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It is a given that you should never mention the “R” word. People immediately assume you mean the end of the world: death, disaster, and destruction. Unfortunately, the Federal Reserve​​ (Fed)​​ and the​​ U.S.​​ Government also believe​​ that​​ recessions “are bad.” As such, they have gone to great lengths to avoid them. However, what if “recessions are a good thing,” and we just let them happen?

 

“What about all the poor people that would lose their jobs? The companies that would go out of business? It is terrible to think such a thing could be good.”

 

Sometimes destruction is a “healthy” thing, and there are many examples we can look to, such as “forest fires.”

 

Wildfires, like recessions, are a natural part of the environment. They are nature’s way of clearing out the dead litter on forest floors, allowing essential nutrients to return to the soil. As the soil enrichens, it enables a new healthy beginning for plants and animals. Fires also play an essential role in the reproduction of some plants.

 

Why does California have so many wildfire problems? Decades of rushing to try and stop fires from their natural cleansing process as noted by MIT:

 

“Decades of rushing to stamp out flames that naturally clear out small trees and undergrowth have had disastrous unintended consequences. This approach means that when fires do occur, there’s often far more fuel to burn, and it acts as a ladder, allowing the flames to climb into the crowns and takedown otherwise resistant mature trees.

 

While recessions, like forest fires, have terrible short-term impacts, they also allow the system to reset for healthier growth in the future.

 

No Tolerance​​ for​​ Recessions

 

Following the century’s turn, the Fed’s constant growth mentality exacerbated rising inequality and financial instability. Rather than allowing the economy to perform its Darwinian function of “weeding out the weak,” the Fed chose to “mismanage the forest.” The consequence is that “forest fires” are more frequent.

 

Deutsche Bank strategists Jim Reid and Craig Nicol previously wrote a report that echoes what other Austrian School economists and I have been saying.

 

“Actions are taken by governments and central banks to extend business cycles and prevent recessions lead to more severe recessions in the end.” 

 

Recessions Are A Good Thing, #MacroView: Recessions Are A Good Thing, Let Them Happen

 

Prolonged expansions had become the norm since the early 1970s, when President Nixon broke the tight link between the dollar and gold. The last four expansions are among the six longest in U.S.​​ history.

 

Why so? Freed from the constraints of a gold-backed currency, governments and central banks have grown far more aggressive in combating downturns. They’ve boosted spending, slashed interest rates or taken other unorthodox steps to stimulate the economy.” – MarketWatch

 

Recessions Are A Good Thing, #MacroView: Recessions Are A Good Thing, Let Them Happen

 

But therein also lies the problem.

More Debt Leads​​ to​​ Less​​ of​​ Everything Else

 

The massive indulgence in debt, what the Austrians refer to as a “credit induced boom,” has now reached its inevitable conclusion. The credit-sourced boom led to artificially stimulated borrowing, which sought out diminishing investment opportunities.

 

Ultimately, diminished investment opportunities led to widespread malinvestments. Not surprisingly, we saw it play out “real-time” in everything from subprime mortgages to derivative instruments previously.

 

Recessions Are A Good Thing, #MacroView: Recessions Are A Good Thing, Let Them Happen

 

When credit creation can is no longer sustainable, the markets must clear the excesses before the cycle can restart. Only then, and must be allowed to happen, can resources be allocated towards more efficient uses.

 

Such is why all the efforts of Keynesian policies to stimulate growth in the economy have ultimately failed. The ongoing fiscal and monetary policies, from TARP and QE to tax cuts, only delayed the clearing process allowing it to grow larger. That delay worsens the current impact and the eventual reversion.

 

The economy currently requires roughly $5 of total credit market debt to create $1 of economic growth. A reversion to a structurally manageable debt level would require a reduction of nearly $40 trillion. The last time such a clearing process occurred, it was called the “Great Depression.”

 

Recessions Are A Good Thing, #MacroView: Recessions Are A Good Thing, Let Them Happen

 

The chart shows why “demands for socialism” is now “a thing.”

Austrian Theory​​ of​​ Business Cycles

 

“As the inevitable consequence of excessive growth in bank credit, exacerbated by inherently damaging and ineffective central bank policies, which cause interest rates to remain too low for too long, resulting in excessive credit creation, speculative economic bubbles, and lowered savings.”

 

In other words, the proponents of Austrian economics believe that a sustained period of low rates and excessive credit creation results in a volatile and unstable imbalance between saving and investment. In other words, low rates tend to stimulate borrowing from the banking system that, in turn, leads, as one would expect, to the expansion of credit. This expansion of credit then, in turn, creates an expansion of the supply of money.

 

Recessions Are A Good Thing, #MacroView: Recessions Are A Good Thing, Let Them Happen

 

Therefore, as one would ultimately expect, the credit-sourced boom becomes unsustainable as artificially stimulated borrowing seeks out diminishing investment opportunities, ultimately resulting in widespread malinvestments.

 

When the exponential credit creation is longer sustainable, a “credit contraction” occurs. Such ultimately shrinks the money supply and the markets finally “clear.” The clearing process allows resources to be allocated back towards more efficient and productive uses.

 

As shown in the chart above, the Fed’s actions halted the​​ much-needed​​ deleveraging of the household balance sheet. With incomes stagnant and debt levels still high, it is worth little wonder why 80% of Americans currently have little or no “savings” to meet an everyday emergency.

 

Furthermore, the velocity of money has plunged as overall aggregate demand has waned.

 

Monetary Velocity

 

What the Fed has failed to grasp is that monetary policy is “deflationary” when “debt” is required to fund it.

 

How do we know this? Monetary velocity tells the story.

 

What is “monetary velocity?” 

 

“The velocity of money is important for measuring the rate at which money in circulation converts into purchasing of goods and services. Velocity is useful in gauging the health and vitality of the economy. High money velocity is usually associated with a healthy, expanding economy. Low money velocity is usually associated with recessions and contractions.” – Investopedia

 

With each monetary policy intervention, money velocity has slowed along with the breadth and economic activity strength.