Sunday, August 7, 2016

The Nature of the Business Cycle and the Current State of the Economy

A comment at the post: My Beef With Austrian-Lites:
Guy NoirAugust 7, 2016 at 4:34 AMRW, I respect your work, however I am completely flummoxed by the cognitive dissonance in focusing on the results of manipulation in defining your boom and ignoring everything else pertaining to the real economy, which is generally in weak to awful shape. Could you do a post on something like why industrial production declines or corporate earnings declines should be disregarded?
RW response:
Focusing on Fed manipulation a problem? 
What other role does Fed monetary policy play other than manipulation of interest rates, which distorts the consumption-savings ratio. As I say, there may be other problems in the economy but they are problems that are not caused by the Federal Reserve. Minimum wage laws and Obamacare regulations, for example, can impact employment in the economy but they have nothing to do with Fed policy or the business cycle as defined by Austrian School business cycle theorists.
The types of things you would expect to see in the boom phase of a Fed created boom-bust cycle are what you are seeing now. That is, strong employment numbers, record highs in the stock market and climbing real estate prices.
Your focus on aggregate corporate earnings distorts the picture. There are weak sectors, especially energy, but these are sector problems rather than an overall economic problem. Telcom, healthcare, consumer staples. consumer discretionary and financials are all showing earnings gains.
The big whack, again. to earnings is the energy sector with earnings down 30% in the first quarter, and down 60% last year. But, again, this is a sector "problem," the result of a technology explosion which dramatically boosted the supply of oil in the world.

Here's a rough snapshot of 2009. It was a completely different picture. Earnings were down across the board. This is what a recession looks like:

When you say the "real economy" is having trouble. I have no idea what you mean. People are working. What exactly is this measure the "real economy" ?

As for industrial production, the decline is also heavily weighted by the decline in the energy sector. The industrial production decline is completely correlated to the decline in oil prices. It is highlighting a sector change not a problem with the overall economy. It doesn't look anything like the collapse in 2009 during the recession.

Here's the major sector breakdown via the Federal Reserve. The only down category is mining, which is mostly the oil sector.

Bottom line, when you throw out dips in certain indicators and claim the economy is in trouble, you are not understanding what is behind the dips or their context.

The indicators that are the most direct indication of where we are in the boom-bust cycle, employment numbers and capital goodsprices (as measured by the stock market and real estate) all point to the fact that we are in the boom phase of the boom-bust business cycle.

There will always be movements within sectors that are contra to the general trend but sector dips are not what a recession is about.


  1. Excellent couple of posts. I'm not an investor, otherwise I would subscribe to the EPJ Alerts, but I really appreciate your writtings.

  2. I couldn't agree more, we can't find qualified people to work in our manufacturing plant because unemployment is so low. I talk to other managers in different sectors and they tell a similar story.

  3. When people talk about "the real economy" I think they are trying to refer to economic activity that is in response to actual market signals. Most of what you are pointing at is arbitrary activity spurred on by Fed money creation. It may be activity, but it is not necessarily economic activity. Artificial money creation isn't mere caffeine, making people do more faster, it is PCP, making people do all sorts of things they would not have otherwise done and short-circuiting the feedback mechanisms that would tell them to stop.

    I think you are correct that we are not in a recession, but the growth you point to is mostly tumors.

    1. The "tumor" boom. I'm going with that analysis!

  4. What is the erased entry between Energy and Health Care?

    1. It showed a 777% gain in the financial sector which was meaningless in terms of understanding was going on in the economy overall, since that was about the bailouts.

  5. Thanks, RW. I get your perspective better, but respectfully see things differently.