Your daily education lesson on economics

From The Daily Capitalist

In George Orwell's brilliant novel Nineteen Eighty-Four, one of the characters, Syme, in discussing the nature of Newspeak, says "It's a beautiful thing, the destruction of words." Newspeak was a systematic attempt by the dictators of Oceania, a totalitarian society eerily similar to North Korea, to control thought by eliminating words that gave rise to ideas they disapproved. What Syme and Orwell are talking about is that the destruction of words is the destruction of ideas.

There is a parallel to this in contemporary economic thought. Mainstream economists, Keynesians, Neo-Keynesians, and Neoclassists, would have you believe that what common sense would call "good" is now "bad." Conversely, "bad" is the new "good." I don't mean to suggest that we are heading toward becoming a North Korea. My point is that that the experts seem to abandon common sense and yet most people instinctively understand that good is good.

Common sense is the crux of Austrian theory economics. Austrians look at how individuals act, not how "economies" or "nations" act or behave. Ludwig von Mises, the greatest Austrian thinker, and in my opinion the greatest economist, entitled his great work, Human Action (not National Action). The Austrian School was referred to by the Germans as the Psychological School because its analysis started with individual action and how those actions would either attain or fail to attain the goals sought by individuals. In other words, it involves a lot of the "common sense" that guides human behavior most of the time. It is comforting to know there is a philosophy of economics that conforms to what human being actually do rather than how some economist thinks we ought to behave.

Examples of economic Newspeak flourish, especially if you listen to President Obama's economic team. My favorite example is the present conflict between consumer spending and consumer saving. Since the crash, consumers have cut back on spending and are increasing their savings. Most economists are saying this is bad for the economy; they urge us to spend, spend, spend to save the economy.

Actually, it is just the opposite: saving is the road to recovery.

It seems rather obvious that during a downturn of the economy it would be natural for people to save more and spend less. They are uncertain about their jobs, the values of their homes have plummeted (about 30% since the peak in 2006); their stocks have declined, and their debts are high. Isn't it common sense that people are doing the rational thing by saving? This is something our parents and grandparents understood well.

Yet Keynesian economists, the dominant economic theory today, tell us that consumers should be spending rather than saving. "Don't you realize," they say, "that 70% of our economy is based on consumer spending. Why do you think we have all that unemployment? We won't recover until we can get people to starting buying stuff again!" Since we aren't spending they have got the government to do our spending for us. Paying one man to dig a hole and paying another man to fill it is, under Keynesian theory, the path to recovery.

According to their logic, we had the biggest financial bust in world history because consumers wrongfully just stopped spending. If that was the case, it's funny we didn't hear these guys warn us about too much consumer spending during the housing bubble.

To explain why saving is good and why economists are wrong, we have to ask why we keep having these boom-bust cycles. Here is where common sense really has been thrown out the window by mainstream economists. Almost all economists believe that you can make the economy prosper by printing huge amounts of new money and throwing it at the economy to make it grow.

Does it make sense that by printing more pieces of impressive looking green paper that you can create wealth? If that were the case, why aren't the Zimbabweans the richest people on the planet? Yet, this is what economists believe and this is what the Fed practices.

To cut this short, this is exactly what the Fed did starting in 2001. Over a five-year period, the Fed reduced its Fed Funds rate from 6% to 1%. Money flooded the economy. Housing projects that made no sense but for the cheap money and the false appearance of paper prosperity, were hugely over produced. When the Fed stopped the gusher of money in 2006, the whole thing collapsed and pulled the economy down in the biggest bust the world has ever experienced.

Consumers, as we are referred to by economists, lost $10 trillion of wealth in the bust, and were left with huge debts from their wild spending. They borrowed against the value of their homes, they borrowed on their credit cards, and they borrowed to buy big new cars. Now about 25% of Americans have more debt on their homes than the homes are worth.

So what would you do in those circumstances? Spend more? I don't think so. And that is why consumers are saving. Yes, it reduces consumer spending, but how else are we going to save when unemployment is high and wages are stagnant? Savers are making rational, informed choices and economists just can't see that.

There are two major benefits from savings. You could say that reduced spending doesn't boost the economy and it causes housing and other asset values to decline. But that ignores a critical point, and one that is hindering recovery: how else are you going to get rid of the homes and commercial real estate and that were overproduced during the fake boom? This really is simple economics: supply and demand. As prices fall, buyers will be attracted to the market, and gradually the excess disappears. The longer those assets and their related debts hang around, the longer this recession will last. This, I believe is the most critical issue in the economy right now: by letting the economy solve the problem of all these overproduced assets, credit will start flowing again.

Another critical benefit is that new savings builds up capital for future expansion. In addition to the $10 trillion lost by us consumers, the entire wealth of this country was reduced by maybe another $30 to $50 trillion (these numbers are hard to pin down). With all that capital wiped out, you may ask where the capital will come from to finance a revival of the economy once the dead wood is cleared away. We already know that it can't be done by printing money. It can only be done by savings.

I say, "Thank you my fellow Americans for doing the right thing to help our economy recover. Please ignore the economists. Take care of yourselves and you'll be taking care of the economy." Good is good. Bad is bad.