The Austrian economist Joseph Schumpeter in his 1942 masterpiece “Capitalism, Socialism and Democracy” described the process of capitalist wealth creation as being one of “creative destruction.” It’s a lesson that policymakers have not taken sufficiently to heart, largely because they have to answer to sentimental democratic electorates. Creation sells well to an electorate whose instincts, as demonstrated by the “Occupy Wall Street” crowd, are largely socialist. But destruction doesn’t poll well. It is therefore ignored, not only in the bloviating speeches of politicians seeking election, but also in their policies when they have taken office. Throughout the world, the lack of sufficient attention to destruction is a major part of today’s economic problem.

The late lamented Steve Jobs exemplified this principle perfectly. While his succession of Apple products exemplified creativity at its finest, he was never afraid to destroy previous generations of hard-won product territory. Each generation was engineered for its own sake, not for compatibility with previous generations. Thus while Microsoft’s Windows and Office software was engineered so that it could cope with programs derived from previous generations, no such attempt was generally made at Apple. The result was a Windows sequence that by the Vista generation was vast and buggy compared to Apple products that remained slim, both physically and intellectually.

Truly free market capitalism involves a considerable amount of destruction along with the creativity. When new businesses arise, old ones are killed. In the tech sector, the Palm Pilot was a decade ago the gadget everybody had to have, then it became RIM’s Blackberry, then Apple’s IPhone and now the iPad. Thus in this sector, the multiples of 30, 40 and even 100 times earnings that gullible investors award their favorite companies are absurdly high. Because of the pace of creative destruction, tech sector companies should sell on four or five times earnings, reflecting their likely lifespan plus possibly a modest residual value at the end from the patents.

New products very often involve the destruction of their slightly inferior predecessors, as Henry Ford discovered when his Model T became obsolete and RIM is now discovering to its cost. Sometimes the destruction can be encompassed within one company, as Ford was able to do by shutting down his production line for a year and re-tooling to make the Model A. Sometimes the destruction involves the entire enterprise, as happened to Polaroid and may now be happening to Kodak.

Two forces have in recent years hampered this necessary process of destruction, loose money and governments.

Loose money prevents destruction, because there is no force forcing bankruptcy. Companies can run for years increasing their borrowings, repaying them with the occasional stock issue if they can find a compliant accountant. The premier example of this is Japan in the 1990s, where banks continued increasing their loans to real estate companies that were hopelessly insolvent, given the 70% drop in real estate prices from their 1990 peak. For a few years under Junichiro Koizumi (2001-06), rates were tightened and the banks were made to write off the worst of their bad debts, as a result of which Japanese economic conditions began to improve. Since Koizumi’s departure however, incipient recessions have been met with public spending sprees and further monetary easing, with the result that the Japanese “zombie companies” have proliferated and economic recovery has gone into reverse.

Now following the Fukushima reactor disaster we learn that its owner Tepco is also to be kept in operation through a banking system bailout, with no attempt made to liquidate its vast collection of “non-core assets” and ensure it is efficiently run which, given that Japanese utility tariffs are set on a “cost-plus” basis, it most certainly is not.

Europe has always been bad at allowing destruction, but in this recession it has got even worse. The Belgian bank Dexia was a model of sleepy inefficiency when I used to visit the Belgian savings banks from which it was formed in the 1970s and early 1980s. Since they had excessive ability to leverage and no proper asset generating capability, we made very nice money arranging Belgian Franc private placements for foreign government borrowers, all of which were placed with the same half dozen institutions. As it has since proved; our fees were well earned since we exercised a modest quality control on the borrowers – if we had provided them with duff paper our nice Belgian Franc placement business would have been kaput!

Merging these banks, giving them an expensive new headquarters and allowing them to compete for the dozier forms of lending with much sharper-clawed banks in the rest of the EU, without friendly merchant banks exercising quality control, was a recipe for disaster, and disaster has duly occurred. EU government paper was readily available – Greece would take any money you could lend it, at the low rates prevailing – and naturally Dexia filled its boots. The bank serves no useful purpose and while very large is should certainly not be regarded as central to the European financial system. Belgium, a gigantic beneficiary of the EU’s Brussels headquarters with vastly excessive public debt and not much of a non-bureaucrat economy except for some nice restaurants, certainly does not need its own banking system and Belgian taxpayers should not be milked to subsidize one.

The central cause of the EU debt problem, as of the U.S. subprime loan problem, is of course government regulation. In this case the regulation concerned is the monstrous Basel Committee regulation that says that holdings of OECD government paper could be weighted at zero when calculating banks’ capital requirements. Naturally, overleveraged banks in Europe have taken advantage of this provision to fill their balance sheets to the gunwales with dodgy government paper. The OECD membership requirement imposes a little quality control, but as Greece has shown, not much – without it, we would have doubtless seen massive multi billion dollar financings replicating the notorious 1822 bond issue for Poyais, a country that did not exist.

This absurd subsidy to the public sector (because holding capital costs money, and is priced into the cost of loans that require it), has been increased with the recent central bank requirements to raise extra capital, against which government debt is STILL not counted. It is the principal cause of the PIIGS government debt glut. Without it, bank appetite for the paper of gluttonous governments would have been far less, and interest rates on that paper would have soared even before the 2008 crisis.

The solution is to reduce or ideally eliminate the preference for government paper in calculating bank capital requirements, while throwing Greece, entirely uncompetitive at its current wage rates, out of the euro altogether. Banks will be forced to take writedowns against their holdings of Greek paper, and, in order to satisfy the new capital requirements, to sell other countries’ paper to institutional buyers. (Their immoral threats to stop lending and crater the European economy if forced to hold more capital should be treated with the contempt they deserve.) The banks that thereby become insolvent should be liquidated forthwith.

Thus the necessary destruction will be accomplished. Witterers who moan about “contagion” to other PIIGS or other banks should be quelled; one of the saddest results of the current attempts to pour yet more money into the Greek rathole has been the collapse of the fine Slovakian government, and its likely replacement by the bunch of not-very-ex Communists and kleptocrats that form the opposition. As Ireland has shown, it is possible to climb out of a banking crisis hole in a remarkably short space of time – and Ireland would have still fewer problems if it hadn’t foolishly guaranteed bank obligations in the first place. An equivalent austerity, perfectly possible under the capable Silvio Berlusconi and the incoming Spanish government would save Italy and Spain, although alas possibly not Slovakia, where the damage is probably done. Portugal also seems likely to save itself, but if not, it must share the fate of Greece.

Finally, here in the United States, bank balance sheets are endangered by the failure of the foreclosure process on underwater homes to proceed as it should and, still worse by the government’s conspiring with the trial lawyer lobby to make the banks responsible for a problem that was largely the fault of the government and the witless borrowers themselves. Instead, the government has kept the utterly damaging Fannie Mae and Freddie Mac in business and has attempted to force still money to go into the over-invested U.S. housing sector.

The great Andrew Mellon in December 1929 is alleged to have said “Liquidate, liquidate, liquidate.” With the statist Herbert Hoover in the White House, they didn’t do it then, and suffered a decade of depression as a result. We should be wiser now, in Japan, the EU and the United States. Subsidizing failure should no longer be an option.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)