Trying To Prevent Recessions Leads To Even Worse Recessions

Deutsche Bank strategists Jim Reid and Craig Nicol wrote a report this week that echos what I and other Austrian School economists been saying for many years: actions taken by governments and central banks to extend business cycles and prevent recessions lead to even more severe recessions in the end. MarketWatch reports –

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The 10-year old economic expansion will set a record next month by becoming the longest ever. Great news, right? Maybe not, say strategists at Deutsche Bank.

Prolonged expansions have become the norm since the early 1970s, when the tight link between the dollar and gold was broken. The last four expansions are among the six longest in U.S. history .

Why so? Freed from the constraints of gold-backed currency, governments and central banks have grown far more aggressive in combating downturns. They’ve boosted spending, slashed interest rates or taken other unorthodox steps to stimulate the economy.

“However, there has been a cost,” contended Jim Reid and Craig Nicol at the global investment bank Deutsche Bank.

“This policy flexibility and longer business cycle era has led to higher structural budget deficits, higher private sector and government debt, lower and lower interest rates, negative real yields, inflated financial asset valuations, much lower defaults (ultra cheap funding), less creative destruction, and a financial system that is prone to crises,’ they wrote in a lengthy report.

“In fact we’ve created an environment where recessions are a global systemic risk. As such, the authorities have become even more encouraged to prevent them, which could lead to skewed preferences in policymaking,” they said. “So we think cycles continue to be extended at a cost of increasing debt, more money printing, and increasing financial market instability.”

As I have explained in the past, when central banks like the U.S. Federal Reserve cut interest rates to low levels, they manage to create economic booms by encouraging borrowing and higher asset prices. These economic booms are often based on dangerous economic bubbles that burst and lead to recessions when interest rates are normalized again. As the chart below shows, financial crises and recessions (see the gray vertical bars) occur after rate hike cycles, including the dot-com and U.S. housing market crashes.

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