We Can't Even Afford An Economic Recovery

Commodity prices are down a lot, although they seem to have stabilized since December, but is that because of deflation? With interest rates near zero and the federal government running a deficit of over five hundred billion dollars, how could the US be going through deflation?

Clearly, the money supply is growing: the fed is still printing money, and the government is putting that money into circulation. 

It is certainly true, however, that the velocity of money has been falling for at least the last several years, and that could cause deflation. On the other hand, is that decline in the velocity of money the cause or the effect of a sluggish economy? Generally, economic slowdowns cause reduced velocity as people spend less.

Of course, the velocity of money also tends to drop as the money supply grows. It could be that keeping interest rates so low has caused the velocity to drop, in which case higher interest rates could cause inflation.

My fear, however, is that we have put ourselves in a bizarre situation where we cannot afford an economic recovery. With the fed having printed so much new money, the only thing preventing crippling inflation has been the slow velocity of money. If the economy were to really pick up, that velocity would increase, and we'd suddenly have all that money circulating quickly: hyperinflation.

All that being said, it seems obvious that what we need is either a significant reduction in federal spending to bring the budget into balance, or we need higher interest rates. You cannot have zero interest rates and five-hundred-billion dollar budget deficits without crippling the economy. Unfortunately, either policy would probably make the economy worse in the short run.

In the early eighties, Paul Volcker's decision to raise interest rates sky-high to break the back of inflation caused a major recession, the biggest recession between the Great Depression and the Great Recession of today. As a result, many people thought it would be impossible for Reagan to be reelected unless he dumped Volcker. Reagan stood by Volcker, however, and the recession passed, and Reagan was reelected. I wonder whether and of the Republicans running today have Reagan's fortitude.

Oh, by the way, the transcription of this interview was filled with typos. It really needed better editing.

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This comment was left by Oddstar7 at Real Clear Politics - Read more of Oddstar7's comments at https://disqus.com/by/oddstar7/

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