E Economic Theory Is Dead. New Normal Means No Recovery

Economic theory is dead. It is like an emperor who has been stripped of his clothing. It is nothing of consequence in the New Normal.

And that bodes ill for recovery. Before I get into John Mauldin's timely comments about this sorry state of affairs, we can look to see if monetary theory still applies.

John Maynard Keynes was right about monetary theory in his time. But that was then and this is now. Somebody needs to prove me wrong but I don't think they can until the powers that be change the rules.

Here is what Keynes said, paraphrased:

When interest rates are low, the opportunity cost of holding money is low, and the expectation is that rates will rise, decreasing the price of bonds. So people hold larger money balances when rates are low. Overall, then, money demand and interest rates are inversely related. [Emphasis mine]

Well, it ain't happening that way folks. Bonds are being hoarded even when interest rates are negative, in Europe. And US bonds are being hoarded. Interest rates are low, and real rates are likely negative, and Keynes rule does not work now. The rules have changed, and unless they are changed back, money demand and interest rates are no longer inversely related.    

 The New Normal has forced the rules to be changed. What is the New Normal? The New Normal at Google Search is defined this way:

 A previously unfamiliar or atypical situation that has become standard, usual, or expected.

Why are economists, and investors who listen to them, expecting interest rates to rise? Because they live in that parallel universe of old. That rule does not apply here and now. They are fossils, dinosaurs, and they are wasting everybody's time.

Interest rates and money demand are not inversely related when bonds are being hoarded for collateral. Keynes didn’t have that issue, apparently.

But Keynes got one thing right. Applying it to the New Normal is chilling. It is positively chilling. Keynes said rates rise during expansions. But since they are not rising, we can be assured that we will never have an expansion! Never, never, never, never.

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Disclosure: I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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Dallman Ross 4 months ago Member's comment

Well-argued. I fear you could be right.

Gary Anderson 3 months ago Author's comment

Yes Dallman, sorry for the delayed comment. I certainly hold that fear. We are in a new environment, and who knows where it will lead?

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