"Liquidity Trap" is Fast Approaching

When velocity is low the nation essentially winds up in a “liquidity trap” which is a situation where monetary policy is unable to stimulate the economy either through lowering interest rates or increasing the money supply. This was the condition that Japan found itself enveloped in from 1989 to present. We expect the same problem in this country and hope (really hope) to be wrong. Words: 672

So says Comstock Partners (http://comstockfunds.com) in an article which Lorimer Wilson, editor of www.munKNEE.com, has reformatted below for the sake of clarity and brevity to ensure a fast and easy read. (Please note that this paragraph must be included in any article reposting to avoid copyright infringement.)  Comstock Partners go on to say:

Government Debt Replacing Private Debt As the Major Problem
We have been predicting for over 4 years that the government debt (including public, gross, and state and local governments) will increase substantially, while the private debt (all forms) will roll over and decline substantially [and that is what has, is and will continue to happen well into the future].

No Inflation Foreseen in Near Term
Most bears on the stock market are fearful that, [with] the Fed printing so much money, this will result in potential runaway inflation. We, on the other hand, do not think the results of the Fed’s balance sheet increasing through quantitative easing (QE) will result in inflation in the next few years, although it could very well be a serious problem further down the road. We believe the private sector debt will continue to decline (deleverage) regardless of what the Fed and Administration do to attempt to jolt the economy.

The reason that the attempt at money printing to juice the economy will not work, in our opinion, is that the whole private sector is frozen due to the fear of losing more money. Corporations are continuing to build up cash positions and individuals are afraid of taking risk in this environment…

Quantitative Easing Has Failed
The Fed believed that Quantitative Easing (QE) would stimulate the economy but in the current credit crisis QE is not working as well as the Fed and Administration expected. While it has succeeded in jump-starting the monetary base it has failed to increase the money supply or velocity (the ratio of economic transactions to the money supply). Thus, while the banks now have the ability to make new loans, not enough qualified borrowers are interested in borrowing money, and banks are not willing to loan money to anyone that is not a prime borrower.

Velocity of Money is Needed
What we need to stimulate the economy is “velocity” which measures the rate at which money in circulation is used for purchasing goods and services. The velocity of money is computed by dividing the nation’s output of goods and services by the total money supply (circulating currency plus checking account deposits). Velocity of money is also influenced by interest rates. When rates are low, people hold more money in cash, when rates are rising, they put more money in interest paying investments.

A “Liquidity Trap” is Developing
When velocity is low the nation essentially winds up in a “liquidity trap” which is a situation where monetary policy is unable to stimulate the economy either through lowering interest rates or increasing the money supply. This was the condition that Japan found itself enveloped in from 1989 to present. We expect the same problem in this country and hope (really hope) to be wrong.

If we are lucky we will be able to go through the slowdown we expect (or double dip) and repair the household balance sheets enough to grow out of this mess in less time than it is taking Japan.

*http://comstockfunds.com/default.aspx?act=newsletter.aspx&category=SpecialReport&AspxAutoDetectCookieSupport=1

Editor’s Note:

• The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
• Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above.