by Kurt Richebächer (Austrian School of Economics)
THEY HAD IT IN THEIR GUTS
Worldwide, the economic news is going from bad to worse.
Never before has the world experienced such massive
destruction of stock market wealth; never before have
business profits and business capital spending suffered
such steep declines. Yet there remains, particularly in
the United States, a general flat refusal to see anything
foreboding in these developments.
Blind faith is overwhelming bad and worsening facts. This
faith has two main objects: first, Fed Chairman Alan
Greenspan creating money and credit with reckless
abandon; and second, the consumer borrowing and spending
with equally reckless abandon.
This faith is utterly amazing. But it confirms our long-
held suspicion that the American consensus remains at a
complete loss to appreciate and understand that the
extraordinary excesses of these two, Mr. Greenspan and
the consumer, have been crucially responsible for the
present economic and financial mess. Even more of the
same excesses are hardly the solution. While postponing
the day of reckoning, the consumer is ever-worsening his
position by loading himself with more debt that he is
unable to repay.
We continue to track the chief causes of this developing
American economic and financial crisis. Our finding is
that they keep worsening. There is nothing in sight that
might be regarded as healthy readjustment.
In his book Crises and Cycles, published in 1936, Wilhelm
Röpke, Germany's leading economist at the time, lamented
about the general posture of American economists to
indulge in the collection of detailed statistics about
the economy, simply looking for regular sequences in the
business cycle while grossly neglecting analytical
research about underlying causes and conditions.
For the great European economists, economics was in
essence a branch of logic with minimal statistics; for
American economists, it is traditionally a branch of
statistics with minimal research and logic.
The main concerns of the European economists were the
need for sufficient rates of saving and capital
investment as the key sources of wealth creation and
productivity growth. For them, capital formation was the
future. Under the dominating influence of Professor
Wesley Mitchell (1874-1948), economic thinking in America
took a diametrically different route. He had no interest
in the conditions of long-term economic growth. His whole
attention centered on the recurrent oscillations in
economic activity.
His primary thesis was that each phase of the cyclical
oscillations grows out of the preceding phase. Under his
influence, the business cycle became a fad with American
economists and the business community, and forecasting
became a national sport.
With the change in the target of research came a radical
change in the kind of research. While the European
economists emphasized the need for a theoretical concept
to properly assess economic policies and prospects, Mr.
Mitchell discarded such abstract theorizing as a useless
exercise.
Pointing out that business cycles generally follow the
same pattern, Mr. Mitchell advocated that economists
should therefore contend themselves in their studies with
purely empirical, descriptive analysis. Instead of trying
to search with theoretical concepts for causes and
conditions, they should look for regular sequences and
leads and lags of the significant economic and financial
variables, trying to trace unfolding fluctuations.
Putting it briefly and bluntly: while the European
economists searched for causes and conditions that
determine long-term economic growth and its repeated
upheavals, Mr. Mitchell practically turned American
economics into a science of statistical symptomatology,
refuting the necessity to identify underlying causes and
conditions.
Still, although very skeptical of any theory, he
emphasized in his writings that the quest for profits is
the central factor controlling economic activity.
Accordingly, he said the whole discussion must center on
the prospects for profits, which is really the
theoretical assumption of crucial importance about the
workings of the capitalistic economy.
Looking back over the five decades since World War II, it
is true that the industrial economies developed very
smoothly and that cyclical fluctuations showed, indeed,
the very same pattern as presumed by Mr. Mitchell. There
appeared to be no need for a theoretical concept.
But we think that this interpretation is grossly
misguided. With the Great Depression in their memory,
policymakers, economists, entrepreneurs and the public
worldwide entered the postwar period with strict views
about what is sound and what is unsound in economics.
They didn't need a theory; they had it in their guts that
saving and investment were needed to increase living
standards and wealth. Americans were proud of repaying
the mortgages on their houses. They would have thought it
irresponsible to increase an existing mortgage. In the
same vein, deficits in government budgets as well as
deficits in the balance of payments were generally
abhorred. Minor deteriorations tended to cause prompt and
heavy adverse market reactions in the markets, forcing
governments to undertake quick, corrective action.
What prevented prolonged spending excesses was, clearly,
not only prompt monetary tightening, but rapid, adverse
market reactions and a general sense of responsibility
and unwanted consequences among the public. This kind of
thinking went completely out the window in the United
States in the 1980s with unprecedented private and public
borrowing binges.
Whether plunging personal saving, a soaring budget
deficit or a soaring trade deficit, none of it mattered
anymore for the economy's health in the eyes of American
consensus economists. For the first time in history,
national and international lenders and investors readily
financed extreme American borrowing and spending
excesses.
There was still a lively, critical public debate inside
America about the negative effects of the soaring budget
deficit and lower personal saving on national saving and
the pace of domestic capital investment. Net national
saving as a percent of GDP declined from around 7% to
almost 2% during the 1980s, while net private investment
(gross investment minus depreciations) shrank over the
same period as a share of GDP from a little over 7% to 5%
of GDP. Clearly, this reflected a consumption boom, not a
supply-side boom.
We have recalled this episode and the notorious American
disregard of economic theory because these negative
trends in saving and capital formation that started in
the 1980s have dramatically deteriorated in recent years.
Measured by the new slide of net saving and net capital
investment, consumers and businesses have ravaged the
economy's capital structure in the past few years as
never before. Yet this time there is zero discussion,
zero research and zero worry.
Net national saving has slumped again to around 2% of
GDP, and continues to shrink as minimal personal and
business saving is being joined by a soaring budget
deficit. Net capital investment still accounts for about
5% of GDP, about half-and-half nonresidential and
residential investment.
Manifestly, this is not a garden-variety type of economic
downturn; that is, one triggered by rising inflation and
monetary tightening. Rather, collapsing profits induced
businesses to slash employment, fixed capital investment
and inventories. The profit slump is the one very unusual
feature. The fact that it occurred against the backdrop
of the most rampant money and credit growth in history is
the other one.
During 2001, broad money growth (M3) accelerated to
$912.5 billion, from $573.7 billion in the year before,
while GDP growth, measured from fourth quarter to fourth
quarter, decelerated to $5 billion. To put this into
perspective: Broad money (M3) grew by $468 billion
overall, from 1990 to 1995 or $94 billion per year.
Worst of all are the credit figures. In 1991, borrowings
of the non-financial sector soared by $1,108 billion and
those of the financial sector by $916 billion. During the
second quarter of 2002, the debt explosion went
astronomic. Total non-financial debts exploded by
$1,531.4 billion (government $451.3 billion, consumers
$705.5 billion and businesses $201.1 billion) and
financial debt by $916.3 billion, all at annual rate.
Altogether, this produced an abysmal increase in GDP of
$58 billion, also at annual rate.
One would think that such a horror picture of grossly
ineffective record money and credit growth would provoke
some critical questions about underlying causes. But we
see nothing of that kind. Few, if any, people seem to
have noticed.
The past U.S. boom was anything but normal, and so is the
downturn. The question to examine in the face of the
obvious, massively abnormal features of boom and bust is
how, and to what extent, they condition the future,
either for better or for worse.
Regards,
Kurt Richebächer,
for The Daily Reckoning
Editor's note: Dr. Kurt Richebächer's articles appear
regularly in The Wall Street Journal, Strategic
Investment and other respected financial publications.
France's Le Figaro magazine did a feature story on him as
"the man who predicted the Asian crisis." Dr. Richebächer
is currently warning readers to remain cautious in the
face of The Bogus Recovery. |
