The Invisible Recovery

The 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?

Bonds 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.

IMPORT GOODS, CUT PRODUCTION

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. . . .

The 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. . . .

ISM’s 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. . . .

The 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.

“The 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 Ore.

THE NEW MERCANTILISM

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.

AMERICA’S JOBS OF THE FUTURE

Americans 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. . . .

Global 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.

Nobody 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.

Parks, 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?

THEN WHY THE STOCK MARKET BOOM?

American 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.

CONCLUSION

Bonds 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.

Stocks 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.

July 28, 2003

Gary North is the author of Mises on Money. Visit http://www.freebooks.com. For a free subscription to Gary North’s newsletter on gold, click here.

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