Booms and Busts: The Economic Cycle in Action

Marcus D. NiskiMarcus D. Niski

Booms and Busts…

As we have already observed, the economies of all countries are subject to what is known as cyclical affects or affects which influence their economic cycle in terms of both what is known as short run and long run factors…

Booms:

An economic boom is characteristics by a range of economic factors in the cycle such as:

High levels of investmentHigh levels of employmentHigh levels of demandHigh levels of spendingBuoyant share pricesPsychological optimism regarding

employment, spending and the general health of the economy

Strong housing prices

Busts:

Characteristically, busts are an opposite trended of the reverse factors – also characterised by pessimisms in general terms about the state of the economy and d it short-medium term future.

Busts are known as a period of recession in the economy where growth is slow and the prevailing economic data suggest what economists in the media often refer to as ‘sluggish’ behaviour.

Depressions: a severe economic downturnDepressions: a severe economic downturn

Depressions are Depressions are technical extended long technical extended long running periods of downturn in the economyrunning periods of downturn in the economy that are characterised by three quarters of that are characterised by three quarters of negative growth in the economy.negative growth in the economy.

Depressions often result in massive social and economic instability and have profound consequences for any society as they impact at the every level of the economy and society.

The Great Depression of The Great Depression of the 1930sthe 1930s

The Great Depression The Great Depression The Great DepressionThe Great Depression was a severe worldwide was a severe worldwide economic depression in the decade preceding economic depression in the decade preceding

World War II. World War II.

The timing of the Great Depression varied The timing of the Great Depression varied across nations, but in most countries across nations, but in most countries it it started in about 1929started in about 1929 and lasted until the late and lasted until the late 1930s or early 1940s.1930s or early 1940s.

It was the longest, most widespread, and It was the longest, most widespread, and deepest depression of the 20th century, and deepest depression of the 20th century, and is used in the 21st century as an example of is used in the 21st century as an example of how far the world's economy can decline in how far the world's economy can decline in global terms…global terms…

The depression originated The depression originated in the U.S with the famous in the U.S with the famous CRASH on Wall Street.,CRASH on Wall Street., starting with the stock starting with the stock market crash but quickly spreading to almost every market crash but quickly spreading to almost every country in the world. country in the world.

The Great Depression had devastating effects in The Great Depression had devastating effects in virtually every country, rich and poor. Personal virtually every country, rich and poor. Personal income, tax revenue, profits and prices dropped, and income, tax revenue, profits and prices dropped, and

international trade plungedinternational trade plunged..

Before we move on to further analysis, Before we move on to further analysis, let’s pause for a moment a look at let’s pause for a moment a look at what happens what happens when a market collapseswhen a market collapses and what sort of factors might be at and what sort of factors might be at work.work.

Let’s look at the so-called Let’s look at the so-called tech wrecktech wreck of the early 2000’s as an example. The of the early 2000’s as an example. The technological ‘bubble’ that followed on technological ‘bubble’ that followed on from rapid investment in the Internet from rapid investment in the Internet in the late 1990s and early 2000’s is an in the late 1990s and early 2000’s is an excellent example of what happens excellent example of what happens when a market crashes and the sorts when a market crashes and the sorts of economic and psychological factors of economic and psychological factors that are involved.that are involved.

Like Like many bubbles before itmany bubbles before it, the , the tech wreck is a good example of a tech wreck is a good example of a sometimes highly predictable crash.sometimes highly predictable crash.

Indeed, the tech wreck was brought Indeed, the tech wreck was brought about by a number of factors about by a number of factors including:including:

– – Inflated prices based on paper values rather than real Inflated prices based on paper values rather than real values (asset v price bubbles)values (asset v price bubbles)– – Investor over confidence Investor over confidence - Elements of corruption/ manipulation of the business - Elements of corruption/ manipulation of the business

model model – – Psychological bull run behaviorPsychological bull run behavior

Consequently Consequently the market crashes due tothe market crashes due to::

–– Prices plummeting for stocks based on a Prices plummeting for stocks based on a correction to the above as both the correction to the above as both the perceived and real re-evaluations took perceived and real re-evaluations took placeplace

– – Mass selling behavior Mass selling behavior – – Loss of confidence in the sector by Loss of confidence in the sector by

investorsinvestorsExposure of poor real values to Exposure of poor real values to

perceived valuesperceived valuesBusinesses in the sector not making Businesses in the sector not making

anticipated profitsanticipated profits– – Panic through the marketPanic through the market

So let’s move back to the Great Depression…So let’s move back to the Great Depression…

Economic historians most often attribute the start of Economic historians most often attribute the start of the Great Depression to the sudden and total collapse the Great Depression to the sudden and total collapse of US stock market prices on October 29, 1929, known of US stock market prices on October 29, 1929, known as Black Tuesday.as Black Tuesday.

However, However, SOME DISPUTE EVEN TODAY THAT THE SOME DISPUTE EVEN TODAY THAT THE CRASH WAS A SYMPTOM RATHER THAN A CAUSE OF CRASH WAS A SYMPTOM RATHER THAN A CAUSE OF THE GREAT DEPRESSION.THE GREAT DEPRESSION.

Even after the Even after the Wall Street Crash of 1929,Wall Street Crash of 1929, some some optimism persisted for some time; optimism persisted for some time;

John D. Rockefeller said that: "These are days when John D. Rockefeller said that: "These are days when many are discouraged. In the 93 years of my life, many are discouraged. In the 93 years of my life, depressions have come and gone. Prosperity has depressions have come and gone. Prosperity has always returned and will again."always returned and will again."

The stock market turned upward in early The stock market turned upward in early 1930, returning to early 1929 levels by April, 1930, returning to early 1929 levels by April, though still almost 30% below the peak of though still almost 30% below the peak of September 1929.September 1929.

Together, government and business actually Together, government and business actually spent more in the first half of 1930 than in the spent more in the first half of 1930 than in the corresponding period of the previous year.corresponding period of the previous year.

But consumers, But consumers, many of whom had suffered many of whom had suffered severe losses in the stock market the previous severe losses in the stock market the previous year, cut back their expenditures by ten year, cut back their expenditures by ten percent, and a severe drought ravaged the percent, and a severe drought ravaged the agricultural heartland of the USA beginning in agricultural heartland of the USA beginning in the summer of 1930the summer of 1930..

By the mid 1930s interest rates had dropped to low levels and consumer investment and spending were both depressed.

Conditions in the farming sector also declined and commodity prices declined.

Protectionist tariff polices ensued and the US government moved to instituted the Smoot- Hawley Tariff Act aimed at protecting US trade against the actions of its competitors.

• Some economists argued that this in fact help to exacerbate the situation because it further slowed down US international trade, which in turn, affected US stocks of gold that further aggravated the crisis rather than alleviated it

By 1930 a steady decline in the world By 1930 a steady decline in the world economy in that would reach the bottom by economy in that would reach the bottom by 1933….1933….

““25 percent of all workers and 37 percent of all 25 percent of all workers and 37 percent of all nonfarm workers were completely out of worknonfarm workers were completely out of work.” .” (Great Depression, by Gene Smiley, The Concise (Great Depression, by Gene Smiley, The Concise Encyclopedia of Economics)Encyclopedia of Economics)

By 1939, in fact, the world would be at war By 1939, in fact, the world would be at war with Hitler’s Germany invading Poland. with Hitler’s Germany invading Poland. Ironically , a war economy would help to Ironically , a war economy would help to repair the damage done to the US economy repair the damage done to the US economy eventually leading it to becoming an eventually leading it to becoming an economic engine of growth by the 1950s with economic engine of growth by the 1950s with the re-construction of Japan playing an the re-construction of Japan playing an important role in this process.important role in this process.

Causes of the Great Causes of the Great DepressionDepression

““What caused the Depression? This question What caused the Depression? This question is a difficult one, but answering it is is a difficult one, but answering it is important if we are to draw the right lessons important if we are to draw the right lessons from the experience for economic policy. from the experience for economic policy. Solving the puzzle of the Depression is also Solving the puzzle of the Depression is also crucial to the field of economics itself crucial to the field of economics itself because of the light the solution would shed because of the light the solution would shed on our basic understanding of how the on our basic understanding of how the economy works...”economy works...”

Current US Federal Reserve Bank Governor Ben S. Bernanke, At the Current US Federal Reserve Bank Governor Ben S. Bernanke, At the H. Parker Willis Lecture in Economic Policy, Washington and Lee H. Parker Willis Lecture in Economic Policy, Washington and Lee University, Lexington, Virginia, March 2, 2004 in a speech entitled– University, Lexington, Virginia, March 2, 2004 in a speech entitled– Money, Gold, and the Great Depression Money, Gold, and the Great Depression

Causes of the Great Causes of the Great DepressionDepression

““During the first decades after the Depression, During the first decades after the Depression, most economists looked to developments on the most economists looked to developments on the real side of the economy for explanations, rather real side of the economy for explanations, rather than to monetary factors. than to monetary factors.

Some argued, for example, that overinvestment Some argued, for example, that overinvestment and overbuilding had taken place during the and overbuilding had taken place during the ebullient 1920s, leading to a crash when the ebullient 1920s, leading to a crash when the returns on those investments proved to be less returns on those investments proved to be less than expected. Another once-popular theory was than expected. Another once-popular theory was that a chronic problem of "under-consumption"--that a chronic problem of "under-consumption"--the inability of households to purchase enough the inability of households to purchase enough goods and services to utilize the economy's goods and services to utilize the economy's productive capacity--had precipitated the slump.” productive capacity--had precipitated the slump.” (ibid)(ibid)

““The slowdown in economic activity, The slowdown in economic activity, together with high interest rates, was in all together with high interest rates, was in all likelihood the most important source of the likelihood the most important source of the stock market crash that followed in October. stock market crash that followed in October.

In other words, the market crash, rather In other words, the market crash, rather than being the cause of the Depression, as than being the cause of the Depression, as popular legend has it, was in fact largely the popular legend has it, was in fact largely the result of an economic slowdown and the result of an economic slowdown and the inappropriate monetary policies that inappropriate monetary policies that preceded it. preceded it.

Of course, the stock market crash only Of course, the stock market crash only worsened the economic situation, hurting worsened the economic situation, hurting consumer and business confidence and consumer and business confidence and contributing to a still deeper downturn in contributing to a still deeper downturn in 1930.” (ibid)1930.” (ibid)

Time Line to The Great Time Line to The Great Depression… Depression…

19291929

U.S. decline in industrial productionU.S. decline in industrial production

August: The recession begins, two months before the crash. August: The recession begins, two months before the crash. Production falls by 20%.Production falls by 20%.

October 24: Stock market crash begins.October 24: Stock market crash begins.

October 25: Brief surge on the market.October 25: Brief surge on the market.

October 29: October 29: 'Black Tuesday'. U.S. Stock market collapse.'Black Tuesday'. U.S. Stock market collapse.

Decline in the commodity prices.Decline in the commodity prices.

The stock market crash had little substantive effect on The stock market crash had little substantive effect on the recession because only 16% of the population was the recession because only 16% of the population was involved in the market, and only 10% of wealth was lost. involved in the market, and only 10% of wealth was lost. However, the crash created uncertainly in people’s minds However, the crash created uncertainly in people’s minds about the future of the economy. This distrust in future about the future of the economy. This distrust in future income reduced consumption expenditure. As demand for income reduced consumption expenditure. As demand for commodities decreased, so did their prices.[1]commodities decreased, so did their prices.[1]

19301930 February: Federal Reserve cuts interest rates from 6% to February: Federal Reserve cuts interest rates from 6% to

4%4%

June 17: Smoot-Hawley Tariff Act passed.June 17: Smoot-Hawley Tariff Act passed.

September - December: First U.S. bank failuresSeptember - December: First U.S. bank failures

19311931

May: Creditanstalt, Austria's premier bank, goes insolvent.May: Creditanstalt, Austria's premier bank, goes insolvent.

May-June: Second U.S. bank failures / Change in people's May-June: Second U.S. bank failures / Change in people's expectation of the economyexpectation of the economy

If people expect the deflation to continue, they anticipate If people expect the deflation to continue, they anticipate that prices will be even lower in the future than they are that prices will be even lower in the future than they are now. They hold off on purchases to take advantage of the now. They hold off on purchases to take advantage of the expected lower prices. They are reluctant to borrow at any expected lower prices. They are reluctant to borrow at any nominal interest rate because they will have to pay back nominal interest rate because they will have to pay back the loan in dollars that are worth more when prices are the loan in dollars that are worth more when prices are lower than they are now. In short, the real interest rate lower than they are now. In short, the real interest rate rises above the nominal rate (Temin 56).rises above the nominal rate (Temin 56).

July: Germany banking crisisJuly: Germany banking crisis

September 21: Britain goes off the gold standard.September 21: Britain goes off the gold standard.

September - October: Substantial amount of dollar assets September - October: Substantial amount of dollar assets are converted to gold in the USare converted to gold in the US

September - December: Fed increases interest ratesSeptember - December: Fed increases interest rates

Fed wanted to stabilize the dollar without going off the Fed wanted to stabilize the dollar without going off the gold standard. As a result, production continued to gold standard. As a result, production continued to plummet and the depression intensified.plummet and the depression intensified.

November - Summer 1932: Foreign trade restrictions / November - Summer 1932: Foreign trade restrictions / Imperial PreferenceImperial Preference

19321932

April - June: Government conducted open market transactions to April - June: Government conducted open market transactions to increase money supply.increase money supply.

July: The Government discontinued open market operations.July: The Government discontinued open market operations.

19331933

Franklin D. Roosevelt elected President.Franklin D. Roosevelt elected President.

US goes off the gold standard.US goes off the gold standard.

US goes on silver standard.US goes on silver standard.

The Great Crash of 1929The Great Crash of 1929

http://www.http://www.youtubeyoutube.com/watch?v=RJpLMvgUXe8.com/watch?v=RJpLMvgUXe8