Cause of Economic recession and the Path to Recovery
Economic recession or depression involves the loss of capital. The government use of economic stimulus plan on the other hand does not try to substitute or replace the lost capital, but rather seek to aggravate the problem. The author of this blog compares this to a situation of an individual with deprived sleep, who tries to solve the problem by using sleep inducing medications, rather than addressing the underlying causes of sleep loss. To understand the situation, the author defines the various terms and explains their relation to the idea of economic depression and stimulus package, as a remedy to the problem.
Capital refers to the accumulated wealth owned by an individual or a business establishment that is used for purposes of earning interest or profit. It includes land, factories, mines and machinery, or any equipment used in production, office establishment, communication and transport means as well as finished goods owned by a business. Capital plays a role in economic system in that it determines the potentiality of the economy to produce goods and services and to use labor, besides purchasing consumer goods on credit. The essence is, the higher the capital, the higher the ability to do all these things and the vice versa is true.
Saving is the act of refraining from consuming money that has been generated in the sale of goods and services. Capital is thus generated on basis of saving. However, it does not mean not spending or hoarding of funds, but it means not spending for consumption purposes. Hence, saving may entail spending for production purposes.
Hoarding on the other hand entails cash holding by businesses due to an increase in demand for money and a reduced potential of lenders. Businesses need money to pay wages, bills and other expenditure, and when they realize they can no longer rely on lenders for to execute this function, they hoard cash as opposed to saving (Saving is spending on production purposes or not buying for consumption purposes). Hoarding occurs during times of sharp decline in total savings. For instance, the rise in hoarding that is currently experienced is as a result of a major plunge in real estate and stock markets, of several and substantial corporate bankruptcies and of big loses on the part of banks and other financial institutions. This reflects a decline in the value of accumulated savings. The drastic fall in the savings in the current economic system has driven most people including popular economists to fear saving in perception that stimulating consumption is important. This instead worsens the situation rather than improving it.
Depression and credit expansion
Economic depressions and recessions and the losses that result from them are caused by an attempt to create capital through credit expansion as opposed to saving. Credit expansion can be understood as the lending out of new and extra money, created by the banking system from nowhere with support from the government. This money is perceived as additional and new capital, while in the real sense it is not. In fact, it encourages an artificial reduction in the demand for cash for hoarding. Recessions and depressions occur as a result of capital loss in the mal-investments and overconsumption caused by credit expansion. The housing bubble is a good explanation of the mal-investment and overconsumption resulting from credit expansion, which led to recession. This led to lenders losing significant capital and the firms that relied on them for loans had to close down and retrench their workers.
Keynesian ignorance and blindness
The general perception of most people to the issue of economic crisis lies on Keynesianism. This school of thought emphasize on the consumption as the start and the end of an economic activity. Keynesians fail to acknowledge the role of capital and saving in an economy.
Nature of Stimulus Packages
In the light of what has been discussed above, what economic recovery requires is to recreate its stock of capital through encouraging saving relative to consumption. Unfortunately stimulus packages result to continued loss of capital. This is an extension of the Keynesianism. In essence, stimulus package is credit expansion. It entails government financing of consumption, in the belief that it will lead to increased employment and production in replacement of what is consumed. Instead, stimulus packages lead to a decline in supply of capital hence worsen the recession or depression.
To get out of recession, what is needed is an increase in capital and savings. This means that, for any economy to improve from recession, they must increase production in excess of rising consumption. This is what Germany and Japan did in the wake of the Second World War, which helped them recover from massive economic meltdown.
Stimulus packages may help generate additional economic activity but cannot achieve any kind of significant economic recovery. They result to the creation of a system of public welfare in the pretext of work. For economic recovery to be realized, stimulus packages need to be stopped as their existence lead to capital decumulation, to a point where shortages of capital goods such as inventories of consumer goods possessed by business begin to push prices up. a rise in consumer goods` prices can potentially stop further capital decumulation resulting from the stimulus packages.
Reisman, G. (2009 February 21). Economic Recovery Requires Capital Accumulation Not Government “Stimulus Packages.