What Causes Recessions?

People love to blame the free market for economic downturns, but every economic downturn, from the creation of the Fed on, has been caused by the Federal Reserve.

That’s not to bash the Federal Reserve. One of the reasons the Fed was created is that, before the Fed, changes in the value of gold, relative to other things, would cause recessions. Every gold rush threatened to throw the value of all goods and services, measured in gold-backed dollars, into question, causing a recession. Every time a gold rush ended, the value of gold suddenly spiked, causing the value of all goods and services, measured in gold-backed dollars, to fall into question, causing another recession.

The Federal Reserve was supposed to keep the value of money constant – essentially smoothing over short-term fluctuations in the value of gold – such that changes in the value of money would become a thing of that past, and our economy would become largely recession-proof.

But the Fed has done a poor job keeping the value of money constant.

And we no longer back our money in gold.

The truth is that the free market cannot cause a diverse economy to fall into recession, as though every industry has a boom and bust cycle, all of those boom and bust cycles are different. A healthy economy always has some industries in booms, and others in busts.

An economy that is NOT diverse can go into recession, just based on market mechanics, as whatever industry drives its economy will have booms and busts, but a diverse economy will have some industries going into booms as other industries go bust, all the time…

Only a handful of things are capable of throwing an entire, diverse economy, into a boom, or a bust, all at once. Those things are:

1) Natural disasters,

2) Government Actions, and

3) Rapid, unexpected changes in the value of money.

As large as the United States is, geographically, we don’t have to worry too much about natural disasters causing recessions, except locally. That leaves government actions, and rapid, unexpected changes in the value of our money.

The Federal Reserve is particularly onerous, and you can see that by reading their reports. When the economy is strong, the Fed loves to tell us how masterfully they manage the economy, and then every time there is a down turn, all the Fed will talk about is how little influence over the economy they have.

When someone tells you that they exert masterful control during good times, and no control during bad times, both statements cannot possibly be true, and yet people believe the Fed, and blame free markets, every time there is a down turn.

Two related myths are particularly cringe worthy…

One is the blaming of oil for the collapse of Venezuela’s economy. This is cringe worthy because it is somewhat true. Before Hugo Chavez, Venezuela had the richest, most vibrant economy in South America. Chavez did what all democratic socialists promise to do – he subsidized consumption, and taxed production to pay for it. Eventually, nobody produced anything anymore, except oil (which had been nationalized), and Venezuela’s economy, which had been quite diverse, was suddenly totally dependent on oil.

Blaming the collapse in oil prices for the downfall of Venezuela ignores the role Chavez played in making sure that Venezuela was completely reliant on sky-high oil prices.  Hugo Chavez caused Venezuela’s economy to collapse.

The second cringe-worthy myth is that of either giving Trump too much credit for our current economic growth, or to claim that Trump’s economic policies are about to cause a recession.

Trump does deserve credit for helping to get government more out of the way, as far as growth goes, but the economy is growing because that is what free markets do, and though Trump has made a number of significant free market reforms, Trump is not driving the economy.

Trump deserves credit for reversing the policies that had previously been holding our economy back, but the economy itself deserves credit for our current cycle of growth.

Trump could cause a recession, but since he has done more to get the government out of the way, than to get government more in the way, the idea that he will cause a recession through government action is absurd. Really, the only way Trump is likely to cause a recession is by intimidating the Fed to play politics with interest rates (and he has tried to do that), which could lead to a rapid and unexpected change in the value of the dollar, and THAT could cause a recession…

The best way to help prevent the Federal Reserve from causing a recession (with or without Trump intimidating it) would be to eliminate the Fed’s dual-mandate, of ensuring full employment, as well as maintaining a stable supply of money.  The Fed should focus solely on maintaining a stable supply of money, and should let the job market take care of itself.

Mankind has, as of yet, not found a perfect system of money, so even without a dual mandate, the Fed might find new and creative ways to cause recessions.  Whatever the case, the free market has not caused a recession, and we know this because the free market CANNOT cause a recession. It is, quite literally, impossible.

So the next time recession hits, whatever you do, don’t blame free markets.