Causes of the Recession

The Dynamics of the American Economy

    This is by no means only a Jewish topic. It interests everyone, whether directly affected by the current downturn of the economy or only peripherally involved.

     The American economy contracts and expands constantly. This has nothing to do with the occupant of this or that political office. This can be verified by the evidence that these business cycles last more than a year, and often several years, so that a number of incumbents come and go during one of these cycles.

     Corporate profits are most affected by business cycles, which have four phases. First, economic activity expands. During this period many people spend more than they can afford by using credit cards and other devices to increase their purchasing power. When the cycle has reached its peak and few if any can borrow any more money the cycle declines. This contraction continues until the economy reaches a point at which it will not decline further because everyone needs to eat and pay for basic needs. Furthermore, all are not affected by the decline. Even during the “Great Depression” of 1929-1939, 70% of Americans were working and 30% were unemployed. That is a nightmare. Yet, most people were still earning something.

  Then, as the level of activity slowly increases, we enter phase four, as a new expansion begins.

    The four phases of the business cycle are, therefore, expansion, contraction, the peak, and a trough. These economic cycles repeat themselves again and again, although their length varies each time. For example, the depression which began in 1929 ended in 1939 not because of any program instituted by the Roosevelt administration, but because the Second World War began on September 1, 1939 with the invasion of Poland by Germany and the declaration by Britain of war against Germany. That led to a tremendous amount of wartime employment in aid to Britain, although we were not in the war until December 7, 1941. It was Hitler, not Roosevelt, who ended the depression.

    During the century and a half since 1857 there have been 27 business cycles in this country. Such cycles occur in all industrialized countries, although the United States is today a post-industrial country, as anyone can recognize by considering the fate of our steel industry and all the other “outsourced” business enterprises.

    Our economy is based on six characteristics. These are: 1. Private ownership of the means of production, 2. Freedom of decision making, 3. Profit, 4. Use of capital, 5. Use of money and credit, and 6. Worldwide markets.

     The principal reason for these cycles is the over expansion of credit. Bluntly, this means that too many people spend more than they can afford, so that it is inevitable that the day must come when payment is demanded of those who cannot pay. This includes governmental waste on the part of all levels of government, from the politicians in Washington to those in the county legislature. The need to be reelected causes politicians to spend for all kinds of programs the taxpayer cannot afford. Therefore taxes go up and up and private spending is curtailed more and more until there is not enough left to pay the mortgage or the car payments. Therefore one solution to a downward curve in the economy is a tax cut. This increases spending power, in turn employs more people, and therefore increases government revenues.

    It needs to be understood that the losses during a recession are irrevocable. Somebody who is not working cannot make up his losses later, nor is his talent to be stored in a refrigerator. Human brain power cannot be held somewhere for later use. This is also true of a good deal of equipment which rusts or loses its use altogether. 

    In addition, every recession leads to losses by both large and small enterprises. Small business is sometimes unable to recover, so that all the labor and effort put into such business is wasted and workers who have been trained are laid off and their skills lost. When business improves, most of those already trained will have left or found work elsewhere and new employees must now be trained. Finally, the standard of living falls. At first only “luxuries” are sacrificed. Later, food, medicine and rent become a problem.  Hard working and self respecting people lose their savings.

     In such a depression even those who are working are frequently working only part time or at minimum wages just to have an income. Marriages and family planning are postponed and many a life is ruined before the business cycle improves again.

    There are a number of explanations for all of this. Surely one of these is our inability to prevent overspending. When millions buy homes costing more than they can afford, when millions more use their “plastic” to go into considerable debt, when banks loan mortgage money to those who cannot possibly meet their monthly payments and car dealers sell expensive cars to those who cannot make their payments, then the day must come when the banks call for their money, when the car is repossessed, when wages are garnisheed and jobs dry up.

    Consider also the influence of interest rates on the economy. When interest rates are low, more stores increase their inventory by ordering more goods from manufacturers. The manufacturer now borrows money from banks so as to buy the needed raw materials to meet the increased demand. This in turn leads to an increase in the interest rates as the banks want to profit from the demand for money. The banks then provide loans to people who want them even if they may not be able to maintain their current level of income. These loans increase purchasing power, leading to price increases and increases in interest rates. Therefore, banks gradually reduce the amount they are willing to lend lest they themselves lose their liquidity.

    Now merchants reduce their inventory because they cannot pay the high interest rates. Therefore, manufacturers receive fewer orders and lay off some workers who cannot buy much because they only have unemployment compensation to spend. Now credit shrinks and banks gradually build up so large a reserve that they lower the interest rates in order to lend more money, etc. etc. etc.

   So the whole cycle goes on and on. There is of course also a psychological factor involved in business cycles. Pessimism concerning the economy will lead many business people to curtail employment, decrease inventory and reduce investments. The opposite is true for optimists.

    Everything we have so far mentioned here is criticized by one economist or another. There are innumerable “theories” as to the business cycle. None are universally supported. All are criticized. Economists agree on nothing.

    Therefore, sociologists come to the rescue. We begin with the view that there is a good deal of difference between myth and reality and that sociology teaches us to look at things as they are and not as they seem. Things are seldom what they seem to be.

    This is also true of the economy. Business cycles are produced by human behavior. They are not supernatural events nor inevitable. Suppose no one spends more than he can afford. Suppose all who have borrowed money can repay on time. Consider that each of us limits his expenses to his income after saving ten percent. Imagine that politicians do not waste our taxes on their need to get reelected by spending our taxes on some project that gets them publicity. What if we taught economics to every schoolchild beginning at age 8 so that even children could balance a checkbook. Explain to school children what it costs to run a family of four (or more).

   Our horrible economic problems are self created. The vast majority of Americans have no idea how to run their own private economic life, let alone how the American economy works.

   We who teach college students do our best to explain it all. Yet, we are up against raucous music, beer, stupid television, utter lack of foresight, and, most important, the inability to discern the difference between myth and reality.    After all, money wasted on alcohol cannot be used to later pay the rent.

     The American economy will of course come back despite the Democrats. Meanwhile we have to guard against failure to see the facts of life as was the case with all those fools who invested with Madoff and never looked into his machinations. There are a whole lot of Madoffs in this world. Many are in politics. They talk a lot and those who do not want to know reality but follow myths “elect” loud, arrogant and ignorant egoists who do us no good but want to gain an office so they can be an “incumbent”. The Latin word incumbare means “to lean down”. It refers to politicians who hold an office and do nothing but collect a salary at our expense and then brag about it.

      Do yourself a favor. Read an economics book and a good sociological analysis of the economy. It is not to be found on TV.

Shalom u’vracha.

Dr. Gerhard Falk is the author of numerous publications, including Fraud (2007).

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