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Is the US economy facing a credit crunch

Gerard Jackson

Monday 19 November 2007

Every time an economic crisis seems to be on the horizon you can bet your last dollar that scores of advisers will be warning that a drop in consumer confidence will cause a fall in consumer demand which will drive the economy into recession. For the umpteenth time, business spending drive the economy and not consumption. The Bureau of Economic Analysis now includes intermediate goods in its calculations, producing what it calls “gross output”. This figure shows business spending at about 50 per cent of aggregate spending. My own calculations put total spending at about $30 trillion

If we take a look at the BEA’s Survey of Current Business for 2003 we find that GDP is $10,083 trillion and consumption spending is $7,385, which is 73 per cent of GDP. But spending on intermediate inputs was $8,297. Therefore aggregate spending equalled $18,380 trillion, putting consumption at about 39 per cent of “gross output”.

Let us now take 2001 and see if we can deduce a rough rule of thumb for calculating consumption as a per centage of total spending. GDP is $10,082 trillion, other costs minus depreciation equal $15,098 trillion giving us a total expenditure of $25,180 trillion. (This is not the BEA’s concept of “gross output”). Private consumption is $6,987 which is approximately 28 per cent of total spending. Therefore our rule-of -thumb tells us to multiply GDP by 2.5 to get a rough estimate of aggregate spending.

Because GDP has severely skewed the consumption data economic commentators and advisers are apt to state that recessions are always caused by a fall in consumer spending. A Brief look at the Great Depression proves otherwise. Taking July 1929 as an index of 100 we find that by September 1934 the production of capital goods had plummeted to 43. A calamitous decline of 57 per cent. However, for the same period the output of consumer goods fell 16 per cent. (Prices in Recession and Recovery, National Bureau of Economic Research , Inc., Publication No 31, 1936, p. 419). This is what classical economists called “disproportionality”, a concept that has been largely lost to the economics profession.

The Austrian theory predicts that not only are the producer goods industries hit the hardest, they are also the first ones to go into recession. For example, by July 1929 US manufacturing was already going into recession and shedding labour, even though the stock market and consumption still boomed. We had exactly the same thing for the 1990 recession and Clinton’s recession — for which the Dems and their media allies blamed President Bush. What is particularly interesting about the last recession is that consumer spending continued to rise. How can this be? Well, we have the answer to that. If I had followed the advice of these commentators I would have had to say that there was no recession because consumer spending was still increasing. Now wouldn’t that have been a daft thing to do?

It has been reported that Jan Hatzius, Goldman Sachs chief US economist, estimated that credit losses on outstanding mortgages could come out at around $400 billion or, according to our estimates, about 1.4 per cent of gross spending. From this back-of-the-envelope calculation Hatzius goes into full panic mode by warning that this loss could see a monetary contraction of some $2 trillion. The first thing to note is that though this would be about 15.5 per cent of GDP it would be probably be in the region of 5 per cent of total spending.

What is being argued is that the banks will strive to build up their reserve ratio. If , for example, the reserve ratio is 10 per cent, this means that every dollar added to the reserve causes spending to drop by $10. The problem with this line of thought is that it ignores the role of the Fed. I do not doubt for a moment that if an attempt by the banks to rebuild their reserve ratio looked as if it would trigger a deflation the Fed would immediately step in with freshly printed greens, regardless of the impact on the CPI.

Prices are clearly on the rise. As usual, the real culprit — the Fed — gets off scot free. It was loose money that eventually drove down the dollar and raised import prices while giving US manufacturing exports a good shot of whiskey. But for sometime now money supply has been comparatively flat.

Instead of looking at consumer spending as bringing about a turndown, commentators would do themselves a favour by paying a little more attention to monetary policy. As for debt problem, let us not forget who it was that created the credit that made enormous debts possible.

Gerard jackson is Brookesnews’ economics editor

*Note: The Austrian definition of the US money supply is currency outside Treasury, Federal Reserve Banks and the vaults of depository institutions.

Demand deposits at commercial banks and foreign-related institutions other than those due to depository institutions, the U.S. government and foreign banks and official institutions, less cash items in the process of collection and Federal Reserve float.

NOW (negotiable order of withdrawal) and ATS (automatic transfer service) balances at commercial banks, U.S. branches and agencies of foreign banks, and Edge Act corporations. NOW balances at thrifts, credit union share draft balances, and demand deposits at thrifts.

AMS definition therefore equals cash plus demand deposits with commercial banks and thrift institutions plus saving deposits plus government deposits with banks and the central bank.

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