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…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

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