In the second quarter of the year GDP grew by 2.8 per cent. This was up from the 0.9 per cent increase posted in the first quarter. According to the orthodox view these figures -- disappointing as they are to the markets -- clearly show that the US is not in recession, defined as two consecutive quarters of negative GDP. So how can anyone argue to the contrary?
The first thing to note is that GDP does not measure economic growth, meaning capital accumulation. In fact, GDP is not even a gross figure. While it is supposed to represent total economic activity it deliberately omits the massive amounts of business spending that take place between the stages of production. Mainstream economists are aware of this omission but justify it on the nonsensical ground that it would be double counting. (Any accountant who adopted this view would quickly find himself joining the unemployed). Instead of being a gross figure we find that GDP is in fact a value-added figure, a fact that economic textbooks readily admit without seeing the contradiction.
Austrian economic analysis skips the fallacious GDP concept by drawing attention to the pattern of total spending. In other words, the Austrian focus is microeconomic: the very opposite of the aggregate approach that now dominates economic thinking. Now we must once again briefly examine the economic consequences of central bank meddling with interest rates.
By forcing the rate of interest below its market rate the central bank is unintentionally signalling to business that there are more real savings available for investment that actually exists. By real savings I mean that part of the community's income that has been diverted from consumption (present goods) to the production of future goods (capital goods). Therefore, in a free market in which the rate of interest is solely determined by market forces the supply of capital would equal the demand for capital.
As interest is the price of time a lowering of the rate of interest will encourage more investment in longer (more time consuming) projects. It ought to go without saying that credit expansion -- the child of a manipulated interest rate -- is the means by which these projects -- which are malinvestments -- are funded. Eventually these businesses find themselves in an economic vice, squeezed by falling demand for their products and rising production costs they reduce their demand for inputs particularly labour, causing manufacturing unemployment to rise.
While this is being played out consumption expenditure, which is about 66 per cent of US GDP, remains positive. Moreover, even as manufacturing sheds labour consumption spending can for a time maintain the aggregate demand for labour. As the boom approaches the final phase unemployment in the lower stages or production (those close to the point of consumption) begins to rise, causing an increase in aggregate unemployment. This is what happened with the Clinton boom and the Bush boom. The following quote from the WSJ confirms this line of reasoning:
U.S. employers shed jobs last month at the fastest pace in five years, as weakness in the job market spread from the ailing manufacturing industry into services and even the public sector. [Italics added]. Nonfarm payrolls declined 159,000 in September, more than double the average pace throughout the year, the Labor Department reported. The unemployment rate, based on a separate survey of households, held at 6.1% after a sharp increase in August. The employment report suggests the U.S. economy is in recession or headed into one. "We're going through the painful adjustment of clearing out enormous excesses in housing and in finance," ... (Wall Street Journal 4 October 2008)
What should strike the reader as strange about this report is its failure to even consider the statistics it used as indicating that there is a distinct pattern here that strongly suggests the existence of a potent disequilibrating force is behind these figures. Oddly enough, the report made the observation that a "painful adjustment" is necessary if "excesses" are to be liquidated. Yet there is not the slightest hint that the author has considered the possibility that the origin of these "excesses" -- what Austrians call malinvestments -- is purely economic and avoidable.
The Institute of Supply Management has provided even more grim news. Its September report shows its PMI (performance manufacturing index) has dropped to 43.5. (Anything below 50 indicates a contraction). Since August manufacturing production has dropped by 11.3 per cent, from 52.1 to 40.8 while employment fell by 7.9 per cent
In an article I wrote in 2004 I warned readers to expect an economic crisis in 2008. So how did I do it? Well, it certainly wasn't guesswork. By applying the Austrian theory of money and capital it was evident that the Fed's loose monetary policy was creating a pile of imbalances -- "excesses" -- that would have to be liquidated at a later date. By examining the data I saw that there was a tendency for the economy to slow after 3 or 4 years. This is a fairly old pattern. After the 1920-1921 financial crisis the US economy started to slide into recession. This trend was quickly reversed by a monetary injection by the Fed.
Despite the fact that I obviously used a very rough rule of thumb, I do believe that monetary injections wear off rather quickly which accounts for ever-increasing monetary injections in an attempt to ward off recession. During the 1950s and 1960s in the UK this monetary policy became known as "go-stop". I think the same can be said of the US economy.