Economic Theory Meets Main Street Reality

Since the end of the financial crisis, there has been an ongoing debate about the economy. However, the debate I am speaking of is not between investors and Wall Street, but rather between economic theory and “Main Street” reality.

Over the last few months, in particular, economic and media “experts” have become more vocal about the ongoing detachment between economic theory and actual economic activity. The ongoing hope, as point out by Myles Udland recently, is “this time is different:”

“Right now, this ratio is spiking, indicating that businesses in the US are accumulating a stockpile of goods (this ratio measures how many months it would take businesses to sell down their current stash of stuff).

So the most basic question to answer is: are these inventories being accumulated because businesses can’t sell these goods or because they’re anticipating selling them soon?”

Inventory-Sales-Ratio-111615

“But if businesses think that the long-awaited surge in consumer spending that’s supposed to follow the decline in gas prices over the last year is finally coming down the pike, then it would make sense to be prepared to this influx of spending. Or more accurately, it made sense three or six months ago to increase futures orders in anticipation of a big holiday shopping season.”

Here is the problem that continues to elude academic theory; falling gasoline prices has no “net effect” on economic growth. As I explained previously:

“If I spend less money at the gas pump, I obviously have more money to spend elsewhere. Right?

The problem is that the economy is a ZERO-SUM game and gasoline prices are an excellent example of the mainstream fallacy of lower oil prices.

Example:

Gasoline Prices Fall By $1.00 Per Gallon
Consumer Fills Up A 16 Gallon Tank Saving $16 (+16)
Gas Station Revenue Falls By $16 For The Transaction (-16)
End Economic Result = $0

Now, the argument is that the $16 saved by the consumer will be spent elsewhere. This is the equivalent of “rearranging deck chairs on the Titanic.”

Increased consumer spending is a function of increases in INCOME, not SAVINGS. Consumers only have a finite amount of money to spend. Let’s use another example:

Example:

Big John Has $100 To Spend Each Week On Retail Related Purchases
Big John Fills Up His Truck For $60 (Used To Cost $80) (+$20)
Big John Spends His Normal $20 Per Week On His Favorite Craft Beer
Big John Then Spends His Additional $20 Savings On Roses For His Wife (He Makes A Smart Investment)
————————————————-
Total Spending For The Week = $100

Now, economists quickly jump on the idea that because he spent $20 on roses, there has been an additional boost to the economy. However, this is false. John may have spent his money differently this past week but here is the net effect on the economy.