I know my readers have heard about QE2. This is the second Federal Reserve attempt to bring down interest rates. The entire process is ludicrous because we have the Japanese example of failure. At the beginning of the 1990’s Japan suffered from a real estate bubble and followed the preposterous Keynesian advice of Paul Krugman. Japan had a zero growth and zero interest rate pattern for the next 20 years until now. Japan is still in the same 20 year old morass, today.
It is hard to understand why the Democrats in Congress and the Federal Reserve cannot look at that twenty-year experience and see that we are facing the same outcome. Aside from this absurdity of policy, let us look at what is actually happening that is not perverse.
The federal government is much like a water pump in a fish tank. Every year the water circulating pump processes about one quarter of the water tank and leaks about 40% of what it processes (the government has a multiplier of 0.6). Forty percent of one quarter of the water is 10% of the water in the tank...totally lost. The government actually takes 10% of economic activity out of the economy every year.
During the past two years, with the stimulus package (a multiplier of zero) the government lost roughly another 10% of the water in the fish tank. That is a two year loss of 30% of the water in the tank.
For the fish tank to have the same amount of water requires that about 10% new water be added annually. (15% per year for the past two years).The new water comes from innovation, export and start up businesses. For the amount of water in the tank to increase that requires more innovation, more export and more start up businesses.
Three issues have kept the amount of new water added to the tank from growing above the normal level. First the financial bubble was corrected with a failed strategy and the banking industry was taken out of the lending business (banks only invest in safe Treasuries at this point). That affects about 20% of the economy which is now growing only based on its internally generated profits. Secondly the federal government introduced tons of uncertainty producing programs: national healthcare and bankers reform which significantly reduced the amount of innovation investment in the society.
Three, a rapid shift in the location of economic growth and skills has occurred in the past decade and the labor market has been slow to adapt.
Unemployment is insignificant in the whole picture. With roughly 110,000,000 people working, 20 million additional people in government, the 10 million above normal unemployment is trivial and irrelevant. The unemployed subtract very little in the way of resources.
Summary
The Fed has made a mistake; nothing can be done about that; however alternative sources of finance will slowly emerge as large corporations start putting their money back into productivity. Profitability has been strong for the past two years and I would expect that the next two years will show significance growth in the economy.
The best investments will be in Internet and telecom related businesses. That is where productivity is growing most rapidly.
2011 will start roughly where 2008 started out.
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