Tuesday, May 13, 2008

Recessions Don't Exist?

The Little Recession That Never Was
Howard S. Katz May 12, 2008
Since the sub-prime crisis broke last August, there has been a great deal of discussion of a coming recession. I am calling this discussion to an end with Katz dictum #375:
DICTUM #375: Nobody who believes in recessions is allowed to call himself a gold bug.
First, let us go back in time and see what Adam Smith had to say about recessions. Adam Smith is merely the creator of the science of economics. So maybe he had some useful things to say on the subject.
But Adam Smith does not say anything about recessions. Not a word. They must not have existed in his day. Smith does talk about economic fluctuations. He talks about a cheap year and a dear year. A cheap year was a year when the crop was good. Hence prices were low. And everyone was happy (because they had more food to eat or had more left over after they had purchased their food). A dear year was a year when the crop was short, and prices were high, and people were unhappy.
Well, perhaps a dear year was Adam Smith lingo for recession? But no, in a modern recession prices come down, or at least their rate of increase comes down. In a dear year, prices are rising rapidly. Conversely, in a cheap year prices are falling. This is what the modern economist calls “deflation” or “depression.”
Of course, we all remember 2001 when the Wall Street Journal was trying to alert its readers to the threat of a coming “deflation.” Prices were about to collapse, the Journal assured us, and this was a horrifying possibility. Indeed, one can find this same message in a great many Bernanke speeches.
And yet, the period 1866-1896 in American history was a long period of declining prices. An average consumer item which cost $1.00 at the start of this period was down to 30¢ by its end. Was this long period of declining prices a bad period in American economic history? Not exactly. It was the period which bridged the gap between the colonial world and the modern world. It saw the great development of the American railroads. It saw the invention of the automobile. It saw the invention of the electric light, the telephone, the phonograph as well as a great many other products based on electricity. The airplane and motion pictures were knocking on the door. It was during this period that the United States moved into the economic leadership of the world. No only was this not a bad period in economic history it was the greatest period which has ever existed.
Let us examine another period of declining prices: 1929-1932. Prices fell by 10% per year for 3 years running, a net decline of 30%. This is called the Great Depression, sort of a super recession. Who can doubt that the American people got poorer during this time?
One good measure of wealth in this period was per capita consumption of meat. Eating meat every day had been considered a luxury in the 19th century, but in 1928 the Republicans bragged that they had made it possible for the average American to eat meat every day: “a chicken in every pot.” Actually, this claim was not yet true when it was made, but events soon changed that. What happened to meat consumption during the Great Depression? It rose from 129 lbs per person in 1930 to 144 lbs per person in 1934. (Source, Historical Statistics of the United States, Colonial Times to 1970, Dept. of Commerce, series G-881, p. 330.)
Similarly, during the Great Depression people shifted from margarine to butter and gave more to charity. THIS IS NOT THE BEHAVIOR OF PEOPLE WHO ARE POORER.
If you study Adam Smith, you find that his great discovery was that of a harmony in human (economic) affairs. What impresses the reader of Wealth of Nations is that whenever some disturbing factor enters the economic system, the system moderates the disturbing factor and rights itself. For example, if an enemy lays siege to a city causing a shortage of food, then the economic system (via supply and demand) causes a rise in the price of food. This in turn leads the citizens of the city to economize their food consumption, and it provides an incentive to smugglers who will risk the enemy blockade. Supply is increased, and demand is decreased, and the system moves in the direction of harmony. The same is true for earthquakes, hurricanes, droughts, every natural or man-made disaster. Rational man, acting in accord with the laws of economics acts to restore harmony.
So who are these people telling us that large scale disharmonies (recessions) appear from time to time with no cause and no explanation? What is their argument? Well, they have created a group of indicators to measure the economy, chief among which is Gross Domestic Product.
Gross Domestic (or National) Product was invented in the 1930s by Simon Kuznets, a Keynesian who worked for the New Deal. Keynes once remarked,
“Pyramid-building, earthquakes, even wars may serve to increase wealth.”
Based on this idea that earthquakes may create wealth these people developed Gross Domestic Product. Today they tell us that the economy is wonderful (because GDP keeps going up) while around the world people are rioting for food.
The period of greatest economic decline in American history was 1942-1945. During this time no one could buy a new car, and no one could buy a new home. Butter, eggs and meat were rationed. Gasoline was limited to 3 gallons a week. It is not a surprise that the country was poorer during this time. 10 million men had been taken out of the labor force and set to blowing up Germans, and the Germans were returning the complement. And yet real Gross Domestic Product showed the greatest growth in any comparable period of American history.
Why did GDP go up so strongly at the very time that the economy of the U.S. was collapsing? It was rather like a thermometer which rises sharply in January and plunges in July. We ought to conclude that such a thermometer was not an accurate measure of the temperature. A similar situation occurs with a comparison of West Germany and Italy in the late 20th century (1955-1987). Anybody with a grain of common sense knows of the “German economic miracle,” and yet poor, confused Italy, the sick man of Europe, showed a faster increase in real GDP. What good is a measuring tool which gives such absurd readings?
For the past 70 years, we have had quarter after quarter of rising real GDP, with only rare exceptions. Even the “recession” of 2000-01 was revised away by the BEA. (However, most establishment economists are not yet aware of this.) In the U.S., the real wages of the average worker have declined since 1972. This is quite a change from the late 19th century when real wages almost doubled over a 30 year period.
And what are conventional economists doing and saying about all this? Did they predict the world shortage of food? Of course not. And what have they been saying, right up to yesterday: “Recession is coming.” In their twisted little minds, this means that prices are falling.
What we need to do is to lay these people to rest. When they discover the truths of economics, they will be able to make correct predictions. In a free market economy, there is a natural harmony which resists disruption and tends to stabilize human affairs. While there may be cheap years and dear years, neither of these are recessions, and there is nothing that the Federal Reserve can do to make them any better (but a lot it can do to make them worse). At the present time, we have too many houses and not enough food. The reason for this is that for a quarter century the Fed encouraged home building and discouraged food production. To listen to the self-serving propaganda of these people is an outrageous waste of time. And anyone intelligent enough to be a gold bug should give them no heed.

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