08 May Managing The Economic Cycle (Part 1)*
Managing The Economic Cycle (Part 1)
An Economic Cycle has four stages. Simply stated, there’s (1) an expansion that reaches (2) a peak and results in (3) a contraction that reaches (4) a trough. Then the cycle repeats. Sometimes an expansion is rapid and robust, reaching a higher peak. Sometimes the contraction is deep and quick and results in a deeper trough. In modern times, the deepest troughs occurred during the Great Depression and the Great Recession of 2008-2009. Until the Great Recession, the post-WWII economic cycle generally followed a relatively clear path. The highest peaks often presaged the deeper troughs. Similarly, it was the deepest troughs that presaged the fastest recoveries and highest peaks. Not so following the Great Recession. The current expansion has been different. Despite the speed and depth of the Great Recession, the resulting economic expansion has been modest. There has been slow and steady annual GDP growth, muted inflation, historically low interest rates that have stayed historically low, a rising tide of corporate profits, and gradually receding unemployment without rising wages. There has also been a raging bull market in stocks, bonds and real estate. In sum, it’s been a Goldilocks Expansion, neither too hot nor too cold.
Some believe that the science of economics has evolved to the point where Economic Cycles now can be controlled, that a Managed Economy can sustain growth for another decade or longer even though the current expansion in the U.S. will soon become the longest since WWII. They point primarily to deft management of interest rates and money-printing by the Federal Reserve (see “The Fabulous Federal Reserve” in the April 19th TLR and “1937” in the March 11th TLR).
Others fear that growth, modest as it is, has been manufactured by Central Bank manipulations, by money-printing, artificially low interest rate policies, inappropriate Central Bank purchases of bonds and equities that have artificially inflated their prices, and a variety of further Central Bank measures that have created the illusion of a robust global economy without the substance. They see fatal flaws in excessive money-printing and false bravado in Central Banker pronouncements that there “will never be another financial crisis,” that there may never be another interest rate hike “in our lifetimes,” and that the Central Bankers will do “whatever it takes” to successfully prevent another economic crisis. They argue that at some point investors will realize that the measures taken by Central Bankers were neither wise nor temporary and that the world’s economy cannot be sustained by perpetual money-printing and ever-increasing government debt, that sustainable growth requires investment in productive capacity rather than in financial assets, that history proves that the policies that have been adopted by the Central Bankers will lead to a loss of investor confidence, in the ability of governments to pay off their debts, and in the value of fiat currencies themselves, and that the result will be runaway inflation, inflation they believe is found today only in the prices of stocks, bonds and real estate.
The two views reflect two divergent economic philosophies: Monetarism and Keynsianism.
Monetarists believe that a healthy economy requires that growth in the money supply mirror growth in productivity and demand. They see the post-Great Recession actions of Central Bankers as fundamentally flawed since the printing of fiat currency and the artificial maintenance of historically low interest rates have created a distortion and a mismatching of money supply and growth. There is no disagreement that there is such a mismatch. The only disagreement is about the consequences of the mismatch. Monetarists and Austrian School economists react to the mismatch similarly, the Austrian School economists believing that increasing the money supply, as Central Bankers have done, creates a vicious circle in which the Central Bankers must continually increase their money-printing until they lose control of the money supply. The result, they fear, will be runaway inflation.
The Austrian School view that money-printing must accelerate is supported by the recent 30-year experience of Japan and, arguably, by the acceleration of monetary easing actions taken by the Fed and the European Central Bank over the past 10 years. A decade of extreme monetary loosening has created massive Central Bank balance sheets reflecting massive government debt and excessively low global interest rates without correspondingly high productivity or GDP growth rates. Whether Central Bank monetary easing will lead to an inflationary spiral, however, has yet to be seen.
Keynsians, on the other hand, believe that Economic Cycles can be managed up to a point by stimulating demand through money-printing and deficit spending … and by reversing that stimulus as and when the economy responds – that is, that monetary and fiscal actions taken by Central Bankers and governments can smooth out and lengthen economic cycles. They cite former Fed Chairman William McChesney Martin who said that, just when the benefits of monetary easing are being felt, the Federal Reserve “is in the position of the chaperone who ordered the punch bowl removed just when the party was really warming up” because “[i]f we fail to apply the brakes sufficiently, and in time, we shall go over the cliff.” The Fed accordingly has been fine-tuning its monetary policy by progressively lowering and then progressively raising interest rates and gradually buying and then gradually retiring U.S. government bonds and then suspending both activities. Many modern Keynsians argue that the benign economic expansion of the past decade is due to the expert monetary machinations of the Fed and that the expansion can continue under the same careful management so that troughs
cease to exist are successfully minimized. They argue that the U.S. can sustain a slow-and-steady rising standard of living and GDP growth forever indefinitely for a quite lengthy period by alternating stimulus with economic braking. Whether the Fed indeed has the ability to pull this off has yet to be seen. (Nevertheless, the Fed’s Keynsian approach to stimulus apparently has a high level of bipartisan support – see “They’re All Keynsians Now” in the March 27th TLR and President Trump’s tweet of April 30th in which he said: “We have the potential to go up like a rocket if we did some lowering of [interest] rates, like one point, and some [further] quantitative easing.”)
Economies react not only to monetary measures implemented by Central Bankers but also to fiscal policies pursued by national governments. In the modern world, the two are intertwined and ordinarily are complementary. Unfortunately, during most of this Century (except during the darkest days of the economic crisis of 2008-09), coordinated fiscal and monetary policy implementation has not existed. When faced with a crisis – the possibility of a Second Great Depression –, the Bush and Obama Administrations managed to push through bipartisan legislation (the Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009, respectively). Thereafter, when the crisis had abated but further fiscal and monetary coordination was required would have been constructive, bipartisanship disappeared and no consensus could be reached to supplement the stimulus efforts of the Fed. The abject potentially disastrous failure of the U.S. government to take fiscal action led the Fed to adopt overly-aggressive increasingly daring, ever-more stimulative measures. Well after the Fed had implemented massive and broad monetary stimulus, the Trump Administration enacted the Tax Cuts and Jobs Act of 2017. The effects of the Fed’s monetary easing were boosted by the stimulus provided by the 2017 tax act, leading the Fed to continue tightening interest rates for a full year thereafter (there were a total of nine such increases between December 2015 and December 2018). The Fed has since taken its foot off the economic brakes and, at the suggestion of President Trump, may be considering a light tap on the accelerator once again.
As both Monetarists and Keynsians would agree, tinkering with monetary and/or fiscal tools in an attempt to repeal, control or manage Economic Cycles is hazardous. Maximizing the odds of success at the least requires thoughtful coordination between the Fed and the then-current administration as well as a large dose of bipartisanship. Fiscal responsibility and bipartisanship during the current expansion have been notably absent.
Commentary on the economic hazards of centralized economic management as well as of the future direction of the U.S. economy will continue in Friday’s TLR.
Finally (from a good friend)
The following are the 2008 Darwin Award-winners. (The Darwin Awards, named in honor of Charles Darwin, commemorate those who improve our gene pool by removing themselves from it.):
Nominee No. 1: [San Jose Mercury News] An unidentified man, using a shotgun like a club to break a former girlfriend’s windshield, accidentally shot himself to death when the gun discharged, blowing a hole in his gut.
Nominee No. 2: [Kalamazoo Gazette] James Burns (a mechanic), was killed as he was trying to repair what police describe as a “farm-type truck.” Burns got a friend to drive the truck on a highway while Burns hung underneath so that he could ascertain the source of a troubling noise. Burns’ clothes caught on something, however, and the other man found Burns “wrapped in the drive shaft.”
Nominee No. 3: [Hickory Daily Record] Ken Charles Barger accidentally shot himself to death. Awakening to the sound of a ringing telephone beside his bed, he reached for the phone but grabbed instead a Smith & Wesson 38 Special, which discharged when he drew it to his ear.
Nominee No. 4: [UPI, Toronto] Police said a lawyer demonstrating the safety of windows in a downtown Toronto skyscraper crashed through a pane with his shoulder and plunged 24 floors to his death. A police spokesman said Garry Hoy fell into the courtyard of the Toronto Dominion Bank Tower as he was explaining the strength of the building’s windows to visiting law students. Hoy previously had conducted demonstrations of window strength, according to police reports. Peter Lawson, managing partner of the firm Holden Day & Wilson, told the Toronto Sun newspaper Hoy was “one of the best and brightest” members of the 200-man association.
Nominee No. 5: [The News of the Weird] Michael Anderson Godwin had spent several years awaiting South Carolina’s electric chair on a murder conviction before having his sentence reduced to life in prison. While sitting on a metal toilet in his cell attempting to fix his small TV set, he bit into a wire and was electrocuted.
Nominee No. 6: [The Indianapolis Star] Gregory David Pryor, using a cigarette lighter to check the barrel of a muzzle loader, was killed Monday night when the weapon discharged in his face, sheriff’s investigators said. Investigators said Pryor was cleaning a 54-caliber muzzle-loader that had not been firing properly. He was using the lighter to look into the barrel when the gunpowder ignited.
Nominee No. 7: [Reuters, Mississauga, Ontario] A man cleaning a bird feeder on the balcony of his condominium apartment slipped and fell 23 stories to his death. Stefan Macko was standing on a wheelchair when the accident occurred, said Inspector Darcy Honer of the Peel Regional Police. “It appears that the chair moved, and he went over the balcony,” Honer said.
Finally, THE WINNER!!!: [Arkansas Democrat Gazette] Two local men were injured when their pick-up truck left the road and struck a tree near Cotton Patch on State Highway 38 early Monday. Woodruff County deputy Dovey Snyder reported the accident shortly after midnight Monday. Thurston Poole and Billy Ray Wallis were returning to Des Arc after a frog-catching trip. On an overcast Sunday night, Poole’s pick-up truck headlights malfunctioned. The two men concluded that the headlight fuse on the older-model truck had burned out. As a replacement fuse was not available, Wallis noticed that the 22-caliber bullets from his pistol fit perfectly into the fuse box next to the steering-wheel column. Upon inserting the bullet, the headlights again began to operate properly and the two men proceeded on toward the White River Bridge. After traveling approximately 20 miles, and just before crossing the river, the bullet apparently overheated, discharged and struck Poole in the testicles. The vehicle swerved sharply right, exiting the pavement and striking a tree. Poole suffered only minor cuts and abrasions from the accident but will require extensive surgery to repair the damage to his testicles, which will never operate as intended. Wallis sustained a broken clavicle and was treated and released. “Thank God we weren’t on that bridge when Thurston shot his balls off, or we might both be dead,” stated Wallis. “I’ve been a trooper for 10 years in this part of the world, but this is a first for me. I can’t believe that those two would admit how this accident happened,” said Snyder. Upon being notified of the wreck, Lavinia (Poole’s wife) asked how many frogs the boys had caught and did anyone get them from the truck??? (Though Poole and Wallis did not die as a result of their misadventure as normally required by Darwin Award Official Rules, it can be argued that Poole did, in fact, effectively remove himself from the gene pool.)
*┬® Copyright 2019 by William Natbony. All rights reserved.