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BEST OF KURT RICHEBACHER
November 22, 2002
BUBBLE AFTERMATH
Since World War II, all recessions in the United States, as well as in the rest of the world, had their main cause in monetary tightening by the central bank, implemented in response to rising inflation rates. As soon as the central banks loosened their shackles, the economies promptly took off again. Also important, the business cycles in America and Europe never used to coincide and cumulate, but instead used to follow each other. The fortunate effect of this regular sequence was that it stabilized the world economy.
For the first time in the whole postwar period, the U.S. economy has slumped against a backdrop of the most aggressive rate cuts by the Federal Reserve and the most rampant money and credit growth ever. Implicitly, the forces depressing the U.S. economy this time are radically different from those that fueled past recessions. It is the goal of this letter to explore and identify the unusual causes of this economic downturn.
Among these causes, the profit implosion is the most obvious and also the most important. Essentially, it must have its own specific causes. Searching for them, we identified three major profit killers: first, a surging share of depreciation charges in gross investment; second, inflexible, record-high interest charges; and third, the gaping trade deficit. Widespread hopes of an early rebound in U.S. corporate earnings are doomed.
But there is another crucial novelty to this economic downturn. That is its global synchronization. The problem is that the global economic upturn of the past few years was equally synchronized, as economies around the world adjusted to the roaring U.S. asset and spending bubble. During 1997–2001, American spending on imported goods and services exceeded earnings from exports by altogether $1,428.8 billion. To put this into perspective, U.S. GDP growth during these four years was $1,055 billion in real terms and $1,763.8 billion in nominal terms.
It is a familiar postulate of Austrian theory that the extent of the bust following a boom tends to be rather proportional to the scope of the excesses and the adherent economic and financial imbalances that accumulated during the boom. Gottfried Haberler’s Prosperity and Depression (1937) says, "The length and severity of depressions depend partly on the magnitude of the ‘real’ maladjustments which developed during the preceding boom and partly on aggravating monetary and credit factors."
This postulate of the proportionality between boom and bust has convinced us from earliest times. Manifestly, it is diametrically opposite to conventional thinking in America that, under the influence of Milton Friedman, discards past boom excesses as things of the past. Past is past, and the only thing that counts for the present and the future is current monetary policy.
In this view, the Depression of the 1930s owed nothing to any credit excesses and related maladjustments in the economy and the financial system during the boom years, but resulted exclusively from the Fed’s flawed policies after the stock market crash. Common to this opinion is furthermore the conviction that proper monetary policy is capable under all circumstances of preventing recession and depression.
IT IS WORSE THAN IT LOOKS
It goes without saying that this kind of thinking is prone to foster illusions about what monetary policy can do. What we generally hear and read from American sources reveals that there is, in fact, a widespread, inordinate complacency about the U.S. economy’s woes, even though troubling economic data abound lately. A strong, preconceived view appears to hold sway that everything is bound to come up roses in the end.
We stick to our view that the world economic prospects are significantly more bleak than most people realize. The existing imbalances and structural distortions are too big and the room to cut interests far too small to fight the spreading weakness. But as to prevailing illusions, America is apparently on top. The rest of the world clearly lacks the dynamics for self-made economic growth. But Europe, above all, has no prior excesses to cope with. Our particular concern about the U.S. economy arises from the recognition that the world’s greatest bubble in history has in many ways grossly imbalanced it, hampering growth for a long time to come.
The decline of profits is already the worst since the 1930s. What’s more, it started long before the economy began to slow down. Yet it is not alone in depressing the U.S. economy. Strong, correlative depressants are those maladjustments that Austrian theory puts at the center of its investigations, but which American economists in general completely ignore.
Measured as a share of GDP, profits before tax of the corporations in the nonfinancial sector are already well below their level during the recession in the early 1990s. There was an uptick in early 2002, but for reasons explained, the trend remains downward.
The popular, optimistic spin persistently coming out of Washington and Wall Street always ends up with the vacuous claim that the economy’s "fundamentals have never been sounder." However, they have very funny ideas of what actually represents an economy’s crucial growth fundamentals. Low inflation rates and a high rate of productivity growth appear to enjoy their highest esteem.
That’s truly new economics. For the old economists, and in the same vein for us, low inflation rates are nothing to brag about. They are one of various obligatory conditions that are needed for healthy economic growth. And as for the miraculous productivity growth, we have explained many times that in the U.S. case it reflects more statistical than economic magic.
For the old economists, and just the same for us, healthy, long-term economic growth depends primarily and crucially on adequate national saving and net investment, making for capital formation and increasing the productive capital stock. It may always be arguable which rates are adequate, but the obvious thing to see about the U.S. economy is that its savings and investment performance in the past few years has been most miserable.
There is a lot of talk nowadays about the need for economic restructuring in other countries to compete with the U.S. economy. It is true that the latter has been massively restructured. Unfortunately, it was a kind of restructuring that generations of economists would have dismissed as utterly destructive for future economic growth.
The U.S economy’s macroeconomic "restructuring" in the past several years had four interrelated components. Its decisive, primary force was an unprecedented consumer borrowing and spending binge that sent personal consumption to its highest level ever as a share of GDP. This had three directly related counterparts in the economy: (1) sharply lower personal saving; (2) sharply lower net business investment; and (3) an exploding trade deficit. From a macroeconomic perspective, and considering also the scope of these imbalances, this was outright murder of the economy’s supply side.
CONCLUSIONS:
The world economy is caught in a general profit and investment depression. The preponderant, single hope is that further interest rate cuts by the Federal Reserve will, after all, tip the balance and lay the foundation for a sustained recovery of the U.S. economy and its stock market, pulling the rest of the world with it.
Tracking economic data and the developments in the economy and the financial markets, both stocks and credit, we see nothing but aggravating conditions. Renewed drastic weakness of the U.S. economy is the great shock waiting to happen for the world.
A slumping dollar will turn it into a nightmare. |
