The Great Recalculation debate

This debate about why we deflated starts with Arnold Kling and his theory about a recalulation. His theory, as near as I can tell, states that we are in a recalculation, tying to find production systems for goods that meet stability requirements. Something is not working in the economy and we have stopped to figure out a better way. He has a summary, and I will link to it in this post when I locate it.

On the other side of the debate are some monetarists who think we are recovering from a mild recession mad much worse by central bank mistakes.

The chart above is the central issue. The chart shows the amount of financial paper in the market and the velocity at which that money changes hands. The switchover point is the point of collapse for the current economy. In QM Theory, we might say that money velocity is the transaction rate(s), and total money is proportional to the lot size for each transactions. The deflation event consisted of slowing down the number of transactions and increasing the size of each transaction, (in standard units of Good). Hence the yield curve shrinks and the short end has zero interest rate at the one year term, rather than the overnight term. Essentially, the economy is seeking economies of scale by reducing the number of steps in the production of goods.

In QM Theory, then, we expect the transaction rates for all goods to fall in a general deflation, not necessarily just money. The velocity computed above is based on money, but I would expect the same velocity collapse in shoelaces as well as other goods. In particular, I think that oil collapsed and seeks economies of scale. John Taylor expressed it succinctly when he said "everything slows way down", the economy wants to mainly go wholesale, the retail sector cannot find an equilibrium.

Now money and oil are both highly correlated with economic activity. We need money and transportation technology to go to the store. Did something happen to money or oil to cause the deflation? That is the question.

More later.