The wobbling of the stock market, jitters about deflation in Europe, and the sharp decline in the price of oil have renewed doubts about the believability of the economic recovery from the tremendous strains of 2008 and 2009. These were inevitable after the official response in the United States was to increase the accumulated national debt of the country from $10 trillion  where it had arrived, in 2009, after 233 years of American independence  to $18 trillion less than six years later.

Something like a third of that additional debt was not sold at a yield that met the free-market test of attracting arms-length buyers voluntarily on the basis of fair value and the risk-reward ratio. Rather, the Federal Reserve, a 100 percent subsidiary of the U.S. Treasury, bought the unsold bonds and paid for them, not in cash that the government could use to pay its expenses that created the deficit, but in Federal Reserve notes that were largely swapped to banks for cash. Many of these banks had the cash to swap because of funds advanced at the height of the financial crisis to ensure liquidity.

The fact that most of this cash is still sitting in those formerly distressed or at least unstable banks, despite six consecutive years of almost negligible interest rates for substantial borrowers, indicates the lack of confidence on the part of borrowers and lenders in overall economic conditions. The fact that Berkshire-Hathaway has more cash on hand than ever in its history  $55 billion  may be taken as an indication that Warren Buffett, despite his noisy support of the administration, is sitting on his hands and his money-bags waiting for a descent of equity values. (And much of the stock-market rise has been caused by softness in most of real estate and low yields on other instruments because of the governments ambition for low interest rates to avoid an even more stupefying rise in the deficit.)

As I have written here before (and many others have made the same and similar points) it is not surprising that there is a lack of confidence in the reliability of a recovery that has required the infusion of $8 trillion in six years, in debt that in fact has most of the characteristics of a straight money-supply increase, and that in earlier times would have been described as printing money. This is the classic formula for inflation: simply increasing the amount of money in circulation (including assets that can be easily liquidated, such as bank deposits), in no relationship to productivity increases. The other traditional method of inflation is cost-push increases in the cost of everything: an overheated economy.

What we have  massive deficit financing, so extreme that the bond markets wont take it voluntarily, coupled with spurious debt issues that are really just running the presses  is far more dangerous, as it is the result of an under-heated economy and is an attempt to generate demand. Cost-push inflation has too much money chasing too few goods and services, forcing their price up, and what is then called for is a reduction in demand to prevent an inflationary spiral, which can be done comparatively easily, though it is painful to many (usually achieved by just raising interest rates).

Now, corporations and serious people will not borrow even at 2%, because they do not believe in the prospects for genuine economic growth, i.e., a benign cycle of increasing production to fill spontaneously increasing appetites for more goods and services. What we are getting has many of the characteristics of stagflation, as at the end of the Carter era (197881), when the United States was at or near double-digit inflation and unemployment, and interest rates were hoisted up to over 20% to cool out demand. The Reagan tax cuts and defense-spending increases that followed were accompanied by and encouraged an era of rapid technological advances that spurred sharp productivity increases.

Even though millions of jobs were eliminated as obsolescent to the modernized manufacturing and service industries, or inadequately remunerative to American workers and better filled by cheap-labor countries, a net 18 million jobs were created in six years. Organized labor and the left wing of the Democratic party screamed like banshees that all the new jobs were for hamburger flippers, pizza deliverers, or people taking in dry cleaning, but most of the new jobs were related to new applications of advanced technology.

Today, inflation is significant at the basic level of food and other necessities of life, and very strong in the high end of luxury goods: couture, deluxe automobiles (which can now cost up to $1 million), highest-end residential real estate, fine jewelry, and the art market. The majority, who make less than $250,000 per year, and to whose welfare the present administration claims to be fervently attached, is under great strain: Unavoidable costs like the price of milk or of university education are rising quite crisply, but incomes are not.

I believe the sluggishness that is evident is the result not merely of incredulity that the vast federal borrowing and creation and disgorgement of money is really a solution. It is also, rather, the result of the evolution of an economy in which too little that is really saleable or even desirable is produced, and too much of the labor force is mired in parts of the service industry that add little value. It isnt just that there are too many lawyers and stockbrokers and not enough plumbers and mechanics. Ultimately, a society cannot become more prosperous if value is not being added to its economy by an adequate number of employed people. Any extractive and transformative industry adds value, and so do some service industries, but much of finance, consultation, and the operation of the vast civil legal apparatus is just the velocity of money.

With the increasing sale of intangible services, by lawyers, consultants, and other specialists, has come the resurgence of the merchant banks, which is based on companies buying other companies, a process that is generally financed by borrowings or issues of stock or corporate debt and by administrative efficiencies of the enlarged company. The process generates huge commissions to the advisers; the shareholders of the target company are enriched and other investors or lenders finance the transaction, but it is all just the velocity of money: Nobody is adding any value to anything, apart from the company making the takeover, which becomes a stronger competitor in its field (though many of these takeovers prove to have been bad deals, over-priced and not really affordable).

Two weeks ago, I wrote here of the fallacy of the Keynes theory that there was a natural balance in the economy in which there would be minimal inflation and unemployment, and of the Hayek theory that any government intervention in the economy was bound to have negative effects. There is no such balance as Keynes claimed and there never was, and, while Hayek is deservedly an eminent philosopher of individual liberty, it is neither possible nor advisable for governments to fold the welfare system completely or be too neglectful of national defense, including defense-production industries. What the knowledgeable markets are waiting for is a soft landing to the U.S. debt binge and a comfort level that the economy is on a sound footing.

There are, to be sure, some optimistic signs: The progress toward American energy self-sufficiency is clear and inexorable, as long as the authorities are steeled to the more nonsensical keenings of the eco-extremists; and the declining oil price inconveniences the countries that bankroll terrorism, and the Russians. Manufacturing is gingerly returning to the U.S. and the talent and quality of the unprecedentedly productive American work force is undiminished. The number of self-employed, living quite successfully by their wits, such as day traders and specialized craftsmen, is increasing steadily.

But what is needed is preemptive modernization. Obviously, the vast physical establishment and bloated personnel cadres of universities will have to stop. Tuition is $20,000 to $60,000 per student per year: It is unsustainable, it has created another debt bubble, of student loans, and most of the university process is on its way onto the Internet. Many thousands of relatively sophisticated jobs will vanish and vast and portentous edifices will be left in Ozymandian disuse.

Governor Scott Walker of Wisconsin has led the way in curbing public-sector unions. The right to strike should be banned everywhere in the public sector, and all these retrograde, Luddite public-sector unions should be decertified. We should have tax policies that raise the tax on elective spending, and reduce personal and corporate income taxes, in proportions that seriously shrink the deficit; and encourage the return of manufacturing and of oil and other natural-resources production. Defense spending is the best form of economic stimulus, and the cuts in it should stop, though the spending might be apportioned more effectively.

Drastic measures should be taken to consolidate laws and reform the rules of practice so that fewer cases are receivable and the courts function better. I will not subject readers to another airing of my views on the need for a radical revision of the countrys disgraceful criminal-justice system, but the needless squandering of millions of lives in false convictions and over-sentencing must stop. The corrupt fraud of the War on Drugs must end: Legalize all of them but require treatment for hard-drug users. There are better and cheaper ways to punish nonviolent offenders than by imprisonment.

Capitalism is the best system because it best responds to the universal desire for more. But what we have now is a system that has become so contorted by special-interest groups and venal politicians that it doesnt work very well. The mighty garden of the American economy must be allowed to grow, and jobs will be created where they are needed by free-market criteria, not the antlike encroachments of the legal cartel and the gluttonous engorgement of the stock-jobbers (in Jeffersons phrase, misapplied to Hamilton) and asset-strippers.

Financial engineering is necessary and can be artful; gaming the system is not bad but it doesnt strengthen it. The mere velocity of money makes us dizzy, not strong, and redundant transactional activity within the economic marketplace should not be tax-favored. Pure capitalism must be reaffirmed, including by not over-iconizing, at least in fiscal concessions, the brazen golden calf. Let America be America; confidence will return and prosperity will spread.

[email protected]. From the National Review.