Prescribed Fire Economics
I enjoyed Market Talks quote of the day:
I wish free money was really free and that there was a painless way to move from severe recession and high leverage to robust and sustainable economic growth, but there is no short cut.
– Kansas City Fed President Thomas Hoenig, arguing the Fed needs to raise interest rates.
It seems everyone is looking for a painless solution. Even Felix Salmon comments about “causing unacceptable amounts of pain” in his half-supportive half-opposed article on Santelli’s righteous (and right on) recent rant.
If we let housing find its bottom naturally, true, many financial institutions will cease to exist. True, we may look back at 2008 as the “good ol’ days” before things got really ugly.
But at this point, letting things get ugly is exactly what we need for the long run. Let the fittest businesses survive.
The analogy I like to use is a technique often used in forest management, i.e prescribed burns.
Imagine a world completely fearful of the tiniest of forest fires. Whenever a fire broke out, even a mild one, the entire Federal (Forest) Reserve was called out to extinguish it. Years and even decades go by without even a single lost home due to forest fire. People started talking about a Great (Forest Fire) Moderation. Some even proclaimed that the forest fire cycle that used to be standard reading material in many, now obviously obsolete, forest management textbooks for years had been defeated by the Federal (Forest) Reserve.
The mantra became, “Let all vegetation flourish!” Never fear. If natural selection has lead certain vegetation populations to dwindle in the past, we’ll have none of that. Come one and all. Prosper in the new age of forest fire management where forest fires no longer exist.
Guess what happens? The forest floor becomes flush with vegetation (read fuel). All around, as far as the eye can see, nothing but flourishing vegetation (read fuel). Forest Rangers are happy. Politicians are happy. Everyone is happy.
But one day, there is a particularly strong wind. The Federal (Forest) Reserve has not yet figured out how to control the weather unfortunately. A fire breaks out and quickly spreads. At this point, the brush is so dense providing a never ending supply of fuel. Similar to the critical neutron mass of a nuclear reaction, the fire spreads exponentially. Soon, there is an inferno far larger than the world has ever seen.
Monetary policy should not be about avoiding forest fires at all costs. Monetary policy should be about prescribed burns. Let the vegetation that is unfit for survival perish. It is better to have a controlled burn now and then than to have an uncontrollable inferno.