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Thursday, August 19, 2010

The Economy

Back in the 1970s, the economy was stagnant. The velocity of money slowed. From what I've read, the government had this big idea that inflation would cause people to spend their money, for fear of having it inflated away. I also heard that inflation was associated with economic boom times. So if you cause a lot of inflation, the economy should start growing again, no?

The result was that people had to invent a new word for the situation because apparently no one had intentionally tried such a dumb idea before.

There is a flaw in the human mind which insists that the future will look like the past, despite hundreds of years of evidence showing that to be false. Even worse is the view that the future will simply be an extension of the near past.

In the 1990s, the Fed was pouring money into the economy and observing very low inflation. The problem was that they were measuring it wrong. Stocks were inflating. When the stock market bubble burst, they continued to pump money into the economy and continued to allow the government to assume the risks while private investors reaped the profits from bundling up mortgages and selling them, backed implicitly by the US Government. This allowed massive amounts of money to be loaned out at low interest rates to people with bad credit. Housing prices went up, then the bubble burst. I remember people telling me years ago that housing prices never go down by much.

Ordinary people are getting three-point-something percent 15 year loans backed by real estate whose value is still not entirely clear. There's something going on. The cost of money is far, far too low right now and it's holding up the prices of things that are purchased with money, especially borrowed money, way too much. It's propping up the stock market so that the risk premium is way too low. I worry that it's propping up the housing market, as well.

Now, the government continues to pump money into the economy in the form of "stimulus" and big government spending. Inflation still appears to be low. But there's some sort of bubble inflating somewhere. It's just a matter of time before we find out where. Probably somewhere within the government or its politically connected cronies. Glenn Reynolds argues that there's a higher education bubble.

I don't recall any time, and I've never read about any time in US history, when the government and associated politically connected people were so far disconnected from the views of ordinary citizens as they are today. People are holding up 1994 as the measure of what will happen in November. They'll have to invent a new measure when it's all done.

Fortunately in the US, we can have a hostile takeover of the government without the horrors of war and revolution.

I have no idea where the stock market will go, but it may depend on what happens in November, or what looks like it will happen.

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