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« Understanding the Employment Issue | Main | The Dunning-Kruger Effect: Can We Profit? »

June 16, 2010



Ken -- Thanks for such a thoughtful comment, and I am sorry that my mini-vacation delayed my reply. I hope that readers click through to the video and enjoy your presentation and charts.

I have three general reactions:

1) I do not accept your criticism of forecasters based upon the 2007-09 period. There were specific consequences from the fall of Lehman, starting with a complete cession of lending. I have an earlier article on this topic where I suggest that it is like forecasting an earthquake. You would not use that important but low probability event as part of a model forecasting traffic in San Francisco, for example. Alternatively, do you have your own forecasts? What forecasting method do you prefer?

2) Even if the consensus forecast is a little high, we are still well between the golden goal posts. Meanwhile, you should note that only half of the stimulus money has been spent so far, so it is not over. I did not find Mish to be very persuasive on government.

3) There is a big gap to make up, and your panel did an excellent job of highlighting that point. As a public policy/poli sci specialist, I am making observations about how our political system "works". Mostly it is slow to address problems because it is democratic. You and I cannot just huddle up and agree on solutions. I think that the expiration of the Bush tax cuts will force some horse trading. I also think that social security changes will happen only with an outside commission leading the way. It has worked before.

At some point we'll have a higher retirement age and various adjustments to health care.

Thanks again for your comment, and for your excellent presentation at the conference.


Ken Houghton

The OECD economists, and the 53 pros in the WSJ survey are constantly following the markets. They know about and have considered every "headwind" identified by your favorite bearish pundit.

Uh huh. That's why those OECD/WSJ predictions were so spot on from late 2007 and up through the third quarter of last year.

Don't get me wrong. I would love to see 3%+ real growth--it's rather essential, and even rather low for a "recovery period." But the algebra doesn't bear it out.

_I_ is muted by cash-hoarding and banks holding mispriced assets not being willing to lend. (they may be mispriced, but the banks don't believe the marks either.) And that's ignoring the lack of demand, which brings us to

_C_ -- Debt ratios are improving, but that appears to be mainly because of forgiveness/writeoffs, not savings. And you can't increase consumption if you can't spend savings.

_G_ - So far, the stimulus has balanced to cuts in state/local governments (ask, for instance, TX, which turned a $9B deficit into a $12B surplus). But there won't be a Federal stimulus this year, and the requirement of a balanced budget remains a requirement in 47 or 48 of the states. Even if there is a recovery, the "hangover effect," plus the lack of remaining "rainy day" funds is going to drag this one. Which leaves

_NX_ - Devalue the dollar? Great idea. Except that (1) others will try to do the same, (2) the "safe haven" argument abides, and (3) the other major areas are either in worse shape near-term (EUR, GBP). (Hans-Werner Sinn, one of the perennial OECD/WSJ economists, told me about a year ago how great the Spanish banking system was doing in the face of their own silly homebuyer lending. Anyone think he still believes that?)

On balance, _I_ will go up some; has to. _C_ will probably go up some, just because of how far it dropped. _NX_ has a possibility of coming back some if the rest of world calms down a bit. _G_, as Mish noted, is problematic at best: the places that are in the most trouble are the largest economies (e.g., CA, IL, FL, NY, NJ) with some that were getting support (TX, AZ, OH, MI, GA) likely to suffer more this year. And most of the others (IN, MO, NV, etc.) aren't exactly driving growth.

You can get 3.0-3.2% growth out of that (ballpark 2.5% I, 2.0% C, -0.5% NX, -1.0% G) if a lot of things break right. But it's not the way to bet at even odds, and it's a weak recovery at best.

Can you balance the budget, keeping most of the Bush tax cuts and leaving Medicare Part D intact? Last time I looked that was about a 2.5% of GDP gap. The surpluses run at the end of the Clinton Administration weren't that large, and the 2001 and 2003 tax cuts took GovtRevsas%GDP down around 1.5-2.0% (spending went up even more, to 2006).

That's a big gap to make up, even after you argue that the subsidies from the SocSec and Medicare tax increases are just "part of the Unified Budget" when they are surpluses but "something we have to cut" when there's a good chance they won't be.

Mike C

Wanted to add this thought. I've spent countless hours thinking about the inflation/deflation question in the context of the overall debt level. Absent moves by government and central banks, I have zero doubt the natural tendency of the system would be for a massive deflationary drop with massive debt default. That would be the natural equilibrium for a system that piled this much debt the past 20 years which leads me to my next point...

I had asked you the likely policy response in a previous question because I think governments and central banks will face the same dilemma a number of times as fall 2008 so I really am very interested in knowing what they WILL do, not what they SHOULD do. They probably should follow the Carnegie approach of "liquidate it all, purge the rottenness" from the system but from reading you consistently I've come to believe that is 0% probability. Everything possible will be done to reflate the system.

Ultimately, that is very, very bullish for gold long-term. We are in the same geographical region, so I owe you a very high-priced dinner if I make as much money on gold as I think I will because it will be the belief in the policy response that keeps me this bullish.

Mike C

Very witty title and excellent note.

As Cam points out the market might swing dramatically between inflationary and deflationary expectations depending on how government fiscal and central bank monetary policy plays out. BTW, in my humble view, you really should consider adding him to your list of recommended blogs. My must read list is pretty short (about 15 names) and includes both him and you.

David Merkel has talked about bicycle versus table stability. I think we are in an era of bicycle stability and politicians and those in authority will do everything possible to keep the wheels turning (as you have pointed out very well). Whether they succeed is another matter entirely. As a single datapoint, it looks like housing is beginning to collapse with the expiring of the tax credit. What is next in the bag of tricks to stimulate housing?

History shows gold does well in both deflationary and inflationary times (30s and 70s). Homestake Mining was one of the best stocks of the Great Depression. Gold does terrible during periods of stability. Gold lost 3/4 of its value during the "Great Moderation" from 1980-2000.

Having a MODERATE allocation to gold in the current environment probably makes sense given the uncertainties on how all this will play out the next 5-10 years, but it would be NUTS to go to 0% in stocks and 100% gold. Personally, I think vice versa is close to as nuts.

Aside comment. Most blogs have an option to check to get e-mails on responses to comments or subscribe to comments. This would be a nice feature if possible so one could see the conversation develop without having to check back at the blog page.


scm0330 - The story in Illinois is similar. Maybe worse.

But this is not an article of optimism, but one of realism. All I said was that we will probably avoid the worst cases, have modest economic growth, do some compromising on tax increases, and eventually cut entitlements.

The fact that this seems optimistic to you is evidence for my point about the intensity of fear and pessimism.

Just a thought ---



I wish I were so optimistic. Our federal government (and yes, we the people who vote the turkeys in) got us here. What has changed about the political system, its inhabitants, and its processes, to make you think we can reverse course, particularly when the policy model of "buy now/pay later" (health care, SS, Medicare, public pensions) is so rampant. I live in NY, renowned for its statehouse dysfunction, and while the state teeters with a late budget and epic fiscal mismanagement the warring parties still fight for the wheel as the car heads off the cliff. No one can bring themselves to slow the car down, agree on a change of course, etc.

Humble Student

I have thought extensively about the inflation/deflation policy dilemma and I agree with the poltical agnosticism stance as it is helpful for understanding policy.

However, as an investor I believe that the markets are fragile and sentiment likely to swing wildly between inflationary and deflationary expectations. Under those circumstances a trend following model can be useful in this kind of environment. See


Wow. This is so helpful. I don't have any other place to go where I can get such a balanced approach. One that includes the nature of and effects of public policy.

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