Re-interpreting recession dating committee’s double-dip language for debt deflation dynamics

Last week, I wrote a post “Is the recession dating committee preparing for a double dip?” the gist of which was to question whether the NBER recession data committee thought a double dip was likely.  But an e-mail exchange I had this morning, with Paul Brodsky and Lee Quaintance of QB Asset management amongst others, lends a more depressionary interpretation to the NBER language.

Is the NBER hedging on a 1980-82 double dip scenario

At issue is the following paragraph on the NBER website:

In both recessions and expansions, brief reversals in economic activity may occur—a recession may include a short period of expansion followed by further decline; an expansion may include a short period of contraction followed by further growth. The Committee applies its judgment based on the above definitions of recessions and expansions and has no fixed rule to determine whether a contraction is only a short interruption of an expansion, or an expansion is only a short interruption of a contraction. The most recent example of such a judgment that was less than obvious was in 1980-1982, when the Committee determined that the contraction that began in 1981 was not a continuation of the one that began in 1980, but rather a separate full recession. [emphasis added]

Clearly, this, the second paragraph in a recent NBER statement on dating recessions, is signalling the NBER’s reluctance to date this recession’s end because they need to make sure the recent uptick in economic activity is not just a blip but something more sustained. That’s what the highlighted text reveals.  In talking about the present situation, the NBER reference the double-dip recession of 1980-1982, which is the main reason I interpret the paragraph as a hedge against a potential double-dip recession.

Also see What does a double dip recession look like? which analyses the data from 1980-82.

What about hedging against one continuous downturn?

However, another financial episode should also be in the back of your mind, namely the Great Depression and the 1929-1933 period.

Unfortunately, I do not have month-to-month data from that period to track the economic path. Last year, Barry Eichengreen and Kevin O’Rourke did a wonderful job of tracking the 2009 to 1930 comparison. But, their data set hasn’t been updated since September.  Anecdotally, the News from 1930 website provides some tidbits showing some parallels have continued; However, there is nothing from which you could draw any conclusions.

The overall import of the 1929-1933 period was the role the Gold Standard played in inducing debt deflation dynamics. Eichengreen has data which demonstrates those countries which de-linked from gold actually pulled out of depression quicker [pdf file here]. As an aside, I should mention Michael Pettis’s recent FT piece“Why trade war is very likely to break out this year” because many point to trade conflicts as the trigger for the second leg down in the Great Depression.

What made me think of the Great Depression in interpreting the NBER’s language was an e-mail exchange which highlighted some similarities between then and nowregarding debt deflation.

Here’s my thinking based on that exchange and Paul Brodsky’s analysis:

With the abandonment of the Gold Standard, the U.S. dollar has acted as the reserve currency. In this very real sense, 2010 U.S. dollar reserves act as the equivalent of 1930-31 gold reserves. This puts the U.S. in a unique situation and results in the Triffin dilemma.

The Triffin dilemma, less commonly called Triffin paradox, is the fundamental problem of the United States dollar’s role as reserve currency in the Bretton Woods system, or more generally of a national currency as reserve currency. Briefly, the use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: to maintain all desired goals, dollars must both overall flow out of the United States, but must also flow in to the United States, which cannot both happen at once.The dilemma is named after Belgian-American economist Robert Triffin, who first identified the problem in 1960.

During the Bretton-Woods era, this problem was manifest in the continual loss of gold reserves in the U.S. since the tether to gold had not been completely broken.  But, eventually the U.S. had to drop its peg to gold in 1971 as the pressure became too much to bear.

In the post-1971 period, as emerging economies have grown and developed economies expanded credit, the U.S. has been forced to satisfy global claims for U.S. dollars. This has induced an even larger deficit because there has been no check on balance of payment imbalances without the gold anchor. These imbalances are unsustainable as it puts the U.S. in a situation in which U.S. dollar denominated public and private credit claims cannot be settled with the current dollars outstanding. Either more and more U.S. dollar net financial assets have to be manufactured or the dynamics of debt deflation will kick in. 

In plain English: the reason credit has surged dramatically over the last generation has much to do with the monetary system; unless we successfully reflate asset prices, the claims on dollar-based assets cannot be met under this jury-rigged monetary system with the U.S. dollar at the core.  I see this as a Ponzi scheme which is now in its final chapter.

There are two exit strategies from this.

• Manufacturing more U.S. denominated financial assets. Implicitly, this is the strategy we are now following. The goal is to limit the currency depreciation through the additions from the real economy value which ostensibly underpins these new net financial assets. Obviously, if you think spending more money is likely to misallocate resources, as I do, you aren’t going to like this approach.
• Maintain existing money stock despite the credit claims. Debt that cannot be repaid, won’t be repaid. It’s as simple as that.  The problem here, of course, is that this is deflationary. Yes, it rewards savers by not diluting their assets, but there is the real threat of a deflationary spiral and geopolitical tension as a result.

Both of these solutions have major problems.  The first solution is a form of Ponzi finance in my view. It’s kicking the can down the road as it leads to debt deflation eventually anyway – unless you want to go the Weimar or Zimbabwe route.  The second is deflationary and puts acute stress on economies with high levels of indebtedness due to debt deflation and resulting social unrest that accompanies it.

Ultimately, I hope this highlights the untenable nature of current currency system, because that is what is at the heart of the problem.  From a U.S. perspective, a diminished reserve currency role will actually help alleviate much of the problem.

On this topic, see Credit crises, market equilibrium, economic policy and fiat currencies, The Age of the Fiat Currency: A 38-year experiment in inflation and A New World Order.