The Second Great Depression has now begun

First, read this article as background.

if all sectors taken together aim to run a financial surplus, i.e. want to spend less than their expected income and use the difference to pay down debt - the economy will tend to operate below potential.

We can illustrate this point using some simple assumptions. First, we assume that the current account is fixed at a deficit of 3% of GDP. This is a big simplification, but it does capture the fact that at least some of the factors causing a retrenchment in the United States are also causing a retrenchment in other countries that experienced a credit bubble.

Second, we assume that the public is uncomfortable, or Congress believes that the public is uncomfortable, whenever the general government deficit is above 7% of GDP. While larger deficits are possible for short periods of time, Congress ultimately responds to them by cutting spending and/or raising taxes. The precise number is obviously arbitrary, but we do believe that there is a level of government deficits beyond which the political demands for retrenchment become difficult to resist.

These assumptions imply that the private sector cannot aim to run a financial surplus of more than 4% of GDP without sapping aggregate demand. This is a serious problem because our analysis a few weeks ago concluded that the private sector may target a financial surplus of significantly more than 4% of GDP for the next few years in order to reduce its debt burden at an acceptable pace.
--http://www.zerohedge.com/article/will-public-austerity-cause-private-sector-paralysis

What we have, ladies and gentlemen, is a Mexican standoff. There are three parties involved, and no one wants to back down. First, there is the private sector, which includes consumers and private companies, who for some reason insists on saving more than 4% of its income. (Saving in this context includes paying down or defaulting on debt). Second, there is China (and other foreign exporters to the US), who insists on exporting in excess of 3% of GDP in order to keep its own economy running. Third, there is the government, which refuses to run deficits in excess of 7% of GDP for any extended period of time.

We are going to remain in this paralyzed zombie-like state (which really is the essence of a Depression) indefinitely, until someone back down.

The solution here is Hayek. Cut taxes, or at least roll back the scheduled tax increase to give the consumer a break. Yes, this will increase the deficit, but it will break the standoff. Yes, it will increase the chance of a sovereign default, but that will hurt only the bankers, who need to take a haircut.

The blame, since we need to point figures at someone, fall squarely on Obama. If you are going to be a Keynes disciple, you have to follow him all the way through. You don't cut spending (e.g. massive cuts to Medicare) or raise taxes during the middle of a recession. A depression is guaranteed, and if it hasn't already begun, it will on January 1, 2011 when all the massive tax increases will kick in.