The American economy:
not if but when
By Gerard Jackson
No. 110, 8-14 March 1999
It is becoming plainer by the day that though puzzlement about the American economy's growth rate continues worries are now piling up faster than rationalisations. There is less talk of a "new era" economy and more about a "correction". What is it that is bringing about a more subdued assessment in certain quarters? Commodity prices is the answer. Last week I explained that the problem with commodity prices is not their falls but the the squeezing of commodity price margins, the difference between costs and prices. This is an important signal to look for yet, like the Titanic's SOS, no one seems to be listening. It's the same old problem of not seeing the trees because of the wood. And in this instance, price margins are the trees. Price margins for commodities are like location for real estate agents.
We have recently seen mood swings from overvalued stock to falling commodity prices and back again. First, so we are told, the former could burst and send the economy into recession; on the other hand, a continuing fall in commodity prices will tip the world into a global recession. Well, which one is it? Neither, is the answer. Falling commodity prices can no more cause a recession than falling share prices can. And yet the two are closely linked just as some clusters of mergers are. In economics, everything is connected to everything else and prices are the means by which this is accomplished. Distort prices and you discoordinate the whole economic process. This, unfortunately, is precisely what the Fed has been doing. What is also unfortunate is that the vast majority of economic and financial commentators are totally oblivious to this fact.
Loose monetary policy has fuelled the stock market boom, encouraged corporate mergers while having a malign influence on commodity price margins. Commodities tend to be inputs. As I explained in previous articles, artificially lowering the rate of interest causes over-expansion in higher stages of production. Commodities are part and parcel of those stages, meaning that lower interest rates also raises the demand for commodities, even though their secular price trend is downward. Once the higher stages find themselves in a profits squeeze as rising costs and falling demand puts them in a financial vice, this will feed back into a reduced demand for tthese products which in turn reduces their price margins. This is why commodity price margins rather than commodity price trends should be followed more closely. And this is why the message is not good.
So the same thing that fuelled the stock market is the same thing that caused commodity price margins to be squeezed. But where do mergers enter the field? Two periods in American economic history throw considerable light, at least in my opinion, on "corporate mega-mergers". Readers will recall that I have referred several times to the 1920s economic "new era". But the boom of 1896 to 1903 was also very much a "new era" phenomenon. Now 1924 to 1929 was characterised by considerable take-over activity, just as the 1899-1902 period was. These "new eras" were marked by 'cheap credit' and feverish stock market activity. With ample credit available and stocks rapidly rising it becomes easier to issue abundant securities, which makes it easier to buy out other companies and consolidate holdings. Once again, it's what fuels the action that counts rather than the action itself. Each era of considerable merger activity was fuelled by credit expansion.
America is going through not a business cycle but a cycle of ignorance. The belief that the business cycle is built into market economies is so ingrained that it is rarely questioned. For nearly 2,000 years the Aristotelian belief that heavier objects fall faster than lighter objects held sway over the European mind. Then one day Galileo completely demolished this belief by simultaneously dropping from the top of the Tower of Pizza objects of different weights. It is not as easy to refute the fundamental belief that the trade cycle is a product of monetary mismanagement, especially since the birth of Keynesianism. But until we do our economies will continue to undergo periodic booms and depressions.
Even though the Austrian School has provided an analytical refutation of Keynesianism it has yet to receive the recognition it deserves. I think, however, that recognition is, albeit slowly, on its way. In the meantime, tighten your seatbelts.
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