A Few Words About The Business Cycle

     You’ve seen that phrase before, haven’t you? I’ll bet a few of my Gentle Readers have even used it in conversation. But the ease with which it rolls off the tongue contrasts sharply with the general ignorance about the business cycle: specifically, what causes it and keeps it cycling.

     Most people look at the behavior of the economy the way an ant would look at an avalanche: from way, way down at the bottom of the mountain. For them, “business cycle” is merely an incantation used to deflect or dismiss their expressed concerns about their own financial well being: “It’s just the business cycle,” the analyst or counselor says, as if to murmur “And there’s nothing to be done about it.” And from the perspective of the average American, there really is nothing to be done about it, except perhaps to remain cautious as it peaks and to brace for its troughs. But that doesn’t mean the business cycle is a phenomenon written into the laws of the Universe.

     Many people believe the business cycle to be tied to warfare. There’s some truth in that, as warfare is one of the rationales for what really drives the business cycle. But we’re here to take a deeper look, one that respects the observable fact that the business cycle as we understand it began only about a century ago. Mankind’s been fighting wars for a lot longer than that.

     Some really interesting things started about a century ago, and you should be aware of their consequences.

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     When financial analysts scout for the entry to the “trough” phase of the business cycle, they all look for the same thing: a retreat from investment by major corporations. That is, companies that had been spending on growth begin to pull back in a consistent fashion from such investment patterns. The key indicator is an overall decline in the purchase of capital goods: commercial land, buildings, and the equipment used to make products for sale (including products sold to other companies). It “should” be “obvious” that such a retreat presages a retreat from hiring for volume production. And indeed, that does follow.

     A retreat from hiring puts downward pressure on wage levels. It can take a while for the effect to manifest itself, as virtually no company actually cuts wages these days. But the pressure is there, and will be expressed in several ways, including overall workforce reductions and a leveling off in salary offers to persons newly hired. Frictional unemployment is swallowed by the real thing, as laid-off workers struggle to find new jobs. Financial reporters soon see the sort of trend in GDP we’ve been taught to call a recession: a period of no or negative growth.

     Now, it’s plain that even in a generally healthy, growing economy, there will always be companies that “aren’t making it” and must pull back or, in the worst case, cease to operate. That’s part of capitalism; not every venture will succeed, and those that fail must contain the losses to themselves. What matters is the overall trend among companies: toward or away from growth-oriented investment. When the trend is away, a recession will follow.

     That the trend recurs at irregular intervals suggests that the “business cycle” is only evidence of another, deeper cycle: one that businesses cannot countervail.

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     The birth of the Federal Reserve System in 1913 produced a state of affairs which rendered the dollar a commodity of unstable quantity and value. The Fed was given the authority to create new money, supposedly to assure that the American monetary system would remain “flexible.” In point of fact, the Fed can only create new money under one condition: borrowing by the federal government.

     The federal government borrows so that it can spend more than it takes in through taxation. The annual federal deficit is the measure of how greatly Congress’s spending has exceeded its income. The federal debt is merely the accumulation of all the deficits Washington has incurred over the years. But the salient fact for this discussion is that when Congress borrows and spends, it does so by virtue of the Fed’s creation of new money for that purpose.

     The federal government doesn’t buy things at the corner store. Its purchasing is always in vast quantities, the sort that produces huge spikes in the revenue curves of companies that sell to it. Thus, the newly borrowed / newly created money enters the economy in large lumps through the coffers of large corporations. Those lumps cause their in-house analysts to foresee growth in the immediate future. They counsel corporate management to invest in anticipation of an ongoing increase in business. Capital goods are purchased. Workforces are enlarged. Wages increase.

     This brings about the “peak” portion of the business cycle. The “peak” fades into the “trough,” discussed in the previous section, when it becomes evident that Congress’s purchases are not a true indicator of continuing revenue growth. Capital goods purchases decline to previous levels or still lower ones, workforces are pared back, and the “cycle” is renewed.

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     There are other important consequences to federal deficit finance, of course, but this is not the time for that discussion. Few of those who have pontificated about this “cycle” of immense importance have delved into its causes, or reflected on why the “cycle” began only a century ago. Indeed, they speak of the “cycle” as if it were a phenomenon familiar to the Cro-Magnons. It is our mission here at Liberty’s Torch to spread useful information those others don’t want disseminated. If you’ve wondered, now you know.

     This piece was stimulated by David De Gerolamo’s roundup of some ominous economic numbers. It’s an interesting list overall, but the part that speaks most loudly to me is this one:

     This is the worst slump for core U.S. factory orders in three years.

     That suggests that we’re closing in on a new “trough” in the business cycle. It looks as if it will be a deep one. Americans should brace themselves. Don’t let your luxuries become necessities. Consider yourselves forewarned.