What Kind of Recession Are We in?

Trying to spark a debate in Australia about the nature of the boom-bust-cycle is worse than talking to a brick wall. Our establishment rightwing stubbornly refuse to consider any theories that fall outside their own narrow views on the subject. For example, John Stone — former head of the Australian Treasury — argues that we are experiencing "not a conventional recession but a much rarer 'balance sheet' recession, in which the main focus of firms or householders is de-leveraging or debt repayment" (Old formulas don't fit, John Stone, The Australian, 26 May 2009). Much as I fear to contradict the eminent Mr Stone, he is, nevertheless, dead wrong. The recession fits the normal pattern perfectly.

When speaking of the boom-bust-cycle we are referring to a specific economic phenomenon. The first sign that a boom has run its course is a decline in manufacturing output (a vital fact that classical economists noted and one that today's economists ignore). Even as manufacturing contracts and sheds labour, aggregate unemployment can still fall while aggregate GDP continues to rise, leading some economic observers to conclude that a "dual economy" has emerged. This is exactly what happened in the US in the period 1999-2000. Now if Mr Stone is correct, then the Australian experience should be very different. It isn't, as the following chart clearly shows.

We can see that in December 2007 the PMI and the production index peaked at 58.4, after which they both fell, bottoming out last April at 30.1 and 28.8 respectively. But it was not until May 2008 that there was a significant shedding of labour that then levelled out until about the following September when the rate of dismissals quickly accelerated. One can see from the chart that it was in this month that both manufacturing indexes plummeted. However, the next chart reveals that aggregate unemployment did not begin rising until August 2008.

The next chart shows that even though manufacturing started contracting in December 2007, GDP continued to grow until September 2008, after which it too declined. Of particular interest is the observation that per capita GDP actually started to decline in the previous March, a fact that John Stone did stress in his article. However, the GDP figures severely understate the drop in total spending because they omit transactions between firms on the spurious grounds that this would be double counting. (If this spending was accounted for consumer spending as a proportion of total spending would probably fall to about 33 per cent).

It is plain to see that if manufacturing is contracting then inter-firm spending must be falling. If this drop in spending was taken into account then gross spending figures would — in my opinion — show that the Australian economy had definitely fallen into a recession. By overstating the role of consumer spending in the economy the GDP fallacy has led economists to grossly understate the importance of business spending to the extent they have adopted the egregious error that it is consumer spending that drives the economy. Yet most pre-Keynesian economists were alert to this arrant blunder as the following quote reveals:

For as Professor Slichter has well stated, the income of consumers depends directly, and largely, upon the volume of business spending: "This means that the fluctuations in consumer incomes, which produce fluctuations in consumer spending, are the result of changes which have already occurred in business spending. Consequently, the explanation of fluctuations in the total volume of spending must be sought, not in spending by consumers, but in spending by business enterprises." (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, pp. 228-229.)

Irrespective of what Mr Stone asserts the evidence shows beyond a reasonable doubt that the current recession does indeed fit the classic narrative. What should have been clear to our economic pundits is that if any recession involves a particularly large of "de-leveraging," then this should immediately suggest that borrowing had been especially extensive. This in turn should raise the question of why so many households and firms borrowed so much at the same time and what in heavens name was the source of those fund?

Instead we get comments about "de-leveraging" that amount to nothing but a dog chasing its tail. Let me give you a clue. It's called monetary expansion. From March 1996 to October 2008 currency rose by 129 per cent, bank deposits by 201 per cent and M1 by 185 per cent. It is my contention — in keeping with the Austrian analysis — that this reckless monetary growth fuelled the boom, sent house prices zooming and sucked in imports and gravely distorted the capital structure and made a recession inevitable.

Whether or not one agrees with my Austrian approach and conclusions it cannot be denied by any reasonable person that the boom-bust-cycle is an extremely important issue that needs to be seriously debated. Unfortunately Australia's self-appointed guardians of free market thought have decided that for reasons of their own that no such debate will take place regardless of what is best for the country.

Comments

[Davewmart:]

Thanks for a valuable article.
I take it that in your opinion no recovery is possible until debt is paid down or written off and that current measures have just delayed the inevitable?

Sep 11 06:35 AM

[jamup:]

Yep your are right Davewmart,but it,s a cartch 22, debt can not be paid off until business starts to spend on hiring back people and capital expenditures , the old saying down on the farm,is that you can,t get blood out of a turnip. looks like a lot of debt will have to be written off,but this administration is hell bent on pilling on more taxes and other burdens like health care and other b.s. on small business,therefore catch 22, go figure.

Sep 11 07:39 AM

[Davewmart:]

jamup,
That's what I think, but I am interested in establishing what someone in the Austrian school thinks - although I am familiar with the term and some of the principles, I am no economist, and haven't studied the various ideas and ideologies.
From what I have picked up, I like most of what the Austrian's seem to be saying, and it makes a lot of sense to me.

Sep 11 07:50 AM