The Little Known Corollary to Newton's Laws of Motion

I think we should blame the entire economic mess on Sir Isaac Newton and those damn apples.

If it wasn't for Isaac Newton sitting under a tree and getting bopped by a Macintosh (or Granny Smith) we would never be in the sinking boat we are in. That little bump on the head forced Sir Isaac back into the library where he famously developed his laws of motion:

• The 1st law is Every object in a state of uniform motion tends to remain in that state of motion unless an external force is applied to it.
• The 2nd law is The relationship between an object's mass m, its acceleration a, and the applied force F is F = ma. Acceleration and force are vectors (as indicated by their symbols being displayed in slant bold font); in this law the direction of the force vector is the same as the direction of the acceleration vector.
• The 3rd law is For every action there is an equal and opposite reaction.

Well, Sir Isaac would be proud. The 1st law worked like a charm - our economy kept humming along until a couple of evil traders at AIG applied an external force to it - greed. The 2nd law probably has something to do with the fact the more money those AIG/Citibank execs made, the faster the economy would crash. The 3rd law also worked as expected - for every dollar those AIG/Citibank/Lehman execs took another subprime mortgage was issued and another home would be foreclosed.

Little known is the corollary that comes with Newton's third law - his Third and a Half law - sometimes the reaction is not so equal.

Life comes with so few guarantees - Death, Taxes, The lunacy of Michelle Bachman - and now probably inflation. We are starting to hear that the economy has crossed some "invisible" threshold, that things are getting a bit betters, the we are not looking down the precipice, that everything's coming up roses.

Well to quote Tom Coburn (AH-Oklahoma) via Ricky Ricardo, someone's got some 'spalining to do. Let's take a quick look at where we stand vis-a-vis the economy.

When George W. Bush was sworn installed into office on Jan 21, 2001 (the real day that will live in infamy in American history) - the Federal deficit stood (the amount of money the government owes via debt instruments like T-Bonds) at $5.7 trillion and the Federal budget had a surplus of $128 billion.

Fast forward 8 years - and George W. Bush waves bye-bye to the suckers he swindled in the US and retires to his guarded mansion in Dallas (with both a hefty pension and Secret Service protection on the taxpayer dollar) after literally running the country (like he did to every company he owned) into ground. His checklist included a useless, immoral (and expensive) war in Iraq, a fruitless, misplanned (and expensive) war in Afghanistan, a massive, poorly-managed (and expensive) new bureaucracy known as Homeland Security, and gazillions in (expensive) tax cuts for people that needed it most - those making more than $500,000. These are the people of course would keep the US economy afloat with that vaunted and well-proven form of voodoo economics - trickle down your pants Economics.

On getting out of Dodge City day - January 21, 2009 - the Federal deficit stood at $11.4 trillion (double from the Bush starting point), enough to charge $37,000 to every man, woman, child and asshole (like Bush) in the country. And the Federal budget - which had a surplus in 2001 and was projected to increase that surplus to $700 billion by the time dickwad left office - ended up having a deficit of $1.8 trillion. One point eight trillion of unfunded government spending that will require more debt (see above, Federal Deficit) to be issued by the Treasury.

A mess.

Add on top of this a collapsing economy primarily due to greedy Wall Street execs, a plummeting of consumer spending, high unemployment and a complete shutdown of credit markets to consumers and business.

A fine mess.

I do not know if President Obama is doing the right thing the right way with "stimulus" spending and TARP rescue money for financial institutions - but I do know something had to be done. There was no choice. Leaving aside the good, bad and indifference of the Obama plan (that is an entire post unto itself, left to much smarter people than I) - the fact he is spending such massive amounts of money to (hopefully) turn things around comes with consequences.

There are three way to clean up this debt mess

1. the government can raise taxes (which of course NO ONE ever wants)
2. the government can cut spending (which of course everyone says they want, but no one really wants)
3. the government can print money (which is what every laymen wants because they think that is a good thing and it will not affect them)

As I said for every action - in this case an increase in the debt - there is some sort of reaction. Think Isaac Newton and the apple falling on his head - for every action there is an opposite and equal reaction. Except when it is his Third and a Half corollary - there is a reaction alright, but it ain't always equal.

Since the first two seem off the table due a) government by Grover Norquist and b) government by insuring votes every two years - that means the 3rd way seems the most likely.

Printing money with nothing behind it (meaning economic activity and production and humming along economy) generally means inflation is somewhere down the line. When you are in debt - you like inflation - since it cheapens the value of that debt. And with Uncle Sam is up to his eyeballs in debt - there is a good chance he wouldn't mind a healthy dose of inflation, even though the rest of us are going to hate it. Right now the Treasury has to raise $15 billion a day just to service that debt - you gotta believe the very schmart minds at the Treasury are considering every thing possible to get this under control, including a little dance of inflation.

I have written extensively about wheelbarrels. With that in mind, I would buy stock in some company that makes them. Also buy TIPS, ETFs with TIPS or Mutual Funds that hold TIPS. I bought the Vanguard Mutual Fund (VIPSX).

The likelihood of inflation hitting right now is pretty slim - this is going to be a delayed version of Newton's 3.5 law. With unemployment nearing 10% and factory capacity at 67% - the conditions are not ripe (yet). But they will be. And when it hits - one of the outcomes will be an increase in interest rates. Which of course will make that 30-year fixed mortgage at 4.75% look cheap and that 6% saving account payout look attractive. Except that $39 loaf of bread might be a bit problematic, as will prices of other goods and services as corporate borrowing becomes very expensive.

And finally - one of the worst outcomes of inflation could be a collapsing dollar. If inflation gets out of control (do you know anyone who wants to own Zimbabwean Dollars? right now $1 US= 37,410,000 ZDs) you will see China and other countries push more and more to actually drop the dollar as the world's premiere currency instead of just threatening to do it (again that is another post).

And that collapsing dollar, well it means we have to raise interest rates to attract foreign investors, which means......

But I will leave you with Newton's Fourth law - The only thing worse than an inflationary economy is a deflationary one.