Recession, Depression and Monetary Mismanagement

The Institute for Supply Management reports that May was the "16th consecutive month of contraction in the manufacturing sector". Even though the contraction appears to be slowing, the demand for capital goods continues to drop with no sign of a reversal in sight as of yet. Of course, this fall in demand has hit the producers of capital goods. In the meantime, unemployment continues to rise with some commentators expecting it to reach 11 per cent before the year is out and maybe even climb to 12 per cent next year. Therefore the current signs suggest the US could be sliding into an actual depression, if it isn't there already.

It seems that Obama's borrow, spend and inflate policy is proving to be a complete failure. The idea that government borrowing is counter to recession was always a myth. The notion that transferring purchasing power from individuals to bureaucrats and politicians would expand aggregate demand is so stupid that — as George Orwell said with respect to another matter — only the intelligentsia could "believe a thing like that: no ordinary man could be such a fool". And Keynes was no fool. When he spoke of deficits and borrowing it was always with reference to monetary expansion. It's his disciples who keep getting it wrong.

Part of the current problem is that the US economy has accumulated masses of malinvestments that need to liquidated. Pumping money into these failures will sabotage economic recovery, a lesson that Obama and his economic advisors seem incapable of grasping. Of course they could argue — as some are now doing — that the fall in consumer spending combined with the rise in the personal savings rate is holding back recovery. On the contrary, more real savings is just what the economy needs, not less.

A reduction in the demand for consumer goods makes more resources readily available for production and makes it easier to get rid of malinvestments. However, what is being called savings is — in my opinion — largely an increase in the demand to hold cash balances. Given the uncertain state of the economy and the level of personal debt this is a perfectly rational thing to do. Anyone who argues that this process damages recovery is revealing an ignorance of how recessionary forces work themselves out if not hindered or even checked by political decision-makers as happened during the 1930s.

Nevertheless, the myth that the consumer is the economy's saviour lives on. As I tirelessly point out, consumer spending is only about one-third of total spending. It is the fallacious rule that intermediate spending should be excluded from the national accounts that conceals this fact. This has led to the grave error that consumer spending is the driving force behind the economy instead of business spending.

Now if intermediate spending was included we would immediately see that not only is the drop in consumer spending very small in relation to the drop in aggregate business spending but that it followed the latter. Yet the same people who ignore this fact nevertheless call attention to the fall in demand for inputs, which are really intermediate goods. Evidently the contradiction completely eludes them. Therefore "the need for households to return to a normal tendency to consume in order to ensure recovery" is an erroneous prescription.

Unfortunately America is being governed by the most anti-business administration since F. D. Roosevelt. Obama inherited a $4.5 billion deficit and then immediately transformed it into a $1.8 trillion deficit which is about 12 per cent of GDP. Not satisfied with that he set about implementing a borrowing and spending regime that was not only unprecedented and unnecessary but also reckless to the point of smacking of criminal negligence. He then did the manly thing and blamed his predecessor for the mischief. (Obama cultists still mindlessly send me emails asserting that Bush did it. I will get round to Obama's outrageous lying on this matter in a later article.)

As I have said before, watch out for monetary policy. Virtually overnight the very accommodating Bernanke doubled the country's monetary base and in doing so planted an inflationary time bomb. No wonder Chinese students laughed when Geithner told them that China's dollar assets were safe. A monetary expansion of this magnitude would undermine any currency and those students know that. Moreover, so does Geithner.

The Fed's criminally loose monetary policy is closely tied to Obama's unsustainable fiscal policy. John Taylor, a professor of economics at Stanford University, estimated that because of Obama's spending plans, the government would impose a 60 per cent across-the-board tax increase to balance the budget by 2019. Read that again: 60 per cent. There is no way to support this colossal spending binge without resorting to the printing press, which is exactly what the Fed is doing.

The weakening dollar and bond prices are clear evidence that the markets are taking Bernanke's monetary shenanigans into account. (Nor should we ignore the fact that China is surreptitiously accumulating gold and commodities as well as trying to buy into other real assets. It seems that Russia might be doing likewise.) True as it is that the growth in the monetary base has yet to make itself fully felt it has nevertheless contributed to a weakening in the demand for US Treasuries.

When the expanded monetary base turns from a trickle into a river there will be no checking the inflationary pressure. This will lead to an irresistible rise in interest rates which in turn will force down bond prices. What is a central banker to do in the face of accelerating Inflation and the government's insatiable demand for credit? The only way to force rates down would be to buy bonds. But the only way the Fed can do this is by printing more money, which will see investors dropping more bonds. This is not really a dilemma. It is not a choice between equally undesirable alternatives but between sound monetary management and the Fed's grotesque monetary mismanagement.

However, sound monetary management is not sufficient. What is also needed is a return to free market solutions. (It wasn't free markets that created the present crisis but the lousy economics that central banks practise and what politicians mindlessly parrot.) Free markets are to be severely curbed, regulated and bled by taxation. And why? Because in the fevered imagination of Obama's leftists mind only the state can deliver economic growth.

Comments

[whidbey:]

Some excellent points. The debate will rage on while the dollar burns, the temporary reprieve notwithstanding. This administration is not about fiscal accountability it is about restructuring the society and governmental roles.

Jun 22 09:34 AM

[sether:]

Freemarket fetishist and econocaust denier Gerard Jackson attempts once again to claim that it wasn't 30 years of deregulation, globalist freemarketeering, and massive tax cuts that caused this mess, but rather, not enough of those things. Oh, and Fed policy. Well, that policy tied everything together and kept your bubble going; almost long enough to push it out past Bush 2, but not quite.

Jun 22 09:42 AM

[Mad Hedge F...:]

Careful. Paul Krugman made an insightful point on his New York Times blog (see krugman.blogs.nytimes.com/). The surprise 17% improvement in new housing starts for May, which many heralded as a bonafide green shoot, is not what it seems. Sure, 17% is a nice number, but we’re coming off such a low base the number is meaningless. 17% ain’t what it used to be. It’s like General Motors (GXM) (note new ticker symbol) going from $2 to $3. Sure, it’s a 50% move, but it doesn’t mean the bankrupt company is back in the pink of health. You could use the same argument for the 40% move in the S&P500. Since virtually all of our economic data is recovering from once a century extremes, they will have to be viewed with many grains of salt.

Jun 22 09:58 AM

[The Simple ...:]

The author's discussion of the role of "consumer spending" in the economy is misguided. All demand is ultimately driven by end user demand (i.e., consumer spending, or government as proxy for the consumer). Everything else is short term inventory adjustments. Even where a business is the end user of a product, such as office supplies, its demand for that product is driven by consumer demand for its own product outputs. This should be self evident. Anything to the contrary is missing the forest while looking at the trees.

Jun 22 10:05 AM

[Donald Ingram:]

Keynes and his adherents have had their day and failed miserably.
For over 60 years Keynes and his theories have been given full throttle by different administrations and economists. Time for change.
Consider the following quote by Ludwig von Mises, one of the founders of the Austrian School of Economics; "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crises should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."
The present economic thinking is dead. Time to get back to some 'common sense' that is provided by those that follow Austrian economics. Either that or........

Jun 22 01:49 PM

[Moon Kil Woong:]

"Virtually overnight the very accommodating Bernanke doubled the country's monetary base and in doing so planted an inflationary time bomb." Actually it was 400% over about a year.

Regarding spending both Obama and Bush Jr. are guilty of running massive deficits thus the problem is not really a party issue as much as politicians perchance of throwing endless parties without paying for them.

The main problem with even stimulus spending is it tends to turn into dependency and systemic spending which can not be racheted down without the "benefit" drying up and going away thus "damaging the economy".

Jerard Jackson is right that, in actuality, allowing for the contraction of sectors that don't perform allows for a misallocation of labor and resouces to be eventually allocated to productive uses rather than a drain on society. To keep the sector on life suport not only prevents the re-allocation of resources but also cripples an economy by becoming a drain on the rest of the productive components of society thus robbing real growth and recovery.

In Keynsian theory this is masked by runing up money supply so no one sees that such spending is actually a tax since the cost is masked in inflation and future taxes through debt rather than being paid for up front.

Although, priming the pump makes sense in the case where the economy is stuck in a permanent rut, spending in good times, in downturns, and all the time is not Keynsian, it's madness. They can call it what they wish, but in the end it's just irresponsibility and incompetence.

The economy must have its cycles and corrections. When leverage gets to be too high it must come down. If they want to concern themselves with moderating the cycle they should focus on mitigating the leverage on the upside rather than increasing leverage through government waste on the downside.

Thanks for the article.

Jun 22 11:50 PM

[Gregman2:]

So, you're a liquidationist...that's fine. What's your take on the Bush years?

Jun 23 04:43 PM