In my last “Bond Deer” installment the story of the investor caught in the risks of the bond market like a deer in the headlights I highlighted that a housing recovery might be responsible for pricking the “bond bubble.” But a self-sustaining recovery is still in its infancy and could easily be derailed.
Massive monetary accommodation averted a global financial collapse in 2008. Today, pundits are hotly debating whether Quantitative Easing (QE) in its various forms is still necessary. The pundits fall into three camps:
- The Believers, who insist that QE is needed to combat the deflationary pressures of a large output gap, high unemployment, and ongoing deleveraging;
- The Skeptics, who contend that QE isn’t doing much for the real economy
- The Monetary Abolitionists, who argue that the Fed’s attempts to avoid a recession (what I referred to as the “Credit Express”) are creating the conditions to basically ensure one, namely:
- Out-of-control government spending and deficits, made acceptable to politicians by a collapse in funding costs; and,
- Corporate paralysis, caused by an artificial investment landscape that has led to anemic capital investment and a stalled-out re-employment cycle.
Since the Abolitionists are warning that the Credit Express is going to make “road-kill” out of the bond deer, let’s examine the first concern in this installment.
Government Spending: The “paradox of thrift,” coined by John Maynard Keynes, describes how an individual’s thrift, if practiced simultaneously by all members of a society, can paradoxically hurt an economy. Thus, a drop in private consumption and investment needs to be offset by an increase in government expenditures to avoid turning a recession into a depression. Since 2008 consumers have been practicing “thrift”, reducing their debt loads, or de-levering. But it is clear from the below graph that we are still a long way from a reasonable long-term average.
In the meantime, the government has been doing it’s “Keynesian” best to offset this drag…
When we separate Federal from State and Local government debt into their components, we see the increase has largely been at the Federal level.
Keynes also advocated that once the private sector was ready to resume investment, government expenditures (and debt) should decline. But government expenditures are sticky and politicians rarely get re-elected by cutting back. Thus, a crisis is needed to focus the political mind . . . Can you say “Fiscal Cliff?” Still, with two out of the three major contributors to GDP de-levering, it’s reasonable to ask: is it too early for the de-levering baton to be handed off?
I believe it is too early — Europe tried this experiment and it resulted in an ugly outcome. But I also believe that uncertainty over the future path of spending and deficits is helping to paralyze private investment and re-employment. What is needed is a Simpson-Bowles type of plan that tackles the real “cliff” facing us over the next decade: the un-sustainability of our entitlement system. This would at least give investors a sense that the path of Federal deficits and debt accumulation was at least sustainable . . . but that is for another blog.
In the next installment, we will examine the Abolitionists second “bullet” more fully, to determine the willingness and ability of the corporate sector to provide the next leg of the recovery in 2013 and beyond, or whether bond deer need to worry more seriously about the Credit Express.