Economic Commentary
Daniel Laufenberg, Ph.D.

Numerous economic data series are released between the publication dates of the Laufenberg Economic Quarterly (LEQ). Therefore, this page is designed to provide commentary on the more recent data and their implications for the economic outlook.

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Doomsday forecasts: Honest people can disagree
(April 26, 2013)

During my professional career as an economist, I have been asked by clients to review several books written by doomsayers. I most likely would not have read the books on my own simply because I do not need to be reminded that extreme outcomes are possible. Those who do need reminding probably should read the doomsday books to get a better appreciation of the range of risks to the outlook. But just because someone writes a book about doomsday does not mean it will happen, even if some features play out as predicted. So if you must, read them but discount them for what they are worth—a reminder that extreme outcomes are possible and something worth avoiding if we can. That being said, you should never adjust your investment behavior to a doomsday forecast unless you think doomsday is the most likely outcome.

Despite efforts by policymakers to the contrary, business cycles still occur. And while the downsides of such business cycles are painful, they are very unlikely to be the doomsday scenarios that are often suggested. For example, a recent doomsday forecast was that the end of the Mayan calendar on December 21, 2012 would mark the end of the world. A few people were so convinced that it was going to happen that they actually changed their lives in anticipation of that outcome—or at least that was their excuse for quitting their jobs, maxing out on their credit cards, or spending all their savings. As it turned out, they may regret what they did. Of course, if they had a really good time, maybe not. But most people discounted the prediction as a very unlikely event.

So here we are again. The latest doomsday scare (despite claims that it is not meant to scare anyone) to come across my desk is from Porter Stansberry, founder of Stansberry Investment Research, in the form of a video that has gone viral. He suggests in his video that U.S. government debt outstanding is already at an unsustainable level and spells a major crisis for the U.S. in the next twelve months. In particular, it is the large share of U.S. government debt held by foreigners that will trigger this crisis, as they refuse to take on more debt and indeed rush to sell what they already own. This refusal to hold dollar-denominated assets will cause the foreign exchange value of the U.S. dollar to collapse. According to Mr. Stansberry, this dollar crisis will lead to an economic and financial crisis even more severe than the last one. Indeed, Mr. Stansberry suggests that it could mean the end of America as we have known it for the last 50 years.

A key feature of Mr. Stansberry’s forecast is that the U.S. dollar would no longer be the reserve currency of the world. He points to the debilitating experience of Great Britain following the end of World War II, when the British pound collapsed after losing its status as the reserve currency, as an example of what to expect here. Mr. Stansberry contends that the U.S. faces a similar threat. He argues that the collapse of the dollar would make it very difficult for the Treasury to continue to rollover its outstanding debt, let alone issue new debt. Inflation would accelerate and interest rates would zoom upward. The concern would be that the government would default, causing government programs to end and the economic and financial systems of the U.S. to implode.

At first blush, it seems possible. But after some careful consideration, it is very improbable. First, the loss of reserve status of the British pound did not cause the economic problems in Great Britain after World War II. Indeed, the end of the pound as the reserve currency was a symptom of the economic and financial stress in Great Britain following the war. Indeed, they had to rebuild their country, while paying down its debts from the war. Also, recall that for international transactions, the world was still under the gold standard, which meant that the fixed-exchange rate for the pound was most likely too high (in terms of gold) and needed to be adjusted downward. The problem is that under the gold standard, such official devaluations of the currency were always extremely painful.

Second, what would cause the U.S. dollar to lose its reserve currency status? To answer that question, I think it is important to determine why the dollar is the reserve currency in the first place. A few things come to mind. In particular, at the end of World War II, we were the largest, strongest, and safest nation in the world. It made perfect sense for the U.S. dollar to replace the British pound as the world’s reserve currency at that time.

Of course, this does not mean that the U.S. dollar needs to be or will be the reserve currency forever. I contend that a basket of currencies may be more appropriate and more diversified as reserves. However, if the status of the U.S. dollar as the reserve currency changes, I doubt very much it will happen in the next twelve months—maybe not even in the next 50 years. It will take time and considerable change for another currency to establish itself as a viable alternative. Indeed, what currency would replace the dollar in that role? Would it be the yen, euro, yuan, Swiss franc, ruble, or Canadian dollar just to mention a few? None is as qualified to serve as the reserve currency as the U.S. dollar, issued from the largest, strongest, and safest economy in the world.

Gold is not an option. If the world went back to a gold standard, then only governments could own gold, forcing individuals to relinquish their holdings to the government. I doubt that individuals would be willing to give up their gold.

Mr. Stansberry would probably agree that the U.S. is the largest, strongest and safest economy in the world but that it would quickly lose that status without the financial power behind it, and that the dollar’s collapse would cause such a loss. For one thing, he points to the fact that we are a debtor nation—that we owe the world more than they owe us. However, being a debtor nation is not a problem if you have the wherewithal to service that debt. As shown in Chart 1, the federal government still has the means to service its debt, even at the current elevated levels of debt outstanding. Indeed, the outlays to service the federal debt as a percent of gross domestic income is actually down from where it was 20 years ago and back to where it was about 35 years ago. One could argue that we are currently in a better position to service the federal debt than we were a few years ago. The downside of this is that the low servicing cost makes it easier for the federal government to borrow even more.

chart 1

Of course that does not mean it must remain this way, which is why it is so important to reduce budget deficits when we can. Unfortunately, there will never be a perfect time to do so, only a better time. And that time may be now. Unfortunately, sequestration is not the answer. It puts the bulk of the burden of deficit reduction on discretionary spending and very little of the burden on nondiscretionary spending. The need is for a more balanced approach to deficit reduction, but that is a topic of another commentary.

It is important to note that federal government credit owed is only a part of all credit obligations outstanding. The credit owed of households, businesses, and state and local governments are also part of the total liabilities of the U.S. economy. Total credit outstanding will continue to grow but at a slower pace than our ability to service that credit. As such, it is very unlikely that government credit outstanding will overwhelm us anytime soon. Could it someday? It is possible but not probable. It is interesting that while the federal government has been increasing its leverage, the household and financial sectors have been deleveraging. The result is that at the end of 2012 total credit outstanding by all sectors of the U.S. economy, both public and private, as a percent of gross domestic income was actually lower than it was only a few years ago (see Chart 2). Moreover, total credit outstanding as a percent of household net worth at the end of 2012 was down as well despite the fact that home prices have only recently started to rebound. Both ratios still are higher than we probably would like but they are moving in the right direction; certainly not in the direction that would suggest the end of the U.S. as we know it.

chart 2

Another aspect of Mr. Stansberry's argument for a crisis of confidence in the dollar is the very aggressively accommodative policies persuaded by the Federal Reserve in recent years. He contends that the Fed is pumping liquidity into the system to keep interest rates artificially low, allowing the federal government to continue its addiction to debt, which will drive inflation higher and the dollar lower.

First, the Fed is effectively serving as a substitute for short-term Treasury obligations in the banks portfolios, without really adding much to loan demand or the money supply just yet. In other words, the effect on the economy is almost the equivalent of raising reserve requirements, even though I doubt that was the intent. What makes it different this time is that the Fed pays interest on reserves, something it did not do in the past. More importantly, the Fed pays 25 basis points, which is more than banks can earn on very safe short-term debt in the market (the federal funds rate is about 16 basis points and the 6-month Treasury bill rate is 6 basis points. In other words, banks can make more money holding reserves at the Fed than they can from buying Treasury bills or lending in the federal funds market. As such, much of the liquidity that the Fed has pumped into the banking system is not finding its way to the economy--yet.

Second, the Fed is convinced that it has the tools and skills to manage credit flows such that inflation never becomes an issue. I am less confident in this than the Fed but inflation does not have to get very high--nor will interest rates have to get very high--before it starts to take a toll on the economy. The experience of the 1970s has provided the Fed with the knowledge to fight inflation but it is unclear that we will enjoy the battles--Fed easing is a lot more fun than Fed tightening.

Although I expect inflation to eventually become a problem, I do not expect it to be the life altering experience that Stansberry Investment Research suggests it could be; at least, not this time around. There will be another recession because greed and fear are impossible to regulate. It is usually only after the fact that we realize we were excessively greedy on the way up or fearful on the way down. Moreover, a weaker foreign-exchange value of the dollar, but not a dollar crisis, most likely will be part of the story. period

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1 One example is Lakshman Achuthan of the Economic Cycle Research Institute, who has appeared on CNBC recently claiming that the U.S. economy is in a recession.

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For the current economic forecast, as well as other analysis and commentary, please visit the Stonebridge Capital Advisors website.

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The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.


2013 Commentary

Doomsday forecasts: Honest people can disagree
(current article)
-- April 26, 2013

Making sense of the February jobs report
-- March 10, 2013

Growth gyrations continue
(current article)
-- January 28, 2013

2012 Commentary

Optimism, not irrational exuberance
-- October 15, 2012

Disappointing but far from disastrous
-- July 31, 2012

Assessing the recent weak economic data
-- June 8, 2012

Consensus too pessimistic about everything
-- April 16, 2012

Risks to the forecast
-- March 7, 2012

A good finish to 2011 but still not good enough
-- January 27, 2012

2011 Commentary

More evidence of a strong finish
-- December 22, 2011

Finishing Strong
-- October 14, 2011

Living in interesting times
-- September 8, 2011

A not so pleasant surprise!
-- September 2, 2011

Surprise!
-- August 16, 2011

Debt ceiling politics
-- July 25, 2011

Q2 growth: Another disappointment likely
-- July 14, 2011

Interpreting the ISM manufacturing index and the employment situation report for May
-- June 4, 2011

A slower start to 2011 than anticipated earlier
-- April 14, 2011

Is the dollar's status as the reserve currency at risk?
-- March 21, 2011

More trouble in the Middle East
-- February 26, 2011

Searching for the next debt crisis
-- January 13, 2011

2010 Commentary

What's going on?
-- October 15, 2010

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