Can You Smell It?


Gee, is everyone “all-in” and now we need to find more suckers — fast?

The “new normal” U.S. economy is starting to look more like a classic expansion. Signs of a quickening recovery are casting doubt on the notion that lasting stagnation has become the norm for the world’s largest economy, a view advanced by Pacific Investment Management Co.’s Bill Gross, Northwestern University’s Robert Gordon and former Treasury Secretary Lawrence Summers.


Yeah, right.

Look at what is cited:

Behind the improved outlook: Consumers spending more freely after working down their debts, less drag from government budget restraint, a housing recovery and continued easy monetary policy.

Except….none of that is true:

So where’s the “contraction” in debt?  Well, let’s look – there are two places.  First, there is less mortgage debt among consumers, but in all other areas it’s higher, and on-balance the difference between 2008 and now is small.  Very small.

However, everywhere else except in one place — Financial instruments — there is more debt, not less.  And if you look at the facts you find a disturbing thing — Federal Government debt has picked up what “financial instruments” lost, basically.

I pointed this out back in 2009 when it first became apparent — that what was happening was a transfer of banking liabilities to the federal government.  The rest of the changes were, net-net, lost in the noise.

If this is the premise of a return to the “old normal” then I would allege that someone needs to move to Colorado, stat, because that’s one of the few places in the United States where you won’t get arrested for smoking what’s in your pipe.

Here’s the other problem:

This is arguably the best “net-net change” statistical image you can find.  The red line is the plot (in dollars change) quarterly in GDP; that is, the raw number of dollars that GDP has either gone up or down in a given three month period.  The blue line is the number of dollars of debt, among all sectors, has gone up or down in a given three month period.  And the gold line is the adjusted change in GDP showing actual production change, which is simply the gross GDP change minus debts taken on, because (1) each dollar of debt is spent and thus counts in GDP and therefore (2) if you wish to know what actual and tangible production paid for with economic surplus is then you must subtract debt additions from GDP additions to find that value.

When this line is below zero we are borrowing from tomorrow’s production to have today.

This is by definition the formation of an economic bubble; it is the consumption of that which we cannot pay for with our economic output in current-production terms.


very small deficit in this regard is probably sustainable, since some amount of borrowing from tomorrow’s production enhances today’s output.  But history suggests that the maximum sustainable amount of this deficit is in the $100 billion range per quarter, or under $500 billion annually.

Unfortunately as of last quarter we are running at five times that rate, and are now in the range where we got in lots of trouble from the years of 2004-2007.

No, we’re not (yet) to the level of excess immediately preceding the crash, but we are at a much higher debt:GDP ratio to start with.

How long can this continue?

I have no idea — but that it is unsustainable is obvious from history — including recent history.

The Market Ticker

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