ECONOMYNEXT  – US markets tumbled, initially spooked by tech stock layoffs, amid what is claimed as fears of jobs losses and a recession, are outcomes that economists have shown to be the automatic consequences of full employment policies.

On Monday, the Dow Jones Industrial Average fell 1,033 points, which is only 2.6 percent, and the S&P 500 lost 3 percent and the Nasdaq composite 3.43 percent on top of losses last week as fears of unemployment rose.

Though financial media is portraying the fall as a failure of the Fed to cut rates in time, non-macroeconomists have long pointed out that the manufacture of unemployment by the Fed is an automatic consequence of full employment policies favored by ‘economists’ since Keynes.

That the Fed printed money and delayed rate hikes to claiming inflation was due to supply chain blocks and Putin is forgotten.

That the US was ripe for turmoil was repeatedly warned by classical economists including Steve Hanke. Hanke, who predicted the 2022 inflation very close to target, also warned that a recession was ‘baked in the cake’ given money supply developments.

Related Sri Lanka could get hit from a disorderly US tumble: Bellwether

One classical economist who clearly explained the outcome of inflationary policy was Friedrich Hayek, who debated with J M Keynes when they were both alive before and after the consequences of such policies were widely known.

The Manufacture of Unemployment

The ‘independent’ Fed has created several big crises, including the 1960s inflation which ended in the collapse of the Bretton woods and Great Inflation, oil shocks and the Housing Bubble which led to severe unemployment and more state interventions.

The original peacetime Great Depression which came in the wake of the invention of the policy rate and open market operations in the 1920s, was triggered before formal independence was given to the agency in 1951 through the Fed Treasury Accord.

“The truth is that by a mistaken theoretical view we have been led into a precarious position in which we cannot prevent substantial unemployment from re-appearing,” Economist F A Hayek said in his Noble prize-winning lecture in 1975 as the Bretton Woods lay in shambles and the ‘independent’ Fed was mired in Great Inflation without a credible anchor.

“Not because, as my view is sometimes misrepresented, this unemployment is deliberately brought about as a means to combat inflation, but because it is now bound to appear as a deeply regrettable but inescapable consequence of the mistaken policies of the past as soon as inflation ceases to accelerate.”

Hayek was one of the economists who challenged Keynes in the 1920s but failed to convince him, leading to widespread currency collapses in the 1930s and retaliatory import protectionism.

After World War II as macro-economists wound up politicians, he gave comprehensive warnings against what is now called stimulus.

In 1946 the US had already enacted the Employment Act which mandated all agencies to help boost employment, which was interpreted as applying to the Fed as well leading to what is now known as the dual mandate.

Misdirected Jobs

The “manufacture of unemployment by what are called ‘full employment policies’ was a complex process, Hayek explained.

“During a process of expansion the direction of demand is to some extent necessarily different from what it will be after expansion has stopped,” explained Hayek as far back as 1950 in Full Employment Planning and Controls.

“Labour will be attracted to the particular occupations on which the extra expenditure is made in the first instance. So long as expansion lasts, demand there will always run a step ahead of the consequential rises in demand elsewhere.

“And in so far as this temporary stimulus to demand in particular sectors leads to a movement of labour, it may well become the cause of unemployment as soon as the expansion comes to an end.”

Among key areas are capital goods sectors. Property is a key area where printed money flows and unemployment starts as soon as inflation stops leaving half-built buildings.

Financial sector and bank collapses is another area. IT has been a prominent area to collapse in the last two decades of the century.

Arrears of Unemployment

“Any attempt to create full employment by drawing labour into occupations where they will remain employed only so long as credit expansion continues, creates the dilemma that either credit expansion must be continued indefinitely (which means inflation) , or that, when it stops, unemployment will be greater than it would be if the temporary increase in employment had never taken place,” Hayek explained.

“If a policy is pursued over a long period which postpones and delays movements, which keeps people in their old jobs who ought to move elsewhere, the result must be that what ought to have been a gradual process of change becomes in the end a problem of the necessity of mass transfers within a short period.

“Continued monetary pressure which has helped people to earn an unchanged money wage in jobs which they ought to have left will have created accumulated arrears of necessary changes which, as soon as monetary pressure ceases, will have to be made up in a much shorter space of time and then result in a period of acute mass unemployment which might have been avoided.”

Alan Greenspan, who has been blamed for ignoring the ’employment’ leading to a loss of industrial jobs (de-industrialization so-called), but created Great Moderation and some of the lowest levels of unemployment in the last century amid a productivity boom.

“He had a reputation for being strongly anti-inflation, focusing more on controlling prices than on promoting full employment,” according to the Federal Reserve itself.

Greenspan’s last term however led to a massive bubble, as the economy was reflated under the influence of Ben Bernanke, who was a ‘depression scholar’, triggering inflation to counter productivity which ended in what is now called housing bubble.

Controls and State Planning

While floating regimes see commodity and asset price bubbles as well as retail inflation when rates are suppressed with printed money, central banks with reserve collecting countries in Sri Lanka or Bangladesh see forex shortages, reserve losses and depreciation.

They are also buffeted by commodity bubbles fired by reserve currency central banks.

Monetary stimulus also leads to varied government controls, ranging from import to exchange controls to price controls as the effect fall upon the public. Price controls in particular would lead to further dislocation of industries and employment.

“As is regularly the case in such circumstances, the governments will then find themselves forced to take measures to counteract the effects of their own policy,” Hayek explained.

“The effects of the inflation have to be contained or “repressed” by direct controls of prices and of quantities produced and sold: the rise of prices has to be prevented by imposing maximum prices and the resulting scarcities must be met by a system of rationing, priorities and allocations.

“It is usually a particularly pernicious kind of planning, because not thought out beforehand but applied piecemeal as the unwelcome results of inflation manifest themselves.”

In Sri Lanka import controls led to the collapse of many businesses, ranging from television repair shops which were without parts to larger industries. Price controls led to the collapse of poultry egg producers.

One of key fallout of macro-economics, whether employment or potential output is targeted by printing money, politicians pay a price while macro-economists escape.

In Sri Lanka the International Monetary Fund gave technical advice for macro-economists to calculate potential output in 2015 as inflationary policies found favour in the US again in the wake of the housing bubble as the Great Depression influenced Keynes.

In countries with reserve collecting central banks, currency depreciation promoted by the International Monetary Fund since 1978 has led to outmigration,

Domestic employment reduced compared to the 1970s as controls were taken off. Out migration in countries like Sri Lanka reduces the overall unemployment rate.

Political Upheavals

Hayek warned that the prescriptions of macroeconomists in keeping rates low with printed money, will lead to political and social upheavals.

“The great problem in all those instances is whether such a policy, once it has been pursued for years, can still be reversed without serious political and social disturbances,” he said.

“As a result of these policies, what not very long ago might merely have meant a slightly higher unemployment figure, might now, when the employment of large numbers has become dependent on the continuation of these policies, be indeed an experiment which politically is unbearable.”

Rate cuts in Sri Lanka led to the ouster of then President Gotabaya Rajapaksa. At the time the lack of an IMF program was blamed, though understanding of rate cuts were there.

In Sri Lanka tax cuts were also blamed. Tax cuts only lead to higher interest rates. External troubles and depreciation were blamed on not having an IMF program in place.

In Bangladesh, the currency collapsed after two years of forex pressure from macro-economists keeping rates low as the economy recovered and a further steep depreciation under an IMF program two months ago.

In most countries the administration that implements “stabilization policies” also gets kicked out, if they are identified with the original inflation or the currency continues to depreciate.

Sheikh Hasina had to flee the country, after trying and failing to put down the country’s version of Aragalaya. Some ruling party people had blamed Gotabaya Rajapaksa for not acting decisively to put the ‘aragalaya’ by using the military.

However, given the consequences of Bangladesh attempting to put down a struggle by violent means, Rajapaksa seems to have taken the correct decision.

Sri Lanka’s inflationary policies, whether severe import and exchange control backed policies of the 1970s which led to unemployment of 20 percent or constant currency depreciation has led to steady outmigration from the 1980s which masked the unemployment rate, macro-economists escape the consequences.

Economists or macro-economists write the narrative and the blame is put on politicians and deficits.

The Lost Generation Returns

Hayek warned in 1975 that the temporary backlash against macro-economics would only be temporary since universities would continue to teach that inflation was necessary for growth.

This can be seen in Sri Lanka legislating potential output into the new IMF backed central law as well as the 5-7 percent inflation target as a consequence to get that ‘output’.
In each monetary policy statement, the term potential output looms

To give the central bank credit, it has not yet triggered 5 percent inflation, and the exchange rate has been stable.

Hayek warned that while macro-economists were “beginning to discover its fatal intellectual defects which they ought to have seen all along,” in the 1970s, it would only be temporary.

“Yet I fear the theory will still give us a lot of trouble: it has left us with a lost generation of economists who have learnt nothing else,” he wrote in Choice of Currency.

“One of our chief problems will be to protect our money against those economists who will continue to offer their quack remedies, the short-term effectiveness of which will continue to ensure them popularity.

“It will survive among blind doctrinaires who have always been convinced that they have the key to salvation.”

In most countries, the narrative of an economic collapse is written by macro-economists themselves, and the original trigger – inflationary rate cuts – to target employment, growth or nominal inflation rates of 5 percent or more is forgotten.  (Colombo/Aug06/2024)