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Home | Library | The Anatomy of Growth

The Anatomy of Growth

April 15, 2004

Let us look at the fundamental question of how we characterize growth in the modern economy. Familiar usage and complacency of thought have allowed the idea to arise that any increase in prosperity can be measured strictly in terms of the macro-economic entity called Gross Domestic Product (GDP).

This has led to a horrible inversion of means and ends. Relying on the GDP encourages ever more monetary and regulatory violence to be visited on the free economy by self-serving, collectivist politicians and bureaucrats. These people believe that keeping GDP expanding at some arbitrary minimum rate during their term of office is their primary function, whatever economic or social harm this causes along the way.

Indeed, the collectivists have deluded both themselves and their uncritical electorate that without this interference, the capitalist free market would implode under its own contradictions.

The whole business of national income accounting enshrines Keynes's perverted and patronizing view of the economy. Those of us who reject its premises are condemned to an Orwellian struggle to articulate our heretical thoughts within the narrow framework of an alien language and an antagonistic epistemology.

The origins of the devotion of resources to the compilation of GDP numbers are rooted in the efforts of Keynes's contemporary, Simon Kuznets. Kuznets provided Roosevelt's statist Brain Trusters with a template on which to realize their Mussolinian fantasies of how the nation's affairs should be ordered.

Their efforts were largely responsible for prolonging the dislocations associated with the pricking of the inflationary bubble of the late 1920s through more than a decade of the Great Depression. Once the seeds of conflict and extremism had thus taken root in American economic soil, the second great extension of their statistical efforts arose out of a need to coordinate the totalitarian wartime command economy. Given all this, one might begin to regard reliance on national statistical aggregates with suspicion.

Even if we were to suspend our questioning of the simplistic algebraic formulations of the Keynesian economy that produce the data, it remains that even Kuznets had grave qualifications to its usefulness:

"The statistician who supposes that he can make a purely objective estimate of national income, not influenced by preconceptions concerning the 'facts,' is deluding himself; for whenever he includes one item or excludes another he is implicitly accepting some standard of judgement, his own or that of the compiler of the data. There is no escaping this subjective element." (Kuznets, National Income and its Composition, 1919–1938, NBER, 1941.)

A few numbers will help flesh this out.

In 2001, GDP—measured in the depreciated dollars of the day—was reckoned at just above $10 trillion. This breaks down as $7 trillion in personal consumption expenditures, just under $1.6 trillion in private investment, and $1.9 trillion of government outlays, less just over $300 billion to account for the surplus of imports over exports registered that year.

Even as thus baldly stated, there are problems aplenty here.

One in four of the over three million production workers laid off from manufacturing in the past three years has ended up on the bloated payroll of the State instead.

One problem is that fixed investment is measured on a gross basis while inventory accumulation is measured net. More importantly, there is the issue of just who gets to determine what comprises "consumption" and what comprises an "investment." There remains the question of whether this distinction is a valid one to set in place of the classically correct separation of resource use into "productive" and "exhaustive" categories.

Software, for example, used to be treated as an intermediate business consumption outlay and was thus excluded from the final reckoning. Its subsequent reclassification in the mid-1990s was a move akin to the sort of manipulation of "revenue recognition" that WorldCom and the other corporate miscreants of the previous bubble used to practice.

Another problem inherent in the GDP numbers is that, in order to add apples to pears, each of the myriad of different goods and services exchanged in the economy must be reduced to a common denominator. Money is the only obvious candidate for this task, but money depreciates at a fluctuating rate (the rara avis of its appreciation being elusive indeed these days).

This gives rise to the calculation of reams of "implicit price deflators" to allow for these changes.

To see the backflips that result, compare the entries for the nominal and real versions of the high-tech component of private fixed investment. Here, the resulting distortions have become so embarrassing that the sub-entries have recently been left blank, with an admonitory footnote to the effect that the omission arises because the numbers are not to be trusted!

Ask yourself next whether the near 20% of GDP accruing to the activities of the State has any place in the reckoning at all.

Though one cannot deny that some benefit is derived from the activities of the 21 million or so employed in the public sector, there is also much that the apparatchiks (price-fixers, environmental inspectors, secret policemen) do that is openly destructive.

Even where some benefits produced by public workers can be identified, the provision of government services is compulsory and is never subject to the disciplines of the market. Hence, attaching a value of any sort to even these "benefits" remains fundamentally problematic.

That this is not just a pedantic distinction can be seen in the fact that around one in four of the over three million production workers laid off from manufacturing in the past three years has ended up—conceptually, if not individually—on the bloated payroll of the State instead.

Here, the new drones enjoy salaries a third higher than the metal-workers were paid and receive benefits one sixth greater. This implies that each member of the shrinking number of manufacturing workers has had to become over 8% more productive just to support the monstrous regiment of extra bureaucrats, whose number has burgeoned from 169 to 214 per 100 manufacturers just since 2000.

It should not be a matter of much dispute that this game of Keynesian piggyback, rather than contributing to the common weal, can in fact be doing the nation no good whatsoever.

Leaving this contention behind, yet another glaring inconsistency in the presentation of the "facts" involves the disparate treatment noted above of what may loosely be termed fixed and circulating capital.

In the case of fixed capital, the choice to ignore the effects of depreciation adulterates the numbers. For example, it implies that a peasant who keeps buying sickly donkeys that die after only two years' work is adding more to national income than his brother who buys donkeys that can endure for four.

Thus, we are left wondering whether even nominal national product should be reckoned as $10 trillion, as it is presented, or as $8 trillion after we subtract government, or $7 trillion after we deduct the estimates made of private capital consumption.

But we still have not finished, for we find that a good deal of "expenditure" is not monetary at all, but takes the form of "imputations." The Bureau of Economic Analysis tells us these are "transactions recorded in the national income and product accounts that are not transactions of the market economy." That is, these imputations are numerical phantoms purporting to adjust for implicit services rendered, but not charged, to their recipients.

To give a flavor of the sleight of hand achieved here, look at how imputation helps solve one mystery: Given a citizenry increasingly in debt and whose net financial assets, for the first time in at least fifty years, are falling; how can this citizenry enjoy annual net interest receipts of around $900 billion—roughly 10% of the unadjusted total income they collectively receive?

Here is the slight of hand: What we do is deduct from interest paid $350 billion in mortgage interest payments which are made, not by the homeowner, but by an imaginary corporation set up in accounts to buy his house for him.

Next we add the $260 billion reckoned to be the value of the free check book your bank gives you from interest received. Now the net difference soars around 225% from an actual monetary total of $275 billion to the published $900 billion. Presto!

To see how risible this is, consider an implication of the second of these adjustments: The next time you go overdrawn, you can give your unused checkbook to the bank and tell your account manager that you should both just call it quits.

In toto, what this blizzard of numbers means is that the GDP ends up being swollen by perhaps 16%. This gap has widened appreciably from the 1964–73 difference of around 10% (not that anybody's fiddling the numbers intentionally these days, you understand).

So, was the 2001 economy $10 trillion in size in 2001 dollars, $8 trillion ex-government, $7 trillion ex-depreciation, or under $6 trillion ex-imputation?

Clearly, given the gaping differential between the lowest and highest of these numbers, any collectivist central planner should be asked to judge which is most representative of economic reality. After all, based on this judgment he will trample on our property rights to achieve some arbitrary target for what he likes to think of as growth, but which is usually only spending.

Moreover, even all the foregoing does not come close to providing a full view of the controversy we face, for it has still been framed in Keynes' and Kuznets' own terms.

The West is already displaying symptoms of the eradication of the middle class in favor of the governing military-political elite and at the cost of buying off its feckless urban proletariat with a higher dole and more spectacular circuses.

Conversely, if there is one thing the Austrian School teaches, it is the fundamental importance of the division of labor. Another is the crucial element of time and of the instrumentality of capital in mastering this.

Yet another Austrian teaching is the key role played by individual entrepreneurs in disposing of scarce resources to meet current and prospective consumer demand. A final one is the function of saving in facilitating this role.

On this basis, we can recast the official statistics, with all their provisos and precautionary notes, in a radically different way.

We can maneuver them using an approach first outlined by Professor Reisman, to give us a feel for what Hayek depicted as a "right-triangular arrangement of production in the modern economy."

To achieve this, we take the Bureau of Labor Statistics' (BLS) input-output tables that show, in addition to the now-familiar GDP numbers, all those intermediate business-to-business flows that are later simply cancelled out. Adding imports to the domestic total—to include total, not just net, exports—leaves the sum of business revenues from sales to other businesses, to end consumers, to government, and to foreigners.

Subtracting depreciation and profits from this, we are left with above-the-line business costs. To these we can add the entries for net inventory accumulation and gross fixed investment, which represent below-the-line outlays.

Thus, we have identified the total of all domestic productive spending. We can compare this to the sum of personal consumption and government expenditures and residential real estate "investment" to determine the scale of domestic exhaustive spending.

In 2001, productive outlays came to a grand total of $18.2 trillion, against which was $7 trillion in personal consumption, $1.8 trillion in government spending, and just under $1/2 trillion laid out for real estate, for a domestic exhaustive use of $9.3 trillion.

Thus, it could be argued, the circulation of money—hence also the transfer of goods and services—through the real economy amounted not to $6, not to $8, nor even $10 trillion, but to a whopping $27.5 trillion. Some two-thirds of this represented not the final consumptive exhaustion of wealth emphasized in the orthodox approach, but intertwined, mutually worthwhile, purposefully-undertaken, non-automatic entrepreneurial expenditures.

Bear in mind, however, that even now we are still tempted to describe the economy by means of a single number. This urge keeps leading us back to a narrow conceptualization akin to capturing the geology and topography of the Rockiesby measuring the volume of rock they contain.

The Romans, it is said, had little concept of cartography. There is apparently no word in Greek or Latin for "map." Instead, their world-view was based primarily on the mileages set out in their periploi, or linear itineraries.

Thus, when the Rooseveltian tyrant who thought he could cure rampant inflation in the 3rd century by fixing prices, the emperor Diocletian, came across a man who had constructed a two-dimensional map of the world, he had the man executed, lest his enhanced knowledge make him a danger to the Empire.

Keynesians and other mainstream financial market economists, with their fetish for aggregate numbers and their reliance on pre-determined coefficients of mass behavior, share a similarly myopic outlook. Their distrust of more deductive and individually-centred schools of thought makes of them and their masters all mental Diocletians!

In contrast, we Austrians must always strive to attain a wider purview and preserve a sense of the variability and of the complex interrelations that characterize the world of acting men laid out before us.

To make this more immediate, look at what those who read the financial press, listen to the business news, or follow the knockabout of politics, should recognize as what passes for popular wisdom today:

# # # # #

America, thanks to the actions of the Federal Reserve in slashing interest rates, and due in good measure to President Bush's tax cuts—has weathered a shallow recession and is now growing at the fastest rate in two decades, according to the headline statistics. Thus the US is once more the locomotive of growth for an ungrateful world.

The heroic American consumer who makes up 70% of the economy has gone out and shopped for victory, releasing some of the wealth contained in his appreciating home for the purpose. And now, as uncertainty subsides and revenues rise, businesses, too, are spending money on investments.

As growth picks up, the absence of inflation—especially "core inflation," measured by an index to which the Fed would draw our attention—and the existence of so much idle capacity worldwide together mean the Fed can be patient about raising the short-term interest rate from the present "accommodative" setting.

True, there are a few clouds to spoil this shining prospect of prosperity to come:

For starters, businesses seem too productive to need extra workers to meet all this demand, but that will soon pass as they "exhaust the possibilities of applying new technologies," as our beloved Chairman is wont to say.

On the other hand, where jobs are being created, they are moving offshore to Shenzhen and Calcutta, partly because the perfidious Chinese—though not the Japanese or the Koreans when they do the same—keep buying US dollars and so unfairly suppress the value of their own currency. If they keep cheating the rules in this manner, we should start to enforce our will by limiting their ability to send us their exports and by compelling American businesses to buy goods and services here at home.

Moreover, the wily Orientals are now gobbling up the world's natural resources and spare energy capacity, pushing up their prices as they do. Note, though, that this is not inflationary since it is "cost-pushed, not demand-pulled," as the Korean central bank chief Park Seung told us last week.

More fundamentally, real resources are "far smaller in today's economy than they were twenty or thirty years ago. In fact, an ever-increasing part of our economy is becoming conceptual, rather than physical ... all of the items which are in the standard commodity indexes ... are essentially physical, rather than intellectual," as Mr. Greenspan told a Congressional interlocutor last month.

Next, there is rising personal debt. But again, this is nothing compared to the increase in household wealth: If debt service becomes a problem, people can always refinance their homes—preferably with an adjustable rate mortgage—and pay down other, higher-interest forms of credit with the proceeds.

Then there are "risks associated with deflation," though these have thankfully "receded very substantially." Even so, "trend inflation has ... reached levels that are too low" to the point that the "benefits of low inflation are lost," as Governor Bernanke cautioned in February.

Finally, there is the flipside of tax cuts: the ballooning budget deficit. But a new Democratic administration will address that by taxing the undeserving rich once more; or a re-elected Republican administration will close the gap with the increased revenues to be expected when their policies at last shift more of the undeserving poor off the welfare rolls and back into tax-paying jobs.

Either way, once the political back-biting ends after the elections, something will turn up. Besides, don't fret: Even if deficits "did count," as Vice President Cheney apparently doubts, we "owe it to ourselves" anyway.

# # # # #

Does this ring true? Could it have been mouthed by a CNBC talking head or featured in a NY Times editorial?

If you agree it could, you might be amused to know that this brief synopsis contains around two dozen logical errors, economic fallacies, and blatant inconsistencies. Most of these would be obvious to a classically liberal thinker of our grandfathers' generation, but some of the consequences—political, economic, and financial—can be recognized today only by an Austrian.

That these fallacies and inconsistencies go unexposed by the mainstream economics profession and unchallenged by the educated layman is not only a sad mark of the depths to which sustained reasoning and critical thinking have fallen. It is also proof of Henry Hazlitt's 1978 warning:

"Only by . . . repeated emphasis and varied iteration of certain truths can we hope to make headway against the stubborn sophistries and falsehoods that have led to the persistence of inflationary policies over nearly half a century."

So, now, armed with these insights of the Austrian school, let us run through and dispel the falsehoods nested in this simulation of the mainstream view.

  • America is recovering "thanks to the actions of the Federal Reserve in slashing interest rates…"

The assumption that lower interest rates—when imposed by monetary manipulation, rather than arising spontaneously on the free market—are a panacea is an old delusion.

If low rates and a cheap currency were a solution to hardship, then we should have to impeach Alan Greenspan for being too pusillanimous in ending want and for not allowing his colleague Ben Bernanke the full access to the printing press he so patently desires.

  • "President Bush's tax cuts . . ."

Reducing taxes—and reducing them on producers, rather than on consumers—is of course laudable. However, refraining from funding tax reductions with an equal assault on spending is but to substitute the government for the private agents who are the beneficiaries of the tax reductions as the party liable for the extra inflationary debt brought into being.

That this is inflationary has been especially true over the past six or seven months: US commercial banks, foreign monetary authorities, and the Fed itself have bought such prodigious amounts of government paper, simply by expanding their balance sheets, that they have more than accounted for the whole increase in marketable debt in that time.

This process is called "monetization" and it puts the US on the same inflationary road to ruin as has been travelled by all those previously practicing this subtle fraud.

Besides, lower taxes are one thing; higher subsidies, renewed tariffs and threats of quotas, more burdensome legislation, more expensive welfare programs, and the pervasive threat of arbitrary legal assault are another. There is little sign that the Bush White House has done any more to lighten these crushing impediments to wealth creation than has any other "progressive" administration of recent times.

  • "America has weathered a shallow recession and is now growing at the fastest rate in two decades, according to the headline statistics."

This "shallow recession" has seen manufacturing payrolls plunge to their lowest level since before Pearl Harbor. Total hours worked have suffered a steep enough decline to win this "shallow recession" the title of worst post-WWII contraction, even over the savage recession of 1982.

Net, non-residential fixed investment has fallen by its greatest extent in over 50 years, as has the proportion of total net investment to GDP. Cumulative non-financial corporate profits—now, admittedly on something of an upswing—also fell by their greatest extent in that period.

  • "The US is once more the locomotive of growth for an ungrateful world."

Only if you still subscribe to the 400-year-old errors of the mercantilists (as all Keynesians do), and you confuse money with wealth and credit with capital, could you see the present-day Anglo-American role as a benign one.

Asian laborers, mostly—though not exclusively—with a low standard of living are sweating in their factories to sell us Westerners cheaper goods than we can produce, and are accepting our irredeemable and largely unenforceable paper promises in return.

Thus, rather than being a "locomotive," the more apt metaphor is that of a surly and aggressive brother in-law, who arrives to eat you out of house and home, touch you for the odd fifty bucks here and there until a payday that never arrives and a horse that never wins, and then reviles you before his pals in the local bar for your long-suffering charity.

  • "The heroic American consumer who makes up 70% of the economy has gone out and shopped for victory, releasing some of the wealth contained in his appreciating home for the purpose."

Yes, the consumer is 70% of GDP, but the map is not the territory, as noted above. The personal consumer might exercise the biggest part of that final $1-a-vote franchise which is the free market, but remember, his spending amounts to perhaps no more than a quarter of the overall invoices raised and bills settled up and down the chain of production.

Besides, it is saving, wisely utilized by honest and far-sighted entrepreneurs, and not spending, founded largely on the inflationary collateral-credit spiral that is the US housing market, that will lead to our material enrichment.

Anyone with a basic grasp of accountancy, much less economics, can see that monetizing a notional gain in the value of an unproductive asset by borrowing more against it and then spending the proceeds on instant gratification can hardly be construed as liberating wealth, but only as destroying it.

  • "And now, as uncertainty subsides and revenues rise, businesses, too, are spending money on investments."

It is true that there has been a pickup in some of the indicators of capital goods spending. However, this increase is largely unremarkable given the size of the O'Neill tax incentives and the highly accelerated obsolescence of much New Era equipment, not to mention the scale of the preceding drop in such investment.

It is also true that the inflationary effect of the aggressive "stimulus" policies being enacted at home and abroad, coupled with a decline in the value of the dollar, has helped corporate cash flow. Indeed, it would be a singular event if there were not at least a temporary and unevenly distributed boost under these circumstances.

But how much of this will be revealed as capital consumption, how much will disappear if this deliberate inflation either decelerates or switches channels, and how soon costs will again rise along with prices, are things we cannot know in advance, but are developments for whose signs we must be watchful.

Another feature, often overlooked, is that all this easy money flows straight to the bottom line of corporateAmerica in a very different manner than in the past. This is because even nominally non-financial corporates now have more financial assets than tangible ones on their balance sheets, meaning that these firms are half machine shop and half consumer finance house/pension fund manager.

Thriving on the proceeds of a steep yield curve, on soaring (especially speculative) bond prices, and on rapid asset growth, official financial corporate profits have climbed to a record $60 for every $100 earned by their non-financial brethren.

If we were to assume the latter derived the same amount of mileage from their overlapping activities as the former, returns from the credit bubble alone could therefore amount to 65–70% of all profits earned—a complete and inherently disquieting inversion of the ratios typical of the 1960s and '70s.

  • "As growth picks up, the absence of inflation—especially 'core inflation,' measured by an index to which the Fed would draw our attention—and the existence of so much idle capacity worldwide together mean the Fed can be patient about raising the short-term interest rates from the present 'accommodative' setting."

Inflation is not synonymous with rising prices, of course, but rather is the prime causative factor. Inflation is a situation where more money exists—however "money is" defined—than is subjectively required by individuals. The money is thus more eagerly exchanged into goods, services, other financial assets, or the monies of other polities.

The broad M3 measure of money and credit is up by over a quarter since the end of 2000—a gain of around $3 trillion, which is more than the total stock of money called into existence in all of the first 208 years of the Republic. You would have to have the twisted perceptions of a Fed governor not to believe that these are inflationary times.

Mortgage debt is up nearly 40%, financial debt is up by a third, and state and local government borrowing is up by 30% in the past three years. This amounts to an aggregate increase of over $7.5 trillion and a climb of 50 percentage points from 368% to 418% of private net domestic product. The size of this officially-sanctioned Ponzi scheme is hardly unnoticeable for any who care to look.

As for the "spare capacity" argument, this is another old canard. If you reflect for a moment, it becomes obvious that those businesses with a glut of capacity today are precisely the ones whose managers, during the late boom, most misread the true state of consumer demand vis-à-vis the costs of the inputs they needed to try to meet it.

Therefore, there is little choice but for these businesses to release as many of those resources as possible for other uses and to shrink back, better to balance what the market will actually buy from them and what it will also sell them at an affordable price.

It seems unlikely in the extreme that by artificially pumping up consumer demand in the general, unfocused way it has to be done, the authorities will, for example, call many of the hundreds of millions of miles of unlit fiber optic cable into employment.

Further, it is often overlooked by the aggregationists that one sector's overcapacity is another's shortfall: Resources misdirected towards the first phase of feverish malinvestment were inevitably directed away from what may have been more deserving outlets.

You only have to consider that while semiconductors and servers were building to unsustainable levels, natural gas and oil refining were neglected—not to mention the steel mills now making the nightly news.

As Hazlitt himself put it:

"Capacity is reached when we have fully employed our most scarce resource or complementary productive factor, whether that is an important key industry, specialized labour, plant or some raw material. When this situation occurs, the price of the scarce factor will start to soar, and this rise will soon force increases in other prices and wage rates."

  • "For starters, businesses seem too productive to need extra workers to meet all this demand, but that will soon pass as they 'exhaust the possibilities of applying new technologies,' as our beloved Chairman is wont to say."

Beginning with the quote from Greenspan, since when did investment depend only on the technological possibilities available, rather than on a careful weighing up of the returns achievable by deploying the available savings to that end?

And even if it did—and NASA was the most profitable entity on earth!—why should we ever expect to "exhaust" such possibilities? Have we already applied all the techniques of which we are aware? Has every economic entity taken advantage of them? And can we no longer look forward to more technological advances?

Sorry, Mr. Greenspan, that explanation doesn't fly.

Less frivolously, an individual business or even a group of businesses may well find it profitable to substitute capital for labor, but is it likely that they have all suddenly decided this is the best course of action? Even if this were somehow the case, would it not be telling us not that labor is not too productive, but rather that it is not productive enough of realized economic value?

In all the interminable talk of a productivity revolution, it is often overlooked that the Fed's oft-cited numbers are aggregative and hedonically manipulated. The Fed counts things made and not value received, they undercount hours of work, and they ignore those non-labor costs that can amount to as much as 50% on top of the direct wage bill.

Even by their own dim light, it should be noted that the aggregationists also artificially ascribe the bulk of all productivity gains to labor, thus pushing the increase in this quantity in the late 1990s to a 2.5% annual pace—the best since the early '80s. However, this ignores the fact that returns on capital of negative 1.9% between 1997 and 2001—the worst showing since the 1979–83 recession—took so-called multi-factor productivity down to its most anemic level since the troubled 1989–93 stretch.

Increased productivity—the employment of more useful capital per head of the population—is the route to riches, not mass redundancy. But this is true only if markets are unhampered and if prices and costs are allowed to adjust to reflect the new plenitude of goods being made, thus speeding the useful re-employment of the labor released from its former drudgery.

  • "Where jobs are being created, they are moving offshore to Shenzhen and Calcutta, partly because the perfidious Chinese . . . keep buying US dollars and so unfairly suppress the value of their own currency."

Here again we see the glaring paradox that we, who are supposedly so effortlessly superior in terms of productivity, can't compete with a newly-hired factory hand in Hainan or Hanoi. Then again, economic rationality was never much of a match for cheap populism.

The contradictions here are manifold, for the Chinese today run very little of a trade imbalance across all their partners. They therefore have a disincentive to unpeg the Yuan, potentially upsetting the entrepreneurial calculations of all those involved.

Indeed, China's surplus over the past year amounted to around $20 billion out of a total global trade volume of over $800 billion—only 2.5%. The US, by contrast has just racked up a record goods deficit of over $49 billion in a single month, a shortfall amounting to nearly 30% of the total. This is rather a lot to be blaming on a single bilateral currency distortion.

  • "If they keep cheating the rules in this manner, we should start to enforce our will by limiting their ability to send us their exports and by compelling American businesses to buy goods and services here at home."

"Yessiree! Punish the American consumer by denying him the benefits of the international division of labor. That'll show them pesky Chinamen! And if Fu Manchu wants to give away his Nike sneakers, we still won't take 'em. We'd rather make the citizens pay some unionized, over-regulated, inefficient good ol' boys from the cotton belt to make 'em for us for $120 a pair and be grateful of it when they vote for us afterwards!"

Besides this sort of illiteracy—sadly becoming part of the electoral platforms of both those Yale alumni, Tweedledum and Tweedledee—we should ask what rules, precisely, the Chinese are breaking by seeking to keep their unit of account stable against the world's reserve currency. This is the same currency, by the way, they were lauded for selflessly shadowing throughout the crushing collapse of the 1997–98 Asian Contagion.

The Chinese run an export surplus with the US, receive reserve assets in exchange, and then allow domestic credit to increase on the base these provide. They thus drive up both internal prices and the demand for goods on either side of the border. This is a simulacrum of the workings of the classical and internationally munificent gold standard.

Where it breaks down, of course, is that the reverse should be happening in the United States, with the withdrawal of reserves serving to contract credit and deflate prices to the point where a balance is once more achieved.

The Chinese can be held culpable for what is at work here only under the rules of what Jacques Rueff scathingly called the "childish game of marbles," in which the winners (the Chinese) return their spoils (the excess dollars) back to the American losers at the end of each round, mainly by buying US Treasury and Agency bonds. This is a result of what the great Frenchman termed the "monetary sin of the West," the fact that the dollar hegemony allows the US to go on mindlessly inflating and blaming others for its own lack of financial virtue. Even then the crime of the Chinese is only that of being an accessory after the fact, while the main perps are inside the Beltway.

  • "The wily Orientals are now gobbling up the world's natural resources and spare energy capacity, pushing up their prices as they do."

Damned if they do and damned if they don't.

If the Chinese accumulate dollars and return them to the US Treasury they are "not allowing the market to determine" the value of their currency (read: they are not accommodating the GOP in devaluing the dollar more broadly). If, instead, they seek to buy real assets—whether for immediate use or, as some suspect, by way of "strategic" stockpiles—thus transforming their work into tangible wealth of their own, they are to blame for highlighting the fact that perhaps there isn't quite as much "idle capacity" across the globe as some would have us believe.

In the unlikely event that the US were to stop inflating—or under the less fantastic scenario that China's very real, Austrian-style bubble were to implode of its own accord—the pressure on these scarce factors would relax considerably.

  • "…but this is not inflationary [in other words, no central bank needs to restrict credit just yet] since this is 'cost-pushed, not demand-pulled,' as the Korean central bank chief Park Seung told us last week."

To see the fallacy of this, imagine you had only $10 and you were going to treat yourself a final two $2.50 beers and a last $5 hamburger before going broke.

If, when you got to the store, you found the price of beer had doubled, you would have to rearrange your preferences, doing with less or finding a substitute snack.

That would assuredly NOT be "inflationary," merely the wholly natural and welcome functioning of the price mechanism. Prices tell entrepreneurs that beer is now relatively more urgently demanded than before and that production schedules should be adapted accordingly.

However, if your fairy godfather—Greenspan—appeared in a flash and simply conjured up the extra $5 you needed, you could have the beer AND the beef, forgoing nothing, economizing on nothing.

That would be inflationary and it is what the Korean's Mr. Park and his more well-known peers clearly intend to do should raw material prices (like the beer above) continue to rise, lest some real-life producers (like the cattle ranchers who provide the beef above) be forced to accept a lower price as compensation for the higher ones enjoyed by others.

  • "'In fact, an ever-increasing part of our economy is becoming conceptual, rather than physical . . . all of the items which are in the standard commodity indexes . . . are essentially physical, rather than intellectual,' as Mr. Greenspan told a Congressional interlocutor last month."

Alan Greenspan has long been able to will vast effusions of money and credit into existence, frustrating the market process and underwriting the speculations of the money trust without effort. He has fallen into a folie de grandeur, however, if he believes we can will a gallon of gas into our tank or a loaf of bread onto our table.

Such dangerous flights of fancy only serve to show that those involved in the painstaking business of building and cultivating the capital by which we are all enriched have too few advocates in the corridors of power.

  • "[Rising personal debt] is nothing compared to the increase in household wealth: If debt service becomes a problem, people can always refinance their homes."

As noted above, cashing in some of the gains in an asset price spiral not by selling some of it outright, but by increasing one's leverage against it, is hardly the soundest of financial practices. As for the reliability of the household wealth measure itself, we have more to say on that below.

  • "There are 'risks associated with deflation,' though these have thankfully 'receded very substantially.' Even so, 'trend inflation has . . . reached levels that are too low' to the point that the 'benefits of low inflation are lost,' as Governor Bernanke cautioned in February."

What exactly the "benefits" of even low inflation are—aside from providing an insidious transfer of wealth and keeping labor subtly lagging the firm's owners and financiers' share of the pie—only Bernanke himself knows.

As for prices, yes, the highly dubious Consumer Price Index may still be behaving modestly, at least by today's lax standards. But prices of homes rose at their fastest in 30 years last quarter, and the nation's residential real estate is now valued at an aggregate $16.5 trillion, even if this total is a nonsensical number meaningful only to those who allowed the marginal revolution in economics to escape them completely.

Caveats notwithstanding, at this steep level, the real estate capitalization figure represents an unprecedented 205% of private GDP—up 20 points from the zenith of the late 1980s boom—and a record price-to-replacement cost ratio of 170%.

Significantly, despite having risen 30% in three years and having doubled in ten, homeowners' average equity languishes at a record low 55%. This is no wonder, when homeowners have extracted what Greenspan calls "wealth" to the tune of $600 billion since the end of 2000.

The rise in the stock market needs little comment, of course, except to note that its aggregate price/book, price/trailing earnings, and capitalization/GDP ratios are back at levels seen only during the post-1995 bubble itself.

All manner of other financial assets, especially the more exotic ones, have reached new highs in price and lows in absolute or relative yield in recent weeks. These assets include junk bonds, emerging market debt, structured products replete with risky derivatives, and the least substantial stocks such as those trading on the speculative hothouse that is the OTC bulletin board.

Back in the real world, you will need no reminding that medical expenses, insurance premiums, and tuition are also rising by double digit amounts, and that it costs more than ever to fuel up your Hummer.

The National Federation of Independent Business agreed, in its January survey:

"Price hikes were pervasive in the service sector and it appears that things are looking up in agriculture. Providers of professional services also managed to post price hikes fairly frequently."

Their bigger brethren at the Institute for Supply Management revealed that prices paid were the highest since the bubble peaked in March 2000, and were the second-highest in a decade. On top of this, last month, the well-regarded Philadelphia Fed survey came complete with the second highest price forecast in 15 years.

The prices of widely traded commodities confirm this. Though some commodities have slipped back recently, they are still characterized by rapid double- and even triple-digit percentage gains.

For example, the Journal of Commerce index has risen by 50% annualized since spring 2003—the fastest ever such rise. Steel prices are up perhaps 160% from recent lows. Aluminum is 50% above its 2002 nadir, copper 120% and tin 88% higher than their 2001 bottoms. All three are now at 8½-year highs.

We could continue quoting rapid price rises and often multi-year highs for lead, nickel, zinc, gold, platinum, silver, palladium, lumber, oil, natural gas, coal, cotton, soy products, corn, palm oil, rice, rubber, and more.

Emphatically, the only "risks associated with deflation" are those from clinging too long in the naïve faith that the value of one's money will be preserved by a central bank—a bank that can still talk about such an eventuality while the malign effects of its inflationary policies are obvious everywhere.

  • "But a new Democratic administration will address [the deficit] by taxing the undeserving rich once more; or a re-elected Republican administration will close the gap with the increased revenues to be expected when their policies at last shift more of the undeserving poor off the welfare rolls and back into tax-paying jobs."

The ballooning budget deficit may not be obviously crowding out investment at present, for, as we saw, it is being monetized so effectively that interest rates remain subdued and stock prices elevated. But the government is still commandeering too many resources (to the detriment of private endeavors that could be using them at a commensurately reduced cost), and it is demoralizing thrift, enterprise, and self-reliance in the bargain.

The West is already displaying symptoms of the eradication of the middle class in favor of the governing military-political elite and at the cost of buying off its feckless urban proletariat with a higher dole and more spectacular circuses. The more the state expands in this way, the more success it will enjoy in the only one of its wars on abstract nouns it wages unremittingly and a outrance—the War on Capital.

  • "Don't fret: Even if deficits 'did count,' as Vice President Cheney apparently doubts, we 'owe it to ourselves' anyway."

Yes, they do; and no, "we" don't.

Some of us owe it to others, which is a different animal. And in any case, not having been invested in anything worthwhile but merely payable in depreciated dollars out of general taxation (by rolling over principal and interest as they come due, at the expense of some future dupe), this deficit is hardly an "asset" in its strictest sense.

Furthermore, the abiding evil of a "funded" and permanent public debt is precisely that it teaches people to count as assets the taxes to be visited on themselves and others when the public administration returns to pay its slaves once more for the labor of making their own shackles.

If no less than Jefferson fulminated against transplanting this medium of the great Whig corruption from the Metropolis to the infant republic; if Hamilton cynically espoused it as a means to bind the interests of the ruled to those of their patrician rulers; then we can safely set their opinions above the amoral braggadocio of the good Mr. Cheney.

So where does this leave us?

Hopefully with a healthy distrust of bald macro-economic statistics as typically presented and spun; hopefully with heed to the caution required in drawing any conclusions from the irrationally exuberant optimism of Greenspan and his acolytes.

In the real world, it is a matter of simple logic to predict that jobs will be added only in those industries where the costs of hiring—all costs, including the monetary ones of benefits and wages and the more intangible ones of regulation and legal jeopardy—do not hinder, but enhance the profitability of the production of goods and services.

Conversely, if the present environment makes the hiring of American workers seem too expensive and/or risky for any given firm, then workers will not be hired and capital will be substituted for labor where possible. Further, this capital will be directed overseas if need be.

Adding capital per head is the only sustainable way of enhancing productivity and thus the general standard of living. This investment, though improving, is still well below its recent best in quantitative, if hopefully not so much in qualitative, terms. We still have quite a hill to climb.

Moreover, where materials and energy inputs rise so as to preclude new investment—as is the case, at least anecdotally, for increasing numbers of businesses right now—then not even those higher-order industries that benefit from equipment orders will be able to flourish.

Thus, both the direct and the indirect takeup of the unemployed will be thwarted by higher resource prices, prices that have risen to a considerable extent because of the very policies being undertaken to ensure "full" employment.

Thus, the artificial boost delivered by a 25% currency devaluation, negative real interest rates, and a $500 billion budget deficit might yet dissipate itself in a variable and inherently unpredictable rise in costs. This will dash any entrepreneur's hopes of securing healthy gains from the rise in the prices he expects to receive.

If so, it will usher in a renewed stagnation in production—a stagnation which, remember, will be partially disguised by the helpful inflationary effects of government fiscal and monetary policy for a few fortuitous industries.

If this is not to lead to a commensurate reduction in consumption, it can only be offset by recourse to yet more credit, credit presumably built on further asset price inflation, especially in the housing market (if the Fed is lucky).

Indeed, to keep this game going will require a good deal of finesse, another large dose of disingenuousness regarding inflation and—you may want to underline this—a further period of inordinate laxity in setting interest rates.

Therefore, the overriding imperative to avoid a housing implosion, coupled with the self-imposed erosion of America's competitive edge on the world labor market, seems almost to guarantee that policy, both here and abroad, will stay too loose for too long in the vain belief that this will ease the problems caused by previous policy that was too loose for too long!

Thus, the likelihood is that the development of full-blown symptoms of an inflationary excess across much of the globe is presently as much of a certainty as anything in this volatile world with its top-heavy, distortive, and unstable monetary system can ever be.

Pessimists—especially the foreign variety who have investments tied up in the US—will here find resonance in the words of the Yankee treasury secretary, Henry McCulloch, quoted by Henry Hazlitt in The Inflation Crisis and How to Resolve it:

"It is corrupting the public morals. It is converting the business of the country into gambling and seriously diminishing the labour of the country. . . . Men are apparently getting rich while morality languishes . . . . Upon the demoralizing influence of an inconvertible government currency it is not necessary to enlarge. . . . It is not to be expected that a people will be more honest than the government under which they live, and while the government of the United States refuses to pay its notes according to their tenor . . . it practically teaches the people the doctrine of repudiation."

Optimists will turn for comfort to the voice of Adam Smith, whom Hazlitt cites in The Conquest of Poverty:

"The uniform, constant, and uninterrupted effort of every man to better his condition . . . is frequently powerful enough to maintain the natural progress of things toward improvement, in spite of the extravagance of government, and of the greatest errors of administration."

While you decide to which camp you belong, some among you might also recall Hazlitt's own scathing summation of Keynes's General Theory to the effect that:

"I have been unable to find in it a single important doctrine that is both true and original. What is original in the book is not true: and what is true is not original. In fact, even much that is fallacious in the book is not original, but can be found in a score of previous writers."


Sean Corrigan is a principal of www.capital-insight.com, a London-based economic consultancy. He is also comanager of the Bermuda-based Edelweiss Fund. See his Mises.org Articles Archive, or send him MAIL. This essay is drawn from the Henry Hazlitt memorial lecture, Austrian Scholars Conference 2004.  Listen to the lecture here. Comment on this article on the  blog.


Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

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