Push on a string or pull on a rope.

The Fed is not going to save us from this economic contraction. It can't. It has done everything conceivable to prevent things from getting worse by buying government debt and at one point backing essentially the entire commercial paper market (might still be for all we know). If the economy was going to spring to life from monetary action it would be sprinting and tap dancing.

UNLESS...

the economy is in a different mode from what it has been in since the end of World War II. Which it is. An economy operates in two different modes. Normally, when things are going well, the intent is to maximize profits (if you are a company) by expanding production or utility (if you are a consumer) by buying and taking on consumer debt in the form of credit and loans.

But there is another mode- instead of maximizing profit/utility the current mode (again, not seen in the US since the Great Depression) is to minimize debt. This insight, made by Richard Koo from his analysis of the Japanese economy and the Great Depression, aligns perfectly with the behavior we are seeing now. The Fed, now as in the 30's is in a position where it can make the situation worse by forcing further contraction, but cannot drive expansion. like a string, you can pull on it, but can not push against it.

The reason is simple- if you are leveraged to the hilt as a consumer, and someone offers you another loan the only reason you would take it (sensibly) is if you could refinance an existing loan at a lower interest rate. And if you are unemployed then your options are even more limited. Businesses are in the same boat, particularly in the banking sector. Bank of America is hesitant to make loans because it needs all the cash it can hold on to, after all, the bad loans it made (or Countrywide made) need to be written down, and the last thing it needs on its books is more risk. So companies and households hoard cash.

What sector is left to push the economy forward? You guessed it- government. And here's the most infuriating part of that- all through the '00s the government should have been battening down the hatches against debt and instead it fanned the flames with regressive tax cuts, two wars, and deregulating the finance industry to allow it to expand leverage (debt) by using peoples savings as collateral.

Its no wonder that trust in government is so low, but here is another grain of salt to rub into the mood. In this day and age if you don't have the backing and protection of a strong central government then you are going to lose on the global stage. If you think small government is better and no government is best, then take a look at Somalia. If you think bigger stronger government is worse then look at China.

I know, I know- every Tea Party whiner will cry about "government spending" and "wasteful spending". You think the private sector isn't wasteful? I think HP just blew billions of dollars on its WebOS investment. I've worked at firms where rivers of money flow off cliffs, so it is foolish to pretend that governments are always wasteful and the private sector isn't.

Finally, there is a difference, and a crucial difference, between spending and INVESTING. Instead of an economy where people buy trinkets and cheap imported shoes and too much sugary snacks at the level of the retail environment (buying imported crap) there is an alternative. Is is perfectly viable to have an economy driven by spending on infrastructure investment that promotes a virtuous cycle of domestic spending on steel and concrete to repair and replace our crumbling highways and bridges, make trains and rail lines, high density housing and water and sewage systems, fiber optic cable for improved telecom, and the jobs and worker skills needed for all of that.

Its our collective choice, America- a third world lifestyle buying someone else's cheesy exports or get a decent tax structure in place, control the waste in our healthcare system (socialize it) and rebuild the country our grandparents built that made this country great. And if you DO need a new BluRay player you might pay a little more, but at least you are more likely to have a job to pay for it in the first place.