A prolonged double dip recession or a permanent state of structural insolvency?

After decades of failed Keynesian policies and looting of the Treasury for political gain and ignoring numerous signals that the crisis was due to arrive, it’s coming down to what type of structural crisis we want to deal with: a prolonged double dip recession or a permanent state of structural insolvency.

Under the double dip scenario we could grasp we are in a cycle of deleveraging and actually improve ourselves by taking a dose of bitter Austrian economics and allow asset prices fall to market levels; write down impaired assets; reduce surplus capacity; align capacity with demand; shrink the size and scope of government; reduce incentives to spend; introduce incentives to save; and become a wealth creating nation. This will not happen as it would inflict considerable economic pain until the process of purging and renewal has run its course. This would be anathema to politicians.

I’m not as alarmed as the author about the US and the current administration being too quick in withdrawing expansive fiscal and monetary support. The recently announced budget features a $1.3 trillion deficit built upon somewhat optimistic assumptions, raising the distinct possibility it will actually be more. A fiscal budget deficit on the order 9% of GDP by my math is very “stimulative” and the Fed is fairly clear it will keep rates low until a recovery is at hand. What has changed is that a number of special lending facilities have been closed and presumably the Fed will wind down its purchases of agency backed MBS after buying $300 billion of treasuries. This decision, however, could easily be reversed. And my bet is that it will be.

Whether we stay on the current course or add further fuel to the fire, we are on our way financial Armageddon/Ragnarok with national debt exceeding 90% of GDP and government borrowing dominating capital markets and reducing efficiency of capital allocation. At this level of indebtedness, history strongly suggests our long term growth potential will permanently reduced by 1.5 to 2.0 percentage points because of the weight of carrying debt and the government dominating capital markets and crowding out others that can put capital to more productive uses. We are well on our way to this inflection point it’s really a matter of how quickly we get there. Additional stimulus, rather than having its advertised effect, would mask things a bit and accelerate the official arrival of our becoming a permanently disabled and sclerotic economy.

- CautiousInvestor

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• “SPENDS TOO MUCH, TAXES TOO MUCH, AND BORROWS TOO MUCH”
• The market is propped up by a virtuous circle:
• Falling treasuries to bring more banks down

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