Why Is the Rebound Taking So Long?

12/27/2011 7:30 am EST

Focus: MARKETS

It’s one thing to be patient, but this is getting a bit ridiculous, writes Terry Coxon of Casey Research.

The rebound from the recent recession is the slowest economic comeback in living memory—so slow that some doubt whether it is happening at all.

The recession bottomed (the economy stopped shrinking) in June 2009, so the recovery is now two years old. The sleepwalking during the last 24 months is all the more remarkable, given that the economy has been treated with the biggest dose of monetary and fiscal stimulants ever administered in US history. Why the continued weak pulse?

Each recession has its own story—how long it lasts, how deep it gets, industries worst hit, particular bubbles burst. But in every recession, the heart of the problem is the same—namely, an imbalance in the market for cash.

Every recession begins when the aggregate amount of cash that people want to hold (given their wealth and the other things they want to own) is more than the amount of cash actually in existence. That imbalance—the demand for cash exceeding the supply—depresses the entire economy, because the flip side of the market for cash is the market for everything else.

All markets and all industries are hit, and most of them contract because most people are trying to sell more than they buy…which is the only way for anyone to increase his cash holdings, and which is impossible for everyone to do at the same time.

In the period from the end of the Civil War to the end of World War II, most recessions began when the government, by plan or by blunder, contracted the supply of cash, so that it fell below the public’s demand for cash. Since World War II, every recession has begun when the government, again by plan or by blunder, allowed the growth in the supply of cash to lag behind the growth in the demand.

The early stages of a typical pre-WWII recession would push some commercial banks into insolvency, which would shrink the supply of cash even further, since insolvency meant that some part of the deposits held by bank customers were lost. As the recession proceeded, an increase in the demand for cash by worried investors, worried businesspeople, and worried workers would make the cash shortage even more severe.

Every recession between the Civil War and World War II ended on its own. In no case was a recession brought to an end by the actions of an alert government agency or with the advice of learned economists. Recessions were cured, automatically, by falling prices.

Falling prices were the cure because they increased the real value (purchasing power) of whatever amount of cash the public was holding. Prices kept falling until the real value of the existing supply of cash grew to a level that exceeded what the public wanted to hold. Then, as individuals and businesses began to spend the excess, the economy would begin to recover.

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