U.S. Economy and the Illusion of Prosperity

By: Frank_Hollenbeck

President Obama and Federal Reserve chair Janet Yellen have recently been crowing about improving economic conditions in the U.S.  Unemployment is down to 5.5% and economic growth in 2014 hit 2.4%.

Journalists and economists point to this improvement as proof that quantitative easing was effective. They seem to have political blinders on. The boom is artificial and has been built by adding debt on top of excessive debt.  Total household debt increased 2.5 % in 2014 – the highest level since 2010. Mortgage loans increased 1.5%, student loans jumped by 6.6%, and auto loans swelled a hefty 9.6%.  The improving auto sales are based on a bubble of sub- prime borrowers. Auto sales have been brisk because of a surge in loans to individuals with credit scores below 640. Auto loans to individuals with strong credit scores, above 720, have barely budged.

Sub-prime consumer borrowing climbed $189 billion in the first 11 months of 2014.  Excluding home mortgages, this accounted for 41% of total consumer lending. This is exactly the kind of lending that got us into trouble less than a decade ago. This trend can only end in tears.

Here’s the lingering question: is the current boom built on sound foundations? Do we have sharp increases in productivity or real wage growth?

The truth is productivity has barely budged since 2010 and real wages have flat lined, or declined for decades. From mid-2007 to mid-2014, real wages declined 4.9% for workers with a high school degree, dropped 2.5% for workers with a college degree, and sunk 0.2% for workers with an advanced degree.

So is the boom being built on broad base investment in plant and equipment?  The average age of plant and equipment in the US is currently the oldest on record.

It is now clear that the shale boom was an illusion of prosperity.  The same is true about improvements in housing. Following the financial crisis of 2008, real estate prices should have dropped, much, much more than they did relative to other prices. Housing should then have remained in a slump possibly for a decade or more, until the overhang of construction in residential and commercial real estate had cleared off. The new ratio of relative prices would have allowed resources to move into the production of goods and services more in line with what society would demand in a functioning market.

Today, housing is back, with price increases at bubble-era levels and construction activity is picking up. The improvement is being driven by professional investors stretching for yield in the buy- to-rent market and by historically low long-term mortgage rates of below 4%.  Yet, the overhang from the previous boom has not disappeared. It has just been left in limbo, because of the “extend and pretend” strategy of banks made possible by the central bank’s massive printing over the last 6 years. The number of vacant units in the U.S. still stands at over 18 million units- a level reached back in 2008-2009. The number of units held off the market is still at a record level of over 7 million units. Of course, when market forces return interest rates to more normal levels, the adjustment in housing will be even more disastrous.

As Austrians have always warned, don’t be fooled by the euphoria of a boom built on a mountain of malinvestments.  A sustainable boom can only be built on a foundation of sound money. Any other is destined for a bust. Our current economic policies seem to be geared to create a never ending series of booms and busts.  We must find a way to get off this merry-go-round.

The economic policies followed over the last 6 years can only be described as delusional. The problem in 2008 was too much debt, so the solution according to the geniuses in the Eccles Building is to lower interest rates to boost demand to induce households and governments to borrow even more.  In other words, you just had a heart attack because you are obese and your doctor tells you your diet is too restrictive and you need to eat even more by loading up on different types of debt….sorry…..food.

We don’t need central banks to “boost” demand. This faulty widespread educational indoctrination about aggregate demand is the poison eating at the heart of macroeconomic theory.  It is not a lack of demand that is hampering growth but a misalignment of supply with demand. Once you understand this fundamental economic reality, no amount of printing will solve this problem.

Printing money cannot correct a misalignment created by government’s incessant interference with the workings of the price system. This printing however will actually make things worse since it alters relative and absolute prices, causing a greater divergence between what society wants to be produced and what is produced.  Interfering with interest rates is by far the most damaging policy imaginable since interest rates are the price of time preferences and play a crucial role in aligning output with demand across time. The greater the misalignment across time, the greater the adjustment.

It is too late to avoid the necessary reset and the coming adjustment will be horrendous. Yet, have we learned anything? Will we repeat the same policy mistakes of the 1920s, or of the dot com and housing bubbles? When will we realize we must shut down the definition of evil, the central bank, and its fraudulent sidekick fractional reserve banking? How many times will we continue this rinse and repeat of booms and busts?

Frank Hollenbeck teaches finance and economics at the International University of Geneva. He has previously held positions as a Senior Economist at the State Department, Chief Economist at Caterpillar Overseas, and as an Associate Director of a Swiss private bank. See Frank Hollenbeck's article archives.

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