QUERETARO, Mexico, Nov. 6 (UPI) -- You can't fool people: that might be a definition of the rational expectations school of economic thought that first emerged in the 1960s. To this observer, the idea has always looked wrong. There seems to be plenty of foolishness around. Yet perhaps "rational expectations" goes some way to explaining why the doubts persist about the current 'recovery' in the U.S. economy.
"Rational expectations undermines the idea that policymakers can manipulate the economy by systematically making the public have false expectations," writes Professor Thomas Sargeant of Stanford University.
In the rational expectations view, spend more government money and the public, wise to what the government is doing, will realize that the government deficit is going up, the government will be carrying more debt and spending cannot keep being raised (but might have to be cut on useful things in order to be able to afford that debt servicing.) Raise the money supply to an inflationary level and the public will realize that the value of its money is being diluted.
But is man rational? This column spends much time pointing at what is far from rational. Was the stock boom of the second half of the 1990s rational? Perhaps, as Abraham Lincoln said, you can fool some of the people some of the time.
Can you fool Norbert Ore? Ore is the head of the U.S. Institute of Supply Management's monthly survey of activity by manufacturers. "This is the best report that we have seen in quite some time in terms of the overall strength of manufacturing. The picture continues to improve, and it appears that manufacturing will finish 2003 on a very positive note, assuming the recent trend continues," said Ore in a press release Monday accompanying the ISM's October figures.
"Assuming the recent trend continues," seems to us a wise caveat from Ore. He was also quoted as saying, "This is not a typical recovery by any means."
Why not? What Ore was referring to was the fact that the pick up in activity and orders and exports in manufacturing had not yet led to a pick up in hiring. So that while the overall Purchasing Managers Index for manufacturing registered a very positive 57 percent in October -- above 50 indicates expansion -- the employment index remained at just 47.7 percent.
The ISM's data is not the only data to point to the continuing reticence of employers to employ. On the contrary, firms seem still to want to cut jobs. According to the October survey released on Tuesday by the job placement firm Challenger, Gray & Christmas, U.S. firms planned to cut 171,874 jobs in October, more than double the 76,506 layoffs planned in September. This was the worst figure released by the firm since the 176,010 job cuts of October 2002.
The bad news on jobs is all the more worrying because it coincides with strong economic growth.
The U.S. economy grew at an annualized rate of 7.2 percent in the third quarter, the government announced last week. Consumer spending rose at a very high annualized rate of 6.6 percent. Two percentage points of that growth were supplied by consumer spending on durable goods, which was up at an annualized rate from the previous quarter of no less than 26.9 percent following a previous rise in the second quarter that was almost as large. Have tax break, will spend. Whoopee! (But is that rational?)
Firms, meanwhile, are selling goods and even investing more in order to produce more. "Equipment and software" investment rose by 14.4 percent in the third quarter. And yet the confidence to hire staff is not there. Perhaps firms do no believe the recovery can be sustained. Why not?
It may come back to rational expectations. Consumers and employers all know that the U.S government of President George W. Bush has paid out tax rebates this year in what was initially billed, in the presidential campaign of 2000, as a principled returning of surplus money to its rightful owners but which has now become a deficit-inducing effort to get the economy moving. But how much more of this giving back is coming? Rational man would be right to conclude that there can be little or no more by way of government rebates. The federal government is moving towards a half trillion dollar deficit. State governments are trying to cut their deficits. Municipal governments are doing the same: seeking desperately to balance the books.
And what about another boom that can't keep going? The housing one. In the 7.2 percent growth of the third quarter, residential investment provided 0.9 percentage points -- an unusually large role for housing in growth. Housing activity and prices have set fresh records this summer. All that refinancing and house purchasing and house furnishing is a big source of buoyancy for the U.S. economy. But the "affordability" of housing, the key determinant of this phenomenon, is falling.
The National Association of Realtors said in a press release on Monday that its housing affordability index fell to 136.6 in the third quarter of 2003 from 143.8 in the second quarter. This was the lowest reading for the index since the 135.3 of the third quarter of 2002. The NAR's chief economist, David Lereah, said that "During the first half of this year, the housing affordability index experienced the highest levels in 30 years."
"Affordability" is going down because mortgage interest rates have risen from the remarkable lows of May to June this year. Mortgage applications reflect the rise in rates. The Mortgage Bankers Association said Wednesday, that its index for loan applications in the most recent week was down by 34.3 percent compared with the same week one year earlier. It is a big decline.
The fuel behind the 7.2 percent growth in the thrid quarter is running out. Growth is going to fall back. But the government deficit and house buyers' huge mortgages will remain. And house prices are up in the stratosphere, the trade deficit is at a record level, the stock market is at a sixteen month high.
If you were rational, you might think that we are not at the beginnings of recovery but at the peak -- of a little, expensively-bought, entirely false 'recovery.'
Global View is a weekly column which reflects on issues of importance for the global economy. Comments to [email protected].
