Here it is folks. Our current recession and economic crisis neatly wrapped up in 9 easy to understand slides.
Global Recession – Where did all the money go?
It’s kind of hard to summarize 9 slides when they are short already but one equation stands out at the end. This really does make all our economic issues simple to understand…
mv=pq
In other words, m is the amount of money in circulation,
v is the velocity at which it moves,
p is the price set for goods and services,
q stands for the quantity of economic output.
Here is what I see that changed the equation.
Velocity slowed down. I have talked previously about the speed of money in my article “Why Politicians Keep Telling Us to Spend, Spend, Spend!!!”
Once velocity slowed down something had to give on the other side. That something was the price of goods and services.
We are seeing this in the price of stocks and real estate right now, and also in cars and other “big ticket” items that most people buy with credit. We will probably see a fall out effect for many other goods and services too. Everywhere except the most basic commodities that are necessary and where demand does not change much.
And here is where governments and businesses are trying to effect the equation.
Most people don’t care about velocity, they care about price. Higher prices mean higher profits (in most cases), and higher prices also mean less unemployment (in most circumstances). When the pricing structure comes down (because of slack demand) we have a recession. A recession defined, once again, as a two consecutive quarter decrease in GDP.
So once V came down P had to come down to balance the equation.
To bring the equation back up the government could do something. Increase the money supply. If the equation holds true than an increase in the money supply would cause inflation and would cause the prices of goods and services to come up.
What we are seeing are price increases for certain goods and services, and price decreases for other goods and services. Apparently this isn’t such a great strategy.
Businesses for their part have decreased production. They have shut down plants and laid of many workers. As long as the left side of the equation is fixed, a decrease in production should lead to an increase in price. Simple supply and demand, right?
Well there is a problem. The more people they lay off the less money they have to buy the goods and services they produce. The vicious cycle continues. Changing q won’t do much for changing p in this climate.
What are we setting ourselves up for?
Worst case scenario: Confidence is partially or fully restored and the government really does get money flowing again. M is permanently higher and V increases by some unknown amount.
Prices for goods and services soar while businesses will be slow to rehire people. People will struggle to afford things for awhile until businesses decide to hire people again. People will probably buy more basic goods and services on credit than ever before.
Fundamentally, we will have changed the entire system to have it based on credit more than ever. In other words, we will have to face these situations every couple of years, and people will continually see their buying power erode away.
Best case scenario: We stop throwing more and more money into the supply and let velocity level itself out. We let demand arise organically (instead of artificially through price manipulation) and let business satisfy the need by increasing output.
We will all learn how to pay for things that we get now right now instead of in the future. We will all be forced to be more disciplined in our finances. We will all have to strive a little harder to find ways in which we can be productive members of society.
We will probably have a lost decade where economic growth flatlines, but if we accept the fiscal responsibility we all should, we will all be better off in the long run. If we go with the worst case scenario then we will probably have to face a similar situation in the next 10 years.
Hi Jeremy – The Lost Decades, here in the U.S. in the 30’s and in Japan more recently, were exacerbated by government intervention. The only thing that got us out of the Great Depression was WWII. Who are we going to go to war with to get us out of this mess? Another $30 billion for AIG isn’t solving the problems with the company – and that situation is indicative of the global situation as a whole.
Massive spending budgets to provide governmental services to fearful people who want to be taken care of, as well as taking ownership stakes in everything from health care to financial service companies to the auto industry propel the issue into our grandchildren’s generation. What we’re seeing is a drastic sea change in the economic landscape in this country. People can’t buy basic goods and services on credit if credit isn’t available, as you rightly point out. And they can’t afford to purchase at all when prices increase due to inflation.
The government is moving to be the ‘go-to’ source for everything – need a student loan? Go to the government. How about a mortgage – go to the government. Sick? The government is your only choice. How much salary can you make? The government will tell you. Buying insurance or a teacher’s annuity? The government owns a greater stake in Citigroup and AIG, among others. The heartbeat of America – owned by the government? Anyone bothered by this??! (crickets)
The lost decade could very well be lost generations unless something happens to curb the current plans. Unfortunately, it would seem the current geniuses want to intervene at levels unforeseen, and we’re letting them.
Betsy Wuebker’s last blog post..NETBOOKS – LESS IS MORE THESE DAYS
Hi Betsy,
I will raise my hand and say I am bothered by this spending of MY tax dollars. I am also scared to see where all this will lead. I don’t like the emphasis on rushing to give money that may or may not do any good. As always, we shall see…
Cheers,
Jeremy
the last quarter of 2009 seems promising as we have seen lots of signs of econic recovery against the massive economic recession. i hope that in 2010 all our economies would be back on track. recession really sucks.
Hi Betsy,
we are not letting the government be the ‘go-to’ source for everything. People protest, stand in front of Washington, etc. What are we as a people to do about “what” the government (wants) to do? It is clear they are NOT listening to the people who voted them into office. If you protest you stand a chance of going to go to jail. They don’t want to hear it! The government is going to do whatever they want to. We can’t stop them. People say, vote them OUT of office. We vote them out, then the New Officials just do (more) of the same. Nothing changes, we are stuck with that!
I thought when President Obama first took over the office, he should have let the U.S. go bankrupt and just start (over) again. I don’t see where printing money out of thin air is going to help the U.S. out of ANYTHING. It will just dig the U.S. in deeper and deeper.
I had high hopes for President Obama when he first took over office, but he has fallen short of my expectations, along with other peoples I am sure. I think in the end that the U.S. will go bankrupt anyway. It is just a longer, slower, more painful process this way. To print worthless money for this, just doesn’t make any sense. What is our government thinking? We as a people will pay, pay and then pay some (more) for all of this.
Jeremy, I raise my hand and agree with what you said to Betsy ….100%! I am scared out of my socks, as you can see. I love America and hate to see it come to this!
Susan Glover WA