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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
• 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
•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
• 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.