Why a new recession is quite possible

By Arthur Middleton Hughes

The
US has been going through a severe recession since 2008. Unemployment by 2011
is at 9.2%. GDP growth is less than 1.5%.
Millions of unemployed have stopped looking for work. The picture is
bleak.

To
help solve the problem, the Federal Reserve has been maintaining interest rates
at a very low level – hoping that as a result, banks will make more loans, and
the resulting spending will put people back to work.

 This
policy has not been working.  Banks are
not lending, the GDP is not growing and the unemployment rate is rising.
Fortunately, however, prices are not rising.

Source:
US Bureau of Labor Statistics.

Looking
towards the future, there may be inflation ahead.  The interest rates are being held
artificially low by the Federal Reserve by means of inflating the money supply.

The
True Money Supply (TMS) was formulated by Murray Rothbard and represents the
amount of money in the economy that is available for immediate use in exchange.

The benefits of TMS over conventional measures calculated by the Federal
Reserve are that it counts only immediately available money for exchange and
does not double count. MMMF shares are excluded from TMS precisely because they
represent equity shares in a portfolio of highly liquid, short-term investments
which must be sold in exchange for money before such shares can be
redeemed.  The TMS consists of the
following: Currency Component of M1, Total Checkable Deposits, Savings
Deposits, U.S. Government Demand Deposits and Note Balances, Demand Deposits
Due to Foreign Commercial Banks, and Demand Deposits Due to Foreign Official
Institutions. Looking at the past several years, here is the true money supply
as calculated by the Ludwig von Mises Institute:

What
is likely to be the result of the massive increases in the money supply?
Eventually there should be a serious increase in the consumer price index which
will force the Federal Reserve to change its interest rate policies.

The
sequence of events is this:  The present artificially
low interest rates are going to make investment in a number of higher stage
industries much more likely than they were a few years ago.

These
higher order industries represent about 40% of the economic activity taking
place in the US economy.  Unfortunately
their activities are not included in the GDP statistics computed by the
Department of Commerce due to Keynesian concern with double counting. Higher
order industries are very concerned with interest rates.  Their investments usually take many (from
five to fifteen) years from inception until they pay off. These investments are
financed on an annual basis. This means that a $500 million investment that
will take ten years from start to completion when it begins to pay off will be
financed a year at a time.  Lower stage
industries are not as dependent on the interest rates. They are close to the
consumers.  Their investments usually
take a year or less to complete before they produce a return. If they perceive
a profit opportunity, they will not hesitate to invest whether interest rates
are high or low.  The result of several
years of artificially low interest rates on higher stage industries is that
very likely many higher order industry projects are being started today – projects
that will be profitable only as long as the interest rates continue to be low. These
projects do not show up in the GDP because they do not produce consumer goods.

The
great increase in the true money supply combined with the low level of GDP
growth can eventually have an impact on consumer prices –  more dollars available and less goods
manufactured.  When and if this happens,
the CPI could begin to grow at 2008 levels (3.8% or higher).  Gasoline prices have already increased by
much more than that – but the gas price increases are due to world shortages of
supply rather than the money supply increases.

When
the CPI begins to go through the roof, there may be a public cry for the
Federal Reserve to do something to bring prices down – just as the public has
been asking for government action on gasoline prices.  The Fed will at that point be forced to
increase the interest rates as they have in the past whenever the CPI gets too
high.  The result will be that many
higher order industry projects, dependent on low interest rates – will be shut
down or become bankrupt.  They will lay
off their workers. They will create the start of a new recession.

About Arthur Middleton Hughes

Arthur is currently Vice President of The Database Marketing Institute based in Fort Lauderdale, FL. Arthur is the author of 11 books, the latest of which is Strategic Database Marketing 4th Edition (McGraw-Hill 2012). A BA graduate of Princeton with an MPA in Economics and Public Affairs, Arthur taught economics at he University of Maryland for 32 years. He is an Austrian Economist.
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