Brad DeLong - Liveblogging John Cochrane - USA vs Argentina - "We know what it looks like when the market expectations are that expected future primary surpluses are as high as they can go, and cannot go any higher. It looks like Argentina in 2000. In times like that, the discount factors on government debt are low because government debt is perceived--rightly--as being very risky, and the current consumer price level moves essentially one-for-one with additional debt issue. That is not where we are right now. We are not there at all. The discount factors on U.S. Treasury debt are not low because such debt is perceived as risky given the inability to finance more of it by raising future primary surpluses. Instead, the discount factors on Treasury debt are very high as the market perceives U.S. Treasury debt to be extraordinarily safe. And the price level is definitely not moving proportionately with additional debt issue...
Important things that I had not known before that I learned from the paper:
1. That if you add in a Phillips-curve friction--so that production and employment fall in deflation--and a credit-channel friction--so that the interest-rate spread and thus the interest rates on Treasurys depend on the capitalization of the banking sector--then the fiscal theory of the price level strongly militates for a helicopter drop of money to banks as the best policy to fight a financial crisis and the resulting recession: a TARP, a TALF, a PPIP, or its left-wing version of bank nationalization is exactly what the government can do to most effectively stem and cushion the deflation.
2. How large is the fall in the primary surpluses Peter Orszag and his successors will have to raise in order to amortize the debt without accelerating inflation. The marginal investor has long believed that the U.S. debt is very safe--that no matter what happens, Peter Orszag and his successors will be able to raise the primary surpluses needed to amortize the debt without a big rise in the price level. As a result of the financial crisis, the required future primary surpluses have fallen roughly in half, so that we now have much more fiscal headroom than we had three years ago (if, that is, the long end of the Treasury yield curve can be taken as rational forecasts of the interest rates at which the debt will be rolled over and amortized)."
Ben Bernanke - Thinks he has avoided the mistakes that led to Great Depression and compares himself to Roosevelt - "The lesson has been learned. In the current episode, in contrast to the 1930s, policymakers around the world worked assiduously to stabilize the financial system. As a result, although the economic consequences of the financial crisis have been painfully severe, the world was spared an even worse cataclysm that could have rivaled or surpassed the Great Depression.
That lesson brings me to the second one--policymakers must respond forcefully, creatively, and decisively to severe financial crises. Early in the Depression, policymakers' responses ran the gamut from passivity to timidity. They were insufficiently willing to challenge the orthodoxies of their day--such as the liquidationist doctrine of Mellon and others, or the rigid adherence to the variant of the gold standard adopted after World War I. A key turning point, in the United States, came with Franklin Roosevelt's commitment to bold experimentation after his inauguration in 1933. Some of his experiments failed or were counterproductive, but his decisions to declare a bank holiday upon taking office in March 1933 and to sever the link between the dollar and gold helped arrest the descent of the U.S. financial system and set off a strong, albeit incomplete, recovery.
In the Depression, effective policy responses came only after three to four years of financial crisis and economic contraction. In our own time, policymakers acted sooner and with greater force than in the 1930s. For example, in October 2008, just weeks after the sharp intensification of the crisis, the Congress authorized the Troubled Asset Relief Program (TARP) to support stabilization of the financial system. It was far from perfect legislation, but it was essential for preventing an imminent financial collapse. For its part, the Federal Open Market Committee, the monetary policymaking arm of the Federal Reserve, sharply and proactively cut its target for short-term interest rates from the fall of 2007 through 2008. After the target could go no lower, the Committee embarked on an unprecedented (for the United States) program of long-term securities purchases, recently completed, to support private credit markets, including the mortgage market.
Also, in the spring of 2009, the Federal Reserve led the Supervisory Capital Assessment Program, known as the bank stress test. In some ways, its effect was similar to Roosevelt's national bank holiday. During the holiday in 1933, banks temporarily shut their doors. Examiners were dispatched to evaluate them, and banks that were declared sound reopened to renewed depositor confidence. In the 2009 stress tests, multidisciplinary teams of examiners, economists, financial experts, and other specialists calculated how much capital 19 of the nation's largest bank holding companies would need to remain healthy and continue lending during a hypothetical worse-than-expected economic scenario. The Treasury Department committed to supplying additional capital as necessary from the TARP. Critics had warned that the stress test could backfire, but as it turned out, the release of the results last May helped restore confidence in banks, and many institutions have since been able to raise capital from investors and repay the capital the government had injected."
Michael Pettis - China's bad loans - "As I have discussed often in earlier posts, pessimists are starting to worry about excessive debt levels in China, about which they are very right to worry, and many are predicting a banking or financial collapse, which I think is much less likely. Optimists, on the other hand, are blithely discounting the problem of rising NPLs and insisting that they create little risk to Chinese growth. Their proof? A decade ago China had a huge surge in NPLs, the cleaning up of which was to cost China 40% of GDP and a possible banking collapse, and yet, they claim, nothing bad happened. The doomsayers were wrong, the last banking crisis was easily managed, and Chinese growth surged.
But although I think the pessimists are wrong to expect a banking collapse, the optimists are nonetheless very mistaken, largely because they implicitly assumed away the cost of the bank recapitalization. In fact China paid a very high price for its banking crisis. The cost didn’t come in the form of a banking collapse but rather in the form of a collapse in consumption growth as households were forced to pay for the enormous cleanup bill.
When US leverage was rising and the world growing quickly, the cost of that collapse in consumption was easily masked by China’s surging trade surplus, but it was real nonetheless. The bank recapitalization resulted in a brutal exacerbation of China’s already unbalanced growth model, and made it all the more vital for consumption in China to surge, especially as the world’s appetite for Chinese trade surpluses is dwindling rapidly. As happened in Japan after 1990, when households were forced to clean up their own massively insolvent banks, the consequence could be a slowdown in consumption growth just as the country is being forced to rebalance its economy towards consumption.
If there is another surge in NPLs and government debt, once again the banks will need to be recapitalized, but the cost this time will be much more difficult to manage. If NPLs surge, in other words, don’t expect a banking collapse. Expect further downward pressure on consumption growth."
Kenneth Rogoff - "When equity bubbles burst, investors who made money in the boom typically swallow their losses and the world trudges on, for example after the bursting of the technology bubble in 2001. But when debt markets collapse, there inevitably follows a long, drawn-out conversation about who should bear the losses. "
"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008