By John L. Chapman, Ph.D.

Writing in the New York Times over the weekend, Harvard Professor of Economics Greg Mankiw correctly points out that investment outlays have been weak in the recent recovery, and this has been a reason for lack of robust economic growth and, in turn, job creation the last few years.   Mr. Mankiw, an advisor to the Romney Presidential campaign, points out that

…from the economy’s peak in the fourth quarter of 2007 to the recession’s official end, G.D.P. fell by only 5.1 percent, while investment spending fell by a whopping 34 percent.  ….. The subpar recovery has coincided with a historically weak investment recovery. Compare our recent experience with that of the early 1980s, when the nation last experienced a deep economic downturn in which unemployment topped 10 percent. That recession ended in the fourth quarter of 1982. In the subsequent two years, investment spending grew by a total of 54 percent. By contrast, in the first two years of this recovery, it grew by half that amount.

In addition to a greater volume of capital investment, Mr. Mankiw also cites the need for better trade and regulatory policies: he says the free trade agreement with South Korea, for example, after languishing for four years over Democrat constituency concerns (viz., organized labor, or environmental issues), should be passed immediately, as it would be accretive to growth and job creation right away.  And he points out that the National Labor Relations Board’s objection to Boeing’s billion-dollar plant in South Carolina, thanks to it being non-union, is harmful to all such plans for job-creating investment.

He is precisely correct here as far as he goes, and indeed, he merely ratifies a theme long propounded by economist Robert Higgs.   Mr. Higgs echoes Mankiw’s point and goes even further:

“Gross private domestic fixed investment fell steeply after the second quarter of 2007, and in the second quarter of 2011 it remained 19 percent below its pre-recession peak (emphasis ours).  This figure fails to show how bad the investment situation really is, however, because the bulk of the investment spending now taking place is for what the accountants call the ‘capital consumption allowance’, the amount estimated as necessary to compensate for the wear and tear and obsolescence of the existing capital stock.

“The key variable is net private domestic fixed investment—the investment that builds the productive private capital stock. Quarterly data through this year are not currently available…. but the annual data show that an index of its real amount peaked in 2006, fell substantially in each of the following three years, and recovered only slightly in 2010, when the index showed net private domestic fixed investment was running about 78 percent below its level in 2005 and 2006 (emphasis ours).  Here is the true reason for the recession’s persistence.”

To reinforce his point, Higgs goes on to point out that the Keynesian fear of aggregate demand drop-off due to declining consumption is not operative at this point either: according to data from the U.S. Labor Department’s Bureau of Economic Analysis, real personal consumption expenditure (PCE) recovered from its recession decline by the fourth quarter of 2010. Higgs adds, “Continuing to grow, PCE now stands (as of the most recent data, for the second quarter of 2011) even farther above its pre-recession peak.”   And of course, government spending is well above its pre-recession peak in real terms.  Why then the lag in investment pick-up?  Mr. Higgs answers this in a more forceful manner than the diplomatically-inclined Mr. Mankiw: Higgs calls it regime uncertainty, which is a fancy way of saying “fear”.   Like FDR before him, President Obama has forced scarce capital to the sidelines, as if the U.S. economy were burdened by an exogenouosly-produced storm that was beyond our control.    But of course that is not correct, and as Mr. Mankiw rightly notes, better policies will induce job-creating investment once again.

Given the foregoing, why does this writer have a quibble with Mr. Mankiw?   Because of two glaring omissions to his thesis, one major, and one minor.  The elephant in the room that Mr. Mankiw misses is the unfortunate plight of the U.S. dollar, and the lousy monetary policy that has produced it.  Indeed, it is always interesting to observe how the greatest minds in the economics profession view the world, and process reality.  Perhaps showing his biases too glaringly, Mr. Mankiw does not so much as mention the dollar or monetary policy.  But he cannot be oblivious to the fact that one of the reasons for weak investment in the U.S. is a weak dollar (which itself is a proxy metric for US economic policy as a whole), and that investors have no faith in the Fed’s (or Treasury’s, together) maintaining the international trade value of the dollar.  Fed Chairman Bernanke gave lie to his biases in a speech in Minneapolis last week, when he stated in response to a questioner that for him, a strong dollar was embodied in a relatively flat consumer price level.  Well, sir, we certainly have had that in the last decade and more — but can anyone other than Messrs. Bernanke and Greenspan claim that monetary policy has been optimal in that time?  Indeed, the trade-weighted value of the U.S. dollar has declined 38% in this millenium, and a terribly unfortunate inflation in the quantity of money and credit in the dollar-zone revealed itself over time in inflated housing and financial asset prices, thanks to falsified interest rates that were courtesy of the U.S. Federal Reserve.  Is New Keynesian Greg Mankiw purblind to the huge mistakes of the Fed during this period?

Indeed, there has never been an historical example of economic growth sustained over time alongside a weak and vacillating currency.  As such, the self-repeating intellectual error — that has Keynesian roots — that a manipulated currency and its devaluation can be good for exports and growth must be exposed for the fraud that it is: as an easy example that makes the point, Japan’s greatest era of explosive growth, circa 1960-90, occurred when the yen-dollar ratio went from 360:1 to 83:1.  A strong currency encourages intra-country investment that induces growth and the saving that feeds it: a weak currency breeds inflation or mis-priced capital assets that eventually scares away, if not destroys, real capital investment.  Sound money is a necessary, albeit not a sufficient, condition for strong economic growth.

The “minor” item we wish that Mr. Mankiw had mentioned, of course, is out-of-control federal spending, which is not unrelated to monetary policy: indeed, the Fed’s monetary profligacy has long aided and abetted fiscal promiscuity (alliterated to make a point).  Any sustained recovery in the U.S. economy must per force include a new commitment — and a credible one — to fiscal conservatism.

We salute Greg Mankiw’s quite correct concern over lack of investment in recent years.  Its occurrence is a manifestation of a huge and disappointing gap in the thinking of the Obama Administraion.  But even as we recommend his fine textbook to any serious student of macroeconomics, we ask him as well to never fail to point out the seminal importance of a return to a sound dollar as equally important — and something our solons in Washington could fix tomorrow, were they ever to apprehend their own culpability in the present economic torpor.

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Dr. Chapman is reachable at