War and Peace

Obama’s surprise Nobel peace prize has caused a reality rift in the US; On the right, Peggy Noonan writes that the Nobel peace prize has always been “an award by liberals for liberals”. She can’t believe Reagan didn’t get one. Yeah, Reagan. The guy who called the Soviet Union “the evil empire” and pushed for the star wars program to militarize space. Bret Stephens wants to give one to Harry Truman. You know, the guy who killed 300,000 civilians by dropping the bomb on Hiroshima and Nagasaki. No serious historian puts forth the claim that this barbarous act was necessary to get Japan to surrender. On the left, Howard Zinn asks, how can you give a Nobel peace prize to a man who’s continued two disastrous wars?

Meanwhile, Australia’s central bank has reversed the course of slashing rates to raise their overnight loan rate by a quarter point. Glenn Stevens, Australia’s chief central banker, warns of the danger of being ‘too timid’ in raising rates. Australia, it seems, wants to avoid the pitfall of being the world’s carry trade sop. Could that award be coming the US? If so, the strategy of borrowing in dollars, then dumping them to buy stocks or bonds in other currencies will weigh on the dollar’s value. The dollar hit a 14-month low recently.

US Fed chief Bernanke and Treasury Secretary Geithner talk of wanting to maintain a ‘strong dollar’ but actions speak louder than words. It seems more plausible that what is wanted is a steadily weakening dollar, which will make the government’s large and escalating debt easier to pay.

The average worker is likely to see continued pain from such a strategy, as wages continue to fall. Colorado has decreased its minimum wage, as their standard is tied to the CPI, and deflation slightly reduced the CPI last year, mostly due to falling oil prices. However, the weaker dollar places pressure on import prices, such as the prices of goods at Wal-mart and other low-cost retailers relied upon by the lowest-paid workers in the US. During a recession, prices and wages tend to fall, but not necessarily by the same amount. However, certain prices are rising again. Oil is now at $75, and gold is over $1060. We could easily see the worst of both worlds, stagnating economy combined with inflation.

The Fed has injected trillions of dollars of money into the economy, in a bid to prevent deflation. But all that money has to go somewhere; so far it seems to have gone into the stock market, and commodities like copper, oil, and gold. It’s hard to believe that the Fed could reverse course anytime soon and start raising rates like Australia. Imagine what a rate increase would do to the still-weak economy. Without one, the dollar will continue to slide.

Maybe the Nobel peace prize should be given to the economy. As the dollar loses value, the US will find it difficult to finance the imperial adventures in Iraq and Afghanistan; at least, that is my hope, though it hasn’t happened yet.

Price Levels

Everyone’s attention seems to be focused on whether we’ll see deflation or inflation in the US economy (and in the global economy) as we move forward.

On the deflation side, we have the moribund housing market, falling or stagnant consumer spending, along with falling incomes and rising unemployment, and on the inflation side we have truly massive money creation led by the Fed, followed by the Treasury, and finally by the Federal government in the form of federal stimulus packages, all on borrowed money.

Which of these two forces will prove to be more powerful?

I live in San Francisco, one of the more expensive urban centers in the country. In my neighborhood, I see flyers posted that say “One Hour Massage, $40”. It caught my attention because I think that price is half to a third the price you would have paid two years ago. Basic economics: if goods and services won’t sell at a given price, then the price will fall.

The bond market may provide us with a clue, as bond investors are highly concerned about inflation. The yield on the bellwether 10-yr US Treasury bond has been dropping rapidly. Since mid August, the yield has fallen from 3.8% to close below 3.2%. This may mean that bond investors are taking a stand on deflation, but it may also mean that investors see the rally in the stock market ending soon, and they’re getting back into Treasuries for a safe haven. The surge in gold prices to close above $1,000 for six days seems to lend support to the safe haven thesis, but it also could support the inflation thesis.

Oil and copper are also important signals to the strength of the global economy. Both seem indecisive after strong gains this year. The same can be said for the CRB commodities index, which is up 25% from its low this year, recorded back in March.

Given all this indecision, we may see a bifurcation, with certain commodities and services rising while others fall. We await, with bated breath, the next round of economic developments. The latest labor market data indicate that the US economy shed 263,000 jobs last month, for a total of about 7.2 million jobs lost so far during this recession. That is a truly stunning number, made all the more serious when one considers that the economy must create 150,000 jobs or so each month in order to simply keep pace with population growth.

Is Inflation Coming Soon?

Most economists will tell you that there’s a tradeoff between inflation and unemployment (called the Phillips Curve), making it unlikely that a high unemployment economy generates unemployment. Well, expect to see the unlikely happen soon.

Here’s a chart of monthly inflation, as measured by the Consumer Price Index, since 2007:

The Federal Reserve is waging war against deflation, funnelling trillions of new dollars into the financial system in an attempt to defeat deflation.

The Fed will win; in fact, they’re already winning. Inflation has simply been channeled into the stock market. Oil has doubled in price. Gold has recovered from its low of the fall of 2008, when it dipped below $700, and is currently pushing $950. These are early signs of inflation.

An interesting feature of the CPI is that it’s not designed to measure changes in the cost of living. It’s designed to provide a measure of how much money it takes to maintain a constant level of satisfaction. That means the Bureau of Labor Statistics must do a very difficult thing: instead of merely measuring prices, they must measure our satisfaction. They do this by imputing value to technological changes, and by using sophisticated averaging techniques which attempt to measure how consumers make substitutions between products in response to price changes. The outcome of this fancy guessing-game is the most widely-quoted measure of inflation in the US, but CPI has little to do with what most think the CPI measures.

My guess is that we’re already seeing the kind of inflation that the Fed so fears: consumer price inflation. Prices ought to fall during a recession, and some have. But I think prices have not fallen as much as they should, given the extreme weakness in consumer demand. If the effect of money creation is the prevention of falling prices, that’s inflation, it just doesn’t look like it when we look at the CPI.

It’s clear that the Federal government would prefer inflation to deflation. With the ten-year deficit now officially projected to add $9 tril to the public debt (which would bring it above $20 tril), some inflation sure makes the interest easier to pay in depreciated dollars. I wonder if the American consumer will go along for this ride. Sure, inflation will probably kill your real wages, but it can also zap the value of your debts. Perhaps the average American won’t complain too much if inflation begins to roar. Much depends of what happens to the unemployment numbers as we move forward.

Economic Medicine and Poison, part 1

The most helpful thing we could possibly do for the economic corpus is to create a sound currency that is linked to a stable banking system.

Right now we have neither, and so we have risks to the economy that are simply unknown. A risk that you don't know is always worse than one you can understand. Will your bank be around tomorrow? This is no longer an idle question.

Creating a stable currency would not be hard. It's a simple matter of pricing, and there is nothing that markets do better than pricing, when they are allowed to function without interference. Take an item of real value, one that cannot be produced by the printing press. Let's say, I don't know, how about the gold standard of money?

Gold has been used as money for 5000 years or more. Let's say we go back to using gold as money. You want to sell something. OK, how many grams of gold would you accept to part with it? You want to buy something. How many grams would you give up to obtain it?

The thing is, we're used to using dollars as our standard. We think, "how many dollars is that worth?", not "how many grams?" Like visitors in another country, we'll be running the numbers through our heads, converting to dollars. At least for a while. Pretty soon we'll get the hang of it.

If we get rid of the risky fractional reserve system (perhaps following this great plan by Kotlikoff and Leamer), then we have the absolute best basis for economic prosperity. Systematic inflation becomes impossible. And deflation has no power to wreak economic havoc. Deflation becomes your friend, because deflation is simply falling prices. We only associate deflation with the end of the world because deflation has typically occurred only at the end of a credit bubble, as the harbinger of deep recession, bringing with it financial panic and high unemployment.

The problem is how the stable currency would interact with the dollar. The dollar decays like a radioactive isotope. A stable currency operating in parallel with the dollar would instantly reveal what a poor currency the dollar really is. Fewer assets would be held in dollars, and fewer transactions would be made in dollars. Both would cause a reduction in the demand for dollars, and a depreciation in the value of the dollar. Perhaps that would be viewed as an "attack" on the dollar. It's not an attack to remove lipstick from a pig. (My apologies to Mrs. Palin.)

The dollar is worth about what the paper it's printed on is worth, and to put it next to a commodity with real value simply reveals that truth.

What Will It Take to Pay Off the Federal Debt of the US?

The US is awash in debt on every level: Federal, state, local, as well as households and businesses. But for the private part of the economy, there is a different consequence for bankruptcy than for the public side. If a private individual or business goes under and fails to pay their bills, the creditors lose money, of course. But when a government goes under, it tends to go under in a way that inevitably affects everyone, for it devalues the currency.

Of course no government destroys its own currency with malice aforethought, but the pressures that come to bear on governments are such that destroying the currency seems at the time to be the right thing to do, given other options. Circumstances are already headed in that direction now, and pressure on the dollar continues to build in the face of rapidly expanding Federal debt.

The current Federal debt is $11,659 bil, and with the stimulus and other unfunded expansions in Federal spending, it’s widely believed to expand by at least another $1,800 bil in the next year alone, and to nearly double in ten years. It’s an open question as to how the Federal government expects to get the funding for that level of debt, as our foreign creditors are already reducing their purchases and seeking to ‘diversify’ their assets. China is inking trade agreements with Brazil and Argentina to conduct trade in the Renmimbi rather than in dollars. China is also channeling more of its massive currency hoard into durable commodities like copper, gold, and oil. Every day it seems, the discussion of the status of the dollar becomes a bit more open, a bit more honest, as countries seem to feel increasingly free to point out that the dollar’s days as the reserve currency of the world are numbered. Dollar-denominated Treasury debt is like a game of musical chairs: in the end, not everyone will get a seat.

In the past, the US has relied on economic growth to reduce its debt. Is that possible now? Total Federal government revenue was $2,554 bil in 2008. Let’s say that average rates of US growth resume immediately (3% per year) and continue indefinitely. Say that Federal revenue increases at the same pace. Say we immediately run surpluses, so that we can pay the interest on the debt plus an additional 1% of Federal revenue to pay the principle. (In 2008, that combination would cost $451 bil in interest plus $25 bil in principle, instead of the $458 bil deficit that actually occurred). Even with these rosy assumptions, it would take about 90 years to pay back the debt. Ninety years of solid economic growth and perfectly balanced budgets (plus the 1% surplus). No government on earth has such a record. (This analysis doesn’t include all the unseen obligations the US government has, such as Social security and Medicare, which add up to trillions more).

It seems likely that at some point, the United States’ largest creditors will demand repayment in some other form than dollars. Perhaps they would demand payment in their own currency, but that seems unlikely. The traditional asset for international settlements is gold, so gold is the most likely candidate, especially given that our two largest creditors, China and Japan, have relatively low gold reserves, while the US has the largest gold hoard in the world.

Let’s consider what would happen if the debt would have to be paid off in gold. According to the US Treasury (www.fms.treas.gov), the US government is in possession of 261,498,899 Troy ounces (8,133 tonnes) of gold, which at a gold price of $964, is worth $252 bil. The US gold stock is unaudited, and since it is also routinely leased to other parties, how much of it is owned free and clear by the government is unclear. The way that gold is leased is through a kind of repurchase agreement called a gold swap, which gives the US Treasury cash in exchange for a firm commitment to buy back the gold at a specified point in the future. For example, Goldman Sachs may give the US Treasury $1 bil today, using the gold as collateral, to receive $1.05 bil in one year, whereupon the gold reverts to the Treasury’s possession, though the gold has never left the vault. While 5% isn’t a great return, I’d say that Goldman can use the contract as an asset, since it’s backed by gold and the full faith of the US Treasury, which allows Goldman to obtain a risk-free return on the $1 bil, and still put the money to work in other ways to obtain returns.

The Gold Anti-Trust Action Committee (GATA) has estimated that the total amount of gold that is leased through gold swaps is between 12,000 and 15,000 tonnes, about half the total of all gold held by central banks. Individual nations don’t publish the extent of their gold swaps, but let’s say that half of the US Treasury’s gold has been leased, meaning that the gold is no longer an asset, but rather an obligation. If the Treasury really owns just half the gold in its possession, then it has about 131 mil Troy ounces of gold, worth $126 bil.

Now let’s imagine that a few of the large holders of US Treasury debt were to demand that the debt be repaid in gold rather than in dollars. The US Treasury holds its gold at a book value of $42.222 per Troy ounce, rather far below market prices. (If only one could buy a few ounces at that price!) Say that China and Japan (which own $1,477 bil) demand repayment in gold. Of course, these countries wouldn’t be so unreasonable as to ask for all the money all at once; let’s say they simply stop buying new debt, and ask for the interest on the debt outstanding to be paid in gold. If any large buyers were to stop or even slow their buying, yields would rise. Let’s say the yield rises only to the historical mean of about 6.5% (an event like this would probably push the yield far higher). At that yield, the interest would come to $96 bil a year, which would quickly drain the US Treasury’s entire gold stock. In fact, it would be gone in less than 18 months. If China and Japan started asking for gold, other countries would no doubt follow, as would large domestic holders, both institutional and individual. If the entire interest bill had to be paid in gold, it would come to $63 bil per month, and the Treasury would be out of gold in two months.

Now if there are no new buyers for Treasury debt, either the Federal government must immediately balance the budget, which seems unlikely, to put it mildly. More likely the Fed will step in and buy the debt directly, with money it conjures out of thin air. This leads to further depreciation of the dollar against gold, and would probably lead to a lot more demands for payment in gold, as creditors realize that their dollars will get less gold than before.

So we can’t grow our way out, and we can’t fall back on gold. The only other possible avenue is to depreciate the dollar. But how much depreciation would it take to reach the equilibrium that markets demand? If the situation arises where gold is sought for repayment rather than dollars, the question is, at what price? The US government will have give up the accounting fiction that the gold is worth $42.22 an ounce, and set an exchange rate between the dollar and gold. The rate chosen will not be below the market price, it will be well above the market price. How high is anyone’s guess—I’ll say $10,000 an ounce just to get the guessing started. This option allows the US to service its debt without the humiliation of an outright default, though it will still probably result in chaos, just as it did when the US last tried it, in 1933. It also creates a de facto gold standard. With gold at $10,000, the Treasury’s gold is worth $1,310 bil, and can now be used to pay the interest on the debt!

Where things go next is hard to foresee. But it’s clear that the debt is far too large to pay off, and that the United States’ creditors will demand payment in an asset that the US government can’t depreciate at will. The signal to investors is pretty clear: get out of Treasury debt and into gold. One way or another, the US will repudiate its debt. The other lesson is equally clear: the inevitable depreciation of the dollar simply follows the logic of the market, and cannot be denied by either money creation or fiscal stimulus.

Deflation

The Bureau of Labor Statistics released the Consumer Price Index yesterday, which shows a very small monthly increase since April (0.1%), but the story that's grabbing the headlines is the 12-month drop in prices, or deflation, to the tune of negative 1.3%.

It's a bait and switch story. What number do we emphasize? The scary number, about the deflationary monster? Or perhaps the core inflation number, which excludes food and energy, and shows a 12-month increase of 1.8%? Only two categories in the CPI fell: transportation and energy. Both are tied to the fall in oil and gas prices. Every other category increased.

What does this tell us?

Expect inflation, not deflation to prevail in the coming months.

Ah, Krugman!

To sum up: A few months ago the U.S. economy was in danger of falling into depression. Aggressive monetary policy and deficit spending have, for the time being, averted that danger. And suddenly critics are demanding that we call the whole thing off, and revert to business as usual.

The above is a quote from the marvelous Paul Krugman. I love him; and yet, he's so wrong right now.

Let's be clear: aggressive monetary and fiscal policy have not averted any danger to the economy. The danger is not inflation, nor is it deflation. The danger is economic distortions. That is, massive investment in unproductive economic activity (retail, advertising, finance, etc.). This kind of economic activity does not produce anything, and hence it is the major threat to the economy.

Why are there economic distortions? Why should it be the case that the market, which often gets things right, ought to be disastrously wrong? What causes the distortions is the massive inflation of the money supply. That may lead to inflation or it may even lead to stable prices, even deflation for a time. It all depends on how the extra dollars are used. If they are saved, no inflation in consumer prices. If dollars are spent elsewhere in the world, no inflation (at least in the US). If those extra dollars are spent in the US, expect to see some inflation.

Rising or falling prices is not the danger. The danger is that there is a prolonged period of confusion: what are my assets worth? Is my business viable? Should I start this business? What is the market saying?

If the answers to these questions are unusually obscure for a long period of time, the result will be stagnation, low growth, and unemployment. This is the danger. And it's in full bloom now. More aggressive monetary and fiscal policy will worsen the situation, not make it better.

Arthur Laffer on Inflation

Arthur Laffer created the Laffer Curve, a rather dubious piece of economic theory that entered the economic canon without ever passing through the peer-review cycle.

He has a rather good piece on inflation and monetary expansion in the Opinion section of the Wall Street Journal.

His argument is that the monetary base has increased dramatically, and that this should result in inflation. Since I've been saying the same for some time, I like the argument.

The Rise of Oil and Gold Is An Early Sign of Inflation

(This filthy-looking pool of oil is from the Exxon Valdez oil spill)

The Federal Reserve must be happy now; they're doing their job: fighting deflation by creating money out of thin air.

The oil price is over $65 now, and gold is over $978. This is an early sign of inflation. We're in an odd situation economically; certain items are in deflationary mode. Deals are

everywhere on housing, furniture, cars, appliances, clothing, travel. These are items that consumers are cutting back on.

Since oil and gold are investment commodities, they are seeing appreciation now because of fears of inflation and the desire to protect assets. A good way to get exposure to the oil price easily is through the oil ETF USO. (This is good for long-term exposure; USO doesn't always track short-term movements in oil prices accurately, because it is the target of arbitrage)

What about the ethics of investing in oil? My dad won't touch it; he says it's a dirty business. Similar concerns have been raised about gold, which is produced by crushing tons of rock into a fine powder, then using acid to dissolve the metal, a process that uses copious amounts of energy.

Each person's ethics come from within. For me, I don't rule out profits from oil or gold, because it doesn't seem helpful to me to say I won't invest in something but I will use other products. I own a car, I own electronics, I have gold in my teeth. If I touch it as a consumer, I'll touch it as an investor, where at least there is an opportunity to make a profit. These things have to be decided on a case-by-case basis. Every corporation is guilty of something, as is every individual.

Reasons for Economic Optimism

I was inspired by Justin Fox's recent post in Time, 5 Reasons for Economic Optimism (he gives 4). Although I differ with him rather sharply on what exactly are the reasons to be optimistic, I agree with his premise: it's vital to look for the ways in which the current economic situation is or will be, for the greatest good. Before I give you my list of reasons, let's take a look at Mr. Fox's list.

1. The Stock Market Is No Longer Overpriced

My response: stocks are still heavily overvalued. The current bear market has taken stocks more than 50% below their peak, to a low of 6548. As of 4/21/09, the dividend yield for the Dow was 3.51%, while that of the S&P 500 was 2.61%. A bear market historically reaches its bottom when the dividend yield is 6 to 8%. The stock market is coming off a 27-year bull market, which took the Dow from 800 to over 14,000. (check out my earlier piece on this) A bull market of this magnitude is not corrected in a few months. As a matter of mass psychology, we'll be near a bottom when the overall consensus is that putting money into stocks is as wise a thing to do as setting fire to your money.

2. The Government Is On The Case

My response: Unfortunately, much of what the government is doing is interfering with the process of adjustment which is necessary to restructure the economy, clear out losses, bring an end to corporate strategies that were essentially unsound, and move the economy toward productive economic activity. Expect the government to engineer massive amounts of inflation, as Greg Mankiw and others believe would be helpful.

3. Consumers Are Adjusting to the New Economic Reality - And Fast

My response: Mr. Fox argues that the speed at which consumers are cutting spending is a good sign, for it will lead to a rebound in consumer spending that will help the economy. Interesting point, but I don't find it persuasive. What we need is more investment, not more consumption. To that end, saving is needed, for ultimately, there is a macroeconomic equality between savings and investment. Though we have been able to avoid that equality for some time because of financial out-flows (i.e. the financing of US current account deficits and budget deficits through foreign buying of financial assets), savings ultimately equals investment. So more saving is good in itself, not only as a sign that the carnage of lower consumption is almost over.

4. Reinvention and Change Are What the US Is All About

My response: It's hard to argue with this one. And Mr. Fox also correctly identifies that many economic activities of the boom years were unproductive: he singles out finance and real estate as two of the big culprits. Unfortunately, he believes this means that the US dollar will continue to be the world's reserve currency forever. Does he fail to see the many signs that the reign of the dollar is nearly over? The strength of the dollar since Fall 08 is only a temporary response to fears of financial armageddon.

* * * * *

OK, so here's my list.

1. Moving from an economy dominated by unproductive activity to one dominated by productive activity will be good for America. For too long, American innovation and entrepreneurship went into venues that were basically deceitful, put others at risk in order to generate profits, or were unsustainable. We've gotten to be masters of finance, real estate sales, and retail sales. It will good for our innovation to be re-channelled into activities based on sustainable growth.

2. As I mentioned above, consumer saving is a good sign. Living with a zero or negative savings rate is unstable and tends to lead to volatile investment. A high savings rate should ultimately lead to a high level of investment. The fact that consumers are spending less means they are facing reality. That's a good thing in itself.

3. The End of Bling focuses our attention less on conspicuous consumption and more on the things that really matter. That will differ for each one of us, but it seems likely that the recession will lead to a decreased level of materialism in society, and an increased understanding that consumption should be in the service of the purpose of our life, not the other way around. Once one's basic survival needs are met, the kinds of things that tend to make people happy in a lasting way are having deep relationships, being able to meet one's responsibilities, and making a meaningful contribution to the world. This crisis offers us the opportunity to re-evaluate our lives.

4. The environment will be a beneficiary of decreased consumption among the rich nations. America cannot continue to consume 25% of the world's resources.

5. The financial crisis will end the international hegemony of the US dollar, and encourage nations to consider sound, honest money, based on an item of real value. The natural choices are money based on gold, silver, copper, or other metals. There are other possibilities for backing money, including a basket of commodities. (These are less desirable to me, for reasons I'll describe in a future post) Moving away from a world monetary order based on fiat currencies will be good for the US and good for the world, because fiat currencies are essentially dishonest.

6. The crisis will end US military adventurism in the Middle East and elsewhere. The reason for this is that as the dollar loses its status as a reserve currency, we will not be able to afford to continue to occupy Iraq, Afghanistan, or any other country. We will have to dramatically cut all government spending, for deficit spending will no longer be an option. When we have to balance the budget, these foreign military adventures will simply become untenable. They were only possible based on the unrealistic idea that we wouldn't have to pay for them. Americans are not motivated enough to go to war in distant lands when they realize it will mean fewer schools, hospitals, roads, and smaller pensions.

So take heart America! This crisis will return us to our core values.

How Long Will the Stock Market Rally Last?

Here's where I go out on a limb. My feeling is that the rally will take the Dow to 8300 or so, before the market returns to its downward course. How long will that take?

On the one hand, the rally that began after the March 9th low has only been around 5 weeks, but already it has wrought a powerful change in sentiment. There is big money on the sidelines hoping to recoup some losses. Some have no doubt been tempted to get back in.

On the other hand, it feels as though the rally has already begun to cool. Yes, the last few days have shown gains, but it feels like the winds are changing. Perhaps we'll see the market move sideways for a while, as it did today, ending flat (+5.90 or 0.07%).

The recession is just beginning. How will the market respond to further bad news? Has the market discounted all the bad news? Has the market already looked ahead?

I don't think so. The conventional wisdom is that the recession will last the year. My own view is that we are in for a 5 to 10 year recession.

An interesting possibility is how the market may respond to the inflation that is coming soon, once the deflationary pressures have abated. Will stocks leap ahead, encouraging investors that the bear market is over, a rally that is stimulated by inflation, not real underlying growth? That is a distinct possibility.

Krugman vs. Austrian View of Booms and Busts

Robert Murphy has an interesting blog post on the Austrian economic explanation for booms and busts. Austrian economics is based on the writings of Carl Menger, Ludwig von Mises, Friedrich Hayek, and Murray Rothbard.

This post is a critique of a recent post by Paul Krugman, who seems to intentionally misunderstand the views of other schools of thought in economics. Is it so difficult to understand each perspective and give it a fair hearing before attempting to refute it?

It seems this crisis may offer an opportunity to test which of the predictions from these schools of thought end up being more accurate: the Keynesian view, as seen in Paul Krugman's writings, or the Austrian view. For example, Krugman writes:

Just a quick note on the new, pessimistic CBO budget projections:
1. These projections have no bearing on the case for a large stimulus now — none. Adding, say, another $600 billion to stimulus spending would, on net, add around $400 billion to debt a decade from now (net is less than gross because the stimulus expands GDP, which leads to higher revenues that partly offset the initial outlay.)

This is a testable hypothesis. We shall see if it is the case that spending another $600 bil actually results in an addition of (only) $400 bil in debt in a decade.

Just to be fair, let me throw in my own prediction: this crisis will be a severe test of the Keynesian faith in monetary and fiscal stimulus, for neither one is capable of solving the problem. All indications point to an inflationary recession and stagnation, much like the Japanese experience of the 1990s. Of course, Japan did not have the world's reserve currency. We do, and we're tempted to use that power to inflate away our massive debts. I predict we will do so, like Roosevelt did in 1933 when he essentially defaulted on US debt by suspending the gold standard and devaluing the dollar by 41%.

Rather than saying, along with Krugman, that debt doesn't matter, we ought to be recognizing that expanding the Federal debt burden to finance an economic stimulus is exactly the wrong direction. We ought to trim spending and cut taxes, and get out of the way of the inevitable economic adjustment to equilibrium.

"No reputable economic forecaster is predicting a depression"

Says Edward Leamer, Director of the UCLA Anderson Forecast, on Marketplace. He sees no depression in the near future:

We've frightened consumers to the point where they imagine there is a good prospect of a Great Depression. That certainly is not the prospect. No reputable forecaster is producing anything like a Great Depression. So it's still OK if you spend a little bit. You do not have to put all your money into a mattress.

Dr. Leamer also sees the economy in a "healing cycle" by the second half of 2009, without "significant growth", but with fewer of the "large negatives" we've seen so far.

We shall see. I do not think that the errors and excesses of the boom years will be corrected by then. My guess is that the inflationary recession will continue for a period of years rather than quarters, particularly since government policy seems driven to prevent markets from reaching equilibrium, and the Fed is producing monumental amounts of new money, much of it secretively, off its balance sheet. Estimates of Fed off-balance sheet money creation are in the trillions of dollars.

Here are a few analyses of the magnitude of these Fed activities: ritholtz.com/blog, nowandfutures.com (this site also has a reconstruction of M3, the broad monetary aggregate that was discontinued by the Fed in 2006.)