By Jeff Harding.
In order to understand the present state of the U.S. economy you have to understand that there are two things happening at once. For the most part they are in conflict with each other, in that one track can negatively impact the other.
Lest I be accused of putting out conflicting information, there is evidence that the economy is recovering in some fashion, but not because of the reasons most economists and politicians think. There are still substantial prevailing winds blowing against the kind of recovery most commentators are hailing as fact. But economies have a tendency to repair themselves. The feds have a more profound impact on this than they understand.
Here are some of the economic data that have come out this week, in no particular order:
[table id=6 /]
Take your pick. What is real?
The basic questions we need to ask here are:
1. Why do economies recover?
2. Are we recovering?
Q. Why do economies recover?
A. They recover because bad investments made during the bubble are liquidated, valuable capital is no longer being wasted on them, new capital is formed from savings, and profitable enterprises attract new capital to expand. Low real interest rates caused by increased savings encourage borrowing, manufacturers use the capital to make new machines, producers of consumer goods buy them, cash goes through the system, consumers see things are getting better, more consumer goods are produced, and consumers buy them. It has to happen this way or the recovery will fail.
The difficult part of a recovery is ugly. Bankrupt firms need to fail so that valuable capital resources are not wasted on their continuing activities. This means that unemployment rises (10.2% now) and business bankruptcies are high. Trillions of dollars of asset values are wiped out. But if you leave the process alone, recovery will happen quickly.
While not good for those impacted, it’s not “bad” as Keynesians would have us believe. If consumers feel the need to save and not spend, how does dropping interest rates to near zero change their preference to hold cash? It doesn’t. They’re scared, much poorer, and see personal savings as the one thing they can do to protect their financial future. They don’t understand the “patriotic” need to spend to come to the aid of the economy. Your fellow citizens aren’t stupid.
If you do what our government has done and prop up failing enterprises through zero interest rates, massive stimulus spending, and rack up a huge national debt, then it only drags things out and results in economic stagnation as these zombie companies struggle to recover. This was the result of Japan’s very similar interference with the recovery process. Twenty years later their economy is still sluggish (average 0.6% GDP over 10 years) because they followed the Keynesian prescription for recovery.
Unfortunately that is what is happening here. Massive federal injections of money into the system prop up firms that should have failed. With TARP, TALF, FDIC, Fannie, Freddie, federal debt, and all the guarantees, the total is in the trillions. But who’s counting?
The standard argument is that we had to do it because these financial and commercial businesses were too big to fail. That’s an interesting proposition, because the bailout probably did stem the worst impacts of the financial collapse. But, so what. It’s not that a financial collapse didn’t happen, it did; we’re just arguing over the extent of the fallout to the economy. Some argue that it would have been much worse, with neolithic implications if the feds hadn’t stepped in. Maybe, but I can say that all it will do is just cause the pain to last longer, and cause greater economic damage than if they had done, well, nothing. (Do I have to say “Japan” again?)
Q. Are we recovering?
A. Yes. No.
There are two factors driving the numbers quoted above. One is the fiscal and monetary stimulus. But that doesn’t create real economic growth. That is, the government can’t create wealth by spending someone else’s money. Only real capital employed by private enterprise can do that. I’ve pointed out that the Q3 GDP numbers are mostly the result of federal stimulus (Clunkers and the home purchase tax credit). My opinion is that this activity will die out once the money is spent. Otherwise all the government would have to do to create wealth is take all our money and spend it.
But there is another process, and that is the underlying economic recovery that I talked about above. Unlike Japan, except for some mega-corporations, we are letting companies and banks fail. This means that as their obligations are wiped out, new businesses will take their place and compete for capital and customers. This is real and self-sustaining.
The question is, is a real recovery taking place? And, the answer is hard to know because of all the stimulus. The stimulus does create economic activity. That is, money is spent on things the government wants, the money goes through the economy, and it gives a little bump in the numbers. But since the government isn’t creating wealth when they spend, the economic activity will eventually dry up. Ask yourself: if the government stopped defense spending, would that industry survive? Not likely.
The raging debate among many free market economists is: are there sufficient real savings to create economic growth? And that is hard to tell. So, I will guess. Based on a pending bottoming out of the housing market, bad debt will then be wiped off of the books of lenders and holders of MBS. We aren’t there yet, but it’s starting to find a bottom. Yes, I am aware of the shadow inventory and the problems with CRE. But I think housing is the key to everything since home mortgages are the foundation of the bubble. If Congress passes the new home purchase credit bill, the recovery process will cease and housing will be falsely reflated. Welcome to Bubble No.2.
Q. What happened in the crash of 1920 that didn’t happen in the crash of 1929?
A. First, don’t think that it was that different back in the Twenties. It wasn’t. More complicated today, sure, but the underlying forces that were at work then are still at work now.
The market crashed in October, 1920 (down 33%) and unemployment was almost 12%, yet the 1920-1921 recession lasted only 18 months. The 1929 crash started in September, 1929 and peaked in November, with a stunning 52% loss in the Dow. Yet, the market started to rally in November, but never got off the ground. The market continued to slide until June, 1932 having lost 89% of its peak value.
The difference between the two events? In 1920, Warren G. Harding was president (no relation). In 1929 it was Herbert Hoover. In response to his crash, Harding, at least by today’s standards, did nothing. Hoover was the consummate interventionist and implemented many policies that trashed the economy and started the Great Depression. Roosevelt nurtured it until he died. The Dow did not recover its 1929 peak until late 1954!
Maybe I’m just being simplistic. Maybe I don’t understand Keynes. Maybe free market Austrian theory is bunk. Maybe there are sky hooks. Maybe everything will be just fine.
On the other hand, maybe Obama, Summers, Geithner, Romer, and Krugman are naive. Maybe they don’t have a clue of any economic theory other than Keynes. Maybe they wear rose colored glasses when they examine the history of Japan and the Great Depression. Maybe they believe in sky hooks.
Note: Where I have italicized the word “real” that is to distinguish it from the commonly used meaning of inflation adjusted vs. non-inflation adjusted (“nominal”). I mean to use it in the Austrian economics sense, which distinguishes such savings or growth from government induced savings or growth.