Gerard Jackson's  Instablog

The same media types who screamed blue murder with undisguised glee when unemployment hit 5 per cent under Bush are now telling us that the current 10.2 per cent rate is being driven by rising productivity and so there is little that can be done about it in the near future. I find this reasoning very suspicious. It looks to me as if Obama supporters have resigned themselves to a persistent high rate of unemployment and are looking for an excuse to rationalise it. Now let's take a look at their simplistic reasoning. As two of these brilliant economic analysts put it:

My last article on Obama's energy policy (Cap and trade would sink the US economy and permanently change the political landscape) certainly provoked an angry response from the green energy brigade. Now experience has taught me the futility of trying to reason with those who dogmatically cling to ill-informed opinions. Nevertheless, considering the extreme importance of this issue it is pretty clear that the nonsense that is being dished up in defense of Obama's energy policy needs to be refuted. I don't imagine for one moment that my critics are open to a closely reasoned argument. Hence this response is for those who prefer facts and reason to green dogma.

The first thing I noted is that all of the criticism was completely void of economic reasoning. It seems that for these people economics really doesn't matter, particularly if its conclusions run counter to green dogma. Secondly, I was left wondering in some cases whether the critic had actually read the article. My third observation was the tendency of some critics to rely entirely on logical fallacies.

One line of attack is that mine is an old and tired argument that was discredited by the clean air acts. Therefore, as these acts did not hurt American industry then neither will Obama's energy policy. This is a non sequitur. It does not follow that because these acts allegedly had no detrimental effect on industry and therefore living standards Obama's energy policy will not damage the US economy. Moreover, it simply is not true that stringent environmental controls did not have damaging consequences. Like it or not, environmental regulations are not costless.

First and foremost, cap and trade is a carbon tax on capital, which really means a tax on economic growth. To get some understanding of the severe ramifications of Obama's proposed carbon tax we need to get a grip of basic capital theory. In everyday parlance capital has several meanings. It can be what an entrepreneur needs to start a business or what a business needs to expand output. It can also be an individual's assets: his house, savings, investments, etc. Using the term capital in this way is perfectly legitimate. However, in economics capital is something else altogether: it is the material means of production. It consists of those tools by which we eventually transform lower-valued resources into those higher-valued products we call consumer goods.

Unfortunately the vast majority economists tend to treat capital as a homogenous lump in which capital goods are perfect substitutes for each other. When challenged on this approach they readily admit that it is pure fiction. On the other hand, (there's that phrase again) they would argue that from a theoretical point of view it ultimately doesn't matter whether capital is treated as homogeneous or heterogeneous. This is a dreadful error that is preventing economists from grasping the enormity of Obama's insane energy policy.

Economic textbooks once contained diagrams illustrating the fact that production took place in stages and that these stages formed a capital structure consisting of heterogeneous producer goods, e.g., lathes, furnaces, trucks, drilling machines, etc. Goods moved down this structure until they reached the consumer. (Please understand that this is a highly simplified explanation). To keep on raising real wages and hence living standards for everyone the structure needs to be continuously extended. (What economists usually call raising the ratio of capital to labour). This is can only be done by using savings to add more and more complex stages to the structure that embody new technologies. It is this process that raises what economists call the value of labour's marginal product and therefore wage rates.

One doesn't need to be an economic genius to see that the US dollar is in trouble. That Americans are hopelessly confused about what is happening to their currency is no surprise. However, before we get to the point of whether Obama's economics will do the dollar in I think it is important to provide a brief outline of the history behind the economic thinking that is sometimes used to explain exchange rate movements in the hope that this will give readers a better understanding of the current situation.

Economics is not as easy as some people think, particularly those political activists who are passing themselves off as honest journalists. Unfortunately, most of the economic commentariat are not much better informed. Regardless of what some commentators assert a weak currency does not necessarily reflect a weak economy. More than 80 years ago Mises pointed that those who argue that a strong economy must always mean a strong currency

It is economic theory that informs statistics and not the reverse. In other words, statistics should be interpreted according to theory. Unfortunately the failure of a large number of economists to grasp this fact, including some of the very smart ones, has had the most adverse consequences, consequences that are still with us. The now discredited Phillips curve immediately springs to mind. This little statistical study purported to show an inverse relationship between unemployment and the rate of inflation, despite historical evidence to the contrary and basic economic theory.

It was therefore concluded that all that was needed to prevent unemployment from rising was a little more inflation. Members of the Austrian school warned that the statistics had been misinterpreted and that the recommended monetary policy would eventually result in more inflation and more unemployment. Events proved them correct.

This brings us to the current state of US manufacturing. It is being reported with glee by the media that US industrial production expanded for the third consecutive month and that industrial capacity inched up from 69.9 per cent in August to 70.5 per cent in September. (Marginal movements like this under a Republican administration are always met with derision from America's corrupt media). The ISM Performance Manufacturing Index has been above 50 since August, lending support to the view that recovery is underway. Many economic commentators have now assumed that this expansion must increase the demand for labour and that the only reason this has not happened so far is that unemployment is a lagging indicator.

The Reserve has led the world's central banks in raising rates in the presence of a great deal of unemployment and idle capacity. Clearly the bank is making a pre-emptive strike against inflation. That this was also a strike against Keynesian orthodoxy went unnoticed, even by those who made the decision. According to Keynesian thinking inflation does not pose a danger while there still remains a great amount of idle resources. Evidently the Reserve has correctly concluded otherwise.

Now every economic crisis always supplies a crop of solutions to the problem of the so-called boom-bust cycle, and the current crisis is no exception. Sebastian Becker, an economist with Deutsche Bank in Frankfurt, defines the problem of booming asset prices as one of excess liquidity (fancy language for inflation) which he defines as a quantity of money in excess of an economy's needs. In other words, the supply of money exceeds the demand for money.

This line of thought leads to only one conclusion: to prevent another asset boom the central banks must reduce the rate of monetary growth when it appears that asset prices are accelerating. A policy of using the money supply to stabilise asset prices is a first cousin to the stable price-level fallacy which has it that a stable prices mean the absence of inflation, a fallacy that even the great Knut Wicksell succumbed to.