Economy Tanking as Politicians Look the Wrong Way

Recent economic commentary has merely served to demonstrate once again how bad our economic pundits are. Devoid of any critical faculties they relentlessly parrot the fallacious doctrine that consumption is the key to economic recovery. Every movement in consumption and consumer sentiment is monitored as carefully as a doctor notes the pulse of a feverish patient. It never occurs to them to question the method of national accounting. It never crosses their minds to consider that omitting from the accounts the masses of spending on intermediate goods just might be a terrible error, just as they never raise the simple question: "If the accounts are value-added then how can they be gross?"

Failure to see the gross error at work must result in erroneous conclusions. For example, Greg Evans director industry policy and economics at the Australian Chamber of Commerce and Industry, claimed that the Rudd Government's initial $10.4 billion spending binge saved the economy from a steep contraction. George Megalogenis — and economics writer for The Australian — argued that the financial crisis was caused by consumers who "closed their wallets across the world in the December quarter" (The live now, pay later trap, 21 March 2009).

From the earliest days of the so-called "business cycle" observers noted that the higher stages of production — particularly the capital goods industries — not only felt the first impact of a recession but the drop in output in these sectors greatly exceeded the contraction in the consumer goods industries. We are witnessing the very same phenomenon today.

If Megalogenis were right then the closing of "wallets across the world" would have preceded the contraction in manufacturing. Yet manufacturing in the US has been contracting for 13 months and for at least 9 months in Australia. According to Greg Evans' logic Rudd's $10.4 billion spending splurge should have seen manufacturing rebound. Instead it continued to contract. The table below shows what an awful state manufacturing is in.

Moreover, we can expect the situation to worsen. In response to a downturn it was the central banks' rule to lower interest rates which in turn would stimulate industry and trigger an economic recovery. In simple English, central banks would 'steer' the economy by manipulating the money supply. It should be stressed that monetary expansion is the heart of this monetary policy.

The following chart shows that the money supply has been comparatively flat for sometime. We can see that in May last year the Reserve raised M1 and bank deposits significantly but then let them go flat again. Of particular interest is that the sudden increase in the monetary base that started last September had no effect on M1 or bank deposits, at least up to January. Should this situation continue one can expect the Reserve to once again lower interest rates.

Source: Reserve Bank of Australia.

It should have been obvious to our economic commentariat that faced with a flat money supply manufacturing would eventually contract and that this contraction would not only precede the contraction in consumer spending it would be proportionally much greater. This is borne out by the figures. Manufacturing has suffered a significant decline while in comparison consumption remains stable.

All that Rudd's spending did was to increase consumer purchases. Desirable as this is from the point of view of the consumer it does nothing for economic growth even though it can cause GDP to rise. What matters is not consumption but spending on projects that raises the value of labour's output. This and only this can raise real wages. Encouraging consumption at the expense of savings will retard this process.

Rudd, like Obama, is following in the destructive footsteps of Gordon Brown. Australia, the UK and the US are being led by economic and historical illiterates, men who are criminally ignorant of how free economies functions and the forces that destabilise them. Unfortunately our media commentators are every bit as bad.

Comments

[Jason Rines...:]

"What matters is not consumption but spending on projects that raises the value of labour's output. This and only this can raise real wages. Encouraging consumption at the expense of savings will retard this process."

Correct. After WWII the U.S. was heavily in debt. It was the wartime innovations such as the Computer, Jet Power, Rocketry, Space exploration, Radar etc that created entire new sectors of skilled jobs or bolstered existing sectors facilitating demand. Higher paying skilled jobs allowed the citizens to pay down the public debt. The current strategy of all or nothing gamble on QE and deficit spending (which historically does not work when a nation is already at this point) only works when the productive portions of the economy are stimulated to create such innovation. Unfortunately, those in charge of the financial system and there paid for politicians are looting the Treasury. So the $2 T in real wealth that could be utilized to fund the innovators is mostly already been transferred out of country. What a disaster... American citizens will be paying $10 for a loaf of bread and a gallon of gas within the next three years. Corporate chronie capitalism (or call it mercantilism) hates competition and these are the blinders of our nation and those advising the politicians on 'what to do' about this crisis.

Mar 30 12:10 PM

[roywil:]

Perfectly presented. Is anybody listening?

Mar 30 02:11 PM

[CJJ:]

Why don't you just hope some magic comes and makes everything better.
The same people who say 50% of the economy is worthless say to just invent something to make the economy more efficient and higher wages and "real" growth will commence.
Talk abou politicians who lie.
I guess the good thing is you're trying to lay out steps for progress unlike the people who really just want the world to cease from spinning on its axis.

Mar 30 10:25 PM