I'm not going to comment on the details of Henry's notes, but [interrupted
by Eudora's malfunctioning] a lot of it makes sense to me. If the Fed
pursues low-interest policies, that can cause the quality of loans to fall,
raising the risk premium that banks charge and bond-buyers insist on
getting. This in turn means that the Fed has to lower rates again if it
wants to prevent a hard landing. There are limits to how far the Fed can
and is willing to go with rate cuts, so that recession is quite likely.
Given the accumulation of corporate and private debt, this recession is
likely to be more painful than usual (probably worse than the 1990 one).
The reason that may explain a broad-based rise in the risk premium is that
if the economy relies increasingly on credit creation to expand aggregate
demand in the non-Wall Street "real" economy and also emphasizes volatile
types of spending (luxury consumption, real investment), the economy's
growth path becomes increasingly fragile. [My article in the 1994 issue of
RESEARCH IN POLITICAL ECONOMY explains the background to much of my
analysis here.] The fragility of the economy is likely to cause widespread
riskiness of paper assets.
(BTW, another reason for growing unease in the corporate bond market is
that the supply of safe treasury issues is shrinking -- as the government
"pays down" the debt -- so that speculators can't diversify away the risk
of corporate debt as easily.)
One thing that could help here is if the profit rate rises and stays high
(as suggested by the data in the most recent issue of LBO). The problem
with this is that the rise in the profit rate is based on the stagnation of
wages relative to labor productivity, and thus the stagnation of consumer
spending that's not based on debt accumulation, so that the volatile types
of spending mentioned above have to become more important to keep the
economy growing. And a little glitch in aggregate demand -- which is more
likely due to the economy's emphasis on volatile spending (and the fact
that the stock market seems way out of whack in terms of price-earnings
ratios) -- can cause a realization failure that smashes profit rates, which
also kills luxury spending and real investment. Then it's hard landing time.
All of this is less likely to occur if exports or the government pick up
the slack. Exports seem unlikely to do so in an era when the dollar is high
(and are likely to change slowly in response to the dollar's fall, so that
the balance of trade and the current account deficit are likely to get
_worse_, following the famous "J-curve" effect) and so many countries are
pursuing austerity (what I've called competitive austerity, egged on by our
friends at the US Treasury and the IMF). If the non-US world recovers, that
would help the US tremendously, but that seems unlikely. If the US goes
into a funk, on the other hand, that likely would pull the "consumer of
last resort" prop out from under their slow recoveries or intensified their
continued stagnations. So it's a world hard landing. We should hope that
"the worse the better" logic works (so that depression encourages socialist
movements), though it seldom does.
The government might solve the problem by reversing its pre-Keynesian
policies of "paying down the debt" (budget surpluses, which hurt aggregate
demand), which seems quite unlikely, no matter who ends up as President.
(By the way, why can't George W. and Uncle Albert settle this thing in the
old-fashioned way? it worked for Aaron Burr.) If I were to guess, Gore
seems more likely to stick to pre-Keynesian economics than is Bush, so that
a Bushie victory is more likely to help the economy (with tax cuts). In any
case, gridlock seems likely to prevail, since neither of these worthies
will have a "mandate." Cockburn likes the idea of a Washington deadlock,
but there is a downside... Of course, it's unlikely that we'd see a mass
re-conversion over to Keynesian economics. The original conversion took a
decade or two (from 1936 to 1962 or so). (I'm not counting FDR's conversion
at the start of WW2, since wars have _always_ overridden the pre-Keynesian
commitment to a balanced budget.)
The most likely way that the US government could deal with the problem is
via automatic stabilization, in which government deficits rise (surpluses
shrink) automatically as the economy falls. The problem is that the
automatic stabilizers have weakened. More and more of the so-called
"entitlements" (e.g., Aid to Families with Dependent Children) have been
shifted to the states, most of which must balance their budgets (due to
their constitutions) and thus would have to raise taxes or cut benefits in
response to the surge of applicants that occurs in a recession. The states
are part of the recession problem, rather than being part of the potential
solution.
as Doug says in the most recent LBO, we live in interesting times...
[Speaking of computer malfunctions, when I woke up this morning, my PC had
forgotten the D drive, the extra hard-drive I installed last year. Luckily,
resetting it brought the drive back into existence, but it's quite a
mystery how such a thing could happen. On the same general subject, I
recently called the Palm Pilot People's technical support to complain about
my Palm's malfunctioning. Said I: "I don't know whether it's still under
guarantee or not." Said he: "we can't tell, since our software's not
working." Luckily, he decided that he'd send me a replacement anyway. The
problem, BTW, was that I had to hit the damn thing to make it work, like
with an old TV.]
Jim Devine [EMAIL PROTECTED] & http://bellarmine.lmu.edu/~JDevine
