Gerard Jackson - Monday 22 October 2007
On Friday the 19 October the Dow Jones industrial average plummeted by over 360 points. This immediately sent alarm bells ringing throughout the financial community -- along with nightmares of October 1929 when the Dow Jones dropped from 400 to 145 in November. This dramatic fall in share prices was not confined to America. From March 1929 to June 1931 the prices of Dutch shares dived by 60 per cent; for Germany it was 61.7 per cent from April 1927 to June 1931, and French share prices dropped by 55.7 per cent from February to June 1931. (Wilhem Röpke, Crises & Cycles, William Hodge and Company Limited, 1936, p. 57 )
Unfortunately the somewhat limited world of the share market is not noted for its historical perspective. To begin with, most observers missed the fact that America was definitely sliding into recession in July 1929, some months before the market crash. The terrible depression that followed was entirely due to political meddling combined with an atrocious degree of economic illiteracy by Hoover, which in turn was continued by the Roosevelt administration. (Naturally, our leftist media always makes sure that Hoover gets 100 per cent of the blame1).
Now some financial reporters were quick to point out that the market crash of 1987 on Black Monday October 19 witnessed a fall of 508 points without being followed by a depression. The reason is simple: there is no way a stock market crash can start a recession. The recession argument goes something like this: "irrational exuberance" starts an unsustainable market boom. When it is finally discovered that share prices are greatly inflated panic sets in, shares prices dive shrinking spending power in the process which in turn reduces consumption and hence triggers a recession. Balderdash.
Even if investors have extravagant expectations regarding future share prices their trading -- no matter how enthusiastic -- cannot bring about a boom. A stock market boom requires a continuous flow of bank credit. In other words, credit expansion. Fritz Machlup nailed this fiction with the statement that a
... continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply. (Fritz Machlup The Stock Market, Credit and Capital Formation, William Hodge and Company Limited, 1940, p. 290).
For "irrational exuberance" read reckless monetary policy. Therefore we should look to 1987 for guidance, not for economic wisdom but for an economic fallacy. Immediately after the crash I advised people not to panic. There would be no recession because the central banks will flood their economies with money. Which is exactly what they did. However, I also warned that this could only delay the impending recession. Sooner or a later it would strike. For many people it was a lot sooner than they expected. My rather laboured point is that economic events need an economic explanation, something that is becoming increasingly rare in the media. So let us see what we can do.
In 1999 I repeatedly warned that conditions in American manufacturing pointed to a recession. I repeated these warnings throughout 2000, emphasizing that the then increase in the demand for labour was hiding the effects of job-shedding in manufacturing, and that this could not continue. And of course it didn't, resulting in a recession for which the mendacious media is still blaming President Bush. To be brief, the unfolding of the 2001 recession mirrored the nineteenth century classical description of a recession. It was always noted that the beginnings of a recession first manifested themselves in manufacturing (the higher stages of production) after which the economy contracted.
The Bush boom -- just like the Clinton boom -- has been driven by a loose monetary policy, with one significant difference and that is the Bush cuts in capital gains taxes. It should not -- though it is -- be doubted that these cuts added greatly to investment, which I think might still be playing an important role in keeping the economy afloat for the time being2. Therefore, using manufacturing as a leading indicator we find that from June to September capacity remained comparatively stable at around 80. For the same period total industrial production also remained stable at about 82.1, and also from primary and finished goods at approximately 82.
What is truly striking about these figures is that from January 2006 to September 2007 AMS3 (Austrian money supply) did not change. Ordinarily we would expect manufacturing to have felt the effects of this monetary tightening some months ago. But bear in mind that the Austrian approach never loses sight of the vital importance of savings in maintaining the production structure. This is what I think may have happened here. Moreover, "American exports are now coursing their way around the world at a record level". (Ron Scherer The Christian Science Monitor, Biggest export last year? Nuclear reactors. Sales of boats and harvesters surge, too,17 October 2007).
A falling dollar appears to have greatly increased the demand for US manufactures. One does not need a PhD in economics to figure out that lowering the prices of American products in terms of other currencies will help delay a recession. Lord King explained spoke of this process more than 200 years ago, saying that
... an exporting merchant ... will receive, besides the usual profit, the amount of the depreciation which will have taken place in the currency between the time of purchasing the goods and the arrival of the remittance in return. (A Selection of Speeches and Writings of the Late Lord King, Longman, Brown, Green, and Longmans, 1844, p. 85).
These additional receipts will be used to direct more production into exports. But this is no magic pudding and a time will come when painful adjustments will have to be made on a global scale. What we have been seeing is just aspect of an unprecedented world-wide credit expansion that our economic commentariat have carelessly called a "excess savings".
1. Geoff Elliot from The Australian make the patently absurd statement that "Roosevelt's New Deal, which helped lift the US out of depression in the 1930s" (Rising petrol prices fuel anti-Bush backlash, 11 July 2005). Elliot's historical and economic illiteracy is on par for our corrupt media.
3. AMS is defined as currency plus demand deposits with commercial banks and thrift institutions plus saving deposits plus government deposits with banks and the central bank. This definition reveals very clearly that monetary expansion takes place as a result of central bank injections of cash and the commercial banks' practice of fractional reserve banking.