“big picture” thoughts

cyclical ups and downs

If I’m not just projecting a US perspective on the rest of the world (because what I’m a out to describe is the way the US economy works), national governments in general have a goal of achieving maximum sustainable GDP growth. This may not be the highest level objective, but it’s among the top few.

The fiscal and monetary tools that governments have to achieve this are relatively blunt. And their effect comes with a lag, a bigger one for legislation than for changes in interest rates. (The conventional wisdom during my working career was that fiscal policy aimed at supporting growth comes into play so late that it causes more harm than good.) The result has been economies that don’t just keep on chugging along at a moderate pace, but instead expand to the point of overheating and then contract for a short while before starting to expand again.

Stock markets, in the pre-AI trading era anyway, have tended to follow a cycle of lengthy rise (2 1/2 years?), shorter contraction (1 – 1 1/2 years) and then a new expansion. For a long time in the US, this cycle was always about four years and was known as the election cycle, because incumbent presidents pressured the Federal Reserve into lower interest rates excessively so the economy would be booming on election day. The first year of a new term would likely be recessionary as the new administration cleaned up the economic mess the only had manufactured.

Since Paul Volcker, “yes” to the cycle, “no” to the four years (there have been longer up cycles) as the Federal Reserve became more independent. Trump, however, attempted to return to the bad old days, exerting enormous pressure on the Fed to lower rates in the runup to the 2020 election.

shocks to the system

These come in two forms:

—external shocks, like changes in the oil price, or the pandemic, and

—extraordinary popular delusions, like the Internet bubble of 1999, the 2006-07 housing bubble or the zero-interest-rate-driven stock market bubble during the pandemic.

All of these involve a period of extreme optimism, followed by one of extreme pessimism as the dream of unlimited riches comes to an end. The period of substantial overvaluation is followed by one of substantial undervaluation–and an eventual picking up the pieces either as the undervaluation becomes apparent or economic activity picks up again.