The government can do a great deal to speed up the recovery, by getting out of the way. I believe if we do the right things we can come out of this with a much, much more vibrant, sustainable economy than we have had for many decades (the monkey wrench in the situation is debt, which I'll discuss). I hope you will bear with me as I explain what I think causes the distortions in the market which lead to recession, and at the end I'll explain what government can do to speed the process of correction along.
A recession is caused when the market tries to correct for a misallocation of resources. So, for example, we overinvested in housing -- we had way too many construction companies, way too much construction equipment, way too many people employed in construction, etc -- it was unsustainable, because people do not need as many houses as we were producing. Thus, people at a certain point stopped buying so many houses. This effectively sends the signal to these companies, "Whoa! People don't need so many houses -- this labor would be better used elsewhere". Companies downsize or go bankrupt, and the labor is shifted to areas which will more effectively meet people's needs.
Thus, a recession is the period during which labor is being shifted from unproductive areas to productive areas. During the transition, there may be a short period of unemployment, as the industries in more productive sectors tool up, and labor, as well as capitol, is shifted. In no case should this period be more than a year or two, I believe, unless the shift is deliberately hindered.
First, what causes the misallocation of resources in the first place, which later requires the correction of a recession? I see three main possible causes:
1. A rapid and unexpected shift in public needs
2. Massive and widespread human error, or lack of information
3. Government distortion of the market
I'll talk in more detail about each:
1. This more often occurs in a particular industry than in the economy as a whole, simply because public needs usually don't shift so dramatically and quickly -- they more often evolve over time. Although not widespread or drastic enough to cause an economy wide recession, they do often cause local recessions. Examples can be seen in the buggy industry, after the introduction of the automobile, or in the typwriter industry, after the intruduction of the PC. There were entire towns which specialized in one of these defunct products, which were devestated by the change. But, the local economies did recover -- and the people went to work making something new (either autos, or computers -- or something that used to be made by the people that were now making autos or computers).
2. This was part of the problem that led to the current crisis, although not the bulk of it. A great many people invested in housing, thinking that prices would always rise, and a great many people leveraged themselves up to rediculous levels on these investments and diriviatives. This led to a misallocation of resources into housing -- a misallocation which must now be corrected. These mistakes, however, were greatly aggrevated by distortions of the credit markets by the Fed (the third factor).
3. This, I believe, is by far the most significant cause of recession, and it tends to be the only cause that can lead to prolonged recession or depression, because government distortions can be backed by force, and so can be resistant to correction. What I consider to be the greatest distortion in history is of this sort -- the modern banking industry. Yes, we do need banking to some degree, in that we need people who specialize in investment, who can decide the most effective way to allocate people's capitol (which really means people's labor). The degree to which we have overallocated resources in this sector, however, is mind boggling, and the reasons are clear.
To start with, can you take out a loan for 0.2% now? You can't? Your bank can, from the Fed. If the government gave you or I the ability to borrow money at 0.2%, while the prevailing market rate was over 4%, how fast do you think we would become wealthy? Very quickly, simply by loaning the cheap money out at the higher rate. Yet, if we did this, we would be providing no service to anyone, and we would not be increasing the real wealth of the country in any way -- we would effectively be taking freebies from the government. Given they have this ability, it is no wonder that the modern banking industry has ballooned to such a level.
Also, in this context, do you think our indebtedness would increase, or decrease? If the banks had only their own money to lend, they would have to be choosy about who recieves it, just as I might only have a few thousand dollars to lend, so I would have to be choosy about borrowers. In the current context, however, banks have an endless pool of money to lend, and given the large price spread, can afford to loan to irresponsible borrowers.
There are many other ways in which the government distorts the financial markets, some of which we have discussed in earlier e-mails. The Fed and the FDIC ensure that banks can behave irresponsibly, and still recieve deposits -- you may remember the address by president Taft which I included in an earlier message.
Ironically major banks earlier this year proved that they were incopetant in their one legitimate area of business --- the one area in which they actually could increase production of real wealth -- namely, optimal resource allocation. They were bankrupt -- the market was trying to say this: "You have no reason to exist, because you are not increasing anyone's wealth, or producing things people need". What did we do? We bailed them out, so now we continue to have thousands upon thousands of our best and brightest working in an industry which as far as I can tell, doesn't produce anything of use for anybody.
And this brings me to the following question:
If it is given that our ecnomy has misallocated resources, how can we most quickly re-allocate those resources, so that our economy can recover? That is, what would a great economic stimulus plan look like?
1. Get rid of any financial distortions which are causing the misallocation of resources. This means, we need less available credit, not more -- and more importantly, we need the right kind of credit. Credit should not be available for consumption, rather, all credit should be made available for capitol investments in new means of productions. In order to do this, we need the Fed to stop manipulating intrest rates. Currently, our economy is based on ever increasing indebtedness and consumption -- so we have a great deal of retail and services, but not many goods for export, as evidenced by our trade defecit. If we stop manipulating intrest rates, and the government stops borrowing so much, the trade deficit will be forced to disappear -- meaning we'll need to start making stuff again.
Maxim to live by: Neither I, nor my family, nor my country, can consume more than we produce!
Evidence of progress: When the guy that wants to start a farm can get his loan, but the guy who wants to borrow to buy a big screen TV doesn't stand a chance.
2nd Evidence of progress: When the strip mall is bulldozed in order to put in a new factory.
2. Eliminate all efforts to prop up failing industries, or try to prop prices up. If an industry is failing, it is because there are too many resources allocated to that industry. Let the resources shift away, into something more productive. If the prices are dropping, it's a good thing! More people will be able to afford the good or service. This reached such a level of insanity in the 30s that the government was actually intentionally destroying crops in a country with many people on the brink of starvation, just to try to maintain high prices.
Tell me, what good does it do to have more people employed in a particular industry, if the fruits of their labor are being destroyed or are lying unused? They might as well be unemployed.
There may be areas in which industries have been propped up even before the recession. This is a good time to get rid of these programs -- our banks would be a great example.
Also, get rid of as much government bloat as possible.
Maxim to live by: Green pieces of paper don't help anyone, and work that doesn't produce or provide something people need is a waste of time. Do something useful!!
Evidence of progress: Mass exedus from banks and government towards industry and research.
3. Get rid of red tape on new business, and overly complex tax codes. Do you think it will increase the time required for transition, or decrease it, if it takes years to get the government to let you start a business, hire people, develop property, and start production? Also, loosen strict zoning laws.
Maxim to live by: What, you want to hire a bunch of people and start producing or providing something useful? Well, we're sure not going to stop you!
Evidence of progress: When most of human resources has been downsized, but they all found jobs as recruiters for those nitch temp agencies that sprung up last week on the empty lot. Also, loads of beaurocrats and lobbyists in Washington have had to find jobs doing something useful, because those special IRS shelters and regulatory loopholes are now gone or worthless.
Now, the monkey wrench:
The Fed has been distorting interest rates and subsidizing lending for so long, and the Government has been spending recklessly for so long, that we're in debt up to our eyeballs.
I actually like the following approach: Repudiate the government debt, and pass a constitutional amendment banning government borrowing in the future, and mandating a balanced budget. It would destroy the government credit rating, but we wouldn't need it anymore anyway. Otherwise, the only other way to dig ourselves out may be through inflation, which is effectively like repudiation, and is also liable to further destroy our economy.
Here's an analogy I like:
A Tale of Two Farmers ... (quoted)
To summarize this incredibly overlong and hopefully only mostly boring e-mail into one sentence:
We need to get our farm back -- fast -- and we need to figure out what to do about those wheelbarrows full of IOUs farmer Chang's got in his woodshed.
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Originally Posted by hugolp
. By the way, here's a link to the Tale of Two Farmers -- might want to include it -- I didn't quote the whole thing here, for brevity:
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