I know you might be curious about where I found that eye-catching image at the top. It was created by my talented designer friend, Alejandra. Unfortunately, she doesn’t have a website yet, but she’s working on it! If you have any design needs, I highly recommend reaching out to her.
Now, some of you might also be wondering about the animals in the illustration. They’re meant to serve as a visual reminder of the terms “bear market” and “bull market.”
The sad bear symbolizes a bear market, indicating a downturn (specifically, a market decline of 20% or more from its peak). Conversely, the happy bull represents a bull market, where the market is on the rise. With this imagery, you may find it easier to remember these concepts.
As a bonus, when the market drops by 10% from its peak, it’s called a correction.
Now, let’s dive back into today’s discussion.
Economic Cycles
Last week, we explored the significance of productivity as a foundation for long-term economic health. However, in the short term, the economy is influenced more by cyclical patterns.
Why do these cycles occur? If you recall from our previous discussion, the answer lies in credit.
Contrary to popular belief, economic cycles are not simply due to declines in productivity. They stem from decreases in demand, directly linked to credit creation.
Here’s how it unfolds:
- When borrowing money becomes restrictive, consumer spending decreases.
- Reduced consumer spending leads businesses to earn less revenue.
- When businesses profit less, stock prices decline, and they often have to lay off employees.
- This cycle creates a downward spiral. When widespread, it triggers economic downturns.
Essentially, these cycles are predictable patterns of events that tend to repeat themselves.
From last week, we highlighted two cycles that form the basis for much economic activity:
- The short-term debt cycle
- The long-term debt cycle
Let’s examine each of these in more detail.
The Short-Term Debt Cycle (Duration: 5–8 Years)
Commonly known as the Business Cycle, this cycle is primarily influenced by central banks, which adjust interest rates in response to inflation and deflation.
This cycle includes two phases: Expansion and Recession.
Expansion
During the expansion phase, consumer spending outpaces the production of goods and services. This increased spending is often fueled by low interest rates, which makes borrowing attractive.
However, rapid spending can lead to inflation. To combat this, central banks will raise interest rates to encourage more cautious borrowing behaviors.
As borrowing decreases, spending slows, and subsequent lower revenue for businesses may lead to a recession.
Recession
A recession signifies a contraction within the short-term debt cycle. Economic downturns are familiar occurrences that many can recognize.
Typically, consumer spending diminishes, resulting in a decline in the economy. Conversely, this also leads to lower prices during a deflationary period.
Once inflation settles, the central bank may lower interest rates again, signaling a recovery phase. This cyclical nature continues indefinitely.
Key Observation
It’s important to emphasize that during these cycles, debt is rarely paid down completely. Each cycle often begins at a higher debt level than the last, demonstrating a trend of accumulated debt.
The Long-Term Debt Cycle (Duration: 50–75 Years)
Long-term debt cycles have been a part of economic history as long as credit has existed. The concept of wiping out debt every 50 years, known as the Jubilee, can be traced back to ancient texts.
This long-term cycle consists of three stages: Leveraging, Deleveraging, and Reflation.
Leveraging (Duration: 50+ Years)
During this phase, the economy experiences several short-term debt cycles, but debts often go unpaid. As borrowing increases, debt levels rise.
Eventually, the collective need to repay debts forces individuals to cut back on spending, slowing the economy overall.
While lowering interest rates could typically spur renewed borrowing, there comes a point when interest rates hit zero.
Deleveraging (Duration: 2–3 Years)
This phase describes an economic contraction amid a long-term debt cycle. “Deleveraging” refers to reducing debt burdens.
How can you identify a deleveraging period? You’ll notice these three simultaneous occurrences:
- Interest rates hit the zero mark.
- The Federal Reserve increases its money production and spending.
- Budget deficits widen, as the government spends more than it collects in taxes.
These signs indicate economic slowdowns, prompting the government to try to mitigate the downturn.
Ending a Deleveraging
A deleveraging concludes through several means:
- Austerity: Individuals cut back on spending to pay down their debts.
- Debt Reduction: Lenders may reduce what people owe or extend the repayment timeline.
- Debt Monetization: The government may opt to print money to manage economic activity.
- Wealth Redistribution: Higher taxes may be levied on the wealthy to address disparities.
If managed effectively, this process can create a favorable outcome called a “Beautiful Deleveraging.” However, poorly handled deleveraging risks leading to severe economic crises known as depressions.
Conclusion
Today, we learned:
- The meanings of “bear” and “bull” markets.
- The reasons behind economic cycles.
- The structure of the short-term debt cycle and potential solutions.
- The long-term debt cycle and its implications for economic health.
- The conditions that can lead to societal unrest and shifts in political power.
This overview simplifies an incredibly complex topic, but you now possess a foundational understanding of how the economy operates. Give yourself a well-deserved pat on the back!
I look forward to our next discussion!
Be well!
Let me know if you need any further adjustments or more information!