He Loves Me, He Loves Me Not…

picking flower petals

If you rely on the media to get your news and information about the economy, you’re probably in a state of whiplash right now. It seems just a few short months ago that publications were downplaying the possibility of recession this year. Then all of a sudden the papers were full of doom and gloom. And now, once again, we’re hearing that fears of recession are overblown and the economy is going to do just fine this year. What gives?

You almost get the sense that writers on the financial beat choose the topics they write on as though they were pulling the petals of a flower: we’re headed towards recession… we’re doing just fine… we’re headed towards recession… we’re doing just fine. But that’s the natural result of not knowing what causes recessions, and looking at the wrong economic data. Here are three things to look at to determine whether the economy is going to fall into recession.

1. Austrian Business Cycle Theory

Over a hundred years after its first formulation, the Austrian theory of the business cycle remains the best explanation for the business cycle. Austrian School economists sought to explain the booms and busts of the business cycle. They wanted to know why businessmen, who weren’t all idiots, all seemed to make the same mistakes at the same time.

The explanation they came up with still holds today, that government manipulation of money sends the wrong signals to economic actors and causes them to act in ways that they otherwise wouldn’t. When interest rates are artificially lowered, through creation of money out of thin air, it stimulates businesses to invest in projects that they think are going to pay off in the future. But because the interest rates are the result of money created out of thin air, and not of consumer savings, businesses find that their products don’t have a market once they’ve been created.

These artificially lower interest rates cause malinvestment in the economy, in which resources from productive uses that serve consumers, to unproductive uses. It can take years for that malinvestment and misallocation of resources to become apparent, and when it does, recession results.

Companies lay off workers, cut unproductive endeavors, and resources are diverted back to productive endeavors so that businesses and the economy can recover. This is the painful part of the recession, the bust that follows the boom. And, as long as the economy is allowed to recover, life goes on.

What we have seen over the past few recessions, however, is that the Federal Reserve can’t leave well enough alone. It “solves” each crisis with further injections of money, which makes each subsequent bubble even bigger.

Seeing what the Federal Reserve has done since 2008, any adherent of Austrian business cycle theory knows that a major bubble has been blown and a major recession is coming. When exactly that will occur is up for speculation. But you can’t blow bubble this big without having a major bust.

2. Falling Money Supply

Another thing to look at is the money supply. For the past several decades the money supply has been growing at a pretty constant rate. It always increases and never decreases for more than a short period of time. But what we’re seeing today is an actual decrease in the money supply.

The M2 money supply peaked in April of last year and has been slowly falling ever since. It’s not a huge decrease yet, but it’s enough that it’s noticeable.

The last time the money supply fell like this was during the Great Depression, when the Federal Reserve decided to tighten monetary policy in response to the onset of the depression. It was a belated response to the massive monetary increase that had taken place throughout the 1920s, and was arguably what led to the depression being so severe and long-lasting.

If Austrian Business Cycle Theory points out the fact that recessions and depressions occur because of governments and central banks increasing the money supply, it doesn’t follow that shrinking the money supply will forestall a crisis. If you hit a pedestrian with a car and run him over, you don’t undo the damage by throwing the car in reverse and running him over backwards.

In both cases, the monetary authority is monkeying around with interest rates, one of the key prices in our economy. And the negative effects of forcibly decreasing the money supply can be just as destructive as those from forcibly increasing the money supply. Not to mention the fact that those negative effects will show up a lot quicker.

The Fed is playing with fire here by attempting to decrease the money supply in its attempt to combat inflation. If it fails to understand what it’s doing, and overtightens the money supply, it could end up bringing about a recession even sooner and causing it to be even more severe than it otherwise might have been.

3. Persistently High Inflation

The reason the Fed is in the situation it is in is because of persistently high inflation. When you increase the money supply by over 40% in just two years, you’re going to see inflation. That the Fed failed to anticipate this is a damning condemnation of the Fed’s conduct of monetary policy. But even more damning is the Fed’s inability to respond to inflation.

With the latest CPI release showing 6.4% year on year inflation, it’s clear that the fight against inflation isn’t over. Inflation is sticky, even if the money supply has begun to fall slightly. And so the Fed isn’t out of the woods yet. It is having to walk a fine line between fighting inflation on the one hand and not collapsing the economy on the other.

As long as inflation remains elevated, and far above the Fed’s 2% target, you can expect the Fed to stick to tight monetary policy. And that increases the risk that the Fed might overtighten and plunge the economy into a severe recession just like in the 1930s.

Ignore the Chaff

When reading through any media, you have to focus on the wheat and ignore the chaff. Find the kernels of truth amidst all the errors and disinformation. When the media starts to bounce back and forth between saying there will be a recession and there will be no recession, it’s best to take a look at what’s going on with your own eyes.

Many points of economic data will be lagging indicators, meaning that they’ll only start showing signs of recession once a recession has already started. So while things like jobs numbers, jobless claims, and economic surveys can be useful, they aren’t necessarily going to show you anything in advance.

Looking to things like the money supply or the Fed’s open market operations can be much more informative, particularly when you’re looking at them and analyzing them within a proper framework. And if you’re able to anticipate the recession, you’re likely to be better able to protect yourself and your assets by doing things like buying gold.

Many Americans have already protected themselves with gold, taking advantage of its reputation as a safe haven asset during times of trouble. If you’re looking to protect your financial future, call the experts at Goldco today to learn more about how you can benefit from owning gold.

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