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Unemployment (Cont.)

Howard S. Katz
Mar 15, 2010

Some questions were raised by my article on unemployment of last week and so I want to continue the same subject.

Unemployment has become the central issue of our day and perfectly illustrates the genius of Ayn Rand in putting the spotlight on altruism as the central concept which is destroying our society. Today (but not when Rand wrote) the conservatives have adopted the left-wing’s ideas on economics. They are screaming that Obama has failed because, after little over a year in office the unemployment rate is 10%.

The conservatives are doing well in the polls and are looking forward to a big victory in November. Hopefully, Obama will keep talking about health care because every time he opens his mouth about that subject he digs both his own grave and the graves of his fellow Democrats. But if the attention of the American public ever shifts to economics, the conservatives are dead meat.

Last week I touched on cyclical unemployment. This is the kind that makes the headlines and stirs people up politically. For example, from early 2007 to late 2009 unemployment in this country rose from 5% to 10%. From 2000 to 2003, it rose from 4% to 6%. From 1989 to 1991, it rose from 5% to 8%. All of these increases were caused by previous Federal Reserve increases in the rate of interest: e.g., the Fed tightening of 2004-06, the Fed tightening of 1993-2000 and the Fed tightening of 1986-89.

Whenever the Fed changes the interest rate, the effect is to influence interest-sensitive areas of the economy. For example, I have data on the U.S. economy going back to the 1940s. Every time the Fed eases, housing (which is a very interest rate sensitive area) booms. The number of housing starts then goes from approximately 1 million per year to 2 million per year. The same thing happens in all other interest-sensitive areas. The total effect is to significantly reduce unemployment. Then the political left brags that they have reduced unemployment.

Of course, the money that the Fed has to print to promote all this employment then threatens to cause “inflation.” To head off this threat, the Fed then allows interest rates to come back up toward their free market level. Then the interest-sensitive industries suffer a loss of sales, and they lay off workers. In short, the workers are initially drawn into jobs which are fundamentally unstable, and when these jobs disappear, they are thrown out of work again. With regard to housing, I have proof that this has been going on since the 1940s, and chances are that it has been going on for a lot longer than that. Ludwig von Mises coined the term malinvestment to indicate how the central bank is distorting the economy. By analogy, we can speak of malemployment. False employment is created for a few years. It draws workers into jobs which will ultimately disappear. And then, through no fault of their own, they are back on the unemployment rolls.

Who is to blame for this recurrent cycle of unemployment? It is the New Deal version of the Democratic Party, which poses as the party of the working man. Now applying this theory to today, what do we find? We find that interest rates last peaked in 2006 and have made an incredible fall between 2007 and today. This fall in rates will have the same effect it has had every other time. It will stimulate the interest-sensitive areas of the economy. These areas will boom, and they will start to hire unemployed workers. The exact timing on this is hard to predict because it depends on exactly how fast the private banks lend out the money which the Fed is pumping into them. But it is a good bet that we have already seen the peak in unemployment (at the 10% level) and that the official unemployment rate will be down for the remainder of this year.

In short, by drawing the public’s attention to unemployment and saying that Obama has failed to lower it, the Republicans are shooting themselves in the foot. They are also giving credence to the Democratic argument that unemployment is a measure of the economy. It is things like this that give me the impression that everyone is crazy.

Haven’t the conservatives of 2010 heard of a country called the Soviet Union? This was a country that was based on the principle of full employment. The Soviet Union had full employment. However, it did not have (hardly) any wealth. The purpose of an economy is to create wealth. An economy where no wealth is created but there is full employment is a good definition of a prison camp (and this is also a good description of the Soviet Union). Notice that the Soviet Union began to break down its prison camp aspect at the same time that it began to abandon its Marxist (full employment) economic system.

As I noted last week, the free economy of 19th century America had so little unemployment that the language did not even have a word for it until the 1870s. It also produced more wealth than any other society through the entire course of human history. Even this understates the case. Britain and the Commonwealth countries also had a (largely) free economy differing only in having a central bank. And if one compares the English speaking world of that period with the rest of mankind, the wealth gap is absolutely amazing. The English speaking people not only beat the rest of the world. They ran away with the prize.

On the other hand, the full-employment Soviet Union voluntarily dropped out of the race. In 1959, Nikita Khrushchev (head of the Communist Party of the U.S.S.R.) visited the U.S. He challenged the U.S. to a peaceful competition to see which system could produce more wealth (as opposed to the military competition of the Cold War). He predicted that in 25 years the U.S.S.R. would surpass the U.S. in economic production. This prediction was ignored in the West, but it was taken very seriously in the Soviet Union. They had been trying to catch up with the U.S. ever since 1917, and time and again they had failed (badly). Khrushchev gave them one last hope. The leaders of the U.S.S.R. focused on Khrushchev’s prediction. 25 + 1959 = 1984.

What happened in 1984 in the Soviet Union? Its top leaders finally gave up hope of besting the U.S. The Soviet Union finally gave up faith in communism. Communism was not defeated in a great military battle (as many conservatives were looking for). It was defeated from within. In 1989, it abolished itself.

So indeed, we have to ask, why is it that American conservatives are pretty much the only people in the world who are still peddling Marxist economics?

A reader named Mac at asks the following question:

“in regards to stocks and the broader commodities – if we see a pullback/crash in these asset classes, my thinking is that capital will shift back into the US dollar, at least in the short term….I am of the view that it is still possible for gold to take a short-term hit in the event of a global market sell off….I am wondering if a panic in global markets will take the form of ‘sell first, ask questions’ later, where even holders of assets like GLD might start unloading en masse while running to US Treasuries.”

As a theoretical matter, it is important to keep in mind that it is highly unnatural for a stock market to continually go up. In a free market, wealth initially is created by the great producers. Then it passes through to the general public. The stock market is a capital market and, as such, is in competition with all other capital markets. For example for most of the 19th century, safe (what we today call AAA) bonds yielded 5%, and stocks yielded 8%. The extra 3% was what the market felt was a fair return for the extra risk on stocks. This means that the P:E ratio on stocks was always close to 12:1. And since earnings remained constant, stock prices could not climb. (Different companies on the stock market are always in competition with each other. If Ford makes more money, GM probably makes less. For NYNH&H to make more money, other railroads had to make less.)

Charles Dow invented the Dow Jones Industrials in 1896. But he had constructed a rail average as early as 1885. This rail average remained flat from 1885 to 1896. And his Dow Jones Industrials, despite a few ups and downs, did not change from 1896 to 1932. In short, for the 47 years in which the U.S. economy was a free market (and for which we have real time stock prices) these prices did not go up. This validated the prediction made by the free market economists of the 19th century that under a free market (including a gold standard) wealth flows through to the average person and does not remain concentrated in a few hands.

But of course you know what happened next. The U.S. stock market rose by a factor of 341 times between 1932 and 2007. Over the middle of the 20th century, the real wages of the average working man slowed their gains. Once the last tie to gold was cut in 1971, real wages went into the worst decline in American history, and that is the condition which obtains today. That is, it was the revolution instituted by the New Deal to rob from the average working man and give this wealth to the rich people who trade in the stock market. This is, of course, the exact opposite of what you have been taught, and the reason is that your education has been a pack of lies. Whenever there has been a redistribution of the wealth, in any society, at any time in history it has robbed from the poor and given to the rich. (Under the New Deal, the graduated income tax was used to hide this fact, but the wealth transferred via taxes could not approach the wealth transferred in the opposite direction via monetary policy.)

Therefore, the U.S. (and all other) stock market(s) are wildly over priced. If the DJI were to drop to 41 (its 1885-1932 value) or 697 (its 1885-1932 value in real terms), it would be a long overdue correction which would restore the country to economic health. Note the stock bear market of Oct. 2007 to March 2009. It was caused by the Fed tightening of 2004-06. The price structure of the markets is so distorted that even a return to semi-normal interest rates caused a 50% bear market in stocks. What the (U.S. and world) power structure is desperately trying to do is to keep pumping up the markets and prevent such a return to health. However, this gets harder and harder, and we must continually be on the alert for a major stock market decline. This is not imminent and will not occur until Bernanke tightens, but when that happens, it will be beautiful to behold.

Note that gold stocks are affected both by the price of gold and by the price of stocks. They sort of follow a middle-of-the-road path between gold and stocks. So if (when) the U.S stock market tanks, one should switch one’s precious metals portfolio away from gold stocks and into gold or silver bullion.

We will not see another replay of late 2008 where everything went down. That was a very unusual event where the New York Times hit the panic button, scared the blazes out of the entire country and almost caused their own bankruptcy. Their fight with the Boston Globe unions was one for the history books and violated all of the left-wing labor relations principles that they have been preaching to the country for much of the past century. For the most part, gold (and other commodities) can ignore a rise in interest rates for a much longer time than stocks. For example, the Fed tightened in 1973. Over the next two years, the stock market fell almost in half, and the price of gold went from about $65/oz. to almost $200. The Fed next tightened in 1978. From ’78 to ’82, the stock market went sideways, and from ’78 to early ‘80 the price of gold went from $350/oz. to over $800.

A stock market decline will have to be preceded by a Fed tightening, and this tightening will almost certainly be triggered by an outbreak of rising prices (itself caused by the commodity pendulum). When the Fed does tighten, the best strategy will be to be in gold because the lag between the Fed tightening and stocks declining is much shorter than the lag between the Fed tightening and gold declining. You should be in gold, but watching stocks out of the corner of your eye because stock bear markets are easy to predict. They start off slow and build momentum. After a certain point, all signals are lower, and you can safely go short (especially if the play looks to last until October as many stock bear markets end with an October crash).

Thank you for your interest.


Howard S. Katz

Howard S. Katz holds a BA in mathematics from Harvard University. He became interested in Austrian economics and started a successful investment newsletter, The Speculator which focused on gold and gold stocks. He is a lifelong advocate of gold and gold stock investing. Later, he published The Gunslinger for investors interested in gold and gold stocks. In addition, Mr. Katz authored three books on gold, the gold standard and money in politics: "The Paper Aristocracy", "The Warmongers" and the soon to be published "Wolf in Sheep's Clothing". He was involved in the Objectivist movement in New York in the 1960s and was an early member of New York's Free Libertarian Party. Mr. Katz is a contributing author to The Ludwig von Mises Institute where his writings appear along with those of contemporaries Llewellyn H. Rockwell, Jr., Murry Rothbard and Robert Murphy, among others. He has been interviewed on numerous radio programs. He is currently Chief Investment Officer, editor and publisher of the gold and gold stock investment newsletter, The One-handed Economist.

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