Construction as leading economic indicator

The core business of our family company is producing aggregates (sand and gravel) for the construction industry. I focus on our energy activities, and don't have much to do with gravel, so wouldn't normally comment on it.

However, what I have just learnt seems to have broader significance. I understand that, after a brief pick-up earlier in the year, demand for aggregates has fallen back, at a time of year when normally it would be picking up. The Ready-Mix Concrete plant that operates from one of our sites (not run by us) has just had its worst month ever, and it has been there for decades. The only demand still going strong is public-sector infrastructure projects.

Construction has always been a leading indicator of economic activity. And it is obviously linked in particular to the prospects for the property market. So the first obvious point is that this suggests that the recent optimism that the property market is close to the bottom is misplaced.

You might say that this also proves how important it is that the Government maintains its Keynesian policy of trying to pump-prime the economy through infrastructure spending. But I would look at it another way.

The purpose of quantitative easing (QE) is supposedly to pump money into the economy, which eventually filters down to the real world and results in a recovery of demand. But, despite billions having been pumped in, demand in the real economy is clearly not recovering.

We know that most of the QE is being recycled via the banks to the Government, through the banks purchasing gilts to strengthen their balance sheets. If the Government were issuing fewer gilts, not only would gilts-values be better (yields be lower and the Government's cost of money cheaper), but more money might find its way more quickly to the private sectors of the economy, for instance through purchases of corporate bonds instead of gilts.

But that would require the Government to rein in its spending to reduce the deficit that needs to be funded through gilt-sales. To reduce the deficits, the Government would have to spend less, for instance on infrastructure projects. What we are seeing is the effect of government-borrowing and -spending crowding out the private sector and thereby forcing the wealth-generating part of the economy further into trouble.

This is unsustainable. Sooner rather than later, government spending has to be brought into line with government revenue (and in fact brought below revenue for quite a while in order to repay the accumulating debts). The longer the Government tries to "prop up" the economy with Keynesian policies that we cannot afford, the more damage will be inflicted on the private sector that has to produce the revenue from which these debts must eventually be paid. In the short-term, our company may seem to benefit, like many others, from the "pump-priming", but in the medium- and long-term it is being harmed by the policy.

QE is the only thing making this harm possible. The Bank of England is supposed to be independent. Mervyn King warned that Gordon Brown could not indulge in more fiscal stimulus. And yet the Government is running a massive deficit, and the Bank is funding it through QE.

In 1981, clever economists (364 of them) could argue that the aggressive fiscal tightening of Geoffrey Howe's budget was draconian and would damage the economy. Now, clever economists (the vast majority of them) argue that QE and loose fiscal policy is necessary in order to try to keep money-supply increasing (though that isn't working) and prevent a worse collapse of the economy. Now as then, they have a technical point by their own lights (if one accepts the false paradigms of the dominant economic schools). But in a more important, fundamental sense they are wrong (which is why the paradigms are wrong). No doubt a cessation of QE would be painful, as the 1981 budget was incredibly painful. But the softer, easier, clever approach failed to take account of the need to send a message and to change people's expectations. Then, it had to break inflation expectations. Now, we have to break expectations that we can put off the need to balance our budgets (personal and national) until mañana.

Never doing today something painful that can be put off until tomorrow is the politician's creed. But an independent central bank should not help to sustain this pusillanimity. Let's either admit that central banking can never be independent, so we can relocate responsibility for our problems where it rightly belongs - with our government (and particularly with the Chancellor of the previous decade). Or let's see the central bank prove its independence by refusing to continue with QE so long as the banking beneficiaries of the policy continue to use it to bail out the Government and penalize the rest of the economy by buying gilts with the new money.

Of course, this is a complicated way of stating what Austrian economists, defenders of the classical-liberal tradition and only correct economic paradigm, know to be true by definition, without need for empirical or inductive proof - that you do not make other things more valuable by devaluing the currency, nor create any real, sustainable demand. You only prevent the necessary corrections and store up trouble for the future. I wonder, when the Keynesians and monetarists find that their recommended policies have unintended consequences whose negative impacts exceed any illusory benefits, will they admit that they've been wrong, or will they dream up even more complicated systems that need to be followed next time, and excuses for how the measures taken weren't sufficient and therefore a fair test of their theories? (It's funny how governments can never do enough by interventionist economists' standards, and how those economists regard as irrelevant the real-world constraints on governments.) Following their success in painting the interventionist Hoover as a liquidationist, will they even have the brass cheek again to try to pretend that the problems had been caused by laissez-faire and inadequate stimulus, and not the inevitable failure of illusory monetary stimulus?