Recovery Impossible

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The G20 in Pittsburgh will extensively talk about the durable economic recovery that is on its way, however much more work needs to be carried out specifically on European banks if the EU is to avoid years of stifled growth, the Organisation for Economic Co-operation and Development has warned.

Toxic assets as overvalued real estate loans and mortgages not adapted to market value held on bank balance sheets causing insufficient capital levels are issues that must be dealt with to remove uncertainty.

“Finance ministers are set to discuss the results at an informal meeting in Gothenburg early next month, but no plans have been made to release the data publicly.”

On top of the banking issue, the EU must speed up reform in other sectors if it is to secure long-term growth prospects. Stimulating small businesses as Germany did after WII to restart the economy.

“Strengthening innovation, deepening the single market and moving to a low carbon economy are among the areas where reform needs to be accelerated.”

“Raising the level of innovation over the long-term remains a major challenge for the EU” says the OECD, highlighting the need to introduce a European Community patent and a Unified Patent Litigation System.

Europe is lagging behind the United States and Japan in research and innovation, despite numerous initiatives.

And what about the economy? The situation has remained unchanged. There are few problems that central banking can solve; a credit contraction is not one of them. All the bankers can do is to make it worse, by pumping more money into the financial system and consequently delaying recovery, disguising it or diverting it in another direction, such as converting deflation into hyperinflation.

The Dow rose again. As far as can be told, the rally is still on, with the news media and the statisticians in full support.

“House prices rose 0.3% in July.” Of course, the government is giving huge tax credits to new house buyers. Since that program began in January, an estimated 350,000 houses have been bought thanks to the program. Likewise as the cash for clunkers program it was distorting the economic recovery.

“Household net worth also is going up for the first time in two years” - at least, that's what the papers say. Of course, what do you expect? The feds are pushing up asset prices - giving them the biggest push in the history of mankind. But be assured, Mr. market is also doing its usual post-crash bounce. When the bounce ends, so does the temporary wealth effect! In Europe particularly Britain, France and Spain 7 out of 10 people cannot make it till the end of the month with their income.

The huge effort by the feds will make things extremely worse. That is the position taken by Arthur Laffer in a recent Wall Street Journal editorial:

"The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity. If there were one warning I'd give to all who will listen, it is that U.S. federal and state tax policies are on an economic crash trajectory today just as they were in the 1930s.”

"The Smoot-Hawley tariff of June 1930 was the catalyst that got the whole process going. It was the largest single increase in taxes on trade during peacetime and precipitated massive retaliation by foreign governments on U.S. products...beginning in 1932 the lowest personal income tax rate was raised to 4% from less than one-half of 1% while the highest rate was raised to 63% from 25%. (That's not a misprint!) By the end of January 1934 the price of gold, most of which had been confiscated by the government, was raised to $35 per ounce. In other words, in less than one year the government confiscated as much gold as it could at $20.67 an ounce and then devalued the dollar in terms of gold by almost 60%.” That's one extraordinarily additional tax.

"Inflation can and did occur during a depression, and that inflation was strictly a monetary phenomenon..."

"The 1933-34 devaluation of the dollar caused the money supply to grow by over 60% from April 1933 to March 1937, and over that same period the monetary base grew by over 35% and adjusted reserves grew by about 100%. Monetary policy was about as easy as it could get. The consumer price index from early 1933 through mid-1937 rose by about 15% in spite of double-digit unemployment. And that's the story."

There is no doubt that inflation can occur during a depression, in accordance to the papers. Anyone who has followed the Zimbabwe story knows that during a deadly depression enormous levels of inflation can occur at the same time.

But there is something more to above story. Devaluing the dollar in terms of gold had the immediate effect of increasing the money supply like adding zeros to the currency.

Zimbabwe’s desperate government fouled-up the economy by creating hyperinflation that might seem like an improvement. It looks like the US Dollar as reserve currency is following a similar route.

But be not sidetracked by hyperinflation. It is not yet in sight. Nor is its more civilized cousin - normal, polite inflation. The money supply in America - as measured by M2 - is contracting. The banks get money from the feds, but they don't pass it along. The chain of reflation is out of order - or at least temporarily stretched. Currently, it takes a long time for money to get from one end of the chain to the other. The cash tends to get interrupted, either by the bankers, or by consumers themselves. It remains in bank vaults, or in bank accounts. Money is not being multiplied by the speed by which it changes hands. Instead, it is divided by immobility. It sits. It shrinks. It waits for the real boom. Anyone telling that the recovery is on its way either is a wishful thinker or lacks proper understanding of real economics.