and what he organized the Catfood Commission to achieve). People who assert that he is “weak” or “incompetent” are operating under the delusion that he’s some sort of flawed New Deal Liberal. He’s nothing of the kind and he never has been.

    • The Rock says:

      HONK!! HONK!!! HONK!!

      Hillary 2012

    • madamab says:

      Amen propertius!!!

      Too young? BULLSHIT. Barack Obama is very shortly going to be 50 years old. That is not “young” unless you are Rip Van F*cking Winkle..

      Bill Clinton was 42 when he was elected, and he “understood” the Republicans’ intransigence quite well, thank you. Yet HE was accused of being a secret right-winger. The insanity, it burnnnnns.

      Sorry, Obama is doing exactly what he wants to do. He is a bad person who does bad things. The. End.

      • Minkoff Minx says:

        Yes, I think Obama is doing exactly what he wants to…just like the rest of the assholes. It really seems like part of a bigger plan…maybe it is to get rid of all entitlements (Social Security and Medicaid and Pell Grants etc)…I don’t know. None of this makes sense.

      • propertius says:

        Actually, Minkoff, I don’t think he wants to get rid of all entitlements. I suspect we’ll see a proposal to “save” them through privatization before much longer. After all, we have to provide opportunities for those “savvy businessmen” to extract more rent.

  3. bostonboomer says:

    I love Robert Reich. He’s so sensible. Too bad that’s out of vogue these days.

  4. bostonboomer says:

    Obama’s approval rating is down to 40% on Gallup.

  5. The Rock says:

    Great post Dak. Its like hitting your head against a wall talking to ideologically driven individuals about this economy. Die-hard rethugs hate President Clinton so much that they CHOOSE to forget about the 90’s EVEN THOUGH most of the ones I argue with made the builk of their money then. It boggles the mind that the ‘respected’ members of Congress don’t simply take a history lesson and see the similarities between now and the early 30’s. It boggles the mind how the Tea Party-ocrats don’t seem to realize the impact of not raising the debt ceiling.

    I think the time has come for a consitutional ammendment. No one is eligible to hold office unless they can pass a competency test administered after they are elected. Members get 2 tries the first week in office. If both tries are failed, the election that they won should be invalidated, and they should be sent home to their district at their own expense.


    Hillary 2012

  6. bostonboomer says:

    US stocks suffer biggest weekly drop in a year.

    • dakinikat says:

      so much for pro-business Republicans … such a mess

      • djmm says:

        Excellent post, Dakinikat! I keep hoping that Wall Street will start beating heads (figuratively) of Congress-critters, but perhaps they are holding off, hoping they can pick up assets at pennies on the dollar after The Crash.


  7. joanelle says:

    Thanks, Dak – great post!

  8. WomanVoter says:

    Obama Loses 36,000+ Twitter Followers in #Compromise Campaign [STATS]

  9. northwestrain says:

    There’s this bit from

    quote :”While I am reporting this, I should note that the President made news regarding his understanding of the origins of the deficit and our slow growth recently when he said:

    “For the last decade, we have spent more money than we take in. In the year 2000, the government had a budget surplus. But instead of using it to pay off our debt, the money was spent on trillions of dollars in new tax cuts, while two wars and an expensive prescription drug program were simply added to our nation’s credit card. As a result, the deficit was on track to top $1 trillion the year I took office.”

    This is patently false. In fact, this is scary. Dean Baker tells us:

    This is seriously mistaken.

    The Congressional Budget Office’s projections from January of 2008, the last ones made before it recognized the housing bubble and the implications of its collapse, showed a deficit of just $198 billion for 2009, the year President Obama took office. In other words, the deficit was absolutely not “on track to top $1 trillion.”… Obama does not have the most basic understanding of the nature of the budget problems the country faces. He apparently believes that there was a huge deficit on an ongoing basis as a result of the policies in place prior to the downturn. In fact, the deficits were relatively modest. The huge deficits came about entirely as a result of the economic downturn…. This misunderstanding of the origins of the budget deficit could explain President Obama’s willingness to make large cuts to core social welfare programs, like Social Security, Medicare, and Medicaid…

    Hat tip to Brad DeLong for the information

    In sum: The President has no idea why the deficit exploded, we are in jeopardy of default, and we will cut spending in into the teeth of a serious growth slowdown. America is rudderless. God help us.

    • Branjor says:

      That’s what I thought when I read that statement by Obama – that he had it all wrong. It is scary that I, puppy face, know more about our country’s budget problems than the President of the United states does.

    • dakinikat says:

      We are at the mercy of inexperienced egos that don’t learn or listen.