The “Road to Serfdom”


The stock market still has further to fall to catch up with the slowing economy. US GDP will keep decelerating – likely approaching a zero percent growth rate by 2011 – for the following reasons:

  • The long-term trend back towards consumer frugality and higher savings rates remains in full force. This will dampen consumer spending.
  • A double dip in housing prices is likely, because subsidies are ending and the backlog of foreclosure resolutions is about to accelerate.
  • The impact of the Obama administration’s stimulus plan is fading, and is not leading to any real “multiplier” effects because most of it went to plug holes in state government budgets.
  • European and Chinese GDP are slowing for well-publicized reasons.
  • Those who create jobs in the US fear rising tax rates in 2011, rising energy prices from cap-and-trade legislation, the pro-Wall Street “financial reform” bill, and a laundry list of other anti- business policies.

In short, if the status quo remains in place, the US economy will be lucky if it experiences a fate similar to post-bubble Japan. The US government is pursuing the same misguided strategy that has failed for twenty years to revive Japan’s economy. This strategy consists of squandering taxpayer dollars on failed financial institutions, and prop up unaffordable federal and state spending programs.

One key difference: Japan’s competitive export-oriented manufacturing base was strong enough to prop up the Japanese welfare state (until now, at least). The US manufacturing base is certainly powerful and efficient, but it’s nowhere near profitable enough to support both itself and the ever-growing US welfare state.

What policymakers seem not to understand is that each dollar that funds so-called “stimulus” programs must be extracted from the private sector. And they wonder why the private sector is not recovering! A far more effective stimulus plan – as long as the bond market remains unworried about deficits – would have been to slash government spending and slash taxes even faster. While that would also have been fiscally irresponsible, at least we’d be seeing “multiplier” effects on GDP by now.

Big companies remain defensive for many reasons. The July 1 issue of The Economist ran a story on the growth in corporate savings. Capital spending at most big companies is running at a slower rate than depreciation, resulting in rising free cash flows (but at the expense of a deteriorating asset base):

Business investment is as low as it has ever been as a share of GDP. Firms run the risk that their stock of capital is too depleted to meet even sluggish growth in demand. The likeliest outcome is a hesitant recovery in business spending as firms balance the risks of inadequate investment and insufficient cash.

Some businesses aren’t reinvesting because they dramatically overbuilt during the boom; some aren’t investing because their customers are broke; still others aren’t investing due to hostile government policies. These reasons for caution are all entirely rational. But corporate austerity is a worrisome trend for an economy that is struggling mightily to produce job growth.

To judge from this extremely cautious behavior, corporate leaders seem to fear that the US economy is heading towards Friedrich Hayek’s proverbial “road to serfdom.”

This road is now taking the global economy down one of two paths:

  • Painful austerity plans and deflation that salvage what’s left of today’s currency system by promoting savings and encouraging new capital formation;


  • Endless stimulus injections into economies with the promise of austerity “once the economy recovers.” Unfortunately, most Western economies are now thoroughly addicted to government spending. Each fiscal and monetary injection into zombie banks will likely have to be larger in order to offset the withdrawal symptoms of losing the last stimulus plan. Entrepreneurs figure this game out and gradually withdraw from participating in the economy in a healthy, productive manner. This loss of entrepreneur confidence in the system will ultimately accelerate the demise of all paper currencies.

The second path one is more likely in my view, because it’s more politically popular – especially once the European “pro-austerity” camp discovers just how addicted their economies are to the welfare state. Hopefully, a critical mass of people who value freedom over the illusion of economic security can move to wean us off today’s frighteningly powerful roles for governments and central banks. But based on the decisions we’ve seen in recent years – decisions driven mostly by political considerations – I’m not holding out much hope at this point.

Threats from Washington, DC, include everything from raising tax rates, to bailing out cronies at zombie corporations, to debasing the dollar, to implementing an energy policy that will have the effect of dramatically raising prices and worsening the US dependence on oil imports. Case in point: The answer to the BP oil spill is to take away the right for Gulf Coast oil workers to work on statistically safe drilling projects for the next six months, and then put them on BP- funded welfare checks.

No price was too high to bail out the financial terrorists at the “too big to fail” banks. There’s not much desire for the current Congress and the Fed to end embarrassingly large subsidies and guarantees for the big banks.

Bottom line: This environment is dangerous for the stock market. When governments are spending money they don’t have, while corporations are not spending money they do have, the resulting economic “growth” is usually a fraud. Sustainable bull markets require healthy risk appetites among those with capital to invest.

Dan Amoss
for The Daily Reckoning Australia

Editor’s Note: Dan joined Agora Financial from Investment Counselors of Maryland, investment adviser for one of the top small-cap value mutual funds over the past 15 years. Dan has made appearances on MarketWatch, and was quoted in Corporate Finance Review, a Thomson Reuters publication.

Dan Amoss
Dan Amoss, CFA is managing editor for Strategic Investment and a contributing editor for Whiskey & Gunpowder. Dan joined Agora Financial from Investment Counselors of Maryland, investment advisor for one of the top small-cap value mutual funds over the past 15 years.

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3 Comments on "The “Road to Serfdom”"

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TK in Texas
TK in Texas
6 years 2 months ago
This is a well reasoned post on the economics of deleveraging, but suffers from the libertarian tendency to make broad brush precriptive statements that seem like Republican talking points, not real reasoning. Specifically, the reference to possible non-investment due to “hostile government policies” is rhetoric, not reasoning. What are the “hostile” policies. Tacked on to the preceding uncontroversial (overcapacity, and non-investment due to weak customers) reasons for deleveraging, this has an air of truth that is undeserved. The broad brush characterization of “freedom” versus “welfare” doesn’t tell us anything beyond your belief that the balance has tipped too far. Like… Read more »
6 years 2 months ago
It’s hard to argue against welfare in the face of poverty. Welfare is the easy, popular answer but usually fails to address the root cause of the poverty and this is the reason why it may fail to lead to prosperity for the poor. Still, you can’t say no to it, because it would appear cold-hearted, or giving religious organizations the opportunity to grow their congregations through charity. I found an interesting link of US unemployment trends over the past few years: Thinking a bit laterally, or rather learning from historical precedent, we should consider whether the welfare state… Read more »
6 years 2 months ago
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