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Why Recessions are Good (and Required)

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We paint recessions as being a bad thing, but rarely do we talk negatively about credit expansion. Market Ticker explains why recessions are a mathematically necessity in any banking system that uses fractional reserve lending:

As the “spread” between production and net interest expense rises, the economy falters. A higher and higher percentage of the loans ultimately cannot be paid back, even productive loans, because the net interest expense over time exceeds the productive gain of the person who takes them out. The presence of this ever-widening spread, which is inherently part and parcel of fractional reserve banking, means that recessions are necessary and more importantly, some people who have taken out loans and some people who made loans must, during those recessions, go bankrupt.

That is the purpose of a recession – to clear out the excess indebtedness along with excess capacity, resetting downward the “spread” between net interest expense and gross output (GDP).

While many unfit enterprises go bankrupt, forced entrepreneurs create the next wave of innovation that will rebuild the economic system, but failure and time are needed to clear out the underbrush before the next forest is built. If we prevent failure we prevent success by debauching currency and stealing from the winners to pay for the continued failure of the losers.

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March 15th, 2009 at 7:54 am

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