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The Downturn Is Good News

August 15, 2008

Tags Booms and BustsThe FedFinancial Markets

Sometimes the bad news is the good news. So it is with the report that retail sales are down by 0.1 percent in July, the sharpest drop in many months.

Why good news? It means that consumers are starting to cut back. They could be going into less debt. They might be saving more. They are being more careful about long-term plans pending short-term trends.

These are all preconditions for recovery. It's only bad news if one adopts the crude theory that economies are sustained by consumer spending. The truth is nearly the opposite. Consumer spending is the final payoff for the less-visible foundation of growth, which is real saving and investment — that is, making the choice for the future over the present. What declines in retail spending indicate is a coming to terms with reality.

I'll state again what everyone familiar with the Mises-Hayek business cycle knows: the downturn is a response to an artificially inflated economic structure. Loose credit, courtesy of the Federal Reserve, has been sucked into certain sectors and industries in a way that cannot be sustained. The response of selloffs and business failures represents an injection of reality into an unreal bubble.

Far from regretting the economic downturn, then, it is something that should cause us to breathe a sigh of relief. And by the way, this is not new knowledge. F.A. Hayek spelled all this out in his amazing writings between the wars, now recently collected and available for the first time in decades in a new book published by the Mises Institute: Prices and Production and Other Works.

These essays explained not only the Depression but also our current plight, which stems from the same root in a Fed-driven banking system that turns credit on and off like a monkey playing with a fire hydrant. It does damage by sending false signals to investors. But the free market will not be fooled in the long run. And what we are seeing now is the market process.

Nonetheless, the stock markets took the retail news as a bad sign that the stimulus package — you might have received a check in the mail — didn't work. Sure enough, the media are crowing that the rebate was a bust. Surely, the economy would have bounced back by now if Bush had been right!

This kind of commentary amounts to nothing but political one-upmanship. That so-called stimulus is nothing compared with the vast reach of global capital markets. This isn't the 19th century, when small decisions made in Washington had huge effects. For anyone to believe that the pathetic stimulus can actually swing macroeconomic trends is like believing that leaning this what or that on the Titanic would cause it to sink or float.

In any case, listen, folks: there are no controlled experiments in econonomcs and social science generally. We have no idea based on the evidence alone whether the stimulus worked or didn't work. How much lower might the economy have sunk without it? Or what if the economy had bounced back due to some cause completely unrelated to the tax rebate?

It is not as simple as it is in the natural sciences. You can't isolate a control and then change one element to a duplicate and compare the results. The issue is that human beings have volition. They are not atoms, rocks, or planets. Given that there are so many of them moving and choosing at once, there is zero chance that you can empirically isolate the factors that go into events in a way that teases out the cause of anything.

Brush away all the econometric modeling and you end up with the real basis for why people conclude this or that policy "worked" or "didn't work." It comes down to politics. This is one reason we should resist any government program no matter how much we think it will or won't work. In the end, we can't really know the relationship of cause and effect.

 

So how can we know what is true and what is not in the social sciences? You have to use your noggin. There is a long tradition of economics that argues that the way to economic truth comes via deductive logic that is then applied to the real world.

This is precisely the path that Hayek took in his writings. And this is why his model continues to apply to the world around us. He wasn't arguing that loose credit caused only one cycle in one country. He was arguing that whenever and wherever credit is expanded beyond market dictates by a central bank, the result will be economic distortion. In the end, reading his book will profit you more than reading all the ridiculous business-page speculations about the political cause of trends.

Once you understand this, you too will see that what appears to be bad news is often good news. The opposite is also true. So-called good news can foreshadow worsening times. The only way to really discern the difference is to study, think, and pay very little attention to the numbskulls who give running commentary on the government statistics of the day.

 


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