The New Australian America: running on empty and heading for recession By Gerard Jackson No. 99, 7-13 Dec. 1998 First the bad news: America will go into recession. Now for the good news: I expect this to happen under Clinton. (I don't hold him responsible, I just consider it ironic justice.) The editorial in issue No. 92 (19-25 October 1998) predicted, using Austrian analysis, that the U.S. economy would slide into recession and that the symptoms were already emerging. Despite claims to the contrary, Greenspan's rate cuts can do nothing to reverse the situation. Let us first take a look at received economic wisdom (otherwise known as Keynesian fallacies). According to this Greenspan's interest rate cuts will stimulate the economy by increasing the level of spending through credit expansion. That the U.S. has been on a spending binge which has helped fuel the stock market is certainly clear. What is not clear to these economists is that this policy laid the foundations for the coming recession. That most economists are unable to detect the true link between the stock market and consumer spending was made apparent when they expected the 20 percent drop in the Dow between July and December to curb consumer spending. The reason it did not is because both are fueled by the same source — the Fed. Consumer spending is not, never has been and never will be, a function of stock market prices. Unable to free themselves of Keynesian thinking, the failure of the Dow drop to check consumption was interpreted as meaning that consumers are convinced that the good times will keep on rolling and so maintained their optimism and spending. Consumers never even noticed the Dow. So long as their incomes appear secure, they will just keep on spending. In fact, American consumers are spending so much the savings ratio has turned negative, something that has not happened since the depths of the Great Depression: for this you can thank Lord Keynes and his disciples. Without savings, the American economy — or any other economy, for that matter — cannot accumulate capital. And it is capital that raises living standards, not Federal manipulation of interest rates. In other words, the American economy is running on empty. Concentrating on consumption spending is a fatal mistake. Consumption does not drive economies and is only a small part of total economic activity.* This gross error has led some economic observers to speculate that the booming service sector will be the "powerhouse" that will offset slowdowns in any other part of the economy. Austrian analysis comletely explodes this myth and we shall now see why. The Austrians show that by forcing down the rate of interest the Federal Reserve misleads businesses, especially in the higher stages of production, into thinking that the fund of real capital has expanded. They therefore embark on projects for which the capital goods necessary for their completion do not exist. This makes itself felt through various shortages and bottlenecks. As these start to appear many businesses begin suffer a cost-price squeeze as prices are no longer sufficient to maintain expansion or even cover factor costs. Nevertheless, the so-called service sector, the one closest to consumption, undergoes a boom with rising demand and employment. There is no paradox here. Factors must be paid. Companies that responded to the low interest rates used the addtional funds to bid up the prices of capital goods and specific types of labor, which obviously raised their costs of production. This additional expenditure translated into factor incomes which were then spent on consumption goods. This in turn raised demand at the consumption end of the production structure. The increased demand made itself felt throughout the structure by bidding factors away from the higher stages. To aggravate the situation savings actually became negative, meaning that the social rate of time preference was leaving nothing for investment. The pool of real funds had run dry. These higher-stage investments will now turn out to be malinvestments, unsound investments that will have to be liquidated. But before these investments are abandoned they will start bleeding financially. Unable to cover their costs of production they will have to cut outlays, sell their inventories for what they can get and institute lay-off. This is exactly what is happening: manufacturing and mining are beginning to suffer a profit squeeze. Corporate profits are falling, lay-off are on the rise, inventories are being run down and outlays are being cut. Some financial commentators are claiming that the slowdown is already as bad as the 1990-91 recession. And all of this without even a credit squeeze. (The Austrians have always stressed that even without a credit squeeze the crisis will still emerge.) Astute observers realise that the crisis has nothing to do with Asia. However, unable to explain it, especially in Keynesian terms, they are reduced to making statements about the inevitable end of the investment cycle, trade cycles, etc. In other words, they do not know. Even so, many still think cutting interest rates -- i.e., expanding the money supply -- is the cure. It ain't. It's the disease. America is a dynamic and inventive country with a vibrant entrepreneurial culture. What it needs is lower taxes, less regulation and litigation, fewer meddling politicians and a healthy savings culture. What it does not need — and this goes for any other country — is Keynesianism. * The problem is that gross domestic product figures leave out an enormous amount of economic activity on the fallacious grounds that it would be double counting to include it. In fact, the GDP is a value-added concept and is not really gross at all. The New Australian
