After the headline rate of unemployment (U-3) reached 8.5 percent in December 2011 ( the most recent month reported), some commentators began to talk as if the employment situation is now improving rapidly. Some have gone on to suggest that those of us who have emphasized the role of regime uncertainty in retarding the current recovery are now barking up the wrong tree, if indeed we ever had a valid point. To speak of employment woes as old news, however, is highly premature.

The Labor Department has recently made public its preliminary estimate of nonfarm employment for 2011. I have added the department’s data for previous years, back to 1999, to construct this table.

Employees on nonfarm payrolls, 1999-2011

(annual average, in thousands)

Year Total Private

1999…… 128,993 108,686

2000….. 131,785 110,995

2001…… 131,826 110,708

2002…… 130,341 108,828

2003…… 129,999 108,416

2004…… 131,435 109,814

2005…… 133,703 111,899

2006…… 136,086 114,113

2007…… 137,598 115,380

2008…… 136,790 114,281

2009….. 130,807 108,252

2010…… 129,818 107,337

2011(p).. 131,159 109,080

The good news is that private nonfarm employment has grown since its recent trough in 2010: the increase in 2011 amounted to 1.6 percent. This is not much, but it’s better than continued decline.

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Elizabeth Warren, the Democratic candidate for the U.S. Senate in Massachusetts, recently created a media flap when she said:

There is nobody in this country who got rich on his own. Nobody. You built a factory out there—good for you!

But I want to be clear. You moved your goods to market on the roads the rest of us paid for. You hired workers the rest of us paid to educate. You were safe in your factory because of police forces and fire forces that the rest of us paid for. You didn’t have to worry that marauding bands would come and seize everything at your factory, and hire someone to protect against this, because of the work the rest of us did. Now look, you built a factory and it turned into something terrific, or a great idea—God bless. Keep a big hunk of it.

But part of the underlying social contract is you take a hunk of that and pay forward for the next kid who comes along.

Conservatives and libertarians took offense at Warren’s claim that the government has a superior claim to “a hunk” of people’s earnings merely because every individual lives in and benefits from a society to whose creation many other people have contributed.

The critics might well have been grateful for small blessings, however. Warren was prepared, rhetorically at least, to let people keep “a big hunk” of their earnings.

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From time immemorial—from Etienne de la Boitie to David Hume to Ludwig von Mises—political analysts have noted that because the number of those in the ruling elite amounts to only a small fraction of the number in the ruled masses, every regime lives or dies in accordance with “public opinion.” Unless the mass of the people, no matter how objectively abused and plundered they may appear to be, believe that the existing rulers are legitimate, the masses will not tolerate the regime’s continuation in power. Nor need they tolerate it, because they greatly outnumber the rulers, and hence whenever they become subjectively fed up, they have the power—which is to say, the overwhelming advantage of superior numbers—to oust the regime. Even if the regime possesses a great advantage of coercive power, its employment avails the rulers nothing if they must kill or imprison 90 percent of the population, because such massive violence would reduce them to the status of parasites without hosts.

This consideration long seemed to make sense as a critical element of political analysis, and even today one often encounters it. Something akin to it seems to motivate the current Occupy Wall Street movement and its spin-offs in other venues when they represent themselves as members of the (exploited) 99 percent, in opposition to the (exploiting) 1 percent.

Certain long-established trends in the welfare state, however, have progressively weakened the force of this analysis. The main element of these trends is the tremendous growth in the number of people (and in their proportion in the population) who are directly dependent on government benefits to a substantial degree. Researchers at the Heritage Foundation have been tracking this development for several years and have pushed their analysis back for several decades. An index of dependency based on this research increases from 19 in fiscal year 1962 to 272 in fiscal year 2009.

The Heritage index uses information on almost three dozen important federal programs on which Americans depend for cash income and other support—including housing assistance, Medicaid, Medicare, Social Security, unemployment insurance benefits, educational benefits, and farm-income supports—but it is scarcely a comprehensive measure, inasmuch as the total number of federal programs with dependents is gigantic at present. Of course, each such program has government employees and contractors who run it and hence depend on it to earn much, if not all, of their income. Government civilian and military retirees add millions more to the ranks.

The Heritage researchers found that in 1962, 21.7 million persons depended on the programs they included in their index for benefits. By 2009, the corresponding number of dependents had grown to 64.3 million. Adding dependents not included in the Heritage study might easily increase the number to more than 100 million, or to more than a third of the entire population. Thus, the parasites verge ever closer to outnumbering their hosts.

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About a month ago, I posted in regard to what I called “the euthanasia of the saver.” This comment had to do with the fact that nominal interest rates in the United States for financial investments such as bank certificates of deposit and bank savings accounts—the kinds of investments traditionally employed by retired persons and small savers, who wish to gain income without exposing their funds to great risk of capital loss—now fall considerably below the rate of inflation, and hence the real (or inflation-adjusted) yield on such investments is negative. That is, the nominal payoff is insufficient to offset the loss of purchasing power of the money invested.

About a month before I wrote my commentary, my old friend Richard Rahn had, without my noticing, written on the same issue in a commentary article published in the Washington Times, but he had gone beyond the simple point I made. Rahn notes that besides suffering the loss of wealth occasioned by the negative real yield on such investments, the investor has to pay tax on the nominal yield—truly a case of the government’s adding insult to injury. He notes that given the currently prevailing rates of interest, rate of inflation, and tax rates, a small investor who earns a nominal yield of 1% and pays a 20% marginal tax rate, while the rate of inflation is 3.5 %, actually ends up paying a real tax rate of 370%. For example, an investor buys a $100,000 CD, earns $1,000 in annual interest, pays a tax of $200, and incurs a loss of $3,500 in purchasing power on the invested principal. Total (nominal) income is $1,000; total real tax (nominal tax plus inflation tax) is $3,700.

This expropriation of private wealth is not accidental.

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When I introduced the concept of regime uncertainty in 1997, attempting to improve our understanding of the Great Depression’s extraordinary duration, I anticipated that many people—especially my fellow economists—would not welcome this contribution. Their primary objection, I ventured, would be that the concept remained too vague and, most of all, that it had not been reduced to a quantitative index of the sort that modern mainstream economists customarily work with, especially in their empirical macroeconomic analyses.

My argument did not lack evidence, however, and I regarded the agreement of several different forms of evidence as an important element of the argument’s force. The evidence I adduced with regard to changes in the yield spreads for high-grade corporate bonds of differing maturities seemed to me both systematic and especially compelling, though not decisive because alternative explanations of those changes might be offered. (I considered several such explanations and rejected them as unpersuasive in one way or another.) Recently, in my application of the concept of regime uncertainty to help us understand better the persistent economic troubles since 2007, I again advanced several different kinds of evidence, including as before an analysis of changes in the yield curves for high-grade corporate bonds. This time, too, the evidence is consistent with the underlying argument.

Nevertheless, the argument scarcely gained widespread assent, and most analysts either ignored it completely or, like Paul Krugman, dismissed it as a fairy tale—in his view, the sort of wholly fictitious notion that would be peddled only by think-tank whores in the pay of Republican plutocrats. (I trust that everyone who knows me will see how closely I fit this template.)

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Commentators and pundits, some of whom ought to know better, continue to harp on the idea that the recession persists because consumers are not spending. Every Keynesian seems to believe that because consumers are in a dreadful funk, only government stimulus spending can rescue the moribund economy, given (to them, at least) that investors will not spend more because the Fed, having already driven interest rates to extraordinarily low levels, cannot use conventional policies to drive them any lower and thereby elicit more investment spending.

People, please look at the data. They are conveniently available to one and all at the website maintained by the Commerce Department’s Bureau of Economic Analysis, the outfit that generates the national income and product accounts for the United States.

According to these data, real personal consumption expenditure recovered from its recession decline by the fourth quarter of 2010. Continuing to grow, it now stands (as of the most recent data, for the second quarter of 2011) even farther above its pre-recession peak.

Real government expenditure for consumption and investment (this concept does not include the government’s transfer spending, such as unemployment insurance benefits and social security benefits) is also running higher than its pre-recession level. In the second quarter of 2011, it was running more than 2 percent higher (recall that this is “real,” or inflation-adjusted spending; nominal spending has grown substantially more).

The economy remains moribund not because consumption spending has failed to recover and not because government spending has failed to increase, but because the true driver of economic growth—private investment—remains deeply depressed. 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. 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.

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Once upon a time in a land far, far away, there was a country famous for its apples. In fact, it produced nothing but apples and so was called Appleonia. The people ate many apples in many different ways: raw apples, baked apples, apple pies, apple fritters, and candied apples, to name just a few. They found lots of different ways to use their apples, even as fuel.

But Appleonians didn’t consume all of their apples. They saved lots and lots of apples for their seeds so they could enlarge their orchards and grow more and more. For hundreds of years, the Appleonians consumed lots of apples and made their orchards bigger and bigger. Everyone in Appleonia worked in the apple business and prospered.

It turned out though that not every place in Appleonia was perfect for growing apples. Some areas were filled with worms that just loved apples. Little by little, the worms began to infest the orchards. No one noticed until one day a young boy opened a barrel and, taking a big bite out of an apple, bit right into a worm. Undeterred, he picked up another, with the same result, and another and another. At last he found an apple that was as good inside as it was outside.

But word spread quickly that there were worms in the apples and that the worms seemed to be spreading from orchard to orchard. People quit harvesting in the infested areas and, even worse, they could no longer guarantee the high quality of their apples as they had in the past. For the first time, they produced fewer apples, and many people were put out of work.

The Appleonian government grew very worried and, after brief consultation with academic experts, came up with an idea. To put people back to work and restore faith in the apples, the government hired lots of people to polish all the rotten apples. Of course, this didn’t really work: the polished apples may have looked better on the outside, but they were still rotten on the inside. Things didn’t get any better. People were still out of work, and the quality of the apples was still hit and miss. Government officials came up with another plan. They hired another bunch of people to spray a thin layer of wax on the rotten apples. Again, their remedy was superficial: the bad apples may have looked gorgeous, but they were still rotten on the inside, and hence worthless.

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Someone must have imagined that my hopes for improved economic understanding might be excessively optimistic and thus needed to be curbed to restore my normal emotional balance, because that person undertook to smash any such hopes to dust by e-mailing me a link to a Huffington Post article by Paul Abrams, “Economically, World War II Was Stimulus on Steroids.” This screed turns out to be an ostensible macroeconomics lesson composed in equal measure of economic foolishness, historical ignorance, and ideological tendentiousness — the veritable epitome of a worse-than-worthless contribution to public enlightenment.

The opening paragraphs indicate the direction of Abrams’s argument:

The next time someone argues that the New Deal failed, and only the Second World War ended the Depression, as ‘proof’ that government spending does not work, one can respond with the details of economic growth and unemployment reduction up to 1940, or one can ignore the claim and thank them for making your case for massive government spending in a deep, broad recession.

Right wing politicians are loathe to credit the New Deal with any success in hoisting the United States out of the Great Depression, but credit World War II for that achievement, believing that that somehow disproves Keynesian economic theory.

That claim, however, undermines their entire premise.

Abrams concludes that “massive government spending at a time of severe economic downturn and dislocation can indeed get an economy humming again,” as World War II shows; the New Deal was merely too timid. He seems unaware that his argument merely restates the fallacy-ridden hodge-podge of conventional wisdom about how World War II “got the economy out of the Depression” that has dominated the thinking of economists, historians, and the public ever since the war itself.

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For weeks, we have been treated to comic opera in D.C.’s theater of the politically and economically absurd. On the stage, the actors—President Obama, the Secretary of the Treasury, congressional leaders—hop about, shouting moronic lines about the national “default” that will occur unless the government’s statutory debt limit is raised, reciting Chicken Little lines about how such a default will trigger worldwide economic catastrophe. According to a report in the July 5th issue of the Christian Science Monitor,

Facing an Aug. 2 deadline, Congress and the White House are stepping up face time to avert what the Treasury Department has called “catastrophic economic and market consequences” of a default on the national debt.

Think about this statement. Have governments defaulted in the past? Of course, they have, on hundreds of occasions over the centuries. Have these defaults triggered “catastrophic economic and market consequences”? No. When a government defaults, there are consequences, of course, including heightened reluctance of lenders to lend to the deadbeat government in the future or at least to lend at such favorable interest rates. Often partial payments of principal and interest are arranged or debts are restructured. The world keeps spinning.

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For thousands of years, philosophers have told us that if we are to live our lives at their best, we should seek truth, beauty, and goodness. Of course, each of these qualities has raised thorny issues and provoked ongoing arguments. That people have carried on such arguments, rather than surrendering themselves to their raw appetites and animal instincts, may be counted a valuable thing in itself. A final resolution of such deep questions may lie beyond human capacities.

In regard to goodness and beauty, I have nothing worthwhile to add to the discussion. For guidance in seeking goodness, we may look to saints, theologians, moral philosophers, and moral exemplars of our own acquaintance. For demonstrations of beauty, we may turn to nature and to artists, great and small, who have adorned our lives with the grace of music, poetry, and the visual arts. My own professional qualifications, as an economist and an economic historian, do not equip me to contribute anything of value in these areas.

I do feel qualified, however, to speak with regard to truth, because the search for truth has always served as the foundation of my intellectual endeavors. Moreover, my study, research, and reflection within my own professional domains have brought home to me a relationship that others might do well to ponder and respect―a relationship, indeed, an array of relationships, between truth and freedom, such that anyone who seeks the triumph of truth must also seek to establish freedom in human affairs.

When I began my academic career in 1968, my research specialty was the economic history of the United States. I was expected to publish the findings of my research in reputable professional journals. For a young man just beginning to master his field, carrying out publishable research was a daunting task. Thousands of other writers had already contributed to building up the literature in my field, so adding something of enough importance to merit its publication in a good journal was hardly an easy task.

I discovered, however, that one way to proceed was by identifying significant mistakes in the existing literature and correcting them. Moreover, I soon found that many such mistakes had been made. To put this statement in another way, I found that the existing sources often failed to tell the truth about one thing or another, and in some cases the falsehoods propounded by one writer led later writers, who relied on those false statements, to make errors of their own.

We often think of the scientific or scholarly enterprise as a cooperative process in which the establishment of one truth facilitates the establishment of another, but, unfortunately, the process often works in an adverse way, too, as the establishment of one falsehood fosters the establishment of another.

The errors in my fields of study and research take two main forms: factual and interpretive.

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Despite the astonishing flood of more than a trillion dollars in new commercial-bank reserves that the Fed created in late 2008 and early 2009, when it undertook to rescue the big banks and other institutions from the consequences of their boom-time mistakes, Ben Bernanke has insisted that the Fed can and will contain this inflationary potential, and he has emphasized that inflation remains under control, indeed, that potential deflation presents the greater danger. He rests his case on the evidence of standard macroeconomic indexes.

Standard measures of the money stock, for example, have not increased greatly. The year-to-year change (ending in January 2011) in M2 was only 4.3 percent; the two-year change, only 6.4 percent. For MZM (money zero maturity), the corresponding rates of change were 2.6 percent and 4.4 percent, respectively. Thus, it would appear that by historical standards money has grown quite moderately in the past two years.

Bernanke and his supporting cast of monetary economists can also point to corroborating evidence that by historical standards the rate of inflation has been modest. The year-to-year change (ending in January 2011) in the all-items consumer price index (CPI) was only 1.7 percent; the two-year change, only 4.3 percent. The implicit price deflator for GDP, the broadest of all price indexes, reveals even less inflation. This index, which is computed on a quarterly basis, shows a one-year change of only 1.4 percent for the year ending in the fourth quarter of 2010, and a corresponding two-year change of only 1.8 percent.

(I have computed all of the figures mentioned in this article from basic data available at the website maintained by the Federal Reserve Bank of St. Louis.)

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If any one thing estimated in the Commerce Department’s National Income and Product Accounts may be described as the engine of economic growth, private domestic business net investment is that thing. This variable has such tremendous importance because, if accurately gauged, it tells us better than any other measure how many resources are being devoted to building up the private business capital stock and improving it by innovation. An economy that has anemic private business net investment almost certainly will falter soon, if it is not doing so already.

Notice that every aspect of this awkwardly named variable is critical.

• First, it has to do with private investment, not so-called government investment. The latter, which looms fairly large in the official accounts, ought never to have been labeled as investment, because it comes about not as a result of wealth-seeking motives and rational economic calculation, but as a result of political motives, calculations, and actions that often clash with the creation of real wealth, rather than contributing to it.

• Second, we are looking here at business investment, excluding what the Bureau of Economic Analysis calls private “household and institutions” investment, which has somewhat murky underlying objectives, determinants, and consequences.

• Third, we are examining net, rather than gross, investment. The latter includes a large element of expenditure aimed merely at compensating for the wear and tear and obsolescence of the existing stock of private business capital. For example, even at the most recent peak for gross private domestic business investment, in the third quarter of 2007, it was running at $1,661 billion (annual rate), whereas net private domestic business investment was only $463 billion (annual rate), or about 28 percent of the total. (The investment data cited in this article are taken from Table 5.1, Saving and Investment by Sector, in the National Income and Product Accounts, accessed 02/16/11.)

It is obviously important that businesses compensate for ongoing depreciation of their existing stock of capital goods, which includes structures, tools and equipment, software, and inventories. But unless firms do more than make up for depreciation, they do not expand their productive capacity except to the extent that they can embed improved technology in their replacements for worn-out or obsolete capital goods. In general, economic growth requires net investment, and more rapid economic growth requires a greater rate of net investment.

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The Great Depression has been a deeply contested subject from the very beginning. After John Maynard Keynes’s General Theory became sacred writ for most mainstream economists, Keynesian interpretations generally prevailed, notwithstanding pockets of resistance among older economists, in general, and Austrian school economists, in particular. Milton Friedman and Anna Schwartz’s monumental Monetary History of the United States eventually helped to displace Keynesian interpretations with a monetarist interpretation, especially after the stagflation of the 1970s worked to discredit Keynesian macroeconomics.

Nevertheless, in part because mainstream macroeconomics never settled into a fixed orthodoxy for very long, competing interpretations of the Great Depression continued to attract adherents and to incorporate new elements of analysis during the past thirty years. The Austrians, once again attracting young economists to their ranks from the 1970s onward, persisted in waging guerrilla warfare against Keynesian, monetarist, New Classical, and other varieties of interpretation of the Depression.

With the onset of the current economic troubles—what some call the Great Recession—the debate about the Great Depression flared up anew, because many commentators began to compare these two episodes of exceptionally subpar overall economic performance. In 2008, an article by Gauti Eggertsson, “Great Expectations and the End of the Depression,” was published in the leading mainstream journal, the American Economic Review. This article advances a variation on one of the leading themes among mainstream economists, attributing the U.S. recovery after 1933 to a regime change associated with the New Deal’s abandonment of the gold standard and its commitment to active intervention in the private economy, allegedly in sharp contrast to the Hoover administration’s hands-off policy stance.

Steven Horwitz has taken issue with Eggertsson’s article in an important critique published in 2009 in the online journal Econ Journal Watch, edited by Daniel B. Klein. Eggertsson replied to Horwitz’s critique in 2010. Now, Horwitz has rejoined this back-and-forth in a new contribution to Econ Journal Watch titled “Unfortunately Unfamiliar with Robert Higgs and Others: A Rejoinder to Gauti Eggertsson on the 1930s.” No one will be surprised if I recommend Horwitz’s original critique and his follow-up piece as important contributions to this highly significant debate.

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Consider the following commentary on the economic situation:

Foolhardy procedures which are divorced from economic realities, or whose economic implications are not understood by their promoters, do not perforce become sanctified and wise merely by designating them as “action”; tilting at windmills does not draw water.

[W]hen a recovery program, which, while it may appear effective, depends for its efficacy upon much the same kind of “cheap money” inflation which . . . was the main cause of the recession from 2007 to 2009, then the present recovery must ultimately prove as illusory as the boom from 2001 to 2007, and it is the duty of economists to pierce the veil of illusion.

Certainly the recovery movement to the date of this writing [December 2010] is a peculiar one: it is shot through with anomalies. With [more than 15 million estimated to be] unemployed . . . with governmental relief rolls still at high levels, . . . there very obviously is something wrong, somewhere.

The fact would seem to be that the authorities who are undertaking the “management” of the current recovery, and congratulating themselves that prosperity is returning because they “planned it so,” are utterly oblivious of the fact that recovery is being engineered largely by the same means which produced the last boom – and recession. With this difference: whereas the banking system during the recent boom was producing an investment credit inflation by extending credit to business men and corporations, Government is now assuming the role of inducing new deposit currency in the banking system and thereby producing a consumption credit inflation. The Federal Government, instead of private corporations, is issuing the bonds which the banks are now purchasing, thereby inflating the deposit currency structure all over again. These “created” funds are in this instance being used principally to finance consumption expenditures through relief disbursements, make-work projects, and the like. . . . [T]he current inflation tends to conceal and to preserve the fundamental disequilibria which so prolonged the recession after 2007 and which we are now carrying over therefrom without having once squarely faced the problem of correcting them.

Notice, however, that the foregoing commentary, except for the terms in bold font, was written not yesterday, but, in its final form, in 1937. The authors, C. A. Phillips, T. F. McManus, and R. W. Nelson, placed this commentary, along with a wealth of related evidence and analysis, in their unjustly neglected book Banking and the Business Cycle: A Study of the Great Depression in the United States (New York: Macmillan, 1937). The quoted passages, which appear on pp. 212-14, originally read as follows:

Foolhardy procedures which are divorced from economic realities, or whose economic implications are not understood by their promoters, do not perforce become sanctified and wise merely by designating them as “action”; tilting at windmills does not draw water.

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A funny thing happened on the way to the voting booth: Americans discovered that most federal “stimulus” funds were being used to stimulate government, not the economy.

I was on the road recently, driving from my home in southeast Louisiana through a long stretch of Mississippi to Tuscaloosa, Ala., then to the outskirts of Birmingham and on to Auburn, Ala., and finally back to my home by way of Montgomery and Mobile. Along the way I was slowed from time to time as I passed by road and bridge repair projects marked with prominent signs indicating they were funded by the American Recovery and Reinvestment Act, President Obama’s so-called stimulus bill.

Naturally I was thrilled to see my tax dollars at work, although honesty compels me to report that not much actual work seemed to be going on at any of the sites. Most of the visible workers were just standing around. Of course, such standing around is typical of public construction projects, so I don’t suppose that what I saw was in any way owing to the stimulus funding in particular.

This huge legislative enactment provides for a great variety of increased spending and some reduction in taxes over a period of 10 years. The Congressional Budget Office computed that the net amount of money to be injected into, or not removed from, the economy as a result of the stimulus bill totals about $787 billion.

At the time the bill was being debated and discussed, a common plea in its defense had to do with funding so-called shovel-ready projects to repair or replace public roads, bridges and other structures widely taken to be in a state of decay or disrepair. This plea made an appealing talking point, since most Americans place at least some value on such infrastructure.

Alas, only a tiny proportion of the funds expended so far has been directed to this well-advertised objective.

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Writing for CNBC’s “Behind the Money,” John Melloy describes the findings of a recent survey of investors:

Institutional investors fear a government policy mistake far more than inflation, terrorism, a housing double dip, a weak dollar, poor earnings or any other potential risk to the economy, according to a survey of 100 mutual fund, hedge fund and pension fund managers by Citigroup Global Markets.

“Government Policy Missteps” garnered more than a third of the participants’ votes as their biggest fears in the quarterly survey, ahead of the more than 15 percent who cited “Protectionism,” which is also strongly-tied to the actions of the Administration and Congress.

Last week, I had occasion to speak to several wealthy investors, each of whom attested to the apprehensions associated with regime uncertainty. Most of them seem convinced that the Fed is in the process of destroying the dollar, but none of them has a firm expectation about what will replace it as an international reserve currency. Many see no good prospects for domestic investment at present, except in certain commodities. Needless to say, perhaps, such an outlook by investors does not portend a robust recovery from the current recession, if indeed it is compatible with any recovery at all.

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President Obama has asked Congress for an additional $50 billion in “stimulus” money to finance infrastructure projects. The theory is that the additional spending will cause businesses to boost production to meet this demand. Producers will add jobs, triggering increases in consumer spending that will ripple through the economy and fuel a stronger overall recovery.

Unfortunately, however, such government pump-priming hasn’t worked in the past, and there’s no reason to believe it will work now.

Sure, consumer spending accounts for approximately 70 percent of America’s gross domestic product, and increases in consumer spending would provide the economy with an immediate boost. But a drop in consumer spending is not what ails the economy. In fact, as a percentage of GDP, consumer spending actually increased during the downturn, the Commerce Department’s Bureau of Economic Analysis reports—from approximately 69.2 percent of GDP in the fourth quarter (October-December) of 2007 to approximately 71 percent of GDP in the April-June quarter of 2009.

So the conventional wisdom—that a sharp decline in consumer spending caused the economy’s downturn—is wrong.

What did cause the downturn? The answer is: a sharp decline in private investment.

In fact, the ups and downs of the business cycle are always driven by investment spending, not by consumption spending.

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Private saving and investment are the heart and soul of the dynamic market process. Together they provide and allocate the resources used to augment the economy’s productive capacity, generate sustained long-run economic growth, and thereby make possible a rising level of living. Economic crises interrupt this process by discouraging investors and causing them to consume their resources or to employ them in relatively safe, low-yielding ways. Absent entrepreneurs willing to take the great risks that characterize investments in great technological and organizational innovations, the growth process fades into economic stagnation or even decline.

The present recession starkly displays this characteristic crisis-related abatement of the economy’s investment process. Indeed, the decline of private investment during recent years has been much greater than most observers realize. Consider the following data, taken or derived from the most recently revised National Economic Accounts prepared by the Commerce Department’s Bureau of Economic Analysis (Tables 1.1.5, 1.1.6, and 5.2.6).

In 2006, gross private domestic investment reached its most recent peak, at $2.33 trillion (in constant 2005 dollars), or 17.4 percent of GDP. After remaining almost at this level in 2007, this measure of investment fell substantially during each of the next two years, reaching $1.59 trillion, or 11.3 percent of GDP, in 2009. This decline is severe enough, but it does not give us all the information we need to gauge the extent of the investment bust.

The greater part of gross investment consists of what the statisticians call the capital consumption allowance, an estimate of the amount of money that must be spent simply to offset wear and tear and obsolescence of the existing capital stock. In a country such as the United States, with an enormous fixed capital stock built up over the centuries, a great amount of funds must be allocated simply to maintain that stock. In recent years, the private capital consumption allowance has ranged from $1.29 trillion in 2005 to $1.46 trillion (in constant 2005 dollars) in 2009. Thus, even in the boom year 2006, about 60 percent of gross private domestic investment was required merely to maintain the economy’s productive capacity, leaving just 40 percent, or $889 billion in net private domestic investment, to augment that capacity.

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Each summer, Wall Street strategist Byron Wien convenes a meeting of high rollers to discuss the outlook for investment. This year’s meeting brought together fifty individuals, including more than ten billionaires.

Their expectations, as reported by CNBC, are gloomy:

“They saw the United States in a long-term slow growth environment with the near-term risk of recession quite real,” said Wien, in a commentary to Blackstone clients. “The Obama administration was viewed as hostile to business and that discouraged both hiring and investment. Companies and entrepreneurs were reluctant to add workers because they didn’t know what their healthcare costs or taxes were going to be.”

Add this report to the many similar ones to which my colleagues and I have called attention over the past two years.

Of course, for mainstream macroeconomists, such evidence means nothing. In fact, they hold it in complete contempt because (1) their formal mathematical models do not have a variable called “regime uncertainty,” and (2) even if they could be persuaded to take this factor into account, the canned data on which they rely—the product of the Commerce Department’s Bureau of Economic Analysis, for the most part—do not supply them with an “official” data set for their analysis. What you can’t measure, according to their “scientific” credo, does not exist. Their de facto motto (of which I have more than once been on the receiving end) is: you’ve got no formal model; you’ve got nothing.

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It must be a condition of employment that a journalist who writes about the current recession include in his article the statement, “consumption makes up more than two-thirds of the economy” or “consumption spending accounts for 70 percent of GDP.” This seemingly simple, factual statement, however, is nearly always intended to carry some explanatory weight, and on occasion the writer spells out this explanation by adding a statement such as, “unless consumers begin to open their wallets and spend more, recovery from the current recession will be impossible.”

At first glance, this journalistic commonplace appears to make sense. Anyone can understand that, say, a store at the mall will not hire additional employees unless its sales increase enough to justify the additional expense. Hence, would-be employees will remain unemployed; they will purchase fewer consumption goods than they would have purchased if they had jobs; and therefore the stores will not hire more workers; and so forth. The circle of a theory of income and employment seems to be closed, and thus an explanation provided for the lingering recession: consumers are not spending enough.

One does not need a Ph.D. in economics, however, to discover that something must be wrong with this way of thinking about prosperity and recession. Checking the national economic accounts produced by the Commerce Department’s Bureau of Economic Analysis (Table l.l.6), one finds, for example, that the most recent quarterly peak in real personal consumption expenditure occurred in the fourth quarter of 2007. This spending ($9,244 billion at an annual rate) equaled 69.2 percent of contemporary GDP ($13,364 billion at an annual rate)—where the data are expressed in dollars of 2005 purchasing power. Real GDP did not fall significantly until the third quarter of 2008. When it reached its trough in the second quarter of 2009, it had fallen to $12,810 billion, down about 4 percent. At that time, real personal consumption spending was $9,117 billion, down only 1.4 percent, and equal to about 71 percent of GDP. Thus, as usual over the course of a boom and bust, consumption spending varied proportionately less than GDP as a whole.

As every student of the business cycle learns early on, the most variable part of aggregate expenditure is private investment. When real gross private domestic investment peaked, in the first quarter of 2006, it was $2,265 billion, or 17.5 percent of GDP. When it hit bottom in the second quarter of 2009, it had fallen by 36 percent to $1,453 billion, or 11.3 percent of GDP. (Deducting investment expenditures aimed at compensating for depreciation of the private capital stock [Table 1.7.6], we find that real net private investment—the part that contributes to economic growth—in the most recent quarter was only one-third as great as it was at its peak in early 2006.) The ups and downs of the business cycle are obviously driven not by consumption spending, but by investment spending.

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