Great article in the Washington Post about moral hazard on the anniversary of the collapse of Lehman Brothers. Basically, the government said it wouldn’t back up Lehman and when it didn’t, the collateral damage to the economy was so massive that the government came back, begging for forgiveness, and promise no more Lehmans.

The result? Banks could get riskier than ever. Read the article and more about what moral hazard is on the ol’ Wikipedia, and then suggest what you think the government should do. If it lets banks fail, we could have massive and deep recessions. If it doesn’t, then they’ll carry on with the bubble party because they know there’s a sugar daddy waiting to give them a bailout, no matter what.

A few years ago, we had a pretty high velocity of money. That meant, as a nation, we spent our dollars pretty rapidly. We had a lot of financial activity, and it kept our economy scooting along at top speed.

Now, we have low velocity of money. That means we’re not spending like we used to. Our demand is really low, and we’re in a recession.

The USG is going to start printing lots and lots of money. Given our current velocity of money, that will help fend off deflation… if we’re lucky. Once our velocity of money picks up again with an uptick in demand, though, we could be looking at the possibility of almost instantaneous high inflation.

Ouch and ouch, in other words.

“It will not be too bad this year. Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that. So we can’t lose.” – Lou Jiwei, Chairman of China’s sovereign wealth fund

Translation: Oh no, not again.

I thought we were going to deal with the damage from the housing bubble, which came about because we didn’t deal with the dotcom bubble properly. Now I read this and I guess we need to gear up for the commodity bubble that will be coming up soon. Eventually, we’re going to run out of bubbles or the ability to create bubbles and the whole thing comes crashing down that much harder.

Get ready for more Minsky Moments in the future. And if you don’t know what one is, fire up the Wikipedia and add something to this discussion when you’re familiar with the concept.

Krugman seems to have come back to earth. His latest NY Times article is a lengthy discussion of how economists, by and large, got it wrong about seeing the impending financial collapse. Ironically, I’ve only got 6 hours of college economics, 3 of which I CLEP’d out of, and I saw it from a mile off.

The difference? I didn’t pretend to have a numerical approximation for everything. The history was obvious: economic bubbles pop. The dotcom bubble didnt’ properly pop, so wherever the money went from that would lead to a bigger bubble. Lucky us, it went to real estate, where all bubbles go to pop.

But the complete failure of the economic establishment to do the ONE THING they’re supposed to do really disturbs me. You see, economists are supposed to smooth out the business cycles. They are supposed to help us from rising too high and falling too low. Not one of the establishment wonks admitted things were going wrong because of their irrational belief in the complete rationality and efficiency of markets and their participants.

That’s the problem with economics. There’s too much belief in the numbers side and not enough recognition of the game theory side of things. Game theory is part of microeconomics: it should also be part of macroeconomics. Game theory shows how what may be rational choices for an individual can become irrational choices for groups. We just had a spate of irrational group choices and we’re headed for more.

My question is this: if they got it so wrong with the bubbles and the popping, how well-equipped are they to handle what’s up next? And why are they still in charge of things? Is the educational and monied elite that ensconced in our government?

I have a suggestion… how about we just go about disbelieving anyone in power? That way, we can make better plans for our future.

“The US national debt is now over $11 trillion dollars. The interest on our national debt is now $340 billion. This is about at 3.04% rate of interest. In ten years the Obama administration admits that they will add $9 trillion to the national debt. That would take it to $20 trillion. Let’s say that by some miracle the interest on the national debt in 10 years will still be 3.09%. That would mean that the interest on the national debt would be $618 billion a year or over one billion a day. No nation can hold up in the face of those kinds of expenses. Either the dollar would collapse or interest rates would go through the roof.” – Richard Russell

Ouch. That’s if the interest rates stay low. If the interest rates went up by 1%, that would increase the interest payments by $113 billion today and $206 billion in the future. That $618 billion, by the way, would be a third of all tax receipts, so that increase of 1% would mean almost half our taxes would go toward just paying the interest on the debt.

But if we do not run up the debts, we risk an even worse nightmare scenario with crushing deflation – as prices collapse, so does consumer demand and with it, the engine that drives our economy.

But that engine is getting an awful lot of gas… in order to avoid a standstill, we may be driving the economy into a brick wall.

The National Debt Clock.

Dang.

Discuss.