A recession/depression is the process of liquidating malinvestments and redeploying wealth and labor to economically profitable ventures.
If what you say were true, then we wouldn't be suffering from unemployment. We'd suffer from massive writedowns in our wealth (as we realize our malinvestments) but labor would be redeployed to new ventures. Effectively, we'd be working our assess off harder than before, but receiving a lower quality of life in return.
In reality, however, the economy is not at full employment. If we malinvested before (effectively did useless work), that should be a sunk cost. We wouldn't receive the future benefits we expected from that work, but that wouldn't preclude us from continuing to work. Malinvestment is not a reason for unemployment.
No, we're in a liquidity trap. Option A is monetary policy. That has been tried and exhausted. Option B is fiscal policy. Bring out the helicopters!
That's only true if they're continuing to make poor investments. All we know is that lots of companies made poor investments in the past. Letting them fail doesn't change that past, nor does bailing them out necessarily reduce the quality of future investments.
If the person I originally replied to is implying that the current bailouts create too much of a moral hazard, then that's a possibility, but that one sentence that was given doesn't do the issue justice.
Have you seen the share prices lately for the companies that have needed the bailout? Citigroup's stock is down almost 95% since mid-2007. The equity holders have been wiped out. The poor investments don't need to be honestly documented for that to happen. If you know that poor investments have been made, so does the market.
What I mean by wiping out is that the company ceases to exist, its stock is deregistered, and a successor company is created by the bankruptcy receiver. Stockholders in most financial companies have not experienced this, because the government regulators have decided to prop the banks up as zombies.
Suppose a consortium of Arab investors decided to believe Citi's current published balance sheet, and bought $500M of newly-issued Citi common stock at US$2.00/share, a nice discount from its $3.40/share market price. They would most likely lose every penny of that investment when Citi fesses up to the true losses.
Of course the big money investors are no longer that foolish, having been burned several times by U.S. bank "recapitalization investments" in 2007/2008. Everybody is waiting on the sidelines for honesty to develop. This flight of capital has been billed as a liquidity crisis by the Wall Street hucksters, and used to justify mammoth bailouts, but in reality it is a solvency crisis and there is an ocean of hot money itching to be spent on honest companies.
we wouldn't be suffering from unemployment... labor would be redeployed to new ventures
Yes, but redeployment takes time -- especially when everyone looks around and sees all their assumptions about what profits different activities will return are wrong, and need to be recalibrated. That research -- which happens tentatively, experimentally at first -- means some capital/labor sits on the sidelines while the necessary information is collected or created.
Redeploying labor immediately at the first things you can think of might keep people busy but can worsen the wealth destruction, if those activities wind up being of net zero or negative benefit. (By tying up workers on make-work, they could also slow the rediscovery and restaffing of valuable projects.)
Those who have lost their jobs don't necessarily have the right skills for the more economically productive jobs that hopefully get created. Also, they don't necessarily live in the right places.
Not to mention that many who are in the right place and could profitably use new people are not sure of that fact, so they lack the confidence to bring in as many new people as they might otherwise.
Which is why fiscal stimulus is temporary. It's necessary while the economy is at less than full employment, but once the economy starts picking up fiscal stimulus should drop off.
That's the cover story. But how much of the $819 billion in the stimulus bill is set to automatically expire in 2 years, or when the economy reaches certain growth targets? Roughly: none. A lot of the spending won't even get flowing until 2010 or 2011, when the economy may be recovering just fine on its own.
Malinvestment also applies to labor. Workers need to retrain before they can start new productive jobs, and they need capital as well (not easy, since the US are borrowing instead of saving).
It's clear that the massive investments in housing over the last few years won't produce the returns we expected. Yes, we're going to suffer because those were bad investments.
But look at the bigger picture. We have productive economic resources (labor), why should they ever be sitting idle? It's not like we don't have problems to solve. We have to pay off our debt to the Chinese. We have to figure out what to do when the oil runs out. We have to make sure we don't destroy the planet sometime during the next century. We need to figure out how to take care of all the baby boomers once they retire. There's LOTS of work we need to be doing, but we're sitting around twiddling our thumbs. That makes no sense.
This presumes someone (the government? you?) can figure out what to do with that labor. Traditionally, in a capitalist economy, we let the market figure that out. Right now, the market's in a bit of a state.
Yes, in the industries where the bad investments where made (finance). But that alone cannot explain the withdrawing of investment from other industries.
No sectors exist in a vacuum. Take this very simplistic example:
The original source of our financial crisis is the collapse of subprime mortgages. People are getting kicked out of their homes, which has several effects:
- There are now a lot of houses on the market, driving prices down and reducing demand for more construction. Construction companies suffer, as do all of their labour and material suppliers (lumber companies, contract labour companies, etc)
- Banks have reacted to the defaults by attempting to protect themselves from further risk, meaning that it's harder than ever to get a mortgage. The effect is a similar drop in housing demand, with similar results as above.
- As the true scope of the problem unfolded, people began bailing on bank investments, driving prices down, and eliminating wealth that normal people have stored up in the form of mutual funds and such. This loss of wealth amongst "average people" has driven down consumer demand, and thus basically every other industry out there.
- As investors realized that consumer spending will be down, they withdraw their investments in these companies, resulting in further depression of the stock. This in turn causes more loss of wealth for people holding these investments, and causes a vicious cycle.
There's a much simpler explanation: the collapse of subprime mortgages forced people to confront the fact that there is way too much leverage in the economy. Too many people and companies owe money that they won't be able to pay back. The level of production of goods and services was based on the level of consumer and business spending, which everyone now realizes was being fueled by excessive debt. The level of production must now fall to a level that is consistent with businesses and consumers using much less debt going forward, and it will certainly overshoot on the downside because of panic and lack of information.
The question that I see being repeated in the media these days is "what are the banks doing with the bailout money, why aren't they lending it?" Perhaps the answer is that there is currently nobody out there who is a good enough credit risk to lend money to. Another possible answer is that the banks now realize that they've lost the ability to quantify credit risk correctly and they are going to need to relearn that skill.
No, you're ignoring the fact that every time a desk company tools up a new factory, they are investing, and when those investments track a faulty projection on the demand for desks from financial services companies, they too have malinvested.
You don't comprehend the macroeconomic scene if you think we're dealing with a "financial crisis." Dozens of sectors are at over capacity. Debt growth has hit its ceiling and households, governments, and businesses all over the country need to repair balance sheets. This is not about banks or financial firms.
If what you say were true, then we wouldn't be suffering from unemployment. We'd suffer from massive writedowns in our wealth (as we realize our malinvestments) but labor would be redeployed to new ventures. Effectively, we'd be working our assess off harder than before, but receiving a lower quality of life in return.
In reality, however, the economy is not at full employment. If we malinvested before (effectively did useless work), that should be a sunk cost. We wouldn't receive the future benefits we expected from that work, but that wouldn't preclude us from continuing to work. Malinvestment is not a reason for unemployment.
No, we're in a liquidity trap. Option A is monetary policy. That has been tried and exhausted. Option B is fiscal policy. Bring out the helicopters!