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Today's WrapUp by Jim Puplava 05.06.2003 Mon Tue Wed Thu Fri Archive |
We Are Consuming All of Our Seed Corn
The economy is in trouble and there is a great debate going on in Washington on how to fix it. The major philosophical debate is how government can fix an ailing economy. Lost in this argument is the fact that the current mess was caused by government. And now we are asking the very institution that gave us the bubble and altered spending and investment habits in this country to fix the mess it created. A central tenet in American economic thinking is intervention, redistribution and consumption. This doctrine was borne out of the Great Depression where the cause and the effects of the depression were misunderstood. The giant credit and money bubble, which led to the Great Depression, was misinterpreted. What started out as a market correction was turned into a great bear market and a depression.
When stocks crashed in October of 1929, the economy faltered. The following year the market was back in recovery mode, but the Hoover Administration began a series of interventions. At first the Administration cut taxes and increased spending. They then reversed that policy with tax increases, and new spending programs. The Hoover Administration created the platform and spending programs that later became The New Deal. Roosevelt ran against Hoover as a run away spendthrift. After winning the election, the Roosevelt Administration continued the Hoover policies and took them to new levels of intervention in the economy. Rather than let prices fall to a level that would create an equilibrium in the economy and clear all of the excess malinvestments, the Administration tried to intervene and prevent the liquidation and cleansing process from ever taking place. Price supports, taxation, new spending programs and wealth redistribution programs were put in place. All these programs did was to extend the length and severity of the depression. It would take a war to bring the U.S. economy out of depression and correct a 25% unemployment rate.
One Man's Philosophy Became The Backbone of a New Era
The rationale for such policies received its philosophical input from John Maynard Keynes’ General Theory of Unemployment, Interest and Money. The book is considered one of the most influential social science treatises of the 20th century. The book quickly and permanently changed the way the world looked at the economy and the role the government played in society. Keynes criticized the laissez-faire economy and free markets. In their place, Keynes advocated the use of public works to reduce unemployment, having governments run deficits to counter any weakness in the economy. Keynes’ book sought to develop theories that could explain how aggregate output could be determined by influencing aggregate demand. In addition his theories included demand-determined equilibrium, disputing the ineffectiveness of pricing flexibility of the marketplace to cure unemployment, a unique theory of money based on liquidity preference and the marginal efficiency of an investment schedule. Keynes refuted Say’s Law and severed forever the linkage between savings and investment causation. In essence, instead of the natural laws of the market place, Keynes advocated using government fiscal and monetary policy in an effort to eliminate recessions and control economic booms.
From this point forward, the American economy would be subject to periodic booms and busts as the Boom and Bust Cycle became institutionalized through government policy. The result was that eventually the government expanded its role in the economy through constant fiscal and monetary tinkering. As the role of government expanded, it could no longer balance its books and keep its currency on the sound footing through backing by gold. Eventually, in August of 1971 the U.S. government was forced into defaulting on its gold backing by going off the Bretton Woods system. Henceforth the greenback would no longer be backed by gold. Instead, there was no longer anything backing it other than the full faith and credit of the U.S. government. From this point forward, the U.S. government was no longer required to balance its books and since that time has run continuous budget deficits. It began to spend, tax, and print money in an effort to achieve social policy. Boom and bust cycles became more frequent and more pronounced and the value of the dollar lost a good majority of its purchasing power. There was nothing to back it or prevent dilution of its value. The result was a dramatic increase in the cost of living for most Americans. It now takes both spouses working and debt to support a family.
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The result of these polices is that the dollar, which hit another new low today, has lost close to 90% of its purchasing power. The savings rate in this country has fallen to the low single digits. At one time Americans saved between 10-12 percent of their income. Debt in this country has exploded over the last two decades and accelerated during the last decade. As the following charts below illustrate, it doesn’t matter whether it is government debt, consumer debt, or corporate debt; debt has risen to levels never seen in the history of the world. Total outstanding U.S. debt now totals $34 trillion, or $119,442 per man, women, and child. According to Michael Hodges, of the Grandfather report, 61% of this debt or $21 trillion was created since 1990. Contrary to popular myths, the 1990’s weren’t a decade of savings and investment. In place of savings and investment, Americans cut back on savings and replaced it with debt and consumption. |
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National Solvency in Question
As you will notice in this chart from Grandfather Economic Report, the level of debt is growing at a rate that far exceeds national income. This raises the question of national solvency.
This expansion of debt and consumption gets back to classical economics, which is based on prosperity and linked that prosperity to savings and investment. We don’t save and invest anymore in this country. We have replaced the concept of savings and investment with debt and consumption.
The emphasis in government and monetary policy is to enable American consumers to borrow more and spend more money in order to grow the economy. The emphasis for the last half-century has been on expanding credit and debt, and increasing consumption. The result is that we as Americans save little, invest little and consume a lot. We are, in effect, consuming all of our seed corn.
Our manufacturing base is going overseas and now our service economy is being transferred to India and Asia. We are no longer self-sufficient in energy, manufacturing, or capital. In order to finance our trade deficit, the U.S. needs to borrow and consume 80 percent of the world’s savings. The result is that in exchange for consumption we give foreigners dollars, which are then used to purchase our assets such as Treasury bonds, corporate bonds, stocks, and real estate. It is just a matter of time before foreigners refuse to lend us their capital. You can’t run an economy nor can you build prosperity on debt. The U.S. has become a paper economy. The thing we seem to be good at is creating paper, trading paper, and exporting paper.
Some day soon this policy is going to come to an end. I very seldom read or hear in most economic reports where the impetus for the second half recovery will come from, other than increased consumer spending and, if we are lucky, capex spending. However, what will drive this spending? Will it come from increased profits? You can’t spend pro forma profits. Capex spending comes from and is supported by real profits and cash flow, not some factious number made up by creative accountants. Will the consumer go deeper into debt to support further consumption?
Getting To The Crux of The Matter
These are important questions and must be addressed in the debate on how this economy is going to get fixed. At the center of this debate is taxes and consumption. The American tax system favors debt accumulation and consumption and punishes savings and investment. Interest is deductible; while dividends are taxed twice. Savings are taxed at high marginal rates; while borrowing money for a home is deductible. In the current debate over tax cuts there is a reluctance to cut high marginal tax rates that are confiscatory--if not punitive. The debate centers on the concept of consumption. Cutting high marginal tax rates is considered to benefit only the wealthy who would then save and invest that money. Apparently savings and investment, which creates true wealth in an economy, is considered to be bad economic policy. In place of tax cuts, wealth transfers and temporary tax reduction measures are favored. The emphasis from the opposition comes from the fact that cutting higher end brackets benefits the wealthy who would only save and invest the tax savings. The connection between savings and investment has been completely lost. All benefits in the economy are believed to accrue from debt and consumption. People borrow, people spend; this is what the interventionists and consumptionists believe creates economic prosperity.
Cutting taxes would transfer money back into the economy through private means. It is this private means that is so objectionable to social engineers. Only the government, it is thought, can successively implement economic policy--not the market place. This belief is Keynesian at its core. Keynes, who was quite adept at trading the market, didn’t trust the market or the invisible hand of Adam Smith. Instead, he advocated the direct hand of government, which has gotten us into this debt mess. Therefore, there is a major objection to tax cuts because they are thought to limit the government’s ability to direct social policy. Ludwig Von Mises, writing in Human Action, expresses both the thought process and dangers of confiscation and redistribution when he writes,
“…the purpose of taxation is never to raise money, since the government can raise all the money it needs by printing it. The true purpose of taxation is to leave less in the hands of the taxpayer…" It is obvious that the popular belief that this mode of confiscatory taxation harms only the immediate victims, the rich, is false.
If capitalists are faced with the likelihood that the income tax or the estate tax will rise to 100% [prior to John F. Kennedy the tax rates were as high as 90%], they will prefer to consume their capital funds rather than to preserve them for the collector…. Today taxes often absorb the greater part of the newcomers “excessive profits. He cannot accumulate capital; he cannot expand his own business; he will never become big business and a match for the vested interests. The old firms do not need to fear his competition; they are sheltered by the tax collector. They may with impunity indulge in routine, they may defy the wishes of the public and become conservative.” And finally, “Profits are the driving force of the economy. The greater the profits, the better the needs of the consumers are supplied…He who serves the public best, makes the highest profits. In fighting profits governments deliberately sabotage the operation of the market economy.” Ludwig Von Mises, Human Action, p. 800-807
Is it any wonder that the policies of intervention, redistribution, taxes and consumption have led this great nation to its present difficulties? Only when a change in direction away from Keynesian economics and a return to policies that favor savings and investment will a true prosperity in the economy be restored.
Today's Market
Back at the casino, markets rose in anticipation that profits from Cisco will rise this quarter, which is what they did. Cisco reported higher profits thanks to lower operating costs. Sales fell from a year ago and from last quarter, but profits rose because of a 7.8% cut in expenses. Cisco, like many companies this quarter, has been reporting better-than-expected profits as a result of cost cutting. However, top line growth through increased sales has been absent.
The markets had to digest and get past the Fed’s meeting in Washington today. The Fed Open Market Committee left rates unchanged. Fed officials said the risks to the economy are greater and implied that the Fed stands ready to cut rates again if business confidence doesn’t recover quickly. Fed officials are worried about deflation and economic weakness. The economy hasn’t picked up recently despite the ending of hostilities in Iraq and the decline of the war premium in oil.
Markets rose across the board with volume picking up to 1.6 billion shares on the NYSE and 2.1 billion on the NASDAQ. Market breadth was positive by 21-10 on the Big Board and by 19-12 on the NASDAQ. The VIX edged up .02 to 23.26 while the VXN rose by .44 to 32.13. The individual investor is returning back to the market and there are plenty of technical factors that favor a continuance of this trend until the averages bump up against their necklines.
Bloomberg's Overseas Market Summary
European stocks rose for a third day. Oil companies, including BP Plc, led gains as Merrill Lynch & Co. said crude-oil prices may be poised to rise and Total SA reported a first-quarter profit that beat analysts' forecasts. The Dow Jones Stoxx 50 Index added 1.6 percent to 2389.70 London. The Stoxx 600 rose 1.4 percent to 198.92, with energy and banking stocks accounting for about a third of the increase. Benchmark indexes advanced in all 17 Western European markets, except Denmark.
Japanese stocks gained, with the Nikkei 225 Stock Average rising above 8000 for the first time in a month. Exporters such as Sony Corp. advanced as a U.S. services report signaled demand in the world's largest economy may improve. The Nikkei rose for a fourth day, gaining 176.37, or 2.2 percent, to 8083.56. The Topix index added 16.79, or 2.1 percent, to 821.41. Computer-related stocks and automakers contributed a quarter of the index's gain as all but two of the Topix's 33 industry sub-groups rose.
Copyright © 2003 Jim Puplava
May 6, 2003
Charts courtesy of Michael Hodges' Grandfather Economic Report and FRED II
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