Nathan Sass

GOP Takeover Not a Cure All

In Barack Obama, Economics, Health Care Reform, Politics, Tax Policy, Taxes, The Great Recession on November 1, 2010 at 5:00 AM

Should the GOP take control of the House, the Senate, or both on Nov. 2, it will not necessarily be the cure for all that ails the US economy.

In fact, looking at a very basic and fundamental economic equation, it may be the final domino in a chain reaction that the 111th Congress and Obama administration started a little less than 2 years ago.

For nerds like me who remember their macro economics classes, MV=PQ is a pretty easily recalled equation that makes the economy’s condition easy to diagnose.  For the rest of the known universe, the reaction to MV=PQ is “What is that and who cares?”

In MV=PQ, M stands for the supply of money or dollars in circulation.  V stands for the “velocity” of that money, or more simply the number of times a dollar changes hands in an economy.  The P represents prices and Q stands for the quantity of production, or more simply economic growth.

Since the 2 sides must always balance, if you change any one of the 4 variables, one or more others must react accordingly.  If M is increased, V must go down and/or P and/or Q go up.  It works just like a giant scale. 

The Fed has over the last two years been steadily increasing the M in the US economic equation.  In normal times, that would mean either P or Q would go up, too.  That means either inflation (P+) or economic growth (Q+).  In our lifetimes, the V has never really changed much.  A dollar was almost always passed around the economy at the same “speed”.

But this recession has been very different.  When asked by a member of the audience in Milwaukee why we haven’t seen inflation yet with all the money being printed, Ben Stein said that it was due to the V dropping in MV=PQ.  that leaves growth (Q) and inflation (P) pretty much untouched.  This has never happened like this before in modern times.

You can tell V has dropped a lot because of a few things you might see every day.  People are saving more and spending less.  Personal savings in the last 2 years is way up over previous years.  That means when Joe Blow makes a dollar he doesn’t always pass it along, making V smaller.  Major corporations and banks are “saving up” too, increasing their cash on hand by a large amount, pulling V down just like Joe Blow does.

This means that even though we have made M go up a TON, there is no growth or inflation.  Things just stay like they are and while things don’t get worse, they don’t get better either.

If the GOP wins big on Nov. 2, this may change in a big way.  A GOP win may send signals to big businesses and individual consumers that what has been scaring them into saving will be stopped, and all that saved up money will being to go into circulation. 

This means V will go up and since M is already huge, P (prices) or Q (growth) have to respond.

There’s only one problem with that.  The GOP cannot effectively roll back anything that was done the 2 years prior to Nov. 2.  Obama, unless he moderates a LOT, will veto any GOP repeals of health care reform and will likely block a renewal of the full Bush tax cuts among other things.

In plain english, this means that although people will think that the roadblocks for economic growth (Q) will be removed, they will not be.  All that saved money will come back into circulation (V) expecting a rebound of the economy, but the policies of Obama and Pelosi will still be in effect, stifling growth. 

That means in MV=PQ, the Q part (growth) will have a huge obstacle and it will be very hard to make Q get bigger.  Normally Q is the easier thing to increase compared to P, but in this bizzaro world of Obamanomics, it has been made the hardest thing to increase.

Since V is getting bigger, and Q cannot, that leaves only P (prices) to match V’s changes.  That means to you and me that prices (P) will rocket upwards.  That’s inflation, or worse yet hyper-inflation.  Compounding things more, it is inflation with no economic growth associated with it.  Unemployment will not go down much, but your money will be worth less every day.

That is a bad bad place to be.

This same kind of thing has happened before in the US.  In the late 70’s and very early 80’s we hade the same inflation without growth phenomena.  Remember Carter’s “Malaise” speech?  Things were only improved when the policies that limit growth were changed in the early 80’s and Q could once again increase.

So in the next 2 years we may in fact see a real mess economically, and it will be very interesting to see if Obama can effectively lay blame at the feet of the GOP for something he is most responsible for. 

If he can do it, it may mean another term and I cannot even begin to imagine the mess that will result from that.  I hope the GOP knows what’s coming and has made plans to deal with the finger pointing that is sure to follow.

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