Are we about to have a double dip recession and run away inflation?

Newsletter August 2010
creasing in absolute dollars or infla-
Are We About To tion adjusted dollars. From a business
Have A Double Dip standpoint, if sales aren’t increasing
and opportunities to increase revenues
Recession And Run and after tax profits are not there, it
does not feel like a “recovery,” no
Away Inflation? matter what some economist says.
Recently the top 100 economist So where is the economy now?
have been making contradictory As the last quarter of 2009 ap-
statements almost daily about whether proached, we cut through the econom-
we are going into a double dip reces- ic terminology, and explained in lay
sion, or will see a continuing recov- terms that the economic data sug-
ery. They seem equally confused as gested we would hit the bottom of the
to whether we will experience high recession near the end of 2009 or the
inflation or dangerous deflation. With beginning of 2010. We also ex-
this level of muddled economic dis- plained that it appeared that as the
cussion, it is difficult for business to economy hit bottom it would plateau
plan what to do over the coming 6 to and begin a very slow shallow rise.
18 months. From a business planning point
Why all the confusion? Part of of view, this meant if your business
the confusion is caused by how econ- was profitable at the bottom, you then
omists define things like “recovery.” had to plan how to thrive at that eco-
To a consensus economist, “recovery” nomic level with an economy moving
is a statistical term meaning that the in a narrow range. We went on to talk
GDP is increasing. about an “H” shaped recovery and
There is even the further re- what it meant to you.
finement of whether the GDP is in-

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Newsletter
August 2010

That is, in fact, what has hap- recession since the great depression,
pened thus far. The economy has yet there is a simple answer ---- it de-
to experience any meaningful growth. pends!
Businesswise, there were a number of What does it depend on? It
economic factors that contributed to depends on whether the government,
stabilizing the economy. including the Fed, create the type of
As with any recession of the conditions that promote private sector
type we were having, there comes a sustained activity and growth or that
point where inventory restocking retard it. This would require returning
starts to occur and pent up demand liquidity to the private sector for job
begins to gradually revive sales. That creation, facilitating a stable growing
is a critical point in an economic turn- housing market and focusing on mid-
around. dle market small business needs to
If the proper economic condi- name a few key factors.
tions have been put in place, then the To accomplish this requires a
recovery will rapidly gain strength focused coordinated government poli-
and sustained growth will begin. That cy based approach. That is why the
is why we talk about returning liquidi- 100 top economists are so muddled
ty to the private sector. If the proper and contradictory in what they are
economic conditions have not been saying today.
put in place, then the recovery will The consensus economists can-
stagnate and become unstable not tell which way the government
In this “recovery,” U.S. busi- will move. Certain actions would
ness to business sales, not the con- stagnate the economy, while others
sumer, lead the stabilization process. would, in the long run, return us to
Whether the “recovery” remains sus- meaningful growth.
tainable under these circumstances is Had the government taken the
largely dependent on the economic appropriate steps over the past 18
conditions created by the government. months, which economists would
Today, if you ask the question have traditionally expected, the condi-
will we have a double dip recession or tions for sustained recovery would
a recovery like we have had in each

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Newsletter
August 2010

now be in place providing strong wrong, and government should prac-
growth and job creation. tice massive intervention and control
That has not happened to date. outcomes, picking winners and losers.
That failure has lead to intense confu- Others think Reagan meant it is the
sion over whether we will see a quantity and quality of when and how
double dip recession and inflation or the government acts that matters.
deflation. How should government Reagan did not think that his prede-
approach its role in facilitating the cessor had a balanced perspective in
right economic environment? There terms of government’s role.
are really three ways the government Past recessions have benefited
can approach dealing with a reces- from the third alternative approach.
sion. Policy driven by practical economists,
Two are doctrinaire. You can guided by the laws of economics, who
have conservative ideologues who on- looked for flexible versatile ap-
ly think in pure strict non-government proaches with government working
intervention economics. Or you can carefully to foster conditions that faci-
have liberal ideologues who only litated the private, free market based
think in pure strict government inter- economy in recovering.
vention economics. In these ap- Today, Economists cannot tell
proaches, ideology drives the policy. which of the three approaches will
Or you can have practical based prevail as government policy. So they
approaches that believe government cannot tell what the outcome will be
has a role in creating the kind of envi- over the next 18 months. Moreover,
ronment that let a free market based economics is an ever changing art or
economy function. Ronald Reagan science, as the case may be.
once said, “Government is not a solu- For example, in the 1920s busi-
tion to our problem, government is the nesses normally grew and expanded
problem.” based on invested or retained earnings
Conservative ideologues think and capital. If the Fed raised interest
he meant that government should not rates to control inflation, it restricted
intervene in the economy at all. Lib- business and consumer borrowing,
eral ideologues think, Reagan was and consequently slowed sales. Since

3

Newsletter
August 2010

companies didn’t generally borrow to ed to raw material costs which were
finance normal operations, higher in- passed on to the next level. The man-
terest rates did not unduly affect the ufacturer added its markup to the
cost of goods sold. passed on interest costs and also add-
Based on supply and demand ed its own higher interest costs to the
economics, raising interest rates under cost of the finished goods it sold.
these normal conditions reduced buy- The retailer did the same. This
ing and inflationary pressures. But by meant that the higher interest cost
the 1970s, the concept of leverage were passed on as a geometric in-
was the prevailing norm. Businesses crease to the consumer, since at each
used borrowed funds for all aspects of level, interest cost were added and the
their operations. prior costs were increased by the next
Inventories of raw materials level’s profit margin. Therefore, this
and finished goods were financed, approach accelerated the inflation, ra-
primarily, out of short term borrowed ther than reducing it.
funds. When the Fed raised rates to It was not until the 1980s when
21% in the late 1970s to fight infla- interest rate came down dramatically,
tion caused by OPEC’s dramatic in- coupled with across the board tax
crease in oil prices, they were apply- cuts, that inflation was brought under
ing economic concepts proven in the control and the economy returned to a
1920s, not the 1970s. long period of sustained growth.
The Fed’s rise in interest rates This illustrates that the laws of
in the 1970s had the exact opposite economic are constant, while the cir-
effect to what was intended. Raising cumstances of how business functions
interest rates had no meaningful effect in a free market economy change over
on OPEC oil prices. The oil inflation time. Economists need to adjust their
still had to work its way through the thinking and the application of prin-
economy. cipals as conditions change to avoid
Since inventories were financed unintended consequences.
with borrowed funds the rate hike in- There is an old story about one
creased the cost of goods sold at each of the world’s top economists who re-
level of the distribution chain. It add- turned to his graduate school to re-

4

Newsletter
August 2010

ceive an honorary degree. While businesses pay their taxes, directly or
there he visited his old economic pro- by having their owners report the in-
fessor, who showed him his current come on owner’s personal return
final exam. (“pass through business entities) pay-
The top economist gasped ing the tax at personal rates, has
when he read it. He told his professor changed how individual tax increases
“don’t you know this is the same ex- effect the economy. These changed
am you gave when I was a student, circumstances need to be taken into
and that fraternities and sororities account in formulating economic pol-
keep copies of old exams to help their icy.
members study for the final?” The In 1960, when John F. Kennedy
professors laughed and said, “don’t proposed across the board broad tax
you understand in economics it’s not cuts, he said, “a rising tide lifts all
the exam questions we change, it’s the boats.” We should be asking what
answers.” type of tax cuts will restore the econ-
To date, the government, faced omy and create jobs, not trying to sink
with a great recession, has responded some of the boats.
in what we would call an “ideologi- In this recovery, ideology ap-
cal” manner. We have debates over pears to be controlling the decision
whether tax cuts should apply to the making process. The result is that the
wealthiest American’s who make over conditions that would facilitate a re-
$250,000 per year. We should be ask- bound are not in place, and we have
ing what type of tax cuts will return plateaued.
liquidity and restore the economy and How will the economy behave
create jobs, not how do we prevent over the next 6 to 12 months? Where
some people from getting tax benefits. we go from here does “depend” on
We need to be practical, not ideologi- what the government does next.
cal. It is true that it takes time, often
Just as changes in how busi- 6 to 8 months for government policy
nesses finance their inventory to impact the economy. The current
changed how higher interest rates ef- economic data suggests that for the
fect the economy, changes in how next six months we will see the econ-

5

Newsletter
August 2010

omy continue to move in the current These examples should be adequate to
narrow range with modest inflation of demonstrate why what the govern-
about 2.5%. An economist would say ment does about these during the next
the recovery (growth in GDP) will six (6) months, could have an enorm-
continue, but at a slowing pass from ous effect on the next five (5) years.
what we have seen. Our foreign policy has not
There are “game changers” on come to grips with many long term
the horizon. In 2011 we are currently economic issues, including China and
scheduled to have at least a trillion currency issues. The effect of a nuc-
dollars in new federal taxes take ef- lear Iran or war in the Middle East
fect. State and local governments are could have a big impact on our econ-
considering tax and fee increases of at omy.
least as much. If the government continues its
Healthcare costs under the re- current policies, it is possible that we
cent legislation are going up substan- will have a double dip recession with-
tially. The oil spill, new regulations in 12 months. If the government
of the financial industry and others pauses in its approach, we should con-
will materially increase costs and re- tinue in our current narrow range.
duce profits. Government depart- If however, the government
ments whose budgets increased over changes policy and focuses on helping
25% in the last 18 months look to fur- the broader private sector create jobs
ther increase spending. The deficit is and stability, then we could rapidly
increasing rapidly. These are but a begin to see a real rebound. Since no
few of the domestic negatives 2011 one can predict which course the gov-
anticipates. ernment will take at this crossroads,
Each of these will withdraw li- you can expect to see continued con-
quidity from the economy. They will fusion among consensus economist.
make it hard for business to obtain For now, you can plan your
funds or increase employment. It will business based on the economy con-
hurt housing. Artificially low interest tinuing on its current course for the
rates will reduce individual income, next 6 to 8 months with modest infla-
buying power, and tax revenues. tion.

6

Are we about to have a double dip recession and run away inflation?

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