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October 18, 2009

The US Recession: More Unemployment and a Sinking Dollar
by Gerard Jackson

What gives? The Obama administration no sooner assures Americans that labour markets had finally stabilised and mass job losses was at an end when the Bureau for Labor Statistics comes out last Wednesday and ruins the party with the bad news that mass layoffs leapt by over 20 per cent in August. An earlier report estimated that manufacturing accounted for 31 per cent of the layoffs. (I have stressed numerous times that manufacturing always bears the blunt of the boom-bust-cycle).

It certainly looks like manufacturing is undergoing a very ugly shakeout. That the jobs situation is grim was further underlined by a report from the United States Department of Labor for the week ending 19 September which revealed that the 4-week moving average for jobs claims at 553,500. How can this be? The share markets have been moving upwards for some months and the ISM index has turned positive.

The US has experienced a lengthy and extremely irresponsible credit expansion. Irrespective of the Fed's monetary nonsense, money is not neutral. This means that the expansion created masses of malinvestments when it distorted the structure of relative prices. When the boom bust these malinvestments had to be liquidated. It is this process that the country is still experiencing.

Unfortunately, while manufacturing has been largely forced to bear the full impact of the downturn a great many malinvestments in the financial sector have been kept afloat by massive subsidies. If these investments had been denied a government lifeline the bad ones would have gone to the wall while the viable ones would have been saved. This would have had the effect of freeing capital and hastening recovery. Instead the Fed rushed to the monetary pumps while the government -- starting with the Bush administration -- moved to do what it is least capable of doing -- and that is picking winners.

Obama and his crew saw the situation as one that could be ruthlessly exploited to advance their fanatical statist agenda. The result was an unprecedented peace-time explosion in deficit spending which if not rolled back will severely retard economic growth, by which I mean the accumulation of capital. (Forget that nonsense about government spending leading to induced investment). No administration since Roosevelt's has been more hostile to business than Obama's. Given this fact one should not be surprised if businesses becomes extremely cautious in their hiring policies, particularly considering Obama's absurd belief that unions were responsible for the emergence of America's middle class.

A particularly worrying aspect of current situation is Ben "Helicopter" Bernanke's utterly irresponsible attitude toward monetary policy. He considers himself to be something of an expert on the Great Depression. He is anything but. By focusing entirely on money -- as did Friedman and Schwartz -- he completely overlooked 'real factors'. As one economist astutely observed:

...monetary factors cause the [business] cycle but real phenomena constitute it. (Fritz Machlup, Essays on Hayek, Routledge, Kegan Paul 1977, p. 23).

Because his starting premise was the neutrality of money Friedman just could not accommodate the idea of monetary-induced malinvestments despite the massive amount of statistical evidence that supported it. Bernanke -- whether he knows it or not -- is starting from the same premise. This certainly helps explain his cavalier attitude toward the money supply as illustrated by the two charts below. The first chart show AMS (Austrian money supply*) as rising steeply from September 2008 to June 2009. This was an increase of 25 per cent. A slight contraction brought the increase down to about 21 per cent in the following August.

The situation for the monetary base is even worse. From September 2008 to May 2009 it rocketed by 99 per cent. A slight fall had reduced the increase to nearly 92 per cent in August 2009. This expansion is truly unprecedented and extremely dangerous. Moreover, the Fed is still buying 'assets' with crispy new notes. Calling this state of affairs highly inflationary would be greatly understating the situation.

Source: Federal Reserve Statistical Release

Bernanke's monetary policy strongly suggests that he is not only indifferent to the detrimental effect it will have on the exchange rate but that he is probably hoping for a significant dollar depreciation in the belief that it will stimulate exports and raise the demand for labour. (In the 1930s this was called exporting your unemployment). But a devaluation is only justified where the currency was overvalued. In all other circumstances it is a destructive and self-defeating policy.

The monetary figures are bound to have some economic commentators predicting another boom followed by the inevitable crash. I am not so sure. What America could get is a rapid reduction in idle capacity leading an increase in GDP as Bernanke's dollars work their magic. But I cannot help but be reminded of Germany's 1927-29 boom that was also accompanied by a high level of unemployment. In Germany's case the unions kept wage rates above their market clearing levels. In the US today the uncertainty created by Obama's policies could have a similar effect.

There is also the possibility that even Bernanke will be forced to apply the monetary brakes before his inflationary policy has time to bring unemployment down to a politically acceptable level. Whichever way one looks at it, any recovery based on these monetary foundations is doomed to be a short-lived one, thereby ultimately frustrating his policy of using inflation to lower unemployment for the long-term by cutting real wage rates and driving down the dollar.

*There are some differences among Austrians as to what ought to be included in a definition of the money supply. My own approach follows in the steps of Walter Boyd who in his open letter to Prime Minister Pitt in 1801 defined in the following terms:

By the words 'Means of Circulation', 'Circulating Medium', and 'Currency', which are used almost as synonymous terms in this letter, I understand always ready money, whether consisting of Bank Notes or specie, in contradistinction to Bills of Exchange, Navy Bills, Exchequer Bills, or any other negotiable paper, which form no part of the circulating medium, as I have always understood that term. The latter is the Circulator; the former are merely objects of circulation. (Walter Boyd, A Letter to the Right Honourable William Pitt on the Influence of the Stoppage of Issues in Specie at the Bank of England, on the Prices of Provisions, and other Commodities, 2nd edition, T. Gillet, London, 1801, p. 2).

In simple terms, money is the medium of exchange.

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

Copyright © 2005-2009 Gerard Jackson

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