'Mr. Trichet should be commended for courageously taking to the next level one of the most important debates of our time .... Our policymakers, economists, and pundits should read Mr. Trichet carefully and contemplate a course other than inflationism.'<blockquote>
'The title of Mr. Trichet’s remarkable op-ed piece in today’s FT was direct and to the point: “Stimulate No More – It Is Now Time For All To Tighten.” The head European central banker has spoken publicly and in no uncertain terms: unrelenting government stimulus is today fraught with great risk. Mr. Trichet should be commended for courageously taking to the next level one of the most important debates of our time.
...From the astute Mr. Trichet: “With hindsight, we see how unfortunate was the oversimplified message of fiscal stimulus given to all industrial economies under the motto: ‘stimulate’, ‘activate’, ‘spend’!”
...Over the years, top European central bankers argued against U.S.-style “activist” central banking. The ECB decisively won this debate, yet the Fed is today under intense pressure to become only more radically “activist.” Mr. Trichet must have been compelled to interject.
...
I’m of the view that our fiscal predicament has been decades in the making and is much worse than generally appreciated...
My thesis holds that the rapid deterioration of our fiscal standing was only interrupted by an extraordinary (and unrepeatable) 15-year boom in private-sector Credit creation. In particular, this historic debt expansion was dominated by a profound change – including a massive expansion - in financial sector risk intermediation. Between 1993 and 2008, GSE assets ballooned from $631bn to $3.4 TN. Over this period, the agency MBS market expanded from about $1.4 TN to end 2009 at $4.96 TN. The asset-backed securities market surpassed $4.5 Trillion in 2007, up from about $400bn to begin 1993. Broker/Dealer assets began 1993 at less than $400bn and grew to about $3.1 TN. After ending 1993 at $3.3 TN, total U.S. financial sector borrowings closed 2008 above $17.0 TN. In the ten years 1998 through 2007, total mortgage debt jumped from $5.13 TN to $14.5 TN, a historic gain of 183%. These were “once-in-a-lifetime” financial and economic developments.
This enormous increase in debt inflated asset prices, inflated incomes, inflated spending, and inflated government receipts and expenditures. In particular, the huge expansion of household and financial sector debt was chiefly responsible for filling government coffers from Washington to Sacramento. Politicians extrapolated this bonanza and spent unwisely. But the 2008 bursting of the mortgage/Wall Street finance Bubble abruptly ended this cycle of Credit inflation. Much of the debt intermediated through the U.S. Credit system was discredited. The housing mania was terminated, resulting in a collapse in demand for mortgage Credit.'
...Our policymakers, economists, and pundits should read Mr. Trichet carefully and contemplate a course other than inflationism.'</blockquote>
Trichet Challenges InflationismBy Doug Noland
July 23, 2010
Source“The acute fiscal challenges across all industrial economies are no surprise. Our economies are emerging from the worst economic crisis since the second world war, and without the swift and appropriate action of central banks and a very significant contribution from fiscal policies, we would have experienced a major depression. But now is the time to restore fiscal sustainability. The fiscal deterioration we are experiencing is unprecedented in magnitude and geographical scope. By the end of this year, government debt in the euro area will have grown by more than 20 percentage points over a period of only four years, from 2007-2011. The equivalent figures for the US and Japan are between 35 and 45 percentage points. The growth of public debt has been driven by three phenomena: a dramatic diminishing of tax receipts due to the recession; an increase in spending, including a pro-active stimulus to combat the recession; and additional measures to prevent the collapse of the financial sector.” European Central Bank President Jean-Claude Trichet, Financial Times, July 2[2], 2010
The title of Mr. Trichet’s remarkable op-ed piece in today’s FT was direct and to the point: “Stimulate No More – It Is Now Time For All To Tighten.” The head European central banker has spoken publicly and in no uncertain terms: unrelenting government stimulus is today fraught with great risk. Mr. Trichet should be commended for courageously taking to the next level one of the most important debates of our time.
From Mr. Trichet: “…Given the magnitude of annual budget deficits and the ballooning of outstanding public debt, the standard linear economic models used to project the impact of fiscal restraint or fiscal stimuli may no longer be reliable. In extraordinary times, the economy may be close to non-linear phenomena such as a rapid deterioration of confidence among broad constituencies of households, enterprises, savers and investors. My understanding is that an overwhelming majority of industrial countries are now in those uncharted waters, where confidence is potentially at stake. Consolidation is a must in such circumstances.”
Perhaps his stern message was directed at Dr. Bernanke, the Federal Reserve and the Administration. More likely, it was in response to the recent chorus of calls for even more extreme government stimulus and intervention. Especially from some notable American economists, there has been a movement afoot to press Washington (and global policymakers) to completely throw caution to the wind in a crusade of further government spending programs and monetization. From the astute Mr. Trichet: “With hindsight, we see how unfortunate was the oversimplified message of fiscal stimulus given to all industrial economies under the motto: ‘stimulate’, ‘activate’, ‘spend’!”
Meanwhile, the markets this week seemed to demand that our Fed Chairman arrive for his Congressional testimony with a lengthy list of additional measures our central bank is prepared to immediately implement to ensure buoyant markets and a robust recovery. Over the years, top European central bankers argued against U.S.-style “activist” central banking. The ECB decisively won this debate, yet the Fed is today under intense pressure to become only more radically “activist.” Mr. Trichet must have been compelled to interject.
With today’s noon release of the European bank “stress test,” Mr. Trichet’s message didn’t garner the attention it deserved. Not unexpectedly, “test” results were met with skepticism. The most popular complaint seemed to be that they lacked credibility because the tests didn’t factor in the banks’ capital exposure to sovereign debt risk. Well, I doubt there are many banking systems around the world these days that would perform satisfactorily in the event of a domestic sovereign debt crisis. Our banking system would surely not function well in the event of a crisis of confidence – and spike in yields – throughout our Treasury, agency debt and MBS markets.
These days, the marketplace can fixate on deflation risk and feel comfortable holding our debt instruments. With perceptions of scant inflation risk and a Fed predisposed toward additional monetization, bonds are viewed as a low-risk proposition. And, of course, with market yields at historic lows it is especially easy to dismiss the seriousness of today’s unfolding fiscal problems.
I’m of the view that our fiscal predicament has been decades in the making and is much worse than generally appreciated. At about 66% of GDP, most believe our federal government's fiscal position is quite manageable – and is certainly better than many others. At worst, market participants perceive there are still a few years before they must concern themselves with U.S. debt service issues. There is, as well, faith in the prospect of economic recovery rectifying our massive deficits. I fear we have reached the stage where our deficits are unmanageable: in this post-mortgage/Wall Street finance Bubble backdrop, economic recovery will disappoint and prospective governmental receipts and expenditures will really disappoint.
Hear me out on this. I – along with others – believed our fiscal position back in the early-nineties was a disaster in the making. Were we wrong? Our federal debt expanded 134% during the seventies to $779bn. The eighties saw federal borrowings increase another 247% to $2.701 TN. “Fortunately,” GDP inflated massively as well, ending the eighties up 457% in 20 years to $5.482 TN.
As a percentage of GDP, federal debt ended the sixties at 33.8% and the seventies at 30.4%. Enormous deficits, however, saw this ratio deteriorate markedly during the eighties, ending 1989 at 49.3%. A few years of record deficits resulted in this ratio jumping to 58.9% by 1993. Miraculously, the economy set course on a protracted boom, and governmental receipts skyrocketed. By 2001, federal debt had dropped to 41.8% of GDP. Many were contemplating the ramifications of Washington paying back all its borrowings.
My thesis holds that the rapid deterioration of our fiscal standing was only interrupted by an extraordinary (and unrepeatable) 15-year boom in private-sector Credit creation. In particular, this historic debt expansion was dominated by a profound change – including a massive expansion - in financial sector risk intermediation. Between 1993 and 2008, GSE assets ballooned from $631bn to $3.4 TN. Over this period, the agency MBS market expanded from about $1.4 TN to end 2009 at $4.96 TN. The asset-backed securities market surpassed $4.5 Trillion in 2007, up from about $400bn to begin 1993. Broker/Dealer assets began 1993 at less than $400bn and grew to about $3.1 TN. After ending 1993 at $3.3 TN, total U.S. financial sector borrowings closed 2008 above $17.0 TN. In the ten years 1998 through 2007, total mortgage debt jumped from $5.13 TN to $14.5 TN, a historic gain of 183%. These were “once-in-a-lifetime” financial and economic developments.
This enormous increase in debt inflated asset prices, inflated incomes, inflated spending, and inflated government receipts and expenditures. In particular, the huge expansion of household and financial sector debt was chiefly responsible for filling government coffers from Washington to Sacramento. Politicians extrapolated this bonanza and spent unwisely. But the 2008 bursting of the mortgage/Wall Street finance Bubble abruptly ended this cycle of Credit inflation. Much of the debt intermediated through the U.S. Credit system was discredited. The housing mania was terminated, resulting in a collapse in demand for mortgage Credit.
In the post-Bubble backdrop, private-sector (household and financial sector) Credit has contracted, and there is little prospect for meaningful expansion for some years to come. Unlike the early nineties, there will be no miraculous new type of finance to fuel booms in the economy, asset prices, and government receipts. Financial innovation and the reckless expansion of Wall Street finance will not bail out Washington. We're basically left with a massive expansion of government debt until the markets decide to impose discipline.
Our recovery has been completely dependent upon government spending and ultra-loose monetary policy. This has entailed an incredible increase in Treasury borrowings. The markets assume our rapidly deteriorating fiscal situation will improve as the economy recovers. On the spending side, the economy is now dependent on massive federal stimulus. I don’t expect any self-imposed restraint on government expenditures. And, importantly, it would take renewed expansion of private-sector debt to meaningfully boost the ratio of governmental receipts to expenditures. Washington – or the states – can’t spend its way to fiscal recovery. Instead, we’re witnessing a fiscal train wreck. Our policymakers, economists, and pundits should read Mr. Trichet carefully and contemplate a course other than inflationism.