Nouriel Roubini has been called "Dr. Doom", a title to which I would not concur with. His latest book, Crisis Economics: A Crash Course in the Future of Finance, is an intense read that presents a sober, but accurate, analysis of how global finance has evolved in an era of too big to fail.

Roubini is equally critical of Wall Street, Main Street and Pennsylvania Avenue, but the part of this book I found the most intriguing was not the dissection of our current financial situation but his recommendations for reform.

He makes a convincing case that the Wall Street bonus system, which rewards near-term risk taking over long-term prudence, needs dramatic overhaul. He also makes an eye-opening argument for why deregulation of the financial markets in the 1990's, particularly the repeal of the Glass-Steagall Act, was ill conceived. Roubini offers a number of solutions that make sense, yet unfortunately have little likelihood of being implemented by the current political climate.

I actually purchased this book in audio format (and listened to it twice - it was that good), so I don't have a physical book to transcribe a quote, but the Amazon page for the book has an interview of Roubini that I'd like to quote from to give you a sense of his analysis. Here was his response to a question about rising public-sector debt:

The Great Recession of 2008-2009 was triggered by excessive debt accumulation and leverage on the part of households, financial institutions and even the corporate sector in many advanced economies. While there is much talk about de-leveraging as the crisis wanes, the reality is that private-sector debt ratios have stabilized at very high levels. By contrast, as a consequence of fiscal stimulus and socialization of part of the private sector’s losses, there is now a massive re-leveraging of the public sector. Deficits in excess of 10% of GDP can be found in many advanced economies, including America’s, and debt-to-GDP ratios are expected to rise sharply – in some cases doubling in the next few years. 

 

Such balance-sheet crises have historically led to economic recoveries that are slow, anemic, and below-trend for many years. Sovereign-debt problems are another strong possibility, given the massive re-leveraging of the public sector. In countries that cannot issue debt in their own currency (traditionally emerging-market economies), or that issue debt in their own currency but cannot independently print money (as in the eurozone), unsustainable fiscal deficits often lead to a credit crisis, a sovereign default, or other coercive form of public-debt restructuring. In countries that borrow in their own currency and can monetize the public debt, a sovereign debt crisis is unlikely, but monetization of fiscal deficits can eventually lead to high inflation. And inflation is – like default – a capital levy on holders of public debt, as it reduces the real value of nominal liabilities at fixed interest rates. 

Thus, the recent problems faced by Greece are only the tip of a sovereign-debt iceberg in many advanced economies (and a smaller number of emerging markets). Bond-market vigilantes already have taken aim at Greece, Spain, Portugal, the United Kingdom, Ireland, and Iceland, pushing government bond yields higher. Eventually they may take aim at other countries – even Japan and the United States – where fiscal policy is on an unsustainable path.

This is where my mind has been the past few weeks - this sinking feeling that our fate was decided decades ago and we're only now playing out the inevitable end game. Despite being fiscally quite conservative, I concur with the Keynesian notion that what is called for right now is more spending (stimulus) to forestall a deflationary spiral. Here's the problem: we have spent the past fifty years collectively as Keynesians and have nothing left to spend. Adding to the debt marches us closer to the massive inflation tax and social correction we should be dreading.

Inflation = American decline on steroids.

There was this really weird article I came across yesterday - weird for the headline, graphics and web site it was on, not so much for its content -  that was written by Paul Craig Roberts, one of the architects of Reagenomics. I guarantee that if you read the article in that context, you will be surprised at his analysis. As Roberts states:

It is encouraging to see some realization that, this time, Washington cannot spend the economy out of recession. The deficits are already too large for the dollar to survive as reserve currency, and deficit spending cannot put Americans back to work in jobs that have been moved offshore. 

Roubini speaks repeatedly in Crisis Economics about the advantages the United States has as the world's reserve currency. When there is any type of financial crisis (think the recent Greek debt crisis), the market flees to safety by buying U.S. Treasuries. This allows us to keep the interest rate low (with the high demand for dollars, we don't have to pay much return when we borrow money), which allows us to finance our enormous debt at very low rates.

Conservatives worried about deficits and liberals concerned about cuts to the social safety net should be equally petrified at the prospect of losing reserve currency status. If we were forced to pay higher interest rates on our debt, we would have an extremely difficult time making that adjustment. It would force us to make large tax increases, large spending cuts or, as Roberts suggests, print money and risk hyperinflation and loss of reserve currency status.

When Treasury bonds brought to auction do not sell, the Federal Reserve must purchase them. The Federal Reserve purchases the bonds by creating new demand deposits, or checking accounts, for the Treasury. As the Treasury spends the proceeds of the new debt sales, the US money supply expands by the amount of the Federal Reserve’s purchase of Treasury debt.

Do goods and services expand by the same amount?  Imports will increase as US jobs have been offshored and given to foreigners, thus worsening the trade deficit.  When the Federal Reserve purchases the Treasury’s new debt issues, the money supply will increase by more than the supply of domestically produced goods and services. Prices are likely to rise.

How high will they rise? The longer money is created in order that government can pay its bills, the more likely hyperinflation will be the result.

Want to see a spatial shift in our pattern of living forced down our throats? Hyperinflation and the devaluing of the dollar would easily mean gas prices of $5+ per gallon, perhaps more if demand worldwide does not fall in tandem with us. America could not handle $4 per gasoline. We have no idea what a bout of hyperinflation would do to radically alter the American standard of living.

With China slowly reducing its holdings of dollars, with Europe and Japan running huge deficits of their own, who is going to buy the trillions of dollars of debt we need to issue in the next decade? I highly recommend Crisis Economics for anyone wanting a deeper understanding of what is likely to remain the most important issues we face for some time. 


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