Toshio Masuda, Writer, Commentator, and International Economist
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Misreading the U.S. Economy
The Dow Jones Industrial Index declined 514 points or 4.4% over a 6 day period last week. At the same time the Commodities Index suffered its biggest drop in many years. A combination of reports on increasing U.S. consumer prices and the historically high price of crude oil caused inflation fears this week. These fears were accentuated by the U.S. Federal Reserve Bank’s concern that soaring commodity prices could result in inflationary pressures leading the Fed to continue its march of interest rate increases. Another fear concerns U.S. National Debt. Today, the National Debt stands at $83 billion, approximately 7% of the annual $13 trillion of U.S. Gross Domestic Product (GDP). Some fear that 15 more years of deficit spending, and the resulting borrowing that increases the National Debt, would add up to 100% of annual GDP.
1. Misreading Inflation
The fear of inflation is also the fear of rising interest rates. Before we talk about inflation, however, we have to understand the difference between today’s world economy as compared to the world economy that existed before 1971. The pre-1971 world economy suffered from a shortage of money and a shortage of goods. Inflation was indeed the cause of increases in interest rates and consumer prices. Back then, U.S. government’s response was to issue the bonds and incur additional debt to meet this constant demand for liquidity which resulted in “hyper-inflation”.
Today, however, the world economy enjoys plenty of liquidity and an excess supply of goods. In the “old world”, the price of essential goods like food and other basic consumables went beyond what the consumer was willing to pay or, in some cases, what the consumer was able to pay. This was a case of classic inflation. Today, because of the trend of deflation, the average consumer buys more than just essential goods simply because he can. The increase in consumer prices, however, is a reflection of the increase in prices for discretionary (non-essential) goods and services such as iPods and flat screen televisions that result in an increase in the consumer’s living standard.
In my view, increasing consumer prices are being caused by discretionary purchases, not inflation. The higher price does not represent inflation because it does not decrease the value of the goods and services, or money. Thus, increasing consumer prices are really proof of an increase in purchases of discretionary goods and services. The average consumer price is increased by the price and the quality of some goods and services, but not by the price of essential goods such as groceries. Consumers must pay for essential goods even at higher prices, but the consumer never pays for discretionary goods and services at higher prices. So again, the recent increase in consumer prices does not represent inflation; rather it represents expenditures for a higher living standard, not inflation.
2. Misreading the U.S. Debt
The fear of a record U.S. National Debt of $83 billion is a source of concern for some economists. America’s $83 billion debt is roughly 7% of its $13 trillion annual GDP. The concern is that if the same rate of increase in the National Debt continues, it could over a 15 year period equal the annual U.S. GDP. These concerns, however, overlook two important factors: the means and the object of investment. This begs the question, what is the object or the goal of the deficit? A part of the goal is providing necessary funds to create national interests; but a more important goal is to increase America’s net worth. Since 1955, America’s net wealth has been growing at a steady 5-6%, in nominal terms every year by roughly $3 trillion, while it cumulatively borrows $8 trillion. The more the U.S. borrows, the more its net worth increases and at a rate much higher than the rate of increase in borrowing. Now, what is the fear of America’s National Debt and borrowing? There should be no concern.
Last week’s stock market drop has been viewed very narrowly; one needs to have a broader perspective.
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