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Long Term Outlook for the Economy Daryl Montgomery March 3, 2009 Copyright 2009, All Rights Reserved Credit Crisis Backdrop • The 1944 Breton Woods agreement made the dollar the world’s reserve currency. The dollar was backed by gold and other currencies were backed by the U.S. dollar. • When the U.S. left the gold standard in 1971, the dollar and currencies connected to it became fiat – backed by nothing. • Combined with financial deregulation, the restraints that prevented the creation of unlimited amounts of currency and credit were removed. • This allowed the U.S. to run budget deficits from 1970 (except for 1997 to 2001) and Trade Deficits from 1976, which we have to be paid for by borrowing from other countries or by printing money. U.S. Budget Deficit 1960 to 2006 National Debt 1940 to 2008 (1/2) Trade Deficit 1960 to 2007 Global Credit Expansion •The U.S., Britain and other developed economies increasingly based their economies on consumer spending after their manufacturing bases started declining in the 1970s. •Japan did not do this and has been in intermittent recessions for almost two decades. •An accelerating increase in credit creation took place in the 1980s, 1990s and 2000s. Asset bubbles resulted. •By the 2000s, credit was being extended to borrowers who could never pay it back and at interest rates that were well below free-market rates. The % of U.S. economy that was consumer spending after 2000 rose to 72% from the 67% where it had been since 1975. U.S Household Debt U.S. Consumer Debt and Savings Long Term House Prices Mortgage Equity Withdrawal The Blow Up • The 2001 U.S. Recession was the only one in history where consumer spending didn’t drop. • Credit expansion was global. • In July 2007, the U.S. sub-prime market, being the weakest link in the credit chain, collapsed. Estimated cost to fix it is now $3+ trillion. • Other problems, such as Credit Default Swaps ($62 trillion last year, now $30+ trillion) are much bigger. • The Credit Crisis is a major de-leveraging of the financial excesses that have built up in the last 30 years. It should take at least a decade to fix. National Debt, GDP, Inflation • In the 1980s and 90s, the U.S. changed how it calculated inflation, GDP and employment, making all 3 appear much better than they are. • An understated inflation rate causes an overstated GDP. • The U.S. has actually been in recession since 2000, but this was masked by the large increases in credit. • Budget Deficit for 2009, first estimated at $407 Billion, now at $1.75 Trillion (doesn’t include most financial bailout money). • National Debt is at $10.8 Trillion (doesn’t include many items or long-term obligations for social security and Medicare/Medicaid – these trust funds are empty). Actual U.S. CPI Inflation Versus Reported 1980 to 2008 Actual Versus Official GDP 1982 to 2008 After the Blow Up • A large number of major banks in the U.S, Britain, and Europe have required bailouts, were merged, nationalized or went under (worse to come). • Global stock market collapses and crashing real estate (will continue for several years). Dow down over 50%. • Deep recession that will turn into depression. U.S. GDP minus 6.2 in Q4 2008 (minus 8%/9% more likely). • In response to the crisis, the U.S. and Japan have lowered interest rates to zero. Britain will follow. • U.S. has spent $8.5 trillion on bailouts by end of 2008. • U.S. ‘printing’ money at astronomical rates – current asset deflation will turn into massive consumer inflation because this will devalue the dollar. Adjusted Monetary Base 1959 to 2009 Currency Plus Bank Reserves (future inflation) Total Reserves – 1959 to 2009 Sum of Deposits that count for Reserve Requirements Adjusted Reserves 1919 to 2009 Excess Reserves: Total Reserves minus Required Reserves MZM – Zero Money, Seasonally Adj.