If you were to believe world stock markets, the recession of 2007-09 is drawing to a close, with the wisdom of government spending and global monetary easing spurring the world to another economic recovery.

However, we would be foolish to believe the markets, which have long proven to be an unfaithful talisman.

In fact, during the Great Depression, markets also rallied. Plummeting to 195 in November 1929, the Dow Jones rose to 297 six months later. The rally of 1930 would prove short-lived, however, with the index promptly falling to only 42 within two years. The Dow would take more than 32 years to reach its pre-crash levels.

Investors and commentators proudly claiming that the recession is over should take note. So far, the great rally of 2009 has been equally as spectacular as that of 1930. Despite US unemployment approaching 10% (Australian unemployment remains astonishingly low), the Dow Jones index has risen by 52% since February (the All Ordinaries index has even more ebullient, rising 57% since its March depths).

It appears that investors believe that loose monetary and fiscal policy would kick-start a consumer spending binge, resuscitating otherwise moribund global economies and easing unemployment and deflation concerns. Nowhere has this been more evident than in China, which earlier this year reported economic growth of 8% (that is, if you choose to believe China’s economic data).

The problem is that higher consumer spending, while ostensibly a key driver of gross domestic product, is not necessarily a good thing. That is because the aim of economic policy is to improve the living standards of the general community. Too often GDP growth is used as a proxy for rising living standards. It is that thinking that can have disastrous long-term effects.

Earlier this year, Australia avoided entering a “technical” recession (albeit not on a per-capita basis), after GDP rose by 0.4% in the June quarter (led by an increase in consumer spending of 0.6%). Despite the overall rise in GDP, new machinery and equipment investment slumped 9.5%.

What central banks and high-spending governments (in particular, the US Federal Reserve) appear to ignore is that wealth (and higher living standards) is not created by consumer spending (especially consumer spending inspired by taxpayer-funded stimulus). Rather, increased living standards require technological advancements and improvements in capital stock (which is achieved through business investment). If anything, borrowing to increase consumer spending (as witnessed during the “Great Moderation” of the past two decades) is in the medium-to-long-term, detrimental to the economy.

The principle that consumption is not the economic manna many politicians believe, was well explained by economist Steven Landsburg in his best-selling book, More S*x is Safer S*x . Landsburg stated “if you earn a dollar but refuse a dollar, the rest of the world is one dollar richer — because you produced a dollar’s worth of goods and didn’t consume them. Who exactly gets those goods? That depends on how you save. Put a dollar in the bank and you’ll bid down the interest rate by just enough so someone can afford an extra dollar’s worth of vacation or home improvement. Put a dollar in your mattress and (by effectively reducing the money supply) you’ll drive down prices by just enough so someone somewhere can have an extra dollar’s worth of coffee with his dinner.”

In essence, Landsburg’s thesis is that consumption, especially that funded by debt, be it home mortgages or credit cards, is not beneficial for overall living standards (although it would be beneficial to the person with a new 127-centimetre television or Mercedes).

Rather, it is through saving (which leads to capital investment) and technological growth that true economic advancement occurs. That doesn’t happen when someone buys a Louis Vuitton handbag or builds a new McMansion.

The problem however, lies in the fact that governments (and although unelected, central bankers) care not for the long-term living standards of their constituents, but for their short-term political well-being.

By maintaining negative real interest rates (in the United States) and close to zero real rates in Australia, central banks are actively discouraging saving (although in Australia this is less the case with the Reserve Bank have recently changing to a tightening bias). Placing money in a bank with interest rates close to zero means that the depositor is, in real terms, losing money. In addition, they are forced to pay tax on any miniscule nominal gains. By maintaining low interest rate regimes, central banks compel households to spend, rather than save (as occurred before the global financial crisis, when savings levels in Australia and the United States were negative). A society that doesn’t save not only fails to invest in long-term economic growth, but as Landsburg observed, faces higher costs of living through inflation.

It is not only central banks that have actively hindered the long-term economic recovery. Governments worldwide, through their enormous, “New Deal”-type fiscal spending have helped fuel the recovery mirage. The US government bailed out the car and finance industries with borrowed monies. (Handing money over to Wall Street was especially bemusing, effectively rewarding excessive risk-taking with $US175 billion ($A191 billion) in taxpayer funding and further guarantees, only for those same institutions to pay their employees performance bonuses of $US32 billion the following year).

All these monies borrowed and used for the various, global stimulus payments will eventually need to be repaid, with interest, by future taxpayers. Inability to repay the debts accumulation often leads to widespread inflation (as governments are forced to monetise debt) and further reductions in living standards. The Australian government has proudly followed with smaller, albeit similar reckless abandon.

Through one-off cash stimulus payments or the first-home owners’ grant, the federal government has transferred wealth from one part of society to another without leading to an overall increase in living standards. Even worse, the real effect of the policy is a transfer of the form of money from savings (and effectively, investment) to consumption. The federal government has also allowed banks to boost margins and maintain profitability through wholesale funding and deposit guarantees. Those expensive guarantees done wonders for the banks’ profitability but have not flowed through to small and medium business, which the Financial Review reported this morning are still paying relatively higher interest rates and continue to be shut out of obtaining working capital for new ventures.

Fiscal spending and lax monetary policy have a direct and immediate effect on economic growth (consumption consists of about 70% of GDP). Spending borrowed monies on new cars or plasma televisions does nothing to create long-term wealth for a nation, but has led to what appears to be a sort of false bravado. This increased confidence has flowed into a rising sharemarket. For some reason, investors appear to believe that a short-term rise in consumer spending will translate into sustainable earnings moving forward.

The more logical result of government and central bank policy is that a serious problem has been worsened. Governments should be encouraging real investment in income-generating assets (not encouraging wanton spending, or investment in non-value adding goods such as cars). Similarly, central banks should be rewarding savers, not punishing them.