The Invisible Recovery

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stock market is rising. Long-term interest rates are rising,
indicating a recovery, which the public expects will bring price
increases. Mortgage rates are rising, indicating that the housing
boom is getting close to the end of its rope. Manufacturing
is contracting and has been for four consecutive months. Employment
is contracting.

So, is
the glass half empty or half full? Are the lagging employment
and manufacturing statistics no longer providing an accurate
view of the future? Are stocks (up) and bonds (down) giving
us a more accurate picture, i.e., economic growth ahead?

worry me. Why should bonds be falling (interest rates rising)
if production is increasing? Won’t additional goods put downward
pressure on prices? This is the old debate over Keynesianism
vs. supply side economics. The supply-siders see additional
output as providing downward pressure on prices: dollars chasing
more goods. The Keynesians look at consumption-driven increases
in production and conclude, “higher prices ahead.”

The Austrians
look at the money supply and ask: “Why is output rising?” If
it is rising because of lots of new money coming into circulation
through the central bank, they predict price increases if the
economy is coming out of a recession. The boom is artificially
induced. The new money will have its effects: driving consumer
prices higher. But the increase in production for a time may
offset the increased bidding by consumers. Also, businesses
may use the new money to pay off old debt, which will tend to
lower interest rates. So, it depends on where the economy is
in the business cycle, and what business managers’ judgment
tells them regarding the future. But the long-run move is clear:
higher prices in response to additional credit money. This is
what government does to our money.


What we
are seeing today is an increase in imports: a $500 billion/year
payments deficit. This is putting pricing pressure on American
manufacturers inside the United States. Of course, some American
companies are building plants abroad, hiring cheap foreign laborers.
So, we have a rising money supply, a falling dollar, slowly
rising prices at home, more layoffs in the manufacturing sector,
reduced domestic manufacturing, and rising unemployment.

For as
long as foreign investors put their savings in our capital markets,
we can continue to import consumer goods. Americans are now
selling off ownership of income-producing assets to foreigners.
Foreigners are buying up American capital by selling Americans
lots of consumer goods. The productivity generated by American
workers will more and more make foreign owners wealthy. Foreigners
supply more tools for American workers to use. So, foreigners
will receive income generated by their American workers.

The Institute
of Supply Management (formerly the National Association of Purchasing
Managers) releases a monthly report on how well manufacturing
is doing. Supposedly, the recession ended in November, 2001.
But what has happened to American manufacturing in this recovery?
There is no recovery in this sector. According to the July report for June’s figures,
there is a lot of bad news.

ISM’s Backlog of Orders Index indicates that order backlogs
were unchanged in June. Manufacturing Employment continued to
decline in June as the index remained below the breakeven point
(an index of 50 percent) for the 33rd consecutive month. ISM’s
Prices Index indicates that manufacturers experienced higher
prices for the 16th consecutive month. . . .

PMI [Purchasing Managers Index] indicates that the manufacturing
economy declined in June for the fourth consecutive month.
The PMI for June registered 49.8 percent, an increase of 0.4
percentage point compared to the May reading of 49.4 percent.
A reading above 50 percent indicates that the manufacturing
economy is generally expanding; below 50 percent indicates
that it is generally contracting. . . .

Manufacturing Employment Index remained below 50 percent in
June for the 33rd consecutive month. The index registered
46.2 percent in June compared to 43 percent in May, an increase
of 3.2 percentage points. . . .

rate of liquidation of manufacturers’ inventories accelerated
in June as the Inventories Index registered 41.3 percent.
This compares to 46.1 percent reported in May. The Inventories
Index has been under 50 percent for 41 consecutive months.
An Inventories Index greater than 42.1 percent, over time,
is generally consistent with expansion in the Bureau of Economic
Analysis’ (BEA) figures on overall manufacturing inventories
(in constant 1987 dollars). The only industries reporting
higher Inventories in June are: Textiles and Food. . . .

Yet the
report hastens to assure us that in the second half of the year
— that ever-disappointing second half of the year —
things may pick up. This is the opinion of Mr. Ore, who issued
the report.

mood of the survey respondents has definitely turned upbeat,
and is evidenced by the fact that nine industries reported growth
this month. Although the Prices paid indicator is higher, there
is a short list of commodities reported up in price. Last month
we saw a positive reversal of a number of indexes, and this
month we see further strengthening of those indexes. This is
certainly encouraging for the second half of the year,” said


We have
come to expect bad news for American manufacturing. American
workers are unable to compete effectively with growing numbers
of foreign workers, whose productivity is rising because of
capital invested in foreign nations. The ISM issues bad news,
month after month, yet this receives very little attention from
the financial press. The fact that American workers are not
being replaced by Americans is of interest only to Democrat
hopefuls for the Presidency — a growth sector of the economy.
America has lost over three million jobs since March, 2001.

This recovery
is based almost entirely on fiat money. The Federal Reserve
System is creating new money at rates sufficient to drive the
federal funds rate to 1%. Three years ago, it was 6.5 %.

We have
seen this unprecedented decline in short-term rates along with
a refusal of business owners to invest in new equipment, which
is the only basis for long-term growth of employment and per
capita output. As the American savings rate has fallen, foreigners
have taken up the slack. If they are correct, then they will
reap for more of the benefits than would have been true three
years ago. If they are incorrect, they will stop investing here.
Demand for the dollar will fall.

What is
keeping the dollar high? In part, it is the desire of foreigners
to send savings out of their own nations. But governments and
their central banks are the primary reason. Basically, the governments
are in collusion with exporters — a small minority in any
large country’s population. (I am not speaking of Hong Kong
and Singapore.) The exporters pressure their governments to
buy American government debt in order to keep their domestic
currencies from rising against the dollar. Their central banks
create new money to buy American government debt. This props
up the dollar and keeps exports moving to America. It’s a bad
deal for the vast bulk of the foreign populations, but great
for the export sector. The common people are subsidizing the
export industries. It is a huge system of wealth redistribution
inside foreign nations.

This is
a new form of an old error: mercantilism. In old-time mercantilism,
government officials sought gold for their national treasuries.
Exporting was seen as the way to get gold, except for the Spanish,
in which case enslaving South Americans to work in gold mines
was the cost-effective strategy, at least until the gold ore
ran low. In the new form of mercantilism, governments seek the
U.S. Treasury’s official promises to pay dollars. This policy
will blow up on foreign governments eventually. In fact, the
blow-up process has begun. They will be stuck with depreciating
assets: dollars. But, for now, foreign nations’ mercantilism
is great for foreign exporters and American consumers. It’s
bad for American manufacturers and foreign consumers.


will face the day of reckoning in the next decade. Rising Social
Security entitlements by the baby boomers will hit at a time
when foreign productivity will be rising and white collar American
jobs will be flowing off-shore, in the same way blue-collar
jobs are flowing off shore today. English-speaking workers will
have computers and cheap phone service. The outsourcing of American
white collar jobs has already begun. My children’s generation
will face competition from low-wage, high-productivity foreign
workers. The communications revolution will siphon off jobs
in the high-paying white collar service fields. Only suppliers
of services that must be delivered and monitored locally will
buck this trend.

As the
job market is flooded with immigrants from Latin America and
the children of these immigrants, wage rates will cease rising.
The tax burden — Social Security/Medicare — will keep
rising. A few people with unique services to offer will do well,
just as professional athletes do well. But the market value
of a college education in the liberal arts will continue to
fall. In engineering, graduates will be competing with engineers
in India, China, and third world countries that have sent their
best and brightest to go to graduate school here. Today, almost
half of all Ph.D. students in American universities in engineering
and science are foreigners. We had better recruit them and keep
them here. A
recent report
provides the figures.

There is some evidence of an increasing flow of foreign science
and engineering graduate students to a number of industrialized
countries. Enrollments of foreign students at the graduate level
at U.K. universities increased from 28.9 percent in 1995 to
31.5 percent in 1999. Foreign student enrollment is at an all-time
high in the United States, representing around 40 percent of
all graduate students in engineering, math, and computer sciences.
. . .

diffusion of science and engineering knowledge and expansion
of doctoral education abroad imply that a larger share of
academic research and development and scientific knowledge
will be generated outside the United States. This challenges
the United States to devise effective forms of collaboration
and information exchange to benefit from, and link with, the
other countries’ and regions’ expanding scientific capabilities.

In American
undergraduate education, it’s the same story: “Sorry; I no speak mathematics.”

American students, meanwhile, seem to be losing interest in
technical careers — from 1983 to 1997 enrollment in undergraduate
engineering programs decreased by 19 percent. Much of the problem
is simply demographic: from 1980 to 2000 the U.S. college-age
population dropped by more than 21 percent, from 21.6 million
to 17 million. But although that population will increase in
the next decade, we must still worry about the shifting focus
of students. In 1986 college students earned about 24,000 degrees
in electrical engineering and about 5,000 degrees in parks,
recreation, leisure, and fitness. In 1996, they earned nearly
14,000 degrees in each of these fields. Only two years later
4,000 more students were earning degrees in parks, recreation,
leisure, and fitness than in electrical engineering.

blames this on the decline of the tax-funded school system,
despite the fact that there is no other institution that could
conceivably be equally responsible.

recreation, leisure, and fitness: as Americans age, they will
demand more services like these. These are locally administered
services. The problem is this: How will older Americans pay
for this? I can understand choosing such a career over engineering
because parks, recreation, leisure and fitness will not be supplied
by Indians — not the Hindu kind, anyway. But how can anyone
make a good living by supplying services to people with declining
incomes? Who is going to foot the bill for an aging population?


investors look one quarter out. They always dream of the recovery
in the second half. Today, they are buying shares on the assumption
that the second half recovery will continue into next year.
They ignore counter-evidence from manufacturing. They ignore
evidence that corporate insiders are selling over six shares
for every share they buy. The insiders are taking this opportunity
to unload shares on the public. If there is a boom coming in
the second half, insiders don’t see it.

We are
seeing a bear market rally fueled by desperate brokers who have
fallen in hard times and who cannot believe that the boom of
the 1990′s is gone in their lifetimes. They are selling stocks
to equally desperate baby boomers — anyway, the richest
20% of them — on the idea that there will be someone ready
to buy at high prices when they call their brokers and issue
“sell” signals in 2011. As to who that well-heeled someone will
be, they do not ask. Asians, maybe? It surely will not be their
children’s generation, who have put everything they own into
better housing, probably on an ARM contract.

This is
why millions of American students should be taught entrepreneurship.
This is where America has a major advantage. It’s easier to
set up a small business here than anywhere else on earth. But
school teachers are not entrepreneurs. They can’t teach what
they don’t understand and rarely appreciate.


have been hit hard, as monetary inflation produces price inflation,
and the threat of further price inflation threatens the purchasing
power of interest paid in the future.

are rising, despite any signs of rising profits, rising investment
in plant and equipment, and rising expectations by corporate
insiders. This rally has the marks of a sucker’s play. There
are a lot of suckers out there. They will be there until they
finally figure out that ever-stiffer foreign competition is
the wave of the future. So are bankrupt social insurance programs,
a problem that does not threaten Asia.

What do
we need to respond? Lower taxes, less regulation of the economy,
and more entrepreneurship. These are not high priority items
on today’s political agendas.

28, 2003

North is the author of Mises
on Money
. Visit
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