The Market vs. Keynes Manipulation

I do it again.  Here is an article from Forbes that Greg sent along.  He called it Eco 101.  It is, but it is also beautifully written, easy to understand, unlike Keynes and our government.

This article is one, as Thomas More might say, is one to be thoroughly digested, not merely tasted. So, put some time aside, enjoy the prose, and realize the economics is nothing more than the creation of a vocabulary to describe whay you should know about your own life in society.

I recommend we all take our lives seriously and not merely observe and vote for a guy who says things you "feel."  The largest component of the mess we are in is not who is in power, rather it is us who put them there.

Bill Flax

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Why The Recession Recovery Remains Anemic

Jun. 23 2011 - 1:11 pm | 2,513 views | 0 recommendations | 2 comments

Amidst lingering unemployment and moribund consumer confidence, fears of a double dip recession grow increasingly frightening. The recovery is now two years old, yet job markets sputter, home prices continue plunging and our leaders appear impotent.

Washington has already undertaken record levels of both monetary and fiscal stimulus. Interest rates have been cut to extremes. Short term benchmark rates hover near zero and with quantitative easing, the Fed even sought to lower long-term rates too. America’s prosperity should be flowing like a river. Instead, the recovery stagnates in a swamp of government induced malaise.

In prior post-WWII recessions, the average federal deficit was 2.3% and in the immediate recovery, GDP surged. In the seven quarters following the 1982 recession, the last one of this magnitude, GDP growth exceeded 7%. Despite trillion dollar deficits, today’s anemic GDP growth limps below 3%.

Something has clearly gone awry. The problem arises from a complete misunderstanding of what downturns encompass. Washington, following Keynesian logic, mistakes recessions as periods of falling aggregate demand. Thus government should stimulate demand increasing consumption.

As anyone with children can attest, demand is infinite. Who doesn’t want more? Stimulating consumption by paying people to sit idle is foolish. We can only consume that which is produced. Production is a function of our capital. Transferring wealth to failing businesses or perpetually unprofitable industries for political purposes destroys capital. Employing capital productively and efficiently is the key to prosperity.

Government attempts to steer the diffusion of capital are undermined by lobbying and rent-seeking. Subsidizing green technology, building Bridges to Nowhere, or imposing burdensome bureaucracies like the EPA, Dodd-Frank or Obamacare handicaps our capital. Government handouts enabling consumption without production deplete our resources. The myriad Stimulus Bills get the incentives backwards.

Production, not consumption should drive the economy. Markets, not government ought to guide capital. The economy is everyone playing the game of life striving to advance their personal priorities. The market constitutes the arena. We parlay our preferences into spending habits and seek to score as producers by earning profits. Price signals guide the gameplans.

The market compensates according to how well consumers value our output and how efficiently we utilize capital. Economics studies how man interacts with the environment transforming scarce resources into products that enrich life. Profits evidence efficient stewardship of capital in ways which satisfy the market and generate wealth. It’s how we keep score.

While endeavoring to win in life we may change jobs, start new businesses or strive to create a better mousetrap. The economy remains constantly in flux. Some plans succeed garnering profits for the inventor, employees and those providing the necessary capital. Others fail. For every iPhone there is an Edsel.

Downturns occur when these countless daily fluctuations accumulate into numerous firms across varied industries faltering simultaneously. The most frequent instigators of such large scale disruptions are corrupted price signals or war and its aftermath.

Sound monetary policy is thus pivotal. Money represents a measuring stick facilitating commerce. We trade or invest our surplus output using dollars to measure transactions today or to store value for future enjoyment. A debased dollar triggers what Austrian economists term “malinvestment.” Or, if the dollar’s value shifts suddenly as during an oil shock, previously profitable pursuits may quickly become untenable.

Likewise with interest rates. Everyone seeks the greatest return for the least risk. Interest rates provide a barometer for business investments. Benchmark interest rates inform those with capital whether to hire, finance start-ups or expand production. No one risks investing in a new plant if its potential profits are not significantly greater than returns on “risk-free” treasury bonds.

As the dollar’s value fluctuates or interest rates are prevented from finding their true, market-driven level, the scales wobble at the point of transaction. This sends the market misleading price signals, thus confusing producers. Distorted interest rates and uncertain dollars incubate malinvestment, squandering precious capital.

Errant monetary policies instigated the recent downturn. As the dollar fell, real estate, ever the inflation hedge, rose. This spurred an over-investment in residential home construction and associated industries. Interest rates kept too low for too long poured kerosene on the exploding housing market. Low floating rates ushered those who couldn’t otherwise afford higher, long term rates, and speculators who intended to flip the properties quickly, into an unsustainable market.

We built too many homes. When interest rates rose in 2006-7 and then oil spiked in 2008 propelling gas over $4 gallon, such buyers were expelled from the market, businesses struggled and the economy floundered. Home prices fell because fewer buyers demanded homes in certain locations.

The economy reflects a basket of goods and services. Recessions come when our output fails to satisfy the market, or our efforts become less profitable. We must reallocate our capital and resources to what the market now values more. Buyers have advanced to the new, but too much of our capital remains geared to the old. The market must evict capital from real estate in areas people no longer desire to live.

This goes contrary to the nature of democracy; especially one which routinely oversteps its constitutional bounds. Recessions are painful. Suffering voters solicit political support. Washington has an overwhelmingly short-term bias given election cycles. Every politician longs to be seen “doing something” to alleviate the misfortunes of those whose livelihoods are threatened.

Politicians also exhibit a natural propensity to garner power or spend our money lavishly on their supporters. Rather than accept the recession as the market’s self-correcting mechanism back to prosperity, politicians who don’t know Lord Keynes from Herman Cain spout deficit spending as a means to rejuvenate demand.

Today’s recovery stalls because capital was intercepted by politically charged spending shenanigans. Transferring wealth from one class to another to artificially boost real estate prices only delays the inevitable and necessary reallocation. Bailouts and subsidies hinder the market’s corrective forces. Firms wasting capital and resources need to expire so that other enterprises still generating wealth might flourish.

After major wars, our factories shift from producing tanks, bombs and bombers into producing cars, televisions and commercial airplanes. According to Keynesian theory, we should have endured a horrible recession after World War II. Millions of troops returned unemployed. Vast swaths of our economy lost their best customer as Uncle Sam stopped procuring munitions.

But the opposite happened. Freed from government shackles, the quick, disruptive downturn quickly ricocheted into recovery.

Washington has tried everything to offset this downturn, from bailing out failing businesses thus incarcerating capital in economically destructive pursuits; to extending unemployment insurance so workers don’t have to change industries or locations; to manipulating interest rates and offering tax subsidies to support underwater homeowners. Propping up the failures of the past prevents the successes of the future.

Such ploys are equivalent to keeping our factories geared to war production in peacetime. It’s like maintaining bloated troop levels because we fear soldiers losing their jobs. We’ve prevented the ricochet. We haven’t eliminated the need for corrective surgery. We’ve injected cortisone and continued playing. The injury worsens and performance languishes.

Instead of a quick, sharp downturn that quickly bounces into a booming recovery, capital and resources remain trapped producing things few want or bribed to remain idle. If government intervention did anything to alleviate temporary hardship, then it also delayed the recovery, thus drawing the downturn out over a longer span.

And here we mire. Record stimuli have accomplished nothing but a budget crisis and smothered private investment. Those trillions spent by government deprive private enterprise of like amounts that might otherwise generate jobs, wealth and higher living standards.

Economic health is inversely proportional to government intervention.