The fundamentals matter: Part II

Nevada’s troubles have external origins

For more than six months, Nevada's 14-plus percentage rate of unemployment has led the nation in what is widely recognized as the largest cyclical economic downturn since the Great Depression.

Pundits on the Left would have you believe that the Silver State's lagging recovery is a direct result of its traditional (and inaccurate) reputation as a tax haven. In this simplistic view, the perceived lack of resiliency in the Silver State's economy is a symptom of the state's allegedly inadequate financial commitment to public programs such as K-12 education, a belief that relies upon the naïve assumption that higher state spending would translate into a proportional increase in educational attainment.

What are conveniently overlooked by those who adopt this viewpoint are the complex global economic forces that have set Nevada on its present recessionary path. Sure, years of poor public policymaking that included spending increases to appease public employee unions while student performance floundered left Nevada ill-equipped to rebound from the fallout of global economic collapse. Yet, the underlying fundamentals that ensured Nevada was more harshly impacted than its neighbors around the world were laid in place beyond its boundaries.

More than any other cause, Nevada's collapse is attributable to a prolonged overinvestment in the state that was, for years, systematically propelled by central bankers throughout the world. In a classic example of the Austrian Business Cycle, interest rates that were arbitrarily manipulated downward through new money creation by the Federal Reserve and its counterparts around the world sent false signals to investors about the price and availability of savings within society.

For the entrepreneurs who coordinate resources to provide for the needs of humanity, prices play an indispensable role in that they convey necessary information about the need and relative availability of particular resources. Among the most important resources for economic planning is capital — economic production that individuals have committed to save rather than immediately consume — the price of which is commonly referred to as the "interest rate." In a free market, interest rates reflect the amount of savings available for the purchase of "capital goods" such as factories and machinery as well as expensive, "durable consumer goods" requiring financing, like homes or automobiles.

When central banks purposefully distort market interest rates by injecting newly created money into the economy, as they have systematically done over past decades, this important price signal increasingly misinforms investors about the supply of savings available. Downward manipulation of interest rates prompts over-investment in capital goods and/or durable consumer goods, creating "bubble markets" that do not accurately reflect the genuine underlying fundamentals. Thus, central banks like the Fed have extraordinary power to induce economy-wide distortions over resource allocation — channeling investments away from those that ultimately benefit consumers and into "bubble" industries.

When the Fed, in essence, chose to create a bubble market in real estate, the Silver State became a double-target of the Fed's bubble factory. Not only was Fed policy inflating home values in Nevada, as elsewhere, but much of the excess in credit spending fueled by artificial home-value appreciation found its way to Nevada in the form of hotel stays and gaming revenues. Individuals the world over borrowed against illusory home equity in order to finance vacations to Nevada's famous resorts.

So artificially prosperous did Nevada's tourism industry become during this period that the industry's increased demand for labor drew immigrants into the state en masse, further exacerbating the skyrocketing price of housing already produced by the state's federal land stranglehold.

The problem with bubbles, of course, is that they inevitably burst.

The havoc wrought by the Fed's prolonged interest rate manipulation has left the Silver State with the highest unemployment and home foreclosure rates in the nation. The median home price in Las Vegas has fallen 64 percent since the peak and migration has turned negative as the distortions introduced through interest-rate manipulation have begun to correct themselves.

Nevada's dire economic environment is largely not a product of its own making.

However, the Silver State would be better positioned to rebound from the Great Recession if lawmakers had embarked upon serious structural reform to the state's failing educational system many years ago. For decades, while educational quality has slowly deteriorated, the Silver State has profited, not from the industrial competitiveness of its workers, but because of the unique legal status granted to what has become its most significant industry — gaming.

As other states liberalize gaming laws, Nevada lawmakers will once again be forced to realize that the fundamentals matter — which means, specifically, the combination of a low and uniform tax structure with an array of competitive educational choices capable of training a highly productive labor force.

The time to act was yesterday.

Geoffrey Lawrence is a fiscal policy analyst at the Nevada Policy Research Institute. For more visit http://npri.org/.

Read more:

• The fundamentals matter: Part I