Politics & Policy

Misguided Recession Talk

If Washington acts accordingly, today's gloomy economic predictions will quickly become yesterday's news.

You can’t open a newspaper these days without reading a recession prediction. Depending on the commentator, the U.S. economy is already in recession, or will surely fall into recession in the coming quarter or beyond. But if you believe these predictions you also have to believe an economy can be strong one day and weak the next, or that strength in one quarter will lead to weakness in the next.

Economies don’t work that way. Rather, they tend to move glacially in one direction or the other, with recessions most always and everywhere the result of legislative mistakes. To paraphrase J. & W. Seligman president Charles Kadlec, “good economies don’t die of old age, but due to governmental error.” Since economies shrink when economic actors produce less, it would seem more productive to look at what might be causing this lower production than to engage in prediction alone.

As always, the actions of the Federal Reserve loom large. While there are varying opinions on what the proper direction of the fed funds rate should be, uncertainty about what the Fed will do could be weighing on the productive sector of the economy. With the Fed known to concentrate on economic data before making rate decisions, a paradox emerges whereby good economic news means interest rates will be held steady, and bad economic news means rate cuts are due.

Either way, the problem is that businesses frequently make decisions with interest rates in mind. And given the existing uncertainty about what the Fed will do next — compounded by schizophrenic reports on the economic health of the U.S. — businesses might be holding back until the rate picture becomes clearer. In short, the environment of suspense that the Fed creates with its rate-targeting mechanism forces businesses to at times “game” the system rather than produce. Whichever way the Fed is leaning, it would do the economy a favor by getting interest-rate cuts or hikes out of the way with one big decision, as opposed to several smaller rate adjustments over a longer timeframe. 

As for the dollar — irrespective of varying opinions about the implications of its weakness in recent years — its value has clearly not been stable. This is a problem. If you are a homebuilder, imagine what would happen if the length of a foot changed on a daily basis. You could still build houses, but you would necessarily build a lot less given the need to constantly re-evaluate the definition of a foot. (For more on this concept, see Louis Woodhill’s “An Engineer Measures the Falling Dollar.”) 

The same applies to money in a world of paper currencies. The paper itself is nothing but a labor-saving device meant to stimulate the all-important and beneficial exchange of goods. We produce in order to consume, and when the value of paper money is constantly changing, a wedge is created between producers eager to exchange their surpluses. Money is meant to foster an environment of exchange, so when its value moves, the process of trade is retarded.

On taxes, except for the congenitally socialist among us, the 2003 Bush tax cuts were a positive for reducing penalties on individual and investment success. The oft-noted problem with those cuts is that they were passed with an expiration date of 2010. With the electoral environment presently in flux, there’s a great deal of uncertainty as to whether they’ll be made permanent. Businesses and investors must today make decisions about the future while lacking knowledge of what the tax environment will be should their ventures prove successful. On the margin, some will wait to see how Congress acts, or what the political outcome will be in November, while others will move forward with reluctance. Such tax uncertainty will reduce economic activity. On the other hand, should the prospect of tax hikes increase through the election season, economic activity might surge since it will pay more to be active now. This, however, would be a short-lived false prosperity.

With the WTO’s Doha round breaking down, presidential trade-promotion authority lapsing, and Congress’s continued jawboning of China, the trade environment also has become darker in recent years. Politicians decry recessions, but at the same time they ignore the basic economic truth that individuals trade products for products. When governments put up or maintain barriers to trade, they are taxing the sole reason producers create marketable products to begin with: the beneficial exchange of goods. If our trade partners (irrespective of geographical locale) can’t sell to us, then we by definition can’t sell to them. Tariffs correlate well with economic slowdowns since businesses have a less urgent need to produce when willing consumers are absent.

While various commentators continue to predict economic austerity as though it will arise out of thin air, it is useful to remember that the U.S. economy is comprised of individuals who are eager to make so that they can take. Washington cannot legislate this process, nor can it create prosperity. On the other hand, Washington does have the power to foster an environment of stable money, lower taxes, and free exchange, while promoting certainty in all three areas. If it acts accordingly, and removes the barriers to productivity that are presently in our way, recession predictions will quickly become yesterday’s news.

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