The Government Is Doing Everything Wrong to End the Recession

Last week, the National Bureau of Economic Research announced that the recession that began in December 2007 ended as of June 2009 and we have been in an expansion since.

The vast majority of Americans who are struggling to pay their monthly bills would no doubt disagree with this assessment. Millions of unemployed workers are still unable to find work. Companies are simply not hiring like they should after a recession has ended. What kind or a recovery is this?

The answer is that the recession has never really ended because it was not allowed to do its work. It must correct the misallocations from the previous boom. Standing in its way are fiscal policy, monetary policy, and onerous regulatory burdens.

All today’s big government apologists look at when discussing the economy is whether GDP is positive or negative. There is no distinction made between public and private sector growth. It is not understood that growth from the private sector is self perpetuating, whereas growth from government is not only temporary but is a perpetual drag on future growth because the money borrowed to finance it must be paid back, with interest.

The difference seems so elementary that it would hardly be worth mentioning if it weren’t for the fact that the policy makers in Washington actually believe this Keynesian nonsense. They believe spending is spending and it matters not where it comes from. Spending and business activity based on more and more debt is hardly reason to celebrate. We need to step back and realize that it is the private sector that finances government and not the other way around. Government is the parasite, only able to live on the production of the host, which is us. Growing the parasite does not bring prosperity.

Bad bets in housing must be marked to market. Losses must be taken by ill advised lenders. If that bankrupts companies, so be it. The burden will be held by the bondholders and stockholders of those companies. The capital that is tied up must be allowed to be used more efficiently by better entrepreneurs. The longer the capital is protected by a “too big to fail” mentality, see here, the longer the real recovery gets put off. Japan has been struggling with their economy now for more than two decades because they refused to write off bad debts from their housing bubble in the 1980s. Had they not interfered in the markets and instead allowed a severe but short recession to happen, after a period of pain, they would have been back to prosperity. Now they have had two decades of stagnation, and a group of workers they refer to as “The Lost Generation”.

In a free market the people who take the risks and stand to make profits should be held liable for their own actions, not a generation of innocent people. In today’s quasi-socialist world the losses are paid by innocent bystanders through higher taxes, inflation, and un-payable government debt.

As long as the government continues its make-work projects and deficit spending any positive movement in GDP will only be fleeting with no real prosperity. Additionally, the government has added the shackles of increased regulatory hurdles and onerous healthcare requirements for businesses to deal with. It is no wonder we are stagnating. To add one more burden on the free market’s back, next year the tax rates will increase as well. It’s as if the government has a playbook of all the things to do wrong and they are following it to a T.

Most important of all of these is monetary policy, without which the fiscal irresponsibility would not be possible. The Fed ensures a buyer for all the bonds the government sells to finance their spending. If necessary the Fed itself will buy the bonds directly with newly created money. This dilutes the value of the dollar and causes inflation.

As if this inflation of the money supply weren’t detrimental enough to the economy, it is also the Fed itself that actually causes the business cycle from their policy of setting the interest rates below natural free market rates see here. In a market that is not interfered with, lower interest rates occur when the public is saving more. The increased supply of loanable funds pressures rates lower. In both cases, new projects are started because they seem profitable with the lower interest rates. The difference lies in the fact that rates artificially lowered cause projects that are doomed to fail whereas the low rates from an increase in savings initiate projects that can be completed because the savings and resources necessary for their completion actually exist.

As an example, imagine during the peak of the housing bubble a no-money-down, no-income-verification mortgage with a low adjustable rate. This is the type of loan that was prevalent during the housing boom. It was offered as a direct result of the artificially low interest rates from the Fed. By necessity if more debt is offered than the free market would dictate, that additional debt must be lent to borrowers of lower credit quality with less collateral then would be the case with free market rates. It seems hardly a mystery why the housing boom didn’t end well.

The Fed’s mischief doesn’t end once it has created an unsustainable boom. During the bust phase, instead of allowing the malinvestments to liquidate and let market forces find their natural value, the Fed again intervenes. In an effort to avert a recessions of any severity the Fed has magnified the problem. Time and time again the Fed has intervened to prevent the market from correcting its imbalances. Prior to the housing and dot-com bubbles there was Y2K, Long Term capital management, and the crash of 1987. In all these cases the Fed has stepped in with more and more liquidity and lower interest rates. The increase in the supply of base money turns into a ten fold increase in the supply of loanable funds and eventually debt through fractional reserve banking, see here.

In summary, the US government and the Fed are the cause of the business cycle, the cause of coercively misallocating resources through government spending and the cause of onerous regulations that provide negative incentives for hiring workers.

So when will the recession really end and prosperity return? It will end when the free market is able to allocate resources based on market need not based on the whim of federal bureaucrats. The government needs to get out of the way and let the recession happen. Sure it will be severe and it won’t be fun, but it will end. In a free market environment it does not have to last very long. The sooner we let the free market work the sooner we can enjoy the blessings of capitalism, real capitalism, not the special interest, semi-socialistic government/corporate partnership we now have.

1 comment:

  1. Telecommunication, easier travel has made the world borderless for job creation whereas on other hand there are still physical boundries each countries have and also disparity on paper currencies, which only favours some countries over the other towards job creation.

    I feel the above fact bound to create recession in certain countries, while certain other countries might not be as bad (eg, developing nations).