The Free Market 18, no. 8 (August 2000)
The president of the United States was ecstatic. Never had economic prospects in this country looked better. Unemployment was at its lowest level in years, the rate of inflation was relatively low, and the economy had grown continuously for almost eight years. No doubt, said the experts, this country was in the midst of a New Economy.
However, the president was not Bill Clinton and the year was not 2000. Rather, the Commander-in-Chief was Lyndon Johnson, and he made his remarks just before he left office in 1969. What would follow for more than a decade was runaway inflation, deep recessions, an oil crisis, and general political turmoil. The New Economy turned out to be one calamity after another.
We have, supposedly, learned our lessons since the 1970s. Alan Greenspan knows more than previous Federal Reserve chairmen, Robert Rubin was a brilliant Secretary of the Treasury, the internet is providing new ways of doing business, and Bill Clinton has marvelously orchestrated the whole thing. The stock market is rising, and the government (or at least the current regime, according to Al Gore in his stump speeches) knows how to continue the prosperity. This time, we really are experiencing the New Economy.
Pardon me if I dissent. If history tells us correctly, we are in our third “New Economy” in the last 80 years. The first episode of “prosperity forever” came in the late 1920s, as the bull market, low unemployment numbers, and general good times led newly-elected President Herbert Hoover to declare, “In no nation are the fruits of accomplishment more secure.” We know the rest of that sorry story.
That politicians try to identify with an economic boom concurrent to their terms of office is understandable. From William McKinley’s “A Chicken in Every Pot” to Hoover’s “Full Dinner Pail” to Clinton’s “It’s the Economy, Stupid,” politicians have always claimed to have brought on the good times, as though they themselves had saved, invested, and taken the entrepreneurial risks that are necessary to economic growth. Like LBJ, the current crowd in the White House is not above taking full credit for jobs and incomes of individual citizens.
To give modern prognosticators their due, there is much to the present economy to be praised. Unlike the 1970s, when capital markets labored under Great Depression-era regulations that stifled investment in new technologies, especially in telecommunications, and government regulators controlled the nation’s entire transportation and energy sectors, more freedom abounds in vital areas of the economy than we have seen since the 1920s.
Furthermore, it is safe to say that the current economic expansion would not have been possible under the regulatory regimes of the 1960s and 1970s. During that period, labor unions had much more control over the US workforce than they do today, which has allowed for much more flexibility in the workplace than existed 30 years ago.
But for all of the high-technology wonders and the gains made from deregulation, the one substantial part of the New Economy consists simply of an economic boom in all that the phrase implies. The engine behind the boom is also the locomotive behind the inevitable bust: the Federal Reserve and its inflationary policies.
Most economists and laymen mistakenly believe inflation to be a rise in prices, and nothing else. Thus, we get nonsensical terms like “energy inflation,” “housing inflation,” and “health care inflation,” meaning price increases in those various sectors. That prices for most commodities have not risen during this latest boom is seen as proof that the beast of inflation has been tamed, or at least kept at bay.
Such a viewpoint is extremely limited. If one sees inflation as unwarranted increases in the money supply, the picture becomes much different-and more controversial to many. For example, no one can argue that the money supply has grown rapidly in the past few years. As has been pointed out by others writing for the Ludwig von Mises Institute, the yearlong saga of Clinton’s Monica Crisis also brought with it very high levels of monetary growth as Greenspan’s Fed cranked up its open market operations to new levels and simultaneously suppressed interest rates. That money had to go somewhere, and it did: equities and real estate markets.
Some economists like Jude Wanniski point out that gold prices, along with agricultural prices and other commodities, have remained relatively stable. Therefore, they argue, there is little or no inflation. Such a viewpoint says that inflation is a price phenomenon, not a monetary one. However, if the money supply increases and commodity prices remain relatively stable, then, by definition, the value of money has fallen relative to those things.
Even if one takes the example of the falling prices of computers, a more correct way to interpret that situation is to point out that the prices of computers are higher than they would have been otherwise, had not the monetary increases occurred.1 As for increases in commodity prices, they tend to come at the latter stages of the boom shortly before things go bust.
As things stand currently, the once-vaunted bull market is in flux. This is partly due to the government’s arrogance in believing it could attack Microsoft without harming other high technology firms that have been the most visible in the current economic expansion. That the NASDAQ has lost much of its value since Janet Reno’s Department of Justice won the first round of its attempt to dismember Microsoft bears testament to this administration’s foolishness regarding economic matters.
But even without the DOJ’s Microsoft follies, the high-technology sector of the economy faces real problems. First, the bubble that pushed so many of the “dot.com” initial offerings into the stratosphere had burst even before Reno’s pyrrhic victory. Second, the malinvestments as described by Ludwig von Mises and Murray Rothbard that occur as the result of wildly expansive monetary policies by the Fed have been centered in the high-technology sector. The growth of new money that is the signature of inflation can come only through the fractional-reserve banking system in the form of loans, which, as noted earlier, have found their way into high technologies, real estate, and the stock market.
Should a large number of hightechnology investments go bust, or if profit rates disappoint potential investors, the new money will stop pouring into that sector. By that time, we will be seeing an increase of commodity prices, and inflation will be recognized as a serious problem. The next stage will be the beginning of the recession, as the malinvestments that grew willy-nilly during the period of monetary expansion will have to be liquidated.
The US economy the past five years has been able to absorb a large amount of new money, much more so than it could have done two decades ago. That does not mean, however, that it is inflation-proof or is impervious to malinvestments. The Misesian theory of the business cycle is a comprehensive theory. It has not lost its explanatory power in 2000 any more than it was irrelevant in 1969 or 1929.
While we may be currently celebrating a record boom, we have not overturned the laws of economics. No doubt when it happens, the usual Keynesians in the halls of academe and in the media will blame high interest rates and the Fed’s refusal to expand credit. In truth, there will be another explanation, one that people are ignoring now and will ignore then.
William Anderson teaches economics at North Greenville College.
