Recent economic prosperity was primarily driven by growth in the financial economy -- increased money supply augmented the rapid growth in and innovation of financial techniques within the banking system, which then increased the velocity of circulation. This increased the value of the real economy by increasing prices, and also by stimulating expansion in the supply of goods and services.

The GFC has sharply reduced the financial economy; specifically it has decreased the velocity of money. The reduction in the financial economy necessitates a corresponding reduction in the real economy, initially in prices and ultimately by reducing the quantity of real goods and services. Falling prices of financial assets (claims on real goods and services) and, more recently, reductions in production volumes reflect the required economic adjustment process.

Government actions, however well intentioned, seem primarily to be based on the recognition that Ponzi or pyramid games are only bad if they end. All efforts are now seemingly directed at keeping the game going for as long as possible!

The stimulus packages create different challenges. Governments must also borrow to finance their spending. Many countries implementing fiscal stimulus packages already have large budget deficits and also substantial levels of outstanding public debt.

In 2009, governments around the world will have to issue $3 trillion in debt. The US alone will need to issue around $2 trillion in bonds (a staggering $40 billion a week!). This compares to around $400-500 billion of annual debt that the US has issued in recent years. This debt must be issued at record low interest rates.

China, Japan, Europe, and other emerging countries have been major buyers of this debt. It is not clear whether they will continue to buy US government bonds, at least at previous levels.

In 1976, Prime Minister James Callaghan delivered the following grim assessment of Britain’s economic situation, which is still relevant today: "We have been living on borrowed time. We used to think you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candor that that option no longer exists."

Government actions, however well intentioned and significant, may entail pouring water into a bottomless bucket.