Todd Harrison over at Minyanville had some good thoughts last week about the business cycle and the Fed’s attempt to snuff it out:
“I, too, remember when the business cycle was a healthy and natural continuum; when, much like a forest fire, it was a necessary precursor to a fertile economic re-birthing. The economy expanded, contracted, and expanded anew based on fluctuations in production, trade, and business activity. But hey, maybe I’m just showing my age. “
It’s pretty amazing actually, since the creation of the Fed, deflation has virtually been eliminated. Of course, this has simply shifted the playing field from inflation AND deflation to varying degrees of low AND high inflation, but still, eliminating deflation is a big victory. After all, can you imagine having lived during the 1800′s when deflation was a common occurrence and depression occurred almost once a decade?
But it hasn’t all been roses during this inflationary bias. If you include the concepts of the Greenspan Put in this thinking and asset prices then we could argue that the inflationary bias has at least inadvertently contributed to much larger asset price swings than we’re normally used to. Which brings me to an interesting thought. Policy surrounding the economy is a whole lot like portfolio management. What we’re really trying to do with the economic policy is create a steady and stable growth trend. Just like a portfolio manager tries to generate growth without exposing the portfolio to too much risk.
We’ve made great headway, in my opinion, in taming some of the natural negative processes in the economy. After all, the economy is a lot like a living system. And I think it would be rather impractical to argue that that system can’t be helped along by understanding how it works and applying the right medicine at times. The truly free market thinkers who would just let the economy be the economy make me think about how medicine was once confused with witchcraft. But can the economy truly be controlled? Can the irrational participants truly be contained from doing the inevitable? I don’t think so. We’ll never solve all of the economy’s problems just like we’ll never cure all of man’s illnesses. But I do think there’s a balance. And I do think we can aid our economy by understanding it and applying modern medicine where appropriate. But we shouldn’t be fooled into thinking that we can control every aspect of our economy and guide it to the holy grail of perfect risk adjusted growth. Like much of what Wall Street chases, that myth is almost certainly unattainable.