Monday, November 21, 2011


natural parabolic shape
of a recession and recovery
With recessions, the rule is: what goes down must come back up. The natural shape of a recession is a parabola. There’s a sharp drop to as low as it’s going to go, and then the direction changes upward during recovery. If it is allowed to follow the natural course of events, the recovery will essentially mirror the drop—and then keep going up. 

This is a concept my sons, Economic Sphere and Political Sphere, have been sharing with me from time to time. I don’t have the economic math skills to reproduce all the math logic for you, unfortunately. But I think the basic concept will do. Recessions happen because the market needs to correct, from a bubble or maybe a natural disaster--something that interferes with the natural long-term aggregate growth of the free market. But once there’s a drop, then a naturally growing market returns.  

Political Sphere shared an article from Forbes about the concept that recessions follow a natural course—unless interfered with. The article makes that point that the excuse “this time is different” is never true. 

L-shaped recession, natural
recovery is prevented
Real trouble happens when there is interference, usually intended to “help.” According to Wikipedia, one of the shapes a recession can take is the L shape. In this one, the sharp drop happens just as you would expect. But then, instead of bouncing on the bottom and coming back up, the level just sort of dribbles along horizontally near the bottom. Other names for this are “depression,” “lost decade,” and “malaise.” These are all terms beginning to be applied to our current L-shaped recession. They are terms that applied to FDR’s Great Depression as well. 

What is it that causes this recession to be different, to languish at the bottom instead of bouncing back? Government interference. How do we know? 

This is maybe more than you wanted, but here’s a basic formula: 

Y = C + I + G + NX 

Y is GDP (production) in actual dollars.
C is consumption, which is a function of Y-T (taxes).
I is investment, or infusion of new capital (not spending on used materials, or stock exchanges).
G is government spending.
NX is net exports. 

Government can affect Y by increasing spending or raising or lowering taxes. More taxes means less money for consumers to spend, and less taxes means more money for consumers to spend. Indirectly investment will be affected if Y decreases, when there is less profit to be made. But mainly the other way government can change Y is by increasing government spending.  

I had to ask Economic Sphere why the formula includes “+G” instead of “-G.” In theory, G is just another product consumers (we the people) spend money on. To some degree it’s necessary. So the amount spent on G is just another part of the measure of GDP. However, when spending on government is too high—includes debt—it temporarily appears that the G portion of the economy shows actual growth in GDP. But that is an illusion. 

natural ups and downs of
business cycle show a sine wave
It appears, in the short run, that government spending (or stimulus) increases Y. But Y’s rate of growth is, in a natural free market, fairly constant. There is fluctuation, an ongoing sine wave, or little rises and dips, but you can draw a line through that at approximately the natural rate of growth (maybe somewhere near 4%). Government spending can’t change that. It doesn’t affect aggregate supply; it only affects aggregate demand. So it may appear for a time that it has affected growth, but there will be a natural pull back to the equilibrium point where aggregate supply and demand intersect. There will be a correction. So the more government does to try to make the market go up, the greater will be the eventual correction back to the natural rate of growth. 

The longer and greater the government over-expenditures, the more drastic will be the inevitable correction. 

So what happens if government sees that inevitable drop and tries to prevent it—with more government spending? It causes an even greater drop. If the measures are taken after the drop, presumably in an effort to stop more drop or cause a rise, it interferes with the natural recovery. That is what we’re seeing now. 

Greater government spending at a time when great government spending already caused the dip is like hitting the economy over the head and beating it down. Every new interference, every new beat down, leaves the economy languishing down at the bottom, unable to rise because of the repeated drop-causing interferences. When they say, “The economy was in much worse shape than we thought; imagine how bad a shape we’d be in if we had done nothing,” you can know for certain that things are worse because of what they did in their ignorant attempts to control a natural force.  

If government wants to have a positive effect on GNP, it needs to cut spending. Since it can’t (won’t) cut to zero, the next best thing would be to cut to the bare bones of the enumerated powers of the Constitution. At the same time, lowering rather than raising taxes will help. Both lowered government spending and lowered taxes leave more money available for growth.

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