Recessions are good

Recessions are necessary to enable businesses and individuals to reconnect with reality and to address inefficiencies and misallocation of capital. Although many people suffer pain in the process, the net result is overwhelmingly beneficial. It is a natural cycle, like the need to sleep—all attempts to stave it off will be detrimental. The benefits of recessions include:

  1. Fictitious capital is revealed for what it is;
  2. Loss-making companies are liquidated and further waste is terminated;
  3. Unwanted houses stop being built;
  4. The price of housing becomes static (as a multiple of average incomes) and even goes down;
  5. The proliferation of brokers, scheme promoters, and financial charlatans of every type is collapsed and instead they have to find productive and honest work;6.superfluous middlemen and middle management of all kinds are removed, never replaced, and instead go on to obtain productive employment;
  6. Debt is paid down and people begin to live within their means;
  7. Rude and insolent people get retrenched, suffer severe hardship, and are then re-employed with new, lasting, cheerful, and polite work ethics;
  8. Everyone turns up to work on time;
  9. Embezzlers and Ponzi schemes are exposed;
  10. Company jets are replaced with video conferencing;
  11. Profligate people are removed from spending positions and replaced by people who are frugal and obtain value for money.

Depressions are caused by what happens after the crash

If we are industrious, we shall never starve … At the working man’s house hunger may look in, but dare not enter … Industry pays debts, while indolence increaseth them … Diligence is the mother of good luck; and God gives all things to industry.

—Benjamin Franklin. Poor Richard’s Almanac, 1758.

There is no such thing as a natural depression. The nature of individuals, of which economies are comprised, is that they will energetically and continuously seek to improve their position under any circumstances. Even in the Warsaw ghetto during World War II, there was a thriving black market and smuggling operation that kept people from starving. People simply refuse to roll over and die. They fight, they work and scheme, they endeavor, they evade, they do anything they can to improve their situation. The harder and more difficult the circumstances, the more they discover what they are capable of. This nature, when combined with the market system, will always lead to humming economic activity even under the most trying of circumstances. The only thing that can stop flourishing commerce and full employment is lawlessness (whereby property is unsafe), government debauchery of the currency, market intervention and socialism. When this happens, extra effort and ingenuity is rendered futile.

It is true that the force-fed credit inflation of the 1920s drastically distorted the structure of the United States economy. However, that does not explain why it took so long to recover. We know from the experience of West Germany after World War II that no matter how low a country sinks, there is nothing to stop it immediately afterwards building a thriving economy and full employment for all the survivors. By 1948 Germany had lost more than 10 percent of its pre-war population through violent deaths on the battlefield or in bombing raids. Many more were horribly crippled and needed to be constantly cared for. Its entire stock of intellectual property had been confiscated. Millions of its men were captives in Britain, France, and the Soviet Union providing forced labor by way of reparations. The West German coal and steel industry had been dismantled by the occupation forces, and all industrial activity had been banned. All its major cities and vast acres of suburbs had been razed to the ground, and its factories and railway lines had been bombed into ruins. Millions were homeless, and the roads were blocked with rubble. Adult mortality was four times higher than before the war, and child mortality ten times higher. The German Red Cross was disbanded by the Allies, and the International Red Cross was forbidden to operate inside Germany. By 1947 the average calorie intake was lower than during the war. It would therefore be wrong to say the Germans were, in 1948, in a better position than the Americans found themselves at the beginning of the Great Depression.

Ronald Reagan later recalled,

“In West Germany and here in Berlin, there took place an economic miracle, the Wirtschaftswunder. Adenauer, Erhard, Reuter, and other leaders understood the practical importance of liberty—that just as truth can flourish only when the journalist is given freedom of speech, so prosperity can come about only when the farmer and businessman enjoy economic freedom.” (Speech at the Brandenburg Gate, West Berlin, June 12, 1987.)

When Ludwig Erhard in 1948 introduced sound money and abolished both price-fixing and production controls, the so-called German economic miracle took off. Yet there was nothing miraculous about it. It is human nature, when unfettered by socialism, to work hard. Hard work, when guided by market forces, always creates prosperity.

In contrast to West Germany’s speedy recovery, a decade earlier the Americans had writhed in depression and despair for eight years during the Great Depression because they continued to allow the Federal Reserve to manipulate their money. They also allowed President Roosevelt and his rubber-stamp Congress to impose price-fixing, cartels, production controls, and a myriad of other socialist measures on their economy under the banner of “The New Deal.” The lesson is clear: in order to deal with depressions, governments should follow the example of Germany’s Erhard and not repeat the mistake of the New Deal or Britain’s post-war socialist experiment. As Margaret Thatcher observed: “It is said that we were exhausted by the war. Those who were utterly defeated can hardly have been less exhausted. Yet they have done infinitely better in peace.” (Poor Richard’s Almanac, 1758.)

Henny Penny

The collapse of a force-fed credit bubble is not a catastrophe. It is simply the lifting of an illusion. Even the total collapse of the financial system and liquidation of every bank on the planet would not be a catastrophe. World War I and World War II were catastrophes; the enslavement of Russia, Eastern Europe, North Korea and China for multiple generations were catastrophes; a nuclear exchange or worse, a nuclear holocaust, would be a catastrophe. It is important that politicians, central banks, and electorates understand this. Otherwise something as trifling as financial disillusionment will lead to a real catastrophe (which is what happened in the 1930s) through the adoption of wrongheaded measures.

To avoid wrongheaded measures (and therefore real catastrophes) government should apply the same rules to the nation as sensible individuals apply to their private finances during a financial crisis.

The television news often shows interviews with a married couple the day after their home is destroyed by a wildfire. As they stand in the ashes the couple forlornly confess to having no insurance and to having ‘lost everything.’ A silent tear trickles down the wife’s cheek and her husband gives her a hug. Then they both say, “Never mind, we will rebuild. At least no one was hurt or killed.” A financial meltdown is nothing more than the same thing happening simultaneously to many hundreds of millions of people, and should be responded to with the same stoic attitude. It cannot be solved by deceitful means, nor can socialist measures, which provide perverse incentives for idleness, assist in any way.

Should the government encourage the people to consume?

Most definitely not. Consumption is a by-product, not the cause, of a healthy economy. Profligate consumption is a symptom of force-fed credit inflation. Yearning to return to the days of profligate consumption is like a drug addict yearning to be high again. Germany’s post-war government did not encourage profligate consumption to ‘stimulate’ the economy; instead, it let the people put all their effort into clearing rubble, rebuilding factories, repairing bombed bridges, producing goods, and exporting them in return for food. Consumption is not what makes an economy grow; what makes an economy grow is investment.

The imbecilic desire of politicians to stimulate consumption comes from their child-like view that lowered consumption, a symptom of a credit contraction, is the cause of a credit contraction. They see the economy as a game of pass-the-parcel, with the only problem being that the music has stopped. They are oblivious to the fact that the real cause of the problem is the structural derangement of the economy over a long period of time by force-fed credit.

Should the government hand out money?

The worst thing a government can do is hand out money. This is because:

  1. If the money comes from taxation, it will cause unemployment as businesses are obliged to cut wages and payrolls in order to make the sums add up;
  2. If the money comes from the printing press, it will cause monetary inflation, which causes unemployment;
  3. If the money comes from central bank debt instruments, it will prevent the credit market from recovering, stifling investment and trade and so causing unemployment;
  4. If the money comes from government borrowing, it will divert available capital from the private sector and increase the burden of taxes to service the debt.

Should the government invest in infrastructure?

When the government undertakes vast infrastructure projects in order to stimulate the economy, it creates only temporary work. None of the business structures or employment created to service these government orders will be permanent. In the meantime, human and capital resources are denied to the private sector, upon which everything depends.

A nation should invest in infrastructure during fat years, not lean years. Just as an individual does not put an extension on his house, nor a private company lay out a new production line during a recession, neither should the government invest in infrastructure when the country can ill afford it. Such expenditure can only be financed through higher taxes, monetary inflation, or borrowing, all of which cripple economic recovery.

Should the government nationalize banks?

In 1982 in Chile, banks that held half of the deposits were suffering severe liquidity crises. The government took control of these banks. Within three years, the Chilean government had liquidated the insolvent banks and reprivatized the solvent banks. The government set up a new regulatory scheme to avoid mismanagement. These new regulations allowed the market to determine interest rates and the allocation of credit to firms. The short-term costs of the crisis and the reform in Chile were severe, and real GDP fell sharply in 1982 and 1983. By 1984, however, the Chilean economy started to grow, and Chile has been the fastest-growing country in Latin America since then.

In 1982 in Mexico, the government nationalized the entire banking system, and banks were only reprivatized in the early 1990s. Throughout the 1980s, in an effort to maintain employment and investment, the government-controlled banks provided credit at below-market interest rates to some large firms and no credit to others. Even the privatization of banks in the early 1990s and the reforms following the 1995 crisis have not been effective in producing a banking system that provides substantial credit at market interest rates to firms in Mexico. The result has been an economic disaster for Mexico: Between 1982 and 1995, Mexico experienced no economic growth and has grown only modestly since then.

—A report issued by the Federal Reserve Bank of Minneapolis. Timothy J. Kehoe and Gonzalo F. de Cordoba, The Current Financial Crisis: What Should We Learn from the Great Depressions of the Twentieth Century?, February, 2009.

The government should not take over the banks except for the purpose of liquidating them (as Chile did). Banks that are teetering on the edge should be pushed over rather than assisted. This will ensure that only the strong survive, and the banking sector will thereafter be run prudently, to the general benefit of all. The opposite course rewards incompetence and causes economic malaise.

What should the government do?

Instead of allowing vagrancy and tent cities to spring up, the government should operate camps for the destitute. 99 percent of the work to build, maintain, administer, police, and service these camps should be performed by the residents themselves as barter for their food and accommodation.

Democracy within the camps should be encouraged, but inspectors should ensure that high standards of morality, cleanliness and order are maintained. Legislation governing the running of these camps should be puritan. Conviction for infringement of the rules should result in a transfer to a regular poor house or prison. This regime may sound harsh, but the alternative is the squalid filth and crime of Hooverville tent cities.

People will only despair if inflation, high taxes, and socialism prevent them from working their way out of a hole. Good, honest people only resort to crime if they or their loved ones are starving and unable to find shelter from the elements.

Likewise, good, honest nations only resort to appointing dictators when they have been starved and sorely abused over a long period of time by monetary chaos, high taxation, and a breakdown in the rule of law.

Conclusion

When confronted by a depression, the government must neither lend, nor borrow, nor print money, nor tax and spend to stimulate, but instead should devote its meager resources (as tax revenues will be down) to:

  1. Maintaining the legal framework (law courts and police);
  2. Deregulation and reducing the size of government;
  3. Ensuring people are not forced to resort to crime (camps for the destitute);
  4. Ensuring the military is sufficiently resourced to deter external aggression;
  5. Reducing taxes.

If these steps are taken, very quickly real growth, not fictitious capital, will provide employment to every person who wants a job. There will then follow a long period of high growth in living standards. The proof of this lies in the German post-war experience.

This article is an extract from the book ‘Principles of Good Government’ by Matthew Bransgrove