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Deflation Looms

You have to combine money supply with money velocity to get the picture. If velocity falls by half then the money supply must increase commensurately to just stay in the same place. So a 50% drop in velocity must be offset by a 100% increase in money supply.

In a weak economy increasing the money supply gets more difficult. An easy way to increase the money supply is to monetize our debt and run up the deficit, which is exactly what Bernanke has wanted to try ever since writing his Phd thesis. Get rid of the IRS and finance all of our budget by printing money. Under his theory the resulting devaluation of the dollar would be less costly than having an IRS. But the Chinese were quick to spot this agenda and they sent over a delegation to put a stop to us monetizing our debt as a way out of our mess, thus undermining the value of China's US Treasury holdings.

So Bernanke is in limbo with no clear path. Once all this seemed so clear to him. "As long as we have an airplane and a printing press we will never have deflation!" The clarity of his idealistic youth is giving way to the compromises of political power.

Honestly we may have no choice other than to monetize our debt.
The Chinese may make good on their recent threat and may become net sellers of our Treasuries. But that would be a bullet to their head too. Like it or not globalism has tied all our fates together and all our teats are in the same wringer.

The key here is to avoid harsh shocks to the system. Buying time is our only course forward. So if velocity falls of a cliff then the fed must expand the money supply by whatever means necessary, including monetizing our debt as a last resort.

Ultimately our country will have to start producing value for the global economy. Our union oriented labor laws are responsible for most of the mess we are in. If we don't have competitive labor then we cannot compete at all. Unions are too unwieldy, ornery, and slow to fuel a manufacturing economy with viable labor. The basis of our economy's value was always largely manufacturing and now that is gone thanks to our labor laws. So until we look ourselves in the mirror, we will skirt the issue and fool with time wasting half-solutions.

On Sep 13 07:10 AM Michael Clark wrote:

> Actually, you took the words out of my mouth. Give me a cup of Lounsbury
> and a slice of Mauldin and my morning's pretty much complete. (I
> don't believe the deflation will last for two years -- I think it
> will last another decade, and that Japan is a model for where we
> are going -- but I really appreciate the great scholarship of both
> Johns as rational evidence of why we are going where we are going.
>
>
> Thank you, John, for posting here.