Data Summary Shows the US Economy Is in Jeopardy, Part 2

Editor's Note: This white paper was originally published at The Daily Capitalist. Click here to read the first half.

Forecasting Flaws

No one can predict the future. There are too many variables. 

For example, which party will control the government? If the Republicans win, will they make the major changes to government needed for real economic stability and recovery? Regardless of who wins, will Fed policy really change? Will the European Monetary Union disintegrate? Will emerging economies turn away from free market reforms? Will oil production in the Middle East be disrupted by political turmoil? Will major economies endorse leftist-socialist policies?  Will the world break out with free market policies? Will the U.S. suffer another 9/11 attack? Will a volcano/earthquake/flood/tsunami/asteroid destroy a major country or the world? Will someone invent a cold fusion power source. Will …

Stop thinking.

At best we can make educated guesses based on Austrian economic theory and a study of contemporary events. And, at best, we can only make generalizations at that. Friedrich August von Hayek tells us that generalizations are as good as it gets; there are just too many individual decisions being made every day in the “economy” to quantify it and that is why economists’ forecasts are mostly wrong. If they are right, they are probably just lucky. So far I’ve been lucky but at least I admit it.
 
Money

There are three factors driving the economy at this point and two of them are negative indicators. They are:

(i)      real economic production;
(ii)     exports (and imports);
(iii)    quantitative easing.

Each of these factors has something in common and that is money supply and the actions of the Fed.

Real Production

If allowed to function without government interference, “economies” will correct themselves from the consequences of bad investments made during a boom-bust business cycle. People, consumers and business owners alike, will take care of their own problems by reducing debt, selling off bad assets, saving more, spending less, and even going bankrupt. That is, they will do what it takes to try to maintain their lifestyle.

That is exactly what has been going on, more or less under the radar because it is difficult to see and measure. We cannot accurately calculate how much activity is related to this, but the levels of debt write-down, savings levels, and capital spending by manufacturers give us some indication.

The amount of real capital/wealth in the U.S. is prodigious, often underestimated, and it remains the foundation of our capitalistic economy. Real capital is the things we have produced based on organic economic growth, not growth produced as a result of monetary stimulation. During the boom phase huge amounts of what people thought was capital/wealth was created but it was mostly fake, a product of fiat money steroids created by the Fed (“malinvestment”). Eventually malinvestment is always cured by the market. The problem with these boom-bust cycles is that fake capital/malinvestments also cause the destruction of real capital. Since this current cycle has been the biggest boom-bust event in world history, untold amounts of real capital was destroyed and that is what is holding back a recovery.

I don’t wish to belabor points I have covered many times, but federal and state governments are doing all they can to prevent the liquidation of malinvestment; as pointed out above, consumer debt has not been significantly reduced, about 25% of all homes in America are underwater, personal savings are declining, and large amount of underperforming/ troubled commercial real estate loans still plague lenders. Until these things are corrected, recovery will be thwarted. The key to understanding this is that ultimately the markets will cure the problem and all government attempts to stop it are futile and have only served to delay recovery. 

On the plus side, businesses have trimmed operations, including labor, to the proverbial bone, and they are making substantial investments in productivity (capital equipment) and related technology (software). Thus profits in general appear good, but not all profits come from expanded sales, but rather from operating efficiencies. They are positioning themselves for growth or decline and they remain cautious about the future.
The actions by businesses to gain efficiencies is a positive force in the economy and has been one of the drivers of the economy, but it is difficult to measure.