My Two Cents - "Prevent Defense"

10/5/2007 - "The Prevent Defense"

Undoubtedly, I am not alone in my amazement how time and time again, in the waning moments of the big game, defenses give up wins by using the 'prevent defense'. In football, it involves backing up your defense on its heels and allowing itself to be nickeled and dimed to death by any quarterback who can throw a spiral. The idea is not to give up the big play. Despite the best of intentions, however, the results are generally the same: a big loss.

Rest assured the sports analogies end here. Right now in the United States, we have switched over to our own version of the prevent defense. The goal is to prevent a recession at all costs.

We cannot 'afford' a Recession

From an Austrian standpoint, recessions are a cleansing process and an economic necessity. The gentle ebb and flow of the business cycle generally exhibits some degree of mean reversion meaning that any boom (higher than normal growth) will result in an equal and opposite bust (lower than normal growth or negative growth). This sine wave phenomenon is best illustrated by Kondratieff's cycles which occur over longer periods of time.

The recession is the hangover. The recession is the wasted day after a night of excess. The recession is the foreclosure after the foolish and impractical purchase of a grossly overpriced home.  The recession is the unpleasant reality after a bout of euphoria and irrationality. The recession, as it were, has become more and more politically unacceptable, especially in recent decades. We have come to expect that the party will in deed go on forever, the DJ will never run out of records to spin and the punch bowl will somehow remain full.

The problem is, as is the case with most excesses, is that we have stretched out ability to maintain the trend. Consumer activity now represents over 70% of US GDP in dollar terms and the very success of our economy is largely dependent on the ability of the consumer to continue spending. Genuine recessions always entail consumers cutting back on spending, paying down their debt and saving money. Oddly, US savings figures have miraculously been revised and by golly it turns out we've been saving all through this latest binge (sarcasm mine). Many observers have already lost their credibility by underestimating the willingness of consumers to maintain spending habits though and the boom continues.

While it might seem conventional that a recession would give the Fed cover to cut interest rates even further, there will be ramifications if they choose to pursue this action. The dollar would in all likelihood break down driving inflation at home even as the Fed throws gasoline on the fire in the form of rate cuts and mortgage bailouts.

We simply cannot afford a recession.

The Invisible Hand

Regarding the financial markets, we are indeed in one of the longest four-year cycles in history, according to Tim Wood at cyclesman.com  Market forces have been struggling for a reversion to the mean, but the Invisible Hand of the Fed and the PPT has been preventing the cleansing process from occurring. We saw the first shots in this battle fired back at the end of February, with the second volley coming late in the summer. Since then, on the surface things have stabilized to some degree, thanks in no small part to a lack of scrutiny by most media outlets. The DOW even set a new record this past week.

But the invisible hand defense is backpedaling. Rothbard correctly stated many years ago that growing a fiat economy requires ever-increasing amounts of paper currency/credit and therefore inflation.  The problem with this inflation is that the biggest beneficiary of any money creation is the first recipient of the new money. By the time the dollars trickles down (pardon the Reagan era term) the concomitant price increases along the way have already found the guy at the bottom. In this case, the guy at the bottom is the American consumer. And he is responsible for 70% of our economy. He is pinched. In the end, the only way to counteract this situation is to monetize his demand directly. This can be accomplished either by bamboozling him into accepting outrageous sums of credit, convincing him to borrow on the erroneously inflated value of his 'assets', or by making Ben's helicopter moniker stick and putting fresh money directly into his hands.

This prevent defense cannot be aggressive, come up to the line of scrimmage and play tough. It might get burned and the stakes are much too high. So instead it backpedals itself into obscurity and irrelevance just like all of its predecessors.

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. This article and other information is located at http://www.my2centsonline.com Please feel free to distribute, copy or otherwise disseminate this information.