HAYEK, THE FED and THE DOUBLE DIP
By Andrew Kashdan
April 16, 2003
SourceTo even the most casual observer of the stock market and
economy over the past 3 years, the failure of the Keynesian
"print-and-spend" approach to curing a business cycle
downturn has become glaringly evident.
Regardless, most people will continue to believe in it, of
course, but a few are groping for a better explanation of
how we got into our current rut, and why we're having so
much trouble getting out of it.
Today we offer an explanation put forth more than 70 years
ago by F.A. Hayek, because for the most part, his basic
insights hold up as well in today's market as they did
following the Great Crash. Building on the monetary theory
of Ludwig von Mises, Hayek would later receive the Nobel
Prize. Reason enough, we think, to look for guidance in one
of his perhaps forgotten tomes like "Prices and
Production," which Hayek wrote in the depression year of
1931.
Attempts to cope with the Great Depression caused Hayek's
contemporaries to ask: Doesn't the existence of unused
resources in the economy justify the expansion of the money
supply? To which Hayek responded "no", explaining that all
monetary expansion distorts the structure of production.
Similarly, today, Hayek's response explains why Fed easing
and seemingly strong consumer spending hasn't gotten us out
of the slump.
Far from being the answer to our problems, Hayek argued:
"
t should be fairly clear that the granting of credit to
consumers, which has recently been so strongly advocated as
a cure for depression, would in fact have quite the
contrary effect; a relative increase of the demand for
consumers' goods could only make matters worse." The
reason, in brief, is that the structure of production -
that is, the economy's particular use of capital goods -
must be adapted to the true savings preferences of
consumers, as opposed to the distorted consumption and
investment decisions prompted by monetary expansion. In
other words, notwithstanding the sage advice of Dallas Fed
President Robert McTeer, our economy would not be better
off if every American rushed out to buy an SUV.
For those who consider Hayek's stance too dogmatic, it is
interesting to note that he actually acknowledged the
theoretical possibility of a beneficial monetary expansion
that favored producers (as opposed to consumers), if it
occurred at the beginning of a downturn. But the emphasis
is on "theoretical", for such an expansion would have to be
so carefully regulated and then withdrawn that Hayek
admitted, "Frankly, I do not see how the banks can ever be
in a position to keep credit within these limits." He
concluded by arguing against "the well-meaning but
dangerous proposals to fight depression by 'a little
inflation.'" Sound familiar?
Furthermore, while Mr. Greenspan tells us that nothing
could have been done during the boom to prevent the bust,
and now all he can do is address its after-effects, Hayek
held the exact opposite view: "[W]e arrive at results which
only confirm the old truth that we may perhaps prevent a
crisis by checking expansion in time, but that we can do
nothing to get out of it before its natural end, once it
has come."
Yet, not all the blame for post-boom economic distress
should be put on the regulators of the monetary system.
Capitol Hill deserves its proper share of blame as well.
"[C]ertain kinds of State action," Hayek said at the end of
his book, "by causing a shift in demand from producers'
goods to consumers' goods, may cause...prolonged
stagnation. This may be true of increased public
expenditure in general or of particular forms of taxation
or particular forms of public expenditure."
So where does all this leave us? In short, with many
investments that still need to be liquidated before a
healthy and sustainable expansion can begin. Such a process
is difficult in the best of times, and unfortunately war
and vastly expanded government spending will only divert
resources away from economically productive uses, no matter
how much "stimulus" it appears to bring.
The symptoms of the continuing post-bubble adjustment are
all around us. There is weakness in retail sales, consumer
confidence, business investment and employment, to name but
a few areas of malaise. The eternal optimists among us are
quick to blame "temporary" factors like oil prices,
"geopolitics" and cold weather as the culprits. We would
point out, however, that this is merely what happens when
growth is weak and the economy is vulnerable to an external
shock. It hardly matters which particular event triggers
another downturn.
The good news so far is that oil prices have not spiked
further - a sustained increase would certainly send us back
into recession. But a tour of recent economic indicators
makes it clear that we have indeed hit another "soft patch"
(to use the soothing words favored by the Fed chairman).
First, let's consider the labor market. As everyone has
heard repeatedly, the employment situation is a lagging
indicator. But what was a convenient excuse at the
beginning of the recession has now become evidence that the
recovery never quite got on track after all.
As the Fed's Beige Book for the first few months of the
year puts it: "Business spending remained very soft as
geopolitical concerns and uncertainty over the strength of
demand continued to constrain spending and hiring plans."
Stephen Roach, crack Morgan Stanley economist, goes
straight for the jugular when he blames the deterioration
in the labor market for the "high and rising" odds of
recession. Other indicators also bring into sharp relief
the recent setback in the economy. For instance, although
industrial production growth has rebounded from negative
territory, it hardly compares to previous recovery periods,
and already appears to be leveling off.
The manufacturing industry will certainly not find it any
more comforting to hear that GDP growth is still positive.
The Institute for Supply Management's index tumbled to 46.2
in March, below the expansion level, and down from 50.5 in
February and 53.9 in January - now the lowest since right
after September 11. ISM survey chairman Norbert Ore was
correct last month when he observed that the drop seemed to
be more than a temporary blip.
The ISM survey also showed that jobs in the manufacturing
sector continue to disappear. And after it looked like they
might finally be moving in the right direction, jobless
claims are heading higher once again.
Indicative of the investment overhang, non-residential
private construction remains very weak, down 15% from a
year ago, and 30% from its peak in 2000. How long will low
interest rates continue to boost the residential market?
Not forever is our unhelpful guess. Housing starts are
already declining, and the inventory of unsold homes has
risen sharply since the beginning of the year.
Of course, all this could change if the removal of Saddam
Hussein really is the answer to all of our economic
problems. We're just not betting on it. If there is one
benefit to all the troubles we find ourselves in, perhaps
it is the learning of some very old lessons.
War is never good for the economy, and when it comes to
monetary policy, there still ain't no free lunch.
Regards,
Andrew Kashdan
for The Daily Reckoning