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May 18, 2008

Ill-Omens Haunt the US Economy
by Gerard Jackson

One can only blame bad economics for the confusion about the current state and direction of the US economy. Because the economic commentariat have swallowed the fallacy that consumption is what really drives an economy they treat consumer spending much the same way that ancient seers treated the entails of goats, and with just as much success.

If these modern-day seers are correct then consumer spending would be dropping and those companies at the consumption end of the production structure would be contacting. Yet consumer spending is still holding its own once we subtract the fall in spending on new cars. Cars are like houses* in that they are very expensive goods. Few people ever pay for their house or car outright. This means that these goods will be sensitive to changes in interest rates.

Let us assume an interest rate of 4 per cent. This would amount to $4,000 on a $100,000 loan for a year. It is obvious that if the interest drops to 3 per cent then the borrower would save $1,000. What is not so obvious is the fact that if the 4 per cent rate limited the borrower to $100,000 then the new rate would raise his limit to $133,000. Therefore a 25 per cent drop in the interest rate raised his borrowing capacity by 33 per cent. The point of this exercise is to show why the demand for houses and cars responds quickly to changes in interest rates.

We have also been visited by the inverse 'wealth effect' idea, according to which rising house prices will lead to more consumer spending because the owners will now borrow against the value of their houses. There is an awful lot wrong with this thesis. That it has any legs left at all is an intellectual disgrace. To begin with few people increase their demand for consumer goods on the basis of the value of their home. In fact, most people have only a vague idea how much their house is worth. What they borrow for consumption will be largely determined by interest rates and their expectations of their future income.

What about petrol prices, or gas in American terminology? Two points: What is spent at the petrol pump amounts to a change in the pattern of consumer spending and not a fall. The second point refers to imported oil. No matter how much foreign oil is bought the dollars must eventually come home. If Americans really want less dependence on foreign suppliers they must stop voting for the mendacious Democrats. This party's attacks on domestic energy production have been monstrous. (Harry Reid's disgusting hypocrisy and his outrageous lies about oil prices reveal just how low the Democrats have sunk).

To get a realistic grasp of where the economy is going one must look at the state of manufacturing. The Institute for Supply Management's manufacturing index is not looking healthy. Exports jumped from 48.6 in April (any figure above 50 signifies expansion) to 57.5 in march. This is only to be expected considering the dollar's decline. However, the production index had fallen from 50.7 per cent February to 48.7 per cent in March. The picture was just as bad for employment which fell from 49.2 per cent in April to 45.4 per cent in April, a drop of 3.8. There was also a considerable increase in the prices of inputs. These trends neatly fit in with the Austrian School of economics explanation for the so-called business cycle.

Therefore conditions in manufacturing clearly indicate that the US economy is now in recession. Can the recession be averted or the trend reversed? Not really, but it is possible that it could be delayed by a massive monetary injection like the one the Reserve Bank of Australia unleashed on the Australian economy in 2001.

The real question should not be about whether a recession can be averted or delayed but about how economies keeping going through this 'cycle'. The answer is lousy economics. Whether one subscribes to the view that the money supply should be expanded annually by a given per centage or whether it needs to be pumped to expand aggregate demand the result will still be the same -- another boom followed by another recession.

It is now time to take a swipe at America's thoroughly corrupt mainstream media and the political leftwing bigots that infest it. For 8 years they preached economic doom and gloom. When in 1999 the Republicans rightly argued that the economy was in recession the media accused them of "trying talk down the economy". At that time the state of manufacturing clearly showed that recession had arrived. We now find ourselves in a similar situation. Only this time the media have done a 180 degree turn and are now preaching recession.

The template that these leftwing liars use is the simple one of blaming Republicans for every recession and praising Democrats for every recovery and boom. There is no doubt in my mind that in the long run the grotesque dishonesty of the leftist mainstream media pose the greatest threat to every American's freedom.

*Capital goods are future goods. This is because they are used up in the production of consumer goods, regardless of how far away they are from the final stage of production. Put another way, the services of consumer goods are directly consumed while the services of capital goods serve consumers indirectly. According to this definition durability does not define capital goods but their position in the capital structure does.

What is more, the good must be reproducible, i.e., land is not capital. Oddly enough Hayek considers houses to be capital goods "so far as they are non-permanent". Additionally, "we have to replace them by something if we want to keep our income stream at a given level..." (The Pure Theory of Capital, The University of Chicago Press, 1975, pp. 77-78).

But the same thing can be said of cars, televisions, books, furniture, etc. In fact, just about any household appliance. Huerta De Soto uses the same approach as Hayek with respect to durability as a definition of a capital good:

... durable consumer goods satisfy human needs over a very prolonged period of time. Therefore they simultaneously form a part of several stages at once: the final stage of consumption and various preceding stages, according to their duration. (Money, Banking and Credit Cycles, Ludwig von Mises Institute 2002, p. 300)

My criticism of Hayek's 'durability approach' holds for De Soto's approach. The fact that my fridge is extremely durable does not make it a capital good. It's clearly a consumer good because its services are consumed directly by me and my wife.

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

Copyright © 2005-2010 Gerard Jackson

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