Guest post by Ronald-Peter Stöferle
According to the National Bureau of Economic Research (NBER), a recession is defined as a “significant decline in economic activity spread across the economy, lasting more than a few months.” Often, this is understood as two consecutive quarters of negative economic growth as measured by a country’s GDP.
Public opinion is generally quite simple in regard to recession: upswings are generally welcomed, recessions are to be avoided. The “Austrians” are however at odds with this general consensus — we regard recessions as healthy and necessary. Economic downturns only correct the aberrations and excesses of a boom. The benefits of recessions include:
- Sclerotic structures in the labour market are broken up and labour costs decline.
- Productivity and competitiveness increase.
- Misallocations are corrected and unprofitable investments abandoned, written off, or liquidated.
- Government mismanagement of the economy is exposed.
- Investors and entrepreneurs who were taking too-great risks suffer losses and prices adjust to reflect consumer preferences.
- Recessions also allow a restructuring of production processes.
At the end of the corrective process, the foundation for a renewed upswing is more stable and healthy. We thus see deflationary corrections as a precondition for growth in prosperity that is sustainable in the long term. Ludwig von Mises understood this when he observed:
The return to monetary stability does not generate a crisis. It only brings to light the malinvestments and other mistakes that were made under the hallucination of the illusory prosperity created by the easy money.
Can the Government Save Face?
However, in addition to leading to true temporary hardship for the malinvestment-affected areas of the economy, an economic recession in the near future would represent a harsh loss of face for central bankers. Their controversial monetary policy measures were justified as an appropriate means to nurse the economy back to health. That is, their efforts to end or avoid helpful recessions were claimed to contribute to the eagerly awaited self-sustaining recovery.
But the attempt to combat a crisis that was triggered by too-loose monetary policy by the very same means will not lead to sustainable prosperity. It will only delay the crucial adjustment processes of a deflationary phase. The longer they are delayed and the more the central bankers and politicians attempt to keep them at bay, the more uncomfortable this adjustment will become.
Politics Trumps Economics
In general, there is the tendency in every democratic system to prevent too-painful adjustment processes as its nature of short-term bitterness and long-term benefits conflicts with the result scheme politicians are reelected for. No democratic government that is presented with the bill for the obvious successes and failures of its administration at the next election, will voluntarily allow a deep recession to occur — even if it were to agree that the adjustment was necessary.
Hence, inflationary policy is always a welcome method of impoverishing the population by decree and thereby pushing through a real adjustment of prices by force. The debasement of money as a rule always hits a society’s most underprivileged the hardest, as rich people can more easily avoid a devaluation of their wealth.
Concern from Outside the Austrian Camp
Nonetheless, representatives of the Austrian school are no longer alone in warning about the fatal long-term consequences of the zero interest rate policy. Even the Bank for International Settlements, often referred to as the “central bank of central banks,” understands that endless attempts at avoiding recessions can have truly negative effects.
The BIS explains:
Particularly for countries in the late stages of financial booms, the trade-off is now between the risk of bringing forward the downward leg of the cycle and that of suffering a bigger bust later on.
New debt serves primarily to keep the fragile edifice of debt from collapsing; it doesn’t lead to new investment activity. In this respect, the BIS sees parallels between Western industrialized nations today and Japan in the 1990s. These policies, the BIS contends “destabilises the banking sector directly but also acts as a drag on the supply of credit and leads to its misallocation.”
This year, the ECB, which as the successor of the German Bundesbank has long kept the flag of inflation reservation flying, finally capitulated and began betting on increased monetary stimulus — in keeping with the motto: “It isn’t working, so let’s do more of it!”
Nevertheless, according to F.A. Hayek, these united global crisis defense mechanisms only postpone the crisis which will take place at any rate, only later and much more severely:
To combat a depression by means of a forced credit expansion is akin to the attempt to fight an evil by its own causes; because we suffer from a misdirection of production, we want even more misdirection — an approach that necessarily leads to an even more serious crisis once the credit expansion comes to an end.
Ronald-Peter Stöferle is Managing Partner and Fund manager at Incrementum AG, based in the Principality of Liechtenstein. The company focusses on asset management and wealth management and is one hundred percent owned by its partners. Ronald manages a fund that invests based on the principles of the Austrian School of Economics.
This post first appeared at the Mises Daily.
- “So to answer the bubble man’s question, the worst start to a year in history — the 1930s included—is not at all due to what has happened since January 1st; its the sum of all the folly that has gone before.”
The Sleepwalkers Awaken – David Stockman, CONTRA CORNER, January 20, 2016
- “If the ‘boom’ is the part where the central bank's rocket fuel sends everyone out on a bender, and the ‘crisis’ is the part when you wake up in the morning and realise you've left your credit card with the hooker and her six cocaine-addled friends, then the ‘depression’ is the part where you ring the credit card company and cancel the card. The depression is the recovery phase. … The ‘depression’ is actually the process by which the economy adjusts to the ... Time to stop worrying then, and learn to love the recovery.”
Why you should stop worrying, and learn to love depressions – NOT PC, 2008
- “A recession (or depression) is actually the recovery phase after an unsustainable boom. It’s the period where all the misallocations and malinvestments are shaken out. You have no choice about the pain of an economic depression (or recession). But you do have a choice about how long the pain lasts.”
Hayek on Handling Recession – NOT PC, 2014
- “Mainstream economists say that "The recession is caused by a vast drop in demand." They say that it’s caused by “a general collapse of prices.” Not much of an analysis, is it? But that's the only answer your mainstream economists have got. That's really the best they can do.
“In fact, the Depression isn't caused by either a vast drop in demand or by a general collapse of prices -- in fact those are both part of what, by definition, constitutes a Depression. They’re actually two of the defining characteristics of a Depression. But so far are they from being a primary cause of depression, they’re actually the result of earlier actions. But your mainstream economists know nothing about that.”
Understanding economic crises – NOT PC, 2009
- “Mainstream media discussion of the macro economic picture goes something like this: ‘When there is a recession, the central bank should stimulate. We know from history the recovery comes about 12-18 months after stimulus. Central banks stimulated, they printed a lot of money, we waited 18 months. So the economy ipso facto has recovered. Or it’s just about to recover, any time now.’
But to quote the comedian Richard Pryor, “Who ya gonna believe? Me or your lying eyes?” A Martian economist arriving on earth would have to admit the following: the US economy has experienced zero real growth since 2000. This is what I call the permanent recession. Permanent, because, unlike past downturns — there will be no recovery.”
Say’s Law and the Permanent Recession – Robert Blumen, NOT PC, 2014
- “If deepening recessions and making them longer is your aim, then John Maynard Keynes is your man. If the most first lesson we learn that makes us adults is that there's no such thing as a free lunch, then Keynes is the man who made ‘free lunch’ economics sound smart -- who said you could eat your consumption and and have your production too. But you can't.”
John Maynard Keynes: The destroyer of monies – NOT PC, 2008
- “The world crisis was caused by an enormous worldwide increase in the money supply—around twenty percent year-on-year for more than a decade, compounding—which flooded into credit markets, distorting the capital structure and giving finance companies what they thought would be a never-ending spigot, and spilled over into the world’s housing market, creating the world’s most expensive and biggest-ever housing bubble.
It is being now “fixed” by nothing less than the same again—only this time on steroids. More cash pouring out of the Fed’s printing presses … injecting huge tranches of counterfeit capital into the economy . . . ”
The Fed’s new “super-stimulus” will not stimulate but destroy ... Bernard Hickey is a moron – NOT PC, 2010
- “The more government blocks market adjustments, the ‘longer and more grueling the depression will be, and the more difficult will be the road to complete recovery.’ Rothbard argues it is possible to logically list the ways market adjustment could be aborted by government action and such a list would coincide well with the “favorite ‘anti-depression’ arsenal of government policy.’ The list almost perfectly matches with policy responses to the crisis during both the Bush and Obama administrations. Here is Rothbard’s ‘Don't Do’ list, with my comments in brackets . . . ”
Recessions: The Don't Do List – NOT PC, 2013
- “In a more rational world, the world would have been out of economic depression in February last year (2009). That would be the sort of world in which those alleged economists whose theories either caused the crash (or blinded them to what was about to happen) would have been kicked to the kerb in short order. Sadly, that hasn’t happened . . . ”
The next Great Depression has already been YouTubed – NOT PC, 2010
- “Both malinvestment and overinvestment appear whenever credit expansions are initiated by a central bank, because in such circumstances the subsistence fund will be inadequate to sustain the new, artificially-lengthened production
process. An excess of money and credit creates the problem. The solution takes time, because real capital goods cannot be transformed into real consumer goods overnight. Monetary changes can be effected rather quickly, but once undertaken, their impacts on real goods cannot easily or quickly be reversed. . . .
“A subsistence fund that is adequate only for one time period will lead, in subsequent periods, to capital consumption as the production process is forced to become more ‘momentary’ and less roundabout.”
Explaining Malinvestment and Overinvestment – Larry Sechrest, QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS, 2006
- “Richard Salsman had an admirable goal in mind, a goal with which the present writer utterly sympathises. He wanted to defend capitalism against the “slings and arrows” of statists of all stripes. He wanted to set the record straight about the Great Depression. It did not constitute a massive ‘market failure’ but a colossal government failure. One could not agree more. But along the way, Salsman also was determined to demonstrate that he alone knew the true cause and consequences of that momentous event. All economists had it wrong, even the passionately laissez-faire Austrians. Tragically, in his rush to convince the reader of this, he cast aside fair-minded scholarship, clear reasoning, and many inconvenient facts. The result is largely a tortured, muddled mess.”
Missing the Mark: Salsman's Review of the Great Depression – Larry Sechrest, JOURNAL OF AYN RAND STUDIES, 2008 [PDF]
- “George Reisman offers a more general rule of thumb for measuring whether we're in schtuck: ‘A depression is characterized not only by falling prices, but also by a plunge in business profits (which may even become negative in the aggregate) and by a sharply increased difficulty of repaying debt. It is also characterized by mass unemployment.’”
Recession – NOT PC, 2008