"The Velocity Factor"

In John Mauldin's latest Thoughts from the Frontline newsletter, "The Velocity Factor" (PDF), Mauldin argues that the Federal Reserve "not really expanding the money supply, so far" because the expansionary effects of Federal Reserve actions so far have been offset, to a large extent, by the decrease in the velocity of money as financial innovations that increased velocity (e.g., securitization) are being unwound. Mauldin asks,

How much monetization will be enough to halt deflation and overcome the slowdown in the velocity of money and the rise in personal savings? No one knows. There is no fancy equation or model which can encompass all the factors, or at least not one I know of.

We will also soon see which of the additional deflation-fighting policies that Bernanke outlined in his 2002 "helicopter" speech the Fed will adopt. It is highly likely that we will see more than a few of them. It is quite possible that we will see the Fed start to set rates on longer-term bills and even bonds in an effort to pull down longer-term rates for corporations and individuals.

We will explore all the deflation-fighting options and what the results might be in future letters, but remember that there will come a time when the Fed will have to "take back" some of the liquidity they are going to provide. That means we could be in for a multi-year period of slow growth after we pull out of this recession. And this recession could easily last through 2009.

Here is a link to the 2002 "helicopter" speech by Ben Bernanke that Mauldin referred to above: "Deflation: Making Sure "It" Doesn't Happen Here".

McCain Should Bring Back the Straight Talk Express

Can a Republican married to a beer distributorship heiress win the presidency by railing against Wall Street and otherwise engaging in populist demagoguery? That doesn't seem to me to be a promising strategy. Why not engage in a little of his famed straight talk and point out that one of the causes of the current crisis was that millions of Americans borrowed recklessly and then walked away from their obligations?

Obama has followed a similarly dishonest populist tack, as even his ardent supporter Andrew Sullivan acknowledges,

Instead of telling Americans in no uncertain terms that their recklessness has consequences, he too is peddling populist blather. He too will spend money the government doesn’t have to protect small-time borrowers from the consequences of their folly. He too blames companies that operated within the rules as dictated by Congress for maximising their profits by irresponsible lending.

All the more reason for McCain to try to differentiate himself by not pandering, but that would require smarter positioning than his campaign has demonstrated over the last week. The smart thing to do now is to be statesmanlike and express support for the bipartisan rescue being negotiated this week. No more stream-of-consciousness musings about firing administration officials -- if anything, express confidence that we're in good hands with Paulson and Bernanke. The next step is to start looking ahead, for the next bounce of the ball. That means acknowledging, as Mark Cuban mentioned in his blog, that this rescue will be a fiscal game changer¹. The economic proposals made by McCain and Obama that were unrealistic before won't become any more feasible after Congress allocates ~$700 billion to buy up distressed mortgage debt.

McCain can benefit from recognizing this reality first. That may require him to walk back some of his tax cut proposals, but that will probably cost him less politically than it will cost Obama to walk back his promises, simply because Obama has made more generous promises to a broader cross-section of the electorate. A Republican candidate who maintains even the faintest claim to fiscal conservatism, as McCain once did, can't beat a Democrat in a Santa Claus contest anyway, so why try? Why not propose policies that will lead to a stronger, stabler economy in the long run, and trust the American people to vote for them instead of trying to promise them a bigger free lunch than the other fellow?

¹It's also important to distinguish between the fiscal response to the current crisis, which needs to be hammered out within days, and the regulatory response, which doesn't and which would benefit from a thoughtful deliberation by the next administration and the next Congress.