Monday, February 16, 2009

The Ponz and the Great Moderation

Late in 2007 most of the central bankers of the world were fawning all over themselves in an unseemly attempt to congratulate one another for yet another victory in what they had come to call the Great Moderation. After all, the sub-prime crisis of the summer had been "contained", the price of housing had moderated a bit, but that was probably just part of reaching its own permanently high plateau, and the juggernaut of the US economy looked to be very gradually slowing, which was anticipated to ease the inflationary pressures which seemed to be everyone's only major worry.

So, it occurred to me today that this was the very best sign one could have wanted that the whole thing was about to explode. Why? Well, I've put together a little graphic novel showing the logic. First, you have the Great Moderation, which is the precipitous decline in the volatility of GDP since the early 80's. The Fed paper cited above explores a few explanations of what might have caused this, but I think that privately the keeps of the money trust were pretty sure it was their beneficent wisdom and foresight.

What the Fed paper does not seem to explore is the fact that there was coincidentally an explosion of debt at the national, corporate, and household level over precisely this same period. So this chart shows you aggregate US indebtedness as a percentage of GDP.

More than a little curious, no. And so but well, then, what did we do with all this debt anyway? It must have gone to build more stuff, and that can't be such a bad thing, right? Unfortunately, the all this new debt got less and less effective over time, meaning that instead of being invested in some productive asset, it was basically just going straight into consumption. In other words, it's pretty easy for you to buy more stuff if you just go further and further into hock.

Now, you tell me where you think the Great Moderation maybe came from. And what you think it was a sign of. And who you think should be lauded for its wonders.

In fact, we've recently seen another remarkably moderate pattern of increases come to an abrupt end. Here is what happened to your money if you invested with Bernie Madoff:

It's interesting that I have yet to hear anyone apply the same logic to 30 years of American economic growth that they seem to trot out so intuitively when we talk about why Madoff's performance was suspicious -- it was too consistent to be real.

At any rate, I presume that eventually we will fix the jukebox, set the music to playing and the bankers to dancing, and happy days will be here again -- but for now, the age of the Ponz is over.

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