Sennholz.com

 Thoughts from Roland F. Sennholz:

Problems and Symptoms

September 19, 2012

Doctors have a tricky job: they have to find out what symptoms a patient is having and use those to figure out what the problem is. Sometimes, they figure out the problem, cure it, and the symptoms go away; other times, they mistake the symptoms for the problem, and just make things worse.

If one wants to “cure” the economy, one faces much the same problem, but on a bigger scale. Think about some of the things you’ve heard about: low consumer spending, low interest rates, unemployment, and inflation. I want you to categorize those things as symptom, problem, or cure. Have your answers? Good.

Now, let’s start with consumer spending. Why is it low? Think about that for a moment: why aren’t you out there buying more cars, more clothes, a bigger house, or other consumer goods, and doing your part to “stimulate the economy?” Chances are, your answer is that those things cost too much. Hopefully, when the economy gets better, you’ll be able to find a better job and afford them... right?

But, what makes us so sure the economy is going to get better? Let’s think for a moment: what’s an economy? It’s when lots of people work together to produce things that others value. Each person produces and sells something, so they can buy other things they want; so long as they make more money than they spend, they’re earning money. But, almost anyone can make something or provide a service and sell it! So shouldn’t most of us be getting richer?

I want you to think about something you do every day: you eat. The money you spent on that food doesn’t earn you anything—for you, it basically disappears from existence. What about that nice new shirt you bought earlier? The money you spent on it disappears, too. The money you spent on the shiny new car in your driveway to replace the five-year-old one? Gone. Lost to “consumer spending.”

What about the money you spent on a new tool kit, or computer program, or smart phone? If you’re a carpenter, that new tool kit might help you make money. You might be able to get more done in an hour, and even charge more for your services if you can do more kinds of jobs. If you’re a web designer, the new program might help you put together nicer websites, or make them faster. If you’re a salesperson, your smart phone might help you keep track of all your appointments and the people you need to call. Now, make no mistake—the money you spent on those things is gone, too. But, it’s only gone temporarily; notice that this kind of purchase ultimately gives more back to you than you spent on it. It’s an investment, not consumption.

If an economy is made of individuals, then when individuals get richer, the economy gets richer, and when individuals get poorer, the economy gets poorer. To make an economy grow, more people have to be getting richer (saving and investing) than are getting poorer (consuming).

So, can more consumption help the economy? No. It can only shrink it. So, is low consumer spending the problem? No, it must be a symptom.

What’s the problem, then? The problem is that individuals aren’t saving and investing enough; they’re getting poorer. Why? Well... it’s funny you should ask that; let’s move on from low consumer spending to low interest rates, and we’ll answer your question shortly. Are low interest rates a symptom, or a problem?

Well, what are interest rates? Interest rates represent the time value of money—the amount that people are willing to pay in order to have money now, rather than later. When you borrow money to buy a car, you pay interest because you’re not paying the car’s whole price right now; instead, you’re paying it off over time. When you put money in the bank, the bank pays you interest because it can use that money right now, but you’re not going to use it until later, in the future.

So, what would an interest rate ordinarily represent? It would represent how much the individuals in the economy value having things now as opposed to later. It would represent whether they value saving or spending more: if individuals value saving, the banks will have lots of money to lend, and interest rates will drop to encourage borrowing. If they value spending, the banks will already have lent out most of their money, and interest rates will rise to keep more people from borrowing.

But, not all in the land of the free and the home of the brave is free. The interest rates that banks charge, for example, are heavily influenced by the Federal Reserve. They say that the Fed’s low-interest-rate policy is supposed to increase consumer spending, so they’re trying to fix one of the symptoms—but do they recognize that it’s a symptom? Do they recognize that their “solution” of lowering interest rates also fools people into thinking they can borrow more money than they could normally afford to borrow? It certainly doesn’t look like it.

But if low interest rates aren’t a solution, but a symptom, what’s the problem? The problem is that interest rates can’t move up, or consumption will decline and the economy will experience the mother of all crashes.

If you’re raising your hand to ask a question at this point, that’s good. I know I would be. Why do we have to choose between consuming, which slowly destroys our economy, and a crash, which does it more quickly? Why can’t we produce more, and pull out of our nosedive?

I’m going to have to ask you to hold on to that question, because we haven’t looked at all the pieces yet. It’s time for the next piece: unemployment. First, to satisfy our curiosity about why employers might not be hiring, let’s put ourselves in their shoes for a moment: why aren’t we hiring more people? Because they cost too much.

Every time employers wants to hire someone, they have to provide that person with all kinds of benefits, like wages, health insurance, or retirement plans. Let’s have an example: say you’re interviewing a bright young man whose efforts are worth $6 an hour to you. Can you hire him at that rate? No, because minimum wage is higher than that, and that doesn’t even mention the other benefits you’re required to provide. So, you have a choice between hiring him at minimum wage and losing money, or not hiring him and leaving his work undone (because why would you or one of your employees do something that’s worth $6 an hour, when you could be doing something else that’s worth $16 an hour?). You’re probably going to choose to leave his work undone, because it costs more to get it done than you’ll make by having it done. I won’t even go into government-required health care, social security payments, or the lawsuits that employees can bring (or cause).

So, is unemployment a problem, or a symptom? Well, why do people employ other people? They do it to get work done. Employers don’t employ just to have employees, they employ so employees will produce for them. If production is the goal, low employment is just an indicator of low production—which makes low employment a symptom of the problem of low production (but also vice versa). In fact, as we saw above, production is actually so low that the economy is shrinking. So, we come back to the same question I put off answering before: why aren’t people investing more, to turn the economy around?

The answer is related to our next and last question: what is inflation, and how can we categorize it? Most people say inflation is when prices rise; government economists say inflation is a solution to our current crisis because it’s better than deflation. The problem with deflation, they say, is that prices fall and everyone waits to spend money because they know they can get something cheaper in the future. That makes consumer spending drop, and then—wait, what’s that? Deflation is bad because it decreases consumer spending? Hmm...

But, let’s not get sidetracked. Inflation means prices are rising, but that sounds like an effect, not a cause. What’s the cause? Well, the government creates inflation by printing more money. Money normally acts as a stand-in for goods (so we don’t have to barter)... but what happens if we create more money without creating more goods? Each piece of money is going to represent fewer goods, isn’t it? Or in other words, each piece of money becomes worth less. That’s why prices rise: because each good is still worth the same thing, but the money you’re using isn’t.

But wait, where does the value of our money go? Think about it: where is the money that’s been created out of thin air? It’s in the hands of the Federal Reserve Bank, which lends most of it to the federal government. Your money loses its value, while they get more money to offset its decrease in value. So, what is inflation: problem, solution, or symptom?

This is a trick question: for the federal government, it’s a solution, and for you, it’s a problem. The federal government has a mountain of debt, which it can reduce by taking the value out of the dollar while giving itself more dollars to counteract the reduction in value. But you? You’re losing money because your dollars are becoming worth less, and the goods you want to buy with them aren’t... not to mention what happens if you’re holding U.S. government debt.

Think about it for a moment: the government is made of individuals, too. If it’s a choice between them and their government friends, and you and your citizen friends, guess who they’d rather drop the crash on?

But, I’m getting ahead of myself. That last question assumes they can’t save us both somehow—which leads, once again, back to our hanging question: why aren’t people investing more and turning things around?

The answer is misinformation. The federal government misinformed the individuals that make up the economy by controlling interest rates, by inflating the dollar, and by measuring success in terms of consumption rather than production (when was the last time you decided how well a company was doing by how much they were spending?). Those individuals thought they were investing when they were actually consuming. For example, take the housing bubble—because the interest rates were manipulated lower than a market rate, people bought houses they couldn’t afford, just to turn around and sell them at even higher prices. When the Fed raised the banks’ interest rates, the banks couldn’t keep lending like that. People discovered they couldn’t afford those houses at the higher rates, and everything fell apart.

You might be wondering: why is investment so low if interest rates are so low? The answer is: if you’re thinking about low interest rates, you’re thinking about borrowing...and you can’t borrow your way out of debt. Say you’re a business owner; why aren’t you investing in new equipment for your business? You might not have the money any more (you’re probably in debt), or you might not have the demand for your product because people don’t have money to buy it (they’re in debt, themselves). Banks might not lend to you for expansion, or to buyers so they can buy your product (banks are deep in debt, too). Where did all the money go? Much of it was spent on consumables bought from other countries such as China. Apparently, China is friendlier to people who want to earn money than the United States is.

Once you’ve mis-invested, the only way to correct the problem is to accept your loss (waste) and write it off. Most people can’t or won’t do that (especially when their new car or home turns out to be the mal-investment), and so instead they go bankrupt. If this happens to enough people, no one wants to spend any money... and right now, we’re long past “enough people.” The federal government’s methods can only prolong the time until we crash, but we’ve gone past the point of no return—the crash is inevitable.

So, can we start producing and turn the crash around? No: we can’t tell investment from mal-investment right now because our compass (interest rates) is broken, and our money is tied up in houses, cars, academic degrees, and business projects we can’t afford. We need to stop mistaking our instruments for controls, and free up the resources currently occupied in mal-investments so they can be used according to market demands. That means letting the crash happen. The idea that a company can be “too big to fail” only prolongs our economic problems by preventing us from cleaning house... even if things get uglier in the short term while we’re cleaning.

So, how’d you do? Did you correctly identify the problems and the symptoms? If you didn’t, don’t feel bad: the economists in the federal government seem to be doing a pretty bad job of playing doctor, too.

But, given that they don’t want us to find out that the federal government is the reason behind our economic crash, is that really surprising?

Roland F. Sennholz