While I am somewhat pessimistic about the U.S. economy in the short run, I consider myself to be a long-term optimist.  I think there is still something of an entrepreneurial spirit in America that does not exist to the same degree elsewhere.

It is socially acceptable to make a lot of money in the United States.  In fact, it is something that many aspire towards.  Of course there is class warfare, but it is to a much lesser extent than in many other countries throughout the globe.

There is unquestionably an economic mess in the U.S.   The national debt is approaching $20 trillion, while the unfunded liabilities are likely in excess of $200 trillion.  At some point, the U.S. government is going to default on some of its promises.

In the more short run, there is also the issue of the Fed’s massive monetary inflation from 2008 to 2014, which likely created huge malinvestments that will eventually need to correct to reflect actual consumer demand.

This will all be self-correcting to a certain extent.  The Fed can only print so much money without risking massive price inflation, or even hyperinflation.  Even with money printing, there are limits.

When price inflation finally shows up in a significant way, and interest rates go higher, then the Fed will finally be forced to keep a tight stance, as it did in the late 1970s.  Congress will essentially be forced to scale back and actually cut the budget.  I know this sounds hard to believe now because they have kept this game going for so long, but the day will come.

My biggest fear is that we will be like Japan.  I don’t think we will be, but that should be our biggest worry.

The story of Japan almost seems to practically refute all of economics, if such is possible.  They have had massive monetary inflation just in recent years, while the debt-to-GDP ratio is in the neighborhood of 250%.  Meanwhile, price inflation has actually remained low and interest rates are near zero, or even negative in some cases.  It almost doesn’t seem possible.

But if you study Austrian school economics, the most important thing to understand is that economics is really the study of human action.  And for this reason, the story of Japan doesn’t refute economics.

If anything, the story of Japan refutes Keynesianism.  The Japanese government and Bank of Japan have done exactly what the modern-day Keynesians (such as Paul Krugman) say is supposed to be done.  They have ran huge deficits and engaged in huge monetary inflation. Yet, the economy there continues to suffer dramatically.

The problem with Japan is that the people there apparently have way too much faith in their government and central bank.  They buy bonds at ultra low interest rates.  I don’t understand if they just don’t know better or if it is some kind of patriotic duty.  I guess the bond investors have been right in a sense up to this point, just as any investors in a bubble are right, as long as they aren’t still holding their investments when the bubble eventually bursts.

At some point, things are going to come crashing down in Japan.  The problem is that a correction should have happened a long time ago, and it should have been allowed to happen.  The massive government spending and debt and inflation is just making the problems worse, as resources are continued to be misallocated.

From 2008 to 2014, the Fed mostly got away with its huge monetary inflation.  Much of the new money went into bank reserves.  This, coupled with the increased demand for money, has kept consumer price inflation relatively low.

The problem is that resources are still being misallocated, as capital is diverted away from the private (voluntary) sector.  So even though there is low consumer price inflation (according to government statistics), the Fed’s inflation is still very damaging.

I don’t think it will be like Japan though.  I don’t think it could last as long.  The Fed has actually kept its monetary policy tight for two years now.  If the Fed goes through with another round of massive monetary inflation, I think Americans will be more likely to not hold their money for as long.

This will eventually happen in Japan too, but I think the population is too trusting of its government and its currency.  They are fearful, and rightfully so, but they have a high demand for money because of this.  The fear is more about the economy without consideration of the depreciating currency.  At some point, there will be fear that will include a fear of a bad currency.  That will lead to greater velocity, as money changes hands more frequently.  It will bid up prices.

I don’t want a scenario like Japan to happen in the U.S.  It just prolongs the pain.  We should hope for a correction that cleans out the bad investment.  If the Fed is going to print money (digitally speaking), we should actually hope for higher price inflation, so that at least the Fed will get blamed.

Americans should hope that their government and central bank will do the opposite of the Japanese.  But if that is not the case, then we can at least hope that Americans will not be as trusting, and that our fear will result in less desire to hold dollars in a bank account.

If the central bank is going to engage in monetary inflation, we are better off feeling the pain in terms of higher consumer prices, rather than have the misallocation of resources drag on for a long time.