Is it Possible to Eliminate the Business Cycle?

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.


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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  1. I think you could have a business cycle which fluctuates between varying rates of growth without actually experiencing declines in activity.

  2. I don’t agree with you on this occasion. I don’ think we have made any headway whatsoever.

  3. The cruel irony is that the Fed’s determined involvement in markets has created a new era of boom and bust cycles…replacing the healthy, natural business cycle, a cycle that would respectfully lay to rest uncompetitive, unprofitable businesses while allowing new, vibrant innovative businesses freedom to expand and grow. It’s like Bernanke did a $75K frame off restoration and total engine rebuild on his 1995 Chrystler Sebring with 350k miles on it. His supporters point to the fact that the car looks good and seems to be running great now. For me, I can’t get over the fact that he’s driving a $75k Sebring.

  4. Cullen, I agree with you that you that the human psyche plays a large role in economic cycles and can´t be controlled by policy. I don´t think that the fed will be succesful in preventing eventual severe deflation. They have enabled the irrational participants by continually backstopping unsustainable credit growth IMO, and as people have changed their spending habits and their views on sustainablity versus consumption, the “perpetual” credit growth machine will break down. In summary, the fed has not eliminated deflation, but has put off what is going to be a much more severe and destructive form of credit destruction as society changes their consumption patterns.

  5. >> After all, the economy is a lot like a living system…

    Exactly !

    So you cannot have endless growth in a finite planet. Stop with this utterly nonsense. Please economists and aficionados, try at least one time in your life to read an introductory book about the laws of thermodynamics and their conseguences. Consuming a resource is deflationary with or without Bernanke. Enthropy is what rules our life. What you can have is endless growth in knowldege that is immaterial. Less cars and more intelligence, less junk food to feed the belly of a population of heavily overweighted people and more food for brain. Less bankers and more teachers.

  6. Knowing perfectly how a race car operates is a wholly different enterprise than driving one at Indianapolis 500 through the fog of “Public Choice”.

  7. I do not think it was the Fed who ended deflation. It was the possibility of deficit spending, made possible by larger government and the eventuak abandment of the Gold standard.

  8. Gee, I had no idea we got rid of the business cycle. I just assumed we ignored the painful part by socializing debt and giving a pass to incompetent people who thus have been rewarded for their incompetence. Sure it is now more difficult for competent people who were not overleveraged in 2007 to compete with the morons who run us into the abyss but it’s not like we are actually in a capitalistic system anymore , are we?

  9. If one spends, saves, and invests responsibly, what is so bad about a whiff of deflation to keep people, businesses, and government off the overconsumption bandwagon, and over indebted.

    i.e. What is so great about managing to avoid the Scylla, by sailing triumphantly into the “arms” of the Charybdis.

    If the Scylla is deflation, the Charybdis is “non-honest” money, which ends up undermining the rule-of-law, (and thus, free enterprise capitalism), creating a plutocratic state, who enrich themselves at the expense of everyone else because of their proximity to easy money.

    i.e. stability leads to instability.

    The recognition that debt can go bad is a reality that no one and no society should try to escape.

  10. “After all, can you imagine having lived during the 1800′s when deflation was a common occurrence and depression occurred almost once a decade?”

    Funny, how the US rose to be the largest economy and a superpower while having all those deflations in the 1800s and first half of the 1900s. Well, maybe your point is that they were unnecessary, but they certainly didn’t seem to have held the country back?

    And, isn’t deflation a normal outcome? I’m so depressed that computers now cost so much less than in 2000.

  11. I agree. Understanding the operational insight of the monetary system is investor education job number one if you want to be able to invest in a world dominated by Fed and Washington, but when it comes to the business cycle, I think we have actually fallen backwards.

    What the Federal Reserve has done is merely turned failed market capitalism into state capitalism. Hence, understanding how the state works is the investment thesis.

  12. Doesn’t the absence of volatility make market participants weaker? Minsky understood this well. The more stability we try to push on the economy through activist policy the more likely we’ll be to create even greater volatility in the future. Failure is a valuable feedback tool that informs future players about what works and what doesn’t.

    I’m not saying the 1800s is a model to live by. I’d like to see a floating payroll tax rate that shifts up and down with the inflation rate. Some rule that’s always in play rather than active, subjective policy makers operating in an environment far too complex for them to understand and make well-informed decisions that appreciate all of the consequences. I expand on this concept with my Too Big To Succeed thesis:

    Central bankers are the epicentre of decision makers way over their head with too much power and too little information to use that power well.

  13. Cost drop of computers is NOT deflation. The people in the computer industry are making increased profits and not suffering any inability to pay their debts as a result of the price decreases. These price decreases are good ones because they come as a result of coordiantion of action leading to lower production costs. Of course the driver of all this is all the people who wish to use computers. If there are lots of customers for something you can make the large investment to undertake mass production where you are able to spend the same producing your next 10000 units as cheaply as you made your first 10.

    Deflation means generalized price drops not warranted by increased productivity and sales. In fact its grossly decreased sales and bankruptcies.

  14. The side effect of “taming the business cycle” is we become a nation of burger flippers, house builders etc. The economy adapts by shifting to what the gov/Fed targets. Low productivity services.

  15. “What we’re really trying to do with the economic policy is create a steady and stable growth trend.”

    Sounds like an endorsement of NGDP targeting. Is it? I’ll call Sumner and give him the good news : )

  16. Agreed. I do not subscribe to the save the banks to save the citizenry theory. Enslavement of your population is not a growth strategy.

  17. Does the inflation index (used to determine monetary policy) account for products where this holds vs where it doesn’t?

  18. Wage deflation has not been ended !

    The FED has just avoided asset inflation, the only thing that monetary polices can do and it will not last forever if wages will not pick up.

  19. “So you cannot have endless growth in a finite planet. Stop with this utterly nonsense.”

    Bit of a strawman. No one’s saying that we can have endless growth.

    Obviously, growth will end at some point. But we’re nowhere even close to hitting the physical constraints to growth on this planet, and there’s no point in trying to run economic models on what society will look like in >100 years.

    I say this as someone who’s got a PhD and who works with thermodynamics everyday: Stop bringing up thermodynamics and entropy as constraints on our economic growth. They’re just not relevant; at least, not how you’re trying to apply them. The Earth is bombarded with more solar energy in an hour than the entire global economy uses in a year.

  20. Business cycles like any other natural cylces will always prevail. Human psychology works in a up and down manner and this always drives things/ events in a cycle.

    Whenever one tries to control anything , there is always a section that will go against it. So the cycle continues.

    All said and done, you cannot control nature and its eventualities. They will always be there to drive you cyclically.


  21. All these people have a PhD too, teach in two of the most important universities in the world and have a few hundreds papers published on the most important scientific magazines in the world and they disagree with you. I’ve a degree in engineering and a master in finance, I’ve worked for 30 years and when I decided to retire I was the CEO of a 500 million firm; now I’m essentially studying all these topics in deep, I’m not important and as knowdeldgeable as Prof. Patzek but I’m not an ignorant. Yes, even my 8 years old nephew knows that solar energy is everywhere but you can’t drive your car with it, and you cannot pump enough energy from solar fields to fuel hundreds of steel plants etc… and batteries are not a viable solutions for cars unless you reduce the weight of your car from 2000 lbs to 500. And cutting forests too grow crops for biofuels is just a shortcut to kill the biosphere. Bees are much more important for life than us… efficency is the key but it will reduce the GDP… which doesn’t mean we will live a poor life, but that most of the current assets are overvalued or worthless.

  22. “After all, can you imagine having lived during the 1800′s when deflation was a common occurrence and depression occurred almost once a decade?”

    First: deflation is a natural outcome of productivity gains. Fighting deflation means that the productivity gains never reach the broad population, but accrue to the producers only. Deflation is dangerous only after a credit bubble has been created. That is why the Fed has everyone brain washed that deflation is bad. Including Cullen obviously.

    Second: stop bashing the 1800s and check real GDP growth. It was much higher than in the inflationary bias period post 1970s.

  23. “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.”

    Yes put the system on heroin or some performance enhancing drug (i.e. a credit binge) and start high-fiving how great a “portfolio manager” you are. The pendulum has swung too much to the other side, so that your “progress” has become regress. The economy is long past the optimal level of leverage. The Fed is a real witch-doctor.

  24. No but i don’t believe it needs to though.
    Deflation is a general drop in all prices and greatly decreased demand for credit. You don’t look for deflation in one thing it’s a market wide phenomenon It’s a mass exit from the credit markets
    that makes exit impossible as incomes fall and no one can pay debts