When the official unemployment figure dropped by 0.2 per cent to 10 per cent the so-called media were quick to claim it as evidence that the economy was now moving in the right direction. But how could this be if firms were not hiring? To any reasonable observer of the economic scene it was obvious that the number of discouraged workers must be rising. The jury is now in, making this conclusion official: The Labor Department has reported that 929,000 "discouraged workers" ceased looking for work.

This dismal statistic is up from 642,000 a year earlier. Chris Rupkey, an economist with Bank of Tokyo-Mitsubishi, called the finding "astonishing" and estimated that if these workers were still included as part of the work force the official unemployment rate would be 10.5 per cent. Moreover, 20 per cent of working-age males are now unemployed. This is a staggering figure that reinforces the view that the real level of unemployment greatly exceeds the official rate.

The great majority of economists argue that the problem is weak consumer demand. What is even more troubling, in their view, is that persistent unemployment could result in a significant increase in loan defaults that would further retard economic recovery and create even more unemployment. The latest report from the Fed that consumer borrowing had fallen by $17.5 billion in November, the biggest drop on record, can only deepen the gloom, particularly in light of the fact that households are paying off debt and building up their savings rather than maintain their consumption. Well, they needn't worry because their analysis is wrong through-and-through. As Nassau Senior explained:

[T]he difference between saving and spending, is to be found in distinguishing... productive from unproductive consumption. To save is to consume for the purpose of reproduction; to spend is to consume for the purpose of enjoyment. The amateur who builds and mans a pleasure yacht, and the merchant who builds and mans a trading vessel both employ laborers to produce commodities and perform services. But the merchant uses the vessel and the crew for the purposes of reproducing an equivalent or mor than an equivalent for the cost of the ship, and the wages, and the victualing of the crew; the amateur uses both ship and crew for no purpose except his own amusement. (Nassau W. Senior, Industrial Efficiency and Social Economy, Vol. I, Henry Holt and Company, 1928, p. 142.)

Senior strengthened his argument by stressing the economic difference between building a palace and building a factory. He was pointing out to Malthus -- as did Ricardo before him -- that to "save is to spend" but to spend on capital goods, what the Austrians sometimes call "future goods", and by doing so adding to the future flow of consumer goods. (The majority of economist still do not differentiate between savings and cash balances.) The inexorable conclusion is that demand springs from production. (Say's law.) It follows that if 'demand' is weak it must be because production has fallen, which of course it has.

It ought to follow with equal clarity that as demand springs from production total economic activity must exceed the value of consumption by a multiple amount in a society that employs multiple stages of production. This is exactly what the Bureau of Economic Analysis found when it took into account spending on intermediate products, a fact that was accepted by many pre-Keynesian economists. Once we include total spending we find that consumer spending drops from about 70 per cent of total economic activity to about 33 per cent. Therefore it is not consumption that drives the economy but business spending. If this fact had been accounted for it would have revealed that the economy had indeed fallen into a depression. This would also explain why trucking has been hit exceptionally hard.

What follows is, unfortunately, not self-evident. The economy has a capital structure to which there is a time dimension, the key to which is the "natural rate of interest" (its market rate). As we live in highly advanced economies we should expect the boom-bust-cycle to have its greatest impact on manufacturing because this is where the most time-consuming processes are to be found. (The housing industry responds largely the same way, not because it employs roundabout methods of production but because the very high price of its durable product makes it particularly sensitive to changes in interest rates.)

The boom-bust cycle does have a specific pattern. The first thing to note is that manufacturing leads the recovery. When the boom is coming to an end this is first signaled by a contraction in manufacturing*. In other words, production leads consumption, with the higher stages leading the recovery. As we know, virtually the whole of the economic commentariat are focused on consumer spending. But if they were right then no recovery in manufacturing would be possible and yet the Institute of Supply Management reports that manufacturing is expanding with steel production and capital goods leading the way. The news was buried by reports that "U.S. consumers and businesses are filing for bankruptcy at a pace that made 2009 the seventh-worst year on record, with more than 1.4 million petitions submitted". Moreover, small and medium-sized businesses are still shedding labour.

These conflicting reports strongly suggest to me that the US economy is still badly out of kilter and that the increase in manufacturing activity might not be able to maintain momentum, especially once interest rates rise significantly. (The extent to which manufacturing activity is being driven by pure cost cutting and exceptionally low interest rates is generally overlooked.)

Obama's borrowing and spending binge point to an eventual rise in long term interest rates severe enough that if it does not kill off investment it will severely curb it. It can never be sufficiently stressed that sustained economic recovery means capital accumulation, otherwise called economic growth. Obama's policies are anti-growth, whether he knows it or not. His green jobs policy is a prime example of gross economic illiteracy and amounts to nothing but a 21st century version of pyramid building that will do as much for the American economy as did the building of the Palace of Versailles for the French economy.

There is no such thing as a spotty recovery. When an economy is making a genuine recovery from recession it does so in a set pattern. That pattern has yet to emerge. Moreover, a rapid fall in unemployment and a swift rise in output would not in itself mean a sustainable recovery was underway. Rising output simply means a reduction in idle capacity is taking place. What matters for real wages and hence living standards is a sustained process of capital accumulation that exceeds the rate of population growth. I just cannot see this happening to any meaningful extent under the present administration. I therefore remain as pessimistic as ever.

*Some people imagine that a consumer boom is no different from the usual boom-bust cycle. Hence all that is needed to achieve recovery is to focus entirely on consumer spending, even if it meant giving everybody a blank check. Once spending picked up the accelerator principle would kick in and the recession would be over. This ignores the fact that capital is heterogeneous and that there is a relative price structure. A totally consumer-oriented policy would result in a great deal of capital being abandoned in the higher stages of production. In this case we should expect the emergence of a "rust-belt". (William H. Hutt demolished the accelerator concept in his book The Keynesian Episode, LibertyPress, 1979, chap. 17.)