Is the US Economy Close to Hitting Bottom?

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Most experts
and commentators are of the view that the worst of the US recession
may be over by year’s end. My own prediction is for an illusory
recovery of government-constructed economic indicators, but
nothing more than that.

It is held
by most experts that a recession is typically set in motion by various
unpredictable shocks. For instance, it is argued that the present
recession was triggered by the crisis in the real estate market.
Since, as a rule, various shocks tend to weaken consumer demand,
it is the role of the central bank and the government to replace
this shortfall in demand by boosting monetary pumping and government
outlays. Thus, the central bank and the government counter the effects
of various negative shocks by means of monetary and fiscal stimulus

The monetary
and fiscal stimulus is aimed at boosting overall expenditure in
the economy, which (it is believed) is the key for economic growth.
On this logic, spending by one individual becomes the income for

Following this
way of thinking, since September 2007 the US central bank has aggressively
lowered its interest rates. The federal funds rate target was lowered
from 5.25% in August 2007 to almost zero at present. The yearly
rate of growth of the Fed’s balance sheet (that is, the pace of
monetary pumping) jumped from 4% in September 2007 to 152% by December

With respect
to the fiscal stimulus, aggressive government spending has resulted
in a massive deficit. For the first nine months of fiscal year 2009,
the budget deficit stood at $1.086 trillion. That compares with
a shortfall of $285.85 billion in the comparable year-ago period.
The twelve-month moving average of the budget had a deficit of $105
billion in June – the largest deficit since 1960.

It would appear
that recent strengthening in some key economic data raises the likelihood
that various stimulus measures have succeeded in reviving the economy.
Seasonally adjusted retail sales increased by 0.6% in June after
rising by 0.5% in the month before – this was the second consecutive
monthly increase. The pace of deterioration in industrial production
appears to be softening as well. Seasonally adjusted production
fell by 0.4% in June after a fall of 1.2% in May. (Note that in
January production fell by 2.2%.)

If recessions
are caused by a fall in consumer demand as a result of various unforeseen
shocks, then it makes a lot of sense for the government and the
central bank to beef up the overall demand in the economy.

Why Popular
Statistics Provide Misleading Signals

Observe that
various economic data, which serve as a guide to establishing the
state of the economy, are derived from monetary expenditure data.
This means that the more money that is created, the larger the expenditure
(in terms of money) is going to be. Hence, various derived statistics
are going to mirror this strengthening. For instance, the so-called
gross domestic product (GDP), which is pivotal in the analysis of
various experts, reflects the rate of growth in money supply.

Once the state
of an economy is assessed in terms of GDP, it is not surprising
that the central bank appears to be able to counter any recessionary
effects that emerge. By pushing more money into the economy, the
central bank’s actions will appear to be effective, since GDP will
show a positive response to this pumping, following a time lag.

Even if one
were to accept that GDP depicts a well-defined "economy,"
there is still a problem as to why recessions are of a recurring
nature. Does it make sense that unconnected, various shocks cause
this repetitive occurrence of recessions? Surely there must be a
mechanism here that gives rise to this repetitive occurrence?

Also, how can
an increase in demand boost economic growth? After all, in order
to be able to generate an increase in the output of goods and services,
there must be an increase in various means to support the increase
in the production of goods.

If the key
to economic growth is an increase in demand, then poverty world-wide
would have been eradicated a long time ago. Every central bank in
the world could have generated massive demand by means of monetary
pumping, which according to popular thinking would have generated
massive economic growth. That this is not the case – have a
look at Zimbabwe – should raise questions regarding the soundness
of this popular way of thinking.





Loose Monetary
Policies Cause Boom-and-Bust Cycles

Careful examination
actually shows that, rather than protecting the economy, loose monetary
policies are the key source of boom-bust economic cycles.

The source
of recessions turns out to be the alleged "protector"
of the economy – the central bank itself. Further investigation
demonstrates that the phenomenon of recession is not an indicator
of the weakness of the economy as such, but rather an indication
of the liquidation of various activities that sprang up on the back
of the loose monetary policies of the central bank.

Loose monetary
policy sets in motion an exchange of nothing for something, which
amounts to a diversion of real wealth from wealth-generating activities
to non-wealth-generating activities. In the process, this diversion
weakens wealth generators, which in turn weakens their ability to
grow the overall pool of real wealth.

The expansion
in activity that sprang up on the back of loose monetary policy
is what constitutes an economic boom – in reality, false economic
prosperity. Note that once the central bank’s pace of monetary expansion
has strengthened, irrespective of how strong and big a particular
economy is, the pace of the diversion of real wealth will also strengthen.

However, once
the central bank tightens its monetary stance, it slows down the
diversion of real wealth from wealth producers to non-wealth producers.
And as activities that sprang up on the back of the previous loose
monetary policy receive less support from the money supply, they
fall into trouble – an economic bust, or recession, emerges.

the rest of the article

25, 2009

Shostak [send him
] is an adjunct scholar of the Mises Institute and a frequent
contributor to He is chief
economist of M.F. Global.

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