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Gresham’s Law at Work

November 1, 2002

The debate rages whether the economy is recovering or is continuing to slip. Government and Federal Reserve economists assert that recovery is on track, while economists from private concerns openly talk about recession. Stephen Roach, of the Wall Street investment firm Morgan Stanley, is a major bear on the economy.

Late last month, Roach said, "Restrained by the headwinds of excess debt, sub-par saving, excess capacity, a massive current-account deficit, and the lack of pent-up demand, there is a compelling case for a persistently sub-par recovery . . . " For readers who like numbers, he sees 2% "underlying growth going forward," which is an "anemic pace well below America’s 3%–3.5% potential growth rate."

At CMI, we suspect that government economists would welcome a 2% growth rate over the next twelve months. Their real fear is that the GDP (the official measure of economic activity) will turn negative. Recent results out of Detroit portend really rough times ahead.

In November, US auto sales fell nearly 18% compared with November 2001 sales. General Motors, the world’s number one auto maker, suffered declines greater than 18%, and number two Ford saw sales fall more than 20%. Number three (in the US) Chrysler, now a part of DaimlerChrysler, sales sank 11.9%. Sales of foreign makers’ cars also declined, but not nearly as much. Toyota, the world’s third largest auto manufacturer, suffered "only" a 5.2% decline, while European overall sales rose 0.3%.

More ominously, US auto makers’ market share fell to 58.8%, the second time ever below 60%. In its own backyard, the US auto industry now claims less than 60% of the market. With sales likely to fall further, this does not bode well for the US economy and the hopes for even 2% growth. After 9/11, "zero financing" lifted US auto sales. Now, despite "zero financing," auto sales are falling.

The real problem is that zero and low-cost financing have stolen sales from the future. Sales that should have been put off until 2003, 2004, or later were shifted backward to sustain the US economy in the aftermath of 9/11. Now, those stolen sales are not here to bolster today’s sales. It is the same in the housing industry.

In 2001, the Fed lowered interest rates a record eleven times. Consequently, mortgage rates fell, stimulating new home sales, resales, and refinancing. Yet, new home sales and resales have slowed tremendously, even turned down in some regions. Refinancing remains robust, but there are limits, and refinancing alone cannot carry the economy. (Refinancing enables homeowners to "pull equity" out of their homes, which fillips the economy as the "new money" is spent. [Believe me, it is new money, freshly created by the Federal Reserve and our fractional-reserve banking system.])

The basic problem is that surplus assets have been manufactured. All those cars and new homes stolen from the future must be consumed, during which time there will be a reduced demand for autos and houses. While those assets are being used up, excess capacity will sit idle and unemployment will rise. The same applies to other sales shifted backward.

If the Fed had not reduced interest rates and if the auto industry had not done zero financing, the economy would have probably turned recessionary quicker. And, the recession would have been milder than what we are now facing.  An economy that the government attempts to manipulate usually ends up in recession.  (The Great Depression is the perfect example. For the best look at the Fed’s ineptness that caused the 1930s debacle, see Murray Rothbard’s America’s Great Depression. www.mises.org is a great source for Rothbard’s books.)

Many readers may ask what is wrong with the government attempting to avert a recession. The problem is the government (and the Fed) cannot prevent a recession; they can only delay it. Once an economy has been artificially boosted, via easy credit and/or deficit spending, a recession is necessary to wash out the malinvestments. When money is too easy, incompetent persons enter business, making mistakes.

For a while, the artificially-induced economic boom masks those bad investments. In time, however, those mistakes surface as the economy slows. As the malinvestments are washed out, the economy suffers a recession. The more the government messes with an economy, the worse the results. Unfortunately, the people running the country do not understand Austrian economic theory; consequently, they attempt to put off correction periods (recessions).

Additionally, they are politicians first, last, and foremost. They promise everything to the voters and attempt to deliver, leaving the problems for the next generation. Our Social Security mess is perhaps the perfect example of leaving a mess for our children to clean up.

Without the easy money of the mid to late 1990s, the stock market would have never risen to such astronomical levels and the economy would have corrected in the ‘90s with a mild recession. Now, we face a severe recession.

Think of our economy being a car traveling down a road. At times, curves have to be navigated. Call those curves recessions. If the car slows, the curves present no real problems. However, if the driver steps on the accelerator and attempts to sped through the curves, then crashes often occur.

When our economy showed signs of slowing in 2000--remember that was before 9/11--Alan Greenspan stepped on the accelerator to speed through the curves. Now, it looks like he is about to skid off the road. Yet, few government economists and officials will admit that Alan is driving recklessly. They rationalize that today’s "circumstances" justify the Fed’s massive creation of new money.

The piper will be paid, and CMI believes that payment may be soon. So, put CMI in the camp that says a recession continues and that it will grow worse. Gold’s strong performance--up $50 over the last twelve months--supports our position.

Call CMI at 1-800-528-1380 for answers to any questions or clarifications.  Our hours are 7:00 a.m. to 5:00 p.m. Mountain Standard Time, Mondays through Fridays.  Our offices are in the middle of the Phoenix, Arizona financial district.  CMI has had the same bank account since its inception in 1973.  References available on request.  http://www.certifiedmint.com

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