“We have tried spending money. We are spending more than we have ever spent before and it does not work,” stated Henry Morgenthau, Secretary of the Treasury in the Roosevelt administration, making it clear that —despite what too many historians and economists fallaciously claim— the New Deal did not bring the United States out of recession, but transformed it into a deep and prolonged depression from which the U.S. economy emerged only after the Second World War.
This happened not because of the military spending, forced savings and displacement of the unemployed to the front lines that that huge conflict entailed, but because of the belated redirection of ill-invested capital into new productive investments due to the end of rationing, the cessation of central planning and price controls of the early New Deal and the subsequent war economy.
Biden-Harris administration towards a great green bubble
Today the United States is heading towards the great green bubble of the Green New Deal which, for now covertly, the Biden administration is advancing by pushing a bubble that will burst like all bubbles of artificially cheap credit and contrived public spending.
The eternal road to recession
Economist Jesús Huerta de Soto summarizes the inevitable passage from credit bubble to recession —and with it to the final correction of the bad investments of the expansive “irrational exuberance”— through the effects of credit distortion on the capital structure by means of six microeconomic processes that tend to reverse the errors of the artificial credit boom.
One: The bubble causes a rise in the price of the original factors of production —raw materials— because the monetary impact causes entrepreneurs to demand more of them. This demand depends on a credit expansion growing at a much higher rate than savings, which will inevitably raise the prices of consumer goods.
Two: Prices of consumer goods rise because the money flowing to businesses pays their suppliers, who in turn pay their suppliers, and finally the inflated money flowing to consumers. Since the rate of time preference has normally not changed, they continue to consume and save in roughly the same proportion, and thus the price of consumer goods rises. In addition, as long as the lengthening of the capital structure through investment in higher-order goods is not completed (and most of it will not be completed before the recession), bottlenecks are created that delay the arrival of consumer goods on the market, causing additional price increases.
Three: This inflation causes corporate profits of companies closer to consumption to grow faster than expected from capital investments undertaken thanks to credit expansion. A signal that casts doubt on the viability of investments in capital structure extensions. Very few investors detect the bubble in the making and redirect their investments in preparation for what is to come later.
Four: The rise in the nominal price of consumer goods causes a relative fall in real wages, and at the margin, capital investment becomes relatively less attractive, so there is a tendency to hire more labor, discarding new capital investments, and to question those already underway. This produces a fall in the demand for capital goods and the investments that had been made in response to the previous increase in demand -prices- are jeopardized.
Five: Finally, the Central Bank assumes an —almost always long-delayed— increase in interest rates. Since credit expansion is injected into the capital structure through the banking system, when the central banks reduce the interest rate, the banks not only reduce the interest rate they ask for credit, but also make all credit conditions more flexible. With the money supply resulting from credit expansion driving up prices, the interest rate must incorporate risk and expected inflation, and interest rates rise, because to compensate for the loss of purchasing power of money, lenders are forced to incorporate an inflation component to charge the same real interest rate. Moreover, Hayek showed in 1937 that investment in capital goods generates additional autonomous demand for more capital goods of a complementary nature, and that entrepreneurs will usually assume the higher interest rates to try to complete the extensions in which they have invested, rather than assume the failure of projects in which they invested huge volumes of resources on credit.
Six: The perfect storm of these five factors is portrayed in accounting losses in the stages relatively more distant from consumption, towards which credit expansion was initially oriented. Thus, both the magnitude of the entrepreneurial investment errors caused by the credit expansion and the unfeasibility of a large part of the investments aimed at a future demand, wrongly expected before the time when it could actually come into existence, are clearly visible. The paralysis and liquidation of bad investments came with a slow and inevitably incomplete displacement of the resources that could be moved —capital is not homogeneous and a good part of the investments are non-transferable between sectors so distant— from the stages furthest away from consumption to those closer to it. And so, the bubble of the boom bursts.
All cycles follow the same script, but if the distortions caused by artificially cheap credit are added to those caused by tax increases, new and increasing regulations and the political will to concentrate the bubble in privileged sectors through subsidies and regulations, as was the case with the New Deal and will be the case with the Green New Deal, the mistakes will be bigger, worse and more costly.