The Face of the Economy

March 19, 2000

Doubts Hit the Mainstream

Both yesterday's and today's business sections of the Clarion-Ledger cautiously observed that some of the economic indicators were not all rosy, but concluded that we should have a strong economy for a while. We think that the caution was well-taken and, for reasons we have already published in the Jackson Progressive, the United States has not yet discovered the solution to the business cycle.

In Mississippi, for instance, sales tax collections are up, compared to January of 1999, whereas income tax collections are down. One would expect the two to be roughly in tandem, on the assumption that falling incomes would result in fewer purchases and therefore lower sales tax collections. If income tax collections decline, thus indicating a decrease in incomes in Mississippi, rising sales tax collections indicate that people, on average, are reducing their net worth in order to spend more on goods and services.

If this is the case, and the numbers do not prove this for certain, it would reflect the general conclusion discussed in our previous article that the current economic boom is being sustained by Americans' reducing their net worth, either by drawing down their savings or going into debt to consume.

And Then Oil Prices Hit

Headlines on the Sunday business section of the Clarion-Ledger: "Consumer prices rise with gas." As a result, the Federal Reserve is expected to raise interest rates by .5% next week to keep inflation under control. An increase in the consumer price index of 0.5% for the month of February is the basis for the Fed's worries about inflation, even though virtually all of the increase of the CPI were in the energy and food categories. Other prices were "well-behaved," as the economists say.

So what are we to make of this? In a real, competitive, market economy, the economy that appears in college economics textbooks, consumers, having to pay more for gas and food, would have less to spend on other items, whose prices would correspondingly decrease with the decrease in demand. Alternatively, consumers could reduce their purchases of gas and food to the extent that the reduced demand for those goods would depress their price. In either case, the overall price level should remain the same.

Instead, we are told that the increase in oil prices will cause prices to rise throughout the economy, because oil is used either directly or indirectly by all segments of the economy. Farmers, for instance, must use fuel to run their machinery; fertilizer, pesticides and herbicides are all manufactured heavily from oil. If the farmer must pay more for his inputs, the theory goes, then he must charge more for the food he grows. Does that happen? In the case of farm products, no. Farm products are pretty much a pure market. Farmers cannot control the price of their products, which are set by bidding between many buyers and many sellers. If the farmer cannot get more than his costs when he sells his crops, then he simply loses money. If he loses enough money, he goes out of business. That's how the market works.

On the other hand, consider the auto manufacturer. There are relatively few automakers in the world and an increase in the cost of raw materials, including oil, unless offset by an increase in the prices of the manufactured products, will reduce or eliminate profits. What happens? We all know: the prices go up.

Why can't farmers raise their prices like auto manufacturers? It doesn't take a lot of intelligence to conclude that the auto market is not like the market for agricultural products. There may be competition, but it is never so fierce (or so "textbook") that it eliminates or seriously reduces profits.

What can we expect?

So what can we expect from an increase in oil prices? Expect some prices to go up. Those are the sectors of the economy that have some market control and can make the prices stick without other sellers breaking ranks and underselling them. Some prices will go down. Those are the sectors of the economy in which real market competition prevails, such as agriculture and other commodities.

And Labor

One of the outcomes of the vicious anti-union policies of the Reagan/Bush/Clinton administrations has been the further commodification of labor. Even though wages, especially at the bottom of the economic ladder, have not profited much from the economic boom, expect even more downward pressure on wages as employers strive to keep up the historically astronomical profit margins that stock market has come to demand. Expect the Congress, in the face of political pressure from Wall Street, to be far more hesitant to raise the minimum wage.

The Fed

And then expect the Fed, thrust by the general acceptance of neoclassical monetary theory into the role of sole economic controller, to employ the only tool it knows, reducing the money supply, and, consequently raising interest rates. If the tool is used with sufficient vigor, lending will slow due to the increased cost of borrowing, investment in new plants and facilities will slow, and the growth of consumption will eventually decrease, leading to layoffs. If enough people are thrown out of work, we call it a recession. And by depressing wages, it tends to dampen inflation, but at a terrible cost.

We think that a recession is likely in the next six months. Here's why:

• First, the present boom is fuelled by increasing debt. See our article on that subject. Aggregate debt can increase indefinitely only if the entire economy increases as fast as, or faster than, the debt load. That isn't happening.
• Second, the Fed will overreact. Why? Because at the present time it is philosophically blind to all problems but one: inflation. A tightening of lending will inevitably lead to a shrinkage of the money supply, or at least a lessening of the growth of the money supply. With a government surplus and an enormous deficit in the current account balance, it is virtually impossible for anything else to happen.
• Third, we could reduce imports, which would lessen the negative current account balance, but would create extreme difficulties for our trading partners, which have relied upon exports to the U.S. to shore up their shaky economies. Many of them, particularly the countries of Southeast Asia, have structured themselves, under the tutelage of the World Bank and IMF, as well-behaved neo-colonial colonies, that is, as export economies, rather than self-sufficient nations. Without the foreign exchange that exports bring, many of these countries would be literally unable to feed themselves.
• Finally, our leadership is locked into a "surplus is good" and "deficits are bad" ideological stance reminiscent of Herbert Hoover, a stance that will make it almost impossible for the government to stimulate the economy with deficit spending when the recession does arrive. Most of us experience difficulty in seeing the surplus as a monetary vacuum-cleaner, sucking money out of the economy, but that is exactly what it is. It sounds so thrifty, so wholesome, that it is unlikely that the political will to reverse course will form until circumstances are desperate.

That's our analysis. You read it here, in the Jackson Progressive. If you disagree let us know.