“human nature,” and “the velocity of money” - John Maudlin

quote:
Presently, major sectors of the U.S. economy are experiencing a debt deflation that is causing a massive destruction of wealth, thereby curtailing jobs, income and spending. Irving Fisher who, according to Friedman, was the most brilliant of all U.S. economists has noted that when the economy enters a period of “debt and price disturbances”, those forces will eventually engulf the economy. Fisher developed that concept by examining the 1929-33 depressionary period, as well as the depressions of 1837 and 1873, as examples of when excessive debt and subsequent price declines controlled “all or nearly all” other economic variables. This theory of excessive debt and its pernicious and unrelenting deflationary impulse to the economy has been best chronicled by other notable economists: Charles P. Kindleberger (1910-2003), Hyman Minsky (1919-1996), Nikolai Kondratieff (1892-1938) and Joseph A. Schumpeter (1883-1950). Fisher contends that once extreme over indebtedness occurs, fiscal and monetary policy become impotent in spurring economic growth because money velocity will decline — something that is currently happening. Individuals and businesses struggle to repay debt with harder dollars, and saving begins to rise as caution prevails.
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and regarding the velocity of money,

quote:
Friedman and Bernanke both believe that if the money supply is increased sufficiently velocity will stabilize and Fed actions will at least be able to keep nominal GDP stable or growing slightly. Fisher, on the other hand, argues that if a generalized debt deflation takes hold, velocity will decline, just as it did during the Great Depression.

Our analysis suggests that the Fed will not achieve the desired results of stable velocity. Velocity is a function of financial innovation, rising during periods of new innovations and falling when these innovations are reversed or unchanging. Fisher also suggested that velocity rises when leverage increases and falls when leverage abates. So far the evidence at hand suggests that velocity is thwarting the efforts of the Fed. In the fourth quarter velocity plummeted, completely offsetting the increase in M2. Thus, nominal GDP declined at a very rapid rate.
http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2009/01/19/the-great-experiment.aspx
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There you have the great dilemma Pres. Obama faces. Two theories. The one is held by his advisers as well as the advisers Bush and Clinton had and basically all Presidents since 1913. In spite of failure after failure for 95 years, we are still relying more on the theory with so many historical failures and ignoring the other, because it is an “unknown.” Yet, I would venture that when you add “human nature” as a determining factor in which theory is best, I would say the one not supported by Pres. Obama’s advisers is the sound one.

Related Posts:

• If you truely don’t believe that inflation is purely a money supply phenomenon…..answer yourself this one simple question:
• Inflation is rising money supply which we have. Rising CPI is a symptom of inflation, not inflation.
• Bernanke’s speech yesterday tells me we are heading for a depression.
• Money velocity is also a part of the picture.
• Early economist Irving Fisher argued that the predominant factor leading to the Great Depression was over indebtedness and deflation; Almost 80 years later this looks very familiar, doesn‘t it?

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