Can we avoid a double dip recession?

[WhoWee]

The long term debt problem has two sides: Economic Growth and Spending Cuts.

If we can get some good economic growth started, we will need less spending cuts in order to balance our budget and get our debt under control. With good economic growth, a great deal of pressure is removed from safety net programs and tax revenue goes up. We also need spending cuts in military and Medicare along with an expiration of the bush tax cuts. But we have to be careful of cutting too much too soon because a reduction in government spending will cause our GDP to contract.

The problem is we are politically unable to take care of any of these issues. Republicans do not want to cut military spending or allow the bush tax cuts to expire. The democrats don't want to cut entitlement spending on Medicare and Medicaid. In addition, the strategy for debts must include a road to economic recovery. If we only try to cut our way out of this mess, we'll cause very sharp contractions in our economy. So we need a formula of front end infrastructure spending with back end cuts including changes to mandatory spending laws.

S&P has lowered our rating mostly because of a legitimate concern about our political stability and predictability.

So our largest problem right now is not debt or even the economy; instead, it is our political system. The government by hostage strategy pretty much defeats the purpose of checks and balances, and it creates a great deal of uncertainty.

When the Democrat leaders Reid, Pelosi, and Obama rammed through $Trillions of new spending (2,000 page Obamacare for instance) without debate - that could have been labeled "hostage taking" - couldn't it? Actually, they said Obamacare was a jobs creation program and designed to solve the deficit problem - I guess the financial sector doesn't believe this assertion?

 

[russ_watters]

No, that's not what I'm saying. I'm suggesting that the rates for short-term CURRENTLY ISSUED debt will be negative in real terms (and sometimes nominal terms). Despite issuing new debt, the interest we are paying on the national debt hasn't been climbing that rapidly- compare the debt service projected for this year to 2007. Our debt increased by 50%, the amount we are paying in debt service WENT DOWN.

I've been in my house for the past 5 years and had a variable interest rate. I got a letter as I was working on a refi saying that my rate was about to go down. I could have:

1. Stuck with the variable rate.
2. Gotten a new variable rate mortgage (fixed for 5 years) at about the same rate.
3. Gotten a new fixed rate mortgage at a higher rate.
[edit] 4. Gotten an interest-only mortgage and a home equity line of credit to go with it.

The cheapest option in the short term would have been #1. But it carries with it uncertainty based on future interest rates. I chose option 3. [edit] The US is doing #4.

If one thinks interest rates will be very low until the debt is repaid (even setting aside the fact that we have no intention of repaying it), a variable rate is fine. But the US debt isn't going to be repaid in 20 years, much less five. Interest rates are going to go up and our interest payments just to tread water (if we even ever stop sinking) will go up. The fact that they are low today is not a good reason to pile on more debt. It is irresponsible and short-sighted.

That's the problem the markets and rating agencies see.

Thats my point- the market is uncertain about the equity markets, but QUITE CERTAIN about US government debt- so much so that they'll give the money to the government at a negative nominal rate rather then invest in index funds in the short term.

The fact that bonds were a safer bet than stocks last week doesn't have anything whatsoever to do with whether bonds last week were safer (or less safe) than bonds 5 years ago -- or bonds 5 years from now. Clearly, a lot of different markets and a lot of different agencies are spooked right now and concerned about the future.

Read the S&P statement instead of the wall street journal filter. They make it pretty clear the downgrade was mostly about political brinksmanship, and not any near-term financial crisis.

I don't see any mention of brinkmanship, only concern about the prospects that Congress can deal with the debt. The S&P statement says the debt deal didn't do enough to address the debt, then it says it doesn't think the government is capable of addressing the debt. Doesn't sound like it is an issue of brinkmanship to me, but an issue of not dealing with the debt.

http://www.businessinsider.com/sp-aaa-rating-us-2011-8

Could you post a quote referencing what you are talking about, please?

 

[russ_watters]

The long term debt problem has two sides: Economic Growth and Spending Cuts.

You forgot taxes.

If we can get some good economic growth started, we will need less spending cuts in order to balance our budget and get our debt under control.

Agreed.

With good economic growth, a great deal of pressure is removed from safety net programs and tax revenue goes up. We also need spending cuts in military and Medicare along with an expiration of the bush tax cuts. But we have to be careful of cutting too much too soon because a reduction in government spending will cause our GDP to contract.

Agreed.

The problem is we are politically unable to take care of any of these issues. Republicans do not want to cut military spending or allow the bush tax cuts to expire. The democrats don't want to cut entitlement spending on Medicare and Medicaid.

It's dangerous to stereotype, but those are the stereotypes, yes...

In addition, the strategy for debts must include a road to economic recovery. If we only try to cut our way out of this mess, we'll cause very sharp contractions in our economy. So we need a formula of front end infrastructure spending with back end cuts including changes to mandatory spending laws.

I would prefer an economic plan that doesn't directly create more debt to one that hopes spending ends up reducing debt in the future. I'd rather not create the debt in the first place than hope I can fix it later.

S&P has lowered our rating mostly because of a legitimate concern about our political stability and predictability.

They explicitly cited the debt plan. Debt plan. Debt plan. It's political ability and predictability wrt dealing with the debt.

So our largest problem right now is not debt or even the economy; instead, it is our political system.

Well...I tend to think of problems as in terms of whether they are external or internal. An internal problem isn't physically real. A negative cash flow is a physically real thing. An inability to make a proper decision due to political deadlock exists only in the heads of our politicians. It's not real in that all one has to do to fix it is to simply decide to fix it.

The government by hostage strategy pretty much defeats the purpose of checks and balances, and it creates a great deal of uncertainty.

Dang, and we were doing so well...

I think checks and balances between the power of individual parties is exactly what the founding fathers had in mind!

 

[SixNein]

You forgot taxes. Agreed. Agreed. It's dangerous to stereotype, but those are the stereotypes, yes... I would prefer an economic plan that doesn't directly create more debt to one that hopes spending ends up reducing debt in the future. I'd rather not create the debt in the first place than hope I can fix it later. They explicitly cited the debt plan. Debt plan. Debt plan. It's political ability and predictability wrt dealing with the debt. Well...I tend to think of problems as in terms of whether they are external or internal. An internal problem isn't physically real. A negative cash flow is a physically real thing. An inability to make a proper decision due to political deadlock exists only in the heads of our politicians. It's not real in that all one has to do to fix it is to simply decide to fix it. Dang, and we were doing so well...

I think checks and balances between the power of individual parties is exactly what the founding fathers had in mind!

Have you read the report by S&P? They cited the debt deal as a factor in their decision. But they go on to say that more broadly it was the instability of our political system that led to the downgrade.

The economist has a good assessment here:
http://www.economist.com/blogs/freeexchange/2011/08/sps-credit-rating-cut

As far as to cut or spend, I think Gowers had a good assessment of the problem on his blog:
http://gowers.wordpress.com/2011/05/15/to-cut-or-not-to-cut/
Although he's referring to the British system, the same idea is perfectly valid in the US situation.

 

[mheslep]

This has literally nothing to do with treasuries. If the government issued no treasuries whatsoever, this would STILL be the case. If small businesses are getting high rates (and hence not borrowing) its not because of crowding out, its because of credit risk.

That's an unsupported assertion.

(You are asserting away, BTW, the possibility of crowding out ever happening: in any event we see higher interest rates demanded on loans, they can never crowd out business lending, no, those higher rates are only happening because of perceived credit risk.)

As far as the connection between treasuries and lending to business, I submit the banks are making a choice, as per my earlier reference:

Banks Choosing Treasury Bonds Over Lending.


Here, you tender 'A':

Banks can pretty much ALWAYS make a profit on treasuries, the spread between interbank/LIBOR and treasuries is always positive.

then a conflicting 'B':

Treasuries are objectively a terrible investment right now- other than 'fear over the weak economy' why wouldn't any rational actor put their money in LITERALLY ANYTHING else?

Which is it, A or B? I take it the conflict comes from the hang up on negative real on treasuries you've mentioned several times which is irrelevant in the case of banks. The bank borrows from a central bank and then lends back to government which nets out the inflation factor. Unsurprisingly, banks arehttp://online.wsj.com/media/treasurys_cs_20091109123734.jpg" , and have been since ~2008.

Meanwhile http://www.moneynews.com/StreetTalk/Greenspan-Treasury-Crowding-Out/2010/12/03/id/378841?s=al&promo_code=B3B7-1"prominent economists suggest that there is indeed crowding out ongoing. While I concede that others disagree, you might give the 'textbook' appeal to authority a rest.

 

[WhoWee]

I'm just suggesting we take S&P at their word. Why would they lie in their report?

Interesting development:
Chris Wallace asked David Beers (of S&P) directly about the $2Trillion difference in calculations - cited by the White House in their response to the downgrade.
http://foxnewsinsider.com/2011/08/07...er/#more-73463

"Q: The White House isn’t happy – they say you made a $2 trillion overstatement and then changed your justification for the decision…

Beers: “[That's a] complete misrepresentation of what happened. When we made the modification, we did so after talking to the Treasury; it doesn’t change the fact that even with an agreement, that the underlining debt is building and is rising and will continue to rise.”"

Who should we believe now?

 

[SixNein]

That's an unsupported assertion.

(You are asserting away, BTW, the possibility of crowding out ever happening:

I don't think crowding out is happening for two reasons:
1. Crowding out generally happens when the economy is running full steam.
2. We are using a fiat money system instead of a money system tied to a finite resource like gold.

We are witnessing a liquidity trap instead of a crowding effect.

 

[mheslep]

I don't think crowding out is happening for two reasons:
1. Crowding out generally happens when the economy is running full steam.

Yes i.e. at full demand, that's the suggested typical scenario. In today's case note there is indeed ample demand by small business for lending that is unmet by banks because, as the links above point out, they apparently prefer treasuries to make a profit, treasuries only made available at this scale because of the government's $1.7T deficit.

2. We are using a fiat money system instead of a money system tied to a finite resource like gold.

Fiat money only escapes crowding out versus gold if the government/central bank wildly prints money, causing other problems.

 

[ParticleGrl]

Yes i.e. at full demand, that's the suggested typical scenario. In today's case note there is indeed ample demand by small business for lending that is unmet by banks because, as the links above point out, they apparently prefer treasuries to make a profit, treasuries only made available at this scale because of the government's $1.7T deficit.

The demand for small businesses loans aren't being met because the banks are judging them too high a credit risk, and are charging rates the businesses find unacceptable. This has NOTHING TO DO WITH THE SUPPLY OF TREASURIES. You are simultaneously arguing that low treasury rates do NOT mean low rates for businesses AND lowering treasury yields a few basis points will lower small business rates enough to kick start lending?

Keep in mind that right now rates are so low that treasuries and cash are nearly the same thing- a few days ago, nominal rates on 30 day treasuries were negative- holding cash was better. If banks stop buying treasuries, they'll just hold cash.

Treasuries are NOT HIGHLY PROFITABLE FOR BANKS. In some cases, the NOMINAL interest rates have gone negative- cash is just being thrown away.

You are asserting away, BTW, the possibility of crowding out ever happening

No, I am not. Let's assume I can acquire some capital that will be profitable for my business if I can secure a loan at x%, but right now treasuries are just a few basis points below x%. The bank will say "hell, I can get a safe investment that pays almost the same." Thats how crowding out works. My capital doesn't get acquired. It requires that treasury yields start getting near the potential yields from business loans. This is basic econ/finance. What I am asserting is that crowding out can't happen with negative yield treasuries. If you think it can- what's your story? Whats the mechanism?

Please try and remember that interest rates are (on some level) a measure of the opportunity cost of the lender giving you that money. If loaning money to the government is taking money away from useful private sector spending, then that opportunity cost is high, and the rates go up.

Which is it, A or B? I take it the conflict comes from the hang up on negative real on treasuries you've mentioned several times which is irrelevant in the case of banks. The bank borrows from a central bank and then lends back to government which nets out the inflation factor.

Both- there is always a positive spread between treasuries and interbank- that means banks can always make some profit from treasuries. However, with treasuries this low, they make a very small amount of profit. Treasuries would have been a much better purchase for banks in 2007 then they are now (the spread was much larger), and yet banks have increased their holdings of treasuries? Why?

Your assertion is that banks are NOT making loans to small businesses at real rates of about 4-5% in order to invest in treasuries with real rates of -0.02% or so. Why aren't they? Whats the rationale? How much lower would treasuries have to go before the 5% return is appealing?

 

[WhoWee]

Yes i.e. at full demand, that's the suggested typical scenario. In today's case note there is indeed ample demand by small business for lending that is unmet by banks because, as the links above point out, they apparently prefer treasuries to make a profit, treasuries only made available at this scale because of the government's $1.7T deficit.
Fiat money only escapes crowding out versus gold if the government/central bank wildly prints money, causing other problems.

Yep - worse yet, Quantitative Easing printed money wildly to pull Treasuries out of the banks.

IMO - the real question relates to the value of the Government debt held by the Fed and the Social Security Trust Fund? The Government held debt appears worthless to me given the trajectory of the debt.

Perhaps the media should be asking Geithner and the President these questions; 1.) are they planning to borrow more to pay themselves interest, 2.) do they plan to write down this portion of the debt, 3.) is the plan to print more money?

 

[WhoWee]

The demand for small businesses loans aren't being met because the banks are judging them too high a credit risk, and are charging rates the businesses find unacceptable. This has NOTHING TO DO WITH THE SUPPLY OF TREASURIES. You are simultaneously arguing that low treasury rates do NOT mean low rates for businesses AND lowering treasury yields a few basis points will lower small business rates enough to kick start lending?

Treasuries are NOT HIGHLY PROFITABLE FOR BANKS. In some cases, the NOMINAL interest rates have gone negative- cash is just being thrown away.

Not necessarily - I don't recall the small business package being exhausted yet - I'll try to find a source.

 

[mheslep]

...
Both- there is always a positive spread between treasuries and interbank- that means banks can always make some profit from treasuries. However, with treasuries this low, they make a very small amount of profit. Treasuries would have been a much better purchase for banks in 2007 then they are now (the spread was much larger), and yet banks have increased their holdings of treasuries? Why?

Because the profit is not small. Profit equals profit per transaction times volume, and a bank's volume is theoretically infinite, limited in reality by capital reserve requirements imposed by law and its own taste for risk. There is essentially zero risk to holding treasuries using borrowed money from the Fed, at least under these conditions.

 

[mheslep]

...
IMO - the real question relates to the value of the Government debt held by the Fed and the Social Security Trust Fund? The Government held debt appears worthless to me given the trajectory of the debt...

They're clearly not worthless today; there's a huge market for treasuries, and today at least that's all that matters when setting the value of anything - that someone is out there that will buy your treasury. Now, having some huge holder, such the SSTF start to sell off a couple trillion dollars worth of treasuries would necessarily drive up the rate (lower its value), as would happen with anyone flooding the market with any item.

 

[WhoWee]

They're clearly not worthless today; there's a huge market for treasuries, and today at least that's all that matters when setting the value of anything - that someone is out there that will buy your treasury. Now, having some huge holder, such the SSTF start to sell off a couple trillion dollars worth of treasuries would necessarily drive up the rate (lower its value), as would happen with anyone flooding the market with any item.

I understand you point - please consider this - when a public company wants to increase or support the price of their own shares (and they have cash available) they re-purchase their own shares. If they borrowed money to buy their own shares it would raise a great many questions from shareholders.

While the stocks are equity and the Treasuries are debt - the Government did basically the same thing except they didn't have any cash and instead printed cash to pull back the debt under Quantitative Easing. The other component of this is the artificial suppression of interest rates.

They've changed the rules and manipulated the system into uncharted waters.

If the debt ceiling is not increased the next time - where would the re-payment of US Government held US Government debt be prioritized - I don't think the left pocket paying the right pocket will be a priority and smart lenders will tell them the same.

 

[ParticleGrl]

Because the profit is not small. Profit equals profit per transaction times volume, and a bank's volume is theoretically infinite, limited in reality by capital reserve requirements imposed by law and its own taste for risk. There is essentially zero risk to holding treasuries using borrowed money from the Fed, at least under these conditions.

You have missed the point. Every dollar in a treasury is a dollar not somewhere else. Why are banks putting money into treasuries at a real of -0.02% when they could put that money into business loans at a real of 4-5%?

There is never any risk to holding treasuries using borrowed money from the Fed. Again, it would have been WAY more profitable in 2007, why weren't they doing it then?

You've also ignored a series of questions I posed- "Your assertion is that banks are NOT making loans to small businesses at real rates of about 4-5% in order to invest in treasuries with real rates of -0.02% or so. Why aren't they? Whats the rationale? How much lower would treasuries have to go before the 5% return is appealing?"

Until you answer these questions, I don't see much point in continuing this.

 

[Proton Soup]

You have missed the point. Every dollar in a treasury is a dollar not somewhere else. Why are banks putting money into treasuries at a real of -0.02% when they could put that money into business loans at a real of 4-5%?

There is never any risk to holding treasuries using borrowed money from the Fed. Again, it would have been WAY more profitable in 2007, why weren't they doing it then?

You've also ignored a series of questions I posed- "Your assertion is that banks are NOT making loans to small businesses at real rates of about 4-5% in order to invest in treasuries with real rates of -0.02% or so. Why aren't they? Whats the rationale? How much lower would treasuries have to go before the 5% return is appealing?"

Until you answer these questions, I don't see much point in continuing this.

some would say that the point is a pretty obvious manipulation of the economy.

 

[mheslep]

I understand you point - please consider this - when a public company wants to increase or support the price of their own shares (and they have cash available) they re-purchase their own shares. If they borrowed money to buy their own shares it would raise a great many questions from shareholders.

While the stocks are equity and the Treasuries are debt - the Government did basically the same thing except they didn't have any cash and instead printed cash to pull back the debt under Quantitative Easing. The other component of this is the artificial suppression of interest rates.

They've changed the rules and manipulated the system into uncharted waters.

If the debt ceiling is not increased the next time - where would the re-payment of US Government held US Government debt be prioritized - I don't think the left pocket paying the right pocket will be a priority and smart lenders will tell them the same.

You're conflating government practices that you don't like (nor I) with the assertion that treasuries are worthless. You might argue that treasuries may loose value with some inflation to come, etc, but to say without caveat that they are worthless, today, is silly.

 

[WhoWee]

You're conflating government practices that you don't like (nor I), with the assertion that treasuries are worthless. You might argue that treasuries may loose value with some inflation to come, etc, but to say without caveat that they are worthless, today, is silly.

I understand your argument - but you said it yourself and I agree.
"Now, having some huge holder, such the SSTF start to sell off a couple trillion dollars worth of treasuries would necessarily drive up the rate (lower its value), as would happen with anyone flooding the market with any item."

 

[WhoWee]

You're conflating government practices that you don't like (nor I) with the assertion that treasuries are worthless. You might argue that treasuries may loose value with some inflation to come, etc, but to say without caveat that they are worthless, today, is silly.

Let's look at this a different way. Quantitative Easing (2) - involved printing $600Billion in US Dollars. These funds were used to purchase Treasuries back from member banks. This $600Billion was initially held in reserve in the banks.

The most obvious question is what have the banks done with these funds since QE-2 ended? I've listed a few possibilities - there may be others?
1.) Do the banks still have the (freshly printed) cash?
2.) Did the banks make (US business) loans - if so how much remains in reserve?
3.) Did the banks purchase new US Treasuries (and how much)?
4.) Are these banks now participating in the European bailout plans?
5.) Did the banks purchase alternative securities?


Listen to this analysis from August 1, 2011 - it discusses the possibility of QE-3.
http://video.ft.com/short-view As the video predicted, the President hinted at another stimulus Bill in his speech today - but that will be difficult to pass - the second prediction is QE-3.

Now consider this - if the banks still hold the cash in reserves - what would QE-3 accomplish in building cash reserves higher? If the banks have purchased new US Treasuries - would buying the new ones with more freshly printed money effect the value of the Treasuries purchased and held by the Government?