Economic Lessons

“But the point is consumption does not lead to investment. It is the other way around. If you have sharp increases in investment, you have immediately rising consumption, because the  investment spending creates consumption.”

Several weeks ago, I reported to you that my colleague Rick Barnard traveled to Cannes, France, with a list of questions I had for Dr. Kurt Richebächer. Rick has returned to Baltimore…with four hours of audiotapes. Luckily, he condensed down those four hours to these answers Dr. Richebächer gave below.

I can’t say I agree with all his answers. But I don’t have nearly the experience Dr. Richebächer does. He was born during the great German hyperinflation of the 1920s, grew up during the Depression, and briefly fought in World War II before a paralyzing injury changed his life. He’s one of the only living economists with direct experience of history’s most valuable economic lessons.

I couldn’t think of a better man to ask about the urgent questions facing the American economy. Enjoy.

U.S Business Economics:1. Can U.S. economic statistics on employment and wage rates be trusted?

All I can say is there is a lot of absurdity in the American statistics. U.S. statisticians are practicing various methods to calculate both inflation rates and employment that are unique in the world. And that means they are not comparable with the same numbers for other countries, in particular Europe.

It’s not hard to see why. These statisticians are under enormous pressure from the government, which wants to pay less for Social Security. They are also under enormous pressure from Mr. [Alan] Greenspan, who wants low inflation rates in order to justify his low interest rates.

So the statisticians have developed sophisticated methods to measure “actual” inflation or unemployment, for example, instead of using the real numbers. And while their assumptions seem very rational, they don’t make any macroeconomic sense. Meanwhile, these overstatements and understatements have vast impacts on other aggregates.

In no other countries are these things practiced.

U.S Business Economics: 2. Is the U.S. economic establishment obsessed with statistical analysis?

Yes. I have the impression that in America the belief in statistics is like the belief in God.

I see the most evident failure in American thinking is the high assessment of consumption as the engine of growth. They have a model that says consumption is the biggest and most important demand component in the economy, and when there is sufficient consumption, there will be sufficient investment. That is one of the key postulates in American economic thinking.

But Austrian economists say that, in the end, if consumption takes a growing share of GDP, other shares must decrease. If you have too much consumption, you end up with less and less investment and with a growing deficit in the trade balance.

This is precisely what we are observing in the United States. This wild consumption boom in history has not created an investment boom – it has killed the investment boom.

U.S. Business Economics: 3. If you could replace the focus on statistical analysis with one indicator of the state of the economy, what would it be? The savings rate? Business investment?

For me, savings and business investment there are crucial for sustained economic growth. The key is that investment must be as high as savings.

If the two are in balance, your balance of payments is also in balance. The balance of the two keeps the whole economy in balance. And that has been true in the world for decades.

4. When it comes to consumption (spending), is there an ideal allocation between business, consumer, and government? What percentage of GDP is consumer spending in a healthy economy?

The key is not the portion, the key is the increase. Measuring it against GDP growth gives you a more precise picture of what is developing now.

When you measure economic growth from 2000-2004, American consumption growth was more than 100%. It can be more than 100%, because so much went into imports.

But the point is consumption does not lead to investment. It is the other way around. If you have sharp increases in investment, you have immediately rising consumption, because the investment spending creates consumption.

The problem in the United States is that consumption is increasing, but investment has not.

5. Does business investment fluctuate with the business cycle?

Of course. Business is where investment is a key variable in the fluctuations of the business cycle. This has never been disputed – until now. And it is the Americans, with all their statistics, who are now disputing this.

But the fact is the last downturn of the American economy began with plunging investments. And that is the rule all the time.

Consumption, meanwhile, is a very stable component. It is the biggest component, but it fluctuates the least. It’s easy for investment to plunge by 20%. But it’s a lot when consumption declines by 2%.

6. What kind of business investment produces the most multiplier effects (increases in employment and wages)? Or put another way, is capital spending on one type of asset more beneficial than capital spending on another type of asset for the economy in aggregate?

The biggest multiplier is caused by long-term investment. When you build a steel factory, it has endless multipliers. Building the factory alone could take 5-8 years. In all this time, there is spending on various capital goods and on consumption.

In other words, building factories means you’re creating employment and consumption.

The opposite is the new high-tech. It is not capital intensive…nor labor intensive. It is intensive in nothing, except in statistics.

Dan Denning

The Daily Reckoning