Sunday, December 20, 2009

GDP growth vs Debt growth:

I listened to an economic debate last night on NPR between Jeremy Siegel and John Mauldin. Jeremy Siegel is a professor of economics at the Wharton school of business at UPenn and has in the past been a perma bull. John Mauldin writes one of the most widely read economic newsletters on the internet and is more of a perma bear. Here is the link if you want to listen:

Each economist gave his prediction of the strength in the economy over the next few years.

Jeremy Siegel predicted that the economy will rebound at a 6% to 7% pace over the next few years. His only premise is that the the current recovery will mirror recoveries of the past after similar deep recessions.

John Mauldin predicted that the economy will rebound at a 2% to 3% pace over the next year with a chance at a double dip recession in 2011. John's premise is that this situation is not like other recessions. In the next few years we as a country will deleverage and will have to start paying off our debt. We will even have to start saving. He also stated that there will be tax increases in 2011 as the Bush tax cuts phase out. His last observation is that it could take a decade or more for unemployment to trend below the 8% range. We are in a new "muddle through" economy.

Who do I think is correct?

It will be directly related to how much we borrow as a nation.

For Jeremy Siegel to be correct the government will have to borrow $2 trillion a year.

For John Mauldin to be correct we will only have to borrow $1 trillion a year.

Either scenario can be correct depending on how much debt our government creates. We could even create other scenarios by borrowing more money. $3 trillion, $4 trillion ... how much GDP growth do you want?

Both scenarios of Jeremy and John use debt, inflation, smoke and mirrors to solve our financial problems. Both of the scenarios will create bloated government and each will create huge distortions in the capital markets.

Why are both outcomes equally distasteful? Because our country's financial problems are already systemic and as a nation we just don't care. We have more debt financed at lower interest rates than anytime in our nation's history. The Federal Reserve has made a huge bet that it can create inflation to get our country out of this monstrous debt. The bet is premised on creating enough additional debt to force inflation so we will be able to pay off the monstrous debt that we already hold.

How monstrous is this debt?

The most recent Flow of Funds information from the Federal Reserve shows that the net holding value of homes with a mortgage is zero. Yes zero. $10 trillion of mortgages netted against a housing value of $10 trillion is zero for homes with a mortgage.

It is very odd to think that if you take out the subset of people that own their home outright then our housing stock is worthless. Of course as an accountant I might tend to value it at less than zero due to the $600 billion in sales commissions to exit this worthless $10 trillion investment.

Strike One.

Presently our banks are allowing hundreds of thousands of speculators to live in houses without paying mortgage payments. These squatters have been living in the homes for as long as two years before the bank will start to foreclose. The banks are doing this because if they foreclosed on everyone right now then their balance sheets would be insolvent. Presently The Federal Reserve is funneling trillions of dollars of taxpayer money(future debt) to the insolvent banks so the banks can allow the speculators to occupy the bank owned homes. This government debt also allows the banks to give out record bonuses this year.

Strike Two.

Presently the banks are not lending enough money to keep real estate prices in a bubble. Wall Street and housing speculators don't want to give back the false profits of the real estate bubble. Therefore the government is creating more debt through Fannie Mae and Freddie Mac to keep the bubble prices propped up. This will cost hundreds of billions in the next few years as Fannie and Freddie make bad loans to the next wave of speculators in this insolvent market.

Strike Three.

So the group of people that have mortgages on their homes are insolvent. The banks are insolvent and our government is insolvent. The only thing that is keeping this game going is debt.

Wall Street economists have already made the policy decisions for our nation. Negative GDP is not an option. Affordable homes are not an option. Lower prices are not an option. Losses for speculators are not an option. Sound government is not an option.

Whatever GDP number we get for the forth quarter will be smoke and mirrors. A large amount of debt by the government to create a small amount of growth for our economy. It really does not make sense. Unless or course you are a Wall Street economist.

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