25 October 2008

Escape Velocity: Take it to the Limit One More Time Like Its 1933

Escape velocity: in physics, the speed where the kinetic energy of an object is equal to the magnitude of its gravitational potential energy. It is commonly described as the speed needed to "break free" from a gravitational field without any additional impulse.

In economics, the growth rate at which the energy of monetary expansion exceeds the magnitude of deflationary forces generated by deleveraging of a prior monetary overexpansion.

In both cases, something gets put into orbit.

On 26 September 2008 Adjusted Monetary Base Rises to Record Levels we noted that the Fed was putting pedal to the metal, boosting the monetary base to levels higher than 911.

Here's an update.

When this reaches escape velocity it could be something to see. The last two times the Fed hit the afterburners we had stock market rallies leading to impressive highs.

Here is an interesting look at the history of the monetary base.

Hopefully the Fed has learned to allow the liquidity to percolate a little to trickle down to the real economy before yanking it back. We believe that this was the hypothesis of Friedman and Schwarz.

When the Fed does put on the brakes to stop the growing inflation, it might be even more impressive for those of you who were not around when Paul Volcker did his interest rate exercise in monetary restraint. Hint: zero coupons were a great buy at the top.