Wednesday, July 22, 2009

What makes this recession so severe

Many of us are wondering why this recession is so much worse than usual. Well one of the factors is that, unlike in the Great Depression, today's economy is not moving in the direction of production, but consumption. Whereas in the beginning of the 20th century the federal government took loans in order to invest in infrastructure and production (which was to be sold at a later time to its creditors), now it takes loans to purchase any number of goods from those same creditors.
Things have deteriorated further by the stubbornness of the government and its determination to keep companies in the game that, stupidly enough, follow policy leading to the unreasonable utilization of capital that has led to their impending bankruptcy.

The market, however, has a mechanism that eliminates unproductive management of capital and transfers it into the hands of people who will put it to better use. This is accomplished precisely by the bankruptcy we are so scared of.

In this scenario the productive parts of any company will gradually transfer from its current bad management toward a more capable owner. The unproductive parts will be eliminated, but this is a small price to pay for the continual growth of our economy.

During this transition, despite our government's predictions, there won't be a huge spike in unemployment, or it will be very brief; the factories are not going to be closed. We are not going to lose our cars or lending institutions. They are just going to change management.

But the sad truth is that, at this moment, a second depression is inevitable and the longer we delay it, the more severe its consequences are going to be.

If you leave things to the market, we may experience a few hard years, but the reallocation of capital will allow its more effective utilization and thus prompt a new period of growth. However, in order for this to happen, some sacrifices must be made, sacrifices that, sadly, our politicians in Washington refuse to make.

Special thanks to Stephen Douglas for editorial review and corrections.