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Triangulating Economics

Everybody agrees that we need economic growth.  Originally, the Austrian or Classical school of economics argued that profligate spending by governments depresses growth.  Following the Great Depression, conventional wisdom found that the deficit spending of Keynesians really helped end the ten-year depression.  Following the stagflation in the late 1970s, Supply-siders successfully created some economic growth by cutting taxes.

Once again, we are in desperate need of growth.  The Supply-siders argue for yet another tax cut, but academics has largely discredited the Laffer Curve, which is the foundation of Supply-side economics.  So, that’s out.

There is a rebirth of interest in the typical Keynesian solution of deficit spending to increase demand, but that doesn’t work when there is already so much debt that our credit rating is damaged.  So, that’s out.

That leaves the old-fashioned Austrian approach of cutting the deficit with both spending cuts and tax increases.  Certainly, that is a great idea, but Americans seek instant gratification, and this old-fashioned approach will take far too long.

Economists are fond of debating the “Liquidity Trap,” which occurs when there is a sea of cash but interest rates (and investment returns) are too low to be worth investing.  The investor doesn’t care if he holds cash or income-producing investments, as both produce zero.

The two ways out of the Liquidity Trap are debasing the currency or creating significant inflation.  Debasing the currency or dollar makes our manufactured goods cheaper for the rest of the world to buy.  This causes our export industries to boom.  We have exported our way out of recessions in the past, but this was a very severe recession.  In addition, it is a foreign policy disaster for our trading partners.

Creating significant inflation for a few years would speed the recovery by reducing loan-to-value ratios on homes and by making enough assets appreciate in value that investors are willing to borrow money to buy those assets and benefit from that appreciation.  Debasing the currency also helps cause inflation, as imported goods are then more expensive.  Inflation is not all bad, but it is like letting a camel stick its nose into your tent.  It moves in quickly and takes over.  Inflation is very painful to eliminate once started.

This is probably a time for the Austrian approach but with more inflation and a depreciating dollar.  Economists have to triangulate economics, while politicians have to navigate voters, and which politician can say he is in favor of raising taxes, depreciating the dollar, and increasing inflation.  Maybe, that’s why politicians have to be so vague and economists don’t?  “Vote for me, you’ll get a weaker dollar and higher prices!”