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Obama Understands Part of the Correction

"It is likely that the banks have not fully acknowledged all the losses that they're going to experience," says President Barack Obama, and so more banks are likely to fail. The president apparently recognizes that the bubble in the banking industry has yet to pop, and more unsustainable projects are subject to liquidation if economic sustainability is to be restored.

If only he understood that this phenomenon is endemic throughout the economy. When there is an artificial bubble, massive malinvestment requires that many economic undertakings must be abandoned, shut down and sold off if the recovery is ever to commence.

This is one of the most pernicious consequences of central bank inflation. The easy money and credit are concentrated in some entrepreneurial ventures, as there is a false expectation for their profitability. This is because in a market setting, easier credit is a signal for less demand for credit and therefore more savings. More savings, in turn, signifies more money in the hands of consumers for future consumption. Easy credit inspires investors to finance huge long-term projects that they expect will pay off in the long term, as today's savers become tomorrow's consumers.

But in an artificial bubble, these consumers never come. In an inflationary setting, interest rates are lower and credit is easier even though no corresponding credit is taking place. So the boom is the simultaneous mass investment in long-term projects -- and all the employment and activity they spur -- along with people still buying a lot for current consumption and encouraging economic activity in the present.

Eventually, those long-term projects become unsustainable, as consumers do not have the money to buy all that has been produced and to keep financing their long-term construction. This boom and bust together constitute the Business Cycle.

This is only a systematic problem in the economy when government artificially lowers interest rates and makes credit unnaturally easy. The Business Cycle is a consequence of government meddling and it can only be corrected in one way: The malinvestments must be liquidated. The long-term projects that do not make sense anymore must be abandoned, converted, sold off, turned to profitable use. Losses are inevitable, but they must be cut. Lemons must be made into lemonade.

Instead, the government will tend to try to prop up the inherently unsustainable assets, as it has been doing with banking institutions. The government tries to keep prices high even as they do not make any economic sense. The correction, which when left alone will necessarily be sharp and painful but need not be prolonged, is drawn out and obstructed by this further government interference.

Obama is right that some banks will keep failing, but does he understand why? And does he see that this is true of much else in the economy? The United States, given our economic reality, has too many banks, too many hotels, too many casinos, too many strip malls, too many trendy restaurant chains, too many houses and many other malinvestments that must be liquidated and have their prices plummet for us to experience recovery.

Those interests directly involved do not want to see their assets lose value, so they ask for bailouts, price supports, nationalization or any other fix. This just delays the day of reckoning. The longer correction is delayed, the worse it will be.

Another intriguing tidbit from the article:

One of the proposals discussed in Washington is the creation of a so-called “bad bank” with the authority to acquire troubled assets from lending institutions and other credit-related companies. Obama refused to confirm or deny that such a plan was on the table, saying, “If I say that we’re doing one thing, then the markets might interpret it differently from what it ends up being.”

Obama does not seem to understand, however, that his entire agenda of massive and conspicuous and unpredictable intervention is going to confuse the market. This is just what happened during the Great Depression: Investors were intimidated by President Franklin Roosevelt's radical New Deal regime, which put their property rights in constant jeopardy. They feared that investments might be nationalized or made unprofitable by FDR's capricious intervention, and so this slowed down investment and delayed recovery. For the definitive work on this phenomenon, which economist and historian Robert Higgs calls "Regime Uncertainty," see his paper of the same name.


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I do not think so.

Obama understands the whole system

And will do his part to make sure that all the slaves stay docile and hard at work for the ruling class.

Obama understands

how the system works.His job is to bankrupt the country and he will do a darn good job!