Sometimes very wise things are also very simple: like a story for children. I am a mentor volunteer for local disadvantaged fourth graders. This week’s reading assignment was to read and discuss Wildfires, a short children’s book written by Seymour Simon.
The author’s theme seemed contradictory: wildfires are not always harmful. Rather, they are part of the natural cycle of forest life. They occurred well before man populated North America. Extended droughts provided the necessary environment so that when lightning storms arose, wildfires ensued. No firefighters or park rangers impeded the natural order of things. Eventually, enough rain fell to extinguish a fire, or a fire would run out of fuel.
In elegant language understandable to fourth graders, Mr. Simon advocates a controversial and grown up point. The US Forest Service actually did a disservice to the long term health of our forests. Our ecosystem needs fires to allow light to reach the forest floor, to remove kindling which could cause even larger conflagrations, to permit certain animal species to reproduce, and to allow tree seeds to travel and reproduce. New and natural growth cannot occur without the cleansing effect of a wildfire. We now understand that aggressive firefighting was poor governmental policy that actually damaged the environment.
An Economy Managed Like a Wildfire?
The economic analogy is obvious. When the 2008 great financial crisis occurred the Treasury and the government overreacted. Treasury pleaded with Congress to create bailouts: TARP, TALF and an alphabet soup of other programs. The Federal Reserve aggressively lowered interest rates to zero and made bank purchases of distressed mortgage-backed securities and other poorly-rated assets. Finally, the Administration went on a policy and public relations campaign to save GM, Chrysler, GE, AIG and other large private companies. Government chose to aggressively fight the financial wildfire.
Policy makers forgot that, like a healthy forest, capitalism requires “creative destruction.” Coined by Joseph Schumpeter in his work entitled “Capitalism, Socialism and Democracy” (1942), this term denotes a “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.”
In a properly functioning capitalist economy, old or dysfunctional businesses must be discarded and replaced by more dynamic enterprises. If not, we would still be powering computers with vacuum tubes instead of advanced generations of semiconductors.
Killing the Business Cycle
On Friday, David Goldman’s blog Inner Workings pointed out the fallacy of aggressive governmental steps to arrest the financial crisis. His prediction: we will be mired in a little or no growth mode for years.
I’ve been on Larry Kudlow’s CNBC show arguing that the US will have 2% growth indefinitely–no real recovery, no double dip, no banking crisis, but no bank stock rally. Today’s depressing numbers are in line with my depressing expectations. We’ve got a creative-destruction economy, without the creation: the startups, the venture capital, the entrepreneurship. MySpace and LinkedIn don’t count: they are a faddish extension of old technology, a means by which Americans who bowl alone can pretend to have lots of friends. The People’s Republic of America Reports 1.8% GDP Growth (or: Why this is NOT a Business Cycle)
Lending to create new businesses has evaporated. In fact, credit creation is moribund. Banks are happy to borrow at low interest rates and reinvest at higher interest rate government securities without undertaking the riskier business of lending. New business formation is harmed. Multinational corporations are satisfied with earning profits outside the United States, which means we have anemic job growth. We are mired in a non-recovery recovery.
Let the Light In
In our wildfire analogy, the largest trees are the ones that most need to be eliminated. These are the ones that block growth on the forest floor. Government may have temporarily arrested financial decline, but at what cost? I grant you that it will be painful to permit the creative destruction of our “tallest trees”: poor performing banks and industrial companies. The pain would be sharp but not prolonged. Using another analogy, we needed to rip the economic band aid off quickly to minimize prolonged pain.http://www.prophetwithoutprofit.com/wp-admin/post-new.php
Mr. Simon in Wildfires pointed out another flaw in aggressive fire fighting: putting out smaller fires too early. Dangerous residual undergrowth became tinder for more destructive, larger, out of control wildfires. Similarly, our government did not fix the financial problems of 2008; they only postponed our date with a larger financial conflagration.
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