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This economy is no rose garden
Gerard Jackson
The same commentators who didn't see the recession until it ran over them and who still cannot grasp what the hell caused the financial crisis are now telling us that happy days are on the horizon and, apart from a couple of troubling spots, the Australian economy can now look forward to steady growth and a falling unemployment rate. But falling unemployment is not in itself a sign of a healthy economy. In 2000 I warned that the US was sinking into recession despite the fact that unemployment was falling. The official rate is now 10 per cent with the unofficial rate being very much higher. Economic trends are basically statistics and one needs a theory if they are to be properly interpreted. And a theory is precisely what our economic commentariat does not have.
Housing is the "trouble spot" that most bothers commentators. New figures reveal that the demand for new home loans has fallen significantly since interest rates started rising again, with last November experiencing a drop of 6.2 per cent. Naturally the commentariat warn that this could abort the recovery, putting an end to their otherwise cheery prognosis. According to their line of thinking "falling investment in housing" reduces aggregate spending. In addition, interest rates will reduce demand for durable consumer goods, renovations and other large commitments.
But this is to say no more than rising interest rates dampen the demand for loans. It has completely escaped these people that genuine loans can never add to demand because they involve a transfer of purchasing power from the lender to the borrower. The only time a loan adds to demand is when it is the product of the banking system's process of credit creation.
Manufacturing is other pesky little "trouble spot". That so little attention is paid to manufacturing indicators tells us just how little economic understanding these economic commentators really have. It's the cost of housing that makes the industry sensitive to interest rates. Although it would be easy to assume that the same goes for manufacturing these pundits cannot even make that connection.
Even if they did their thinking would still be extremely superficial. It is not merely the cost of capital goods that makes them sensitive to changes in interest rate but their combinations. The more time-consuming the processes are that employ them the more sensitive they will become to interest rates. In other words, the further they are from the stage of consumption the greater will be their response to changes in rates. Therefore a high interest rate regime leads to greater investment in shorter but less productive processes which in turn lower productivity. From this we conclude that manufacturing should be slowing down, which is exactly what is happening.
Managed' interest rates usually mean changes in the money supply. (For Australia I use M1). That monetary changes can have severe consequences for manufacturing never seems to get a mention in Australia. (Interest rates and the recession — what you weren't told). As expected, the PMI and the production index move in tandem. Production peaked in September and then began to decline. The PMI peaked in August after which it levelled off before starting to decline in November. M1 was flat into April after which it rapidly expanded. It then contracted before once again expanding until September after which it too started to contract. (The current monetary figures only go to October.)
BrookesNews.Com
Monday 18 January 2010
It looks like manufacturing, housing and the money supply are responding negatively to rising interest rates. (The situation is more complicated than this. One does not need a monetary contraction to trigger a slowdown in manufacturing during a boom.) Assuming the monetary trend continues one should expect manufacturing to contract further. Moreover, manufacturing is facing rising input prices in the face of fairly weak domestic demand. To make matters worse the rise in the exchange rate is making manufacturers uncompetitive. (Will the exchange rate kill manufacturing.) I really don't see any joy here.
Some point to the resource sector as the economy's saviour. There is absolutely nothing wrong with exporting resources. It beats leaving them in the ground. But not a single member of our economic commentariat has considered the possibility that the demand for our resources combined with monetary mismanagement is giving Australia an over-valued currency that in effect amounts to a tax on manufacturing in particular and the capital structure in general.
Professor Kevin Davis, research director of the Melbourne Centre for Financial Studies, recently expressed the opinion — and one shared by many others — that perhaps a large financial sector is not really all that beneficial, particularly when so many who work in it "get paid far too much for what they do". What I find interesting is that it evidently did not occur to Professor Davis that loose monetary policies not only inflate asset prices but that they also grossly inflate the financial sector, including salaries and staff. If only some of our economic pundits would take an interest in economic history. As Bresciano-Turroni observed about the Weimar inflation:
The increase in banking business was not the consequence of a more intense economic activity. The work was increased because the banks were overloaded with orders for buying and selling shares and foreign exchange, proceeding from the public which, in increasing numbers, took part in speculations on the Bourse. The banks did not help in the production of new wealth; but the same claims to wealth continually passed from hand to hand. (As Constantino Bresciano-Turroni, The Economics of Inflation: A Study of Currency Depreciation in Post-War Germany, John Dickens & Co LTD, 1968, p. 216).
What is being overlooked is the vital fact that money is not neutral, a fact recognised by some of the classical economists and one that Keynes referred to. (John Maynard Keynes, A Treatise on Money, Vol. I, Macmillan and Co. Limited, 1953, p. 92.) As such, monetary expansion, particularly in the form of credit expansion, changes the pattern of production, not only in manufacturing but also in the financial sector with the result that ever-increasing doses of bank credit artificially inflates the number financial transactions.
Not only do the number of these transactions multiply but newer financial activities and intermediaries also emerge to exploit the abundance of credit that the banking system created. (Think of this as part of the Cantillon effect). It was this process that Bresciano-Turroni described. And the same thing has happened again. (Someone tell Obama: Americans did not cause the financial crisis, the world's central banks did)
Gerard Jackson is Brookesnews' economics editor