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I am not an economist. I want, nevertheless, to address four broad topics, and hope that those more competent than I might consider them:
- A slowly growing money supply, with lagging price increases, is an economic analogue of an energy pumping into the economy, driving growth. A falling money supply, with lagging price drops, is an analogue of energy pumped out of an economy, driving economic negative growth.
- A growing money supply with lagging price increases is inadequate to drive growth unless that money is widely distributed and in hand to most people to spend to drive growth, including business and job creation to make and sell and buy more goods.
- The economy is not best modeled as a single sector, common in macroeconomic growth theory, but an economic web of complements and substitutes, where the economy can be subcritical or supracritical. The former makes few or no new economic opportunities for new kinds of businesses, jobs and goods. (Alberta Canada, exporting a roughly fixed set of goods, oil, wheat, beef and timber, is subcritical, the U.S. and global economies in the past decades are supracritical, making an increasing diversity of job opportunities and new goods.) As I note below, an increasing diversity of goods and production capacities probably drives transition from subcritical to supracritical economies. Professor Ricardo Hausmann at Harvard's Kennedy School has evidence that diversity does in fact drive growth.
- The flow of money through the economic web, captured in Leontief input-output matrices among existing industries, can be analyzed mathematically for optimal power locations in the web to invest to drive growth optimally among existing parts of the economy.
All four issues above may work together autocatalytically.
- In a past post on the "A Downward Spiral: Economics Made Too Simple", I built upon the great John von Neumann's intuition that money was somehow related to energy in physics. Briefly, energy derives in its initial form from Newton's force in F = MA. But this, Newton's second law defining force and built on the concept of mass, M, is built upon his first law, based on the inertia of mass in rectilinear motion, which mass therefore continues in straight line motion unless disturbed by an outside force.
- Economics has no formalized concept of inertia and, thus, no first law of motion. My colleagues and I may have invented/discovered a concept of economic inertia: trade or die. In the simplest terms, 50,000 years ago, two clan members, you and me, meet on the trail. You have caught a rabbit. I am empty handed. "Please let me borrow half your rabbit, I'll pay you back in kind very soon," I ask. You agree. I mark a stick to show I owe you half a rabbit or equivalent. Credit is born in the marked stick IOU which "binds time." You let me borrow half a rabbit today, I pay you back in a few days. We trade or die because resources are scare and fluctuate. We have a first law, where trade or die is the analogue of inertia, and a constant average rate of trade or constant GDP is that first law of economic motion.
- Now consider a slowly growing money supply, well distributed among the population and, critically, a lag in the increase of prices as the money supply slowly goes up. Then we truly have more money per good at current lagging prices, so we consume more shoes, thus we produce more shoes to meet the demand, and GDP grows across the economy. Thus a slowly increasing money supply with lagging prices is like Force in physics, here accelerating the rate of production and trade of goods. We have GDP growth and slow inflation. As in F = MA, when a force is applied, acceleration of motion occurs, so in the above, when economic force is applied trade rates accelerate. Appropriate mathematical integration of this force is the economic analogue of energy — hence meets von Neumann's intuition.
- Right now, and testably, the total money supply, including all forms of credit, is almost surely falling. Then if price drops lag, we have less money per good at these lagging prices, so buy fewer shoes, so produce fewer shoes. And we also save to buy when prices are cheaper, and we also are frightened so save for the rainy day which we are creating.
- This suggests that the Fed needs to print money in quantitative easing just enough to offset a testably falling total money supply plus a bit so money supply grows slowly. In these circumstances, demand for goods should be modestly stronger and hence invite production and job creation. The effect offsetting total money supply shrinking by the Fed printing slightly more money on inflation and the international value of dollars require consideration.
- In the past decades, we have ridden up a bubble of money supply creation partially by credit and borrowing. The credit bubble is now probably bursting in Europe with its sovereign debt crisis, and probably here as well, e.g., the downgrade by S&P of U.S. Treasuries, and the downgrades of municipal bonds in the offing. If what I am saying is basically right and if the Fed here and central banks across the world cannot or do not act, we will probably spiral down. If so, it seems obviously right that we will all share the pain of a collapsing money supply with lagging price drops hence slowing economies, probably made worse by austerity compounding the money supply decline with lagging price drops.
- If total money supply can be sustained or grow slowly with lagging prices we could, if the above is roughly right, be spared. But we all will not be spared if that money supply is not well distributed. How do we get such sustained or slowly growing money into the hands of consumers and actual or potential entreprenurial producers who provide jobs? Some thoughts: i. Government work programs wherever the products built are economically viable as part of our commons, such as infrastructure, and, like wind and solar energy, at or close to competitive with alternative energy sources, particularly oil. ii. While in a downward spiral, a true sharing of losses by banks and home owners, and others carrying credit burdens, in order to lower interest rates paid by those carrying debt burdens so they have cash to buy and produce the shoes we hope to produce and trade. This may help, but cash in hand may only be saved for that rainy day we create during the downward spiral. Companies, banks and consumers are doing just this now. If money supply grows slowly, with lagging price increases, however, money in hand should drive consumption and so production. Commercial banks, car loan agencies, and credit card companies predominately make money by lending, so there is some approximate floor underneath this aspect of credit formation.
- The economy does not grow only by familiar macroeconomic theory, which is largely a model of a single-sector economy. There is a vast economic web of complements and substitutes. Screw and screw driver are complements, screw and nail substitutes. Let each good be a point in a large room. Connect complements by green lines, substitutes by red lines. This is the economic web. Quite good theory shows a very important phase transition: as the diversity of goods and production capacities increase, an economy undergoes a transition from subcritical, where it does not make ever more new economic opportunities or goods, (say Ethiopia or even Alberta, Canada, both almost purely export economies.), to supracritical, (like the U.S. and global economies in the past decades), where new economic opportunities multiply, creating places for new entreprenurial activities, thus business and job creation, hence money in the hands of consumers and legitimate need for credit to operate and expand the new businesses created. These facts strongly suggest that sustaining the diversity of goods and production capacities of the economy is essential in a downward spiral. Indeed, and more ominously, the reverse transition from supracritical to subcritcal economies can occur in a truly severe downward spiral. With Europe in crisis, as emphasized by Time Magazine's cover story, (Aug. 22, "The Decline and Fall of Europe — and maybe the West"), and the U.S. in crisis, a wary eye and far better theory of a catastrophic collapse to subcriticality on two continents are probably needed. Should such a collapse occur, re-transition to supracriticality may be extremely difficult. Rome will have fallen.
- Leontief matrices show money flow between already existing and webbed sectors of the economy. Mathematical tools exist to study optimal points in this web where money injected ripples optimally through the economy. Market forces may or may not be able to identify these points efficiently. If not, policy is needed. Just the above tools may be of help in investing in areas of the economy that, by their widespread ripple effects, best sustains the diversity of goods and productions capacities needed to remain supracritical.