Business Cycles Forever . . . ?

The Great Depression. (Photo credit: Wikipedia)

In the 1930s, the US was in the midst of its Great Depression.  The Soviet Union cheered.  Communists viewed our Depression as evidence that the capitalist system was dying and communism would soon rule the world.

Russian economist Nikolai Kondratiev (A.D. 1892 –1938) disagreed.  He advanced the theory that Western economies have long-term, 40-to-60-year business cycles. These business cycles look like sine waves.  In broad strokes, these waves generally include about 25 “good” years when the economy is expanding a little or a lot (economic “boom”), followed by 25 “bad” years when the economy is contracting a little (recession) or a lot (depression).

According to Kondratiev, the Great Depression was merely a predictable—and temporary—low in the US economy’s business cycle.  As such, the Great Depression did not signal the end of capitalism nor the triumph of communism.  The Soviet government rewarded Mr. Kondratiev for his politically-incorrect research by executing him.

(Apparently, Kondratiev’s execution served as a valuable lesson to all subsequent economists.  Those who want to stay healthy, also stay politically-correct.  Those who dare to tell the truth do so only with such a convoluted use of language, graphs and mathematics that no one can understand what they’re saying.  Better to be a live economist than a dead teller of truth.)

In any case, the former Soviet Union has also been “executed” and joined Mr. Kondratiev in death–but Kondratiev’s view of business cycles has survived.

•  English economist John Maynard Keynes was a contemporary of Mr. Kondratiev.  Unlike Kondratiev (who merely observed and measured business cycles), Keynes determined to do something about them.

Keynes sought to minimize both the extreme highs and lows in the business cycle and cause the business cycle’s “sine wave” to resemble something more like a steadily rising straight line.  If Keynes could succeed, we’d have a constantly growing economy, constant prosperity and no significant recessions or depressions.

According to Kenyes, taxes should be raised and revenues saved during the cycle peaks in order to moderate and reduce the cycle highs.  When the business cycle entered the inevitable downturn, taxes would lowered and the money saved during the previous “high” would then be spent to stimulate the economy and prevent a serious recession or even depression.

As a theory, Keynesian economics made a lot of sense.  As a practical reality, Keynesian economics left something to be desired.

•  For example, Keynesian theory originated when the world still ran on gold- or silver-based monetary systems.  Keynesian theory was later adapted to accomodate fiat currencies, but fiat currencies complicated or even contradicted fundamental Keynesian strategies.

For example, according to Wikipedia,

“Keynes argued that the solution to the Great Depression was to stimulate the economy through some combination of two approaches:

“1: A reduction in interest rates, and

“2: government investment in infrastructure.”

Keynes’ first approach to solving depressions (reducing interest rates) would work well while the money was gold or silver and there were significant physical obstacles (oceans, for example) or political realities (wars or overtly criminal governments) to prevent physical money from moving from one nation to another.  Unable to easily move their money, domestic lenders were trapped whenever government cut interest rates.  Lenders therefore had two choices:  either accept low interest rates and earn a small return on their principal, or sit on their money and earn nothing.  They’d usually take the small return.

Insofar as the lenders’ physical money was “trapped” within a nation, that nation’s government could stimulate the economy by lowering interest rates, force lenders to accept those low rates, and thereby induce consumers to borrow and spend at low-low, “fire sale” interest rates.

But, today, we have a fiat currency that’s largely digital and can travel around the world at the speed of light.  Result?  Our fiat currency is no longer “trapped” within our national economy.  Therefore, lowering interest rates won’t necessarily stimulate borrowing, but may instead stimulate capital flight to foreign countries that pay higher rates of interest.

Thus, lowering interest rates (recommended by Keynes to cope with recessions) will, in today’s world of fiat currency, tend to reduce the domestic money supply and thereby slow—rather than stimulate—the national economy.

•  Keynes’ second approach to recessions (investing in infrastructure) was intended to injects income into the economy, causing more spending and thereby stimulating more production and investment.  The initial stimulation was expected to start a cascade of spending, whose total increase in economic activity was expected to be a multiple of government’s original investment.  I.e., the government might invest $1 billion and the economy might grow by $5 billion or even $20 billion.

That’s a nice theory.  It might even be true.  But it all starts with “government investments”.

So, where does the government get the money to “invest”?

In Keynes’ time, the only money the government could “invest” during a recession would be: 1) revenue previously saved from taxing the people during the “good years”; 2) revenue from current taxes; or, 3) whatever the government could borrow.

Today—in our brave new world of fiat currency and perpetual deficit financing—government has no “savings” to invest.  Therefore, “government’s investments” in the infrastructure can only be from currency that is: 1) borrowed; 2) taxed (“austerity”); or 3) created by the central bank.

In an economic contraction, if government has suppressed interest rates and capital has tended to flee or sit on the sidelines until interest rates rose, government’s ability to borrow from the private sector to “invest in the infrastructure” would be limited.

Raising taxes during a recession (“austerity”) would be stupid and self-destructive.  You can’t stimulate the economy by imposing higher taxes on a people already going into poverty.

Therefore, the only reliable source of fiat currency to “invest” in the infrastructure would be from the Federal Reserve’s creation of new fiat currency.   This is exactly what we’ve seen in the last few years as the US gov-co was unable to sell all of its bonds to private investors and has become increasingly dependent on the Federal Reserve to “buy” US treasuries with freshly-created fiat currency.

•  There are other current contradictions to Keynesian theory.  For example, according to the UK Telegraph,

“The eurozone’s appetite for self-harm knows no bounds.  With one in four Spanish workers unemployed, output contracting and Asturian miners marching through the capital, the Spanish prime minister, Mariano Rajoy, has determined to push through a further €65bn of austerity measures.” 

Spanish (and Greek) “austerity” measures make depressions worse.  More, “austerity” violates Keynesian theory by raising taxes and lowering governmental services during a recession in the business cycle.  Such “austerity” is guaranteed by both Keynes and common sense to push Spain and Greece deeper into an economic depression.

This guarantee implies that politicians advocating “austerity” are either: 1) lying if they claim to be Keynesians; 2) idiots; 3) villains trying to cause a depression in order to stampede Europeans into submitting to a more powerful EU central government; or 4) simply, desperate.

More than one of those answers may be true, but I’d bet on desperation.

Given that Spain and Greece don’t have their own central banks to create more currency, and they don’t have any savings, they therefore have only three options left to generate enough currency to “stimulate” their economies:  1) borrow; 2) “bail-outs” (charity) from foreign banks; or 3) raise taxes (austerity).  Given that their credit ratings are so low, they can’t borrow.  Therefore, all that remains are “bail-outs” (charity) and raising taxes (austerity).

The “bail-outs” offered to Greece and Spain have been conditioned on both nations imposing higher taxes (austerity). These impositions are stupid and possibly spiteful, but Greece and Spain have agreed to impose austerity in return for foreign charity.   To me, that sounds like evidence of desperation.

•  Keynes’ general theory (tax and save during the good years; reduce taxes and spend savings during the bad years) makes sense—on a theoretical level.

The problem is that we live in a real, rather than theoretical, world.  Our world isn’t ruled by sage mathematicians and economists bent on doing the right thing for the people.  Instead, our world is ruled by politicians who: 1) aren’t necessarily too bright; 2) are at least self-serving and may be outright gangsters; and therefore, 3) can’t or won’t do the “right thing”.

In a way, Keynes’ theory is like the Bible.  Both books tell us how we should live.  And yet, immediate reality and self-interest generally trump Keynes’ and the Bible’s admonitions.  Both texts offer great theories that make perfect sense—except when actually applied to most people and politicians whose primary object in life is to “party hearty”.

I.e., Keynes proposed to raise taxes in the good years, but also to save those tax revenues to be spent later in the bad years.  No politician ever wants to raise taxes in the good years and spoil the “party”.

If politicians do raise taxes, they want to spend the increased revenue quickly so as to buy the public’s approval.  Raising taxes now and spending those revenues later is a formula for being voted out of office.

Politicians love the idea of deficit spending (spend now; pay later).  They hate the idea of raising taxes and also saving the increased revenue (pay now; spend later).  Therefore, the same politicians who cheered Keynes’ justification for deficit spending, booed Keynes’ idea of tax now, spend later.

Where Keynesian theory makes a certain amount of mathematical sense, it’s almost irrational in terms of political sense.

•  From a political perspective, incumbent politicians want to help their most important supporters.  And who supports politicians more than people who have lots of currency?  And who has donated more currency to Congress than Wall Street?

Thus, it makes perfect political sense that Congress order the “helicopters” assigned to distribute fiat currency into the recession to dump all their cash over the congressmen’s BFF:  Wall Street.   After all, under the “trickle down” theory, the Wall Street financiers and major banks that received emergency cash from gov-co would soon be lending to the great unwashed, the great unwashed would quickly and irrationally spend every dime they could borrow, and the economy would be quickly “stimulated” back into economic growth.

The whole process is as simple as ringing a bell to “stimulate” Pavlov’s dogs to drool.

In fact, Keynes theory was foolproof, unless:  1) Wall Street doubted that the economy was recovering and therefore refused to lend to the great unwashed; 2) instead of lending at low interest rates to American consumers, Wall Street preferred to lend that currency to foreign consumers at high interest rates; or 3) the great unwashed were so scared by the “crash,” that they refused to borrow and spend.

To some degree, all three of those adverse possibilities took place after the “crash” of A.D. 2008.

However, just because politicians were dumb enough to give the first wave of their fiat currency (Quantitative Easing) to Wall Street back in A.D. 2008 rather than directly to the consumers (who would’ve spent it all like drunken sailors and truly stimulated the economy), doesn’t mean that politicians couldn’t arrange for a second wave of “Quantitative Easing” (QE2) or even a third (QE3).

See, that’s the blessing of fiat currency—you never really run out.  You can print as much as you need, any time you need it.  Plus, the idiot voters will never ever get wise.  If $800 billion isn’t enough to get ‘em to spend, just print another trillion—no!  print two trillion!  No!  Sixteen trillion!    That’s the bait that’ll make ‘em bite.

When you can spin fiat currency out of thin air, you can bribe anyone to do anything.  All you have to do is add one or more zeros to your bribe.  If the idiots won’t jump for $1,000,000, just add a zero and offer ‘em $10,000,000.  Or, if need be, add two zeros or even ten zeros to your bait/bribe.  What difference does it make?  So long as the public reacts to fiat currency like Pavlov’s dogs reacting to the sound of the bell, it’s all just digital ones and zeros on some computer hard drive.

•  Like Keynesian economics, fiat currency is also just about foolproof.   Unless—the voters realize they’re not being “fed” (paid) every time they hear the “bell” (given fiat currency; a mere promise to pay) and stop drooling every time “Helicopter Ben” Bernanke offers more cash . . . or, voters lose confidence in the fiat currency and slip into hyper-inflation . . . or, voters lose confidence in the economy and refuse to take the bribes (invitations to borrow and spend) offered by the gov-co . . . or, if the voters realize they’re already so deep in debt that they dare not go deeper.   If the voters ever start thinking rather than simply reacting to Pavlov’s (or Bernanke’s) “bell,” then, no matter how much fiat currency the gov-co prints, the people won’t take the bait, won’t go deeper into debt, and won’t spend their way out of the business cycle low.

Result?   Recession gives way to depression.  Instead of enduring the periodic, but comparatively short-lived lows in the business cycle, the politicians’ meddling can cause an economy to slip into a real depression that is persistent, long-term and potentially lethal.

•  If Kondratiev was right in predicting a 40 to 60 year business cycle then, given that the Great Depression began about A.D. 1929, it follows that the next American depression should’ve started somewhere between A.D. 1969 and A.D. 1989—but it didn’t.

Instead, we’ve not yet clearly seen another depression begin in over 80 years.

Does this mean:

1) Kondritiev’s measure of business cycles is false?

2) Keynesian-style economic theories have tamed the business cycle and thereby eliminated depressions? Or,

3) Modern economic theories merely postponed the depression that “should” (according to Kondratiev) have begun no later than A.D. 1989 and have thereby bought us at least an extra 20 or 30 years of economic expansion and seemingly “good times”?

I suspect that the answer is #3.  Economists have learned how to postpone—but not eliminate—economic depressions.

If so, we’re left with a couple more questions:

1) Are depressions “good”–or at least necessary—in the sense that forest fires are necessary to clear away the dead trees and branches that accumulate over time?

2)  If the business cycle necessitates depressions, does it also necessitate a certain “magnitude” of those depressions?  I.e., during the boom years, a predictable volume of “dead wood” normally accumulates that is typically “burned off” during the next scheduled depression.  But if the next scheduled depression is postponed for, say, 20 or 30 years, does the quantity of “dead wood” continue grow and thereby guarantee that whenever the next depression finally hits, it may be doubly explosive?

3) Should depressions be allowed rather than resisted and postponed?

•  In the end, an “economy” is not a perfectly rational machine subject to tinkering and fine-tuning by Keynes or other economists.  An economy is more like a collective “mood” that’s vaguely predictable in some regards, but not really controllable.   An economy is “moody” because it’s an association of individuals who are generally just as self-serving, short-sighted, irrational and prone to hysteria as the politicians they elect.  An economy is “moody” because it’s based as much on public confidence and subjective sentiment as objective productivity.

So long as that’s so, business cycles will continue to reassert themselves in the form of painful and long-term depressions.  We may be able to postpone the next depression for a few decades, but we can’t avoid it.

Given that we’re already 20 to 30 years overdue for another “Great Depression,” we shouldn’t be surprised to see the next one in the near future.

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