How do you like this recovery? Pretty good, huh? Except for the jobs, of course. And except for the retail sales. And except for the foreclosures… and house prices. And incomes. And consumer prices. And business profits. It’s like a female impersonator… just like a real woman in every way, except for the essential ones.

At least stocks are doing well. The Dow rose another 36 points yesterday. In terms of time, it’s already beat the bounce of ’30… it’s in its 6 th month. In terms of stock prices, it’s still a laggard, however. US stocks are up about 45% from their low of 6,547 on the Dow. By that measure, the current reading of 9,398 falls a little short of the 50% increase registered 5 months after the ’29 low.

Yesterday’s news was a big disappointment for mainstream economists. It’s ‘back to the drawing board,’ says the Wall Street Journal.

The dumbbells were already celebrating the end of the recession. Just yesterday, we reported on a survey of 53 of them. They figured the stimulus was working and the recession was coming to an end.

Even the Fed seemed to think so. The Washington Post headline: “Fed views recession as near end.”

But here at the Daily Reckoning summer headquarters we were doing some more painting yesterday…

… which means, we were doing more reckoning…

We don’t know when the recession will end… but we’re dead sure that those 53 economists interviewed by Bloomberg… and those at the Fed too… don’t know either. Few of them seem to have any idea what is really going on.

And now comes news that the economy is not recovering as planned.

“Even with Cash for Clunkers retail sales fall,” reports the New York Times. Retail sales were expected to go up in July. Instead, they went down.

Bummer.

Economists also expected unemployment numbers to go down. Instead, they went up in July… and last week, 558,000 people filed for unemployment benefits – up from the week before. That brings the total to 6.7 million jobs lost since the downturn began in December ’07.

Oh… and what’s this? Foreclosures hit another record high in July… making the third new record in the last 5 months.

This is a “recovery that only a statistician could love,” says another Washington Post headline.

You can prove anything if you torture the numbers enough. But if you need a job… or need to sell your house… or refinance your mortgage – good luck to you!

And here… in the spirit of summer… of warmth and camaraderie… we would like to offer the above-mentioned economists a little help: Pssst… it ain’t a recession; it’s a depression.

Since 1945, the US economy – and much of the rest of the world economy – has been carried on the backs of American consumers. First, they spent money they earned during the war years. Then, they spent money they earned in the big boom of the ‘50s and ‘60s. And then they spent money they hadn’t earned at all. They borrowed from future earnings… increasing total US debt from just 120% of GDP in the ‘70s… to 370% of GDP in 2007.

In the last 15 years of that period, especially, each time the consumer showed a reluctance to continue spending, the feds rushed to give him more credit. And during the final 5 years – the Bubble Epoque – debt doubled.

Now, the consumer has dug in his heels. He’s not going a step further until he unloads his excess baggage of debt.

Once again, the feds are trying to stimulate him. The Fed’s key interest rate is practically at zero. The feds are pumping money into the economy as fast as they can. And they’ll give a fellow up to $4,500 if he’ll agree to kill his old car. The Cash for Clunkers programs seem cruel to us auto enthusiasts, but they have been popular, all over the world (more below.) But what good do they do?

Even with the stimulus spending… and the stimulating low interest rates… he’s still not willing to add debt. Of course, this is just what happened in Japan. The public sector spent; the private sector saved. Net result: an on-again, off-again recession that has lasted almost 20 years.

That’s a depression. It’s a point where the model no longer works. Look, how could the US economy recover? It’s a consumer-led economy, so the consumer would have to spend more money. But he’s not earning more money. He has no prospects of earning more – not with 10% unemployment and a punky economy. So, the only way he can spend more is by borrowing. Ergo, the only way the consumer economy can grow is by adding more consumer debt. Is that possible? Could the ratio of debt to GDP go to 400%… 500%… to the moon?

Well, we’ve weren’t born yesterday. We’ve been around long enough to know that almost anything is possible.

This morning’s news tells us that the federal deficit through July comes to $1.27 trillion. We didn’t think that was possible. And despite this inferno of new debt… the 10 year Treasury bond yields barely 3.6%. We never thought that was possible either.

So, anything could happen. But generally, government stimulus only works when it is not needed. That is, it only works when it goes in the same direction as the underlying trend… not against it. Just like you can make a sailboat go faster by unfurling the sails, you can speed up an expansion by offering more and easier credit.

But now, the underlying trend has reversed. It’s no longer a credit expansion; it’s a credit contraction. The consumer has had his fill of debt. He’s cutting back on his spending and paying off debt. That’s what the July figures show. That’s been the history of entire downturn. That’s why it’s a depression, not a recession. It’s a major change of direction that will take years to accomplish. Now, stimulus is not only useless – since it is against the major trend – its counterproductive. It delays and contradicts the adjustments that need to be made.

But wait. We know what you’re thinking – that the Cash for Clunkers program is a success, because it encourages consumers to buy. See. Sometimes central planning really works, right? Yes, and if you look no further than the auto sales figures for proof, who can argue? Alas, a centrally planned economy is a perverse thing… where every positive statistic has the crumpled up bodies of tortured numbers buried beneath it. Take away the ‘free money’ from the feds and there’s nothing left. No real increase in demand… just a temporary demand based on a temporary and unsustainable stimulus.

Encouraging people to buy too much was what caused the problem in the first place. Encouraging them to buy more now is not a solution, it’s just a continuation of the same flawed policy of stimulating consumer demand… a policy that has been in place for decades.

But now the wind is blowing in the other direction. The government may not like it, but they can’t stop it.

***

Vandal Economics

“In keeping with the requirement that old engines be
destroyed, mechanics across the country poured sodium
silicate into crankcases and revved engines, causing mass
car death. “It just don’t make sense,” said a
used-car-parts salesman in Dayton, Ohio. In Glenview,
Illinois, mechanics watched a blue 1994 Chevy Lumina van
wheeze and choke for five minutes before stopping. “That’s
a good American GM product,” said service manager Mark
Rolla, “that won’t die.”

Harpers Weekly

Let’s open up the hood and take a better look. Does ‘Cash for Clunkers’ really work, we ask? In answer, we guffaw. Then, we invite dead economists to guffaw with us.

Richard von Stigl, among others, pointed out in 1923 that there is a big gap between real economics and the vulgar economics that drives policy decisions. On the one hand, serious observers study what happens in a pure, natural economy and draw their truths from its crystal streams. On the other, the meddlers distort the economic world so much that the observations of the old economists hardly matter. Downstream from the meddlers’ camp the water is not even fit to drink.

In theory as well as in fact, the planners never know what they are doing:

“The… knowledge of the circumstances of which we must make use never exists in concentrated or integrated form,” began Friedrich Hayek in 1945, “but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.”

A “good” is a good only insofar as it is good to the person who wants it. The public servant – as able and self-less as he may be – has to guess. History and theory tell us what happens; he usually guesses wrong. Only the individual knows what he wants and how to get it. He compares one good against others – using prices to guide him to where he gets the most good for his money. But when the government steps in with its subsidies, it effectively contaminates the stream of price information. Now, the consumer, with no clean signal to guide him, makes mistakes. He may be lured to buy a new car. The central planners may be pleased. They see the effect they desired – more auto sales. But what don’t they see? We invite Frederic Bastiat for an opinion (1850):

“Between a good and a bad economist this constitutes the whole difference – the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favorable, the ultimate consequences are fatal, and the converse.”

But who listens to Bastiat or Hayek? Ten countries have taken up ‘cash for clunkers’ programs. In Britain the government puts up 2000 pounds to grease the deal… with a total of 300 million earmarked for the program. In America, the ‘cash for clunkers’ program was extended last week, giving buyers a bonus of $3,500 or $4,500 when they turn in an old vehicle. In France, buyers get 1,000 euros toward the purchase of a new car.

Everywhere, the program is hailed as a success. It is widely thought not only to boost auto sales, but to help revive the economy, reduce pollution, cut oil imports and even lower highway deaths. We haven’t heard that buying a new car contributes to weight loss but we haven’t seen the TV news. Even ‘free market capitalists’ such as Larry Kudlow say they like it:

“The cash-for-clunkers rebate program is working. … And the price tag of the program is a mere $2 billion compared with the trillions of dollars Washington has been wasting. So, for once in our lives, Washington spending is giving us a good bang for the buck.”

Bastiat knew better. He described a scene where a boy had broken a shop window. The store’s owner was annoyed, until a foolish economist pointed out that the broken window was a blessing in disguise. It gave work to the glaziers and glass makers. The glaziers then could buy other things… and thus did the whole economy enjoy a bounty from this single act of vandalism.

But wait; Bastiat wanted to know: if you could improve the lot of mankind by breaking windows, why not smash every window in Paris? And if you could improve the lot of mankind circa 2009 by crushing cars, why crush them all? And knock down London and New York too. Think of the boom that would accompany the rebuilding!

Obviously, it doesn’t work that way. Replacing broken windows, or crushed cars, takes resources away from some other uses. This unseen effect is actually greater than the seen effect – the improved market for new cars. Lured by phony price information, buyers send phony signals to the rest of the economy. The automakers produce more cars than they need. Steel, which might have gone to refrigerators is used for car doors. Oil, which might have been used to generate electricity, is used to stamp out fenders. Savings, that might have been invested in new industries, go to prop up an old one.

Kudlow allows himself a peek at the unseen consequences: “… yes, it’s quite possible that government rebates today will steal car sales from next year. But let’s cross that bridge next year… ” Then, he even wonders, briefly, at the obvious foolishness of it… almost as though he were a serious thinker: ‘Well, why not just spend another $100 billion and give consumers checks for everything?’ Or, ‘Why not spend another trillion?’ Well, I don’t want to go there… ”

No one wants to go there. The old economists shake their heads: ‘it’s a fraud,’ they say. The rest of them don’t give a damn.

Source: An Unsustainable Stimulus