My Two Cents

By Dr. George Gathecha.

MARCH 17 2010 UPDATE:

In my last article, I talked about the 9 year economic downturns and slowdowns. I would now like to touch on a topic I call "Concentration of Wealth and Depressions" The ebb and flow that periodically occurs in GNP is commonly called a "Business Cycle" which has characterized western economies as far back as we have had records.

Economic activity usually passes through four phases, recession, depression, recovery and boom.When GNP and employment are declining, the economy is said to be in recession, which when deep enough becomes a depression. When output and employment are rising, the economy is said to be in a state of recovery which eventually becomes a boom as full employment nears, and industries operate at maximum capacity.

Today, I am mainly concerned with the analysis of the declining phase of the business cycle. A recession usually lasts for one to three years during which the rate of unemployment while rising is generally below 12%. When the recession lasts for more than three years and/or the rate of unemployment lies between 12% and 20% then the economy can be said to be in a depression. However, when business stagnates for more than six or more years, then the plight of the nation can be classified as a "Great Depression". Thus, depending on its depth and length, the downswing of the business cycle maybe called a recession, depression or great depression. All business contractions are bad, but depressions are disastrous and great depressions simply cataclysmic.

As prosperous as the US economy has been since the second world war, it has definitely passed through all types of convulsions in its long chronicle. It has frequently faced recessions, at times depressions and even to some extent, a great depression. This is one dilemma that has haunted western society for a long time and economists have offered various cures for this ill. It's sad to note, however that the theory of economic contraction is still seriously deficient.

Despite the appearance of hundreds of hypotheses, all the economists have done is provide a theory of recession, not of depression. However, before analyzing this issue, we need to explore its historical record. Except in the aftermath of the civil war, inflation, regulation and money growth in the US have crested together every third decade for over two centuries. These are called regular or deterministic cycles because they uphold the controversial historical determinism.

Is there an identical cycle with respect to business activity or GNP? The answer is an absolute NO! Yet a similar though not exactly the same pattern can be detected in US annals. Like I stated in my previous article, there has been at least one recession every decade in the US economy.

There has also been a great depression every third or sixth decade in the sense that if the third decade managed to avoid a depression, the next third decade experiences a cumulative effect, an all time disaster. Thus the 1780s witnessed a depression, but the 1810s did not. Three decades later, the 1840s passed through an unprecedented crisis. The 1870s also suffered a great depression, but the 1900s didn't. Hence, three decades later occurred the greatest depression in US history.

There are however a few facts that economists have slighted or completely ignored. True monetary and fiscal policies were perverse around the great depression, but they were not perverse in every major recession of the 19th century. Friedman, the patriach of monitarists himself argues that money growth decreased around every recession in the United States in the 19th century. Similarly, Keynesians recognize that the government tended to balance its budget by raising taxes every recession before the second world war. The accepted doctrine in pre-Keynesian days after all was that, as with a prudent household, government's expenses ought not to exceed its income. Therefore, if tax collection falls as it usually does during a downturn, government should either trim its expenditure, raise taxes or do both. Hence fiscal policy tended in the past to be restrictive whenever a recession occurred.

This time around, it looks like we have dodged the bullet and such extreme measures will therefore not be necessary.  

MARCH 2009 UPDATE:

It seems there is a nine year cycle in the economy, and upon closer scrutiny, we have had economic downturns / slowdowns / recessions in 1964-1965, 1973-1974, 1982-1983, 1991-1992, 2000-2001, and 2009-2010.

Dr. Frank Feather, one of the foremost business futurists predicted the last three of these scenarios in his book, “ G FORCES” and also predicts that the next major downturn should be expected during the 2019-2020 period.

These growth cycles are driven by excesses of various kinds, which exaggerate or diminish the real economic growth. One predictable part of this cycle is the real estate market which follows a 9.5/19 year cycle of boom and bust.

But that cycle was made much worse this time around by the derivative/reckless lending/borrowing. That bubble is still unwinding, and regardless of the latest policy measures on mortgage relief, house prices will drop a further 18%-27% nationally in the United States.

Similarly the stock market was driven to speculative highs which bore no resemblance to corporate earnings nor to the weakening economy which was evident as far back as the beginning of 2007.

Incidentally, the market is yet to bottom out and that will not happen until the summer of 2009. Chances are, that around labor day we will start seeing a semblance of firmness. However the bottom will not occur until corporate earnings have stabilized and lay-offs have stopped.

My piece of advice at this point in time is to not consider buying any stocks. The greater the excesses in the boom, the greater the excesses on the downside on the bust. That is what is very difficult to predict, but the cycle is very precise. The excesses were made much worse by the rampant upward spiral speculation of derivatives[not just on mortgages, but of every kind.] and those are now being unwound or deleveraged as toxic assets.

The current challenge therefore is to restore the stability of the global financial system before it completely collapses. Here lies the danger of debt deflationary depression.

Be that as it may, that is impossible to predict at this point in time, but if economic measures do not get passed by the Congress, the chances of this becoming a reality increase significantly.This kind of a scenario, as strange as it may seem, can occur almost overnight.No matter what happens, one thing is certain, it’s safely predictable that the economy will recover. People need products and services and that in a nutshell is what sustains any economy.

The positive aspect of this shambles is that the dead wood is being pruned out of the system and new growth will drive the economy forward. It’s just that this “creative destruction is more dramatic now than at any other time.

Dr George Gathecha

Dr. Gathecha is a former National Business Advisor for James One Inc., a company that has helped thousands of entrepreneurs with little or no knowledge of running a business to start and run truly successful home based businesses. He has a PhD. in Economics and has years of experience in the finance industry.