On Stranded Capital

There are significant differences between what the current economy feels like, especially as reported by the media, and its underlying strengths and weaknesses.

The cause of the current malaise is the necessary adjustment period after a boom. The current recession was not caused by the financial crisis of 2008. The financial crisis was driven by the boom of 2003 to 2006. During the boom years, optimism for increasing housing prices caused people to spend and invest more than they otherwise would have. As a result, they stranded their capital on a deserted island.

When you over-invest, you take a risk of stranding your capital in an unproductive place. A classic example of an investment is a house: You need a house, so buying one might be a good investment, as it may reduce your costs of housing yourself over rent. Suppose that you are so impressed by the good returns on your first house that you buy a second one. Whether this second investment pays off depends on the external market. If no one wants to buy your second house from you, then all the money you poured into it is stranded until such future time as the market comes back and decides once again that it wants to buy your house. In the meantime, all of that money is tied up in concrete, wood, nails, flooring, roofing, electrical cabling, appliances, and all of the labor that was required to put those items into the shape of a house. You can do nothing with that money because it has been converted into goods. It is stranded. Presuming that the rental market too is down along with the housing market, the house is a stranded investment, providing no payback.

If the entire economy contains a significant amount of stranded capital, then the economy will show the same signs of stress that the owner of the second house is under. Of course, this example is extremely close to what actually did happen in the mid-2000s, and our current situation continues to reflect stranded capital sitting in houses that are not returning any value to their owners or society.

The solution to the current recession is then quite clear: Wait long enough for there to be enough people that those houses can be useful and occupied, or long enough that the capital that was stranded is small compared to the new capital generated by all of the country's other useful pursuits. Any other attempted solution potentially ignores the fundamental problem of the stranded capital, and therefore will not repair the problem.