"Depressions, Deflation, and Debunking" (CITS DEBT WATCH)

**                                                              **
                    W. Curtiss Priest, Ph.D.
          Center for Information, Technology & Society
              466 Pleasant Street Melrose, MA  02176
  E-mail: BMSLIB@MIT.EDU, Voice: 781-662-4044, FAX: 781-662-6882


                           May 18, 2003

                        Public Issue #:101

                          CITS DEBT WATCH

                 "Depressions, Deflation, and Debunking"

             Commentary by Dr. W. Curtiss Priest, Director:

I must continually remind myself that hardly any person, fairly
active, today, has witnessed either deflation or a depression.

And, while some believe that the extended period of time since
the last period of depression and inflation, ending about 1939,
was "so long ago" that we have, as they said in the '20s, entered
a new economic era -- I must say unfortunately this is bullcrap.

***

I expect that historians, some five years from now, will have
the proverbial "field day" about how we lulled ourselves into
the longest boom run in the history of this country.

A NYTs article, about six months ago, commented that with
the recent "dot-com" sell-off, we were only down to a level
of stock market valuation (P/E) that equaled the highest
valuation in 1929.

Understand.  I am not an alarmist.  I simply wish to end busts
and crashes by ending booms.

So, I am writing the book, "Lithium: Debt in Crisis."

And, yes, I use the word lithium to indicate manic-depressive
behavior.  It is a fact that a whole generation can exhibit
both, first a manic phase and a depressive phase.

I present a few of articles that have crossed my desk.

Gosselin, of the LA Times, refers to "Life in the upside-down
world of deflation."

Kotlikoff and Sachs describe an "Economic 'menu of pain'."

And Presidential hopeful Howard Dean says, "Bush would lead
US into depression."

And for your amusement, or edification, I attach the
three articles below.

***

Am I sounding whimsical?  You're damn straight!

I witness extreme borrowing behaviors, extreme spending
behaviors, extreme house prices, and extreme debts stretching
as far "as the eye can see."

The Kotlikoff piece sites the current federal deficit at
$44 trillion.

Please understand -- this is an amount that is over four times
the total U.S. economic expenditures in a given year.

There are about 100 million households, as the U.S. population
is around 286 million.

If we take $44 trillion and divide it by the number of households,
this says that the amount owed by each household towards the
federal debt is $440,000.

ohmygosh

I did and redid the math, because I could not even imagine
a level of federal indebtedness that exceeds the average
value of homes, at about $300,000.  And this does not include
the population of rental households !

Let me do this math for you explicitly:

    The ^ notation is an exponent.  For example, if I wish
to write 1000, I can write it as 1 * 10^3, where '*' means
multiplication.

    10^3, means, three zeros (or a thousand) !

    10^6, means, six zeros (or a million) !!

    10^9, means, nine zeros (or a billion) !!!

    10^12, means, 12 zeros (or a trillion) !!!!

So.

I do this math on the calculator:

    (44 * 10^12) / (100 * 10^6)  i.e. $44 Trillion divided by
            100 million

Every time I do this math, I get the same number:


    $440,000 !


oh, ohmygosh

The "call" on every American household is $440,000 to pay
off the federal debt!

This doesn't even count (based on my 2001 numbers) the
$7 Trillion in household debt, or the $6.3 Trillion in
business debt, or the $1.2 Trillion in state debt, nor, the
$8 Trillion that is loaned from one financial institution
to another.

This total, $66.5 Trillion, is now over 6 times the annual,
total expenditures of this country, and represents, a
$665,000 per household level of indebtedness !

What?  The median household income is around $42,000.

So, the size of this debt in proportion to that annual
income, is $1.583 * 10^9, which, adding 9 zeroes gives
us $1,583,000,000 .

ohmygosh again.

The total outstanding debt in this country is about $1.5
million compared with the median household income!

So, in effect, every household "owes" $1.5 million to
someone, somewhere.

Please, someone write me and tell me I have done the
math incorrectly!

Regards,

WCP

P.S.  As for the Gosselin article I must comment on two
paragraphs.  About 1/3rd in, we have an economist from
Claremont recommending that you commandeer your salary
at its current level.  It recommends that you march
in and ask your "boss" to neither give you a raise, nor
a salary reduction.  To this I say, "good luck."

Also, towards the end, the writer suggests prices may go
down, but your salary may stay the same.  Again, I say,
"good luck."

And, the 2nd to last paragraph, "It feeds a certain relaxation
of attitude because the longer you wait, the lower the price."

To which I say, ohmygod, this is precisely the thinking that creates
depressions.

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May 12, 2003

WASHINGTON DISPATCH Price of Deflation: An Upside-Down World By Peter
G. Gosselin, Times Staff Writer

WASHINGTON -- For half a century, Americans have assumed that when it
comes to prices, there is only one direction -- up.

[Washington -- For a half century, Americans have assumed that
when it comes to prices, there is only one direction -- up.]

We railed against this apparent fact when the inflation of the 1970s
eroded the value of our money. We reveled in it when the boom of the
'90s sent our stock values through the roof. But one way or another,
we've always taken it for granted that prices only rise.

Now comes word from the folks at the Federal Reserve that up may not
be the only direction after all, and that we may be on the verge of a
deflation -- a broad price decline.

If they're right, hold on to your hats. We could be headed for a
looking-glass world in which all the familiar rules of work, money,
investment, even daily life get turned on their heads.

"Alice in Wonderland has nothing up on deflation. It would upset
almost every settled notion we have about our economic lives," said
Roger M. Kubarych, a former senior Fed official who now is an
executive with HVB Americas Inc., the U.S. subsidiary of a major
German bank.

To fully appreciate how different an era of down could be from the now
possibly passing age of up, it's important to make a distinction.

People generally associate deflation with cataclysms such as the Great
Depression, when prices plunged along with almost everything else in
the economy.

But it doesn't have to be this way. Prices can fall gently while the
economy rises, and they have for substantial chunks of American
history; for instance, for much of the period from the end of the
Civil War through the start of the 20th century.

Of course, that wouldn't make the experience of deflation any the less
strange -- or unsettling -- for modern Americans.

*

New Strategy: Avoiding Pay Cuts

Take raises. Most people assume that sooner or later they will get
one. It may not be as big as they want. It may not cover their growing
appetite for wide-screen TVs and DVD players. But it's still a raise.

However, if deflation were to set in, raises would almost certainly
vanish, and pay cuts would become the order of the day.

That's because as prices across the economy fall at, say, 3% a year,
each dollar you receive in wages would be able to buy that much more
and so would be that much more valuable to you -- and to your employer.

A good strategy under such circumstances: "You should march into your
boss and announce that you will not accept a penny more than you make
right now as long as he agrees not to pay you a cent less," said Marc
Weidenmier, an economist at Claremont McKenna College in California.

Or consider debt: Americans were happy to load up on it during the
inflation-wracked 1970s and early 1980s, when rising prices ensured
that the dollars with which they repaid their loans were less valuable
than those they had borrowed. And they have been happy to load up
again in the early 2000s, when extremely low interest rates seem to be
erasing the cost of borrowing.

But matters would look considerably different if prices went into a
general decline, causing repayment dollars to become more, not less,
valuable. Consumers and companies probably would react by throwing
their finances into reverse and paying off loans as fast as they
possibly could.

*

Evidence of Impending Deflation Is Mixed

Given such a disruptive possibility, there is some mystery about why
the Fed chose to highlight the deflation danger this week.

After meeting Tuesday in Washington, the central bank's policymaking
Federal Open Market Committee issued a statement that represented an
abrupt shift from its half-century obsession with eliminating
inflation.

It warned that over the next few quarters "the probability of an
unwelcome substantial fall in inflation, though minor, exceeds that of
a pickup."

The mystery is only deepened by the fact that evidence that a
generalized decline in prices is underway is, well, mixed.

To be sure, some prices have been falling so fast that it is hard to
imagine how companies stay in business.

Personal computer prices, for instance, have been plunging at better
than a 20% annual rate for the nearly five years that the Bureau of
Labor Statistics has been keeping track. New-vehicle prices have been
sliding at a rate of as much as 2% during the same period, according
to the bureau. Television prices have been going down for at least a
decade.

But for each of these declines, there are prices of other, perhaps
even more important goods and services that have been going up. Health
insurance, for example, has been rising at an 8% annual rate. Private
college tuition and fees have been climbing at an almost 6% clip. The
price of postage stamps is up nearly 4%.

"I myself don't see much evidence" of deflation, said Barry Bosworth,
a Brookings Institution economist whose skills at spotting price
trends were first honed in the late 1970s as director of President
Carter's ill-fated Council on Wage and Price Stability.

Theories about what is behind the Fed's new deflation warning run
along two lines.

Tactically, Fed officials are in a nasty bind. With conditions so
weak, they don't want to speak ill of the economy. Having already cut
their benchmark federal funds rate to a four-decade-low 1.25%, they
are running out of conventional steps to take. And in President Bush
and the Republican majority on Capitol Hill, they face a White House
and Congress liable to jam through another big, deficit-ballooning tax
cut if growth doesn't improve.

The deflation argument offers the Fed's Open Market Committee a way
out of this bind. In effect, the central bank declared Tuesday that
the prospects for growth are good enough that Bush and congressional
Republicans need not act.

But, they added, there is another problem -- deflation -- that's
potentially so serious the Fed can be forgiven if it takes
unconventional steps such as pumping so much credit into the economy
that it causes a little inflation.

"Masterful," exclaimed Goldman Sachs economists William Dudley and
Edward McKelvey. "It is hard to imagine a better solution than the one
the committee came up with," the pair said of the Fed's statement.

By contrast, others think the economy really does face a deflation
danger and they believe that Fed Chairman Alan Greenspan and his
colleagues do too.

"Greenspan wants to anticipate what the next problem could be, and it
could be deflation," said David M. Jones, a longtime Fed-watcher and
Denver-based economic consultant. "It's a very dicey economic
situation."

Dicey, if falling prices feed into a downward spiral of wage cuts,
layoffs and plunging demand. But not so dangerous if the price
declines are caused by improving productivity and remain mild.

And not necessarily bad for ordinary Americans.

*

The Upside of Falling Prices

Mild deflation would assure working people (at least those who fend
off pay cuts) of steadily rising real wages.

A 3%-a-year decline in overall prices translates directly into a 3%
boost in people's buying power.

It would offer Americans an appealing alternative to the maddening
task of trying to pick investments, and a tax-exempt one at that. Just
sew your money in a mattress and watch its value rise.

Finally, it might help slow the frantic pace of American life.

Alice in Wonderland-like, "deflation elongates time," said Kubarych,
the former Fed official. "It means that you don't have to hurry out
and buy something for fear the price will rise.

"It feeds a certain relaxation of attitude because the longer you
wait, the lower the price."

That doesn't sound half bad.

[this was reprinted in the Boston Globe, May 18, 2003, p. D5]

***

An economic 'menu of pain'

By Laurence J. Kotlikoff and Jeffrey Sachs, 5/19/2003

UR GOVERNMENT is going broke. The feds face bills that are far beyond
our capacity to pay -- by $44 trillion to be precise. The longer we
ignore them, the bigger they get. Yet President Bush is working
overtime to deepen our fiscal trap. This $44 trillion figure is not
ours. Nor is it some other academics' calculation. It was produced
last fall by economists and budget analysts at the US Treasury, the
Federal Reserve, the Office of Management and Budget, and the
Congressional Budget Office. The study was ordered by then Treasury
Secretary Paul O'Neil and was slated to appear in the president's
budget, released in February.

O'Neil instructed his team, led by Jagadeesh Gokhale, Federal Reserve
senior economist, and Kent Smetters, then deputy assistant secretary
for economic policy at the Treasury, to answer the following question:
Suppose the government could, today, get its hands on all the revenue
it can expect to collect in the future, but had to use it, today, to
pay off all its future expenditure commitments, including debt service
net of any asset income. Would the present value (the value today) of
the future revenues cover the present value of the future
expenditures?

The answer is no, and the fiscal gap is the $44 trillion. Now, that is
big bucks by anyone's definition. It's four times current GNP and 12
times official debt. Imagine everyone in the country working for four
years and handing over every penny earned to pay this bill, and you'll
grasp its size.

Unfortunately, we can't ascribe the $44 trillion calculation to overly
pessimistic assumptions. On the contrary, the assumptions are
optimistic with respect to future longevity as well as growth in
federal health expenditures, discretionary spending, and labor
productivity.

Gokhale and Smetters asked a follow-up question: By how much would
taxes have to be raised or expenditures cut on an immediate and
permanent basis to generate, in present value, the $44 trillion? Their
"menu of pain" is mind-boggling. Entree A is raising federal income
tax collections (individual and corporate) by 69 percent. Entree B is
raising payroll tax collections by 95 percent. Entree C is cutting
Social Security and Medicare benefits by 56 percent. Entree D is
cutting federal discretionary spending by more than 100 percent,
which, of course, is not feasible. Combination platters are also
available. For example, we might select quarter portions of entrees A
through D. But no matter what combination we order, digesting this
medicine is going to be plenty painful.

Why are the nation's fiscal affairs in such a mess? The reason is
straightforward. Baby boomers are just five years from starting to
collect Social Security retirement benefits and eight years from
starting to collect Medicare benefits. When all 76 million boomers are
retired, we'll have twice the number of elderly beneficiaries, but
only 15 percent more workers to pay their benefits.

If the fiscal gap and its associated menu of pain are unfamiliar,
there's a reason. You can scour the thousands of pages of the
president's FY 04 budget, and you won't find the analysis. It never
made it in. When Secretary O'Neill was replaced last December, the
analysis was yanked from the budget.

To be clear, limiting our need to know is not just a Republican
responsibility. When it came to publishing a generational accounting
analysis in the FY 92 budget, President Clinton's political watchdogs
overruled OMB and pulled the same trick. And bankrupting has been a
collective effort of all postwar administrations, each of which has
cared more about the next election than the next generation.

Our current team leader, President Bush, is doing his part. Taken
together, his first tax cut and his proposed second tax cut, which is
about to be passed by Congress, account for roughly a sixth of the
fiscal gap. The president, an ardent believer in voodoo economics, is
convinced his tax cuts will stimulate growth and dramatically raise
revenues. Neither economic theory nor economic facts supports this
view. In fact, the president is not only burying us in explicit and
implicit debt, he's undermining the economy's future performance.

The stakes are now too high for more political games and flaky
economic theories. Democrats and Republicans alike need to send our
leaders a firm message: Deal responsibly with the coming generational
obligations! If we don't, we can look forward to massive cuts in
future Social Security and Medicare benefits, tax hikes, high
inflation, and bitter political strife. Putting aside the president's
latest tax cut would be an excellent start on the road to
responsibility.

Laurence J. Kotlikoff is chairman of the Department of Economics at
Boston University. Jeffrey Sachs is professor of economics at Columbia
University.

This story ran on page A11 of the Boston Globe on 5/19/2003. c
Copyright 2003 Globe Newspaper Company.

***

Bush would lead US into depression, Dean says

By Mike Glover, Associated Press, 5/19/2003

AVENPORT, Iowa - Sharpening his attacks on President Bush's policies,
former Vermont governor Howard Dean asserted yesterday that the nation
will face an economic depression if Bush is re-elected.

Citing a statistic that 2.5 million jobs have been lost during Bush's
first term in office, Dean blamed the president's handling of the
economy.

"Two-and-a-half million jobs in two-and-a-half years," Dean said. "If
we reelect this president, we'll be in a depression. That's 8 million
jobs in eight years."

A job loss of that magnitude would plunge the nation into an economic
crisis far worse than the current recession, Dean argued.

Dean sounded a sharply liberal theme as he sought to differentiate
himself from the others in the nine-member Democratic field. He spoke
during the latest forum sponsored by Senator Tom Harkin of Iowa, who
is seeking to introduce the candidates to activists of the state's
caucuses.

Dean focused his fire on Bush, but he didn't spare his Democratic
rivals, saying most support the tax cut legislation moving through
Congress.

Dean has less money than some Democratic rivals, but he argues that he
has the best chance of defeating Bush because he can draw the sharpest
differences with the president.

"If you make me the Democratic nominee, I'll make you proud to be a
Democrat again," Dean said.

"No Republican president has balanced the budget in this country for
34 years," said Dean. "If you care about the money you send to
Washington, you better elect a Democrat, because Republicans can't
manage money."

He attributed Bush's high approval rates to the inability of Democrats
to make a case against him.

"The reason people like George Bush is they think he's a leader," said
Dean. "The way to beat him is to unambiguously state our Democratic
agenda."

This story ran on page A2 of the Boston Globe on 5/19/2003. c
Copyright 2003 Globe Newspaper Company.


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