The Mistake-Correction Cycle of Real World Economics

We went to our last summer soiree last night. It took place at a neighbor’s chateau, where a large, ancient stone barn had been transformed into a dining room for 100 people.

“We’re screwed…so are you…” said a friend.

First, an update from Wall Street: the Dow was unable to sustain a bounce yesterday. It fell 74 points. Gold dropped $3.

Hiring…house sales…the latest news confirms that there is no real recovery going on. And now this from the AP:

The government is about to confirm what many people have felt for some time: The economy barely has a pulse.

The Commerce Department on Friday will revise its estimate for economic growth in the April-to-June period and Wall Street economists forecast it will be cut almost in half, to a 1.4 percent annual rate from 2.4 percent.

That’s a sharp slowdown from the first quarter, when the economy grew at a 3.7 percent annual rate, and economists say it’s a taste of the weakness to come. The current quarter isn’t expected to be much better, with many economists forecasting growth of only 1.7 percent.

Such slow growth won’t feel much like an economic recovery and won’t lead to much hiring. The unemployment rate, now at 9.5 percent, could even rise by the end of the year.

“The economy is going to limp along for the next few months,” said Gus Faucher, an economist at Moody’s Analytics. There’s even a one in three chance it could slip back into recession, he said.

In addition, the impact of the government’s $862 billion fiscal stimulus program is lessening.

That leaves the private sector to pick up the slack. But businesses are cutting back on their spending on machines, computers and software, according to a government report earlier this week. And the housing sector is slumping again after a popular homebuyer’s tax credit expired in April.

“What we’re seeing is that the hand-off to the private sector is not looking as robust as we had previously hoped,” said Ben Herzon, an economist at Macroeconomic Advisors.

A handoff? What an imagination!

As if the private and public sectors were running a relay…cooperating to make our lives richer and better…based on a game plan developed by the coaches at the Federal Reserve!

We have news: it doesn’t work that way.

“Okay, Mr. Smarty Pants, how does it work?”

Glad you asked.

In the real world, the economy is always making mistakes…and always correcting them. Making mistakes…and correcting them.

And markets are always discovering what things are worth. They figure out what one thing is worth, conditions change…and they change their minds.

There are times when the economy makes a big mistake – especially when it is given the wrong signals from the Fed. And there are times when markets change their minds dramatically.

Investors don’t like it much when the economy and the markets turn down. It makes them look like morons…which they usually are. Businessmen don’t like it much either. Falling sales or failing businesses make them look incompetent and reduce their compensation. The average person doesn’t like it because he loses his job…and sometimes his savings. And the politicians don’t like it because they pretend to have everything under control; when things seem to go wrong, voters blame them.

So, the politicians – with their lackey bureaucrats and stooge economists – take action. They do something! Newspaper columnists and TV commentators argue about whether they do the right thing or the wrong thing…too much or too little…too soon or too late. But actually, anything they do will be wrong – unless it is merely removing some previous “improvement.”

“Wait a minute… Are you saying that all these recovery programs…and raising and lowering interest rates…and providing support for key industries…and help for people who are unemployed… Are you saying all that is a waste of money?”

Oh no, we’re not saying that. We’re saying it is worse than a waste of money. It makes people doubly poorer – first because of the actual cost of the recovery programs themselves…and second because the programs interfere with the economy’s efforts to correct its mistakes and find proper prices.

Even the most apparently benign – and some would say, humanitarian – government interference is far more harmful and costly than people realize. Take jobless benefits, for example. At least they don’t do any harm, right?

Wrong! Jobless benefits rob Peter to pay Paul because Peter has a job and Paul doesn’t. Why do that? Paul might take his time finding a new job.

There are no new jobs, you say? Don’t be ridiculous. There are always things that need to be done. Jobs are like anything else; you just have to find the market clearing price. If wage rates were low enough everybody would have two jobs. But who wants to work for substantially lower wages? No one. Most people will only do so if they have to. As long as he is getting unemployment compensation, Paul doesn’t have to.

“Whoa…this is radical…sounds almost subversive. You’re saying government shouldn’t be involved at all.”

“Oh no… We don’t give advice here at The Daily Reckoning. We’re just saying that if people want to be poorer they should invite as much government meddling as possible…. Get government to make lots of rules and then change them often… Put everyone on the government payroll; turn them all into zombies…”

Bill Bonner
for The Daily Reckoning

The Daily Reckoning