Fed Proposals to Counter “Deflation” Are Misguided
July 30, 2010
David P. Goldman
Senior officials of the Federal Reserve now warn that the United States faces a Japan-style deflation and a prolonged period of stagnation like Japan’s “lost decade” of the 1990s. The New York Times’ website reports:
On Thursday, James Bullard, the president of the Federal Reserve Bank of St. Louis, warned that the Fed’s current policies were putting the American economy at risk of becoming “enmeshed in a Japanese-style deflationary outcome within the next several years.”
The warning by Bullard, who is a voting member of the Fed committee that determines interest rates, comes days after Ben S. Bernanke, the Fed chairman, said the central bank was prepared to do more to stimulate the economy if needed, though it had no immediate plans to do so.
Bullard had been viewed as a centrist and associated with the camp that sees inflation, the Fed’s traditional enemy, as a greater threat than deflation.
But with inflation now very low, about half of the Fed’s unofficial target of two percent, and with the European debt crisis having roiled the markets, even self-described inflation hawks like Bullard have gotten worried that growth has slowed so much that the economy is at risk of a dangerous cycle of falling prices and wages.
The Federal Reserve has conducted the most stimulative monetary policy in its history, keeping the federal funds rate (the overnight lending rate to banks) at only 0.25 percent, while purchasing over $2 trillion in securities from the markets. And that has not helped at all.
Now St. Louis Fed President Bullard wants the United States to consider a “quantitative easing” in the form of direct purchases of Treasury securities from the market. That’s what the Fed has been doing, and that’s what the Japanese did, in massive size. It didn’t help there, either.
It is disturbing to hear such idiocy from senior officials of the central bank. In all the American recessions and recoveries of the past four decades, big businesses shed jobs permanently and startups created new jobs. There is an enormous literature on this phenomenon, which I have reviewed in the past. The Census Bureau and the University of Maryland recently calculated the net creation of jobs by age and size of business, and the results show that new and businesses create most new jobs.
Source: University of Maryland and Census Bureau
The Fed and the administration claim that the problem is that small businesses can’t get bank loans. The problem, they insist, is monetary policy. Big businesses are being rewarded for laying off workers, stripping down to bare bones, and earning profits on their core businesses. They are—wisely, given the fecklessness at the rudder in Washington—hoarding cash; they don’t want to borrow.
But startup small businesses shouldn’t be financed with bank loans (except for secured financing of inventories and receivables). Most small businesses fail. This is Portfolio Theory 101. If you own the stock of 100 startups, and 99 go bust but one becomes Microsoft, you get rich. But if you are a bank, and you lend money to the 100 startups, and only 1 can pay you back, then you go bust.
Thus startups are financed with equity, not debt. This is taught to first-year finance students.
It doesn’t occur to the somnolent wizards of Constitution Avenue that the way to lure capital back to entrepreneurial activity is to increase the after-tax reward to entrepreneurs, by eliminating the capital gains tax, for example, or, even better, eliminating all taxation of capital income. Monetary policy has nothing to do the case. Monetary policy best addresses currency stability. Tax incentives best address economic growth.
Demographics drive deflation, and our demographics are not good. First, an aging population saves, and savings are deflationary. As people near retirement, they must substitute future goods (savings instruments entitling them to consumer in the future) for present goods (consumption)—so the price of present goods falls.
The government may attempt to substitute its own spending for household spending but it never quite works, no matter how many public works projects the government sponsors. Japan poured more cement than anyone else—and the decade was still lost.
As I wrote in July 2009, America’s demographic profile has a disturbing resemblance to Japan’s at the beginning of the 1990s,the beginning of its famous “lost decade.” Its population had just began to age dramatically. Over the decade, the elderly dependency ratio rose from 17 percent to 25 percent. As the Japanese aged, their appetite for savings naturally and rationally grew, and they had to save more and more as their stock portfolios and home values crashed. But the more they saved, the worse the economy did. The government lowered interest rates to 0.25 percent or less and ran up spectacular government deficits and couldn’t change the aging population’s desire to save as much as they could. The result was deflation: falling asset values and a strong yen.
Fast forward to America in 2010, with an elderly dependency ratio of 19 percent, a little higher than Japan’s in 1990. By 2020, it will rise to 25 percent, almost as fast as Japan’s. Americans also have seen their stock prices and home values crater, and—again, naturally and rationally—have suddenly shown an insatiable appetite to save rather than spend.
There’s a second reason aging drives deflation. Old people are creditors, young people are debtors. Inflation transfers wealth to debtors from creditors, because the debtors pay back their debt in cheaper dollars. A country with a preponderance of old people will show strong political pressures against inflation. That’s why the Japanese never objected to deflation. As an aging people, too many of them benefited.
Japan Dependency Ratios Medium variant 1970-2020
United States of America Dependency Ratios Medium variant 1970-2020
Source: United Nations
There is nothing that the United States can do about its aging demographic in the short run. The deflationary headwind is built into our aging population. But that should increase our sense of urgency about the need for pro-growth economic policy, including a pro-family policy that eventually will bring down the average age of the population, so that we don’t end up a geriatric ward like Japan two generations from now. America can’t afford to lose a decade.
David P. Goldman is a senior editor at First Things.
Resources
David Goldman discusses Japanese style deflation on CNBC's Kudlow Report.
Comments:
7.30.2010 | 10:15am
Houghton Grandmal says:
Could it be that the Obama administration actually wants inflation, both to keep the public more 'payable" and to assist in the destruction of the middle class, especially of middle class Boomers nearing retirement who did play by the rules and saved for retirement: to destroy their nesteggs so as to complete the process of making everyone into a serf dependent on the government?
7.30.2010 | 10:27am
roger says:
Mr Goldman,
Thank you for an excellent essay.
It is obviously true that business "start ups" are driven by the profit motive, although the desire to be free of the corporate/government cubicle wage slave culture is also an important ingredient.
Unfortunately the US has evolved to a situation where freedom is hardly valued at all (despite the "land of the free, home of the brave" crock that is parroted). It is clear that the ruling bureaucratic and political class is now overwhelmingly collectivist in its outlook. As an example; Barack Obama, during the campaign, spoke of the profits of the oil companies belonging to "the people", "that is your money" is exactly what he said to his crowd of baying supporters. "Spread the wealth", actually = steal private property, and give it to people who will vote for the spreader, this economic principle is clearly embraced by the democratic party. What economic principles are believed in by the republican party is almost impossible to discern.
We are, as a country, in trouble basically because we pay too many people to do nothing at all, or to do things that are of no economic value whatsoever, and I include in this the costumed and bemedalled princes of the pentagon.
What to do? Well for starters lets:
1. End the wars and reduce the defence budget to a maximum of $100bn/yr.
2. Fire 90% of all civil servants and privatise all public services including police, firefighters and education.
3. Eliminate all corporate and income taxes and replace them with a VAT.
How likely is this? It is impossible, so the fate of the US is clear, not for us the Japanese model of modern industry and high savings in a stable homogenous society. The economic model we will follow is that of Argentina; progressive ruin brought on by the failure of political (ultimately societal) courage.
The social model is even worse; Brazil, where the wealthy live in protected enclaves while the poor white, black and hispanic underclass exist in hellholes of drugs and crime.
Y'all have a great day now, ya hear.
Thank you for an excellent essay.
It is obviously true that business "start ups" are driven by the profit motive, although the desire to be free of the corporate/government cubicle wage slave culture is also an important ingredient.
Unfortunately the US has evolved to a situation where freedom is hardly valued at all (despite the "land of the free, home of the brave" crock that is parroted). It is clear that the ruling bureaucratic and political class is now overwhelmingly collectivist in its outlook. As an example; Barack Obama, during the campaign, spoke of the profits of the oil companies belonging to "the people", "that is your money" is exactly what he said to his crowd of baying supporters. "Spread the wealth", actually = steal private property, and give it to people who will vote for the spreader, this economic principle is clearly embraced by the democratic party. What economic principles are believed in by the republican party is almost impossible to discern.
We are, as a country, in trouble basically because we pay too many people to do nothing at all, or to do things that are of no economic value whatsoever, and I include in this the costumed and bemedalled princes of the pentagon.
What to do? Well for starters lets:
1. End the wars and reduce the defence budget to a maximum of $100bn/yr.
2. Fire 90% of all civil servants and privatise all public services including police, firefighters and education.
3. Eliminate all corporate and income taxes and replace them with a VAT.
How likely is this? It is impossible, so the fate of the US is clear, not for us the Japanese model of modern industry and high savings in a stable homogenous society. The economic model we will follow is that of Argentina; progressive ruin brought on by the failure of political (ultimately societal) courage.
The social model is even worse; Brazil, where the wealthy live in protected enclaves while the poor white, black and hispanic underclass exist in hellholes of drugs and crime.
Y'all have a great day now, ya hear.
7.30.2010 | 10:36am
Sean says:
This is why I don't have time for economics. Inflation is bad. Deflation is bad. Stagflation is bad.
What kind of flation are we looking for, then?
What kind of flation are we looking for, then?
7.30.2010 | 11:28am
Chuck says:
Actually, there's one thing we could easily do about our changing demographics. We have the happy "problem" of having millions of young people from Latin America who share much of our culture and religious traditions, who want (against all odds) to immigrate to our country. We could figure out a way to legalize them. And before you even think it, we've already barred newly arrived immigrants from most welfare benefits - unless you count public schools as a welfare benefit. I'd think of education as an investment (surely a citizen who gets more education is likely to pay back that investment manifold over a lifetime), assuming for the moment that education in public schools really does involve learning.
7.30.2010 | 12:28pm
Craig says:
I agree with Mr. Goldman, but I think the article addresses a symptom and not a cause. The problem is with ideology, not economic theory. We know that stable prices and cuts in marginal tax rates, capital gains, and corporate rates will produce economic growth. But in this case that means that the rich might get richer. The Obama administration is redistributionist, and is thus opposed to this, even though they know the solution. Christina Romer, one of his economic advisors, has published academic articles on this, before she became an economist for hire.
The administration wants a leftward lurch of the country, and the economic policies that have been implemented are a result of this. Nationalize healthcare? Done. Control finance with regulations? Done. Take over parts of the banking, insurance, and car industries? Done.
I'm guessing that when his economic council convenes to deal with deficits, they will suggest a value added tax on top of all this.
The problem is ideological, not economic. From the 1920s, to early 1960s, to the 1983 to 2000s period, the product for growth is the right policy mix of tax incentives and stable fed pricing.
In fact, though I don't agree with him, I think Obama has been a fantastic success for statists. He has accomplished almost everything he wanted. And he still enjoys a low to mid 40s approval rating. The odds are that he will win re-election in a few years. If he can tack on cap and trade and a liberal immigration policy, he will be the most successful liberal president in our history.
I recently returned from Tokyo. They are a depressed culture. They will soon close schools in rural areas because they don't have children to attend. Costs of city living are high, even though jobs are harder to find and incomes aren't doing well. I hope we wake up before we end where they are at.
The administration wants a leftward lurch of the country, and the economic policies that have been implemented are a result of this. Nationalize healthcare? Done. Control finance with regulations? Done. Take over parts of the banking, insurance, and car industries? Done.
I'm guessing that when his economic council convenes to deal with deficits, they will suggest a value added tax on top of all this.
The problem is ideological, not economic. From the 1920s, to early 1960s, to the 1983 to 2000s period, the product for growth is the right policy mix of tax incentives and stable fed pricing.
In fact, though I don't agree with him, I think Obama has been a fantastic success for statists. He has accomplished almost everything he wanted. And he still enjoys a low to mid 40s approval rating. The odds are that he will win re-election in a few years. If he can tack on cap and trade and a liberal immigration policy, he will be the most successful liberal president in our history.
I recently returned from Tokyo. They are a depressed culture. They will soon close schools in rural areas because they don't have children to attend. Costs of city living are high, even though jobs are harder to find and incomes aren't doing well. I hope we wake up before we end where they are at.
7.30.2010 | 12:38pm
Bob G says:
Eliminate all taxes on capital and have a roaring economy in two years.
But Geithner doesn't like that idea. He wants to raise taxes on the rich--the investors. I have no brief for the rich, but that's how our system works. Scores of studies have proved it over and over. You want prosperity, incentivize the investors. You want poverty, tax and spend.
Have you heard about the Fed's brilliant ZIRP (zero interest rate policy)? It works like this. The Fed "lends" $23.6 trillion (sic) to the big banks at 0% interest. The banks then lend those funds back to the Fed at 3.5% Result: $800 billion a year in risk-free profits, from which Goldman pays itself $4 billion in bonuses. Alll behind the scenes of course: the Fed doesn't have to divulge.
Mr. Goldman, let's get to the real issue: how can we ordinary people get on this gravy train? With enough pressure on our Congress, maybe it will force the Fed to ramp up this innovative program.
But Geithner doesn't like that idea. He wants to raise taxes on the rich--the investors. I have no brief for the rich, but that's how our system works. Scores of studies have proved it over and over. You want prosperity, incentivize the investors. You want poverty, tax and spend.
Have you heard about the Fed's brilliant ZIRP (zero interest rate policy)? It works like this. The Fed "lends" $23.6 trillion (sic) to the big banks at 0% interest. The banks then lend those funds back to the Fed at 3.5% Result: $800 billion a year in risk-free profits, from which Goldman pays itself $4 billion in bonuses. Alll behind the scenes of course: the Fed doesn't have to divulge.
Mr. Goldman, let's get to the real issue: how can we ordinary people get on this gravy train? With enough pressure on our Congress, maybe it will force the Fed to ramp up this innovative program.
7.30.2010 | 1:06pm
Houghton Grandmal says:
"keep the public debt more payable" was what I meant in my earlier comment--paying it off with inflated money.
7.30.2010 | 3:38pm
ray tang says:
First thing that economists need to do is to examine the paradigm that population growth is good for economies.
7.30.2010 | 5:06pm
David Goldman says:
Reuven Brenner and I (together and individually) have written three essays in the past eighteen months in First Things addressing these issues. Eliminating taxes on capital income is the obvious way to draw capital to entrepreneurs. Wars are like JP Morgan's yacht; if you have to ask how much they cost, you can't afford them. I believe we should fight wars if we must, even if it hurts the economy. It happens that I think that the original Afghan and Iraq invasions were justified but the subsequent occupation was not, and that we have wasted a lot of money--but that's beside the point. The US can't think in terms of a closed national economy, and if the world falls apart, so will we.
7.30.2010 | 5:12pm
TMR-Brat says:
Up here in Canada, we had charismatic pied-piper leader in the Seventies: Pierre Trudeau. Youthful and charismatic, he won a landslide in 1968, then spent the next 12 years, sprinkling the land with tax-and-spend stardust. His successors from the two dominant parties continued his policies, leading to a debt crisis and the Economist magazine labelling Canada a "third-world" country.
Resisting temptations of both hyperinflation and default, Paul Martin, our then finance minister, grit his teeth, made drastic spending cuts to many deemed-necessary programs--subsidies to provincial governments, healthcare and the military--and saved our way to solvency.
Americans will have to face the cold reality and "bleed" themeselves out of this one.
Resisting temptations of both hyperinflation and default, Paul Martin, our then finance minister, grit his teeth, made drastic spending cuts to many deemed-necessary programs--subsidies to provincial governments, healthcare and the military--and saved our way to solvency.
Americans will have to face the cold reality and "bleed" themeselves out of this one.
7.30.2010 | 5:51pm
roger says:
Mr Goldman,
I don't see anybody suggesting that the US become a "closed economy", trade is great for our economy and our country. We do however have to realign our priorities from empire to commerce. We also need to recognise that our economy, that is our national wealth, has been targeted by Germany, Japan and China, who by predatory mercantilist practices have succeeeded in sucking wealth out of the US. Certainly we need to be engaged but I see no reason why, if the World stays as messed up as it has always been it should affect us particularly or that we should interfere in areas we do not understand and cannot possibly control.
Just a thought; 66 US soldiers have died in Afghanistan this month, think about that, 66 young men are dead who just 30 days ago were alive. For what?
I don't see anybody suggesting that the US become a "closed economy", trade is great for our economy and our country. We do however have to realign our priorities from empire to commerce. We also need to recognise that our economy, that is our national wealth, has been targeted by Germany, Japan and China, who by predatory mercantilist practices have succeeeded in sucking wealth out of the US. Certainly we need to be engaged but I see no reason why, if the World stays as messed up as it has always been it should affect us particularly or that we should interfere in areas we do not understand and cannot possibly control.
Just a thought; 66 US soldiers have died in Afghanistan this month, think about that, 66 young men are dead who just 30 days ago were alive. For what?
7.30.2010 | 8:35pm
DodgerUSA says:
Spengler,
I loved the immigration comment last night -- very funny.
It would have been nice though had we known you were going to be on Kudlow in advance.
I loved the immigration comment last night -- very funny.
It would have been nice though had we known you were going to be on Kudlow in advance.
7.30.2010 | 8:58pm
Dan says:
People in Michigan have a chance to send President Obama a message August 3rd! http://mittromneycentral.com/2010/07/30/we-need-pete-hoekstra-as-michigans-next-governor-vote-august-3rd/
President Obama is trying to knock down Michigan’s best chance at finally having a conservative governor, but we can’t let Obama win! The stakes of this election are simply too high!
At the link, you'll see what Sean Hannity says about this race. August 3rd is the most important day in Michigan politics in years! We need to do what we can to help make sure Michigan sends President Obama a message.
President Obama is trying to knock down Michigan’s best chance at finally having a conservative governor, but we can’t let Obama win! The stakes of this election are simply too high!
At the link, you'll see what Sean Hannity says about this race. August 3rd is the most important day in Michigan politics in years! We need to do what we can to help make sure Michigan sends President Obama a message.
7.30.2010 | 10:11pm
Gregory K. Laughlin says:
First, I couldn't agree more with Mr. Goldman when he notes the role of demographics in the current economic situation. For nearly 40 years, women born in America to parents both of whom were also born in America have had below-replacement rate fertility. That is a prescription for economic decline in the long-term and the long-term is arriving.
Second, immigration of young people can help mitigate this to some extent and that is why a more open immigration policy is needed. But immigration is not a complete substitute for higher fertility among multi-generational Americans because of education and the passing on of social and economic capital which encourage and aid in wealth building and higher incomes.
Third, during the Baby Boom, the capital gains rate was 25%. The economy boomed along with America's nurseries and government had the income it needed to maintain our defense, provide high quality, low cost public education at all levels, build the interstate highway system, and begin the space program, all while paying down the national debt as a percentage of GDP. The elimination of the capital gains tax is both economically unwise and unfair to labor. A 25% capital gains tax worked during the Baby/Post-War boom and it would work now.
Second, immigration of young people can help mitigate this to some extent and that is why a more open immigration policy is needed. But immigration is not a complete substitute for higher fertility among multi-generational Americans because of education and the passing on of social and economic capital which encourage and aid in wealth building and higher incomes.
Third, during the Baby Boom, the capital gains rate was 25%. The economy boomed along with America's nurseries and government had the income it needed to maintain our defense, provide high quality, low cost public education at all levels, build the interstate highway system, and begin the space program, all while paying down the national debt as a percentage of GDP. The elimination of the capital gains tax is both economically unwise and unfair to labor. A 25% capital gains tax worked during the Baby/Post-War boom and it would work now.
7.30.2010 | 10:45pm
Abelard Lindsey says:
The US can't think in terms of a closed national economy, and if the world falls apart, so will we.
This is certainly true. However, the emphasis of foreign policy should be to deal with and invest in the productive peoples and cultures of the world, not the unproductive ones. I am more interested in places like Japan, Korea, China, Singapore, and even Mexico and Brazil than I am in the middle-east and sub-Saharan Africa. I think we need to stop wasting our time and money on the unproductive parts of the world.
This is certainly true. However, the emphasis of foreign policy should be to deal with and invest in the productive peoples and cultures of the world, not the unproductive ones. I am more interested in places like Japan, Korea, China, Singapore, and even Mexico and Brazil than I am in the middle-east and sub-Saharan Africa. I think we need to stop wasting our time and money on the unproductive parts of the world.
7.31.2010 | 9:02am
Disappointed says:
Boy, has FT changed since Fr. Neuhaus died. What has this partisan view of economic theory got to do with the mission of the magazine - or the former mission of the magazine? If I wanted to read this type of material I have a thousand choices. There was only one FT.
7.31.2010 | 9:20am
JP says:
There are a few points that I would like to make:
1)Concerning delfaltion - inflation statistics for the last decade or so do not take into account the price of energy or food. The reason being, these 2 metrics are volatile and do not necessairily relfect the "real price". That may be so, but for the majority of Americans these 2 metrics make up a huge part of thier spend. And for the last decade, the price of energy and food have been rising at a rate of 10% or more. This should come as no suprise, as the price of gold has risen from around $200 an ounce to over $1100 an ounce. Inflation is out there, all right. The price of these 3 commodities relfect the general weakness of the dollar. And this weakness is a function of both monatary and fiscal policies.
2)About 6 years ago I saw this period of long term deflationy recessions. Like the author of this piece,, I saw the aging population of not just the United States but all of the G20 nations as the source. As a matter of fact when compared to nations like Italy, Greece, Russia, Spain, Japan, China (all with fertility rates below 1.5 children per female), the US is sitting pretty good at 1.87 children per female (taken from the CIA Factbook). But, this number also reflects immigration (both legal and illegal). And most of our immigatrants do not intergrate very well into our society. They may be younger and more fecund, but they will remain below th 50% of our median income. Most of the aging in this nation have most of the wealth. The same can be said for Europe and China. When one takes into account that this age group will see the majority of the income redistribution the next few decades, it is not too difficult to realize that there will be little future wealth creation here or anywhere else. Not only will the Baby Boomers begin to tap into thier IRAs, annuityies, 401ks and other investments, but they will receive trillions of dollars in transfer of wealth payments a la Social Security and Medicare. As the author of this piece points out this is deflationary.
3)On a global scale we probably saw a peak in both rescource consumption (food and energy ) and industrial output from 1995-2007. It was during this period that developing nations such as China and other Third World nations began to flex thier economic muscles. Outsourcing of both manufacturing and service jobs to these cheap labor nations led to an explosion in both the manufacturing and consumption of food and consumer goods. Commodities prices went through the roof, living standards improved immeasurably for many nations, and the US and Europe went through its last consumption binge. In the US, many empty nesters and well off professionals bought up in homes. There was a definite explosion in real estate and new home building. As a result, the US and other nations saw an huge uptick in new home inventories. With the collapse of the real estate market, the US now has far too many expensive homes. Emtpy strip malls and McMansions now hang like an albatross over the shoulders of our banks. Not even $2 trillion in federal relief have stopped the delfationary pressures on banks ledgers. That just are not enough younger Americans with the income to buy up all of these homes.
I don' think we will be able to avoid the short term pain (ie lower standards of living). A growing dynamic economy needs people -lots of them. And these people have to be both producers and consumers. A society can chose to be childless; it can also chose to offer very generous public entitlements. But it cannot do both. When Bismarck mandated the first Social Security program, Germany had a fertilty rate of 5 children/female. When FDR implemented our Social Security program in 1937 there were 40 workers per every retiree. Today it is less than 2 workers per retiree. The sad fact is there are just not enough young workers here or in the other welathy nations to support both a growing economy and generous entitlements.
Finally, the current fiscal policies our federal and state governments are pursing are hugely inflationary. In a time when deflationary pressures are causing significant problems, our lawmakers are spending trillions of dollars they do not have. In just a few years the interest on the Treasury Notes our government must pay-off will be over $1 trillion. By 2015 the combined interest payments plus Social Security, plus Medicare and Medicare alone will be over $3 trillion annually. This currency weakness can easily be seen in the price of energy. Oil prices remain at inflated levels despite a huge drop off in demand. The only explaination is inflation due to a weakening dollar. We have gotten our selves into the unenviable position where deflation and a hyperinflation are both possible.
1)Concerning delfaltion - inflation statistics for the last decade or so do not take into account the price of energy or food. The reason being, these 2 metrics are volatile and do not necessairily relfect the "real price". That may be so, but for the majority of Americans these 2 metrics make up a huge part of thier spend. And for the last decade, the price of energy and food have been rising at a rate of 10% or more. This should come as no suprise, as the price of gold has risen from around $200 an ounce to over $1100 an ounce. Inflation is out there, all right. The price of these 3 commodities relfect the general weakness of the dollar. And this weakness is a function of both monatary and fiscal policies.
2)About 6 years ago I saw this period of long term deflationy recessions. Like the author of this piece,, I saw the aging population of not just the United States but all of the G20 nations as the source. As a matter of fact when compared to nations like Italy, Greece, Russia, Spain, Japan, China (all with fertility rates below 1.5 children per female), the US is sitting pretty good at 1.87 children per female (taken from the CIA Factbook). But, this number also reflects immigration (both legal and illegal). And most of our immigatrants do not intergrate very well into our society. They may be younger and more fecund, but they will remain below th 50% of our median income. Most of the aging in this nation have most of the wealth. The same can be said for Europe and China. When one takes into account that this age group will see the majority of the income redistribution the next few decades, it is not too difficult to realize that there will be little future wealth creation here or anywhere else. Not only will the Baby Boomers begin to tap into thier IRAs, annuityies, 401ks and other investments, but they will receive trillions of dollars in transfer of wealth payments a la Social Security and Medicare. As the author of this piece points out this is deflationary.
3)On a global scale we probably saw a peak in both rescource consumption (food and energy ) and industrial output from 1995-2007. It was during this period that developing nations such as China and other Third World nations began to flex thier economic muscles. Outsourcing of both manufacturing and service jobs to these cheap labor nations led to an explosion in both the manufacturing and consumption of food and consumer goods. Commodities prices went through the roof, living standards improved immeasurably for many nations, and the US and Europe went through its last consumption binge. In the US, many empty nesters and well off professionals bought up in homes. There was a definite explosion in real estate and new home building. As a result, the US and other nations saw an huge uptick in new home inventories. With the collapse of the real estate market, the US now has far too many expensive homes. Emtpy strip malls and McMansions now hang like an albatross over the shoulders of our banks. Not even $2 trillion in federal relief have stopped the delfationary pressures on banks ledgers. That just are not enough younger Americans with the income to buy up all of these homes.
I don' think we will be able to avoid the short term pain (ie lower standards of living). A growing dynamic economy needs people -lots of them. And these people have to be both producers and consumers. A society can chose to be childless; it can also chose to offer very generous public entitlements. But it cannot do both. When Bismarck mandated the first Social Security program, Germany had a fertilty rate of 5 children/female. When FDR implemented our Social Security program in 1937 there were 40 workers per every retiree. Today it is less than 2 workers per retiree. The sad fact is there are just not enough young workers here or in the other welathy nations to support both a growing economy and generous entitlements.
Finally, the current fiscal policies our federal and state governments are pursing are hugely inflationary. In a time when deflationary pressures are causing significant problems, our lawmakers are spending trillions of dollars they do not have. In just a few years the interest on the Treasury Notes our government must pay-off will be over $1 trillion. By 2015 the combined interest payments plus Social Security, plus Medicare and Medicare alone will be over $3 trillion annually. This currency weakness can easily be seen in the price of energy. Oil prices remain at inflated levels despite a huge drop off in demand. The only explaination is inflation due to a weakening dollar. We have gotten our selves into the unenviable position where deflation and a hyperinflation are both possible.
7.31.2010 | 11:05am
roger says:
JP:
Thank you for that great analysis.
The only thing I would add is that I do not think we have seen the peak of industrial output and consumption. China will soon overtake the US as the World's largest economy and India will be close behind. The World economy is evolving, it is as if we are in a multi stage theater where the US and Europe have occupied center stage for so long we don't see that the center is shifting to a new set of actors. This is the inevitable result of our demographics.
Thank you for that great analysis.
The only thing I would add is that I do not think we have seen the peak of industrial output and consumption. China will soon overtake the US as the World's largest economy and India will be close behind. The World economy is evolving, it is as if we are in a multi stage theater where the US and Europe have occupied center stage for so long we don't see that the center is shifting to a new set of actors. This is the inevitable result of our demographics.
7.31.2010 | 11:11am
Krakow says:
The financial crisis started in August of 2007. In June of 2008 we were terrified by news of oil scarcity. In March of 2009 we were terrified that banks would fail and foreigners would take possession of prized US assets for next to nothing. In July of 2010, we are terrified by unemployment. What will terrify us next? Maybe it will be some sort of artificial manipulation of human reproduction that could end the human race.
We should have high unemployment for about 3 more years no matter what the administration does. Wait for things to trickle down and get over it. Investors have no choice but to invest in technology whatever the tax code. More importantly, an investor will not put equity into a startup if he doesn't think that the startup will have access to cheaper debt capital in the subsequent rounds. Why? Because investors are greedy and they don't want to be diluted by equity investors in subsequent rounds. Banks will show some level of confidence in startups before a flood of equity capital flows into venture. But if changing the tax code makes you happy to move some money around for generally no good reason at all, so be it.
"This economic crisis doesn't represent a cycle. It represents a reset. It's an emotional, social, economic reset." I am betting that Jerry Immelt's statement is wrong and that this crisis looks like the cotton panic of 1837 or the one before it, whatever it was.
But I could be wrong.
We should have high unemployment for about 3 more years no matter what the administration does. Wait for things to trickle down and get over it. Investors have no choice but to invest in technology whatever the tax code. More importantly, an investor will not put equity into a startup if he doesn't think that the startup will have access to cheaper debt capital in the subsequent rounds. Why? Because investors are greedy and they don't want to be diluted by equity investors in subsequent rounds. Banks will show some level of confidence in startups before a flood of equity capital flows into venture. But if changing the tax code makes you happy to move some money around for generally no good reason at all, so be it.
"This economic crisis doesn't represent a cycle. It represents a reset. It's an emotional, social, economic reset." I am betting that Jerry Immelt's statement is wrong and that this crisis looks like the cotton panic of 1837 or the one before it, whatever it was.
But I could be wrong.
7.31.2010 | 10:13pm
Charles R. Williams says:
I agree with Goldman except that I think he exaggerates the comparison with Japan. The kind of debt deflation that has people frightened is the result of distortions in relative prices that cannot be quickly resolved in the marketplace for structural reasons. The asset bubble in Japan was bigger than the American asset bubble. The Japanese banks were less solvent than American banks are today. Japanese labor markets were far more rigid than the American private sector labor market. American is far better at assimilating immigrants. Suppose we expect prices to fall. Nobody buys and prices fall to clear the market. Expected deflation can exist only if people expect a contractionary monetary policy to persist or there are barriers to rapid price adjustments. Government policy is still focused on avoiding foreclosures, nursing insolvent banks back to health over several years and postponing needed shrinkage in public sector employment and compensation. This is where the risk of deflation lies.
8.1.2010 | 11:04am
TJ Parker says:
This essay is so misguided and proves that a little knowledge can be a dangerous thing.
Let's remember our differential calculus here, please. If the rate of destruction of money is greater than the rate at which money can be replenished through even the most optimistic sort of growth, then deflation will result. The deflationary recession that we have seen now - one following a panic - is not comparable to any seen since the 1930's; others were more standard boom-bust recessions. The Fed's proposed monetary policy to address these issues is nevertheless not a whole lot different, in concept, from its typical response: lower interest rates. Of course, when interest rates are already 0, there's little that can be done through traditional means. ("Pushing on a string") Here is where quantitative easing comes into play, which effectively reduces the interest rate below 0.
Yes, Japan stagnated for a year pursuing similar policies. We also have stagnated for a year, when the last decade is averaged out: the Bush boom disappeared in the wink of an eye because it was an illusion. Trillions of dollars disappeared in the span of a few months.
So what was the alternative for Japan? The appearance of stagnation is pretty good when you're in a massively deep hole and the alternative is a 1930's style depression. We too face this alternative now.
And where do you weigh in on this? I don't know. You're inconsistent:
"Expected deflation can exist only if people expect a contractionary monetary policy to persist or there are barriers to rapid price adjustments."
The Fed knows this and of course is working to prevent this from happening. The bond market has responded, recognizing that the Fed will not let this happen. But your observation above contradicts explicitly the disdain in the next sentence of your conclusion:
"Government policy is still focused on avoiding foreclosures, nursing insolvent banks back to health over several years and postponing needed shrinkage in public sector employment and compensation."
Embracing this shrinkage will of course reduce inflationary expecations. You can't have it both ways.
Let's remember our differential calculus here, please. If the rate of destruction of money is greater than the rate at which money can be replenished through even the most optimistic sort of growth, then deflation will result. The deflationary recession that we have seen now - one following a panic - is not comparable to any seen since the 1930's; others were more standard boom-bust recessions. The Fed's proposed monetary policy to address these issues is nevertheless not a whole lot different, in concept, from its typical response: lower interest rates. Of course, when interest rates are already 0, there's little that can be done through traditional means. ("Pushing on a string") Here is where quantitative easing comes into play, which effectively reduces the interest rate below 0.
Yes, Japan stagnated for a year pursuing similar policies. We also have stagnated for a year, when the last decade is averaged out: the Bush boom disappeared in the wink of an eye because it was an illusion. Trillions of dollars disappeared in the span of a few months.
So what was the alternative for Japan? The appearance of stagnation is pretty good when you're in a massively deep hole and the alternative is a 1930's style depression. We too face this alternative now.
And where do you weigh in on this? I don't know. You're inconsistent:
"Expected deflation can exist only if people expect a contractionary monetary policy to persist or there are barriers to rapid price adjustments."
The Fed knows this and of course is working to prevent this from happening. The bond market has responded, recognizing that the Fed will not let this happen. But your observation above contradicts explicitly the disdain in the next sentence of your conclusion:
"Government policy is still focused on avoiding foreclosures, nursing insolvent banks back to health over several years and postponing needed shrinkage in public sector employment and compensation."
Embracing this shrinkage will of course reduce inflationary expecations. You can't have it both ways.
8.2.2010 | 8:29am
Montreal Calling says:
The only problem with Mr. Goldman's commentary above is the demographic data.
Japan's 'old age dependency ratio' moved from 10% in 1970 to 17% in 1990 and 35% today (there were very few old people in Japan in 1970 because all of the 30 year olds were killed in 1935).
By way of comparison, 16% of Americans were over 65 in 1970, 18% in 1985, 19% were over 65 in 1990, and 19% are 65+ today.
In short, while Japan aged extraordinarily rapidly, the US has had the same old-age dependency ratio for the past 20 years and a more-or-less stable old-age dependency ratio for the past 25. The big demographic change in the US occurred during the 1980s and was followed by 25 years of rapid economic growth.
There are some in the fund-management community who deny that the growth of the 1980s-1990s was really economic growth at all, but, in short, in order to believe that there is a demographic crisis in the U.S., one must deny the economic growth of the 1980s and 1990s --- and therefore, deny that the best-illustrated examples of tax cuts correlating with growth were at all beneficial.
Japan's 'old age dependency ratio' moved from 10% in 1970 to 17% in 1990 and 35% today (there were very few old people in Japan in 1970 because all of the 30 year olds were killed in 1935).
By way of comparison, 16% of Americans were over 65 in 1970, 18% in 1985, 19% were over 65 in 1990, and 19% are 65+ today.
In short, while Japan aged extraordinarily rapidly, the US has had the same old-age dependency ratio for the past 20 years and a more-or-less stable old-age dependency ratio for the past 25. The big demographic change in the US occurred during the 1980s and was followed by 25 years of rapid economic growth.
There are some in the fund-management community who deny that the growth of the 1980s-1990s was really economic growth at all, but, in short, in order to believe that there is a demographic crisis in the U.S., one must deny the economic growth of the 1980s and 1990s --- and therefore, deny that the best-illustrated examples of tax cuts correlating with growth were at all beneficial.
8.4.2010 | 10:59pm
Mikhail Sagarduy says:
David, good intentions would imply idiocy. Goodness is the wrong assumption. They're clever criminals. They are not idiots. They lie. They steal. They con. Don't assume they believe their words.
They work a Plan. And that Plan is: destroy small business and collapse America. Small business is the enemy. Family is the enemy. Transnational cartels are the desired outcome.
Americans used to fight central banking for a reason. It is an old story. Google "United States Bankers Magazine" from the year 1892. Try "Vicky Davis" and "Technocratic Coup d'Etat" for recent details. Alan Watt details family destruction efforts.
They work a Plan. And that Plan is: destroy small business and collapse America. Small business is the enemy. Family is the enemy. Transnational cartels are the desired outcome.
Americans used to fight central banking for a reason. It is an old story. Google "United States Bankers Magazine" from the year 1892. Try "Vicky Davis" and "Technocratic Coup d'Etat" for recent details. Alan Watt details family destruction efforts.
10.16.2010 | 12:39am
Cindie Pawlowicz says:
Mr. Goldman, let's get to the real issue: how can we ordinary people get on this gravy train? With enough pressure on our Congress, maybe it will force the Fed to ramp up this innovative program. Unfortunately the US has evolved to a situation where freedom is hardly valued at all (despite the "land of the free, home of the brave" crock that is parroted). It is clear that the ruling bureaucratic and political class is now overwhelmingly collectivist in its outlook. As an example; Barack Obama, during the campaign, spoke of the profits of the oil companies belonging to "the people", "that is your money" is exactly what he said to his crowd of baying supporters. "Spread the wealth", actually = steal private property, and give it to people who will vote for the spreader, this economic principle is clearly embraced by the democratic party. What economic principles are believed in by the republican party is almost impossible to discern.
10.19.2010 | 7:43pm
J says:
Just saw DG on cnbc
When he stated that the GOP isnt going to fix anything and that OBAMACARE HAS TO BE COMPLETELY REVERSED, I had to send A BIIGGGGGG THANK YOU
SO SICK OF THE RINOS
They are already crying that they will compromise with the Letist scum
When he stated that the GOP isnt going to fix anything and that OBAMACARE HAS TO BE COMPLETELY REVERSED, I had to send A BIIGGGGGG THANK YOU
SO SICK OF THE RINOS
They are already crying that they will compromise with the Letist scum
12.7.2010 | 9:24pm
Jim Aliberti says:
Hi David,
I was watching you on CNBC last night and was most interested in the comments about venture capital or the lack of it for manufacturing ventures.
I am an engineer and in my younger days tried on a number of occasions to start these types of manufacturing companies with innovative products. My efforts to raise capital were a failure, I'm not even sure my business plans were even read.
Recently and on a number of occasions I have tried to contact my newly elected Scott Brown to address venture capital formation and other issues important to business development, never a single response!
I had suggested reinventing the SBA to assist entrepreneurs in the patent application process and writing to assisting them to develop international distribution channels and finally to develop networks of private investors for raising capital.
I too believe exactly as you do that this is a major problem for this country and all too often venture money goes to the well connected rather than the most innovative.
I travel to China fairly regularly and most of the engineers I meet have ambitions of starting a business, they show an attitude that has long past for America. We need to get this back but they system has beat up our innovators to the point where it is just simpler to work for someone.
I am here to help and I would hope that I could work with you by helping get this all important message out.
Please contact me
Jim
I was watching you on CNBC last night and was most interested in the comments about venture capital or the lack of it for manufacturing ventures.
I am an engineer and in my younger days tried on a number of occasions to start these types of manufacturing companies with innovative products. My efforts to raise capital were a failure, I'm not even sure my business plans were even read.
Recently and on a number of occasions I have tried to contact my newly elected Scott Brown to address venture capital formation and other issues important to business development, never a single response!
I had suggested reinventing the SBA to assist entrepreneurs in the patent application process and writing to assisting them to develop international distribution channels and finally to develop networks of private investors for raising capital.
I too believe exactly as you do that this is a major problem for this country and all too often venture money goes to the well connected rather than the most innovative.
I travel to China fairly regularly and most of the engineers I meet have ambitions of starting a business, they show an attitude that has long past for America. We need to get this back but they system has beat up our innovators to the point where it is just simpler to work for someone.
I am here to help and I would hope that I could work with you by helping get this all important message out.
Please contact me
Jim
