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An Entirely Predictable Economic Dip
by John Tamny, Toreador Research and Trading (Guest Contributor)
Six weeks ago this column observed that with the price of gold having passed $1,500, the U.S. economy was already in the midst of a downturn, and that it would be foolhardy to wait for always backward looking and unreliable government statistics to reveal what gold already had. Though unemployment figures are as unreliable as the rest, Friday's anemic report points to a slowdown in economic activity that the dollar's fall in concert with gold's spike foretold.
The reason why is very basic. Contrary to the popular view among economists that currency devaluation is necessary during periods of economic hardship, debasement works against the very investment that drives company formation and job creation given the tautological reality that any returns on investment will come back in cheapened money.
Gold, the most stable constant of value known to mankind (hence its use as a money measure for thousands of years), doesn't rise or fall as much as it rises when the dollar in which it's priced declines in value, and it falls when the dollar in which it's priced increases in value. If you devalue the dollar you drive investment into hard, commoditized assets that already exist, and that are least vulnerable to devaluation.
Conversely, when currency values are maintained with stability in value paramount, investment flows into stocks and bonds of companies set to create that which doesn't yet exist. Devaluation is the proverbial blast to the past, while currency stability and strength are forward looking, and this explains why countries have never devalued their way to prosperity.
If we then look back to the most substantial economic contraction of the 20th century in 1920-21, the fact that the gold standard was unshaken amid this unsettling decline in economic activity tells why the economy rebounded so quickly. With investors confident that their delayed consumption (meaning investment) wouldn't be clipped by the monetary authorities, capital flowed to wealth enhancing activities and the economy roared.
The early '20s offer other lessons that tell us why the economy boomed 90 years ago, but sags at present.
Indeed, contrary to the Krugmanesque view that governments must spend uncontrollably when economic spirits are down, in the early 1920s our federal government greatly reduced its spending burden on the U.S. economy. Though it spent $6.4 billion in 1920, by 1923 total spending had declined to $3.3 billion.
Far from an economic retardant, governmental timidity with the money of others way back when was the correct, classical economic response. Entrepreneurs can't be entrepreneurs without capital, so during periods of economic ill health it's more than necessary for governments lacking resources other than those they tax or borrow from the private sector to sit on their hands. Better to leave always limited capital in the private sector where it can fund real productivity, as opposed to the capital destruction that always animates hubristic government spending.
Of course in modern times, President Obama's predecessor (George W. Bush) took spending to stratospheric heights with no positive economic impact, and then Obama, having failed to learn from Bush's weak-dollar, nosebleed spending disaster of a presidency, has chosen to one-up him on both. The dollar has collapsed further and spending has gone even higher under Obama, and the economic results are once again very predictable.
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Looking into the unemployment rate a bit more deeply, another major government error here remains Washington's bipartisan worship of homeownership. Indeed, while they're couched in compassion (how it's compassionate to spend the money of others is never explained), policies meant to promote homeownership are actually quite cruel.
To understand why, it should be remembered that capital in today's modern world moves at the speed of a mouse click. And because capital is ever mobile, so are job opportunities. But with our federal minders having promoted the ownership of something that makes individuals less mobile, and with the housing market still having not reached bottom due government intervention, individuals who should be renting on the way great mobility are stuck. Unemployment is high today, and as is always the case, our inept leaders in Washington have authored the rising rate.
After that, it's useful to get back to the basics. An economy is not a living, breathing blob, rather it's a collection of individuals acting in their individual self-interest. In that case, to stimulate ours or any economy, it's really quite simple. Remove the roadblocks to economic activity which are taxes, regulation, barriers to trade, and cheap, unstable money.
Right now Washington is violating all four basics, thus making our limp economic outlook a present and future inevitability. Government spending is rising and it's a tax like any other for every dollar consumed by government one less dollar meant to fund real productivity. Tax rates, though not historically high in the 20th century sense, are uncertain, and with them uncertain, the economy's vital few must produce with the future possibility that the fruits of their efforts will be penalized at much higher rates. Beyond that, regulations are increasing at a horrifying pace, trade agreements that would foster the work specialization necessary for economic advancement are on hold, and the dollar, as mentioned, continues to decline.
The answer to all of this is a very simple one. An economy is once again just a collection of individuals, and when the barriers to production are removed, the individuals that drive our advancement will start producing again. Of course until the aforementioned roadblocks to growth are reduced, productive activity will decline, and what we call an economy will continue to crawl.
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Crawling to Damascus...
Informative article which harps on a couple of critical issues. First is what is taught in Econ 101 - the crowding out effect. That is, the government's capital needs crowd out private industry/enterprises as it consumes excessive amounts of capital. There is no doubt that capital is best left in the hands of entrepreneurs and innovators, the backbone of America rather than the government (which in no way, shape, or form is capable of deploying capital more efficiently than private industry). Look no further than the bailouts of the banks, AIG, GM, etc. as have these financing activities really improved the economy and employment levels? Could you imagine what the capital would have done in the hands of real business people.
On this subject it should also be noted that Wall Street, once a rather reliable and efficient deploy-er of capital (decades ago) has not lost its way as well. Wall Street has become nothing more than the movie "Other People's Money" portrayed. Is any real money moving from Wall Street to the American entrepreneur or does Wall Street and the big banks simply have a stranglehold on the capital, using it for their own personal trading and speculative motives? I believe the 10 largest banks control something like 80% of bank assets which reinforces how much of a problem concentration of wealth is becoming.
So the two largest forces in the economy, Washington and Wall Street, now have no idea how to deploy capital (other than for their own personal gain) which is the life blood of the American entrepreneur and ultimately, real economic growth, value creation, and job production.
Finally and just a comment that may ruffle a few feathers is based in the notion that Ben and Fed, although accelerating the devaluation of the dollar, are not the primary reason for the devaluing dollar. This honor resides in the enormous debt levels (both stated at $14.3 trillion and unstated of another $50 trillion plus for the unfunded liabilities) incurred by the politicians in Washington. The path of the devaluing dollar was set in motion years ago as unmanageable debt levels are the root cause of the USD's problems. Just like a business that takes on too much debt and generates losses, it's equity value gets wiped out (e.g., GM before the bailout). The same fate holds for the USD as even the junior most analyst can quickly figure out that the US will never be able to repay its debt given the current economic conditions present.
But I agree completely with the notion that the government needs to shrink in size, reach, depth, and breadth and allow the free market to function properly. If there's any proof the government needs just ask how many jobs were created over the past 3 years and real economic growth achieved after throwing $4 trillion at the problem (I figured an extra $1 trillion in debt per year for three years from Washington and another $1+ trillion from Ben and Fed in NY). If there's ever been a case study for failed fiscal and monetary policy the past three years should be it.
Yes. The returns are in debased currency, so there is really no gain to exporters UNLESS their increase in sales is greater than the debasement (this is because they have to pay TAXES on the higher returns).
Example: Ben debases the purchasing power of the FRN by 10%. Your exports must increase by a minimum of 10% to stay even in real terms. Then you pay TAXES on your additional (nominal) profits! So you lose unless your increase is greater than the debasement and your tax rate.
In your example, substitute the word "wages" for "exports," and you will see that it was not just a coincidence that the Fed and the IRS came into being at the same time.
AH,
Yes, stealth taxation through inflation, and forced taxation on inflated, not real, wages - same phenomena as I deswcribed for exports.
John, excellent article.
You are 100% right that excessive government spending depresses economic growth. Modern Western governments seem incapable of understanding this.
I think of government as a Wealth Redistribution Machine. It takes from producers and gives to non-producers. It is inherently non-productive except for a few crumbs which fall from the table (i.e. consumer technologies from space-race efforts).
The US would be a renewed vibrant economy if the government was slashed by 50% and all taxes and red tape by 50%.
Oh that we should live to see it happen.
i'd just take "pay war(ssss)" myself. what else we got cookin' in this stew?
http://www.youtube.com/watch?v=Yd91A3Qcfkw&feature=player_detailpage
The problem is Wall Street not the Government not Main Street.
Yet another trader jerk ...