Friday, May 27, 2011

Why the recovery continues to be subpar


April Personal Consumption Expenditures were a bit below expectations, but the story remains the same: consumer spending has recovered from the losses of the last recession, but it is growing at a subpar rate and is about 10% below its long-term trend level, as this chart shows.

It's been a subpar recovery, and that shouldn't be surprising. I've been predicting this since early 2009. Fiscal and monetary policy levers supposedly have been set to max stimulus for over two years now, but policymakers never really understood what they were doing.

Monetary "stimulus" that involves very low short-term interest rates and lots of bond purchases can't create growth out of thin air. Pumping money into the economy only makes sense if the economy is desperately in need of money, which was the case in the latter half of 2008. (At the time, the plunge in commodity and gold prices, the surge in the dollar, and soaring swap and credit spreads were key signs of a shortage of money.) Since then, easy money has only served to weaken the dollar, pump up gold and commodity prices, raise inflation expectations, and (finally) push actual inflation higher. Easy money hasn't done anything to strengthen the economy.

Fiscal "stimulus" that involves massive borrowings to fund huge transfer payments, make-work projects, and subsidize state and local budgets also can't create growth out of thin air. Taking money from those making a lot of it (e.g., corporations which have generated record profits) and handing it out to those not doing very much (e.g., by extending unemployment benefits, funding "shovel-ready" projects, and keeping union and public-sector employees on the job) not only can't create new growth, it destroys growth by creating perverse incentives.

Printing money, making money cheap, borrowing to force-feed spending—it's all an exercise in futility and ultimately counterproductive. Growth only comes when money is spent on things which increase the productivity of labor. Our standard of living rises only if our collective efforts result in more output for a given number of hours of work. Government has a dismal record when it comes to making productive investments, because the incentives are not properly aligned; the profit motive is missing. Force-feeding money to the economy only results in more speculative activity, since it's easier to bet on rising gold and commodity prices than it is to risk setting up a new company and hiring new people. Soaring deficits don't create new demand, they only create fears of huge future tax hikes and that dampens animal spirits today.

What has been working to create growth is the inherent dynamism of the U.S. economy, and the tireless efforts of entrepreneurs and workers who strive to improve their lot in life. Businesses have been busy restructuring, laying off nonessential workers, cutting costs, and boosting their profits. The economy has shifted massive amounts of resources from the troubled financial, housing and construction sectors, and into the up-and-coming mining, technology, and manufacturing sectors. The economy is growing despite the best efforts of politicians to create growth. Financial markets have recovered not because the economy is in great shape, but because the economy is much better today than markets feared.

The good news is that the evidence of stimulus failure is plain to see, and the mountain of debt it created is a lasting monument and a lesson to all. Congress has now shifted its efforts 180ยบ: no longer is the debate about how much to spend on stimulus, but how much spending to cut. We really can't continue on the path of the last few years, and that is a great relief. We haven't yet figured out which path to take going forward, but by trial and error someone in Congress or the White House will figure it out. When somebody does, the magic formula will almost surely consist of cuts to wasteful spending and transfer payments, market-based reforms to healthcare, and lower and flatter tax rates coupled with tax-base-broadening reductions in deductions that will truly stimulate growth.

In short, out with the Keynesians, and in with the Supply-Siders.

8 comments:

Stone Glasgow said...

"Our standard of living rises only if our... efforts result in more output for a given number of hours of work."

Our standard of living will rise over time as long as we are producing more than we consume.

For example, if you were alone in the world with nothing, you could become "wealthy" by building a house, farming, etc. Even if the speed of your building and working the land never changes, your standard of living will rise over time; you'll start with nothing and end with a house and endless supply of wine, cheese, meat and veggies.

W.E. Heasley said...

“Government has a dismal record when it comes to making productive investments, because the incentives are not properly aligned; the profit motive is missing.”

Restated:

Politicos through the mechanism of government have a dismal record when it comes to making productive investments, because the incentives are not properly aligned; the profit motive is missing.

Smack said...

Stone Glasgow says:

"...if you were alone in the world with nothing, you could become "wealthy" by building a house, farming...your standard of living will rise over time."

Yet not of that is true. Things become wealth only because of exchangeability. If no one else is alive on earth, no exchange can happen. Thus, the house, the produce of farming and the like are not wealth.

Also, no standard of living can arise because there is no one else for which comparison can happen.

The concept of a living standard is a rhetorical one, often used for political purposes. By what measure does one define the standard?

Is it the number of joules contained in food and heat a person can gain in exchange?

And yet, such a concept exists only to compare one man to another.

Stone Glasgow said...

Smack says:

" Things become wealth only because of exchangeability. If no one else is alive on earth, no exchange can happen. Thus, the house, the produce of farming and the like are not wealth.

Also, no standard of living can arise because there is no one else for which comparison can happen."

If you are alone the house and wine is still exchangeable, even if no one is there to exchange. It still have the ability to be exchanged. If you are uncomfortable with this terminology, imagine there are two men alone in the world (but it's not necessary).

Similarly, a "standard of living" rises in comparison to the man's previous life, with no house, wine or cheese. If this also bothers you, think of two men again, and imagine one of them building a house and the other sleeping on the beach.

The other man is not needed, but you can see that even with your complaints, two men create the comparison and the trade that you desire.

Stone Glasgow said...
This comment has been removed by the author.
Stone Glasgow said...

"Stimulus" spending is probably not inflationary. It may raise the demand for money because of its temporarily higher "velocity," but should have no real inflationary effect. It simply moves assets from very productive people to others who are probably much less efficient, who will produce something that no one really wants.

Fed spending (quantitative easing) is certainly inflationary, and creates misallocation of resources.

Bank lending (also a method for creating new currency) is also probably not inflationary, even at reduced interest rates, because each loan effectively trades ownership of a real asset (like a home) for new assets called dollars.

Because the process of issuing a bank loan effectively shifts ownership of the house to the dollars, and those new dollars can always be traded for the house used as collateral (by paying off the loan with dollars), the new dollars generated by new bank loans are unlikely to be inflationary.

William said...

During this era, we have a novel experiment underway which is unintentional but worth observing. It is the comparison between American "free market" capitalism and Chinese top down management of the Chinese economy with massive government programs for high speed rail, alternative energy, etc.; incentives for other sectors of their economy; and incentives for foreign companies to invest in Chinese companies - with significant restrictions.

We also see the Chinese government encouraging Chinese companies to acquire natural resources assets around the world and, indeed, the Chinese government actually paying for the development of rail lines and seaports by Chinese companies in emerging economies so such natural resources can be shipped to China. The Chinese have a global strategy integrated with the perceived needs of the Chinese economy.

It is an existential test for the USA in a way that the old USSR never was a challenge to our economic system and the "American Way of Life".

TradingStrategyLetter - Weekly Summary said...

Once the strength of the recovery becomes crystal clear it will mark the time to sell stocks.