Montreal, December 15, 2008 • No 262




Harry Valentine is a
free-marketeer living in Eastern Ontario.




by Harry Valentine


          Financial markets from around the world are reeling from the fallout of America's mortgage meltdown. Several governments, including that of oil-rich Kuwait, are guaranteeing bank deposits. Iceland's economy is at a virtual standstill after the government over-extended itself in a variety of state-funded programs intended to benefit its citizens. Many governments around the world are announcing various economic stimulus packages that are intended to restart stalled economies.


          The incoming administration in Washington has proposed an elaborate economic stimulus package that will include a massive public works scheme. Unfortunately, a public works scheme did little to lift Japan out of its economic slump during the 1990s. In Ottawa, the minority government formulated a stimulus package that was perceived as too modest and rejected by opposition parties, who then proposed to form a coalition government. The suspension of parliamentary proceedings in Ottawa will at least serve to delay the malinvestment of that economic stimulus package.

Short-term Gain vs. Long-term Pain

          Of course, there is already massive malinvestment in both the American and the Canadian economies. Both economies are rife with misleading economic signals caused by the ultra-low interest rates in effect during the American housing market boom. The current round of ultra-low interest rates, along with the massive multi-billion dollar bail out packages in the US, have the potential to generate a whole new layer of misleading market signals and a whole new round of malinvestment. The gains over the short term could easily lead to another severe market slowdown in the long term.

          Ultra-low interest rates and government-funded technology development programs financed the high-tech boom and the high-tech malinvestment boom. Consumer and commercial market signals that were riddled with misleading signals led to the development of new cutting-edge technology and innovative software. The only problem was that there was too small a market to support the production of these products and services, or to have warranted their development in the first place. The result was the dot-com meltdown and the high-tech bust.

          Governments worldwide are initiating economic stimulus packages that are intended to bring about economic recovery. Over the short term some national economies may even show signs of economic recovery, but those signals will in turn be misleading and cause malinvestment in some business sectors. The result over the long term will be another and perhaps more severe economic slowdown.

"Economies worldwide need to correct and liquidate a massive amount of malinvestment. Such correction can only occur if governments are willing to allow it to occur."


Accounting Sleight of Hand

          The injection of new money will likely cause consumer prices to rise over the long term and create hardship for ordinary citizens. Of course, government statisticians in several countries now exclude the cost of food and fuel from their consumer price indices. Government officials can therefore deny the existence of consumer price inflation and remain oblivious to the harmful effects of their well-intended stimulus packages. However, there are two ways to measure inflation. The first method, favoured by the Austrian School of economics, measures the percentage by which the central bank increases the amount of money in circulation. The second method calculates the rise in consumer prices over time once new money has been printed and put into circulation.

          Governments have disguised inflation and unemployment in order to make an ailing economy appear much healthier than it is. Over the past decade, Canadian officials have revised the method used to calculate unemployment. After the new method was introduced, the unemployment rate in one region of Eastern Ontario dropped from 16% to 7% without a single new job having been created. Regions can now lose hundreds, even thousands, of jobs with little change in the official unemployment rate.

Delaying Needed Correction

          Economies worldwide need to correct and liquidate a massive amount of malinvestment. Such correction can only occur if governments are willing to allow it to occur. Unfortunately, that badly needed economic correction will be delayed as governments persist in manipulating, stimulating, and generally exerting control over economic activity. In the long run, such state action could lead straight to the very economic depression it is ostensibly meant to avoid.

          US Federal Reserve Chairman Ben Bernanke is well versed on economist Milton Friedman's analysis of the causes of the Great Depression and his proposed remedies to avoid such situations. However, he seems unaware of the fact, revealed by economist Murray Rothbard in his treatise on America's Great Depression, that Friedman may have misinterpreted economic data from the early 1930s. The result of that misinterpretation could play out over the next several years in the form of economic stimulus packages that cause more harm over the long term than good over the short term.