It's Time to Stimulate Supply, Not Demand

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The biggest flaw within the current stimulus plan is not that it assumes spending can stimulate demand, but the suggestion that demand needs to be stimulated to begin with. It is the supply side of the supply and demand graph that holds the solution to the economic crisis.

A basic tenet of economics is that consumers have unlimited needs and wants. The ‘needs’ such as food and gas must be fulfilled at almost any price, whereas the ‘wants’, which are discretionary and the true drivers of growth, will only be fulfilled if the current price is right. To summarize the ‘wants’ side of the equation, you and I would gladly buy a plasma TV for each room in the house if they were cheap enough; the problem is there is no supplier who can profitably produce plasma TVs at such a low price. The solution to the current recession therefore is not to stimulate demand which needs no stimulation, it is to stimulate supply.

Supply stimulation is achieved through the transfer of productive assets from those who paid too much, to those who can put the assets to profitable use at a lower purchase price. The current owners who overpaid are now likely to be capital constrained with few sources of liquidity, and additionally may be contending with significant levels of debt used to acquire the assets during the age of easy credit. The burdens of current owners are creating a situation in whic assets either sit idle, or they’re being operated unprofitably in ways that further erode capital. Examples here include GM’s shuttering of plants, not to mention unoccupied homes that lie empty as symbols of failed attempts at speculation. Both scenarios speak to underutilized assets whose underutilization holds back economic growth.

In order to put those assets back into use to satisfy what is unlimited demand, the current owners must sell their holdings at a loss to a new owner. The new owner, having purchased the assets at a lower entry price, can now put the physical capital to profitable use by offering the finished goods the assets yield at lower, market-clearing prices. This means the ‘fire sale’ purchaser of GM’s idled plants can afford to produce cars more cheaply. Much the same, the real estate speculator must take a loss on his property at a price that is serviceable for a family that is taking on a mortgage. Through the creation of supply at lower prices, demand is stimulated.

There is unlimited and insatiable demand for goods and services, assuming they’re offered at a market-clearing price. Therefore, demand stimulation is unnecessary and, given the ultimate burden on the taxpayer, unproductive.

This economy will not emerge from the current recession, or any recession for that matter, until the supply of goods and services falls to prices at which demand resurfaces. The government’s fixation with propping up assets, whether it be homes or banks, is exactly the wrong solution. The best thing the federal government could do would be for it to take the steps necessary to ensure the bankruptcy process for businesses and individuals is swift and just. If it does that, a natural process will reveal itself whereby productive assets will reach those who will operate them at a profit.

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