Is the US Economy Close to Hitting Bottom?

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 policies.

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 another.

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 2008.

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.

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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.

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July 25, 2009

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