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The Death of Disinflation

Mises Daily: Wednesday, May 22, 2002 by

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The following extract neatly sums up why monetarists and Keynesians are both wrong in their prescriptions about the need to use easy money and Big Government to boost "effective" demand.

From The National Federation of Independent Business April Survey:

"The economy is splitting with the services sector improving and the goods sector suffering," said NFIB Chief Economist William Dunkelberg. "If you make stuff, you are having problems.There is excess capacity everywhere, so you can't raise prices. You can't even take advantage of unprecedented gains in productivity, since increases in labor compensation are still growing and absorbing much of the productivity gains. On the other hand, service sector firms are aggressively raising prices. In financial services, 38 percent reported higher selling prices. Although 39 percent did report higher worker compensation, 27 percent reported higher earnings. Business is a lot easier if you can raise prices."

Now all those supply-side, "death of inflation" types who keep telling us that we need yet more (or, at least, continued) stimulus to ensure the recovery might pause to wonder whether this service sector phenomenon might instead spark a little old-fashioned round of rising prices? The signs are all around us.

After all, while Wal-Mart ("Resistance is futile!") can do wonders to lower U.S. grocery bills by employing Chinese laborers for a nickel an hour, the last we heard, nobody was outsourcing Realtors to Rangoon or chiropractors to Korea, and the Empire’s legionary auxiliaries haven’t yet been posted to patrol La Guardia at a lower hourly rate. 

Mr. Dunkelberg’s statement is, in fact, an encapsulation of two of our most fundamental tenets--that relative prices, not average prices, need to be in synch to sustain a healthy economy and that easy money means that the productive structure is being disastrously shortened (that is, overly focused on consumer goods and services and satisfying State demands) at present.

To emphasize this, consider the following extract from the same source:

Capital spending plans fell 2 points to 32 percent of respondents, and reports of actual outlays in the past six months fell 3 points to 62 percent of all firms. The high for this series was reached in the 1995-2000 capital-spending boom when the incidence of planned expenditures rose to 41 percent. In the current environment, following five years of heavy capacity expansion, there is little need for new capital expansion.

To confirm this, the latest Philly Fed survey also revealed that fewer than one in four of its respondents has any plans to increase capital spending this year in real terms.

While more evidence of productive "shortening," what this doesn’t say is that the burdens imposed upon producers by easy money (yes, you read that right: Easy money) and their consequent lack of profitability are among the main reasons why there is no significant capital expenditure. The overhang from the boom only partly exacerbates this, since much of the outlay undertaken then was wastefully misallocated and is not germane to the needs of the current economy anyway (just think Global Crossing and ITV Digital, for example).

However, "producers" who can’t see their way to a profit have neither the means nor the incentive to invest in new plants and equipment.

Ultimately, this will durably lower the value productivity of the nation, and even now it is making the U.S. ever more reliant on the forbearance of the external creditors who labor so assiduously to undercut their prices, but who bid nothing up in return.

Lest we think this is solely an American problem, consider the figures contained in the UK employment report earlier this week. In the past two years, 290,000 jobs have been lost in manufacturing, which for us, in our small sceptred isle set in its silver sea, is a significant total--around one in every 14 positions in fact.

Despite this frantic shedding of any firm’s biggest variable cost, output per job has fallen 2.4 percent annualized in the past four months, so productivity is still plunging.

But how come? Are we Brits too stupid to read Microsoft manuals? Can we not implement a "change-management, real-time, e-business solution" along with the rest of IBM’s clients? Have we not heard of just-in-time inventory management and all the other buzz phrases of the New Era?

Maybe not. 

But far more likely is the fact that the raging housing boom, yawning trade deficit, expanding government, and credit-fueled consumption binge is pricing resources out of the hands of producers. This brings about a vicious cycle of cutbacks on the part of the main customers of these "higher-order" businesses--namely, other businesses themselves!

The Bank of England may hew to the Greenspan line and bemoan the fact that rates are too high. However, the fact is that rates in the UK are too low, since they are demonstrably well below that natural rate of interest that allows a broad healthy balance to be struck between production and consumption and saving and investment. The same is true--in spades--of the US.

Just as the UK has been woefully hollowed out by this process--and will assuredly pay a heavy penance once the boom fizzles--it is clear from the NFIB comments that a recognition of the same symptoms, if not a realization of the cause of the disease, has been arrived at in the U.S. itself.

Unfortunately, the patient has become so weakened by this misdiagnosis that, while he probably would have survived the surgery 17 months and 11 rate cuts ago, now his only course may be to use the current respite to put his affairs in order.


Sean Corrigan is a principal of www.capital-insight.com, a London-based economic consultancy. See his Mises.org Articles Archive, or send him MAIL.