Some Obama supporters are already bragging about how the 'recovery' will ensure him a second term and therefore save his statist counter-revolution. Not so fast. These people are making the same mistake that many conservative commentators have made in that they are assuming recessions to be indeed cyclical. This means any downturn is eventually reversed and that this is now the case. It also means that these people have learnt nothing from economic history, particularly the policy disasters that the Hoover/Roosevelt administrations inflicted on the country.
The actual and crucial role that money plays in the boom-bust cycle is rarely discussed in the media, even by monetarists who labour under the egregious error that so long as a "managed" money supply 'stabilizes' the price level there can be no boom and thus no bust. Of course, if they were right then there would have been no Great depression. During that dismal period in American history it was noted by minds far more astute than those one now finds teaching economics at Harvard and MIT that
our present difficulties are viewed largely as the inevitable aftermath of the world's greatest experiment with a "managed currency" within the gold standard, and, incidentally, should provide interesting material for consideration by those advocates of a managed currency which lacks the saving checks of a gold standard to bring to light excesses of zeal and errors of judgment. (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, p. 56)
A stable general level of prices in itself means little; it is the disequilibria among particular paces induced by bank credit expansion (or contraction) that is of chief interest and importance for business cycle theory. (Ibid. p. 191).
The one thing that Chicago monetarists and Austrians can agree on at this point is that the so-called 'recovery' is driven by Bernanke's criminally loose monetary policy. This also explains why the P/E ratio has been inflated. There are always time lags between changes in the money supply and changes in production. Because there are no one-to-one relationships in economics we can never know how long these time lags will be. All we can really do is plot them after the event. The following chart shows the change in AMS (Austrian money supply*) and industrial production from September 2008 to last March.
From September 2008 to the following June money supply zoomed by about 25 per cent, averaging an annual rate of 33 per cent. It was this monetary surge that was driving the economy, including the share market. Since last June money supply has entered a downward trend. In January industrial production flattened, seven months after the monetary decline began. (One should not of course base any predictions on a single month's figures.)
Nevertheless, it should be noted that the contraction means that the quantity of bank deposits have also been falling. The fact that commercial and industrial loans have dropped by about 17 per cent during the last three months would clearly indicate that the contraction is squeezing commercial borrowing. Or would it? If a monetary contraction was responsible for such a squeeze one should expect the demand for business loans to drive up short-term rates, which is not the case. We can infer from this that the reports from the banking sector that business demand for loans has been very weak are indeed accurate.
We have a curious situation in which there is a recovery sans an increase in the demand for commercial loans. In addition, we apparently find the same phenomenon with respect to labour. A recovery that takes place without an increase in the demand for business loans and labour is a very strange beast and -- in my opinion -- a sickly one. Critics could argue -- and probably will -- that the employment figures for last month clearly indicate a rising demand for labour. Yet these figures are somewhat dubious to say the least. The ADP reported that "nonfarm private employment decreased 23,000 from February to March on a seasonally adjusted basis".
In short, there was a net loss of jobs. So private payrolls show an increase while the ADP report shows a loss. Even if the 123,000 gain in jobs is accurate it would be a very meagre result given the rate at which the workforce is increasing. What needs to be stressed is that both measures should be rising together. Moreover, the BLS's U6 measure of unemployment (includes the underemployed and long-term unemployed) reached 16.9 per cent in March.
Right now the country has some very dodgy employment figures that even if accurate still do not paint an optimistic picture. There is also the fact that commercial and industrial loans continue to shrink, meaning that business is not borrowing. Then we have the situation of a contracting money supply which in itself strongly suggests an aborted recovery could be on the horizon.
On the other hand, the chart reveals a rapid monetary expansion started in February and continued throughout March. This expansion worked out at an annualised rate of 56 per cent. Whether this extraordinary growth is merely a spike in a downward trend or an indication of accelerating monetary growth remains to be seen. If it's the latter then America is heading into an extremely inflationary period with all that that entails.
Note: It is a serious error to confuse an increase in GDP with economic growth, which is the process of capital formation. At the moment there is no capital formation and hence no real growth is taking place.
*There are some differences among Austrians as to what ought to be included in a definition of the money supply. I try adhere to Walter Boyd's view who in his open letter to Prime Minister Pitt in 1801 defined money in the following terms:
By the words 'Means of Circulation', 'Circulating Medium', and 'Currency', which are used almost as synonymous terms in this letter, I understand always ready money, whether consisting of Bank Notes or specie, in contradistinction to Bills of Exchange, Navy Bills, Exchequer Bills, or any other negotiable paper, which form no part of the circulating medium, as I have always understood that term. The latter is the Circulator; the former are merely objects of circulation. (Walter Boyd, A Letter to the Right Honourable William Pitt on the Influence of the Stoppage of Issues in Specie at the Bank of England, on the Prices of Provisions, and other Commodities, 2nd edition, T. Gillet, London, 1801, p. 2).
In simple terms, money is the medium of exchange. Nevertheless, difficulties do arise. Are savings deposits money? This presents the problem of double-counting. If I take $10,000 in cash and deposit it in my savings account it cannot be seriously I argued that I have now expanded the money supply by $10,000. It therefore follows that if the bank lends out that $10,000 the money supply still remains unchanged. We now deduce that credit transactions do not alter the money supply. Whether we include savings deposits in our definition depends on whether or not it involves double-counting.
By Gerard Jackson
Gerard Jackson is Brookes' economics editor.
Copyright © 2010 Gerard Jackson
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