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Thoughts from the Frontline

Kicking the Can Down the Road One More Time

July 22, 2011

Choose your language

This week we start with the latest version of the solution to the European Crisis, the details of which are now coming out. Then we look at the global economy, and some signs that seem to point to a softening. And then there’s some data on US employment from a friend who has some thoughts about what we really need to do to get unemployment to come down. There is a lot to cover.

But first, we have posted the latest of our Conversations with John Mauldin on the website. It is with Dylan Grice of Societe Generale in London, and he is just brilliant. Subscribers will love it. Basically, Conversations with John Mauldin is my subscription service where you can “listen in” on my conversations with my friends from around the world talking about the topics of the day. Subscribers give it rave reviews, and of course we do transcriptions. You can go to and type in CONV as the code to get a $50 discount off the $199 price. And, of course, you’ll get the past conversations as well, with all sorts of well-known analysts. To learn more just click on the link. And now, let’s turn to Europe.

Kicking the Can Yet Again

My friends at GaveKal point out that this is “… the sixth time in 18 months European leaders have announced a definitive solution to the Euro crisis. Should this version of the final bailout be taken any more seriously than the first and second solutions to the Greek crisis in May and September 2010 or the Irish bailout of December 2010 or the Portuguese rescue package of March…

Discuss This


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Tom Stark

July 29, 2011, 9:07 p.m.

Hi Jeff LIttle,

Very nicely put.  Here’s how it was explained by Mariner S. Eccles who lived though the Great Depression and served as FDR’s Fed Chairman.

Please notice how Mr. Eccles distinguishes between real and money income.  I don’t believe the current financial system makes as much of this distinction and treats money income as though it were real income.  I see failure to make this distinction as a key problem in treating our economic malaise.

From your writing, I would guess you would also be inclined to see this difference.

Tom Stark

Inequality of wealth and income
Marriner S. Eccles, who served as Franklin D. Roosevelt’s Chairman of the Federal Reserve from November 1934 to February 1948, detailed what he believed caused the Depression in his memoirs, Beckoning Frontiers (New York, Alfred A. Knopf, 1951)[24]:

As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth—not of existing wealth, but of wealth as it is currently produced—to provide men with buying power equal to the amount of goods and services offered by the nation’s economic machinery. [Emphasis in original.]

Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.


That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers’ loans, and foreign debt. The stimulation to spend by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product—in other words, had there been less savings by business and the higher-income groups and more income in the lower groups—we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.


The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality underconsumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment.


Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle in a continuing decline of prices. Earnings began to disappear, requiring economies of all kinds in the wages, salaries, and time of those employed. And thus again the vicious circle of deflation was closed until one third of the entire working population was unemployed, with our national income reduced by fifty per cent, and with the aggregate debt burden greater than ever before, not in dollars, but measured by current values and income that represented the ability to pay. Fixed charges, such as taxes, railroad and other utility rates, insurance and interest charges, clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.


This then, was my reading of what brought on the depression.

Jeff Little

July 28, 2011, 1:12 a.m.

Oh, I just noticed one more similarity between Harding and Reagan:

From Wikipedia:

This “America first” campaign encouraged industrialization and a strong economy independent of foreign influence. Harding departed from the progressive movement that had dominated Congress since President Theodore Roosevelt. In the 1920 election, he and his running mate, Calvin Coolidge, defeated Democrat and fellow Ohioan James M. Cox, in the largest presidential popular vote landslide in American history (60.36% to 34.19%) since first recorded in 1824.

Jeff Little

July 28, 2011, 1:08 a.m.

Regarding unemployment:  You can’t look at the last fifty years for two reasons.  One is that the time period is too small to include a lot of times when we came down from a high level of unemployment (and saying that we never went from 6% to 2% doesn’t really provide any information concerning our ability to go from 10% to 6%), and the other is it ignores the periods of high growth between 1933 and 1965 or so.

Economic activity at it’s root boils down to a very simple process with three steps.  a) Someone produces something, b) a transaction occurs, c) someone consumes it.  It can actually be thought of as being very analogous to a chemical reaction with two inputs.  Economic activity could be thought of as proportional to the concentration of people ready and able to produce times the concentration of people ready and able to consume.

In chemistry, whichever of the ingredients is the scarce one determines the rate of reaction.  Similarly, there can be economic climates in which production is the limiting factor, and economic climates where ability to consume is the limited factor.

In computer science, people talk about the baby problem.  Given 9 women and one month, make a baby.  The punch line is, of course, that good software takes both time and talent.  In economics you have the reverse problem.  Given 1 billionaire and 9 unemployed, sell ten houses.

Unfortunately in economics it is hard to tell when we are supply driven and when we are demand driven, except of course when it’s obvious… :)  As Stiglitz mentioned, we have a very large percentage of the population that is underemployed, which means they have the skills to do the job, but the demand to keep them busy isn’t there.

The problems we are facing now remind one of Warren Harding.  He ran for president and won on the promise of returning to laissez faire.  He did exactly what he said while in office and busted unions, deregulated industries (and of course got caught up in a couple scandels), but his crowning achievement was to reduce the top tax bracket from 75% to 25%.  In short he was quite possibly the only US president since WWI more anti-progressive than Ronald Reagan.  He certainly seems to have a lot in common with modern republicans.

The result was a large chunk of change was diverted from the economic consumption cycle into asset appreciation.  GDP growth slowed even as the stock market and real estate had record performance.  As income moved from the middle class to the upper class, a debt-based economy was required to maintain forward progress.  Finally in 1928 (just as in 2010), the top .01 percent of the population earned a full 5% of the national income.

Libertarians like to point out that the economy is not zero-sum.  Well, yes and no.  If you look at production capabilities it is not zero-sum, but if you look at the number of chips on the table, then, ignoring the Fed’s liquidity management and dollars entering or leaving the system (trade deficit, war, etc.) it *is* zero sum.  In a system like Ron Paul’s gold standard, trade deficits are managed via movements of gold, and when a ringer is present, all the chips just fall in his lap that much faster.  The safety valve that lets dollars adjust to production efficiency is price inflation/deflation on an item-by-item basis.

After the middle class transitions from savings-based consumption to debt-based consumption, the system gets more vulnerable to shocks.  When one of those shocks finally happens, the transition back to sanity can be quite rough.

Since 1980, we have spent 20 years under supply-siders (GB senior was probably not completely sold, but he toed the line enough to count) and 10 years under moderate progressives.  The combined GDP growth per capita according to John’s recent graph was 0k under Reagan, Bush, and Bush, and 12k under Clinton and Obama. 

It is telling that Boehner et. al. say you can’t prosper and raise taxes, but Clinton raised taxes and GDP growth in his years out-shined even the early tax cut years when asset growth effectively hides GDP stagnation; Reagan and the Bushes, on the other hand, had the lowest tax rates outside than the Harding era.

In short, the motivations where the same in the Harding and Reagan eras, the policies were the same, the near term effects were similar, and it is depressingly likely the outcomes will end up being the same, although in the modern era we have better tools for managing system shock.

Jamie Schlinkmann

July 26, 2011, 6:14 p.m.

Denny, your point is right on the money. For some reason politicians have gotten in the habit of ‘creating jobs’, or doing things that they believe puts them in positions to take credit for creating jobs. I think I’ll vote for the next politician that states “I’m not going to create any jobs, that’s your job”

Andreas Hartung

July 25, 2011, 3:38 p.m.

The outlook for US unemployment is probably not as bleak as that hostroical analysis suggests, simply because that analysis is faulty. It looks at absolute numbers of jobs gained rather than at jobs gained as a percentage of the workforce (or of the total population). As Russ Abbott commented earlier, it is not adjusted for the size of the workforce. Rather amateurish mistake I have to say.

Hope DC went well, looking forward to hear the results!

Charles Yaker

July 25, 2011, 2:03 p.m.

John while that was a snide remark about Krugman he is not alone. There are others Stiglitz,Robert Reich,Dean Baker and maybe Simon Johnson as well. If I am not mistaken however they are all Deficit Doves and just the other side of the same coin. On the other hand there are a number of Economists and business people who have a entirely different take. First they do not believe that the deficit is a problem more importantly they believe that Governement deficits equal private assets. Among this group are Randall Wray, Warren Mosler, James Galbraith, Marshall Auerback, Scott Fullweiler, Mike Norman and Cullen Roach to name a few. Wray has dispelled the myth about the Feederal Budget and deficits and Mosler has dispelled e myth that business creat jobs consumers do  Galbraith calls the discussion a “figmant” based on conflicting staments “ . Frankly I think you know who these people are. You may disagree with them but not to acknowledge them is in my mind intellectually dishonest.

Eric Blair

July 25, 2011, 12:50 p.m.

The rules and regulations for employers have become irrelevant, small businesses all over the country have been hiring and paying staff off the books for years.  Life will go on and the economy will continue to chug along.  The government is simply cutting itself out of the loop.

mark fichera

July 24, 2011, 4:54 a.m.

In the early 1980’s, didn’t we have unemployment rates comparable to those of today ???  How long did it take to get them down to more tolerable levels ??  What were the jobs numbers during Reagan’s 8 years as President ??  Just a guess, rate was bout 9 % in 1982-1983 and down to 4.5-5.0 % by 1988 !!? 

Please comment !!

Stephen Decruz

July 23, 2011, 10:16 p.m.

Rules and regulations are in place because of the shortcomings of business. Business quest for profit with little regard of impacts on environment, safety of products etc led to the need for government rules. How would you address tha

Edgar StPierre 26025

July 23, 2011, 8:39 p.m.

Totally agree with your comments about the foolishness in Europe. But w.r.t. the mess in Washington—how can you seriously critique Obama when there are republican congressmen who would rather blow up our economy than raise taxes as a small part of the solution? The lack of a specific plan is not a problem if you can’t even get an 80/20 or 85/15 framework in place.

It’s probably a safe bet that you’ll be meeting with republican congressmen next week. I hope you have the courage of your convictions to tell them that taxes are part of the solution, and that they find the courage to no longer kowtow to tea party extremists.

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