by Bobby Akart
The Three Pillars of Supply-Side Economics
The three supply-side pillars follow from this premise. On the question of tax policy, supply-siders argue for lower marginal tax rates. By instituting a lower marginal income tax, supply-siders believe that lower rates will induce workers to prefer work over leisure. Regarding lower capital-gains tax rates, they believe that lower rates cause investors to deploy capital productively. At certain rates, a supply-sider would even argue that the government would not lose total tax revenue because lower rates would be more than offset by a higher tax revenue base—due to greater employment and productivity.
On the question of regulatory policy, supply-siders tend to ally with traditional political conservatives—those who would prefer a smaller government and less intervention in the free market. The conservative approach is logical because supply-siders, although they might acknowledge that government can temporarily help by making purchases, do not think this induced demand can either rescue a recession or have a sustainable impact on growth. A political conservative would warn that this stimulus comes with a hefty price—higher debts and deficits.
The third pillar, monetary policy, is especially controversial. By monetary policy, we are referring to the Federal Reserve's ability to increase or decrease the quantity of dollars in circulation (i.e. where more dollars mean more purchases by consumers, thus creating liquidity). A Keynesian economist tends to think that monetary policy is an important tool for tweaking the economy and dealing with business cycles, whereas a supply-sider does not believe that monetary policy can create economic value.
While both supply-siders and Keynesian theorists acknowledge that the government has a printing press, the Keynesian believes this printing press can help solve economic problems. But the supply-sider thinks that the government, or its central bank, is likely to create problems with its printing press by either creating too much inflationary liquidity with expansionary monetary policy or not sufficiently greasing the wheels of commerce with enough liquidity due to a tight monetary policy. A strict supply-sider is, therefore, concerned that a powerful central bank may inadvertently stifle growth—the law of unintended consequences.
What's Gold Got to Do with It?
Since supply-siders view monetary policy, not as a tool that can create economic value, but rather a variable to be controlled, they advocate a stable monetary policy or a policy of gentle inflation tied to economic growth - for example, three to four percent growth in the money supply per year. This principle is the key to understanding why supply-siders often advocate a return to the gold standard. The idea is not that gold is particularly special, but rather that gold is the most obvious candidate as a stable store of value. Supply-siders argue that if the U.S. were to tie the dollar to gold, the currency would become more stable, and fewer disruptive outcomes would result from currency fluctuations. Linking our currency to gold would also reduce the effect of currency manipulation by our trading partners.
As an investment tool, supply-side theorists say that the price of gold, since it is a relatively stable store of value, provides investors with a leading indicator or signal for the dollar's direction. Indeed, gold is typically viewed as an inflation hedge. And, although the historical record is hardly perfect, gold prices have often given early signals about the upcoming fluctuations in the dollar.
The Bottom Line of Adam Smith's Economic Theories and Supply-Side Economics
Supply-side economics has a colorful history. Some economists view supply-side as a useful theory. Other economists so utterly disagree with the argument that they dismiss it as offering nothing particularly new or controversial as an updated view of classical economics. Based on the three pillars discussed above, you can see how the supply side approach cannot be separated from the political arena since it implies a reduced role for government and a less-progressive tax policy.
Chapter Seven
Inflation
How does the government define inflation? From Investopedia, "Inflation is defined as a sustained increase in the general prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service. The value of the US Dollar does not stay constant when there is inflation."
The Bureau of Labor Statistics is the agency of the Department of Labor responsible for calculating data for dissemination to the public. Over time, the definition has changed and now the widely accepted number is known as the Consumer Price Index. The CPI is often cited in the mainstream media.
Inflation is typically associated with the growth of an economy, but wide swings can actually be an indication of problems.
For example, to purchase an item of clothing in 2009 for $100 would require $110 today. Historically, over a seven-year period, an average inflation rate of just above one percent is considered very low. This is an example of an economy experiencing little or no growth.
On the opposite end of the spectrum, consider the four-year period of 1977 through 1981. An item costing you $100 in 1977 would command $150 just four years later. This is an example of an economy experiencing rapid economic acceleration driven by artificially higher prices. It does not quite give rise to hyperinflation, as in Zimbabwe, but it was accelerating too fast.
Inflation is often referred to as a hidden tax upon your money. As your money sits in the bank, it's losing value because its purchasing power is constantly dwindling.
Moderate inflation, once generally accepted as three percent, is a sign of a healthy economy, as long as wages follow suit. An economy which produces a higher inflation rate than wage rate increases is subject to collapse. Inflation is caused by two economic phenomena—demand pull and cost push.
If the economy is at or close to full employment, then an increase in demand leads to an increase in the price level. As a business reaches full capacity in production, they respond by increasing prices, leading to inflation. Also, near full employment, workers command higher wages which increase their spending power. This is how demand pull inflation works. The economy is heating up, as the media terms it.
Rising house prices - Rising home prices not only cause inflation, but they can create a positive wealth effect and encourage consumer-led economic growth. This can indirectly cause demand-pull inflation.
Cost push inflation results when there is an increased cost to manufacturers to produce their goods or services. Many factors can cause Cost-push inflation.
Rising wages – The collective bargaining laws of the United States allow unions if they can present a united front, to bargain for higher wages. Rising wages are a key cause of cost-push inflation because wages are the most significant variable cost for many firms.
Import prices – The US trade gap is currently $47 billion. There are many reasons for this, but for purposes of the inflation discussion, a massive trade deficit allows for higher import prices leading to an increase in inflation.
Raw Material Prices - The best example is the price of oil. If oil prices rise by twenty percent, then this will have a significant impact on most goods in the economy, leading to cost-push inflation. For example, when the price of oil skyrockets, the costs of certain oil-based products rise accordingly. If the cost of asphalt-based shingles increases due to the higher price of oil, the cost of installing a new roof goes up. Consequently, the building contractor raises the price of the new home he is selling, which is factored into the CPI.
Profit Push Inflation - When a firm pushes up prices to get higher rates of profit, inflation is the result. Profit-push inflation is more likely to occur during periods of strong economic growth.
Declining productivity - If firms become less productive and allow costs to rise artificially by reducing the supply of goods, this invariably leads to higher prices.
Higher taxes - If the government raises taxes, this will result in higher prices, and therefore the CPI will increase. A common misconception is that the government can sock-it-to-the-r
ich corporations with higher taxes and it won't affect consumers. The business simply increases its prices to pass the new tax onto the backs of all of us.
Printing more money - If a central bank prints more money, you would expect to see a rise in inflation because the money supply plays an important role in determining prices. If there is more money chasing the same amount of goods, then prices will rise. Hyperinflation is usually caused by an extreme increase in the money supply. However, in exceptional circumstances – such as recession, it is possible to increase the money supply without causing inflation. During a recessionary period, an increase in the money supply may be saved, e.g. banks don't increase lending but enhance their bank reserves.
Inflation expectations - Once inflation sets in it's hard to reduce. For example, higher prices will cause workers to demand higher wages causing a wage-price spiral. Therefore, expectations of inflation are important. If people expect high inflation, it tends to be self-serving.
Chapter Eight
Recession
A recession is commonly defined as two consecutive quarters of negative economic growth. It is often referred to as an economic slowdown during which trade and industrial activity are reduced, resulting in a fall in GDP. During a recessionary period, real incomes, employment, industrial production and retail sales all suffer. As the economy and the business cycle contracts, household income, business profits, and spending falls. Bankruptcy filings tend to rise.
Many factors contribute to an economy's fall into a recession, but the primary cause is inflation. As a reminder, inflation refers to a general rise in the prices of goods and services over time. The higher the rate of inflation, the smaller the percentage of goods and services that can be purchased with the same amount of money. Inflation can happen for reasons as varied as increased production expenses, higher energy costs and the national debt.
In an inflationary environment, consumers tend to cut out leisure spending, reduce overall expenditures, and begin to save more. But as individuals and businesses curtail expenditures in an effort to trim costs, this causes GDP to decline. Unemployment rates rise because companies lay off workers to cut capital outlays. It is these combined factors that cause the economy to fall into a recession.
Recessions have psychological and confidence aspects. For example, if companies expect economic activity to slow, they may reduce employment levels and save money rather than invest. Such expectations can create a self-reinforcing downward cycle, bringing about or worsening a recession.
What to Watch For
Consumer confidence is one measure used to evaluate economic sentiment. The term animal spirits has been used to describe the psychological factors underlying economic activity. Economist Robert J. Shiller wrote that the term "...refers also to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith. When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people." Shiller's expertise in the field resulted in the creation of the Case-Shiller Home Price Index which is a leading indicator of a future recession caused by a slowdown in the real estate market.
Economists have searched for the perfect recession indicator. Many media sources will dwell upon unemployment numbers. But, by the time an economy is suffering from high unemployment, a recession has already begun. For that reason, economists refer to the unemployment rate as a lagging indicator of recession–an indicator that reveals where an economy has been, rather than where an economy is going.
The Federal Reserve is well aware of the recession forecasting power established by the trend in the unemployment rate. In early 2016, New York Fed President William Dudley discussed the matter explicitly in a speech.
"Looking at the post-war period, whenever the unemployment rate has increased by more than 0.3 to 0.4 percentage points, the economy has always ended up in a full-blown recession with the unemployment rate rising by at least 1.9 percentage points. This is an outcome to avoid, especially given that in an economic downturn the last to be hired are often the first to be fired. The goal is the maximum sustainable level of employment—in other words, the most job opportunities for the most people over the long run."
Other indicators to watch as a predictor of a recessionary period are slowing industrial production and reduced growth in earnings per share of major US corporations. One of the barometers we watch most often is the Conference Board of Leading Economic Indicators.
The Conference Board is a non-profit research group organization located in New York comprised of over twelve hundred public and private corporations and other organizations from around the world. Founded in 1916, the Conference Board publishes a series of indicators for the United States and international economies that are the most widely tracked by investors and policy makers.
Their research reports produce the U.S. Consumer Confidence Index, the Employment Trends Index, and the CEO Confidence Survey. Together with other leading economic indexes which they compile, the Conference Board is considered the world's leader in producing regular global and regional economic outlooks. If economic collapse concerns you, visit the Conference Board organization website regularly.
Chapter Nine
Deflation
Deflation is one of the least-understood economic environments for investors, yet one of the most potentially devastating to the unprepared. When the overall price level decreases so that the inflation rate becomes negative, it is called deflation. It is considered the opposite of inflation.
On the surface, deflation sounds like a good thing. In fact, it is the grim reaper stalking the world's weakest economies in recent years, a threat many nation's central banks have learned to fear. The monster threatening the present world economy isn't inflation and a period of rising prices, but its opposite—falling prices.
Its name is deflation, and it appears friendly. Why should those who dictate monetary policy be concerned when the cash in people's wallets buys more fuel and televisions, not less? Because when deflation grabs hold of a nation's economy, companies and consumers stop spending. It strangles borrowers because their debts get harder to repay—a menace for countries still struggling to recover from the recent 2009 global recession, the worst in a generation. Under these circumstances, inflation comes dressed as a knight in shining armor as policymakers debate how to create just enough of it to keep deflation at bay.
When prices rise at a slower pace, it can help consumers boost their purchasing power. Falling prices can also provide a lift if limited and temporary. Some economists praised the drop in oil and other commodity prices in 2014 as good deflation that would open up room for companies and consumers to spend.
But when prices drop across a wide range of products and for a long time, economic activity can screech to a halt. Companies postpone investment and hiring as they are forced to cut prices. Sliding prices eat into sales and tax receipts, limiting pay raises and profit margins. They add to corporate and government debt burdens that would otherwise be eroded by inflation. Following the 2009 global recession, state and local tax revenues dropped dramatically, but the corresponding governmental operations didn't contract. The result was major municipalities filing bankruptcy and the near-collapse of the State of California.
Deflation fueled two of the worst economic disasters in modern times — the Great Depression of the 1930s, and the less catastrophic but more recent experience of Japan's lost decades with almost no economic growth. Deflation took hold in Japan in the 1990s when banks, wounded by a burst real estate bubble, stopped lending. Wages stagnated and consumers reined in spending.
The International Monetary Fund studied which economies are vulnerable to deflation, and has raised concern that even a period of ultra-low inflation could do damage. "If inflation is the genie," IMF Managing Director Christine Lagarde warned in January 2014, "then deflation is the ogre that must be fought decisively."
A reduct
ion in money supply or credit availability is the usual reason for deflation. Reduced spending by government or individuals may also lead to this situation. Deflation generally leads to a period of increased unemployment due to slack in demand.
Central banks aim to keep the overall price level stable by avoiding situations of severe deflation or inflation. They may infuse a higher money supply into the economy to counter-balance the deflationary impact. In most cases, deflation gives rise to a period of depression, which occurs when the supply of goods is more than that of money.
Central bankers find it easier to beat inflation than deflation. When prices rise too fast, policymakers raise interest rates, then pull back when the economy slows. It's harder to calibrate the right dose of medicine to ward off deflation. Interest rates in most large countries were held near zero for years, and the European Central Bank even cut a key rate into negative territory in June 2014.
In Greece, deflation may be a price worth paying to make the country competitive again after years of living beyond its means. Bond-buying programs like those that helped revive the U.S. and Japan have also had dangerous side effects. They've sent money flowing into stocks and property, boosting the prices of assets rather than products, raising concern that too much easing was creating bubbles. Even so, when the threat of deflation seems small, history tells us that it's a huge risk.
There are fears that Japan's anti-inflation strategy is unraveling as we enter 2016. There have been several sharp rises in the value of the yen (12% in three months) against the dollar in the first quarter of 2016. This signals a trend toward selfishness by the Japanese in combatting their deflationary period. Excess volatility and disorder in the foreign exchange markets create instability in world market's overall. This protection sentiment by the Japanese—boosting its own economy in the hope of higher levels of growth—signals a potential world-wide currency war which harms the largest importers of goods, like the United States.
