I'll play my own devil's advocate regarding my initial conclusion to capacity utilization. To rewind... in my post about used cars and the inflation / deflation tug of war, I concluded (re: excess capacity):
To me this is deflationary over the longer run, with one HUGE caveat / concern... supply destruction.The "until then" may be coming sooner than I thought. The following chart shows the annualized monthly change in TOTAL CAPACITY (not capacity utilization) in the economy today.
This story shows what can happen when there is a significant change in supply (lower supply = higher prices). My fear is that the global economy has another downturn and supply is permanently destroyed when the government finally accepts that they cannot save every GM, Chrysler, etc... At that point I do feel that inflation, even with reduced demand, is a real threat. BUT, until then, deflation is my concern...
While of limited concern in an environment with as much excess supply as we currently have, it may be of increasing importance as the economy comes back going forward.
Source: Federal Reserve
Jake - interesting perspective. It looks like there was a steady trend followed by a huge bubble dropping below zero that then returned (barely) to trend followed by another drop. That would suggest that looking at the cumulative change over the life of your time period ((n+1)-n)/n....((n+m)-n)/n for a timespan from n to m would be interesting.
ReplyDeleteThought provoking indeed.
ReplyDelete1. The level of interest rates.
Does the default rate only ever correlate to the interest rate, i.e. it is causal, hence why monetarists believe that monetary policy works? And/or are different interest rates and the supply of money a condition based on the expected real economic growth rate and opportunity costs of holding money instead of investing it, for different qualities of borrower? If all that needed to be done to rescue the economy was to increase debt and reduce interest rates then the implied causal link is that the size of the economy and the levels of default/hgardship faced by its citizens are solely determined by politicians and central banks. How absurd is it that central banks tour the country with the message that quantitative easing is being employed because without it, everyone would suffer?
2. The "right" level of output.
It can be argued that in the last twenty years we have seen two revolutions. One was the Telecom/Media/Technology of the internet bubble and the other the financial derivative bubble (to include swaps and securitizations). There are three measures of GDP output. Income, Expenditure and Production. These are presumably either negative for Income and Production and massively positive for Expenditure, if you include Govt/Fed/State deficit increases as part of expenditure. I agree that an economy that has emerged from a bubble has to return to the state that existed prior to the bubble, except for "normal" growth in unaffected areas. Since the economy did not contract following the bursting of the TMT/.com/Internet bubble, one could assume that the level of the economy operating between 1990 and 1998, is as good a proxy as any for the economic bottom. That leaves around a decade of growth based on the financial derivative bubble. The effect of leverage doesn't matter in this sense, since all we need to do is return to 1998 GDP dollars to find the base that represents the removal of the cancerous growth since then. So, does this mean that where economic growth of around 3% per annum for ten years (and growing) represents an output gap that must be filled? Does this mean that a central bank should provide triage to an economy to recover this output gap by printing money? Depends if you are a communist/socialist or a free marketer I think.
3. Sovereign Default, National Debt, Wasted money and On-going Waste.
The National Debt has a ceiling set by congress that bares little or no relation to the change in size of the debt. The political machinery approves the debt accumulation ex-post, inthe full knwoledge that ex-ante estimates are different and much larger. The US Government will be in full default on its obligations, not when determined by polticians or central banks, but when the interest repayments on this debt exceed possible taxes. Official debt is probably around $12 trillion plus net liabilities of Agencies (such as the Fed, Freddie and Fannie) of a further $10-12 trillion. Total $24 trillion. The Government takes around $1 trillion per annum in taxes, so a key assumption of a nominal 5% interest rate, for an economy returned to normal, points to current default AT THE CURRENT TIME. ($24trillion x 5% = $1.2 trillion per annum). Taxes can be raised of course, but we know that this can reduce the overall tax take in depressed times such as these. Note also that this reflects the fact that the Administration has a rapidly diminishing to zero discretion in taxes collected.
Wasted money and on-going waste. Given than half of all tax dollars goes on the Pentagon and that this is spent on "colonial activities" abroad, this expenditure is an immediate drain on the economy. So this Administration knows that it will take half of tax payers money and give it away to foreeign economies or blow it up. This is waste and is simply not discussed anywhere. The size of the issue facing the derivatives sector is magnified by this waste.