What Caused the Stock Market Crash of 2008-2009?

[Written for the Borsen-Kurier]
What caused the US stock market to spectacularly crash in 2008 is intimately connected to what caused the market to boom from 1980 to 2007. In broad terms, the long market boom, which took the Dow from 875 to over 14,000 at its peak in the fall of 2007, was the result of two interconnected forces: money creation and redistribution.
Economically, the great puzzle to solve is not why the market crashed, but why it performed so far above the rate of economic growth for so long. Why should the stock market, which is composed of nothing more than a broad section of corporations, on average perform any better than the overall rate of economic growth, upon which it surely rests?
Consider the following graph of the stock market and M3, the Federal Reserve’s broadest measure of money creation (M3 was discontinued in 2006, but the series is kept up by several different private economists). Notice that the performance of the stock market (as measured by the Dow) is far above the rate of productivity growth or the rate of real economic growth.

The fractional reserve nature of most modern banking systems means that money creation takes place in a decentralized manner; during this period, much of that money found its way into financial markets, in the form of leveraged buyouts, stock buybacks, and the effects of increasing leverage on the part of investment banks and the explosive growth of the highly-leveraged hedge fund industry. Much of this borrowing went to purchase equities, bidding up prices dramatically.
At the same time, the shifting balance of power between labor and capital made it possible for corporations to hold down wage growth, resulting in an unprecedented 20 year period of falling real wages in the US. This caused corporate profits to increase, along with share prices, as stockholders re-evaluated the new distribution of income between labor and capital.
The problem, of course, is that neither of these forces are sustainable. The share of income going to labor can fall, allowing the share that goes to profits to rise, but labor’s share cannot fall far without producing resistance. In the US, that resistance was weak, in part because of a new innovation: leverage for consumers. Unfortunately, the new kinds of consumer credit that were invented and eagerly used by US consumers were rarely used for any kind of investment, so debts mounted without an increase in income to pay them back.
As for money creation, it must eventually lead to inflation. No one can truly create wealth out of thin air, so when money is created far in excess of economic growth it must cause rising prices somewhere. If it causes rising consumer prices, we notice it and demand a solution, but if it causes rising stock prices, we celebrate it. But the money is not real, and the prices cannot last. At this point, it seems likely that the Dow will fall to 5500, which would give the Dow a traditional bear market dividend yield of 6%. Given the extent of money creation thus far, a strong possibility is that the Dow shows strong growth, perhaps rising above 10,000, or even above its record heights. While this may reassure investors, such an outcome would simply be the first manifestation of inflation that will not be confined to financial markets this time around.

Economic Stimulus and the Banking Sector

The incoming Obama administration has been steadily increasing the size of the proposed economic stimulus, which now stands at $850 billion. Thus far, much of the debate has centered around the question of how big a stimulus ought to be, and what should be the mix of tax cuts versus government spending. This week, discussion has centered on what kind of spending would be desirable, and while the proposal of ‘green tech’ and repairing infrastructure is appealing, the criticism has been raised that since 97% of construction workers are male, and most are white, infrastructure projects leave out many of the most vulnerable poor, among them women and minorities.
The size of the stimulus will no doubt continue to grow as economic conditions worsen, particularly in the job market, where job losses appear to be accelerating, with 524,000 jobs lost last month. As for the overall effect of the stimulus package, Macroeconomic Advisers estimates that the Obama stimulus will increase GDP growth by 3.2%, and reduce unemployment by 1.7% by creating 3.3 million jobs.
Given the sudden reluctance of consumers to spend, it seems likely that the $275 billion portion of the stimulus package that is tax cuts will effectively disappear into savings or toward paying off household debt. But if lenders receive payment, they can make new loans, right?
I wonder. So far lending has fallen by $133 billion since October 2008, which means the money supply is contracting just as the stimulus is put in place, perhaps by as much as $1.33 trillion, assuming a money multiplier of 10. The big question is if banks continue to reduce their lending. It seems likely that banks will have reduced demand for loans without the mergers and acquisitions boom, and with de-leveraging occurring on all sides. If lending falls by another $100 billion in 2009, it means another $1 trillion decrease in the money supply, which would easily swamp the stimulus. This is one of the great weaknesses of the fractional reserve system: it tends to destroy money at exactly the wrong moment.
Think of the classical quantity theory of money: MV = PQ. The money supply is falling, and it seems likely that the velocity of money is also falling, as consumers spend less and save more. (It’s hard to measure the velocity of money directly, and it is typically inferred by measurements of the other variables.) This leads to falling prices and economic output. The adjustment process shouldn’t take long, if left alone: a year or two at most to purge failed ideas and business models, to de-leverage and move toward saving.
But of course it is hardly being left alone. Instead an ocean of money is being created and borrowed, all to prevent the natural adjustment of the economy back to a sustainable course. This adjustment cannot be prevented, though it may be delayed, it may be drawn out. The casualty of all this will be the US dollar, which is in its last days of being the world’s reserve currency.

Solving the US Banking Crisis

[Written for the Borsen-Kurier]

Most efforts proposed these days go exactly the wrong direction: back toward unsustainable economic activity like debt-funded consumer spending, home buying, and government spending, or away from the transparency that markets need to reach equilibrium (for example, the recent proposal at the G-20 meeting that accounting standards be ‘temporarily’ loosened—as if we could escape our problems through denial).

Here is an economic plan that would work immediately; it would stabilize the banking sector instantly, preventing the crisis in the stock market from reducing business investment in the real economy, thus preventing a major contraction of GDP.

The catch? It will involve some short-term economic pain.

The reason that banks are fragile is that they have only a fraction of their deposits on hand at any given time. Because banks are currently scrambling to increase their reserves, they have restricted lending by $100 bil from October 29th to November 19th. Granted, this is a small decrease when the total volume of loans is over $7,000 bil, but any decrease in lending tends to be pro-cyclical, resulting in the contraction of the money supply at precisely the wrong time. In theory, a money multiplier of 10 would imply that a $100 bil restriction in lending would lead to money destruction of $1,000 bil. Additionally, because of decreased consumption and investment spending, there is a falling velocity of money, meaning fewer transactions per week. This exacerbates the effect of a contraction in the money supply. As of November 28th, 2008, the total money supply (M2) was $7,854 bil. Bank reserves have skyrocketed from $44 bil in August to $652 bil in October, while bank deposits have stayed constant at about $7,000 bil.

Here’s the plan, in two parts.

Part 1: the total cash and coin in the US is less than $800 bil. Print an additional $7,000 bil, and give it to banks in exact proportion to their deposits. Then make sure that bank reserves always equal bank deposits, creating a 100% reserve system. This would cause no net change in the money supply, for we’d simply have printed money to back up bank deposits, money that was already in use. We’d merely replace checkbook-money with paper money. No problem so far. There would be no inflationary pressure, and the cost would be minimal - the cost of printing and distributing the money.

Part 2: Define the dollar as a portion of gold. This is where the sacrifice begins, for it involves a substantial devaluation of the dollar. The US holds 8.133 bil grams of gold, and the IMF has another 3.217 bil grams; if we divide the total money supply M2 by the total US and IMF gold reserves, we get about $700 per gram, meaning a dollar is worth 1/700th of a gram. Now the tough part: we keep this ratio in good times and bad, at all times allowing anyone to trade $700 for a gram of gold. Since the current market price of gold is about $26 per gram, this plan would entail that the dollar must fall to 3.7% of its current value. (The drop would probably be less severe, as this plan would pull gold out of private gold stocks and into service as money).

The sacrifice would begin when all imported goods immediately rise in price dramatically (an imported good that costs $1 may rise to $25). International trade flows would change as markets reach equilibrium. This would certainly cause some dislocation. But we’d skip the lasting pain of a sequel to the Great Depression because the main damage to the economy would be avoided. The money supply would not contract due to banks rational fear of collapsing during the financial crisis. Banks would be on a solid basis, and they could immediately begin lending (from savings accounts only; these would have to be set aside specifically for investment purposes, and would no longer be available on demand).

Sacrifices would continue as the US could no longer maintain a current account deficit without draining US gold reserves. The federal government would not be able to borrow billions or trillions to finance deficit spending. The depreciation of the dollar would mean foreign bond holders would immediately lose money, and large-scale selling of bonds would ensue. While it is unfortunate to break the trust of those who bought US bonds, it is simply unavoidable. The US has too much debt to pay it back. The US government will repudiate its debt, either simply and honestly, as in this plan, or covertly, through inflation.

Without access to deficit spending, cuts in government spending will add to the economic contraction, but the plan will prevent future pain, for the current strategy of massive money creation and fiscal deficits will surely devalue the dollar, without the benefit of ever leading to a sound medium of exchange.

The financial crisis is first and foremost a debt-deflation crisis, which was produced by banks’ wanton money creation during the expansion of the 1990s and early 2000s (an expansion supervised by the Federal Reserve). If we give the market a medium of exchange that can be trusted to hold its value, the extraordinary ingenuity and entrepreneurship that is America’s greatest asset will be unleashed, and we will soon be enjoying prosperous times again.

Inflation-Deflation Seesaw

[A piece for the Austrian paper Borsen-Kurier]
The big news from America is President Obama: a truly great man has been elected president, and he did it in spite of his race and unusual name. It is a great moment for America. President-elect Obama faces a global economy that is more tightly interlinked than ever before, and so trends that emerge in the US (and elsewhere) have global ramifications.
The US Producer Price Index has been falling for 3 straight months: down 2.8% in October, 0.4% in September, and 0.9% in August. The PPI doesn’t reflect the plummeting asset prices in financial markets (the Dow is down 40%) and real estate (down 20% nationwide, according to the Case Shiller index). There is considerable downward pressure on nearly every asset class worldwide, and it seems likely that commodity deflation will continue for at least several more months.
Of course, the central banks of the world are working overtime to combat deflation; the Federal Reserve and the Treasury have borrowed or created nearly $3 trillion out of thin air this year alone. As that new money is absorbed and digested by markets, it will eventually cause inflation. Certainly the announcements of the G-20 meeting, with its statement that the world should work together to re-inflate sagging markets, is also inflationary.
By the current rules of the game, no country that relies on exports to fuel its growth can afford an appreciating currency against the dollar, for the strengthening of the currency would hurt sales in the US and every other country that maintains a dollar peg, which includes some pretty big markets, as well as some high growth markets, such as China. This means that when the US creates dollars, other countries rush to weaken their currencies. With a worldwide crash in equities, countries are not exactly reluctant to create money and funnel it into financial markets, but at some point, this will catch up with commodities again, and we’ll see a resumption of global commodity inflation, which is likely to accelerate.
The US bond market is currently pricing in low inflation over the long term. Indeed, for a time the inflation protected Treasury bonds (TIPS) had a higher yield than the nominal 10-year Treasury bond, meaning that the bond market predicts deflation. But what will happen when the money creation returns to markets in the form of inflation? Bond yields will have to rise, to compensate for inflation, leading to broad-based increases in interest rates across the economy; even though the Federal funds rate is likely to be low, I bet we’ll see high interbank lending rates, with the consequence of rising rates for consumer credit, and rising rates for corporate bonds as well.
There is no easy way out of this, but President-elect Obama has already done one good thing: reminded America that there will be sacrifices ahead. I think we can make sacrifices, if there is an understanding that it’s for a good reason, and it will help to eventually restore solid economic growth.

The US economy has been slowing for some time (the average real growth of GDP from 1980-2005 was 3.01%, while it was 3.95% from 1950-1979), as the economy has shifted more toward finance, insurance, real estate, advertising, and retail. These activities are economically unproductive, meaning they do not directly result in fundamental value creation in the economy (even though they increase GDP). This growth in the unproductive economy creates a drag on the US economy, making it more vulnerable to the financial crisis. Over the long term, the US economy will shift back toward productive activities, like manufacturing and agriculture.
If the economy has been hollowed out by its turn toward economically unproductive activities, why has the stock market seen an incredible run since 1980, with the broad Wilshire 5000 up 1025% at its peak in 2007? For the answer, follow the money.
Specifically, follow the mountains of cash that have been created out of thin air; not just in the last year, when the Federal Reserve has found all sorts of novel ways to pump nearly $1 trillion to investment banks and other firms in a massive effort to re-inflate markets. For the entire period since 1980, broad money creation (M3) has increased 8% per year. You can’t create money on this scale without seeing some inflation, either in consumer prices, or in assets (like stocks and real estate), or both.
Before a tsunami, the sea recedes, exposing the ocean floor and making a sucking noise; then the great wave hits. The US and global financial crisis is in the sucking phase right now, sucking away all the money that has been shoveled into it, but the next phase is certain to be highly inflationary, as the consequences of decades of money creation manifest.
It is particularly interesting then that we begin to see the first call for a new ‘financial order’ from French President Nicholas Sarkozy. The French have a long tradition of chafing under the international rule of the dollar, and my guess is that Sarkozy is seeking to position the Euro as the emerging reserve currency. In the short term, the dollar will continue to attract investors seeking a safe haven from global turmoil in financial markets. But as the crisis fades and the US economy continues to deteriorate while the Federal government continue to pile up huge deficits, investors will look for a stable currency for international transactions.
In the US, most people are looking for the leader who will ‘fix’ the economy: stop foreclosures, get home prices back to rising 15% per year, get gas prices, food prices, and unemployment down, etc. Not all of these things can be done. We got ourselves into this by thinking we could spend all we wanted and pay it back later, and, though it will be a difficult adjustment to make, it will ultimately be better for the world without the US as the ‘spender of last resort’.

The dollar shows a new sign of weakness

A nice post on the newly-criminalized exportation and melting of US coins can be found at:

autodogmatic.com

Of course, this is another bad sign for the dollar. Government decrees have a bad record when it comes to upholding market values; the modern reign of fiat currencies is just a brief exception to this rule.

Comments on R. McKinnon’s “The Worth of the Dollar”.

Dr. Ronald McKinnon, a well-known international economist, wrote an article in today’s Wall Street Journal called “The Worth of the Dollar.”

Oddly enough, the article never addresses the title of the article; Dr. McKinnon never explains what determines the value of the USD. While there is some discussion of how changes in monetary policy affect exchange rates, this does not speak to the essential ‘worth’ of the dollar, only changes in it. Offering a theory of how something changes over time is not the same as explaining how it came to be. Of course, the USD has no intrinsic value; this is why its purchasing power erodes over time. The dollar is worth about 5% of what it was worth at the inception of the Federal Reserve system in 1913.

Dr. McKinnon begins with a provocative question: “Shouldn’t the market now discipline the world’s biggest debtor and bid the dollar down to reduce the trade deficit? Essentially, the answer is no.”

I confess, it’s a bit hard for me to know how to interpret a statement like this. At first, I thought it means the argument that follows will show why a rapid depreciation of the USD is unlikely. But this is not what the author shows. My next thought was that perhaps Dr. McKinnon is arguing that the market should not be allowed to depreciate the USD. Upon reflection, it’s an odd way to begin an argument about the worth of the dollar, because since the worth of the dollar is determined by the global currency market; we can say all we want about the value of the dollar -- it should be higher, it should be lower -- but the reality is that markets don’t run on ‘shoulds’. Why is it, then, that statements by important figures in the US can effect the value of the dollar on the international market? Obviously, currency speculators scrutinize statements made by Federal Reserve officials, the Treasury secretary, and others positioned to affect US policies.

Another odd statement is made in the second part of the piece, where Dr. McKinnon writes, of the US current account deficit: “The “problem” is not new and there need be no crisis unless the never-ending Greek chorus of editorial writers in the Financial Times, The Economist, the New York Times, and so on, praising every (random) decline in the dollar as a welcome step in helping correct global imbalances, somehow foment a run on the dollar.”

Dr. McKinnon makes this sound like a truly bizarre scenario. If the worth of the dollar is secure, then how could the writings of financial journalists destroy the dollar? Are international and domestic holders of dollar-denominated assets so swayed by the opinions of these writers that they’d abandon a sound asset to their own ruin? Then again, if the value of the dollar is perhaps not as secure as one might think, aren’t these sorts of warnings due?

Finally, near the end of the piece, we get to some policy: “The US current account deficit simply reflects the excess of expenditures in the US relative to income, or, equivalently, the amount by which America’s moderate level of investment exceeds its very low saving rate -- both by households and the federal government. So the first order of business in correcting the trade deficit is to reduce the structural fiscal deficit of the US and possibly run with surpluses. The second order of business is to provide incentives -- possibly tax incentives -- for American households to increase their saving. Both require major changes in US public finances and should be phased in gradually but very deliberately.”

It’s hard to argue with this prescription. Although it’s equally hard to actually see it happening. Does either party seem inclined to do what is needed to balance the budget? That is, either large spending cuts, large tax increases, or some combination. As we teeter on the edge of a recession, can you see Democrats voting for a tax increase? Can you see them cutting spending? If the budget was balanced, it would clearly cause a major decrease in aggregate demand, driving the country deeper into recession. How might that affect the value of the dollar? Would the Fed respond by raising interest rates, to keep the dollar attractive to foreign investors, deepening the recession? Or would the Fed yield to political pressure, easing rates and thereby weakening the dollar, raising the prices of most imported consumer goods, which would probably also deepen the recession? It’s hard for me to see a way out of this one.

Dr. McKinnon is willing to provide us not only with policy ideas that will not be implemented in the US, he has policy ideas for the rest of the world as well. Since we have less control over the rest of the world than we do over our own economic policy, it’s hard to see these policies being pushed forward by anyone. These ideas involve the rest of the world (particularly Asia and the oil producers, which Dr. McKinnon incorrectly labels ‘oil emirates’ -- is Venezuela an 'emirate'?) increasing consumption at exactly the same time and rate as the US decreases consumption. This is truly a Panglossian vision. While Dr. McKinnon is probably right that such a thing could theoretically work, he seems to think that there is some country to be found in the world which has as its first order of business ‘stabilizing the world economy overall.’

No country cares about the world economy. Each country only cares about its relative position within the world economy.

Response from Prescott re: 5 Macro Myths

Greg Mankiw has engaged Dr. Prescott on the issue of the "correct" level of government debt equalling twice the level of GDP.

His reply is a bit technical, but I think I've isolated the crux of his argument:

"The important point of our analysis is that it is welfare improving to have government debt rather than taxing the labor income of the workers and making transfers to the retirees where both policies are such that the real interest rate is 4%."

While it may be 'welfare enhancing' in a given model (depending, of course, on what assumptions are made) to borrow from future generations to pay for the consumption of the present one, there is no covering up the fact that Dr. Prescott is advocating borrowing from future generations. That hardly seems a convincing 'bust' of the 'myth' that government debt is a burden to our grandchildren.

Regardless of what the model says, a related issue is that borrowing against supposed future growth in income, taxes, or whatever is inherently risky.

We're currently paying hundreds of billions of dollars toward interest on the government debt. This certainly reduces the possibility of government spending on education, investment in green energy, and so on. It's hard to see the opportunities we're missing. Borrowing more money from our grandkids doesn't seem like the answer.

End of empire

Is there now any doubt that the U.S. is, in fact, an empire? After resisting the charge by Marxists for years, even some right-wing commentators have begun to embrace the idea.

An empire is a nation that successfully projects its political, economic, and cultural might across an ever-increasing geographical area; empire is the logical extension of the concentration of power in the hands of the state. Most nation-states have either achieved it (then lost it), or attempted it; no nation seems immune to the allure of empire.

The U.S. is an odd empire though. Like others in history, the U.S. relies upon its military power, which rests upon its productive capacity. Unlike other empires, the U.S. relies heavily on debt, created by the capturing of the world’s money. No other country in history has been able to secure its sole position as the the supplier of the world’s money. The last empire to have a world currency -- the British pound sterling -- could hardly be described as the sole supplier of money, because the pound sterling was a convertible currency, redeemable for gold. In 1931, the United Kingdom became a fiat currency, due to increased pressure on the pound because of the inflationary creation of new money to pay off its debts from World War I. The monetary instability that resulted from the war and its aftermath certainly contributed to the conflagration of World War II. After the dust had settled, the U.S. stepped in to ‘rescue’ the pound sterling, backing the pound with the dollar. Thus the emerging empire began to take the place of its former colonial master. The US achieved dollar hegemony by lending to Europe and Japan, both of which were basically occupied by US military bases. The creation of the IMF and World Bank, who lend in US dollars, also established the demand as the reserve currency. Finally, the trading of oil on world markets created the ‘petro-dollar’, again providing a reason for all industrialized nations to require US dollars.

Once the world had become accustomed to the dollar as a ‘hard currency’, the stage was set to follow in the footsteps of the UK and sever the tattered connection between the dollar and gold in 1971. Contrary to popular opinion, the US was not on a ‘gold standard’ prior to 1971. That was effectively ended in 1933, when President Roosevelt made it illegal for US citizens to hold more than $100 in gold (about $1500 in today’s dollars).

Everyone in the world would like to be able to print their own money, gaining the ability to trade an item which can be produced with very little labor and expense for goods and services of much greater value. It’s the age-old attempt to get something for nothing.

And here we have achieved it. We can print dollars; other countries are obliged to hold them, if they want their currencies to remain stable. So other countries must set to work to provide us with cheap goods, the fruits of our empire. We ‘print’ dollars or Treasury securities, and the world takes them as payment for real goods and services, exchanging real value for illusory value, and the result is a current account deficit (where trade imbalances between imports and exports appear) and a capital account surplus (where imbalances in flows of financial assets appear). Since by definition the balance of payments, which includes both the current and the capital account must equal zero, this situation seems to be stable, and of course it has lasted for 30 years -- is it a coincidence that these imbalances began only a few years after the US severed the last link between the dollar and gold?

Though we have gotten something for nothing for a while, this is about to end, because the artificial strength of the dollar cannot last. One thing all empires share is hubris. The British came to believe that the value of the pound sterling must always be high, even as their own monetary inflation debased it. In the US, the sentiment is similar. Treasury secretary Paulson must utter the strong-dollar catechism, or risk disturbing sensitive international currency markets.

As Bonner and Wiggin argue in their excellent book Empire of Debt, the dollar is in a long historical process of mean reversion -- but the mean value of the dollar is clearly the value of the paper and ink upon which it is printed: close to zero. Markets can remain irrational longer than you can remain solvent, remarked Keynes; he could’ve added -- markets will not remain irrational forever.

A prediction for the U.S. economy

Ah, the art of prediction. It's like asking to look foolish. Nonetheless, my prediction for the U.S. economy is recession in the first quaarter of 2007. But this is not the serious part; the stage has been set for a rapid depreciation of the U.S. dollar (USD), which will deepen the emerging recession, and perhaps lead to a collapse of the banking sector. The real estate market will not recover to anything close to its present inflated value in the forseeable future. I expect housing prices to languish for the next twenty to fifty years without seeing the kind of rapid growth of the 1996-2006 period. I look for this to begin near the beginning of of 2007. Nouriel Roubini of Columbia University and Roubini Global Economics also forecasts recession for 2007.Q1.

What is the basis of this prediction? My economic analysis:

The stock market is behaving quite strangely; the new records set by the Dow Jones have been widely heralded, but the much-broader S&P 500 index, though it has advanced as well, remains 11% off its record of set back in 2000; the NASDAQ is still well below 50% of its previous 'bubble' record.

Meanwhile, the yield curve for Treasury bonds has become inverted, meaning that the yield on long-term bonds is lower than the yield for shorter-term bills and/or notes. This is extremely unusual, for it's generally the case that investors demand a premium for holding a bond for a longer period, and this inversion almost always presages a major recession.

The housing market has begun to disintegrate; the latest data show that median home prices have begun to fall nationwide, (over 2% from July to August, according the National Association of Realtors) and significant cooling has occurred in the nation's hottest markets. The International Monetary Fund issued a study of housing busts recently, finding that a significant decrease in housing prices caused a recession in 19 of the 20 countries studied. Unrealistic hopes for a 'soft landing' are still riding high.

The other major US market to take a hit is the car market. Ford and GM have both announced deep cuts in production, including widespread layoffs and buyouts. Perhaps the decline could have been predicted, for both companies tied themselves to the SUV, which seems to be rapidly fading in popularity given the level of gas prices, notwithstanding the drop in prices in September; the reign of the SUV is clearly over. Apparently, some 'McMansion' builders were offering a free SUV to entice buyers -- a perfect commentary of the state of American society at this moment.

While the U.S. economy has become unbalanced in consumption, the Chinese economy, in some ways operating as our complement, has become unbalanced in the sphere of investment. Chinese cities are pouring money into building infrastructure; real estate prices in some areas are quadrupling each year. Overcapacity and deflation are looming threats. The chaotic rhythm which manifests here in consumption, appears there in saving and investment.

Though I believe the economic facts are compelling, what has given me the conviction and urgency to make this prediction publicly is my spiritual intuition. Spiritual intuition is received continually, in many ways: in the signs and symbols that we notice, in the words of a conversation overheard, in the whisper of grass, in the feel of the sunlight, in sounds and in silence. I have spent many years cultivating the inner connection which makes this intuition intelligeable and reliable. Since intuition is non-rational, while economic theory is rational, a mediation between the worlds is necessary. Anyone can learn to use intuition, and since it has a basis in the Unity of Being, the results of intuition should be the same for everyone, but the manner of expression may differ.

To protect yourself from the depreciation of the dollar, I recommend buying gold. Though gold bears no return under normal circumstances, the economic crisis to come will cause the price of gold to be bid up far above its value, as in period from 1971-1980.

A Comment on Edward Prescott's "5 Macroeconomic Myths"

The eminent economist Edward Prescott has written an interesting opinion piece in today's Wall Street Journal. In it he argues that the economic position of the U.S. is 'fundamentally sound', though the reason for this is unstated, unless you include the idea that since the economy is composed of 'millions of people making billions of decisions every day to improve their lives, the lives of their families and the health of their businesses' as a reason why there can never be a recession. He then goes on to identify the following 'macroeconomic myths':

1. Monetary policy causes booms and busts.
2. GDP growth was extraordinary in the 1990s.
3. Americans don't save.
4. The U.S. government debt is big.
5. Government debt is a burden on our grandchildren.

My comments on each point are as follows.

1. Probably the two most influential economists who would differ with this assessment would be J.M. Keynes and Milton Friedman. This is to say, across the ideological spectrum, economists agree that monetary policy, though it is not the most significant variable in economic growth and contraction, it does play a role. Particularly, when monetary policy contracts during a recession, as is often the case in U.S. history, when a contracting economy ended a spree of bank expansion, leading to an immediate contraction of the money supply and consequent contraction of aggregate demand. A statement like this makes me wonder if Dr. Prescott believes that booms and busts occur at all.

2. I agree that GDP growth was not extraordinary during the 1990s, a point which is nicely made by Robert Pollin of the Political Economy Research Institute in his 2005 book Contours of Descent, in my view one of the best books about the 1990s economy.

3. Americans have clearly gone through a sea change with regard to their attitudes about saving. To repeat the tired notion that Americans are simply responding to an increase in the value of their assets seems a bit naive, when much of these assets -- especially stocks and real estate, about 75% of total household wealth -- are significantly overvalued. Indeed, according to the Financial Markets Center, the years 2000-2002 are some of the worst years for household wealth since 1950, with net worth declining 1.7%, 2.4%, and 3.9% respectively. Dr. Prescott says this myth is due to a misconceived idea about what it means to save. I'm curious as to what his definition of savings is. Mine would be disposable income minus consumption. With this definition, an increase in asset values is hardly relevant. Especially when the assets in question are notoriously illiquid, as in the case of real estate. Of course, we should also not overlook the point that wealth is quite unequally distributed in the U.S., with the top 1% holding greater assets than the bottom 90% of Americans.

4. U.S. government debt is not big, claims Dr. Prescott, arguing that we should only count privately-held debt in our tabulations. Why is this, exactly? I fail to see how it matters who holds the debt. If the Federal Reserve or other branches of government hold debt, does anyone think they'd be fine with the Federal government declaring their assets null and void? The U.S. government's public debt is, in fact, big: $8,655 billion. Just the interest on it alone was a crushing sum of $354 billion last year. Were we to pay off the principal, it would require additional payments of $172 billion for 50 years. That sounds big to me.

Dr. Prescott writes: "Theory and practice tell us that the optimal amount of public debt that maximizes the welfare of new generations of entrants into the workforce is two times gross national income, or GDP. This assumes 1% population growth, 2% productivity growth, 4% real after-tax return on investments, and that people work to age 63 and live to age 85. Currently, privately held public debt is about 0.3 times GDP, and if we include our Social Security obligations, it is 1.6 times GDP. In either case, we could argue that we have too little debt."

His analysis rests on the supposition that public debt is always undertaken as a productive investment, that will enhance the welfare of future generations. While nothing is impossible, it's almost laughable to characterize the spending of the Federal government thusly. How exactly does the $230 bil in appropriations for the war in Iraq going to help future generations?

I thank Dr. Prescott for a provocative essay on the state of the economy, but I wonder if he's looking at the same U.S. economy that I am.

A new kind of economics

During most of this year, I've worked with my father, Puran Bair, on an exciting new frontier of meditation, applying the method of Heart Rhythm Meditation to understanding -- and influencing -- the economy. We're writing a book called "The Heart of the Economy", which examines the spiritual principles behind the global marketplace.

Our goal is to understand the economy as a whole, in its entirety, embracing all aspects of the economy, leaving out nothing. The problem with this is that economic theory is far too limited to include all facets of the economy. Every economic theory proceeds by identifying economic or social phenomena to explain, and by positing cause and effect relationships. All theories share this feature; it’s what makes theory valuable. Theory is by its nature a generalization, and hence a simplification, of reality. Reality is messy, contradictory, and complicated. Theory is relatively neat and straightforward. Yet every theory has its limitations, failures, and omissions; adherence to one theory often creates areas of blindness, as a theory naturally focuses your attention on only one portion of the complex whole.

Economic theory is, of course, a product of the human mind. While we have the greatest respect for the mind and its creations, we must recognize that the mind has its limits. A brilliant thinker may be able to understand how a few variables exercise an effect on a particular cause, but what if the causes are themselves effects of other causes? What if there are thousands -- or millions -- of causes, each one continually changing as it interacts with other causes and effects? What if many of these are difficult to measure, or unobservable? What if the acts of observation and theorization are themselves causes, which then interact with the millions of others? This is the situation with any complex system such as a modern economy -- indeed, almost anything worth studying will involve these issues of complexity, perception, change, and contradiction.

Practioners of a theory generally deal with this by admitting the theory is incomplete, focusing on the parts of the complex system where practitioners feel the theory is on solid footing, ignoring limitations of the theory, or calling for more research to better understand areas that are weak. Of course, new research opens up new problems; new theories arise, which focus on new issues, asking different questions, or focusing on a different set of cause and effect relationships, and hence deriving different conclusions about the same phenomena. Adherents of each theory then do battle, attacking other theories while defending their own.

We seek a different approach. We don’t want to be limited by any particular theory; we want to draw upon the whole of economic theory, as well as the lived experience of the billions of beings who co-create the economy each moment. We want to embrace all and exclude nothing. This is where the science of economics ends and the science of mysticism begins.

Since the mind is too limited to include all causes, all interactions, all experiences that relate to the economy, we must use a different faculty: the heart. By ‘heart’ we mean the essence, the vital core of our being, without which we cannot exist. The heart is the center of feeling, the key to our physical existence, and the seat of our individuality. The heart contains all the feeling that there is. The deeper you go into the heart, the fewer boundaries and restrictions there are, the fewer words and labels there are attached to emotions, until you arrive at a vast pool of pure emotion, which contains every feeling in its ultimate state: perfect, infinite, and timeless. You discover that your own heart contains much more than you’ve experienced, yet you feel it all. The heart is breathtaking in its glory, sublime in its sensitivity, powerful and dynamic in its enthusiasm and motivation, profound in sympathy and compassion, and tender in the love it gives. Exploring the dimensions of the heart is the greatest of human explorations.

The heart can hold the contradiction that the mind cannot, for feeling is itself contradictory; love is joy intermingled with sorrow, pain, exhaltation, passion, and so many other feelings it would be pointless to list them all. Our approach is the use the heart to perceive, understand, and ultimately influence the economy. In the webcourse, “The Heart of the Economy”, we taught this application of the method of HRM for the first time. Basically, it involves taking into your heart the whole economy, concentrating on the economy intently until you achieve the state of contemplation, where your heart has become the economy itself. What a quantum leap it is to go from concentrating on the economy, to actually becoming the economy -- it completely confounds the mind. Yet there is more, much more -- for it is possible to feel in the economy its own true nature: balanced harmony. By identifying with the unbounded harmony that is the essential nature of the economy, you enter meditation, not on the economy, but as the economy. As you deepen the experience, you find that you can begin to embody the infinite harmony, manifesting it wherever your consciousness rests. Ultimately, you find that there is no difference between you, the economy, and the limitless harmony; your being encompasses all in the state of unity.

We see economics as, in the broadest sense, any effort to understand the complexity of the economy. Assimilating this experience led us to the conviction that a kind of economics exists which encompasses the full range of human experience, what we call the ‘Five Stages of Consciousness with Heart Rhythm Meditation’. This kind of economics is a completely new way of understanding the economy, one which is inclusive enough to contain all economic theories, all of humanity's experience, all our hopes, dreams, emotions, and ideals: an economics felt deeply in the heart, which then rises to illuminate the mind.