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Source link: http://archive.mises.org/7656/are-consumers-driving-us-into-recession/

Are Consumers Driving Us into Recession?

January 15, 2008 by

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 consumer spending 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. FULL ARTICLE

{ 25 comments }

roman January 15, 2008 at 11:30 am

The fact we’re known as a “consumer society” says it all. What an offensive label! Yet the sheeple see no problem with this lifestyle, will they ever?

Keith January 15, 2008 at 12:18 pm

As long as we live in an era of perpetually increasing government and inflation, what is the incentive to save? So you can have less valuable money in the future?

At last if I buy something today, I will have it today and into the future. My main worries will be poor selection and depreciation over time. If I save my money, who knows what will happen to it. I am a prisoner to the whim of politicians and bureaucrats.

Quenton January 15, 2008 at 1:41 pm

“Saving” doesn’t necessarily mean stuffing greenbacks in you mattress. “Saving” can take many forms such as investing your money for a decent return (or at least breaking even with inflation). Essentially, the point is that you should stop spending resources on consumables (extra food, vinyl siding, video games, etc.) and focus on protecting your assets.

Your money may be losing value by the second but that’s no excuse for spending it on things that will lose their value even quicker. Stuffing your cash in the proverbial mattress will still net you a better return than using it to buy a new 50 inch flat screen.

Michael G.R. January 15, 2008 at 2:24 pm

I thought this was a very good article. Should be more widely read.

lester January 15, 2008 at 2:39 pm

people are under the impression that if they don’t spend all they can and more capitalism will fail

tadlad January 15, 2008 at 5:22 pm

The media-hyped fears worsen the natural economic cycle. Selling fear sells ad space and increases loyalty. But clearly, the media’s economic savvy is anything but. It’ll be interesting to see how this plays out.

TLWP Sam January 15, 2008 at 9:09 pm

Why shouldn’t a recession, which causes people to save rather spend en masse, not cause a downward spiral? The various businesses relying on people to spend their spare change gets less revenue leading to lose staff and shut their doors. If people put their money in banks, the banks have limited options to invest the money and if the investments go bad then the back goes belly up or is bailed out (such that a depositor is double-paying a bank). This reminds me of the situation in Zimbabwe where black soldliers got the land that white farmers were driven off from. The soldiers engaged in self-sufficient farming instead of commercial farming which inevitably lead to famine yet the soldiers and their families were content. So why, especially in a gold standard economy, a recession wouldn’t become a depression, and if there’s no consumer confidence then the depression economy become the ‘new economy’?

Mike McD January 15, 2008 at 9:55 pm

Great piece. I agree. I also agree with Keith’s assessment. Damned if you do, and damned if you don’t.

banker January 16, 2008 at 7:48 am

Hilarious: Trade deficit has been sky high for many years now, and the medicine to fix the impending recession is more spending?

Why is it so hard to point out the dichotomy of trade and commerce?

Supply and Demand; Earn and Spend; Produce and Consume; Revenue and Expenses; etc..

One person’s earnings is another person’s spending; one person’s production is another person’s consumption; etc..

I think, if one cannot understand this basic facet of trade/business/economics and expand it to the national/international level then one cannot possibly understand the quandary the US finds itself in today.

Brad January 16, 2008 at 4:41 pm

I wonder how much of the downturn in consumer spending is due to the number of people who have maxed out their credit and have no more left.

My wife and I are looking to move and we found a nice house. But the people are upside down in it, and if we put a bid in on it, we will be in Bank Bureaucratic Limbo for far too long, so we didn’t bother. But these people had too much house and spent way too much on inside stuff all on credit (hence why they are upside down).

Also, a co-worker of mine and her husband are upside down in their house and have about $100,000 of credit card debt to boot. Hence, they don’t spend anymore. Another ex co-worker is in a large house on the lake, and while he and his wife make good money, they are way over extended.

The message? I think this downturn in spending isn’t due to logical and smart personal finance but so many people who have been living fat on credit and there is no more to be found.

My concern is that when the economy blows a nut, our betters are going to bail out the spendthrifts by attacking those of us who were sensible all along. Where else are the assets at?

DS January 16, 2008 at 7:59 pm

If I hear “70% of GDP is consumption” I’m going to throw up. 100% of GDP is Production.

And the government can’t actually “stimulate” either one. They can simply shift things forwards and backwards in time, a little.

fundamentalist January 16, 2008 at 8:52 pm

TLWP: “Why shouldn’t a recession, which causes people to save rather spend en masse, not cause a downward spiral?”

That’s what Keynes taught: consumer spending causes producers to hire more people and the economy spirals upward on the thermal. But Austrian econ teaches just the opposite: savings spur new investment which creates jobs. Those new jobs create more consumer spending.

From an Austrian perspective, I could argue that the slow growth in retail sales is the result of so many people losing their jobs in the home building industry and mortgage industry earlier in the year. Though some of it could be from consumers bumping against their credit limits.

Why don’t recessions turn into depressions without government intervention? Actually, Austrians have plenty of evidence that government intervention has made most recessions worse than they would have been without the intervention. But Austrian econ shows that the natural block to a downward spiral is the fact that people save more during a recession. Those savings lay the foundation for renewed investment and job creation as soon as business confidence (not consumer confidence) recovers.

Alexandre Cesar Weber January 31, 2008 at 6:48 pm

All comments are in the same vein, agreeing to the point that the article makes, but, there are others perspectives ….

First , the article imply that all stimulus to the economy are bad, of course this is not true.

Second, the article takes for done that is impossible to measure when the stimulus you make is in the right direction, this is only true for the one who doesn’t know what look for.

Third, all the conclusions don’t take consideration about the recent years increase development pace in the economy , needless to say, that the author is prone to be surprised by a very, very short recession, one that could not last even three months.

In other words, beside, well write, the article repeats the Misean doctrine, that it takes for the only truth and don’t need to be proved, even when it goings against common sense.

Richard T. January 31, 2008 at 7:39 pm

This piece does not make sense to me. I am in my 60′s and I have been a small business owner my whole life. I never once have considered expanding my production and my business because there was more savings available. What would more savings do for me? It might reduce the cost of borrowing money from 5.5% down to 5%. Big deal.

What WOULD cause me to increase production and expand my business? Increased orders. As increased order come in, I would extend my hours of overtime for my existing workers. As more orders yet came in, I would go out and hire new employees. Finally, as my order increased even more, I might go out and borrow money (the rate would not be all that important) and expand my machinery and equipment.

What is at the base of all these new orders that would motivate new production? Consumer spending! New spending is at the base of all business decisions. The cost of money has very little to do with it. You folks need to come in out of the world of pointy headed academic theories, and into the real world of adult business reality.

P.M.Lawrence January 31, 2008 at 11:39 pm

Richard T., there’s a bit more to it than that. If not enough new orders come in, yes, you won’t expand, and yes, it’s consumer demand that drives that.

However, if you get all that, you still won’t expand if you can’t because of lack of resources. In that situation, interest rates matter because they reflect and/or drive the bottleneck. So, what counts is whatever is the bottleneck at the time – effective demand, or resources to respond to it (in the form of realistic access to credit, to new investment, or whatever). Of course, lowering interest rates when that isn’t the bottleneck is silly, except to the extent that doing that flows through to effective demand (“effective” meaning, it’s not enough for consumers to want things either – they have to be able to do something about it). That’s why there is the famous analogy about some things being like pushing string.

Inquisitor February 1, 2008 at 10:07 am

If I understand the notion of effective demand correctly, it essentially means that in order to consume one must be productive. Anyway, I think P M Lawrence offered a good explanation of how we mean the terms.

Richard T. February 2, 2008 at 1:16 pm

So Mr. Lawrence does agree that consumer demand is the main engine that drives economic growth. His only caveat seems to be that what might prevent this growth is “lack of resources”. By this I can only assume that he means lack of credit or investment funds.

But there simply is no lack of either. The world is awash in a tidal wave of money looking for an investment home. I invest in commercial real estate, and I can tell you that the amount of investment money out there looking for rates of return is so great that it has pressured rates of return on assets ever lower in the last few years. All investment money does is bid up prices of assets. It does nothing to increase actual consumption.

For that, money needs to be spent on consumption, not locked away in yet more investment dollars pursuing ever decreasing good investment assets. For the writer of the original article to state that the best thing to do is for consumers to lock yet more dollars away in investment, rather than continuing to maintain their normal level of spending (for those that can of course) is totally unrealistic. All this will do is perpetuate a continual spiral of lowering consumption and production. One can push the string very effectively if increased spending is channeled into consumption rather that funneled into yet more asset investment bubbles.

Michael A.Clem February 2, 2008 at 4:46 pm

As always, some people only see one side of the story. It’s supply AND demand. “Consumer spending drives the economy”? Where do consumers get the money to spend on consumption? How can anyone consume something that hasn’t yet been produced?
The main thing Austrian economics points out is that increased production CANNOT occur without savings, or the forgoing of some immediate consumption for later consumption. Circumstantial details can vary, of course, but this is so fundamentally true that it should be obvious to anyone who thinks about it.
Consumer demand cannot drive the economy unless the means exists to increase production.

P.M.Lawrence February 3, 2008 at 3:56 am

Richard T accuses me of this: ‘So Mr. Lawrence does agree that consumer demand is the main engine that drives economic growth. His only caveat seems to be that what might prevent this growth is “lack of resources”. By this I can only assume that he means lack of credit or investment funds.’

The polite thing would have been, to ask. As it is, there is so much codswallop there it’s hard to know where to begin cleaning it up.

Take that engine analogy. If a car has a perfectly good engine but no fuel, that does not mean that the fuel is the engine. Consumer demand is not “the main engine that drives economic growth”, and it is offensive to misrepresent me as saying that.

Here is what I think about consumer demand: for someone in your situation, quite a common situation, increase in effective (see above) consumer demand would lead you to expand your operations – since in that situation you do not have the other bottlenecks. However, you can look at the business cycle – since it is a cycle – with any point as the start. The engine, so to speak, is productive capacity, which in the short term is related to installed capital, working capital availability, and availability of manpower with suitable skills. Problems with any of those would hold back the economy far worse, i.e. more immoveably, than lack of effective consumer demand, so in your analogy you should call those the engine and effective consumer demand the fuel.

That should show why “By this I can only assume that he means lack of credit or investment funds” is such nonsense too. Lack of credit or investment funds would certainly give you problems in that area, in a modern economy, but having them wouldn’t do you any good if something else got in the way of getting results in that area. For instance, a bureaucratic screw up meant that cement for new docks couldn’t physically get into Nigeria during the Civil War, so it didn’t make a blind bit of difference that funds were made available for it.

And, whatever the present set of constraints – which are as you describe – that does not make your description universal. It’s still just one kind of behaviour in a much larger area; the fact that you have to look in other times and places for precedents does not make your own experience the whole. It just tells you what needs to be fixed right now – the other stuff is what does not need fixing. But you should still pay attention to it, because if you break it through inattention while addressing what is already broken, you could end up making things even worse.

fundamentalist February 3, 2008 at 8:19 am

Alexandre: “…the article repeats the Misean doctrine, that it takes for the only truth and don’t need to be proved, even when it goings against common sense.”

You’re right that the Mr. Rockwell assumes that Mises’s economics is correct without attempting to prove it. That is because the proof has been done many times before, by Mises, Hayek, Rothbard and many other Austrian economists. So it would be very tedious to repeat those proofs with every article written. If you’re interest in the proofs for the validity of Austrian econ, just visit the “Literature” section on this site.

As for Mises’s ideas violating common sense, you’re right again, if you’re judging Austrian econ by what the average economist thinks. Austrian econ is the only force opposing mainstream economics, which is nothing but variations on Keynesian econ. I earned a masters degree in Keynesian econ before discovering Austrian econ, so I know it well. I can promise you that if you spend the time to learn Austrian econ, you’ll find it to be true, also, and your idea of common sense will change dramatically.

Richard T: “I have been a small business owner my whole life. I never once have considered expanding my production and my business because there was more savings available.”

That’s a very good point and I’m sure a lot of business people think the same way. But I’m afraid you don’t understand Austrian econ very well. Austrian econ is marginalist econ, which means that not everyone in the economy has to do the same thing in order to change things such as prices. The important actors are the ones at the margin. You might think of it as those people who are on the brink of making a decision.

For example, the prices of housing didn’t soar because every single home owner in the country was furiously buying and selling houses. Obviously, most people never bought or sold a house during that time. But those who were busy buying and selling, that is, the ones at the margin, did drive prices up for everyone. Often, the people at the margin are speculators.

So even though most business people won’t borrow more money when the Fed lowers interest rates, those at the margin will, which are those business people who are on the cusp of expanding but need a little push from interest rates.

I would like to know what business you have been in, too, because that’s very important. In Austrian econ. The business sectors affected by lower interest rates are mining, including oil production, and basic manufacturing. These industries are very sensitive to small changes in interest rates. The historical fact that business cycles happen in those industries, and much less in other sectors, especially retail, is what got the Austrian Business Cycle Theory going in the first place. So if you’re not in one of those industries, Austrian econ would predict that you wouldn’t care much about interest rates.

fundamentalist February 3, 2008 at 8:19 am

Alexandre: “…the article repeats the Misean doctrine, that it takes for the only truth and don’t need to be proved, even when it goings against common sense.”

You’re right that the Mr. Rockwell assumes that Mises’s economics is correct without attempting to prove it. That is because the proof has been done many times before, by Mises, Hayek, Rothbard and many other Austrian economists. So it would be very tedious to repeat those proofs with every article written. If you’re interest in the proofs for the validity of Austrian econ, just visit the “Literature” section on this site.

As for Mises’s ideas violating common sense, you’re right again, if you’re judging Austrian econ by what the average economist thinks. Austrian econ is the only force opposing mainstream economics, which is nothing but variations on Keynesian econ. I earned a masters degree in Keynesian econ before discovering Austrian econ, so I know it well. I can promise you that if you spend the time to learn Austrian econ, you’ll find it to be true, also, and your idea of common sense will change dramatically.

Richard T: “I have been a small business owner my whole life. I never once have considered expanding my production and my business because there was more savings available.”

That’s a very good point and I’m sure a lot of business people think the same way. But I’m afraid you don’t understand Austrian econ very well. Austrian econ is marginalist econ, which means that not everyone in the economy has to do the same thing in order to change things such as prices. The important actors are the ones at the margin. You might think of it as those people who are on the brink of making a decision.

For example, the prices of housing didn’t soar because every single home owner in the country was furiously buying and selling houses. Obviously, most people never bought or sold a house during that time. But those who were busy buying and selling, that is, the ones at the margin, did drive prices up for everyone. Often, the people at the margin are speculators.

So even though most business people won’t borrow more money when the Fed lowers interest rates, those at the margin will, which are those business people who are on the cusp of expanding but need a little push from interest rates.

I would like to know what business you have been in, too, because that’s very important. In Austrian econ. The business sectors affected by lower interest rates are mining, including oil production, and basic manufacturing. These industries are very sensitive to small changes in interest rates. The historical fact that business cycles happen in those industries, and much less in other sectors, especially retail, is what got the Austrian Business Cycle Theory going in the first place. So if you’re not in one of those industries, Austrian econ would predict that you wouldn’t care much about interest rates.

fundamentalist February 3, 2008 at 8:44 am

Richard T: “I invest in commercial real estate…”

I should have read your second post before finishing mine. Is commercial real estate your business or an investment vehicle? You should really be able to see how sensitive real estate is to interest rates. Even Keynesian economists are admitting that Greenspan’s low interest rates after 2001 caused the housing bubble that just burst.

Richard: “…and I can tell you that the amount of investment money out there looking for rates of return is so great that it has pressured rates of return on assets ever lower in the last few years.”

Yes, that’s one of the purposes of flooding the country with money. But why does monetary pumping cause rates of return to fall? Because it drives of the prices of the assets without improving their earnings power. The earnings from the assets stay the same but the prices are much higher. People are willing to earn less on assets when interest rates are low.

Richard: “All investment money does is bid up prices of assets. It does nothing to increase actual consumption. For that, money needs to be spent on consumption, not locked away in yet more investment dollars pursuing ever decreasing good investment assets.”

Not exactly. You’re stuck in Keynesian thinking. When people invest in commercial real estate, don’t a few more buildings get built than existed before? Along with the boom in investment in commercial real estate has come a boom in the construction of new commercial properties. Most of the money spent on those new buildings goes to pay the wages of workers. Workers spend most of their wages on consumption.

The main difference between Austrian econ and Keynesian (mainstream) econ is the order in which things happen. In Keynesian econ, consumers spend first, and that persuades businesses to expand. In Austrian econ, businesses invest first, and the wages they pay workers is spent on consumer goods.

If you’ve paid attention to the economy for the past 60 years, you would see very clearly that Austrian econ is correct. Which industries lay off the most people during recessions? Capital goods producers, such as aircraft manufacturers and home/commercial construction. I learned that as a kid because my dad worked in aircraft manufacturing and got laid off every 5-6 years.

Mainstream economists blame a slow down in consumer spending for causing recessions, but they never seem to ask the next question: why did consumers quit spending so much? Are they just stupid, or mean? No. They quit spending because many of them lost their jobs when the housing bubble burst. In addition, higher interest rates slowed investment in capital goods producing industries and slowed the growth of new jobs being created. As unemployent rose, consumer spending fell.

When money is invested, even in existing commercial real estate, it isn’t “locked away.” The seller of existing real estate may buy another piece of existing real estate, too, but eventually, someone who sells will build new buildings and hire workers who earn wages. Investment is never locked away; it pays the wages of workers. Even workers at existing plants depend on the owners investing in continued production in order to keep their jobs. The only time money gets locked away is when someone stashes it under their mattress; if it goes into a bank in any form, it gets invested.

Richard T. February 3, 2008 at 11:11 am

Fundamentalist, I really do not disagree with most of what you say. Obviously there is a cycling of money from production to consumption and back again. What I want to address is the more fundamental question of the original source of money.

I do not know how old that Austrian school of economics is, but it sounds like it was back in the days when the source of money WAS private savings. Now however, we live in the modern era when every modern country has a central bank and something analogous to the federal reserve system. The source of investment capital is through the money creation system of these government systems, and new money is and can be created at the stoke of a pen, with no corresponding debt. It does slightly dilute the value of existing money, but as long as GNP increases correspondingly, no real harm occurs. To say that “increased production CANNOT occur without savings” is simply and demonstrably wrong.

I do not want to get into a big argument about the fed, I know that this causes a lot of jumping up and down and hand waving among some people, I just want to point out that that is the system we have world wide, and for one very good reason. It works.

Again, what I want to do is to come back to my criticism of the original article. To say that the way to respond to the current economic slowdown is to stop spending and save more is demonstrably in error.

Michael A. Clem February 3, 2008 at 6:24 pm

The Fed “works” as long as they don’t do anything stupid (see Venezuela). But Bernanke is no Greenspan. The current economic slowdown was largely caused by the Fed, and the only way to end it is to increase the GNP, as you say, which cannot be done by spending more magically created money, but only by producing more goods.
As I said before, increased production can only occur from savings, not spending. Thus, Bush’s stimulus package won’t help unless that money is saved, not spent.

John February 28, 2008 at 6:49 am

Why not drop the price of all products in the US by one dollar to boost the economy? Do it and see how much more buying power consumers have.

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