An Occasional Economic Reset is Healthy

Emanance · Feb 9, 2013

An Occasional Economic Reset is Healthy

By The Daily Reckoning February 9th, 2013 Related Articles Filed Under

There's a jewelry store in town with a long tradition, a devoted client list, and a good record of solid profitability. But during the last year, it's moved around like the 'oldest established permanently floating crap game' from the musical Guys and Dolls.

It was downtown. Then it was not. It was re-established on the other side of town, in a low-traffic area where people couldn't find it. Then, 14 months later, it moved back to its old location.

Why? It was all about remodeling and renovation. The original building had been added to and added to until no more substantial changes could be made. The owners decided to 'bite the bullet,' as they say. They made the choice to level the old building completely and start again with a new design, renovating the whole thing over from the ground up.

I spoke to the owner at length about the decision. He knew it would mean dramatically lower profitability over the course of 14 months. They would be spending vast sums on the new structure.

The revenue would collapse. They knew all of this, making their decision a fascinating choice. One reason they chose a temporary location in a low-rent area was precisely to save as much money as possible during the transition. They also stopped adding to the inventory.

It is a tricky calculation, one that is possible only with intimate knowledge of the business, the venue, the expected revenues, the seasonal changes, the permanent costs of the business, the cost of losing some customers in the intervening period, and much more.

Did the gamble pay off? The owner is cautiously optimistic. The new store is gorgeous. It is back at its prime location. There seemed to be a lot of shoppers when I was there (but shoppers are not necessarily buyers).

The revenue declined hugely and dramatically during the transition, as expected. But the revenues have been notably impressive since the reopening. However, it could be five or 10 years before they know for sure whether it was the right thing.

What's more, there is no real way to prove cause and effect here. There is no status quo against which to compare the new reality. There are no control groups. You can only imagine counterfactuals and speculate.

This is because business is not like natural science. You can't just hold all things still and change one variable, much less repeat the experiment. The flow of life is forward, and an infinite number of things are constantly changing.

But consider what's going on here. The job of business is to make a profit. The company was making a profit. They deliberately decided to set aside current profits in the hope that more profits would emerge down the line. In other words, you have a business here that set out with deliberation to put itself into a recession. It traded current growth for the hope of future growth down the line.

If you think about it, businesses do this all the time. Next time you are in a hotel with construction work, think about this. The jackhammers, dust, plastic sheets, plywood, hammers, and the rest are extremely annoying to customers. We walk in with a grit in our teeth. The signs saying 'Please be patient with us, we are growing' hardly compensate.

I was at a hotel two years ago that had machinery so loud that I had to practically yell at the clerk so that she could hear me, and she had to yell back.

Thoughtless people imagine this is just incompetence. Hardly. A hotel exists to serve its customers. That's the reason they are there. If you aren't happy, they don't make money. Construction is really a catastrophe for a business like this. It is something they undertake only if they are darn sure that the payoff, and then some, will come later.

Again, this is a very tricky calculus, one that requires vast experience in the industry, intimate knowledge of the market, and a solid sense of what the future holds (or might hold). In these cases, too, they are dealing with something pretty amorphous: the extent to which a new design and new decor are going to make the space more attractive to customers than it might otherwise be.

Mistakes are made, to be sure. But they are borne by the business, not society at large. Private property and private decision-making are preconditions for such difficult management decisions.

Imagine if you were somehow appointed as the head of an entire economy. And let's further suppose that you had a strong sense that the most important thing was to economize on resources and you were dedicated to this task.

It is very unlikely you would make the decision to redesign, remodel, or reconstruct anything ever. So long as businesses were profiting, more or less, or just functioning well enough, you would be likely to just instruct them to keep doing what they were doing.

Real life is different. Private businesses deliberately put themselves into micro-recessions all the time. They know they must do this in their long-term interest. They trade in profits now, accepting a lower rate of return for the hope of greater profits later.

Another example is Wii, the computer gaming company that was all the rage in the late 2000s and then felt the hot breath of several competitors at its back. It went into hibernation for a year or more in the hopes that a new generation of their hardware would grant a competitive advantage in the future.

Wise individuals do this, too. People forgo current income by going back to school, for example, in the hope that they will add to their personal capital stock and earn more later. If they are smart, they think seriously about the opportunity costs of these kinds of decisions.

Two years of school could cost $40,000. At the end, you are out $40,000, instead of being up, say, $80,000. You have to imagine that you are going to earn that income stream back over the coming years, enough to compensate for the missed income and earn more down the line than you otherwise might have.

Government is constantly urging people to do the opposite. I have a memory from the weeks after Sept. 11, 2001, when President George Bush was nudging, urging, and even demanding that people spend more money.

He knew that economic hard times were coming, but instead of suggesting that people do what is in their best interest, he demanded that people do the opposite - on the theory that what might seem bad for you is actually good for society.

Something very similar happened in 2008. The same guy again got on national television and told everyone to go out and spend, spend, spend. It was a very strange thing.

For most of American history - New Deal excepted - even government officials understood that sometimes you have to go through recession in order to experience greater growth down the line. You have to trade off benefits in the present to get greater benefits in the future.

This didn't happen after 2008. The liquidation has never occurred. Instead, the banking system, the real estate markets, the financial system, and the federal budget have all undergone dramatic change in order to support the theory that every bit of benefit needs to be squeezed out of the current system, rather than ever permit it to pull back a bit pending a better future.

The result has been a terrible stagnation, the piling up of ghastly debt, and an utterly broken financial and banking system. Why does government do this? Two reasons stand out. It doesn't really own anything in a real sense. It loots us and passes out the proceeds to friends. Officials bear no personal responsibility for what they do.

Second, government has no local knowledge at all to compare the returns of the present to the returns of the future in any plausible sense. All the incentives of government are to extract every bit of blood from today's turnip, regardless of what that means for the future.

This should be a heads-up for individuals. Government doesn't want you to ever enter into a privatized and personal recession. It tries to convince you that what might seem bad for you now is actually - strangely and through some mystical metamorphosis - good for everyone, including you, later. Under this assumption, the whole of society, including you, is run into the ground.

The great lesson of the liberal revolution of the Age of Enlightenment is that what's good for individuals is good for society. Politicians and bureaucrats deny that truth every day, but you and I don't have to believe them, much less act on their demands.

Regards,

Jeffrey Tucker
for The Daily Reckoning Australia
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DanielM · Feb 9, 2013

One step backwards for two steps forward isn't even close to a reset.

And it is correct, every business is in the business of staying in business. There are so many reasons for a business to disturb the norm, many undergo renovations/installations as a way of tax minimization while adding assets and/or new income streams to a business which is hardly a reset

bordsilver · Feb 9, 2013

DanielM said:

One step backwards for two steps forward isn't even close to a reset.

And it is correct, every business is in the business of staying in business. There are so many reasons for a business to disturb the norm, many undergo renovations/installations as a way of tax minimization while adding assets and/or new income streams to a business which is hardly a reset
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I don't understand these comments in relation to the article. I think you're missing the point of the discussion.

AngloSaxon · Feb 10, 2013

People were incensed at "The Recession we had to have" but the sensible know it was unavoidable.

The Recession the world has to have, has not happened.

Emanance · Feb 10, 2013

hotel 46 said:

AngloSaxon said:

People were incensed at "The Recession we had to have" but the sensible know it was unavoidable.

The Recession the world has to have, has not happened.
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only because they found a can to play with. only they can play with the can though
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Made me think of the latest quote from Paul Krugman: "Given the state we're in, it would be irresponsible and destructive not to kick that can down the road." http://www.zerohedge.com/news/2013-...-kick-can-down-road-it’s-responsible-thing-do

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