Why did we incur such debt in the first place in the developed world?  Could it be that our living standards have stagnated because we have engaged in free trade with low-wage developing countries, exporting jobs while our wages stagnated?   Some data points:

1) U.S. 17 million mfg. jobs in 2000 declined to 12 million by 2011.

2) Goods trade deficit = $650 billion.

3) Apple employing 25,000 U.S. workers and 250,000 abroad.  IPod employing 14,000 in U.S. and 27,000 overseas.

4) China currency pegged to U.S. dollar, not free to revalue upward.

5) U.S. annual economic growth of 1% GDP during Bush years (2001-2008) per Niall Ferguson, if you exclude home equity extraction made possible by bubble.  Okun's law says we need 3% to avoid increases in unemployment rate.  So the bubble just hid a decade trend of higher unemployment.

6) Only 9 million U.S. jobs created between 2000-2007 even with bubble; only 2 million created 2000-2010.  Historically we have created 10+ million jobs.  But U.S. population has increased by 30 million.

Please wake up folks and stop tinkering at the margins.  Either developed countries find efficient means of isolating themselves or they will increasingly submit to lower living standards, until equilibrium is reached with developing countries.  This is undoing 100 years of progress and may make the country politically unstable within a decade.

Spot on. The problem with our anemic recovery has been the reticence of central governments, perhaps for political reasons rather than the protection of their citizens, to allow markets to clear. Here in the US, the FASB change in bank mark to market accounting, the Fed's zero interest rate policy, the home loan modification program, TARP and the TLGP were all designed in an ill-fated attempt to engineer a painless recovery amongst creditors. TARP didn't bail out the US banking system. TARP simply bailed out the shareholders and creditors of the major US banks. Ultimately, as Professor Rogoff describes, wealth must be transferred from creditors to debtors. All else failing, a "soft default" of paying back the debt in greatly depreciated dollars, will ultimately result.

I think Professor Rogoff has done some excellent research, but he misses the boat entirely in his recommendation for the cure: 4-6% inflation. What does he think will happen to interest rates in such a scenario? They will be higher of course. With nominal interest rates at 7-9%, the US government deficit and subsequent interest costs on the debt truly would skyrocket, and housing values would plunge because the mortgage payments for anyone who wants to buy a house would be far too high otherwise.

As it is, Bernanke has been trying to follow this playbook and the only thing we have gotten is the worst type of inflation--higher commodity prices, particularly oil while the two things that Bernanke has been trying to inflate--wages and housing--have stagnated. If Bernanke actually raises interest rates just a bit, at least we could pop the oil speculation bubble. Oil near $95 per barrel is completely artificial given the economy's weakness. It is that high because speculators are using super-cheap money to bid up the price of hard assets that can easily be traded on financial exchanges, such as oil and commodities. Why can't Bernanke see that?

You write: "I argued that the only practical way to shorten the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6% for several years. Of course, inflation is an unfair and arbitrary transfer of income from savers to debtors. But, at the end of the day, such a transfer is the most direct approach to faster recovery."  Do I understand this correctly: that the violence of harming savers is acceptable because it is "faster"?  The politics of such a transfer could just as easily go: let the borrowers (overleveraged) take responsibility.  In any case, too bad those who save are now targets....

Inflation only works if you can get nominal wages to rise.  The FED has tried this since 2009 and it has failed.  All they got was stagnant nominal wages (as labor is arbed away) and higher cost in all essentials such as food and energy.  That, in and of itself is enough over time to create a revolution of the masses...and rightfully so.

One additonal comment.  There is nothing in theory that would indicate jucing inflation would work and in fact might backfire (a higher probibility). Theory would say though that inflation moving from 2% to 6% might in fact cause employment to fall...maybe even 6%.  That would again cause a much bigger problem and the probability of revolution increases by a power of 6.

I think that the overall issue here isn't what possible solutions to the "Great Contraction" should be, but what they shouldn't be. Increase inflation, possible growth but also possible no growth and more stagnation. Increase stimulus, spur growth or increase debt and decrease investor confidence. There is no one solution.

Since employee wages have essentially been stagnant since 2000 and inflation has caused consumer purchasing power to go down, I honestly think that the best and perhaps only way is for private companies and the government to hire more people and give raises to their current work force. This would inject more money into the economy, raise the govt tax income, and increase national productivity levels.

The rub: How do you do that without putting the government deeper in debt and how do you get provide companies to hire/give raises?

Ken...Ok, let's call it a "great contraction", if that floats your boat. A depression by any other name is still a depression. Governments will continue to spend. The constituencies that rely on it, whether they are getting food stamps or subsidies to build fighter jets, will demand it. The question is, should there be a larger allowcation toward food stamps or toward fighter jets?

The last "great contraction" was reversed by massive millitary spending (World War II). We will never know, for sure, if the New Deal would have solved the crisis. We do know that Keynesian prescriptions did not involve killing millions of people. Let's say that one fighter jet costs 1x. For arguments sake, let's assume that providing long term, financial security for one family, costs .1%x. Ok, what do you suggest we choose?

From a policy standpoint, it really is this simple.

Peace

Shouldn't a balance of trade strategy be part of the picture? Perhap's Warren Buffet's suggestion ("Squanderville versus Thriftville"):

http://www.freerepublic.com/focus/news/1053684/posts

Without producing more than we consume we will continue to sink into debt.

So I guess what you're saying is that the Fed needs to somehow stoke inflation to a greater extent than it already has? What additional steps can Ben Bernanke take? 

And what are the ramifications of taking from spenders and giving to debtors with the mechanism of some mid or even long term moderate inflation? 

Won't this disincentivize saving, or at least push up long term interest rates? And if so, won't that be counterproductive? 

And what about the anger this extended term of inflation will cause in the electorates of creditor nations? What policies will they enact as a reaction to their financial losses? What odd new investment vehicles will be created? What will the price of oil do? 

This is all so complicated. Good luck with the recommendations. 

Slow growth and Excessive Leverage, in addition to High Unemployment, Skewed Wealth Distribution, and Stagnant Real Wages. At the same time, steady and seemingly unrelenting expenditures such as Defense and Healthcare. Given all these conditions, I must congratulate successive Governments in keeping the public happy, even if it means injecting a dose or two of steroids. The Government could only do so much - mint a lot of money, and provide free credit (cards) and houses for the masses. 

@Factified

“Why did we incur such debt in the first place in the developed world?”

Because other countries were willing to give us stuff in return for IOUs.  It seemed like dollars and euros were a good investment.  And up to a point, it was (maybe still is).  Globalization opened the floodgates to capital flows and the capital flowed to where the rates of return/security looked best.  Now the “developed” world is saddled with debt that will take years to pay off.  Of course trade barriers are no-no since they go against both neo-conservative and neo-liberal ideologies.  And hey, the people at the top are doing just fine.

Inflation is indeed a smooth and socially acceptable way of taxation.

On your method : history is not physic, you cannot apply statistic laws on historical phenomenas. The current crisis has its own specificity, due to unique historical facts (collapse of the USSR, hubris of the US, surge of China, etc.). 

Says Jagbones: "I wonder what the outcome will be?

 It may come to be that the swamp that was supposed to be drained, is now made to be even more toxic!"

 Tax is what you pay them, to spend anyway they want. You work to pay for the spending, is what they provide as a benefit to you.

 Each tax payer is a beneficiary of the money they no longer have. The politicians are trustworthy to have the best interests of the taxpayer in mind.

 Earnings are taxed so to be beneficial to someone other than the ones that earned it. You will enjoy hearing about the good it does for someone, other than yourself. I could go on .

 All the money collected from income tax, is spent to pay the interest on the national debt. It goes to the loan holders, (right wingers) not the social programs that people think it goes for.

 The right uses the democratic party like a tool, to invoke ever increasing taxes(because if everybody has money, then it is not very valuable) and uses them to make laws that make it illegal to lessen the value of the bank accounts of right wing conservatives.

 So the fundamental problem with the debt ceiling vs spending cuts is that, the idea of a "ceiling" for debt is nothing more than a false deadline for finding new "ever increasing tax increases" rather than doing today what should have done yesterday, to live within our needs, which is well below living withinour means.

 According to DW-TV as of (7/25/11) the U.S. debt to G.D.P. ratio is 98%.

 Does this mean that however much that the U.S. takes in, (in tax revenue) it owes 98% (of that revenue) to service the (loans on the) national debt?

 In what way does this benefit the tax payers of the future?

 How does this benefit the loan Holders (right wingers) today?

 So as long as the U.S. is able to meet the minimum payments, with only producing the minimum of product output, it should put off or abandon any attempt at advancement in space exploration, human rights or the cause of liberty that would interrupt the realm of tyrannical dictators, at least the U.S. will be fiscally sound.

If the world economy is based on the value of a barrel of oil, (demand)  then  you need to use more oil this year than you used last year. (supply) That way, more and more products and energy are consumed and profit is generated. This only becomes more difficult when you keep the world economy based on the value of a barrel of oil, at a time when the world players all know, that there is now (peak oil) only going to be less and less supply of oil, at a time when when it is imperative that the world economy continues to expand or "grow" resulting in greater demand  for less and less oil.  A stable economy is the most important ingredient, in order to maintain relative global stability.

I do not understand. If Great Contractions happen every 70 or 80 years, then how is it possible they had data for, as Professor Rogoff writes,  "quantitative benchmarks based on previous deep POST-WAR financial crises (that) have proved far more accurate than conventional recession logic"?

Rogoff Endorses Government Theft, Ignores Moral Hazards

In his latest piece, Rogoff not only lacks a moral compass, he ignores the moral hazards his recommendations create.  Rogoff argues for transferring wealth from creditors to debtors, “which is inevitable” by any means possible. He does not seem to care about aligning the two parties, and once again, falls victim to placing undue faith in the central planners to manipulate the economy precisely as they see fit. Namely, he calls for Bernanke to institute a 4-6% inflation tax, steal from the savers, and give to the borrowers (ie transfer money from savers and taxpayers to banks and governments). Also, isn’t it just slightly possible people realize what is happening and inflation gets out of control (perhaps Rogoff should conduct his next study on hyperinflation)? By the way, inflation is already 4-6%.

If a bank lent money to a home borrower, the borrower loses his or her job, Rogoff is perfectly willing for the government to take money from other citizens, bail the bank out, and institute more still more taxes on savers so more wealth can be transferred to the bank.  Not only is this morally reprehensible, it’s recommending the creation of more Fannie Mae’s, which is of course, what the government has done. The bank now knows it can lend recklessly and always have the ability to pick the pocket of others to pay for the losses. Like most of these government intervention policies, they are short term good, long term awful and a net negative. Why, because it’s transferring money from the competent to the incompent, from the producers, to the looters and moochers. What should happen is the bank, it’s bondholders, and it’s shareholders suffer the losses as does the homeowner with a hit to his or her credit. Half of whom will learn their lesson for next time around, the rest will jump on the next government induced bubble. But, we’d have to listen to Jim Cramer and the rest panic all over TV and remain calm, and this is not the nature of herd psychology.

As for the rest, Rogoff and Reinhart’s study has held to form. It suggested slow growth and sovereign debt defaults were the norm after a deep financial crises. Paul Krugmanslandering of Rogoff and Reinhart’s work is all the more odd in this light. R&R’s exhaustive research is based on 800 years of history, which is far too much work for the “inbred academics” like Krugman and Bernanke, who prefer to hunt for flawed models that curve fit their ill conceived notions about how people behave. What’s worse, both Krugman andBernanke fail to acknowledge that their very solutions lay the foundation for large misallocations of capital and credit bubbles. Then they use the inevitable bust to justify their existence and central planning.

Funny Joke  : The Central Bank was granted it’s immense powers so it could smooth out the booms and busts in the business cycle. FRBSF

Mr. Rogoff: 

A "sustained burst of moderate inflation" would work only if most debt contracts are in nominal terms. What is the share of debt that is not indexed to inflation and what is the share that has a fixed interest rate? At a minumum, one would like to know what these shares are before advocating such a policy. Also, if nominal wage increases do not keep up with the proposed increase in inflation, this would add to the risk of falling in a deflationary episode. Are you concerned at all?

"Moderate" inflation is Mr. Rogoff percription...it won't work as you MUST that produce higher nominal wages.  What we received from the two previous QE's is higher stock prices (worthless to the general economic welfare outside of wallstreet) and higher inflation in everything but nominal wages.  Raising prices on everything but nominal wages will bring nothing but anarchy and revolution...it's time to put the stupid theories aside and start thinking and addressing the structural issues as painful as that may be and get on with it.  Continuing to bailout wallstreet thinking that there is some trickel down effect of sufficient magnitude is becoming insane.  Let alone the heroine affect that wallstreet is now on is costing taxpayers of today and tomorrow their life savings to support.

It is dangerous to talk and implement solutions when the problem is not defined.

National debts is not the same as debt which we normally experience. When we talk about national debts, the creditors and debtors are not under the same roof, not under the same political system, not under the same accounting system, the entries are not in the same book.

First I have to admit that I have no professional knowledge in economicsm but I really liked the title, especially the expression "contractions", like in the process of labor, when after a series of contractions something new is born. I feel that after every new state of the crisis we learn more and more about the global, totally interconnected system we exist in, and hopefully it will not take too many "contractions" before we realize, that by superficial, or local adjustments, simply by playing with the number we will not be able to succeed. Taking the global nature of our world and the crisis into consideration sooner or later we have to swallow any local, national pride and starts taking into consideration the whole world in any financial, social or political planning decision, in a completely equal and mutual cooperation.

Yes, deleaverageing, default ( by inflation or otherwise)  forbearance ( mortgage write downs) by all means. But there are  two important considerations. i) Class - remedial action is perceived to impinge unfairly on either rich or poor. ii) China - the west simply cannot facilitate hording by such a large state.

If palliative action isn't going to result in civil unrest and further disenchantment then the question of charging large creditors for facilitating savings must be broached. 

"But Great Contractions, as opposed to recessions, are very infrequent events, occurring perhaps once every 70 or 80 years."

Interesting, is it not - that "great contractions" are very infrequent events that might appear to come along just in time to absorb the lifetime savings of the average retiree at a time in their lives when they are helpless to help themselves and their political and social capital is spent?

The money game is no different from the human race: take what you need from the weak and old or the young and helpless, whether you actually need it or not.

Intellectual/moral evolution is a bad, sad, impossible joke.

I don't understand how this inflation goal can be achieved. My understanding is that the Fed has helped boost the monetary base so that it's now three times what it was in 2008, and yet inflation is unmoved. As you say, the point of inflation is to deleverage in order to boost aggregate demand, but don't we also need aggregate demand to increase before we see inflation? It's like we're chasing our tail. If the Fed says it will pursue a policy of inflation is that enough? Can someone tell me how we get there from here?  Thank you!

Gamesmith94134: Dr. Doom Warns Wall Street and Washington---- Heed Karl Marx's Warning!

Mr. Gert van Vugt,

You make the best description on the theory on the economical growth Paradigm that the economic change seems like Malthusian’s diminishing return, and I agree. However, Mr. Roubini makes his point on the social disruption reverse itself through the diminishing demand. If we can put away the elements like the Ponzi scheme and benefactors in social caused deficiency or defects to growth. Corruption by capitalism and the dependency by socialism among societies both caused failure in the economical and societal development.

Perhaps, we focus on the circuitry on the accumulation of wealth and consumable wealth that runs the economy. It seems both the capitalism and socialism ran short and proven wrong in the economical model or social model that became self-destructive; eventually, the economy runs from diminishing demand to diminishing return, or vice versa. So, if we use the living standard as the equilibrium position to the supply line of the circuitry of wealth balanced by both of the diminishing return and diminishing demand.

How about I call my paradigm on the wealth circuitry in economical and social growth that supports and balances both accumulated wealth and consumable wealth; and it created a “Z” shaped development running both on the diminishing demand and diminishing return; which is based on the assumption, the route above the standard of living equal in length with the one below the standard of living is in agreement of its living standard to sustain a viable growth, which contains;

·         The base line as the diminishing return where the societies kept peace with its populace that consumable wealth that cause economical displacement like with its negative growth or no growth; it provides entitlement or social programs with non-productive individual citizens for example, 27% of its population on welfare with add-on with subsidies to sustain a standard of living.

·         The top line as the diminishing demand that ended with accumulated wealth favors of concentrated wealth owned by individuals that ended with profitless, 1% holds 27% of the global or national wealth, plus those with extra wealth is not in production yields to no growth.

·         And the diagonal line that connected to both ends is the support of the price and value in the middle is the standard of living which contains the most of the productive individuals who is moving up and down the ladder of growth.

If more of the wealth accumulated than the wealth consumed, then it causes saturation of the wealth. The diminishing demand under the standard of living agreement made the demand idle because of the shortage of consumption. In the process, the standard of living will go down to meet its demand after the deflationary measure to make it consumable. In reverse, the wealth consumed is over the wealth accumulated, as it is less profitable. Then, it triggers the inflationary measures to aggregate demand to accumulate more wealth in its diminishing return mode; eventually it will balance itself again with the agreement of the standard living with a viable growth.

It is not the supply and demand. It is rather the circuitry of wealth under the spells of the lower living standard that diminishing demand is being part of the deflationary measure. If the accumulated wealth became saturated, then it means the lower living standard that made the demand finite like lesser demand in loan of dollars in ECB.

I am certain I am not being introspective; I may twist the theory a little; but the proof of the lower living standard in Europe made it plausible.

May the Buddha bless you?

If the first "Great Contraction" was the "Great Depression", why not just call this the second "Great Depression"?  Wouldn't that do the best possible job of getting the point across?

Writing down mortgages with future promised payments, writing down Greek debt with future promised payments, 4-6% inflation, and even increased stimulus are all political anathema right now.  Unfortunately, the economists spoke with too many voices, so the politicians took charge.  More unfortunately, as with the first Great Depression, the liquidationists are calling the shots now, and things will have to get worse before they're allowed to get better.

Really? Calling it a "Contraction" is merely the same elitist revisionism that Hoover used when he called that crisis a "Depression" because he thought that the people would react more favorably than calling it another recession. Since that label has stuck in the decades since, why equivocate and not call it for what it is - the 2nd Great Depression?

In case anyone hasn't noticed, inflation is already occuring. Wringing hands about which policy to pursue is rather pointless, so long as it merely serves to prop up the untenable policies and underlying fantasies of capitalism. Alternatives? How about creating infrastructure projects é la the New Deal so consumers will actually have income to spend? How about providing a stimulus that keeps homebuyers in their homes, versus giving it to banks and investors? Start taxing corporations and the wealthy, and it will be paid for.

Potential interest rate increases mean little to the unemployed when they can't make the payment in the first place and are facing the loss of their homes. With prices rising and incomes stagnant, the solution will not be found in policies that simply maintain the status quo.

Jonathan Lam wrote:

Sep 27th 2011 5:27 GMT

Gamesmith94134: Catching up is so very hard to do

Justlistenall said well, ”how about “nations of higher living standards” in lieu of “rich nations”, except for those who really qualify as such?” It was not the yuan or GDP that make China the emerging nation; and the fact is the affordability that gives impetus to growth and not the higher living standard.

If the rich nations must catch up the up-ward growth spiral, they must cut their living standard to make its people live to grow, instead of, strive to survive. The rich nations are only think of their people are rich but they are not; not afford to consume make its economies anemic. If they want to catch up, they must make it affordable for their people.

Even if the troika can get 2 trillion to cover the PIIGS, the onward slow or anemic growth is not getting to the level of the proportion on the normalcy. In addition, the solution is short of the fiscal and tax equation among its EU members. Then, the 2 trillion would be spent in vain if the present higher living standard does not meet its affordability level, then, there is no demand to consume. It is still no growth if the durables or oil do not go down enough to provide the cash flow that will change the marginal affordability level and ready to consume.

The bank or central bank may free of the old debts with the fresh new debts like the 2 trillion with longer term bonds with low interest, however, the low rate will halt lending to commercial based on the non-profitable, eventually, it will die or go bankrupt itself unless banking cut its own size like BOA or JPM. Such condition will turn into another tourniquet to the commercial needs if the bonds are not restructured by 2013 with the short-term basis. Depression will become inevitable even the BRICS can help to restructure the loans.

Inflation and deflation is much as virus in fever and cold to one body as it is to an economy; it is understandable that disease works with one’s body to create its anti-biotic to fight diseases. Now, what our economist is facing the anemic economy with too much of sterilization with sub-prime and long-term interest rate that the body or the economy will not respond till the inflation or deflation can take its effects to make the economy change.

In order to face reality, EU and US must settle on the coming depression, deflation helps in cutting the cost of living in a down turn spiral till the private industries can use human capitals in a lower valuation in wages. If the affordability allows more consumption; then, production will rise. Eventually, growth comes only after there is demand of it.

It is the best of time, our economists can face the facts that depression is inevitable and we must shrink our appetite, even on a lower wages to start utilize our human capital that company can afford to hire, and cut values on the durables even housing that each can own rather than to rent. In order to rebuild America to compete where globalization makes the rich nations anemic, and a lap band to each Americans must apply to cut consumption. It is cyclical on a healthy economy on deflation to refresh itself to grow; likewise, to China fight inflation to ease the tensions built on its publics.

If there is no systematic cut the valuation of the present, and the lowest interest of today only make the financial industry suffers. Let the nature take its course to adjust. Any attitude like no on my watch can only make it-- Japanification.

If the economy is immune to inflation or deflation, then, valuation on price is not valid. I was not surprise if gold can fall 6% in a day; and how about you, Soros? What is you gold standard of monetization if immunization stands?

Anything else is just excuses, isn’t it?

May the Buddha bless you?

Gamesmith94134: A quest for job

American must wake up! There is no middle class job for America like 30K available in America; it is the salary for managerial position or higher for Chinese, Indian, or anybody else and it is relatively high in the competitive globalized job markets. At present, the developed nations suffer the insolvency with sovereignty debt that is so high that they cannot even pay on its interests on the bonds that were sold; and those developed nations’ economy is on the brink of collapsing.

The bills of their equities are running on negative, and the pensions were gone after their investments failed to give a cent on return. It is why the fight within our Congress continues with the ceiling to the debts; shot term relief from some project is not going to solve the problem because it adds more to debt and the present employed will lose his job after the project ends.

So, we must face the globalization seriously with the present competitiveness and compatibility in jobs and corporations. First, our government must reinstate the best of our interest to compete with our products and salary; also, we must not allow the corporations to take advantages on the exchange rate with other nations to put us to skid row. I mean they must be taxed highly for its profits; in order to compensate our loss of jobs in its native land; then, outsourcing is not relatively restricted but administrates through the Chamber of Commerce and State Department.

Perhaps, our government must take itself seriously on the patent law that will distinguish on what is discovered and invented from our innovations. Some may think it cheaper to put its patents oversea rather than have its patents maintained in United States. Then, we can claim our innovations clearly and make them worthy especially when it is a product of ‘Made in America’, and manufactured by Americans. If we can acclaim our prestige of its making like the German made knife or Japanese made cars. Any things would rise to the parallel of Boeing airplane, then, American workers can take its bigger share of earning off the profit according to the competitive sales in the global markets.

There are ways our government can do to retain the capacity to compete in the globalized markets, if only we can put away or focus on the profit margin off the corporation, or appeased on the complacency of the tax our government collected. We must look deeper in how we can motivate the investment on the human capitals America holds just because they are consumers to goods and services we created. Otherwise, we may remain anemic if consumers fail.

Our government must restructure itself to make the better use of the taxes and human capitals. It is not just praise on the ideologues on the marketwise profitability because the balance of the monetary capital and human capital must be accountable in the future planning. So, it is not how to compensate the non-achiever in unemployment or pay welfare to the needed. It is how we can make it affordable to sustain a profitable environment to grow both in business and consumers.

The American Think tank must make the restructuring on the tax code and commercial law smarter in the best utilities of the monetary capital and human capitals. After all, money is very limited in our coming years even if we can revive ourselves from the financial crisis; again, please make it “affordable for both the business establishments and consumers”. Only our government can release our economy to grow after it finds its own footing relatively by comparisons to the globalized trading markets or job markets. There is no “dollar rules’ anymore; if we got debts. This is reality and we must be relatively compatible to the globalization on trading markets and job markets.

So, stop reminisce the middle-class of the 30K with $270,000 home; by contrast, most economists should shot at another level on middle-class of 20K and $170,000 housing our economy can return like a dream if more human capital is considered.  If they do not have to strive to survive, and, they just live the way their fathers did. Can it be after deflation and depression? Punching its own face is not aiming to look health, it bruises.

May the Buddha bless you?

>  But Great Contractions, as opposed to recessions, are very infrequent events, occurring perhaps once every 70 or 80 years.

I think I understand:  The Germans haven't had a good dose of inflation since 1923 and it's almost ten years overdue.