The Party is Over
The latest figures coming from government statisticians reveal that a few problems may be coming down the road. For many years, Americans have been told that we can have easy money from Alan Greenspan’s Federal Reserve and no perceptible inflation, all at the same time. While the whole thing was a lie from the beginning, there was at least the appearance that this non-inflationary "new economy" just might have arrived.
With the consumer price index hovering in the low single-digit range and unemployment rates at a 30 year low, we were having our cake and eating it too. Newspaper columnists and Dan Rather told us that Bill Clinton was doing a superb job of "running the country," while they hailed Greenspan as a god. Robert Rubin was unmatched in his wisdom and foresight as U.S. Secretary of the Treasury, while Janet Reno at the U.S. Department of Justice was looking out for consumers by prosecuting Microsoft.
Little by little, however, this party has been coming to a halt. First, when Microsoft lost the first round in federal court, the NASDAQ took a nasty plunge from which it has not recovered. Next, the once-hot "dot com" stocks turned into near-worthless paper, while the bull at the New York Stock Exchange began to take on rather bearish characteristics.
About the time that the U.S. Supreme Court made it official that Clinton’s underling could not become president, unemployment rates were beginning to inch upward as firms began to lay off employees. Finally, the Producer Price Index for January rose 1.1 percent, which annualized would mean double-digit inflation. Stocks once again took a tumble.
It is hard to know right now if the PPI numbers are an anomaly or a trend for the future. At any rate, they are hardly signs of encouragement. However, it might be wise for us to take another look at economic science to see just how wrong the "experts" have been during this last expansion, and to find how we can undo the great damage they have already inflicted upon us.
As has been expressed on this page many times before, there is no "new economy" any more than the "New Economics" of the 1960s had solved the problems of the business cycle, as its promoters had claimed. Instead, those who lived through the 1960s and 1990s, while seeing much economic growth, also witnessed massive malinvestments of capital through easy money policies of the Fed.
Furthermore, the similar patterns of the ‘60s and ‘90s cannot be ignored. In 1969, the federal budget was balanced for the first time in more than a decade. For most of the 1960s, inflation was relatively low. In fact, when the Consumer Price Index rose to a little more than three percent in 1971, the political establishment was so shaken that hardly anyone complained when President Richard Nixon imposed wage and price controls. The rosy economic optimism that had been the hallmark of the 1960s would give way to the panic and despair of the 1970s.
During the 1990s, budget deficits gave way to budget surpluses. The fed pumped out the easy credit, the stock market rose, and Clinton was able to withstand scandal after scandal as a fawning public gave him credit for creating prosperity. Shortly after he has left office, however, the economy has begun to slacken, something that his scandalized presidency would never have survived.
The parallels are hardly perfect. For one, the amount of economic regulation has fallen tremendously in the past three decades. In 1970, all the financial, transportation and telecommunications sectors were highly cartelized industries. All are much more open and competitive today. In fact, one can easily declare that the prosperity of the 1990s would not have been remotely possible without removal of government restrictions that hampered those industries in the 1960s. Unfortunately, other kinds of regulation, most notably environmental and workplace rules, have taken the place of such agencies as the Interstate Commerce Commission. Just how they affect prosperity will remain to be seen, but when the state imposes burdens for which businesses cannot be compensated, even an economist can figure out that there will be large social losses.
It seems almost certain now that higher inflation will be the norm – at least until the Greenspan Fed realizes that it cannot pump new money into an economy that cannot absorb it. The stock market boom and various real estate booms have either ended or are nearing their end and the next stage of money growth will now affect consumer prices.
The reason for this phenomenon is simple – but almost never is clearly explained. The reason for the dearth of understanding is that standard monetary theory looks at money solely as a quantity variable. New money might as well enter the economy by being pushed out of a helicopter – with individuals grabbing it in the proportions equal to their relative incomes.
In reality, new money arrives through the banking system, or, to be more specific, new loans. Some individuals receive new money before others. The Fed can create new reserves and try to force down interest rates, but it cannot force individuals and firms to borrow money. Companies mainly borrow money for capital expansion – provided the expanded capital is likely to bring new profits in the future. If there is a great deal of malinvested capital already in the economy, investors and firm owners are not going to throw any more good money after bad. Thus, the number of attractive investment options dwindles and an easy money policy cannot bring the bad investments back to life.
Money now is aimed more toward consumer goods than before. Granted, those markets can better absorb the new cash than could the markets of the 1970s and early 1980s, but there are limits to what the consumer goods markets can take. Also, as capital investment opportunities dwindle, banks become more aggressive in aiming their new Fed-created reserves toward credit card users. At that point, the new money flows directly into consumer goods without first having been diverted to the capital sector. At that point, all bets are off.
While Americans have a long tradition of being bamboozled by the political classes, they have really swallowed a big one this time. The believed the lies of politicians who told them that "balanced" budgets had created prosperity, that people did not have to personally save and invest, as the stock market would boom forever. They bought the argument that increasing taxes on everyone – and especially those in high-income brackets – would translate into good times for all. Thus, they now resist even modest tax cut proposals by President George Bush, even though such tax cuts would ultimately make all of us better off, not just those who are already wealthy.
Unfortunately, Americans have been listening to the wrong people. All of us are about to find out that whatever good the Clinton Administration did in regards to the economy will not be good enough to offset the fact that Clinton was as reckless in economic as well as personal matters and that he had plenty of help in Washington. The piper, I’m afraid, is knocking on our door.
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Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.