Pseudo-Economics

Thanks to Brian Wesbury for this commentary.


To paraphrase the late Jude Wanniski – the history of man is a battle between the creation of wealth and the redistribution of wealth. Jude was a Supply-Sider, which means an economist who believes that entrepreneurship and supply (not demand) drives economic growth.

Jude didn't invent this. Adam Smith and Joseph Schumpeter, along with Austrian economists, Eugen von Böhm-Bawerk, Ludwig von Mises and Friedrich Hayek and the late, great Milton Friedman were all instrumental in the development of free market thought; the appreciation of entrepreneurship; and the importance of small government.

The other great contribution of the Austrians and Milton Friedman was in monetary policy. Friedman proved the Federal Reserve caused the Great Depression, while Ludwig von Mises talked of a "crack-up boom" – a money and credit-fueled boom that ended in a massive economic contraction and collapse. While Nobel Prizes have become a joke, both Friedman (for monetary thought) and Hayek (for proving Socialism fails) won them.

These thoughts were the intellectual underpinning of the Thatcher, Reagan, Wałęsa, and Clinton boom of the 1980s and 1990s. They also led to a USSR collapse.

Since then, a cottage-industry of copy-cat, Wiki-reading, blog-writing, pseudo-economists has sprung up. Fueled by a misunderstanding of 2008, these prognosticators, using selective excerpts from Austrian thinkers, have created an entire theory that the US economy today is in a "crack-up boom." The boom, according to them, has been caused by the Fed, QE and zero-percent interest rates, and now that the Fed has tapered and started hiking rates, it's over and a bust is on its way.

These ideas and forecasts find fertile ground because so many investors are still scared of 2008. They have "hypochondria" or "PTSD" as opposed to faith in free markets. And, if someone tells them the only reason stocks are up in the past seven years is because of easy money, and if there is plausible basis for believing this, many investors feel like the market could collapse at any moment.

And this is the nub of the matter. The pseudo-Austrians have focused almost solely on money; they've forgotten the entrepreneur. So, with the Fed tightening, everything becomes bad and requires some reaction by government. Falling oil prices (which should be viewed as a great supply-side success) are viewed as a demand-side (money) problem. China, which is a communist country, becomes a problem that government must manage. In other words, these so-called Austrian thinkers have, in effect, become demand-siders because they focus so much attention on what government is doing.

We view the world through Austrian and Monetarist thought processes, but we don't see anything like what the doom and gloom crowd does. We believe quantitative easing did not boost economic growth because banks shoveled that money straight into excess reserves. Even after the recent Fed tightening, there are still roughly $2.3 trillion in Excess Reserves in the banking system. This is the first Fed tightening in history that doesn't really reduce liquidity in the banking system.

We also believe new technologies, like fracking, 3-D printing, cheap and quick manipulation of the genome map, the cloud, apps, smartphones, faster communication and computer chips – in other words, good old entrepreneurship is driving profits and economic output inexorably upward.

And when we step back, the past six years suggests the creation of wealth is proceeding fast enough to offset the growing redistribution of wealth. The economy is not growing as fast as it could, but it is growing nonetheless. Ludwig von Mises called entrepreneurs "Angels." These Angels have been eking out a victory against big government. It's a small victory, creating Plow Horse growth, but there is no reason to suspect it has come to an end. Stay positive. Real Austrians do. 

The Ghost of 2008 and Pouting Pundits of Pessimism

The ghost of 2008 (a once-in-a-century economic panic caused by mark-to-market accounting) is influencing many analysts, journalists, money managers, and policy-makers, who still don't really understand what happened.

As a result, with the Federal Reserve on the verge of lifting interest rates by ¼ of 1%, these pouting pundits of pessimism are freaking out because it's the first rate hike in a decade and junk bond yields are soaring in a way reminiscent of the Lehman Brothers failure in September 2008.

 A story written in the Wall Street Journal by the well-connected John Hilsenrath says, many economists believe the Fed will lift rates now only to cut them back to zero in the future. This argument is based on some relatively obscure historical data and fears that something bad "might happen."

But these arguments are just forecasts based on fear, and a misguided narrative that economic growth and rising stock prices since 2009 have been a "sugar high," caused by the Fed's easy money policy. We don't believe that. Yes, the Fed bought a lot of bonds, but the banks hold a vast majority of that money in excess reserves. That's why inflation remains low.

Growth has been powered by new technology, not Fed policy. Oil prices are down because of new supply, not a "potential" set of rate hikes sometime in the future. In addition, regulatory over-reach, otherwise known as Dodd-Frank, has limited the depth and breadth of bond markets as banks fear being labeled proprietary traders.

Three small High Yield (junk bond) funds are in various stages of shutting down due to a lack of liquidity combined with redemption requests.  Other funds face redemptions as well, leading many to argue that there is a lack of liquidity in the high-yield bond market.

Is this Lehman Brothers all over again? We highly doubt it. A Fed rate hike has been a long time coming and any investor or fund that wasn't prepared for this is highly suspect. Moreover, now that overly strict mark-to-market accounting rules have been fixed, any systemic problems are highly unlikely.

In 2008, Tier One capital ratios at the four largest banks were just 7.5%. Today, these banks have 12.1% capital ratios. Moreover, after the Fed does tighten, the banking system will still have over $2.5 trillion in excess reserves. In other words, raising rates will not reduce available liquidity in any significant way.

In the past year, the M2 money supply is up 5.8%, commercial and industrial loans have grown 11.4% and corporations have record amounts of cash on their books. There is no evidence of tight money or liquidity constraints. Any business, individual, fund, or institution that needs zero percent interest rates to survive should not exist.

In 2013, when Ben Bernanke said he would like to end Quantitative Easing, the markets had a "taper tantrum." Today's market turmoil is the equivalent of that emotional upheaval. In the end, tapering happened, the economy kept growing and the stock market moved to new highs. The same will be true for this rate hike as well.

Bryan S. Westbury  Chief Economist at First Trust