The Dirty Shirt Theory and the Keynesian Endpoint

June 14, 2010

From Ed Yardeni:

The bears are mostly, and rightly, concerned that many economies around the world are overly leveraged. They claim that both private and public debt burdens are so great now that they are depressing economic growth. This has the potential to cause a deleveraging death spiral for the global economy according to the most bearish of the bears. The bulls believe that the global economic recovery has plenty of forward momentum and is self-sustaining even if many governments are forced to implement austerity measures to placate the Bond Gods.

Speaking of the Bond Gods, I was surprised that the clever folks at Pimco weren’t mentioned in the Businessweek article on the leading stock market bears. They are the ones who coined the phrase “The New Normal,” describing an economic outlook of structurally weak economic growth and persistently high unemployment. They argued that the stock market rally over the past year was a “sugar high.” Last week, they rolled out the “Keynesian Endpoint.” The gist of this concept is that many governments have maxed out their credit lines. As a result, they can no longer borrow as much as they need to prop up their flagging debt-burdened economies. So their only remaining policy options are to devalue their currencies and to restructure their debt, i.e., default. Pimco apparently likes the dollar and U.S. Treasuries because the U.S. is the “least dirty shirt,” according to Pimco’s Bill Gross in a June 4 radio interview on Bloomberg Surveillance with Tom Keene.

Me: Of course, this was the obvious flaw with all the Return to Big Government talk. Such a return is fiscally unsustainable. Markets will prevail.

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