Is the global ‘recovery’ faltering? Is the United States economy heading for a ‘double-dip’? These are the headlines after recent disappointing economic data releases, in particular the weak employment report last Friday.
Truth be told, there never was a proper ‘recovery’, if the term is to denote a process of true healing, of fundamental betterment.
Recessions occur because of economic imbalances – and the imbalances that caused the financial crisis and the following recession are predominantly still with us. The few imbalances that somehow have dissolved or improved have been replaced with new ones. The reason for this is the misguided policy of ‘stimulus’.
Why is the economy weak?
The allocation of capital and the direction of economic activity were, to a considerable degree, misdirected in the preceding boom, which was, as is now painfully apparent, in no small measure an artificial boom based on easy money and cheap credit. At the end of that boom the economy had accumulated various dislocations, from artificially high real estate prices to overextended bank balance sheets. At that point a meaningful recession had become unavoidable. It had to unfold with inescapable necessity.
High levels of debt are not necessarily bad in themselves but presently they are simply not supported by current and prospective real income streams, or by the willingness of the public to save and thus provide the means to allow asset prices and debt levels to remain at these elevated levels.
The recession is the inevitable cleansing process by which economic structures and prices get realigned with the underlying preferences of the public, in particular the public’s propensity to save which sets the speed limit to sustainable capital formation.
Painful? –yes. Necessary? – definitely.
Why is ‘stimulus’ not working?
What is usually discussed under the misleading term ‘stimulus’ is entirely ineffective in solving the problem. Indeed, it is counterproductive. Suppressing interest rates further and injecting more money into the banks and – to some degree – the economy again creates an illusion of high savings-availability. This may – for some time – delay the deleveraging process and the dissolution of capital misallocations, and to some degree it may even encourage new capital misallocations – new projects funded with printed money rather than true savings. Such a policy is designed to mask the extent of the problem and project an illusion of stability.
Furthermore, this policy systematically distorts asset prices. In fact, with QE1 and QE2, it has now become the declared goal of the United States Federal Reserve to manipulate asset prices in order to generate near-term boosts to the GDP-statistics, as explained by chairman Bernanke here. This has “worked” in recent months and quarters in the sense that it has partially arrested the cleansing process and sustained the mirage of normalcy. Not for the U.S. housing market which is truly beyond saving but for the extended financial sector which is subsidized with zero-percent interest rates and the debt monetization program (“quantitative easing”). However, such a policy is constantly pitted against the accumulated dislocations, which are urgently pressing towards a resolution – that solution would be achieved through asset price deflation and debt reduction, mainly through defaults.
The policy of ‘stimulus’ through government spending is, if that is possible, even more absurd. Government spending does not add anything to the economy that wasn’t there before. No new resources are being added. What the government spends it has to take from the private sector. If the government taxes the private sector, that is self-evident. If the government borrows the money it taps into the existing pool of savings, taking money that would otherwise have gone to private sector borrowers, such as corporations. Remember that what is being saved does not drop out of the economy. In order for the saver to receive any interest income or dividends the money has to be invested with someone. Even more troubling is the fact that government spending is now predominantly or fully funded by the central banks and their printing presses – either directly or indirectly via the banking sector. This is now the case in the United States, in Britain, in Japan and in the Eurozone. Not only does this policy increase overall debt-levels and the system’s dependence on ever more money creation, but it also increases – via artificially low rates – the very dislocations that were the cause of the downturn in the first place.
All that fiscal policy ever does is replace the private control over society’s resources with governmental control over those resources. By running deficits and accumulating debt the state obtains more control over resource employment than it already obtains via taxation. Forget the childish New Deal myth – no country has ever furthered its economic wellbeing by handing control of its resources to the state bureaucracy.
As I explained before, the mainstream has adopted the Keynesian concept of “aggregate demand” and thus believes that what matters is that somehow the sum of recorded economic transactions over a given period of time be maintained at some predetermined level, that therefore any activity counts for as much as any other, whether it is voluntary and occurs on free markets, or whether it is directed by government dictate.
Accordingly, the interventionists – the government officials, central bankers, and the mass of economists and commentators who cheer them on – always claim victory whenever their policies lift the aggregate GDP statistics. But all they are doing is treating the symptoms while making the underlying disease worse.
What I described here – in terms of problems, mainstream misconceptions and adopted policies – does not only describe the situation in the United States but also in Britain, the Eurozone and Japan. There are marginal differences but the problems – and the misguided policy responses – are essentially the same.
It should therefore not come as a surprise that the forces of contraction, which emanate from the accumulated dislocations, will from time to time regain the upper hand over the forces of inflationary expansion, which emanate from ever more aggressive and desperate ‘stimulus’ policy.
Continue reading at Paper Money Collapse