Needless to say, Bolt — like the Liberal Party leadership — is a thoroughgoing economic illiterate who is incapable of grasping the fact that inflation is a monetary cancer that can do enormous economic and social damage if left unchecked. It was a monetary explosion that created the boom that Bolt seems to think was a wonderful success.

Let us do what he did not and that is apply a little economic theory, laced with some monetary figures, to the current situation. From March 1996 to December 2007 currency rose by 110 per cent, bank deposits by 178 per cent and M1 by 163 per cent. (Monetary Aggregates - D3 ). What we had was a monetary boom, not a genuine investment boom. It was this boom that sent house prices rocketing, fuelled the current account deficit and greatly worsened the foreign debt.

Not only does every country have a capital structure it also has a price structure. This means that by artificially lowering the rate of interest the resulting expansion of credit distorts the price structure and hence the pattern of production. (This is something that the classical economists understood to varying degrees*). Eventually the monetary brakes have to be applied which in turn brings about a recession.

The preceding brings us to Terry McCrann, according to whom the June quarter GDP figures are a "beautiful set of numbers".(Growth slows in right places, Herald Sun, 4 September 2008). He made it clear that by "beautiful" he meant that the economy was heading into "potentially recession territory" and was therefore not overheating given that the annualised rate of GDP growth is 1 per cent. Moreover, he emphasized that he thought it unlikely that the economy would slide "into recession".

At this point he did what all of our economic commentators do: he turned to the fallacious view that consumer spending comprises about 66 per cent of total spending. Therefore, when consumers reduce their spending this reverberates throughout the economy and causes a recession. But the belief that GDP represents aggregate spending is based on a thoroughly flawed view of spending because it deliberately ignores spending among firms on the fallacious grounds that to include it would be double counting. (By the same logic, firms should not include the prices of inputs among their costs of production).

Allow me to once again point out that during the 'Clinton recession' consumer spending continued to rise. But according to the economic views of our economic commentariat the recession should have started with a fall in consumer spending which then flowed up the capital structure. As I pointed out in 1999, the contraction in US manufacturing was clearly signalling an impending recession even as consumer spending grew and unemployment fell. Failure to see what was really happening led Steve Slifer, chief economist at Lehman Brothers, to state in January 2001:

It’s really an odd-looking slowdown. The manufacturing sector is, in fact, in a recession but not the overall economy. At least not yet.

At the moment it looks pretty much like Australia is being visited by the same phenomenon. Low as the GDP figure is it still shows that consumer spending is positive. What it does not show is that "manufacturing activity fell for a third consecutive month in August. . . [while]manufacturing employment fell for the sixth consecutive month". (The Australian Industry Group's Performance Manufacturing Index). Irrespective of McCrann's somewhat rosy view, the continuing fall in manufacturing output and employment suggest that at the very least the Australian economy is on the edge of recession. Furthermore, if we included total business spending then the annual 1 per cent growth would be transformed into a negative figure that, in my opinion, would exceed 1 per cent.

Now for some more monetary figures. M1 peaked at 231.3 last December, after which it began to contract, falling to 216.3 in May, a 6.5 per cent deflation. (The June figure stands at 224.7, suggesting that the Reserve might be trying to reflate). Yet our economic commentariat completely overlooked these figures. For them it seems that money really does not matter.

It is the Austrian view — and one classical economists observed — that it is always manufacturing that not only signals an impending recession but also bears the brunt of it. For instance, in December 1928 the Federal Reserve froze the money supply: manufacturing output and employment began to contract several months later. Anyone acquainted with the Great Depression would know that it was manufacturing that suffered the most.

So what are we left with? A Reserve bank that practices lousy economics and a commentariat that won't do its homework. No wonder politicians keep getting it wrong.

* The following works are by early economists who discussed the subject of inflationary-induced changes in the price structure and their detrimental effects on investment:

Essay on the Nature of Commerce in General, Transaction Publishers, 2001, written about 1734 and first published in 1752). Henry Thornton's An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, George Allen and Unwin, 1939 (first published in 1802), pp. 194, 239, 243. Thomas Malthus, Edinburgh Review, February 1811, pp. 363-372. John E. Cairnes (sometimes called the last of the classical economists) explained how the gold discoveries in the United States and Australia distorted the price structure, Essays in Political Economy, August M. Kelley, 1965, Chapter II.

Gerard Jackson is Brookesnews' economics editor

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