Fallacies Abound Amidst Market Uncertainty
With the markets once again turbulent due to economic uncertainty wrought by a weakening and unstable dollar, fallacious assumptions abound about the economy. And while the assertions about what’s driving the economy and stock markets are many and varied, the majority make very little sense when put under even the dimmest of critical lights.
Export Driven Growth – A recent Wall Street Journal article on the trade balance noted that the “economic downturn would be worse if it weren’t for exports.” Global Insight economist Nigel Gault asserted that export strength is “dampening the recession,” while UniCredit analyst Roger Kubarych channeled our Fed Chairman in suggesting that, “The weaker dollar and strength of foreign demand is helping to boost U.S. exports.”
Not mentioned was that any perceived trade gains achieved through a weak dollar would be wholly illusory given that increased nominal profits would be wiped out by the weaker unit of account; in our case, the dollar. Inflation surely steals any benefits that supposedly result from devaluation.
Furthermore, the notion that we can export our way to growth is a myth driven by the view that paper money is itself wealth. Quite the contrary. Acquisition of fiat money is merely acquisition of a medium of exchange that allows U.S.-based companies and individuals to import the goods they desire in exchange for those exports. All trade in the end balances, so while we should embrace the truth that foreigners want what we produce, it’s rising imports that we should cheer as a symbol of economic growth. Rising imports are the signal that we’re being productive in ways that we’re receiving a lot in return for our productivity. We export so that we can import, so it’s the latter number that economists should concentrate on in order to divine our true level of economic health.
Consumption – 70 percent of economists polled in this month’s Wall Street Journal survey on the economy said the U.S. is in the midst of a recession. One factor cited was a 0.6% fall in retail sales. The article noted that the decline “reflects a sharp slowdown in consumer spending, which accounts for more than 70% of U.S. economic activity.”
The idea that consumption comprises 70% of our economic activity is frequently cited by economists and journalists as settled truth despite its obvious contradictions. Indeed, how can one consume without producing something first? It is through our wealth-producing labor that our consumption is enabled; consumption really a superfluous word obscuring the process by which we supply in order to demand. All consumption results from production, and to the extent that inheritance or borrowing from banks leads to consumption, that simply means someone else has supplied first so that we have access to money that allows us to consume.
Lastly, in concentrating on the macro calculations that constitute total consumption, economists miss out on how truly enervating rampant consumerism would be for our economy. If we as individuals spent all of our earnings without saving (see U.S. and England in the ‘70s), on an individual basis we would all be poor. Savings are the source of all wealth, and far from detracting from consumption, savings are banked or invested such that entrepreneurs and businesses can access the capital to build their job-creating businesses.
Home Mortgages as a Consumptive Medium – During the property boom of recent vintage, economists and commentators latched onto the idea that rising home prices were a source of economic growth. On CNN’s Glenn Beck Show last week, money manager Bill Fleckenstein said the economy was in trouble due to falling home prices. This is based on his belief that with many individuals lacking appreciated homes to borrow against for spending purposes, those same people will rein in their spending to the detriment of our economic health.
What Fleckenstein missed is that one man’s mortgage is another man’s savings. For someone to borrow in order to consume, there must exist a saver willing to put off current consumption in favor of spending at some time in the future. There’s no net consumption increase to speak of, plus when individuals access money in order to consume it, the latter siphons capital away from the economy’s more productive, job-creating sector.
England and the United States were mentioned above, and both countries experienced high levels of personal spending in the 1970s. Far from an economic stimulant, the heavy spending was the sad result of inflation and confiscatory capital gains rates that made most individuals unwilling to delay consumption. It was only when the barriers to saving were reduced in the ‘80s that people started holding on to more of their money; the savings an economic stimulant for increasing the base of investable capital in all manner of business ventures.
Rate Cuts a Replay of ‘That ‘70s Show’ - Many commentators (including this writer) have argued that the falling dollar is a blast to our unhappy and inflationary 1970s past. Still, there’s a lot of mythology concerning what happened thirty years ago.
Carnegie Mellon professor Allan Meltzer has said that the Fed’s current bias in favor of rate cuts “is a repeat of the mistakes of the 1970s.” The problem there is that the dollar’s greatest weakness in the early and late ‘70s occurred amidst Fed funds rate increases. In May of 1977 gold was trading at roughly $145/ounce with the Fed funds rate at 5.25 percent. By January of 1980, with the cash rate all the way up to 13.75 percent, gold reached what was then an all-time high of $850/ounce.
It’s also thrown around quite a bit that the Fed’s rate-cutting mirrors what happened to Japan in the ‘90s as the BOJ’s bank rate was driven all the way to zero. The major difference there is that as opposed to having an inflation problem, Japan suffered from deflation due to a strong yen that was wiping out debtors who faced rising real levels of debt amidst falling prices.
Our inflationary experience is quite the opposite, but for those who see low nominal cash rates as a signal of inflationary monetary policy, they would be wise to study Japan’s history. Not only did a zero bank rate fail to save Japan’s collapsing real estate industry, it also failed to moderate the yen’s rise.
Protectionist impulses stateside have it such that the yen will never weaken in any large sense versus the dollar, and just the same, it should be said that so long as the Bush administration, U.S. Treasury and the Federal Reserve all countenance and encourage a weaker greenback, no amount of rate hikes will reverse the latter’s descent. If we want a stronger dollar, credible comments in favor of such a move by our monetary authorities would accomplish what is desired in ways that rate increases never have; including from 2004-2006 when 425 basis points of rate increases occurred alongside a 60 percent decline in the dollar versus gold.
Rate Cuts Bail Out Investors in the Short-term – While there are varying views on the positive or negative effects of the Federal Reserve’s actions via the funds rate it sets, there’s a growing belief that rate cuts boost the markets in the near-term such that investors exposed to heavy losses can escape. That stocks have frequently rallied after rate-cut announcements have bolstered this flawed view.
The problem here is that in order for a seller to unload a position, there must also exist a buyer who thinks the securities being purchased have an upside. To believe that rate cuts weaken the economy while at the same time aiding heavily exposed investors is quite the paradox. Indeed, one would have to believe that the seller in every instance possesses information that the buyer is oblivious to. In short, if rate cuts are the market/economic negative that so many assume, this would be reflected in securities prices such that those eager to liquidate would face even greater losses. Instead, what market rallies in the aftermath of FOMC meetings tell us is that there are differing views in the great voting booth that is the stock market on the broad economic impact of Fed machinations. The Fed's agreement to cover J.P. Morgan's downside in its purchase of Bear Stearns constitutes a bailout. When it comes to rate cuts, bailouts they are not.
Negative Sentiment Can Be the Cause of Recessions – CNBC’s Maria Bartiromo has said that economies can essentially be talked into recession. Her view is that if it’s drilled into the heads of people that the economy is contracting, they’ll begin to believe it and will stop consuming. The notion that negative sentiment can induce recession fails on several counts.
First off, economies contract for the failure of economic actors to produce economic value that enables their consumption. What this means is that any negative economic sentiment would follow, rather than precede any economic slowdown.
Secondly, how do we as individuals respond to negative sentiment; the very sentiment that if true threatens our livelihoods? Rather than enervating, the fear of failure focuses us in such a way that we seek to enhance our productivity through taking less time off, spending our office time more productively, and generally doing whatever it takes to be productive such that we escape unemployment. Negative sentiment would if anything enhance our output for fear of failing in ways that would make us redundant to our employers.
If anything, we should say that excessive optimism is the driver of slowdowns, not pessimism. Indeed, it is when we feel good about our economic circumstances that we leave work earlier than usual, take more vacations, and to some degree consume our capital (while becoming lax in our investment disciplines) given the belief that the good times will continue.
And the above leads to the consumption fallacy that entrances so many of the economic and media elite. Always focused on how many cars people buy and vacations they take, mainstream thinkers forget that a failure to consume is a huge economic stimulant for the resulting savings very often flowing into new and existing business ventures that create jobs. Negative sentiment that might cause us to save is a boon for the economy for the pool of available investment capital increasing.
Assuming the economic picture worsens as so many suggest it will, one can rest assured that more in the way of fallacious economic assumptions will reveal themselves. That’s to be expected. Still, what’s rarely mentioned is that free markets don’t themselves cause economic slowdowns any more than rising economies and bull markets die of old age. Instead, they die due to legislative/government failure. In today’s case a falling dollar has created all sorts of economic dislocation that has harmed the broad economy, and generated myriad government “solutions.”
The better answer is for the federal government to get out of the way so that markets can clear, while allowing the productive sector of the economy to resume its growth path. In times like this, it's important to remember that the federal government only exists at the pleasure of taxpayers. And when it inserts itself into private commerce with taxpayer money, it slows down the all-important process by which markets adjust; its interventions consuming capital that if not taken from the private sector, would more likely find its way into the market economy in ways that would shorten the latter's recovery time.