Industrial Insight

good stuff… | June 17, 2011

http://www.realclearmarkets.com/articles/2011/06/17/what_is_a_real_economic_recovery__99079.html
June 17, 2011

What Is a Real Economic Recovery?

By Jeffrey Snider

The housing bubble itself is a microcosm of the larger economy that was built on fiat money and constantly leveraging credit production. Incomes were at best stagnant during that period, but asset prices kept rising and the economy kept growing. As is well known, both were predicated solely on the creation of credit. Without new money to fill the income gap, it all fell apart.

Economic activity based on the price of assets is a disaster waiting to happen, a massive ponzi scheme. In the aftermath of that disaster, it is certainly tempting to try to rebuild exactly as before – it seems like the path of least resistance. There is also a tendency to view the economy just before the collapse as the standard for economic potential and a target for the recovery. Policymakers are intent on getting the economy back to where it was in 2006 and 2007 because they mistakenly believe that economic potential is some historical data series.

It is a fool’s errand. The economy of the pre-crisis period had gotten too far ahead of sustainability because of improper price signals and misaligned credit creation. Maintaining improper price signals and misaligned credit creation hardly seems to make sense now (two economic wrongs don’t make a recovery).

….

This financial miscalculation, fostered by the maintenance of artificial interest rates, bleeds beyond financial investments into business operations. The focus on liquidity makes profitable businesses ignore economically helpful projects. These kinds of expansions are, by their nature, risky and illiquid. Instead, cash is preferred. So are financial maneuvers – stock buybacks over factory expansion or a new research focus; paying a premium for a smaller competitor rather than acquiring a new unproven technology that might take longer to develop. Above all else, immediate returns are demanded at the expense of long-term investment.

As long as liquidity is the primary consideration, profitability is itself a trap. Rather than fostering the sustainable flow of money within an economic system, unilateral profitability is a dead end. Money flows to the bottom line of companies and stays there. Without a real, non-financial outlet for accumulated net income we are all poorer for it. The opportunity cost of dead-end profitability is lost wealth. In the end, wealth-creating activities create a recovery, not financial trading.

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