The analysis presents a plot of housing starts vs population, since 1960, showing that current starts are at a series low.

Using the ratio of starts to population is not the correct metric for understanding the likely future path of housing starts.  It’s true that housing starts are currently historically low, and population remains high, but there are reasons why the Flow (housing construction) could remain low for some time, if there’s too much durable Stock (existing housing units) and persistent low demand for said stock (due to demographic changes).

The construction need is determined primarily by two flows: changes in household size, and population growth — not by population. 100% of population growth needs housing, whereas only 1% of population stock needs to be rebuilt each year, assuming a given home lasts 100 years.  Assuming stable househould size, if population growth previously averaged 2-3% of population, but today averages only 0-1% due to declining birthrate and reduced immigration, that cuts the need for new housing and reduces the required number of starts by 2/3 to 3/4.

Furthermore, in recessionary conditions, household formation drops and household size increases.  With median household size in the range 2 to 3 persons, a change of just +0.1 person per household results in a -3 to -5% change in the required housing stock, equivalent to 3-5 years of replacement production.  This effect can therefore be even larger than the population growth effect.

Household size and population growth were both quite high in the 1960s (when the available data series started, the Baby Boom was peaking).  The decline in household size since the 1960s drove much of the demand for housing but is not sustainable.  If we previously ran a population growth of 2%/year and it is now 0%/year or even slightly negative (as in Japan, Russia, China, Europe…), and if household size is trending back up, we might not need any new homes at all for as long as household size trends upward.

So to me, it’s not at all clear when we’ll need to build more houses.  (If it were clear, investors would flock to homebuilder stocks, would they not?)

Only in the past few decades have we brainwashed ourselves into thinking that debt levels of 40-80% of GDP were normal, or that there could be such a thing as a “sustainable deficit”.  Our forebears were demonstrably wiser than most Boomers today, and I believe we’re about to relearn some very painful historical lessons.

Historically the US, like other nations, has sought very hard to stay out of debt, not to add to it with allegedly “sustainable” deficits.  This is illustrated very dramatically with the historical debt charts.  The ones on Wikipedia are particularly accessible:

U.S. pubic debt was only 20% of GDP in the early 1800s, and the debt was all but extinguished from 1830-1860.  The Civil War led to a debt burden of 30-40%, which was again extinguished by 1910.  World War I led to another 30% burden, which had been cut to 20% when the Great Depression hit.  Even in the GD, the debt only went up to 40%.  It was only World War 2 which pushed the debt to 110% of GDP, and once again as soon as the war ended we sensibly reduced the debt burden, reaching about 25% of GDP in 1970-1980.

Throughout all of these periods, rising national prosperity has led to a reduction in debt relative to GDP.  We have never been able to “borrow our way to prosperity”!

As the more recent data below shows, since 1980 we have gone on a debt binge.  We are not alone. The European PIIGS “canaries” are screaming that we now live in an unsafe “coal mine”, a debt trap!

If we don’t get our debts back into balance, we face horrific declines in our national standard of living, because if we don’t pay the debt off, the alternatives are either default or inflation.  And when debt exceeds 100% of GDP, it’s very hard to pay the debt off.

It is time to bring the Debt-to-GDP ratio back down.  Any incremental debt must therefore have a strong impact on GDP growth.  The current Administration and Congress are unable to deliver.  We need to change, if we are to have hope!

However, I do not currently see, nor do I expect to see, public attitudes shifting quickly enough.  Too many think that we can live with “sustainable deficits”, despite the fact that unexpected events happen every year which force debtors into defaults.  Those who try to “sustain” their deficits find, almost inevitably, that sooner or later they are “unexpectedly” bankrupt.

Unfortunately,  our government (and many others) has accumulated a debt burden which is only sustainable if the bond market chooses to sustain it. The bond market has voted otherwise in Europe, and could easily do so here. These governments, rather than being led by their people’s votes, are now at the mercy of their financiers.

The pattern of accumulating more debt than you can pay off (without rolling or refinancing) needs to be tamed. Because if a nation can pay off its debt without depending on bankers, it has far more freedom. As it is, we have fallen into debt serfdom.  I don’t think the American people will want to stay in that position, so I think we are in for a painful awakening, and a return to more historical attitudes towards debt.

London Banker is one of the most thoughtful economics bloggers, and I’m glad to see he’s back, after evidently taking a break from blogging to work on the U.K. banking system!

There is a quote that Eccles gave in 1933, from W.T. Foster, which resonates today:

It is utterly impossible, as this country has demonstrated again and again, for the rich to save as much as they have been trying to save, and save anything that is worth saving. They can save idle factories and useless railroad coaches; they can save empty office buildings and closed banks; they can save paper evidences of foreign loans; but as a class they can not save anything that is worth saving, above and beyond the amount that is made profitable by the increase of consumer buying. It is for the interests of the well to do – to protect them from the results of their own folly – that we should take from them a sufficient amount of their surplus to enable consumers to consume and business to operate at a profit. This is not “soaking the rich”; it is saving the rich. Incidentally, it is the only way to assure them the serenity and security which they do not have at the present moment.

Now, this message is not real popular with my family, who believe everyone ought to earn what they get, and be able to keep what they earn. And in the current U.S. political climate, there are grave reasons to fear that in “saving the rich” from themselves, we will squander our last chance to rescue the economy through another round of waste, corruption, nonfeasance and injustice.

But there’s an abundance of evidence that the economic structure has made it too easy for too many to keep too much — and on top of that, the amount which “can” be “saved” is simply not enough for everyone who faces retirement and wants to save!

Here is a quick quantification of why the quote matters today:

In the U.S., it’s simply mathematically impossible for 76 million Baby Boomers, representing 1/4 of the population, to save 16-25 times their accustomed (final, peak) annual income and retire on “savings” by drawing out 4-6%/year. Such “savings” would have to amount to well over 4 to 5 times U.S. GDP… well over 60 to 75 TRILLION dollars. This value, 60,000,000,000,000 exceeds by at least $20 trillion the total wealth of the country! And that would leave no room for either older or younger generations to own anything!

Retirement in any civilized form simply cannot be funded by any credible “stock” of real “savings”… it must be a “flow” of goods and services provided by the increasingly productive young to the increasingly numerous elderly.

The same issue applies to China, Japan, and Europe, all of which are now facing similar demographics.

This issue is exacerbated by our credit-based approach to everything, in which very few people stockpile years worth of food, gasoline, etc. in advance in order to survive old age. In a purely tangible sense, the retired, unemployed and wealthy cannot consume more than the surplus produced by the workers.

The economically-dependent can, however, politically squeeze the workers’ share of consumption, in order to have more for themselves!

Interestingly, if one imagines persistent zero interest rates and negative real yields, the financial incentive to stockpile goods should start to impact behavior. Hopefully this will provide the stimulus to restore full production, because otherwise it must result in yet another squeeze on current consumption.

So in the end I’m forced to agree with the quotation.  The economic playing field must be leveled, to restore prosperity for all, and to bring the machinery of production back into full use.  We must not squander what we spend, any further.  But if we can pull this off, the growth in total national wealth should make the sacrifice of the rich a worthwhile investment.

Shiller’s two-week old “frantic beauty contest” argument wasn’t worth the paper it wasn’t printed on.

The market crash was led by and dominated by problems in Europe and had very little to do with the S&P downgrade, other than as an illustration that the U.S. government also hasn’t got a clue, much less a plan, for returning to solvency… The S&P news might have been the proverbial “wings of the butterfly” driving the chaotic “market-weather” system wild, but it WAS “hurricane season” and if not S&P, something else would’ve started the storm.

The stock market tail is being wagged by the huge bond market dogs. We are reaching the end of a 30-year bull market in bonds.  Interest rates have been falling consistently from 1982-present, but now have almost no room to fall further.  The much smaller stock market is being wagged violently because a whole bunch of bondholders at the Emperor’s dinner party have finally conceded that he really doesn’t look good with no clothes on, and they now fear losing the shirts off their backs to cover his new wardrobe bill.

As a result of this belated realization that the Eurozone financial sector is once more deeply insolvent… that our 21st-century Titanic really is going to sink despite all the hubristic “financial engineering”… credit seized up when everyone jumped into the non-Euro lifeboats. Mountains of money (literally, if you think of it in terms of printed $1 bills or 1-Euro coins!) are jumping all over the world.  Some are seeking safe-haven shelters, others need to cover rampaging liquidity problems.  Totally “unexpected” (yet obvious in hindsight) events are catching huge numbers of traders and hedge funds off guard, causing margin-call collateral damage across a number of markets.

And that’s just the most immediate list of crisis issues!  We live in interesting times…

Even the bondholders who emerge with their principal intact can expect only minimal interest, and also only minimal capital gains over the next decade. Particularly relative to the gains typical during the 1982-2010 period, the near future looks very grim.  And those receiving their principal back from their “certificates of confiscation” will be the lucky ones!  The market desperately needs a cleansing wave of defaults to dissuade lenders from taking even more foolish risks in the future.  Some folks, who have made themselves examples of how not to lend, will have to be exposed for the frauds that they are, so that others will learn.

MEANWHILE, back in Shiller’s home country, there’s the emerging data that the U.S. economy recently slid back into recession.  Businesses can feel it and astute traders can see it in the emerging data, but America’s economists and political leaders haven’t got a clue, much less a politically viable plan.  So now we face huge new series of crises, at a time when we haven’t even seriously started to address the fundamental, structural economic problems that were exposed 3-5 years ago.  One can only hope that this time, sensible voters get educated and demand real reforms, rather than letting the financial elites squander another crisis.

Amidst all of this, the S&P downgrade had nothing to do with anything, except in the minds of some politicians and economists.  The T-bond markets totally ignored the news, except for TIPS pricing in an inflationary recession rather than a deflationary one.
The wonder is not whether there’s a volatile beauty contest going on in the absence of news.  The wonder is that this market is as stable as it has been!

Had even one of these issues been on the radar in, say, 2004-2005, it alone would’ve dominated the news cycle and the markets would have swooned as much as they have so far.

As things stand, the two most obvious solutions facing policymakers are, on the one hand, to let bonds default and deflate the government-credit bubble directly at the direct expense of mismanaged capital, or on the other hand to print money and inflate everything away primarily at the expense of labor.  The implications of those two choice result in starkly different valuations for corporate stocks, and the market can be expected to veer up and down wildly until the political outcome becomes more certain.  It could be years yet.

So methinks Shiller should stop grasping at explanatory straws and get ready for the deluge…

Can the bond market’s “implied inflation expectations” be accurate if the TIPS market is totally broken?

One might infer that if sellers were able to raise their prices, there would be a price at which someone would make offers.  In that case TIPS are currently underpriced (yields too high) and the implied inflation expectations are too low (spread to Treasury yields too small).

Another way of saying it is that the supply of 5 and 10-year TIPS is inadequate and the government is, in effect, manipulating perceived inflation expectations to the downside. One would be tempted to consider this a policy choice, but it could just be that no one remembers that supply matters.

Hope to update this later after learning more.

Update 9/13:  Same situation again today. It wasn’t a one-off thing.  It would be interesting to know whether the situation changes after the upcoming 10-year TIPS auction later this month, and again with the 5-year in October…  But with the market this jittery, it seems a lot could happen between now and then!

Right now the U.S. government makes the proverbial drunken sailor look like a pillar of rectitude!  After all, the drunken sailor can only spend money he already has — no one will lend to him!

In the case of Uncle Sam, just because the bond market is currently offering Uncle Sam what amounts to a teaser option ARM loan with zero interest for the next 6 months (or 3 for 10 years even), does not mean we should borrow the funds! The relevant timescale is far greater than 10 years, the bulk of our debt burden is on the short end, and the bond market is a fickle creature.  We could be cut off in less than a year — just ask the countries that have gone belly up in the last 100 years!  We shouldn’t borrow without a _really_, _really_ careful re-examination of what we are buying with the added debt, and an assurance that the marginal loan will produce a real improvement in our economy. Congress isn’t doing that, so the people need to force the issue.  We need to raise the price for our future debt servitude!

From another angle:  Just because the bond market is overflowing with rentiers who are desperate for safe “investments”, does not mean the U.S. can afford to borrow more. Federal debt-to-revenue already vastly exceeds sustainable levels, and there’s absolutely no Keynesian cushion for the next recession!! (Which, if we are back to the classic 4-year business cycle, is due in only a few months, given that the last recession started in Q4 of 2007…)

It makes no sense to borrow more funds for imperial wars, for wasteful tax breaks for people who are already very well-off, for wasteful tax policies that stimulate malinvestment in nonproductive assets, for a medical system that is grossly wasteful - the worst in the developed world. Etc. Dean, why should we lend THIS Congress another dime, without structural policy reforms?  What good will it do?

We need a smarter federal spending prioritization. We need better policies — policies that boost job creation without adding to the deficit. We need to encourage all the spare cash sitting on the sidelines to purchase tangible products rather than financial “investments”. Negative real rates ought to do it… and that would also push out some inflation to bring the nominal debt back to a reasonable proportion of the economy.

I’d be a lot more comfortable with this debt ceiling hike if Congress showed even an ounce of financial sense in terms of how to spend the money to fix the nation’s problems! I see no reason to give Congress more money if all it will do is continue to line the pockets of gluttonous special interests.  What we need is federal investments that deliver… sustainable gains.

Blindly borrowing more is just feeding the squid…

Two years in a row, I ran the handy online simulations of the California budget balancing, and was done in an hour or less each time.  The budget could be balanced.  It required some tough choices but the value of the balanced budget exceeded the costs of those choices.  And the state government eventually did more or less the same thing.

Now it’s Uncle Sam’s turn to go on a fiscal diet. Today we read that a U.S. Representative actually seriously suggested that we void $1.6T in Treasury debt held by the Federal Reserve bank?  And that “Serious Economists” actually gave it consideration???

What have we done to this country???

The fact that we are even having discussions of this sort would have horrified anyone in the country just 5 or 10 years ago.  Go back 20 or 30 years, and the populace would have relegated those responsible for creating the situation to deep everlasting public shame!  How is it that those who blindly created the mess through terrible policies are still in charge?  Perhaps that same blindness is a large part of the reason why they can’t see how to fix it?

There WILL be vast unintended consequences, if we don’t point the ship of state back in a sustainable direction.

If the duly selected “leaders” of this country cannot put their heads together and chart a sustainable fiscal course, the $1.6T at the Fed is irrelevant.  Given the 3-year leadup to the current situation, including the longstanding Icelandic, Irish, Portuguese, Spanish and Greek dramas, the claim that we somehow need more time to put our heads together is rubbish.

Fix the budget now, and we don’t need to risk the consequences of defaulting on the Fed’s asset base.

After 3 years of horrific policy response to an economic crisis resulting from terrible policy, Lady Justice is in tears, and the social contract is deeply in question.  Breaking the Full Faith and Credit of the U.S. Government in ANY fashion, aside from being unconstitutional, will fracture what little remains of that social contract.

The state governments have shown that it’s possible to bring spending in line with revenue, by actually sitting down and prioritizing both spending and revenue options, and making tough choices.  There has been pain but the world has not ended.  If 50 states can do this individually, so can the national government!

The time has come for the Federal Government to take its medicine as well.  We are long overdue to slaughter the sacred cows of both parties.

We don’t NEED two wars, a military-industrial-complex larger than the rest of the world’s combined, a Medicare system that pays out to treat patients who are already terminally ill and which is subject to rampant fraud and abuse, a health-care system that costs twice as much as anyone else’s but doesn’t deliver better outcomes, and a Federal Government that has in so many ways accumulated so much power  that it frequently disregards its own Constitution. I do think we need Social Security, at least the retirement income portion, but it’s time to raise the retirement age again, and we need to give people some notice that those retiring in 10 years might only get 90% of the benefits.

And you know, I don’t think the world would end if overall total tax rates gradually reverted to historically normal levels, provided the deficit was eliminated.  There are a lot of loopholes to be closed, deductions to be phased out, and rates that could be a shade or two higher.It also wouldn’t hurt to go back to the last time the federal budget was balanced, and figure out why it worked then and whether it would work again now.

It is time for shared sacrifices for the greater good.

None of this is hard to do, we just have to decide to JUST DO IT.

It is hard to fathom that during today’s episode of Bankrupt Greeks vs. Bankrupt Bankers, the herd fled into Treasuries, gold and silver, dumping the Euro, stocks and oil.  Given the unsustainable debt levels here, the long-term U.S. economic picture has to include either severe deflation or severe inflation (or both in alternating sequences).  But apparently Greece is on fire now and our own conflagration remains in the future, so the herd has moved here for temporary safe haven.

But isn’t this a bit like hiking to the stern of the Titanic, to avoid going down first with the bow, only to be sunk later?

In an over-financialized world, it’s unlikely that either the debtors or the lenders will win. Deleveraging means de-financialization, and that means less net interest going to the lenders. Some lenders have to lose.

Meanwhile, the lack of new credit means that not only do the ponzi borrowers go broke (those who require fresh loans even to pay interest), but even the speculative ones (who can cover interest but not principal) start to have real trouble rolling over their debts.  And in the maelstrom of inflation, deflation and unemployment, nearly everyone loses something.

It reminds me of the classic line from the movie War Games, when the insane computer finally learns the truth about the nuclear war “game”:  “The only winning move is not to play.”

So how does one “invest for sustainable gains” in this environment?  Shakespeare’s line comes to mind next:  “Neither borrower nor lender be.”

In practical terms, that’s not completely possible, but it does provide a sense of direction when considering options and choosing the next path.  The first move is to minimize fees to the financial sector, and to bring loans (bonds) into balance with debts (mortgage and other leverage). Second is to identify low-debt, high-tangible-value stocks and funds, that should hold their real value regardless of inflation or deflation.

Here we now have a portfolio with an overall 0.25% annual average expense ratio, and we’re closing on on zero net debt holdings (while allowing some room to make contrary rate-spread plays as the herd runs back and forth on the Titanic). The challenge of which tangible-value investments to hold is more challenging…

And, as this grows long, more about that later…

It’s absolutely time to break the endless-increase-in-debt cycle.  It was time 7 years ago when the economy recovered from the dot-com crash. Several trillion dollars later, more waiting won’t improve the situation. It’s time to stop spending “more” and start spending “smarter”.The rate of debt increase since 2004, compared with the lack of corresponding sustainable GDP increase, strongly indicates that we’ve passed the point where additional debt yields worthwhile benefits to the nation (or world) as a whole. Whatever we’re borrowing for, it’s not worth it!

From a certain point on, more debt primarily helps the lenders (who get secured streams of long-term income), not the borrowers.  I think we passed that point a long time ago.  Now we’re at the point where even the lenders are starting to realize that more debt may not help them, because a loan to someone who can’t repay is money gone. Widespread default and insolvency is bad for everyone, and the banksters can’t shift the bad debts onto Uncle Sam anymore without risking losses.

I think the markets know this, particularly after watching Iceland, Ireland, Greece and Portugal.  The U.S. has the advantage of the reserve currency, but we also have a lot of national obligations not consolidated into the national budget.

What I see is that Wall Street isn’t nearly as worried about the debt ceiling per se, as they are about the total unwillingness of Washington to face reality in terms of eliminating the structural deficits and bringing Uncle Sam’s spending back in line with tax income.

Some examples:
(1) Gold and silver have risen a lot in the past year.  It’s not because those investors are worried that there will be a deflationary government shutdown! It’s because investors are worried that there will be an inflationary spiral, unless we break out of our current print-and-spend and/or borrow-and-spend paradigm.

(2) TIPS yields range from -0.5 to +1.8%, whereas historically TIPS have had yields in the 2-3% range.  The historical TIPS yields reflect the fact that historically bonds yield 3% above long-term inflation.  The current low yields say that the market sees bonds as unlikely to yield as much as inflation (-0.5% TIPS for 5 years) or at most 1.8% above inflation.

(3) In stark contrast to the above, the overall low Treasury yields and hoarding of cash by household and corporations both suggest a strong fear of deflation as well.

Some commentators view the fear of deflation and the fear of inflation as mutually exclusive opposites, but they aren’t. It’s possible to be afraid of both, because our economic circumstances suggest that one or the other are becoming increasingly inevitable. For a nation with its own currency, excess debt must inevitably be defaulted upon, or repaid only in devalued money. The one is deflationary and the other inflationary. At this point, for us to avoid one or the other may no longer be possible.

Some people claim that Uncle Sam can borrow a lot more, since “interest rates are still low now”.  But Greek, Irish and Portuguese rates were low, too — even as they borrowed too much. But the lending markets aren’t omniscient, and can have a change of heart in a heartbeat. For those nations, once the market woke up, the credit markets shut down and the sovereign borrowers were doomed. We have to avoid having that outcome here!
Here in the U.S., we’ve got to take the foot off the gas pedal of manic deficit spending. Ideally we want to coast the budget into balance, rather than having a hard stop (or a crash over the cliff). But the most important thing is to quit accelerating our indebtedness.

To “spend smarter”, we will need a lot of thoughtful reprioritization and structural reform in how the government taxes and spends.  But we absolutely have to stop borrowing money for no good reason.  If we borrow money, squander it, and never repay the principal, all we’re doing is feeding the financial sector a perpetual interest income stream, stripped every year out of our nation’s productive output!  Right now I don’t think there’s much, if anything, on the margins of the federal budget for which we really want to further enslave ourselves to the bondholders!

Stop Feeding The Squid!

Michael Hudson: Will Greece Let EU Central Bankers Destroy Democracy?

The majority of today’s financial discussions use bank-centric framing and terminology to discuss the situations facing the debtor nations (and debtor citizens and corporations).  However, there are two sides to every contract, and it’s clear that the borrowers are not exclusively to blame for their over-indebtedness, as a result of fraudulent inducements, bribes, and all manner of self-serving spin from the financiers.  Moreover, when the bankers’ “solutions” consist of (a) more debt for the over-indebted, and (b) taxpayer bailouts for the bankers when the over-indebted finally stop paying, it’s clear that the bankers are part of the problem, not part of the solution — literally!

So I like the article above because it re-frames the issues (with emphasis on Greece and Iceland) in terms of the more fundamental, classical economic issue:  how do we reorganize to optimize national output?  It most likely does not entail continuing to enable the lenders to live off the labors of others, at least not as much as they do now.

Quick implications for debtor nations and investors therein:  (1) Stop feeding the squid!  Get out of debt if you can, and don’t fund the banksters’ shenanigans with your “investments”.  (2) Prepare for higher interest rates due to defaults and devaluation-driven inflation. Obviously more thought will be needed here, but as in the 1970s, a simple stock-and-bond portfolio may result in serious losses after inflation.  Watch and learn from the other nations, before it comes to our own doorstep…