Obama and His Advisors Won't Know What Hit Them When the Economy Finally Tanks

By: Gerard Jackson | Sun, Dec 14, 2008
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An important thing to note -- apart from Obama's utter economic illiteracy -- is that his economic advisors are Keynesians and that it is Keynesianism that got the world, particularly the US, into the current economic mess, that and the fallacious the price rule. The reckless monetary policies of the world's central banks have created enormous imbalance that must be liquidated. These imbalances -- malinvestments in Austrian parlance -- were generated by an irresponsible expansion of bank credit that distorted international prices and domestic patterns of production. As the US economy is about 30 per cent of the global economy the fed's must be held accountable for most of the damage.

Being Keynesians Obama's advisors will have told him that the problem is one of deficient demand. (They will not have advised raising taxes). The problem here is that according to Keynesian doctrine inflation is not supposed to kick in until an economy is fully employed. (It was the Austrians who warned that this was a complete fallacy and that Keynesianism would give us inflation and unemployment). A small fall in the CPI has some commentators even warning about deflation. Bruce Barlett went so far as to say that "I think deflation is our economy's fundamental problem".

How can there be deflation when the money supply is expanding? Because, according to Bartlett velocity (the average number of times a dollar exchanges for a good) is falling. This is the sort of bad economics that one finds in the fed and which has done so much damage. Deflation is a monetary contraction and nothing else. Full stop! Although I'm not going to bore readers with a discourse on the equation of exchange, I still feel impelled to emphasise that it is a tautology that simply states that that which is spent equals that which is received.

The idea of velocity was necessary to make the 'equation' balance. The fundamental point is that I can only spend the same dollars once. Spending all of my dollars from Monday to Wednesday will not make prices rise any more than spending them from Monday to Sunday will make prices fall. Ludwig von Mises observed that the concept of velocity was "fashioned according to the patterns of mechanics" and called it a "spurious notion". (Ludwig von Mises, Human Action, Henry Regenery Company, 1963, p. 399).

What we are probably witnessing is not a change in the so-called 'velocity of circulation' but an increased demand for cash balances brought on by economic uncertainty. Such situations are always temporary and should not divert us from what the fed is doing. From last January to the first of December the money supply grew by 18 per cent¹. Just to make sure that the economy gets just what it needs, Bernanke raised the monetary base from $980,914 billion on 8 October to $1,233,679 5 November, a 24.7 per cent increase in a matter of four weeks.

I have pointed out time and time again that manufacturing is the key economic indicator. Once it starts contracting and shedding labour you know that a recession has started, even though aggregate unemployment could still be rising. The latest ISM (Institute of Supply Management) report shows that manufacturing fell to 36.2 per cent of its index (anything below 50 indicates contraction), the lowest level since May 1982. New orders dropped to 27.9 per cent and are still falling, suggesting that the contraction has still someway to go.

Naturally, spending on intermediate goods is diving. It's very important to take note of this fact because this spending is omitted from the national accounts. If the accounts were adjusted to remedy this omission we would find that business accounts for about two-thirds of total economic activity while consumption is about one-third. This means that the drop in economic activity will be greatly underestimated. Moreover, such an adjustment would give us a negative figure. In other words, the US economy is well and truly in a recession and we could see unemployment rise to 10 per cent to 12 per cent.

Obama is no more responsible for this situation anymore than Bush. The fault, as I have said so many times before, lies entirely with lousy economics. There are two dangerous fallacies at work here: the first one is the belief that the interest rate can be manipulated in a way that can generate sustained economic growth; the second fallacy is that central banks need to maintain a stable price level. Both fallacies are guaranteed to keep the boom-bust cycle going.

Unfortunately, Obama's advisors are no more aware of these facts than he is. Larry summers believes in the discredited Keynesian multiplier and Bernanke is an adherent of the equally discredit Phillips curve. This spells trouble. Summers and his merry band figure that stimulating consumption will raise incomes and the demand for labour. But this misses the point that increases in the real demand for labour come from investment that raises the value of labour's product.

Therefore stimulating consumption has the effect of directing spending away from investment. The very opposite of what is needed. This is one of the reasons that infra-structure projects have never cured a recession. (At a later date I shall explain how the fascist economies appeared to have used infra-structure projects to overcome mass unemployment). To make it worse Obama is planning to create masses of 'green' jobs. This is no different from what Roosevelt and Mussolini did. Roosevelt had his monuments and environmentalist programs as did Mussolini. While Mussolini had his new cities and the Pontine Marshes, Roosevelt had his settlement program and dam building².

The New Deal programs failed dismally to overcome the depression. Obama's proposals will fare no better. His proposed massive two-year spending binge has now been raised to $1 trillion. With tax receipts falling and tax rises in suspension where will he get the money? With Summers and the accommodating Bernanke tugging at his elbow there is every possibility that he would borrow from the fed. This is to say that the fed would monetise the spending. In short, run the printing presses overtime.

If all of this played out then the US could experience a severe inflation and a diving dollar. The irony here is that if this situation emerged he could find his green jobs disappearing as workers are bid away into higher paying employment. At the end of the day America would be facing another crash.

It will indeed be a testing time for the American economy. Under Obama we might discover just how much punishment she can take.

¹ The Austrian definition of the money supply consists of the following: currency component of M1, total checkable deposits, US government demand deposits and note balances, demand deposits due to foreign commercial Banks, and demand deposits due to foreign official institutions, and savings deposits. There is some dispute about whether savings deposits should be included. If savings accounts are not transformed into checking accounts then including them in the money supply would be double counting, even if the bank lends the savings out to clients.

² The Tennessee Valley Authority is often cited as an example of enlightened state intervention made necessary by market failure. What is not well known is that in 1921 Henry Ford laid out a similar plan for the area. Ford's proposal was frustrated by senator George Norris -- a Teddy Roosevelt Republican -- who thought the project too important to be allowed to fall into the hands of private enterprise. In 1924 Ford was forced to drop the project.



Author: Gerard Jackson

Gerard Jackson

Gerard Jackson is Brookes economics editor.

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