More economic meanderings

Economic recovery is tied to increased income. Probably it is more accurate to say that it is tied to disposable income, since income that is consumed by fixed expenses doesn't have much of an impact. Now, in the years of the housing boom, a lot of "income" was related to increase in house valuation, to the extent that Americans were willing to borrow either directly or indirectly against their home valuations.

When prices stopped going up and in fact reversed course, this income disappeared and the cost of the borrowing remained. This led to a tremendous decrease in disposable income and in fact many Americans found themselves unable to pay fixed expenses let alone have disposable income.

Now, this loss of income characterized by the loss of housing wealth led to the steep recession, joblessness and the decline in the stock market. Of course, not everyone was impacted but certainly enough people were to cause a tremendous reduction in demand across the board. This reduction in demand led to deflation in many areas and may still have that impact.

One of the biggest impacts was the tremendous decline in the money supply. Now, when I say money supply, the amount of money actually created by the Federal Government is only the tip of the iceberg. The money used to make loans multiplies the amount of money in the system since the capital reserves are only a percentage of the amount loaned. If a deposit of $1 allows you to lend $10, you have effectively multiplied the money in use by a factor of 10.

As banks started to lose money and stopped making loans, we saw a tremendous decrease in the money supply and a corresponding decrease in prices. As the Government attempted to combat this by in effect creating money by borrowing and making this new money available, it also raised reserve requirements for banks. The measure of the money supply that includes all the bank lending is referred to as M3 and is no longer published by the US Government. However, it is still estimated by a number of economic sites and is not increasing. It is still tracked in Europe where it has been declining.

If M3 is stagnant or decreasing, the risk is hardly inflation, it is deflation. Of course, there is a simple argument that the banks could increase M3 very quickly by increasing credit. However, it seems unlikely in the current environment that they will do that very quickly.

It would seem that many of the jobs that existed just two years ago are very unlikely to come back in the same areas. However, if we can get domestic and renewable energy projects going, that job growth can help significantly. Further, we should be engaging in much more infrastructure repair than we are. Finally, we need to reduce the cost of doing business in this country, by changing our tax system and reforming health care.