Reality strikes Wall Street as the economy stumbles

By Gerard Jackson
web posted January 15, 2001

At last the dreaded 'R' word is echoing up and down the Street. Morgan Stanley has come into the open and said what many have been trying to mentally suppress for many months. Recession is here and Pollyanna really is a fictional character in a book. As if to ram the point home, the bank's chief economist, Stephen Roach, told clients to brace themselves. (Talk about locking the gate after the horse has bolted). With Gloomy Roach preaching doom it can't be long before other economists reality overtaking them, perhaps in the form of pink slips. To tell the truth, any economist who couldn't see what was coming shouldn't be trusted with plastic cutlery.

Despite his gloomy forecasts Roach seems to think the downturn will be mild and short, a view shared by others, including the Bank Credit Analyst research group which also thinks the recession may already have started. These seers, however, are already forecasting a quick economic rescue as the Fed starts throwing out the monetary lifebelt. Not to worry, is the catch phrase. Regardless of the downturn the Fed won't allow the money supply "to plunge to recessionary levels", oblivious to the notion that perhaps it is this monetary policy that is the cause of the coming recession.

What is depressing about this type of commentary is that it doesn't recognise the role of real factors. Only money supply matters, at least when a recession is looming up, otherwise keep rates artificially low and blame the consequences on "irrational exuberance", "greed" or "irrational markets" -- anything or anyone except the Fed.

The National Association of Purchasing Managers' Index makes for grim reading. It stood at 43.7 percent in in December and still looked as if it were heading south. The reality that is American manufacturing was brought home by the NAPM's report which said that: " Orders continue to be a concern as that index has failed to grow since June and New Export Orders fell below 50 for the third consecutive month. Manufacturing activity has fallen sharply in the fourth quarter as the Production Index has been below 50 for three consecutive months." The NAPM's business survey for December show manufacturing contracting, including jobs. Moreover, the contraction has been accelerating. For example, the NAPM's Production Index fell from 49.6 per cent in November to 42.4 in December. In addition, prices of inputs are continuing to rise, with the index showing an increase from 56.6 in November to 61.0 in December. This is exactly the kind of economic behaviour that Austrian analysis predicts. But Keynesians, not Austrians, rule on the Street.

What does all this mean? I've pointed out a number of times that if credit expansion is allowed to go unchecked manufacturing is eventually hit by a profit squeeze as firms find themselves trapped between rising costs and weak demand for their products. This situation is caused by credit expansion generating structural distortions, what the Austrians call malinvestments. The longer the credit expansion the more extreme these distortions will become.

Once an emerging profit squeeze begins to reveal the distortions, even as consumption rises, the cry goes up for ‘easy money', i.e., rate cuts, which really means an accelerating money supply. This is precisely what is happening in the US. If the monetary expansion is large enough it can delay the recession. The stress is on delay, but it cannot stop it.

The question now is whether a 0.5 per cent rate cut is big enough to inflate manufacturing prices to the extent of eliminating, although temporarily, manufacturers' profit squeeze. In my opinion the answer is no, thank God. What the country needs now is liquidation, not inflation.

From a political angle, it is vitally important that Bush constantly reminds the American public that the recession happened under Clinton's watch, regardless of what his lying mates in the media will say. ESR

Gerard Jackson is the editor of the peerless The New Australian. Reprinted with the TNA's kind permission.

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