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Imagine, if you will, that our economy is not 300,000,000+ people, but just 300 people… where you pretty much know everybody, and everybody knows you. This exercise converts the huge, imprecise, impersonal, economy into a local, specific, personal economy with all the macro and microeconomic functions still in tact, just on a smaller scale. Reducing the scale of our community makes the impact of events more personal and more immediate. It reduces the logical distance between micro and macro economics, between government and the citizens, between businesses and customers. If unemployment is at 12%, you know the 36 people who are out of work, and if some group of people decide to start or expand a business and hire six people, you can literally see the effect of a reduction of the unemployment rate from 12% to 10%. If taxes go up, you can more readily see both the impact of the loss of spendable income in families in the community and you can see the impact of fiscal and monetary policy on the people of Microville. Additionally, economic phenomena like inflation, money supply and velocity of money are more apparent.

MicrovilleUSA has all the businesses, organizations, government, schools, concerned citizens and aspiring people of a larger nation. It has a financial system with currency and banks, and a government entity (but rather than having many layers of government: City, County, State, Federal; we only have the local MicrovilleUSA government).

To simplify the model even further, initially MicrovilleUSA will be a closed economy/society. If you want to sell stock in a new business, then the stock must be sold to the other 299 residents of MicrovilleUSA. If you want to build a new road, the resources needed to build it will have to come from the people of MicrovilleUSA and the benefit will go to the people of MicrovilleUSA.

Eventually, MicrovilleUSA will become one community in a global economy, MicroWorld, where there are imports/exports, different currencies, conflicting policies, immigration issues… but for today we have just one community, one currency, one government, 300 people (bakers, bankers, burglers, bishops, bee-keepers, baseball players, busybodies and bums) that all live together and form one community…

…Welcome to MicrovilleUSA.

Copyright 2011 – John H. Lundin, PhD

All rights reserved

…as for the President’s suggestions last evening… I listened carefully and found nothing that will (in my humble opinion) be effective. This criticism is not just with the President’s proposals, it is with *everybody’s* proposals

  • he kept talking about how different government actions would put money back into the peoples pockets (except for the Warren Buffetts of the world)…. and that is not really the problem. Having the money *in* their pockets does not solve the economies problems… it needs to be *spent*, and spent quickly
  • in the economic universe there are a few “laws”… one is the “quantity theory of money” which reads:  M * V = P * Q
    • …or the supply of Money (actual dollars and demand deposits…) times the quickness that the money changes hands (Velocity) [this is the demand side of the monetary equation: let’s say that the money supply is $1,000 and everybody spends their share of it roughly every three days for a velocity of 100 times per year… you now have the purchasing power of $100,000]
    • = the Price of goods and services times the Quantity of  goods and services [this is the supply of dollar denominated stuff available to buy… let’s say we have 50 houses at $2,000 each which equals the $100,000 worth of goods in our little economy… everything is in equilibrium]
    • now comes the crisis and everybody (even rich people and working families) get spooked in a bad or uncertain economy… they postpone buying anything discretionary and those who are in fear of their jobs stop all spending and just hold onto their money… The ‘V’ in the equation drops from 100 to, say, 35… NOW we only have 35 * $1,000 or $35,000 chasing those $100,000 worth of houses, so the price of the same number of houses falls fast and far (that is where we are today… too many houses being chased by too few dollars)… the new equilibrium is $35,000/50 houses = $700/house down from the original $2,000 (ouch!)…

      Velocity of Money and Employment

      parallel graphs of velocity and employment

    • What the stimulus programs have done so far is add to the Money supply, have done *nothing* to improve the Velocity, little to the Price of housing, and nothing to the Quantity of houses (which nobody is building, so it is actually decreasing)… so now the supply of Money is $1250 times 35 = ?? * 45… so now the price of a house is $972… we are in a classic deflationary spiral (why buy a house today when it will be less expensive in 2 months?) [computers have been in this deflationary spiral because the power and features keep improving even if the price remains the same… like getting a bigger house for the same money if you just wait a few months]… *and* both the methods created by the stimulus are inherently “inflationary” [not bad if you can control it]… and they still don’t fix the problem
      • with lots more Money in the economy, if the Velocity comes back, then the economy quickly becomes overheated (too much money chasing the same amount of goods) and the problem with too much money is that you cannot take the money *out* of the economy nearly as easily as you put it *into* the economy [you have to sell bonds… only now there is a substantial inflation premium]
      • and all these “shovel ready infrastructure repair projects” do not increase the actual ‘output’ of the country so even though there are more people with more money, they are still chasing the same number of houses as before  (it is the same effect if you give everybody a 10% raise without any increase in output, now everything costs (surprisingly) 10% more… only here, with our government, that 10% ‘raise’ does not go to you, rather it extends unemployment or refinishes a bridge, so, surprise, if you have the same pay, your pay now buys 10% *less*…
    • two alternatives to really fix the economy:
      • you need to entice everybody with money in their pockets to spend it NOW, not later… in the retail business this is called a ‘sale’ and there needs to be real value associated with the ‘buy it now’ value proposition. Recently, I made one policy/economic suggestion where everybody could fully depreciate anything bought in 2011 and 2012 in the year that it was purchased (just like expensing your car or business building)… Here is the link to that suggestion
      • Something like this will increase the velocity, spend some of the money that is ‘sitting on the sidelines,’ reward successful businesses, hopefully get some additional people hired *and* add some output to the economy (more cars, houses…) so that when Velocity does increase, the economy will already have some additional Q in the economy to keep prices somewhat in check… something like   $1200 * 90 = ?? * 55 … now houses have risen back to $1963 each, prices are on the rise, Velocity is almost back to where it was (some of us think that it never will go back to where it was), the housing market is growing and stable…
  • …but nothing mentioned last night addresses velocity, and unless (perish the thought) we have an event like WWII, we will have the same lethargic non-recovery that the US had during the entire *decade* of the 1930s…
  • The only person in government that fully understands this is our Fed Chairman, and he does not seem to be saying much…
  • Net, net, I don’t like anybody’s proposals right now.
  • Can your mind wrap itself around the ‘quantity theory of money?’  This *will* be on the test!!

What did you think of all the proposals?  J

Give every business and individual the ability to depreciate every capital asset purchased 100% for the rest of calendar 2011 and 2012…

That is it…

Before you just blow me off as some crank, have a quick listen:

  • One of the big issues is getting the ‘velocity of money’ back up (or in the press: how to pry businesses’ and individuals’ tightly wrapped fingers from around the trillions of $$ in cash that they have sitting on their balance sheets). This tempts them to make purchases now especially if they have lots of profits they can write down.
  • This is not a give away… if you take all your depreciation on, let’s say, a car… then next year you *don’t* get to take the normal 20% you would normally take, because it is already fully depreciated… So, the IRS loses the revenue in 2011 but makes it back starting in 2012 for the appreciable life of the asset. Eventually, the IRS will become whole.
  • This will cause a surge in demand for assets which are, arguably, the best in breed. Will this surge be uniform across all products? No, why would you want it to be? It will reward those products that are meritorious in their segments.
  • This surge in demand will spark companies to increase supply… to rethink their projections and employ people to the point fleshing out their ‘slack’ (read: factories that have more capacity)… thus creating more goods. I really like this because our governments’ programs are working on projects that have little or no ‘output’ which is inherently inflationary (more dollars chasing the same amount of goods)… [Ask me why this is such a good idea]
  • Increases in supply will put our manufacturers into a better profit position enabling them to make more business expansion decisions (read: more productive jobs), be more aggressive on pricing, and be rewarded for creative and innovative products.
  • Increased demand will hopefully put upward pressure on pricing (including the housing market) especially if employment increases.
  • Increases in asset demand and supply will have a strong secondary effect on the services markets.
Sooooo, let’s look at the stakeholders for an example. Let’s pick one that is a major contributor to our economy: automotive (I know something about automotive):
  • Vehicle Manufacturers: They would be ecstatic. They are currently spending about $4,000 per vehicle in incentives to help move cars off of dealers’ lots. Volume would increase. Inventories would decrease.
  • Automotive Dealers: More customers… what is not to like?
  • Fleet purchasers: For companies that are profitable, it gives me the option of marking down their profits by the added depreciation.
  • Individual purchasers: pay less tax this year… but more next year and the year after… it may be something I want to do… or not.
  • Banks: should love the new auto loans that are coming from healthy buyers
I have been tossing this idea around for about 2-3 years, thinking that I would eventually discover some fatal flaw. Well, I have found none on my own [this is where you help me…]. The best pair of issues that I can think of are:
  • It rewards the better products and more profitable companies and people (in economic terms: it is asymmetrical). But I really like that. It will show the economy what works and reward products are the best and what job related skills are really needed. We live in a meritocracy and meritocracies reward those who perform… it also expands the parts of our economy that are successful. If we build a better car at Ford or Chevy then those will be the ones that capture the greatest benefit. If not. then people will buy Hondas of Toyotas …that are made here in the US by US labor. How bad is that?
  • It is hard to model and forecast the impact. How many additional cars will Ford and Chevy and Honda and Toyota schedule for production? Which particular models will be most popular? How will they get their suppliers on board with more, say, tires? How many taxpayers will take advantage of the increased depreciation option? How much less revenue will the IRS receive? I do not know of one economist that has a model to estimate the impact short of an uneducated guess. [you econometricians please let me know if you *do* have a model… won’t you?]
But neither of these reasons is sufficient to derail the concept of boosting demand in a soft economy by deferring taxes. The balance sheet of the US Treasury (read: the US taxpayer) changes $0 over the life of the asset, if somebody flips the asset, then they pay tax on 100% of the sale price… Where is the hole in this policy? Most of all, I like this because it is a Demand-Pull policy rather than a Supply-Push policy. Right now our economy is acting strangely like a string and is not doing well being pushed… We, the taxpayers and citizens of these United States, need a ‘real’ reason to release the trillions of $$ that have come out of our economy and push ‘velocity’ back to where it will support a healthier economy. MV=PQ to my economic buddies…. ©Copyright John H. Lundin, PhD, 2011 — All rights reserved

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