So let me come clean and highlight three questions that perplex me. The answers to them may well shape the economy in the years to come…

…If you find an economist who says he knows the answers, listen carefully, but be skeptical of everything you hear.

Now I am not an economist, I’m an engineer. So, like Socrates and unlike economists, I know that I don’t know the answers. But I do have opinions, which I will venture.

How long will it take for the economy’s wounds to heal?

A very long time, because the economy’s problems are primarily social and political – fiscal and monetary policies are symptoms, not the disease. Real incomes have not grown for twenty years – growth in consumption has been funded by debt, not earnings. Incomes have not grown because investment has been lacking and the quality of the workforce has been steadily deteriorating. The economy has not even begun to heal, despite the best efforts of the Keynesians to have the government spend its way to prosperity. The U.S. has given up its postwar role as the global manufacturing powerhouse and now needs to figure out what its role will be in the global economy – by the way, policeman is not it – and invest accordingly. I don’t know what that role will be, but I’m pretty sure that the reduction in consumption needed to allow the US to both live within its means and invest for the future will be painful and unacceptable within the present political and social context. Only when this conundrum is resolved can the healing begin.

How long will inflation expectations remain anchored?

For a long time. Yes, commodity prices have risen dramatically as a result of the Fed’s policies, but the correlation between commodity prices and consumer prices is historically weak. So long as unemployment remains high and the availability of credit remains insufficient to re-create the housing bubble conditions, wages will remain under pressure and businesses will lack the pricing power to get general inflation going.

How long will the bond market trust the United States?

Well I don’t think the bond market exactly trusts the United States. It is more that the alternatives look even worse. Our trade partners end up holding dollars and have to do something with them. They will keep buying U.S. assets until we turn the trade deficit around. I don’t see that happening anytime soon. So long as the real estate market continues moribund, the Fed will need to keep recapitalizing the banks, which means lending them the money to buy and hold Treasuries so that they can make money off the spread without being required to commit scarce capital.

All the folks who are panicking about inflation and the bond market (presumably including Mr Mankiw) are drinking the Keynesian Kool-Aid – believing that the economy is “recovering.” The state to which the economy is presumed to be “recovering” was generated by a debt bubble and the Fed seems intent on preventing the bubble from deflating. It will fail. Somewhere along the line, the debt/GDP ration has to come back into line. It seems unlikely that incomes will rise enough to achieve this, even on a nominal basis. So debt has to come down. That will be tough, and massively deflationary.

We’ve had a “tremendous glut” for quite some time. The end of QE2 is in sight, is what he should have said, and so the potential that the supply of free money from the Fed will soon be drying up is encouraging speculators to take their profits and head for the Hamptons for the summer.

Equities were little affected, considering. Treasury prices remain firm, despite Bill Gross’ and Jim Rogers’ repeated disparagement. The inflation meme runs deep in these guys. I hear second-hand (I’m not paying for his letter) that even Dave Rosenberg has capitulated to it. I’m just a simple soul. If both QE1 and QE2 sent bond prices lower, it seems not unreasonable that the absence of QE will send them higher, although it is counter-intuitive.

The economy continues to languish despite the best efforts of the propagandists to show otherwise. Speaking of whom, the WSJ was caught by an alert blogger blatantly distorting and misreporting the words of Timo Soini, of the True Finn party that threatens to upset the EU bailout applecart. This is a good example of why you should take anything you read in the mainstream media with a very large shaker full of salt. By the way, especially in the original version, Mr Soini comes across very well, I’d vote for him any day. Well, so long as I don’t have to live in Finland, I’ve been there. They have serious winter.

Who are they kidding? Either simply pay a direct subsidy to these countries to allow them to maintain their lifestyles in excess of their ability to pay, or get them to reduce their lifestyles to the level that they can afford from their own earnings. Those are the choices. Un-repaid bailouts on top of bailouts are simply a euphemism for direct subsidies. I suppose the politicians think that the proposed payers, the taxpayers, are incapable of figuring this out.

Unemployment claims rose again today, coming very close to the 500,000 mark. This despite Mr Bernanke’s assertion that the economy is recovering. Is it possible that he is wrong about that, too? And that as government “stimulus” spending winds down, so will GDP, just as it has in Europe?

Is he right about anything?