The Independent Market Observer

Recessions: A Capitalist Perspective

Posted by Peter Essele, CFA®, CAIA, CFP®

This entry was posted on Dec 29, 2021 1:00:29 PM

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What are the effects of a perma-stimulus policy? Commonwealth’s Peter Essele considers whether recessions are necessary for a healthy economy.Is it possible we can learn something about a healthy economy from the National Forest Service (NFS)? For decades, the forest service had a policy of extinguishing brush and wildfires at all costs. Its main goals were to prevent fires and to suppress them as quickly as possible if they started. Over time, however, the NFS came to realize that forest fires have a role in nature, one that is necessary for healthy ecosystems to take form. The same may be true for recessions and the long-term health of our economy.

A Policy of Modest Containment

One reason why the forest service evolved its policy is because its earlier approach resulted in larger conflagrations than the smaller fires that would’ve ensued had nature been left to run its natural course. Over time, the NFS found that strict wildfire eradication policies created a significant buildup of dry tinder that often set the stage for large firestorms. As a result, controlled burns became commonplace, and modest containment is now the preferred forest service policy toward wildfires.

Where Recession Is a Dirty Word

The tactics and policies currently employed by Washington around recessions are the same as those the forest service used in the early days of fighting wildfires: prevention and all-out suppression. These days, even the hint of a recession sends shock waves through Washington. The reaction is often immediate calls for fiscal and monetary stimulus, particularly from the party in power. Recessions are bad for business in Washington, especially around election time.

Stimulus, it seems, has become the preferred rallying cry in Washington. A quarter of sluggish growth or small downward correction in the stock market is immediately met with calls for stimulus by politicians on financial talk shows, in the halls of Congress, or on social media. Since the great financial crisis, we’ve failed to let the economy follow the natural ebb and flow of the business cycle. Instead, the economy is routinely injected with massive amounts of stimulus to stave off any sort of downturn in growth or the stock market.

Living in a Perma-Stimulus World 

It’s possible that the perma-stimulus economy we’ve come to expect is having significant unintended consequences. The throw-money-at-the-problem approach that’s become commonplace over the last 15 years may have resulted in a significant buildup of economic dry tinder. In this case, the tinder comes in the form of inefficiencies and unproductive businesses that may have otherwise failed or reorganized during a garden-variety recession. Economic downturns, as we know, lead to periods of regrowth. Green shoots form, new businesses and opportunities are developed, and many individuals make lifestyle and professional changes. In many cases, recessions are a necessary evil for a healthy economy.

What if we continue down this perma-stimulus road? We must consider whether the lack of a proper business cycle is creating an undercurrent of zombie-like businesses kept afloat via easy access to capital (e.g., zero-interest rate policies) and other types of stimulus. In an environment that provides a constant safety net, will productivity and service suffer as businesses rely less and less on competition to survive? Will the economy reach a stagnant-growth environment that lacks ingenuity, relies on constant government assistance, and is fraught with inefficiencies? A fervent defender of capitalism would argue the economy is heading in that direction.

Economic Vs. Social Costs

It would be imprudent to write a post about recessions without acknowledging the social costs of recessions. As many of our advisors know, recessionary environments create significant psychological and financial burdens, whether they’re around retirement, paying for college, or simply trying to make basic ends meet. At a national level, a lot of pain comes with recessions, and it’s no surprise that we do everything in our power to avoid those stressful periods.

But is the avoidance of the short-term social costs setting us up for larger, longer-term consequences?

If the economy and markets are in a state of perma-assistance that lacks any mechanism for resetting, we may suffer in the long run. Frequent policy enactments that seek to avert even the mildest downturn will see the economic tinder continue to build, ultimately resulting in an economic firestorm. In that case, the economic fallout and social costs could be far greater than anything that would’ve occurred in a naturally cycling economy.

In the years ahead, perhaps Washington should consider a policy of containment as opposed to all-out suppression. In the long run, the latter remedy may be worse for us socially and economically.

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