BY: MIKE PORTER

All economists agree America is currently in a recession. Whether this turns out to be the second coming of the Great Depression remains to be seen, but America is in a serious recession nonetheless. Barack Obama has said, “Failure to act on an economic recovery package could plunge the nation into a long-lasting recession that might prove irreversible.” (1) Our government and the Federal Reserve Bank (Fed) work endlessly to prevent recessions from happening. In most cases, they work too hard to try to prevent them. Few people truly understand what a recession is and what the effects are in the long term. Can our government and the Fed prevent recessions from ever happening? If we do find our country in a recession, what can be done to get us out of it? Do recessions really mean the end of prosperity? The truth is recessions do provide a lot of opportunities, and our government can do very little to prevent them.

What is a recession? A recession is defined as two consecutive quarters of Gross Domestic Product (GDP) decline. When GDP begins to contract, that means the economy is beginning to shrink instead of grow. Businesses and consumers become fearful and hold onto their money. Many may choose to pay down debt instead of expanding their business or purchasing unnecessary goods and services. Businesses holding the line on expenses will tend to cut back on purchasing supplies and even cut back on employees if demand for their product is down. Unemployment goes up as consumer demand falls. Some companies will go out of business and salaries drop as people who are unemployed scramble to find new jobs.

How can recessions be good for anyone? Well for starters, recessions are a time for lagging and mismanaged companies to decline or in some cases, go out of business. While this is hard on the employees who used to work there, it does provide opportunities for the companies who survive as well as opportunities for new companies to start up. Less competition in the market means companies who do not go out of business will start to see some additional revenue with existing customers spread out among fewer firms. A company going out of business in a recession can actually save the other companies in the industry. In some cases, the remaining firms will hire some of the people who lost their jobs to keep up with demand. Some companies are counter cyclical, which means they tend to do more business during recessions than during thriving economies. Some examples of counter cyclical companies are private education companies, service and repair businesses, firms that deal with the bond market, some law firms and mortgage companies. When the government tries to prevent a recession, the government is really telling counter cyclical companies they aren’t allowed to prosper. Doing so could put industries like these in jeopardy and can actually make the effects of a recession more severe.

When a recession begins to loom, the Fed reacts by lowering interest rates and increasing the money supply. The Fed is hoping people and businesses will take advantage of the low rates. Many people use these attractive rates to consolidate debt or refinance their home. Prices tend to come down because demand for goods and services drop. Oil prices have fallen considerably since last summer’s peak of $140 a barrel because of lower demand. For the investor, stocks drop in price and allow the opportunity to buy more stocks at or below what they are really worth. Many investors say recessions are the best time to buy stocks or invest in stock related funds. Those who wish to protect short-term investments will find bond and currency markets may improve as investors look for safe places to put their investments.

A recession is really a normal part of a cycle and unfortunately cannot be stopped. This cycle is known as a business cycle, and these cycles happen regardless of what our government does. Although recessions can be painful for many, they are necessary for any market in the long run. Even the best managed companies in the world do not have record profits every quarter. A recession is the market’s natural ability to keep prices in line when price levels get too high. For example, back during the dot com boom during the late90’s, demand for dot com and tech stocks went through the roof due to Y2K. Dot com and tech stocks were sky high and continued to grow even though most of them had never showed a profit. After the year 2000, the market began to lose patience in the technology industry, which was beginning to slow after Y2K. The market dropped and worsened after the 9/11 attacks. Prices for dot com stocks were too high during the boom so the market shifted and began to sell off their interest. Many dot com companies went under and, as a result, the economy began to slip into a recession. This is an example of the tech stock market correcting itself, and a short recession kicked in after years of prosperity. Demand for Information Technology services slowed after the private sector spent billions on Y2K prevention. After the dot com fallout, the economy eventually recovered and prospered for many years after. This is a perfect example of an economic boom followed by a bust which eventually recovered.

What can our government do? Well in most cases our government can only prolong, speed up the arrival, or make a recession worse. Look no further than FDR for a great example of how big government policies caused the depression to linger (See my previous article titled “FDR’s New Deal Made the Depression Worse”). Our government can only cut taxes and try to create a business environment that is friendly for entrepreneurship and investing. The rest is up to the private sector to recognize and take advantage of that environment. If the market is due for a correction, the market will correct itself and a recession will ensue. Nobody is above the market and markets cannot be controlled by any politician. If an economy enters a recession, eventually market prices will get low enough to where it will be worth the risk to invest again. Once this starts to happen, the market will begin a recovery on its own. Government trying to stop business cycles is just as ridiculous as trying to stop waves in an ocean. The more they try to intervene, the worse the economy will become. That being said how many politicians would say this: “I’m not going to do anything about the economy. I am going to stay out of it because I don’t understand the private sector and I do not want to make it worse. Instead I would like to wait for the economy to correct itself.” I will show you a politician who will lose their election or get forced out of office.

Obama and Pelosi’s stimulus package will be no different than FDR’s New Deal and will make the current recession worse. This stimulus bill, along with most stimulus bills, will do nothing to encourage investment by the private sector. No government program can force the private sector to invest in any economy. Investment has to happen naturally when the investor decides the rewards for a profit outweigh the risks involved. Instead of creating complicated tax incentives and expanding government at the expense of tax payers, it would be nice if all politicians took some time to study the free market and how well it can work with limited government intervention. Our government does not understand that a recession is as much a part of a healthy free market as an economic boom. Trying to bottle up and prevent a recession can actually be harmful to the long term economy. An economy due for a correction is natural and will always correct itself whether our government likes it or not.

(1) http://news.yahoo.com/s/ap/20090205/ap_on_go_pr_wh/congress_stimulus_126