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Disagreeing with Robert Samuelson

By John Tamny

In his Wednesday column ("The Upside of Recession?") for the Washington Post, economist Robert Samuelson made the excellent point "that much of our standard economic vocabulary needs revising, supplementing or at least explaining." Specifically he cited inflation and recession as two basic economic terms that need clarification, though his own explanations somewhat missed the mark.

Samuelson asked the question many ask: Why strip out food and energy prices from core inflation? While there's no disagreement with his basic query, the inflation he describes cannot be. Samuelson specifically points to corn and oil, and demand for both as being indicative of inflation. Where this concept is flawed is that if consumers have to devote more of their income to food and fuel, tautologically they have less money to spend on other goods. The alleged inflationary impact of demand is always a wash, in that rising demand in one area means falling demand elsewhere.

Still, he makes a good point about commodities. Priced in the spot market, they almost instantaneously tell us about changes in currency value that ultimately impact the prices of all goods. Since December of 2000, corn is up 135 percent in dollars, but slightly more than half that much in euros. For a variety of commodities, the story is much the same, with copper up 336 percent in dollars since 2001 versus 179 percent in euros, while oil is up 120 percent in dollars against 40 percent in euros. Core inflation figures produced by the Bureau of Labor Statistics fail analysts of Samuelson's demand-side orientation for stripping out some of life's basic necessities, and for different reasons fail those who view inflation from a classical perspective. Regarding the latter, inflation is a monetary phenomenon, so if our money is losing value as it clearly is, we're inflating.

Moving to the idea of a looming recession, Samuelson calls the generalized aversion to recessions "simplistic." He argues that "downturns check inflation," but contradicts himself by saying that during recessions "unemployment rises, production falls, profits weaken, stocks retreat." The obvious contradiction is in mistaking inflation for anything but something that is monetary in nature.

When more people are working and companies are producing more, both are a very explicit source of rising money demand. Growth in employment and production by definition soak up excess dollar liquidity. The same applies to profits and their impact on stocks. If U.S. profits are high and going higher, demand for the very dollars necessary to purchase U.S. shares also rises.

Samuelson cites six U.S. recessions since 1969, but in arguing that they reduced inflationary pressures, mistakes cause and effect. Excepting the deflationary recession of 2001, the others did not result from too much economic growth, but instead resulted from too little economic activity such that the dollar weakened, and inflation along with sub par growth revealed themselves. Proof positive that growth is not the cause of slowdowns is that since 1982, we've only had two recessions. During that time nominal job growth skyrocketed alongside production, and the Dow Jones Industrial Average alone rose seventeen-fold. That inflation has been largely quiescent during the time in question is proof positive that economic growth is the cure, rather than the cause of inflation.

On the trade front, Samuelson notes that some "sort of recession might also reduce the gargantuan U.S. trade deficit," and sure enough that last time our balance of trade went into surplus was during the '90-'91 recession. The disagreement here is in terms of trade, and the certain reality that all trade must balance: If we're big buyers stateside of foreign goods, then our foreign trading partners must be big buyers of what we produce. The "deficit" is merely an accounting abstraction, where capital inflows into the U.S. for purchases of equities, land and debt don't count in the trade balance, whereas our purchases of microwave ovens and televisions do count.

Rather than bemoan these alleged imbalances that regularly occur amidst strong economic growth, we should embrace a world trading system that enables us to "outsource" the production of low-margin goods such that we have time to create the Googles and Intels of the world -- the very high value companies that attract the kind of investment that enables us to be large consumers to begin with. Samuelson cheers the idea of a lower U.S. trade deficit, but at the same time ignores that it works both ways. If we're buying less from our trading partners, they'll commensurately be buying less from us.

Samuelson concludes that, "the larger lessons here involve perceptions." No doubt that's true, but a major misperception is that we can somehow contract our way out of inflation. More realistically, for driving money demand downward, a recession would merely feed the real inflationary pressures that already exist.

John Tamny is an editor at RealClearMarkets. He can be reached at jtamny@realclearmarkets.com.

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