Decrease in Personal Consumption Is Not to Blame for U.S. Recession

Editor’s Note: This essay was originally published on Mises.org.

With recession looming or already here, the time has arrived for finding scapegoats. Expect a long list of these. Here is the target of the day: tightfisted consumers. A decline in personal consumption, writes the New York Times, "would be the first since 1991, and it would almost certainly push the entire economy into a recession in the middle of an election year."

This recalls Bush's advice after 9-11, when he assumed the mantle of the nation's personal financial planner. He told everyone to go out and spend money so the economy could avoid recession. Even then, there was confusion about whether he was right or wrong. Some sensible voices pointed out that economic expansion is based not on spending but on capital expansion rooted in savings. That is to say, the only path to future prosperity is delaying current consumption in favor of future investment.

One only needs to think of the household budget here to see the point. If you are planning for the future for your family, what is the wisest course? Does one go into debt as much as possible, buy the largest house and the biggest car, throw lavish parties, hand out all existing liquid funds to friends and strangers? Based on the view that personal consumption is the way to avoid economic problems, this would indeed be the right course.

But this also defies everything we know about family finance. The path to a secure prosperity is delaying personal consumption. One should spend as little as possible and save as much as possible for the future, and let that money be used in the service of investments that yield a solid rate of return. Those who have chosen a different path now see the folly: they are being burned in the soft housing market, for example.

The lesson is also true for the nation at large, because the logic doesn't magically change when moving from the family budget to the national stage. Just because something involves "macroeconomics" doesn't mean that we should throw out all good sense. But that is precisely what people have done with regard to the economy, since J.M. Keynes somehow convinced the world that up is down and left is right.

In a recession or a crisis, the right approach for individuals is to save. So too for the national economy. A looming recession will prompt a pullback in personal consumption as a rational response to the perception of economic troubles. This action does not cause the economy to fall into recession any more than more spending can save it from recession. The downturn is a fact that cannot be avoided. We don't blame umbrellas for floods, and, in the same way, we shouldn't blame tightfisted consumers for recessions.

There is no question that this is what is happening. American Express reports that the rate of spending by its cardholders fell 4% in December. Surveys of consumer satisfaction with the economy report a 15-year low. Retailers report that December was a "blood bath" (NYT 's words) for them, with sales growing at the slowest rate in seven years. Market watchers are mostly concerned that high-income buyers are bailing out.

Again, it is critical to keep cause and effect in mind. The pullback on spending is not going to cause a recession. If we think about the long term, this is not a dangerous trend but a hopeful one. The more people pull back and save, the more the foundation is laid for a recovery after the current correction takes its course.

To see that requires that we take a long view. Government, however, seems constitutionally incapable of seeing the long term, much less doing the right thing to prepare for it. Making matters worse, this is that dreaded event called an election year. Prettying things up to make the economy palatable to voters is priority number one.

What does this mean? More monetary expansion. More government spending. We can fully expect the Bush administration to resort to its old program of sending checks out to every American family with the proviso that the money has to be spent, not saved.

No doubt that many people would be thrilled by this. But look beneath the surface. Government has no money to spend on anything that it doesn't extract from the pockets of you and me and the whole American public. This is easy enough to see concerning taxes. It is not so easy to see when the government runs up debt that is guaranteed by the printing presses.

The monetary issue can be understood by analogy to orange juice. The more water you add, the less substance it has. If you keep adding, eventually you come to the point when you can no longer tell that it was ever orange. This is the same with money. If you print enough — literally or electronically through the credit markets — it will continue to lose value. If money grew on trees, it would be about as valuable as autumn leaves.

So long as we have a central bank, government will be tempted to take the easy path of easy money. There do not need to be any secret phone calls from the White House to the Fed. The culture of policymaking itself is capable of broadcasting the right signals to all important players.

In any case, it is a myth that the Fed makes policy independent of political pressure. It is subject to the screams and hollers for looser credit in the same way that bureaucracies are responsive to demands for more regulation.

Yes, government can increase consumption, but by doing so it does nothing to care for the long term. The long-term health of a nation is not different from that of a household budget. Tough times require cutbacks in personal consumption and a beefing up of savings.

So let's not demonize the consuming public for doing what it should be doing. It's a good rule of thumb that when the government tells you to spend money, you should close your wallet.

Regards,

Lew Rockwell
for The Daily Reckoning Australia

Editor’s Note: This essay was originally published on Mises.org. Llewellyn H. Rockwell, Jr. is president of the Ludwig von Mises Institute in Auburn, Alabama, editor of LewRockwell.com, and author of Speaking of Liberty.

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