US markets and depression

By Gerard Jackson
web posted May 8, 2000

The market's recent shenanigans has caused a great many punters to take fright and sell out. As one observer of market behaviour quipped many years ago: "When the bellboys buy, that's the time to sell." The recent fall does not really amount to a market crash, however. But many are now asking whether a crash will plunge the American economy into a depression?

The Pollyannas always answer no. They argue that the economy is fundamentally sound and that there is now a new economic paradigm. That the same things were said about the US economy during the 1920s boom is something they'd rather ignore than ponder. They cite low inflation, rising productivity, innovation, a budget surplus, etc., as evidence that the economy's progress is soundly based. If only that were so.

What they overlook is the frightful state of the money supply. It's probably not too far fetched to suggest that the Reserve has abandoned monetary controls. How else can one explain the country's rapid monetary growth? This rapid growth, most of it in the form of credit expansion, has fuelled an unprecedented debt explosion, raising total private-sector-debt as a ratio of GDP to a record level. The fear is that if the market crashes households might cut their spending to cover their debts. What this really means is that households will have to cease borrowing to maintain their consumption spending, and redirect more of their incomes to repaying debt. The implication is that reduced consumer spending will depress the economy.

It's true that when the economy goes into reverse the demand for cash is likely to rise as people try to pay off their debts. But this is a consequence of a recession and not a cause. The point is that it was the Reserve's reckless monetary expansion that created the environment and the means for consumers to acquire excessive debt, much of which will have to be liquidated. The near-tripling in margin borrowing during the last three years, reaching about $280 billion on the NYSE, is another symptom of the Fed's monetary mischief. Falling share prices would see a great number of liquidations as investors struggled repay their margin debts.

Monetary growth has also stimulated the demand for imports and raised the current account deficit to 4 per cent of GDP, amounting to an incredible 18 per cent of the world's total imports. This is another record the economy US can well do without. But what does one expect when retail sales leapt by 10 per cent in the 12 months to March. Even more ominously the CPI recorded a 3.7 per cent increase for the same period. If this is low inflation I'd hate to see our Pollyannas idea of a high-inflation economy. The truth, however, is that inflation has been bubbling away below the surface for years (thank you, Mr Greenspan) and it was only the insistence of orthodox economists in defining inflation as rising prices that concealed the real inflationary situation from the public.

Another depressing symptom of the Fed's reckless monetary policy has been the growing difference between private savings and investment; this savings-investment gap has now climbed to 4 per cent of GDP, setting another unwanted economic record. This gap, like the current account deficit, is being fuelled by monetary expansion. Another menacing cloud on the economic horizon is the reported squeezing of profits in the "old economy firms" by rising commodity prices.

Whichever way we look we are always drawn back to credit expansion. But as is invariably the case, those tainted by Keynesian doctrines confuse cause and effect, tending to see money supply as passive and money as neutral. These are dangerous concepts which ought to expunged from economics before they cause even more damage.

I've tried to make it clear that market crashes or corrections do not and cannot cause depressions. Bad monetary policy does that. When the market crashed in ‘87 I predicted that central banks, under the influence of Keynes and a misunderstanding of the ‘29 crash, would rapidly expand their money supplies and that this would trigger a short-lived boom followed by a recession. And so it was. Any attempt to repeat that exercise today would send the CPI and the current account zooming. And that is one legacy Big Al has no intention of leaving.

He should have followed the example of Calvin Coolidge and retired when the going was good — now it's too late.

Gerard Jackson is the editor of the weekly The New Australian, Australia's only free market online magazine.

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