Mr. Geithner, Meet Econ 101

Posted: Aug 13, 2011 12:01 AM

Here’s an economic primer for the weekend. 

Periodically, as my old economics professor John Kenneth Galbraith used to say: “Sometimes, it’s good to return to Econ 101” (aparaphrase.) 

In other words, make it simple, because after all, it really is. 

The cycle of growth starts with demand, and to most people that’s understood as sales.  Another old mentor of mine once said: “Nothing happens until you sell something.”

That statement from an old tool and die maker is just as profound as the statement from one of the world’s most renowned economists, JKG.  Yet, it’s important to understand that sales can be misleading. 

For example, much of what we are seeing today is the result of the consumer not paying their mortgage, not paying theirmproperty taxes, and not paying their credit card bills.  In fact, they’re maxing-out their credit cards. 

Circumstances have provided a window of opportunity for people to choose to abrogate their debt responsibilities in order to buy the newest iPad.  Historically, nobody would have ever thought to strategically default on their debt, yet today, it’s a widely accepted practice. 

These kinds of discretionary sales, however, are fleeting,and dictate why businesses are currently not hiring. 

Imagine if you owned a business and believed that sales will ultimately decline.  As a result, you would be very hesitant to reorder product. Without reordering, not counting inventory build, there would be less need for production. 

Here’s where it gets a little complicated.  Most people think of production asproductivity, whereas productivity is producing more with less man-hours.  Production is just simply manufacturing a product, regardless of the number of employees involved. 

With decreased sales, overtime shifts disappear as production plants sit idle week after week, month after month, and year after year. 

Obviously, if the production facilities are too expensive to maintain you would be forced to take action by downsizing employees or moving production offshore where labor costs are dramatically lower.  (Unfortunately, most small businesses can’t implement the offshore strategy.) 

Next, decreasing employment leads to reduced personal income.  Regrettably, as taxes rise and day-to-day costs (food and gasoline) go up, workers need not only a secure income, but also an increasing income, just to keep pace. 

Given that unemployment is a corporate strategy (witness Cisco’s stock rise after announcing 6,500 layoffs) and will be with us for many years (Bernanke’s Federal Reserve) it only stands to reason that for the foreseeable future it will be very difficult for most people to afford the necessities, let alone any discretionary spending, and thus no sales. 

It’s simple. 

No sales, no production, no production no employee, no employee no increasing income, no increasing income no sales, and on and on. 

A very vicious cycle. 

In fact, a cycle Japan has been experiencing forover twenty years.  Unfortunately, ourcruel cycle has just begun.         

Yes, it’s good to revisit Econ 101, but it can also be extremely painful.

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