I got a really interesting incoming searching asking why we have repeated recessions. Not entirely sure what the person was looking for in the way of answers. I assume they wanted someone to blame, or to find out where the idiocy stems from. I can’t answer the question of why we have repeating recessions in any satisfactory way. I mean the most basic answer is subjectivity as it related to greed and desire.
First, realize that there is a difference between a stable growing economy, and a booming one. Growing 5% a year is stable if it’s the stock market for example, for GDP it depends on the country. When the economy is booming these numbers are even higher like 10% or 20%.
Recession (Photo credit: Anders V)
The thing is that humans are not entirely rational, logical, or sane. When things start taking off everyone wants to jump in. When they do hop in growth increases further, and this draws in more people. This creates a positive feedback loop. This is called a bubble, a word you are probably familiar with. The bubble pops when people get squeamish and decide its time to play it safe. Sometimes this is the people who got in really early, and might have created the bubble. So we hit the peak and the bubble bursts and we decline. This might take the whole economy with it. It is most easily visible in the stock market, but applies to the broader economy.
Various things drive the boom and bust cycle. The tech bubble had lots of complex factors that launched it, but a simplification would be that the internet created a market of massive scope, but with low costs to tap into it. The real estate bubble was in a way caused by the tech bubble, and actually stretches back even further. The solution to the tech bubble sparked the real estate bubble along with poor regulation and an atmosphere of greed.
The point is that in the quest to make money people start these bubbles. The first handful are brilliant, but the rest are being sheep. It is like any system out there, once it is public it is worthless. If you discover a way to discover price asymmetries and publish a bestseller, then the asymmetries will disappear. The reason that asymmetries exist is because no one is staring at them. Or only a few are staring at them. Not so many that they collapse the system. However, when the entire market spots those asymmetries, also known as inefficiencies, then it takes a corrective action. A few people benefit, but less than they would have had it been secret.
For example if gold is $1000/oz in town A, and in town B 100 miles away gold is $1500/oz, then you could take a truck and load it up with gold and take it to town B and make a $500/oz profit. This is basically the stock market, except there is no guarantee because you are moving through time hoping for price increases, not transporting. Now imagine everybody knew about the gold difference. The price in A would go up as everyone bought, and the price in B would go down as gold flooded the market. Then they would be equal and it would be impossible to make money. This is not production but simply trade.
Near the end you’d be making such a small profit that it would not be worth the trip. You can make it worthwhile through volume, although with gold that means hauling more weight. The point is that once everyone knows it destroys your cash cow. Inflation works on similar principles. If everyone was rich, then goods would cost an arm and a leg as people threw more money out the window to beat out their neighbor.
So recessions occur because of various factors, but normally something brings some people some wealth and everyone piles in. Then it grows and then collapses. Nowadays money is just paper, and when times are good everyone makes so much. However, a downturn can vaporize all that wealth. That can have broad consequences like tanking demand, and crippling companies or banks. That slows the economy down. Then after all the destruction is over, people have slowly rebuilt their wealth and something new comes along. It starts the cycle all over Obviously this is an oversimplification, but it is the general idea. We have cycles because we can’t see the whole picture. Humans are myopic, but it is not just that. Not everything can be known, and to sit out would be foolish. Boom times can last for a long time.
It is hard to see the collapse coming. Instead you should be innovative in the way you invest. You should be poised to make a profit from both sides. That is right a profit. Hedging to limit your loss is fine, but ideally you want to try to be structured for profit.
Back to the point, the business cycle is a cost of being human and living in reality. We fall into recessions because when times are good and there is a lot of money to go around even garbage succeeds. However, they drain resources and are a waste. Eventually they need to be burned off. If it isn’t you get zombie companies supported by governments and they drain growth. That is what caused Japan‘s Lost Decade (or 2). Hence the problem of too big to fail. Crap needs to be flushed so new things can take its place, but when it’s so massive it could damage the economy so much that you basically have to carpet bomb everything and start over. Quite a conundrum.
We both need government regulation and intervention, and don’t need it. It is about balance. I know this does not answer too much, but the point is there is no fixing the cycle. If we were all machines with the ability to tell the future then fine, but we’re not and we can’t. Don’t look to blame anyone, and don’t believe any politician that will tell you this mess could be avoided (if it wasn’t a real estate bubble it would have been something else the first well understood economic bubble was for tulips, look up Tulip Mania). Just prepare and plan.
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