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Wednesday, November 12, 2003

Ham 'n Cheese Please

That's as in ham 'n cheese for an omelet because an egg won't be enough. In this post Jim presents an article from The Economist to express his concerns about the economy and the contention that people are living beyond their means. Below in bold type is the admission of egg on the face.

EVER since America's stockmarket bubble burst in 2000, The Economist has argued that America faced several years of sluggish growth, if not a deep recession, as the economy worked off the excesses that built up in the late 1990s. Yet the economy has come roaring back, with GDP rising by 7.2% at an annual rate in the third quarter—its fastest sprint for 19 years. Do we look a bit silly? Indeed. But there are still big risks ahead.

The risks that concern me are geopolitical (i.e. a revolution in Saudi Arabia with damage to the oil fields) or a domestic policy shift towards austerity and away from growth (i.e. tax hikes, trade wars...). Absent those types of events, I see some key factors pointing to a broad and strong expansion taking hold. The modest improvement in credit spreads last fall followed by the big improvement last spring along with the huge positive divergence between the household and establishment employment surveys are very positive signs. Low inflation and a 15% tax rate on capital gains and dividends means that the taxation on capital formation is the lowest in over 40 years. This will be a huge positive undergirding the expansion. You will not learn the significance of this from Al Franken and the supply-side Jesus parody in his latest book.

Business investment is picking up, but ample spare capacity will continue to discourage new spending. In September, manufacturing output was running at only 73% of capacity, well below the average of 81% over the past half century. In any case, business investment is too small a share of the economy to keep it aloft in the absence of robust consumer spending.

Business spending is already picking up for the first time in 3 years. Capacity utilization has only upticked slightly from the lows. Capital expenditures usually accelerate early in a cap.ute. ramp, well before average or high levels are reached. It has happened this way before. It would surprise you to know how cap.ute. rates are produced and why the behavior I'm referring to occurs.

Debt levels are high but not unmanageable. As growth takes hold, this concern will fade.

Early last century, economists such as Ludwig von Mises and Friedrich Hayek argued that, if interest rates were held below their “natural rate� (at which the supply of saving from households equals the demand for investment funds by firms), credit and investment will rise too rapidly and consumers will not save enough.

Yes, in theory this is true. In reality, the natural rate of interest is unknowable. I wouldn't be surprised if some economist somewhere is sure that they know how to calculate it. If you want a better understanding of the monetary distortions that rippled through the economy over the last few years, have a look at this Jude Wanniski article titled The Deflation Monster. I might have sent this to Bret and HoneyBee several years ago. The Fed could still snatch defeat from the jaws of victory if they don't start paying more attention to price based indicators and modify their ad hoc approach to monetary policy.

ps all of the essays at the bottom of the page at are worthwhile.

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