US economy: storm clouds ahead
Gerard Jackson
Where is the US economy going? It is a question that many are asking and one which some think they have the answer to. My answer is that it is basically following the same course as the Clinton economy did.
Rather than use the Clinton economy as our starting point in an effort to understand what is happening now, let us instead begin with 1914. From June of that year to June 1920 the money supply* rose from $16 billion to just over $34 billion. This rapid expansion triggered off an unsustainable boom.
In an effort to bring the situation under control the Federal Reserve raised the discount rate to 6 per cent in January 1920 and to 7 per cent June. The boom broke and the 1920-21 financial crisis struck.
About 12 months later the money supply once again began a rapid expansion, rising from $33 billion in June 1922 to $40 billion in December 1924. However, in 1924 the economy began to slowdown in response to the serious malinvestments caused by the monetary expansion. To avert a recession the Federal Reserve lowered the discount rate three times.
From December 1924 to December 1928 money supply rose from $40 billion to about $46.5 billion, at which point the reserve halted further expansion causing industry to start shedding labour in the following July. The final Result was the Great Depression.
We find a similar pattern developing in the '80s and re-emerging during the '90s. For the year 1986 money supply grew by 9 per cent. It dropped to 3.4 per cent for the year 1987, rising to 5 per cent for the following year. The years 1989 to 1990 saw money supply leap to 8 per cent and then drop to 3.4 per cent, falling to 2.6 per cent for 1991. No wonder that in 1990 the Bush recession emerged.
As in all these types of recessions, erroneously called the business cycle, malinvestments caused by credit expansion finally begin to appear. Some argue that if monetary growth is maintained, or even accelerated, the boom can be sustained indefinitely. Not so. To keep the boom going would require a continuous increase in the money supply until the currency collapsed. This is precisely what happened in the Weimar Republic.
From 1992 to 1994 money supply averaged about 1.1 per cent. This tight monetary policy explains the 1996 slowdown. However, in that year monetary growth began to accelerate. From January 1996 to December 2000 money supply grew by 35 percent. Of interest is that monetary growth dropped from 8 per cent in 1998 to 5.5 per cent for 2002. It was in June of that year that manufacturing started to indicate that the country was going into recession.
This brings us to President Bush. From January 2001 to last October money supply grew by 27 per cent. If anyone really wants to where the downward pressure on the dollar is coming from and why the current account deficit is so big they need look no further than the Fed's reckless monetary policy.
I'm betting on another recession in or around 2008. Of course it's possible that the economy might begin to slow much sooner. If that happens it's likely, if history is anything to go by, that the Fed will give the economy "a little a little coup de whiskey" as Benjamin Strong once put it.
The vital point that has to be understood is that the so-called business cycle is a monetary phenomenon that presidents can do nothing about until the economics profession comes to understand that fact.
*1) Currency outside commercial banks, 2) demand deposits or checking accounts of and 3) time deposits of commercial banks. M2 is close enough to this definition for our purposes.
Gerard Jackson is Brookes' economics editor
BrookesNews.Com
Monday 22 November 2004