2011-08-05

Friday Reflections 1/2 : The Economy

And so it begins?

For the past two days, news agencies (CBC, for example) have been reporting on the losses that the markets have been suffering. From my perspective, I don't feel that this is particularly surprising to anyone. For all the stubborn theorizing by folks like Krugman, DeLong, Sumner, et al., the economy has not been recovering. For those who insist that we need "more stimulus," there is absolutely no quantifiable evidence to suggest whatever amount of stimulus was provided has had any impact on markets. The question is why?

The answer is that the economy is not suffering from a demand shock. Previous levels of "aggregate demand" (whatever that concept is worth) were equilibrated to the debt-driven spending spree of the past 10-15 years, depending on how you count it. No Keynesian (or New Keynesian, or neo-Keynesian, or nouveau-Keynesian, or whatever-Keynesian) economist seems to grasp the fact that consuming beyond the global economy's ability to produce results in the cannibalization of capital

More diplomatic economists than I would rephrase that italicized statement to "substituting a large amount of future consumption with present consumption." That's how you phrase a production-based concept in terms of demand. That should make my Keynesian readers happy. If one requires a Keynesian explanation for our present-day events, then it is simply this: The reason short-run stimulus results in long-run recession (something Keynes himself acknowledged, by the way) is because when you consume too much today, you have to consume a bit less tomorrow.

At the individual level, you can compare this to a person who lives paycheck-to-paycheck. If that person is smart, he'll spend his paycheck immediately on his bills, and then go grocery shopping. If he's not smart, he'll take his paycheck straight to the bar and get his drink on for a big night. Then he'll have to eat PB&J for 13 days until his next paycheck comes in. That's inter-temporal substitution.

At the macroeconomic level, we have just blown our wad on a massive, ten-year bender. Anyone who tells you that we won't be eating PB&J for a long time is either lying or living in a fantasy. The game is up. The Federal Reserve is barely pretending anymore. Investors are seeking any minor return they can find. But when all is said and done, we have consumed our productive capital and now it's time to rebuild what we just ate.

When people suggest that 20 years of Japanese growth was "erased" by the "lost decade" in that country, they are looking at pure growth rates. They forecast what the growth "should have been" according to the old growth numbers and compare that to what was observed. They fail to understand that the growth was erased during the boom by over-consumption of capital resources.

What we need now is less stimulus and less political action. We need to be left alone so that entrepreneurs can start investing in longer-term methods of production. None of us have any hope of living the good life until our entrepreneurs build the economy's productive capacity up again.