Consumer Spending Spree Creates Bad Vibes for the Economy

By: Gerard_Jackson

We can divide economic commentators in to two basic groups: The first one consists of what we can loosely term free market commentators while the second one consists of interventionists. Alan Wood and Terry McCrann are representative of group one. The sad thing is that neither group offers any serious economic commentary. Right now Australia is undergoing a boom, consumer spending is rocketing — as is the trade deficit — inflation is about 3 per cent and the unemployment figures have been slashed.

In the good old days of BK (before Keynes) most economists — with the probable exception of the “price stabilisers” — would have been very concerned with these indicators. However, anyone with a nodding acquaintance with economic history and the history of economic thought knows that the boom-bust cycle was a significant feature of the first half of nineteenth century Britain. Once again there is nothing new here. As John Stuart Mill wryly observed more than 170 years ago:

If alI are endeavouring to extend them, it is a certain proof that some general delusion is afloat. The commonest cause of such delusion is some general, or very extensive, rise of prices (whether caused by speculation or by the currency) which persuades all dealers that they are growing rich. And hence, an increase of production really takes place during the progress of depreciation, as long as the existence of depreciation is not suspected; and it is this which gives to the fallacies of the currency school, principally represented by Mr. Attwood, all the little plausibility they possess. But when the delusion vanishes and the truth is disclosed, those whose commodities are relatively in excess must diminish their production or be ruined: and if during the high prices they have built mills and erected machinery, they will be likely to repent at leisure. ( Essays on Economics and Society , University of Toronto Press 1967, London: Routledge & Kegan Paul, p. 275).

Regardless of the fact that Mill lost sight of what drives the boom-bust cycle he was, along with most of his contemporaries, spot on about their formation and eventual collapse. That was then and this is now. Alan Wood, economics editor of The Australian , was critical of warnings that our foreign debt was exerting an upward pressure on interest rates. ( The Australian , There's no dragon in our debt wood , 10 October). In this respect he was right. The forthcoming problem of rising interest rates will not originate with foreign borrowings.

Wood criticised the Treasurer for complaining that the rise of the Australian dollar against the US dollar was not good for the economy. Missing is the possibility that the current exchange rate is due to a rapidly depreciating US dollar rather than the apparent strength of the Australian economy. The truth be told, the current international monetary system is in chaotic state. We have had “65 consecutive months of trade deficits”. Wood's response is to assert that we are in for another 65 months. (Ibid.) In other words, there is no problem.

In his opinion — and I should make it very clear that Wood's economic opinions are representative of our so-called free market commentators — there cannot be a problem because there is no evidence that Australia is paying a premium on its foreign borrowing. This fact in no way proves that we do not have a problem here. At this point Wood back-pedals with the admission that we cannot keep raising the ratio of borrowings to GDP indefinitely, and the same goes for the deficit. Quite. The real question, however, is not the size of the foreign debt and the trade deficit but how we got them in the first place. BK economists would have had no trouble explaining these phenomena. They would have pointed out that in

...the course of the boom, owing to the rise in prices, the increasing demand of industry for more materials, and the increased importance of the home market, there appears a tendency towards an adverse balance of trade, with a corresponding tendency to an increase in foreign indebtedness (that is, a tendency to borrow more from abroad than is lent abroad). (Wilhelm Röpke, Crises and Cycles , William Hodge and Company, Limited, 1936, p. 27)

Another BK economists: In a free economy the principal cause of a cumulative deficit in a country's international payments is to be found in inflation. . . In a country whose currency is not convertible into gold, inflation leads to its continuous devaluation in terms of foreign currencies. (Michael A. Heilperin, International Monetary Economics , Longman's, Green and Co., 1939, p. 123).

And of course when speaking of BK economists one must also refer to the gold standard:

If, as gold flows out, credit is not contracted, then the occasion for the gold flow is not removed. The monetary reformers who, during these years, complained so bitterly that the Bank was deaf to their teaching, complained too much. Unostentiously, without any public repudiation of Gold Standard practice, the Bank was following their policy. (Lionel Robbins, The Great Depression , The Macmillan Company, 1934, p. 85).

What Robbins was saying is that the Bank of England was inflating the money supply at the same time as gold flowed out. In other words, the rules of the gold standard were being violated. Now and then Wood feels the need to make sarcastic comments about the gold standard, parroting Keynes that it was nothing but a “barbarous relic”. The only thing this proves is that Wood does not know a damn thing about the gold standard.

It is a myth that Britain went back on gold in 1925. The fact is that there were very few gold standard countries, the US being one. Britain was actually on a gold bullion standard and the other countries were on a gold exchange standard. This allowed Britain to pursue an inflationary policy that created balance of payments problems on the trade account so that “it appeared by the ‘thirties that imports were outrunning exports to a dangerous degree”. (William Ashworth, An Economic History of England 1870-1939 , Methuen & Co LTD, 1982, p. 350).

Even Bernie Frazer, a Keynesian and a former governor of the Reserve Bank of Australia, stated emphatically that

If demand runs ahead of capacity, it will spill over into imports and widen the current account deficit (CAD). This is what happened in 1989-90 when the deficit reached 6 per cent of GDP. On this occasion the CAD is not expected to increase to the very high levels reached during the lat 1980s. ( Reserve Bank Annual Report , 1994).

What Frazer, Heilperin, Röpke and Robbins are basically saying is that inflationary policies will have the effect of sucking in additional imports. A number of times in the past I have pointed out that one of the effects of credit expansion will be an unsustainable increase in the demand for foreign-made capital goods, which is exactly what has been happening. However, the likes of Mr Wood miss the relevance of these imports.

Terry McCrann, finance writer for the Herald Sun , is very much in the same vein as Wood. He remarks that the surge in spending “is spilling into surging imports” ( Reserve bank may hold key to Federal poll result , 7 October) and that this will lead the Reserve into giving us a “whack” for “actual — excessive — spending” because the “trade deficit doubled from $883 million in July to $1.6 billion in August”.

Odd, is it not, that some like Terry McCrann can point the finger at so-called excessive spending without asking where it is all coming from. Well, how about this — a rapidly expanding money supply. And money is precisely what is missing among our economic commentariat. From March 1996 to July 2007 currency grew by 101.6 per cent, bank deposits by 177.7 per cent and M1 by 169 per cent. In the 12 months from July 2006 to July 2007 currency rose by 6 per cent, bank deposits by 14 per cent and M1 by 14.5 per cent. The word for this is criminal and sooner or later we are going to have to pay the bill for this monetary excess.

By Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes' economics editor.

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