Sunday, October 20, 2019

Uncertainty Creates Its Own Reality

Uncertainty Creates Its Own Reality 

William Rapp 
Director, Leir Center For Financial Bubble Research 

On a macro-economic level, we exist in a circular cash flow economy. When the economy is growing this leads to greater employment, which means there are more wages to be spent. Increased spending puts pressure on supply that leads to more investment and employment and thus more wages to be spent. It may also lead to increased borrowing and depending on the central bank higher interest rates to slow the economy and moderate inflationary pressures. Any fiscal stimulus can add to this circular cash-flow process by increasing employment directly or indirectly through increased purchases plus through tax cuts that increase after tax income. 

But currently this circular flow of cash seems to be slowing despite lower interest rates and a big fiscal stimulus from massive tax cuts. Why? One obvious reason is the uncertainty surrounding the current environment due to the US trade and tariff wars with not just China but Japan, Canada, and the EU as well. When business executives or consumers face an uncertain economic environment, they naturally become less certain, less optimistic and more cautious. They then postpone major decisions until more information is available. 

Check declining auto sales; reduced consumer confidence [Michigan Index]; fewer job offerings [“US employers advertised 7.1 million available jobs in August, down 1.7% from July's figure of 7.2 million, the Labor Department said. August was the third consecutive month of declining job openings”]; declining new hires per month, factories operating below capacity; low interest rates; low inflation; continued wage stagnation, slowing GDP growth domestically and globally. 

However, it is not just the trade and tariff wars. As Engels explained in the 19th Century the Marginal Propensity to consume out of additional income declines with higher income and wealth. It may even approach zero for the super-rich. Thus, the large US tax cut that increased after tax income for the wealthy or corporations that then mostly used the funds for higher dividends or stock buybacks did little to stimulate the economy’s circular cash flow. 

There was never any real capital constraint on businesses in terms of investment. Before the tax cut capital was readily available in abundance at ultra-low rates. Indeed, one might view the rise of the unicorns or the recovery of Greek credit as confirming this view. Since the fiscal stimulus was not spent continued slow growth and low inflation were then inevitable. Add the uncertainty of trade wars and slower growth in other countries and a more cautious economic environment has arrived.

This is not a static situation, though. The greater caution that results in fewer new hires and less investment means slower growth in the cash flow running through the economy. This leads to more caution and slower growth or even stagnation and then recession. This is how uncertainty can create its own negative reality just as confidence and optimism can create a more positive outcome. Those latter factors, though, currently seem in short supply. 

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