In this chapter we examined the interaction between various indicators. In the next chapter we will try to put all these different cycles under one process and see how growth and changes in business cycles take place.
As we have discussed in the previous example, it will become clear that the main driver of a business cycle is the financial cycle. The financial cycle represents the pattern of growth in monetary aggregates or money supply, which is controlled by the Central Bank. An increase or decrease in the money supply creates ripple effects through business activity and prices of assets for years to come.
We have seen that in 1992 through 1994 the Federal Reserve eased aggressively, because of problems that the economy had with real estate and savings and loans. Although we will discuss this in more detail, the Fed kept interest rates artificially lower than what the market would have set these rates. The outcome was a sharp increase in credit, a powerful stimulus for business to borrow and to invest.
The business cycle eventually started in full force and employment, income, and sales grew more rapidly, inventory-to-sales ratio declined to reflect strong growth, the unemployment rate declined to reflect more favorable hiring conditions, and the process fed on itself. However, in 1994 as the economy grew very strongly, eventually it had an effect on prices (the price of money, the price of labor, and the price of raw materials).
In 1994, therefore, the economy experienced sharply rising interest rates, and commodity prices, and some upward pressure in labor costs. Because of the strong sales, earnings per share grew very rapidly. However, the strong growth of the economy created the seeds for the following slowdown. This is the phenomenon of negative feedback. As costs of running a business increased - specifically interest rates, labor, and raw materials - business slowed down its investment activities and hiring. It also started to cut inventories and production. The outcome was slower economic activity in 1995 and lower earnings per share. The slowdown in the economy and the decline in the costs of running a business were the seeds for the next acceleration in the business cycle.
In Chapter 5, we will discuss the analysis of long-term trends and how the U.S. economy went from low inflation in the 1950s to high inflation in the 1970s to low inflation again in the 1980s and 1990s. This analysis will provide important information on the essential features that characterize the volatility of business cycles and its relationship with inflation and monetary policy.
(From Chapter 3 of my book Profiting in Bull or Bear Markets. Published also in Mandarin and on sale in China. The book is available at Amazon.com).
George Dagnino, PhD Editor,
The Peter Dag Portfolio.
2009 Market Timer of the Year by Timer Digest
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