A Way Out

"The only thing that's correlated 10% with job creation - and particularly good job creation - is business investment.  It is our reduced level of capital investment that has produced our low GDP growth rates and our high unemployment." - Fred Smith CEO of FedEx

By any metric the economy is sputtering.  The economy barely grew in the last quarter and unemployment levels are still elevated.  All of this comes more than four years after the Great Recession began and after more than $3 trillion of stimulus.  This is the largest stimulus ever undertaken and still it is like throwing a bucket of water onto a forest fire, eventually the forest fire will die down but the bucket of water is not making much of an impression.  For a better understanding of why this is let's take a look at some basic economics (I know it may seem tedious but I am sure you will learn something so bear with me).

Basic economic accounting will show that the total amount of savings in an economy must equal total real investment in the economy.  There is no other possible way for this relationship to exist as remember that real investment is net of any debt.  So increasing real investment will result in economic expansion or in other words increasing total savings will result in economic expansion.

I	=	(Y - C - T)	+	(T - G)	-	(M - X)
Gross		Private		Government		Foreign
Investment		Savings		Savings		Savings

Let's first look at Foreign Savings. Foreign Savings is a bit of a misnomer in that this amount is subtracted from savings. The more that is imported the lower the savings rate. For this reason governments try to stimulate exports which is normally done by weakening the exchange rate so that exports become cheaper and imports more expensive.  The problem is that countries around the globe are all trying to do the same thing so this is being met with limited success. It is also clear why China, who for decades kept their exchange rate low, ended up with such a huge foreign capital savings balance.

Now we will turn to Government savings. Well if ever there is an oxymoron this is it. Government and Savings are two words that should be the first and last words in the dictionary they are so far apart. The problem is that in this equation there is no way for everyone to be a saver and the Keynesian economists will argue that during weak economic times it is imperative that the government be a net spender in order to absorb the increased level of saving from the private sector. This recession has been particularly bad for the simple reason that the private sector took on too much debt and this debt is being offloaded at a very fast pace. If the government tried to save as well, the corrosion to the economy would be such that an economic implosion would surely have happened. However the Keynesians take it a step further saying that it is this increased savings is what causes the recession.

Their theory is that if you lower interest rates and force consumers to stop saving that this will result in an expansion to the economy and all will be well. For this reason the Federal Reserve is holding interest rates down, taxing savers and throwing huge sums of liquidity into the market. The problem is that all this is doing is promoting speculation rather than investment. The reason for this is that the Keynesians pay little attention to the productivity of the spending but expect that government spending and investment works just as well as private investment and spending. I don’t know about you but I have never seen a government that spends money as efficiently as private business.

The next problem with the way that the Federal Reserve is handling the issues is that during a recession the normal mix of goods and services demanded changes. Goods supplied are suddenly not wanted or not affordable so there is a buildup of unwanted inventory. Until the system changes through innovation this unwanted inventory sits idly on shelves taking up valuable investment dollars. Pumping money into the system without targeting proper investments such as factories, equipment, research and development and capital goods that are demanded by the consumer is just promoting more of the same and is wasted. Furthermore without targeting the benefits employment levels remain low.

In order to stimulate an economy real investments must be stimulated which unfortunately is not being done. Paying people to remain idle or buying toxic debt has not, is not and will not help the general economy. It has the effect of helping a select few at the expense of the majority.  While the quote above is fairly accurate the actual level of correlation between domestic investment and unemployment is roughly 80% (not 100% quoted). Stimulating direct investment therefore would have a profound effect on the unemployment rate however it appears that companies are currently reducing domestic investment.  The result of this will surely be a higher unemployment rate in the near future the exact opposite of what the Federal Reserve is trying to achieve.

So in order to get this economy in gear government spending should be targeted on increasing direct investment. This can easily be done through things such as investment tax credits, accelerated expensing of investments, R&D incentives and other similar programs that I have mentioned in previous blogs. Until current policies target the issues the only people that will be rewarded are the banks and the few that speculate on the markets. This is not a sustainable solution as trying to stimulate an economy by taxing savers with low interest rates has proven time and time again.  So although Mr. Bernanke and his cohorts are patting themselves on the back as the market reaches all time highs it is definitely time to defend your investments or understand that you are now not investing but joining the market of speculation.