The US Economy: Past and Present
Readers often ask if economic history is particularly important. No it is not -- it is vitally important. When we examine, for example, the bodies of past recessions (or depressions as they should be called) we are in fact carrying out post-mortems. But if we are to successfully determine the cause of death we need to apply the appropriate analytical tools.
America's last recession caused some observers to note that it bore a striking resemblance to the nineteenth classical boom-and-bust situation. What passed them by is that this has always been the case.
Examining the Clinton boom will tell us where the Bush boom is heading. (Regrettably the examination, no matter how painstakingly detailed, can not provide us with a time table). The ISM's New Orders Index for March 2002 stood at 62.8 per cent for February as opposed to 55.3 per cent for January. Now the ISM considers anything above 50.8 per cent is consistent with a continuing rise in manufacturing orders. As I have pointed out before, the rise in demand for "aluminium, copper, nickel, and steel" conforms to Austrian School analysis of where the recovery will begin. (A similar situation is now happening in Australia).
A look at the manufacturing figures confirmed this view, with industrial demand rising for rubber and plastic products, chemicals, commercial equipment, primary metals, transportation and equipment, etc. There was also a significant increase in the demand for consumer goods including toys and jewellery. This was nothing unusual. I have continually pointed out that the higher stages of production are always hit harder than the lower stages, meaning those closest to the point of consumption. Therefore consumer demand suffers far less than demand in manufacturing. So when consumer demand continued unabated during the recession the economic commentariat were completely flummoxed.
How could this be? Surely everyone knows that consumer spending drives the economy? But it isn't what everyone knows that matters but what is right. Now I'm forever emphasising the vital role that savings play in an economy. In a sense, savings are to an economy what blood is to the body.
Now a line of Keynesian-inspired thought at the time claimed that if the US had lifted net savings from 2 per cent of disposable income to their 1992 level of 9 per cent within the next few years this would have cut demand by 7-8 per cent of GDP. This Was and is dangerous nonsense. Genuine savings add to demand by expanding output through increased investment. It does this by expanding the capital structure.
One of those who pushed this Keynesian line is Wynne Godley. (I'm assuming it's the same Godley who used to be a member of the Cambridge Economic Policy Group in the UK). Now it's true that a sudden and unanticipated increase in savings would hit consumption, it's equally true that a natural increase in savings will tend to drive down the interest rate, making more capital available for investment.
In other words, a rise in savings means a switch from spending on consumer goods to spending on capital goods, otherwise called future goods. When an economy is sliding into recession such a switch, if big enough, could save some investments from liquidation while accelerating recovery and putting it on a firm footing.
That savings did not seem to be growing was something to be feared, not welcomed. I remarked earlier that consumption always does well in a recession relative to the higher stages of production. It's important to remember this because worrying signs regarding the state of the US economy emerged in 2002 when consumption and manufacturing expanded together though savings were at a dangerously low level. This was not a good.
Several factors are at work here. I have said elsewhere that it's quite possible that interest rates could be forced sufficiently low as to increase the price margins in the production structure, particularly for those firms furthest from consumption. Given the cost cutting, liquidations, etc., that went on for 18 months, this cheap money policy might be raising price margins. But at this point that means utilising idle capacity rather than investing. In the meantime, the same policy is fuelling consumption and discouraging savings.
Housing held its own, not surprising as the ISM index clearly indicated that consumption was still rising. In such circumstances it's possible for rising consumption, paradoxical as this may sound, to choke off a recovery in manufacturing. In addition, forcing interest rates below their market rates can reduce savings, which the very thing that fuels and economy. It's time preference that determines what people save. Force interest rates below this point and savings will eventually decline, given no change in TP, and the current account deficit will blow out.
Considering the economic statistics for the time, monetary policy was clearly driving the consumption end of the production structure while simultaneously trying to stimulate the higher stages of production. In this situation the consumption end always wins and manufacturing output declines. This would happen even if the initial effect of the Fed's loose monetary had been largely felt in manufacturing.
So where did the bush boom come from? Several paragraphs ago I stressed that a genuine rise in saving can reverse an economic slide by directing spending to future goods. This is what happened with President Bush's 2003 cuts capital gains taxes. Bush and his advisors understand that if you want more of a product you must reduce the cost of producing it and vice versa. Therefore a tax on capital gains is a tax on investment and hence economic growth. This fact is so blindingly obvious that Democrats are unable to grasp it. The tax cut also revealed the US economy's remarkable resilience.
Nevertheless recession is still unavoidable. The economic consequences of the Fed's loose monetary policies have let loose economic forces whose outcome is as inevitable as night and day. It is not really a question of when the next recession will strike but whether the true nature of the so-called boom-bust cycle will finally become understood. Until that happy day arrives thousands of articles accompanying each successive recession will still be asking: "Is it over yet?"