Nouriel Roubini's Global EconoMonitor

Nouriel Roubini’s Introduction to Christopher Whalen’s Book, ‘Inflated: How Money and Debt Built the American Dream’ Published by Wiley, 2010

Chris Whalen is one of the leading independent analysts of the US banking and financial system. In a world where too many sell-side analysts of the financial sector are not truly independent, Chris represents a fearless beam of enlightened and independent light that avoids the usual self-serving spin that is presented in so much of Wall Street research.  In this book he also emerges as a leading historian of the US financial system and of the complex nexus between banking/finance, politics and fiscal policy. This tour de force of financial history of the US is also a political history and a sovereign fiscal history of the US. 

You may not agree with Chris’ views—on the state of US banks; on which reforms of the system of financial regulation and supervision are appropriate; on the risks that large monetized fiscal deficit imply in terms of future inflation and risks of a crash of the US dollar—but he is always thought provoking, well versed in the details of financial history and a master of lateral and contrarian thinking that challenges the conventional wisdom. You may believe – like I do – that the greatest short-term risk facing the US is currently deflation as a slack in goods and labor markets implies seriously strong deflationary forces. But Chris correctly points out that large and monetized fiscal deficits eventually may cause in the medium term a rise in expected and actual inflation as they did after the Civil War and WWII. Indeed the temptation to use a moderate and unexpected inflation tax to wipe out the real value of public debt and avoid the debt deflation of the private sector is powerful and history may repeat itself even if the short-term maturity of US liabilities, the risk of a crash of the US dollar and an associated runaway rising inflation, and the related risk that US foreign creditors may pull the plug on the financing of the US twin deficit, may constrain these inflationary biases.

Similarly, Chris stresses the role of poor fiscal and monetary policies and botched regulatory policies in triggering recent and past financial crises. But financial crises existed well before there was a central bank causing moral hazard distortions through its lender of last resort role, before misguided regulation and supervision of banks and well before there was a significant role of federal fiscal policy in the US. Indeed, my recently published book, Crisis Economics, shows that financial crises and economic crises driven by irrational exuberance of the financial system and the private sector – unrelated to public policies – existed for centuries before fiscal deviant sovereign and central banks distorted private sector incentives. Markets do fail and they fail regularly in irrationally exuberant market economies; that is the source of the role of central banks and governments in preventing self-fulfilling and destructive bank runs and collapses of economic activity via Keynesian fiscal stimulus in response to collapse in private demand. The fact that these monetary policies and fiscal policies may eventually become misguided – creating moral hazard and creating large fiscal deficits and debt – does not deny the fact that private market failures, independent of misguided policies, triggered asset and credit bubbles, which triggered a public rescue response. Market solutions to market failures don’t work because in periods of panic and irrational depression markets fail given collective action problems in private sector decisions. Still, there is a long standing debate on whether bubbles and the ensuing crises are due to poor government policies (the traditional conservative and Austrian view) or due to market failure requiring policy reaction (the liberal and Keynesian view). Chris takes the Austrian view, but the Great Depression experience shows that too much Schumpeterian “creative destruction” leads to uncreative destructive depression. On the other hand, the Japanese experience of the 1990s also suggests that keeping alive zombie banks and companies can lead to persistent near depression.

The most fascinating parts of this great book are about the historical similarities in US financial history: cycles of asset and credit booms and bubbles followed by crashes and busts; the fiscal recklessness of US states that leads to state and local government defaults; the temptation to socialize those state and local government losses as well as the losses of the private sector (households and banks) via federal government bailouts; the recurrent history of high inflation as the solution to high public deficit and debt problems and private debt problems both after wars (Civil War, WWI, Vietnam and possibly now following budget busting wars in Iraq and Afghanistan) and in the aftermath of asset and credit bubbles gone bust; the historical resistance of US state, local and federal governments to raise enough taxes to finance an increasing public demand for public services and entitlements that cause these large fiscal deficits, and the schizophrenia of an American public that hates high taxes but also wants public and social services; the trouble being that you cannot have simultaneously public spending like in the social welfare states of Europe and  low tax rates as under Reagan. Europeans, at least, are willing to bear high taxes for the public services that they demand instead of living in the delusional bubble that both the government and the household sectors can live beyond their means piling more private and public debt.

The recurrence of financial crises – especially in the last 30 years (three big bubbles gone painfully bust since the 1980s) after a lengthy 50 year period of relative financial calm following the reforms of the Great Depression – leads to the question of why these crises keep on occurring despite attempts after each crisis to better regulate and supervise the financial system. Here I would like to develop a point that is only half fleshed out in Chris’ analysis of US households and governments living beyond their means and piling public debt on top of private debts; it is the role of rising income and wealth inequality in these financial crises.

Indeed, in the last 30 years there has been a large increase in income and wealth inequality in advanced economies. This rise is due to many factors: winner take all effects of an information society; trade integration of China, India and other EMs in the global economy; knowledge and skill-biased technological innovation; a rise in finance and increased rent-seeking and oligopoly in financial markets.

This increase in inequality led to a “keeping up with the Jones’s effect”: households in the US and Europe could not maintain their living standards, spending and lifestyle goals as wages and labor incomes rose less than productivity with a rising share of income going to capital and to the wealthy.

This rising inequality is the root cause of the American household tendency to spend beyond its means that Chris correctly bemoans in his book. Indeed, this inequality led to alternative policy responses in the Anglo-Saxon countries versus the social welfare countries of continental Europe. In the former group (US, UK, Ireland, Spain, Iceland, Australia, New Zealand) the response was one of democratization of credit that allowed households to borrow and spend beyond their means: the boom in mortgage and consumer credit (credit cards, auto loans, student loans, payday loans, subprime loans, etc) then led to a massive increase in private household debt matched by rising leverage of the financial sector (banks and shadow banks). This financial system leverage was abetted by reckless financial deregulation (the repeal of Glass-Steagall, non-regulation of derivatives, explosion of toxic financial innovation, rise of a subprime financial system, explosion of the shadow banking system). Since households and the country were spending more than its income, all of these “anglo-saxon” countries were running large current account deficits financed by over-saving countries (China, emerging markets as well as Germany and Japan)  So you had an explosion of private debt and foreign debt that eventually became unsustainable and led to the financial crisis of 2007-2009.

The response in Europe, instead, was more social welfare state: government spent more than their revenues and increased budget deficits and public debts to provide households with “semi-free” public services (education, health care, social pensions, extended unemployment benefits and other massive transfer payments) as the slow growing incomes did not allow private spending to grow fast enough. This increased public debt was absorbed by households (that maintained positive savings rates as the government was dis-saving massively), banks and other financial institutions. So the financial system piled on public sector assets (government debt) rather than claims on the private sector (as in the Anglo Saxon countries).

So in one set of countries you had initially a rise in private debts and leverage while in the other group a rise in public debt and leverage.  However, when private liabilities became unsustainable in the Anglo-Saxon countries leading to an economic and financial crisis you eventually had a massive re-leveraging of the public sector for three reasons: automatic stabilizers; counter-cyclical Keynesian fiscal stimulus to prevent the Great Recession from turning into another Great Depression; and socialization of the private losses. This third factor put many of the debts of the private sector (especially banks/financial system but also households and non-financial corporates) on the balance sheet of governments as fiscal costs of bailing out the financial system became very high. So at the end of this cycle the Anglo-Saxon countries also ended up with large budget deficits and stocks of public debt as the democratization of credit and massive releveraging of the private sector (households and banks) became unsustainable.

Therefore, we now have problems of combinations of large stocks of private debts and public debts in most advanced economies: household debts, banks and financial system debts, government debts and foreign debts. That is why crises will continue and we will have an era of Economic and Financial Instability: households will default when their debts are unsustainable; governments will default when their debts are unsustainable; and banks and shadow banks will be insolvent because they are full of bad assets; claims on the private sector in Anglo-Saxon economies; claims on the public sector in the social welfare state economies.

Thus, the problems of Greece and the eurozone are only the tip of an iceberg of large private and public debts and leverage in most advanced economies.  This implies a “new normal” of – at best – slow growth in advanced economies for the next few years as households, financial systems and governments need to deleverage by spending less, saving more and reducing their debts. At worst, if these deficit and debt problems are allowed to fester we will get households defaulting en masse, governments going bankrupt, banks and financial institutions going bankrupt as their public and private assets go sour and countries going bankrupt with more economic and financial instability.  So the coming financial instability and economic crises and twin risks of deflation followed by inflation will be driven not only by the unwillingness to rein in – via proper regulation and supervision – a financial system run amok. They will also be driven by the deeper economic and social forces that have led to income and wealth inequality and a massive rise in private and public debts given the stresses of rising inequality and globalization of trade and finance.

So we can, unfortunately, say goodbye to the Great Moderation and hello to the Era of Financial Instability/Crises and Economic Insecurity. Chris’ book provides us with a fascinating and deep financial history and road map of how we have gone through repeated cycles of great moderations followed by asset and credit bubbles leading to financial crises driven by excessive debt and leverage of the private sector (households, banks, corporate firms) leading to excessive public sector debt accumulation – via socialization of private losses – that leads to twin risks of outright default (usually by US states) or use of the inflation tax through monetization of fiscal deficits (at the federal level).

The philosopher Santayana once said: “Those who cannot learn from history are doomed to repeat it.” This deep study of US financial history may help policy makers avoid repeating the mistakes of the past, even if – in thoughtful Marxist spirit – one could argue that powerful economic, financial and thus political forces drive these repeated cycles of boom and bust that the study of history alone cannot prevent.

Nouriel Roubini is Professor of Economics at the Stern School of Business at New York University and Chairman of Roubini Global Economics (

All rights reserved, Roubini GlobalEconomics, LLC

8 Responses to “Nouriel Roubini’s Introduction to Christopher Whalen’s Book, ‘Inflated: How Money and Debt Built the American Dream’ Published by Wiley, 2010”

yozzNovember 25th, 2010 at 10:47 am

The basic problem is living within your means. The ability to do so is based on learning at a young age to ignore what the Jonses are doing and realizing that your main goal is to sleep well at night.This means being realistic, thinking critically in examining your own financial situation and making decisions or taking risks that are well thought out.Unfortunately, greed fed by ego is fueled by the media who has something to sell that you usually don’t need and most people fall into this trap. It’s a micro-economic issue that becomes a macro-economic issue.On one side you have vendors who promise that their product/service will make your life better, perhaps they will. Put this on a massive scale, in today’s high tech world, where the media plays on your motions, cancelling any rational thought, and your eventually get into massive borrowing to finance the products/services pushed by the Madison avenue experts, who play your mind like a fiddle.Greed is no more than heroin to feed the ego making one feel not important as much as making one not feel unimportant.yozz

economicminorNovember 27th, 2010 at 12:31 am

Nouriel,You are well educated and very intelligent yet what you are finally discovering has been common knowledge by myself and many of your earlier bloggers for many years. Whalen is a good observer as are Steve Keen, David Wallace, Matt Taibbi, Karl Denninger, and many more.What is not sustainable will fail. When a system is built upon debt used to promote consumption rather than productive endeavor, when wars are paid for with more debt and the true costs are hidden, when the general population is enticed to play the debt game in order to get ahead and for many to just pay their bills, when the wealthiest are given tax breaks instead of paying their fair share of the burden of all the above, when pensions are either not funded or they invest in bubbles to maintain their desired or commanded payouts. When all this goes on at the same time, the outcome will be default. When the cost of servicing removes so much value from a system that the only way to continue is to borrow more, this can not continue forever. When the unsustainable can no longer be maintained because debts have to be serviced or repudiated.The US reached the point in mid 2007 when it became glaringly clear that this game was over. The personal defaults started accelerating. All the additional borrowing used to bail out the TBTF banking cartel can/will do nothing to solve the underlying causes. All QE2 will do, if anything, is to cause commodities, gold, silver and oil to be purchased with more and more dollar$. All this can possibly do is postpone the inevitable and make the end worse.Many of our own soothsayers such as Fisher and Minsky all wrote about the cycles of human emotion and how they affect the financial and business world. Yet those in the board rooms, the FED and government failed to listen.As yozz above writes and as you concluded in your above piece, history unlearned will be repeated. The great works of religion world wide have been dealing with these issues for the history of man. Greed, hubris, hording, the quest for power over our own circumstances and others are all human traits. Mankind has the uncanny ability to deceive ourselves into believing that trends never end and that the species of man is capable of changing its basic moral character. Everyone that does not learn from the past and/or failures are destined to repeat their transgressions. Yet history shows us that so far we have failed to do anything else.The US is to confident and to arrogant to make the necessary changes. Those in the powerful positions are more worried about saving their own positions and pride than admitting mistakes much less failures. There has been no learning from their lessons/failures and changing. Just look at Bernanke and Congress for clues and clues from the 1930 or even more recently the Japanese experience to see how things just never change. The TWO party system is so divided and ridiculous that it would be a miracle for the RED and Blue to come together with the White and decided to break up the TBTF, institute real campaign finance reform and pull back from their wars on everything from sanity to drugs to terror and use their intelligence/connections for the good of the people.We are living through one of the great transitions of the world. There have been many from the Egyptians to the Etruscans and the Greeks, the Romans, the French, the British Empire, Spain and now the United States of America. There were some others thrown in between like Charlemagne and Hannibal, Genghis Kahn I’m not writing about their successes but the end of their times. The transition to something else.Housing will continue to decline as will state revenues for a long time unless there is an event to cause a tsunami or black swan. At some point the deflation in assets will overwhelm the system. The rise in commodity prices will continue for a while causing strapped consumers to pull back further. Thus driving house prices even lower. Unemployment will continue to increase, pension funds will eventually have to reduce outlays. Something will happen with health care. The continued 20% per annum increases in cost are way out of bounds of sustainability. These will continue to drive housing lower. At some point the stock market dives as profits are squeezed from both lack of demand and high input costs. The combination will deplete demand further until prices finally fall below production levels and the system resets and starts all over. Only at a much lower real GDP with little or no remaining debt. It is all going to get flushed. It could take a decade or a year but when something can’t continue, it just stops.This is most likely going to be really ugly and world wide. It could even affect the power transmission and fuel systems. It could easily affect the food distribution systems and even basic material production.There is always hope that all this can be averted but not by those who never saw it coming nor those who refuse to admit it is here.Those of us who have been writing and talking about these events for years have been right on many of the consequences. I can’t say we have been so right on the timing but chaos is really hard to time. We have been much more correct than the main steam economists or the main stream media. And you Nouriel have been late to recognize the dire circumstances but I have to praise you for your ability to see thru the fog. You certainly get it more than 99% of your peers. Keep going as the only hope to avoid the next iceberg is to alert the Captain and the officers and hope they can turn and slow this great ship of state enough to at least ameliorate the coming disaster.

GuestNovember 27th, 2010 at 7:38 am

Excellent post Economicminor, the best I’ve seen in a long time, devoid of political partisan nonsense.You say essentially the fidler has to be paid but we are in denial of reality, or rather most of the country, Euro, and USA, are not aware of reality, but they have an inkling perhaps that things are not in balance.Each time there was a bubble from my observation, those in power sort of pulled a rabbit out of the hat to focus on. Dot coms broke, voila, interest rates were brought down, fueling housing bubble, rabbit one, and making the stock market more desirable than CD’s/T bills, etc, for the average schmeckle.Now that we are out of bubble bath mix, the body is laying dead, but the, if you will excuse the expression, erection, is being held up by a rabbit called viagra, fueled again by low interest rates giving nowhere to go but stock.With the rise of China, how can we possibly in the near future create any sort of meaningful jobs for our college grads? So spending more does nothing. Denial of the chinese does nothing.When we stop denying, we start looking at reality and accepting what has happened and what will happen, tighten ourselves up for a transition brought about by many factors, especially technology and communication, we will realize that America is no longer the greatest thing since nylon stockings, then perhaps we can re-tool ourselves to deal with whatever comes our way, otherwise history will take good care of us.yozz

economicminorNovember 27th, 2010 at 5:48 pm

giving nowhere to go but stock.

and commodity speculation plus investments in China and other developing countries. Anywhere but here (or Europe) is the correct choice for the time being.I wouldn’t blame China per se, as they are just part of the imbalanced world. International corporations that have no ties to a country or its people are more of a problem than China or Brazil or India. Especially when there is no real enforcement of their actions. They go where the most profits can be made. Sure many of them have American names but they care nothing for America any longer. Only for their bottom lines and the executive bonuses.And I agree that we need to get our heads out of the sand. The Ostrich Society is no longer apropos. It was once easy to not pay attention but the world has turned and now we find ourselves on a different side. Many of our politicians are the Marie Antoinettes and the rest of Congress and much of America belong to the Ostrich Society. To bad and so sad!To bad Obama has a vagina instead of balls. Maybe he just needs injections of testosterone?

GuestNovember 28th, 2010 at 7:29 am

The question is, what can Obama or anyone else do?The chinese are doing exactly what we do, scour the world for resources, labor and at the best price, they learned from us.I think the only thing that we can do is take some pain for a while, while we raise taxes, ouch, and cut expenditures to get rid of a debt that can actually destroy us in the long run. Yes unemployment will go up, yes we may have deflation, the market will suffer, but until the denial stops and things even out, such as China actually pricing itself out of the game, then we can get back to normal.There will be a new normal, since as technology advances, our idea of conventional work, such as the 8 hour day, may actually decrease to extend employment to all. Anything is possible, but the world is a changing fast.The game now I believe is “defensive”, such as not getting ourselves mired in quicksand of excessive debt.Obama has to tread lightly, this is not war, but the emergence of an economic giant that is breaking out of it’s shell, we simply brace ourselves and adapt.yozz

economicminorNovember 28th, 2010 at 9:32 am

I think if you look at the total debt realistically, you’d come to the conclusion that it would be impossible to pay off. Raising taxes means less consumption and a lower standard of living for most Americans. This in the end means less tax revenue for both the states and the federal government. Cutting spending means the same thing. More unemployment and a spiraling downward of our economy.The cost of servicing all this debt is like trying to run a triathlon with an iron ball and chain attached to your ankles. It is bad in the marathon but deadly in the water when trying to swim. The more debt, the bigger the ball. It has gotten so big that the US and most of Europe can’t even walk anymore, much less compete.Which means that if it is inevitable, then do just do it and get it over with so we can reset and start over. Except do it with intelligence and a plan rather than let chaos do it with the resulting unknown outcomes.I can see few answers at this point other than wiping out the debts and starting over. No matter how painful this is.. I believe it is going to happen, either through planning (not likely) or through the death of the once great athlete.I just can’t come up with a scenario where technology solves the debt problem.As for China being an economic giant, maybe but at this point they are more like the parasite feeding upon the host of the more advanced countries. They do not have internal demand and that is structural and psychological. They do not have the contract law, the space, the physical security that has been enjoyed in the US. Europe never was the consumer that the US was because of space. You need secure space to store all your consumer garbage that the US consumed from BBQs to pleasure boats to RV’s and big screen TVs. We were unique in the world of a thriving middle class with lots of space. I know of nowhere else in the world like here.What could Obama do? Grow some balls for one and get rid of the TBTFs including AIG and go back to work and resolve the lack of anti trust issues with the health care industry for starters. He could quit funding the stupid waste of loans on housing when there is so much inventory and he could accelerate the probes by the Justice Department into all the massive fraud that put the US in the position of potential collapse. He could bring our troops home from all over the world and use them and that money to advance our railroads and efficient electrical distribution systems. Just for starters…

TomGreyDecember 7th, 2010 at 2:17 am

I’d like to say that 110% of the problem is excessive government spending — voters wanting benefits for “free”, meaning “for gov’t to take Other People’s Money”.This voter addiction to spending OPM must stop.There is no agreement on what a “fair share” of taxes, to pay for middle class (world upper class) benefits is.There were also some millions of housebuying speculators who contractually agreed to buy houses too expensive for themselves, primarily with the idea of selling in a few years for a big profit. These non-rich speculators had been fueling the bubble, and were wiped out by the pop.But gov’t bailouts to save the “financial system” meant higher gov’t debt to pay for the mistakes of the rich. This welfare for the irresponsible rich was, and is, terrible.

German ArreolaJune 10th, 2011 at 8:25 pm

I’d be inclined to check with you one this subject. Which is not something I typically do! I really like reading a post that will make people think. Also, thanks for allowing me to speak my mind!