Recessions Made Really Simple

One word with which we are all unfortunately familiar is "recession". In a free market economy, a recession is a significant decrease in business activity over a period of time. But stop and think for a minute, if the population and production capacity are continuously increasing, why should there ever be a recession unless there is some kind of natural disaster or other calamity? We should always be at maximum possible productivity so why do recessions seem to just come along periodically?

Today, I would like to introduce my economic theory to explain recession in a new way.

HOW MARKET FORCES BRING ABOUT RECESSIONS

As we know, a country prints money for the purpose of financial transactions because barter would be too cumbersome. The supply of money in a country is exactly equal in value to all of the goods and services produced by that country that can be exchanged for money. The money supply is thus a mirror image of the value of the production.

My economic theory revolves around the idea of the pathway along which the economy moves. On one side of the pathway is inflation and on the other side is recession. When we mint more money without a corresponding increase in the production of goods and services, it inevitably brings down the value of each unit of currency since the money supply must be a mirror image of the goods and services produced. The free market automatically corrects and the resulting decrease in value of the currency is known as inflation.

Inflation can be caused by natural factors such as drought or raw material shortages but I define inflation as a tax when it is caused by the overprinting of money because it gives the government more money to spend but the consumers pay for it not by direct payment of taxes but by higher prices for consumer goods caused by the overprinting.

Inflation is not good. It hinders lending and investment by eroding away the returns. If someone invests money at 6% interest but there is 4% inflation, their return is only 2%. Inflation causes consumers to focus on essentials so that companies making and marketing less-essential goods struggle or may go out of business. Inflation can lead to recession by hundering spending.

If the economy strays too far to the other side of the path, the result is recession not resulting from inflation. In my view, although recession is often portrayed as an unfortunate event that comes along once in a while, it is, in fact, a natural part of the way the economy is set up. We are familiar with the fundamental law of supply and demand that underlies a free market economy, prices increase when demand is high relative to supply and decrease when supply is high relative to demand. In my theory, we have the economy set up so that periodic rescessions come about by the same law of supply and demand.

In reality, a recession is an absurd situation in which workers produce goods and services but when they go to market, they cannot afford to buy the goods and services that they have produced. This means that production of those goods and services must be cut back since it makes no sense to produce goods and service that will not sell. That means that some of the workers must be laid off (made redundant) so that the workers as a whole have even less money to buy goods and services. That means that production must be curtailed further, and so on. This is a truly absurd and non-sensical situation yet it is what happens every few years.

A recession can be caused by any change in production, either an increase or decrease. If it is a decrease in production caused by drought or other calamity, we will call that a "real recession". But if it is actually an increase in production that leads to recession, it is because the wages of workers did not keep pace with production, leaving unsold goods and services and making necessary an absurd cutback in production. We will call this an "artificial recession" and it is the kind of recession that I think we can eradicate altogether.

When production increases with the same number of workers, that should make goods cheaper relative to wages. But business owners are naturally reluctant to raise wages or lower prices. In not doing so, they set the stage for recession. According the the law of supply and demand, prices should decrease or wages increase when production increases. When this is naturally resisted by business owners, a correction has to happen. Unfortunately, the correction comes in the form of a recession for the simple reason that it makes no sense to produce goods and service unless someone is going to buy them.

If wages and prices are balanced but there is a sudden increase in productivity, it will leave goods and services unsold. Business owners would naturally prefer to lay off workers rather than lower prices much and this feeds the recession. The market "tries" to strike a balance so that wages and prices are kept in equilibrium, but when this is resisted the correction must come from another direction, an absurd and artificial cutback in production, in other words a recession.

Thus I divide recessions into two categories, those brought about primarily by inflation and those brought about by the failure of the wage/price ratio to keep pace with production and so leaving goods and services unsold. Once a recession gets started, news feeds the downward spiral, people read that there is a recession and so hold back on hiring and spending and thus feeding the recession. Inflation and wages operate in a similar spiral that kills lending and investment.

In my theory, the reason behind the absurd and non-sensical artificial cutback in production that is a recession is the fact that our economy is not actually a true marketplace, even though we tend to think it is. A true marketplace involves haggling and negotiating over prices when a purchase is made. These traditional types of market continue in many places today. Rather than setting prices, buyer and seller haggle, or negotiate, the price. Even if there are price tags on goods, they are negotiable.

In such a traditional market, wages are not set either. Day labor (labour) is the rule. Workers and employers meet in the marketplace each morning, spend a few minutes negotiating the wages of a day's work and then are off to the task.

Our sacrosanct law of supply and demand originated in such traditional marketplaces. The reason that our free enterprise economy is not actually a true market is that the daily haggling does not take place. Wages and prices are set and are changed only reluctantly. Eventually, necessary corrections are made, but by then the recession spiral is already underway.

A haggling merchant would lower prices if demand were low that day. Day laborers (labourers) would make sure that their wages for a day's work will be enough for living expenses. This would self-correct the market and there would be no such thing as an artificial recession.

Our recessions happen because business owners today begin cutting back on production if they have to lower prices much. When production increases, they are reluctant to allow a corresponding increase in the wages that are necessary, on the whole, to purchase the goods and services. This resistance to the natural market forces means that the correction to maintain a balance must come from another direction, a cutback in production called a recession.

WEALTH DISTRIBUTION RELATIVE TO PRODUCTION

In my previous writings on economics, I have stated that the economy becomes "unbalanced". What I mean by this is the distribution of wealth among the wealthy and the non-wealthy relative to production. Most wealthy people make their money by selling to non-wealthy people. The vast majority of products and services are produced for sale primarily to the non-wealthy.

Since the money supply must be a mirror image of the goods and services produced, this means that there must be a correction if the distribution of wealth among the wealthy and the non-wealthy does not match the proportions of goods and services produced for purchase by each segment of the population. This correction will come in the form of a recession to eliminate the production of goods that will not find a buyer.

Most goods and services are what we will call "per person" goods. Their sale is in general proportion to the population, largely regardless of wealth. Such goods include cars, refrigerators, computers and, clothes. An average family may have one car, one refrigerator and, one computer. If they were to get rich so that their income was a hundred times as much, they will no doubt spend more. But they will probably not buy a hundred cars, a hundred refrigerators and, a hundred computers.

In America today 99% of the population, let's call them the "lower 99" owns only about 55% of the wealth. This is because the super-rich 1% own 45% of the wealth. The problem with this is that at least 80% of the goods and services produced by the economy are generally per-person goods and services. We expect the lower 99 to buy about 80% of the economic production but we only give them 55% of the wealth.

This is because the wealthy business owners have naturally tried to keep as much wealth as possible for themselves. This is not to blame them, making money is the whole rationale behind going into business. But if the money supply is a mirror image of the goods and serviced produced, 55% of the money cannot buy 80% of the goods and services. A correction has to come from somewhere and you know what it is, it's called a recession.

The flow of money between the wealthy and non-wealthy is the lifeblood of the economy. To the non-wealthy in the form of wages and to the wealthy in the form of prices. It is when this flow is hindered at any point that recession will result. It can be hindered by either the money supply to production ratio resulting in an inflation-induced recession or the production to wage/price ration resulting in a non-inflation-induced recession, when more money goes to the wealthy than comes back to the non-wealthy.

The last thing I want to do is to eliminate the wealthy or destroy incentive in any way but we must balance the production of the economy with those we expect to purchase what portion of the production. If the lower 99 are expected to purchase 80% of the goods and services that are produced, they must have 80% of the wealth or there will be the inevitable recession or maybe a crash. Increases in production must be balanced by corresponding increases in wages or some goods and services will remain unsold.

This is what we could refer to as "demand side economics", the wealth distribution must balance with the proportion of goods and services produced primarily for each segment of the population in terms of wealth.

You might say that "The market will sort all of this out". That is absolutely right, but unfortunately it does so in the form of a recession or maybe an all-out crash, which is what we are trying to eliminate from our economic future. Our recessions are brought about every few years by the law of supply and demand because we ignore this wealth distribution/production balance.

There is a reason that this is not more obvious: credit. It is possible to keep the economy running with the imbalance that I have just described and that is to get people living beyond their means by way of credit. This pervasive dependence on credit is a symptom of this economic imbalance just as are collection agencies. If there were no such thing as credit, this imbalance would be immediately obvious. Credit hides and delays the correction of the wealth distribution/production imbalance but this only means it will be more severe when it does come.

SUMMARY OF RECESSIONS

To summarize, the law of supply and demand arose from traditional marketplaces with haggling over prices and the wages for labor (larbour) on a daily basis. In our modern economy, the same principles do apply but the setting of wages and prices and changing tham only reluctantly means that ours is not as true of a market. The traditional market corrects daily so that there will be no such thing as an artificial recession, but since our economy resists wage and price changes, the correction comes from another direction in the form of recession.

This lack of daily correction by haggling and negotiating means that we must pay attention to another rule besides that of supply and demand because this does not take into account that the wealthy will naturally try to keep as much of the wealth for themselves as they can. This additional rule to avoid artificial recession is that the wealth distribution among the wealthy and the non-wealthy must match the proportion of goods and services that are produced primarily for purchase for each segment of the population in terms of wealth.

In the economy of today, some goods are produced for sale to the wealthy but this comes nowhere near matching the proportion of wealth that they get. The only way to bridge the gap and keep the economy going is by means of credit but this only delays the inevitably correction brought about by the market forces, which unfortunately comes in the form of a recession.

A basic flaw of capitalism is that workers are unable to buy all of the goods and services that they have produced while at work. This is because in a business-friendly environment, the wealthy tend to take as much of the wealth as they can for themselves. This leaves goods and services unsold because wages do not keep up with increases in productivity. The result is an artificial cutback in production, which we refer to as a recession.

Business owners resist raising wages as fast as production increases and would rather cut back on production if they must lower prices much due to decreased demand. This resistance is in contradiction to the forces of supply and demand so the correction comes from another direction, that of a cutback in production to balance the production with the supply of money available to buy the goods and services that have been produced which need not have occurred. The recession often has it's official beginning with a drop in the stock market but this drop always results from some underlying flaw in the economy.

There is so much that simply does not make sense about our economic system as it is. Wages simply do not keep pace with production because business owners naturally want to keep as much profit for themselves as they can. But this hinders the operation of the entire system because it leaves goods and services unsold and results in a needless cutback in production because it does not make sense to produce goods and services for which there will not be a buyer.

How many times do we have a family trying to keep an old car running that has outlived it's useful life because they cannot afford a new car while down the street a car dealership is laying off workers because sales are so slow? It does not make sense and the underlying cause is the lag of wages in keeping pace with production.

MANIPULATION OF INCOME TAXES AND THE MONEY SUPPLY

The truth is that if all business owners in the economy were forced to give employees a 50% pay raise they would, as a whole, get the money back because then shoppers would have 50% more money to spend. Such a tactic would eliminate large amounts of goods and services remaining unsold but business owners would likely raise prices due to increased demand and the tactic would just result in inflation if the increase in wages was not matched by an increase in production.

Another possible way to get more money into the hands of wage-earners to buy unsold goods and services resulting from an increase in production would be to link wages paid out and taxes for business owners. That is, if business owners would agree to give their employees pay raises, they would have their tax rate lowered. But such a system would be laborious and difficult for the government to verify.

Today, I would like to introduce my idea to prevent recessions by balancing the goods and services produced with the money available to buy them. It can be done without requiring business owners to give raises or any other process that is complex and difficult to verify.

There are two other variables in the economic equation that are readily under the control of the government, the money supply and the income tax on wage-earners. My plan is for the government to manipulate these two variables to keep the balance between goods and services produced and the money available to buy them.

Suppose, for example, that over the past year productivity of those goods and services that are usually bought by the average person has increased 7% but the wages of the people who are expected to buy these goods and services has increased only 2%. That could lead to a potential recession except for the use of credit, which as I pointed out is also a symptom of a seriously unbalanced economy. Under my plan in this situation, the government would increase the money supply by 5% and use the extra money to lower the income taxes on everyone earning a paycheck.

Workers would bring home enough extra money to balance the increase in productivity to buy essentially all of the goods and services that had been produced without their employers giving them raises. Business owners could produce and sell as much as they could as long as there was demand for it and government would bring in more tax revenue from business while not losing anything in lower income tax rates from wage-earners. The mints destroy used bills in incinerators and print new money to replace it so it can control the money supply at will.

Can you imagine what it would be like if we put together a balance sheet and income statement for the economy as a whole as accountants do for businesses? It would be horrendous. Only about 15% of workers actually producing any wealth, as I pointed out on this blog in the posting "The Extreme Inefficiency Of Wealth Production", poor coordination between wages and production that was covered up by extensive and unsustainable use of credit. No doubt the managers of such an enterprise would be shown the door immediately.

The Federal Reserve Bank in the U.S. manipulates the Prime Interest Rate, raising it to control inflation or lowering it to fend off recession. Why not maintain the balance between production and wages by manipulating the money supply and income taxes? The balance would not have to be perfect, keeping the gap between production and wages to within 1% or so should be acceptable and make recession just a word in history books.

VISCOSITY IN ECONOMICS

Here is another way of looking at my economic model.

Have you ever wondered why, as a society, we cannot just "do all that we can do"? For example, there is no shortage of building supplies so why can we not build a nice house for everybody? Instead, many people are living in sub-standard housing while builders do not have all the work that they could handle. This is due, plainly and simply, to the innate inefficiency in our economic system.

Today, I would like to discuss what I call "viscosity" in economic terms. Viscosity means the resistance to flow of a liquid. Oil has more resistance to flow than water and so oil is more viscous than water. Viscosity is a term that we usually associate with the oil in a car engine rather than with economics, but I will explain what I mean.

The basis of the concept is simple. It is any unmatched change in the productivity of an economic system that invites a recession as a correction. Suppose, keeping all other factors the same, there is an increase in the productivity of goods and services in the economy. This may sound like good news, but really it isn't. If, in a balanced economy, there is an increase in production while wages remain the same it will mean that there will be goods and services that remain unsold because there is not enough money earned as wages to buy them.

Since the vast majority of goods are produced for the average person to buy, business owners will begin considering cutbacks in production since it makes no sense to produce goods and services that will not sell. The result is that all too familiar word: recession. This just means an artificial cutback in production. Because this means laying off workers, who then have less money to spend on the goods and services that the economy produces, the recession forms a downward spiral.

This artificial cutback in production that we term a recession does not occur in traditional market places where haggling is done rather than fixing prices. That type of market has a fluidity that our modern marketplace lacks because any change in production or availability of goods is automatically corrected for in the haggling over prices.

In our modern market place, business owners strive to increase production but are reluctant to lower prices or to increase wages. Naturally, they want to maximize (maximise) profit because that is the reason they went into business in the first place. So, they decide to cut back on production when they find that they are producing goods or services that are remaining unsold and this feeds the recession spiral.

Thus, capitalism works against itself unless this can be corrected. The reverse is also true, maximum efficiency is like a peak that we can slip from to either side. if we pay workers the same when production decreases, we invite inflation and the recession that it can bring by sapping workers' buying power.

We can have a rightward recession by allowing the wealthy to take too much of the money for themselves. When this happens, it leaves workers without enough money to buy the goods and services that the economy expects them to buy since all of the money in circulation is a mirror image in value of all the goods and services that are produced. The result is goods and services remaining unsold and a cutback in production resulting in recession.

A leftward recession can result if the government spends too much money in relation to the goods and services that are produced. This causes inflation because this spending must "hitch a ride" on the goods and services that are produced and it drives up prices, meaning that workers can afford to buy less. Does anyone remember Britain's strike-inflation spiral of the late 1970s? In America, inflation reached 13% in 1979. We do not want this again.

It is clear then, that prosperity results not just from production but from "matched production". We want maximum production but workers must have enough money to buy all of the goods and services that are produced or it will only result in recession. Productivity is much more viscous, or changeable, than wages and prices so we lack the fluidity of a traditional haggling market place.

My plan is for the government to correct this viscosity imbalance by carefully manipulating two factors that it has control of. One is the currency supply and the other is income taxes. When there is an increase in productivity relative to wages, the government will increase the currency supply accordingly and use the extra money to lower income taxes so that workers will have all the money necessary to buy all the goods and services produces, leaving none unsold. This way, there is no reason that we cannot go on indefinitely increasing production and indeed "do all that we can do". Matched production is the key.