Lessons Learned from 200 Years of Booms and Busts in the U.S. Economy

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11.17.21
THE business cycle in the United States has been characterized by an ongoing series of economic booms and busts, bubbles and bursts, despite efforts by the Federal Reserve to stabilize the ups and downs.

The first recognizable boom and bust cycle in the U.S. economy occurred after the War of 1812 when inflated prices created an unsustainable boom. Expansionist activities of farmers, exporters, and, particularly, investment bankers — spearheaded by the Second Bank of United States — sowed the seeds of the boom leading to the bust. Supply of money declined, and liquidity became a problem for many sectors, and the Panic of 1819 soon followed with all the characteristics of future business cycles in the 19th century.

Boom-bust cycles, for many decades, were called “panics.” Thirteen financial panics occurred from 1792 to 1896, and the last official panic occurred in 1907. After that, panics were renamed — first to depression and then to the milder sounding term, recession.

Following the recovery from the Panic of 1907, President Woodrow Wilson signed the Federal Reserve Act into law in 1913. The Federal Reserve was charged with preventing financial panics and stabilizing the economy. America’s bankers, who spearheaded the effort, finally got a central bank whose mission was to be a lender of last resort, smooth out the business cycle, and maintain the purchasing power of the dollar.

Congress expanded the Federal Reserve’s responsibilities in 1946, directing it to promote maximum employment, production, and purchasing power. And in 1978, Congress added price stability and promotion of long-term growth to its mandate.

Yet, as history proves, the business cycle hasn’t been “smoothed out.” The U.S. has subsequently been rocked by the Great Depression, followed by several recessions. The reoccurring phenomenon of money creation, speculation, boom, malinvestments, crisis, and depression hasn’t ended, but rather, the Federal Reserve destabilizes the economy by manipulating short-term interest rates.

The federal government primes the pump with deficit spending, and the Federal Reserve opens the money spigot to give the economy additional oomph to boost the economy. The inevitable bust arrives when the Federal Reserve raises interests rates and withdraws liquidity from the financial system to dampen the overheated economy.

More recently, the dot-com bubble of the late 1990s and the housing bubble of the mid-2000s reaffirm the consequences of the Federal Reserve’s easy money infusions.

We’re now in what some analysts call the “everything bubble,” which was well underway before the pandemic struck in 2020. If history is any guide, it could last until the end of the 2020s.

The boom-bust cycle, therefore, isn’t inherent in the market economy but instead is a consequence of the Federal Reserve intervening in the short-term money markets ostensibly to stabilize the economy and promote economic growth and full employment.

To ride out the peaks and troughs of the boom-bust cycles, businesses must understand and adjust their behavior to the cycle. Here are ways to identify that the economy’s boom cycle is about to end:

  1. A downturn in the employment rate. The boom phase of the cycle is when widespread optimism creates a kind of euphoric period of increasing sales, plentiful jobs, and a surging stock market. But once employment plateaus, the economy has reached its business cycle peak.
  2. Consumer price inflation unfolds. As of now, we’re seeing evidence that consumer price inflation has accelerated, which isn’t surprising given the 25 percent increase in the money supply in 2020 to respond to the pandemic. Money supply growth always precedes price inflation.
  3. The yield curve tops out. When the slope of the yield curve — the interest rate for short- and long-term securities — turns downward, a recession is likely in the coming year.
  4. A rise in the Fed funds rate. The Federal funds rate is among the U.S. economy’s most important financial indicators. The funds rate is set eight times a year based on economic conditions. It affects critical aspects of the broad economy, including growth, employment, and inflation. When the Fed funds rate stops increasing, the bust is right around the corner.

The U.S. economy has become dependent on more and more debt — and financial boosts — to generate economic growth. But as history shows, when it comes to the business cycle, what goes up must come down.

Published by depatridge

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2 Comments

  1. I read some months ago of economic cycles which described how we are coming to the end of an 80 year cycle and that bad news is just around the corner regards the global economy. I reckon the only thing they didn’t anticipate was that governments globally are hellbent on kicking the can down the road in the hope of a miracle. Short answer is this is prolonging the inevitable regards global economic actions over the past couple of years and the end result will be increased rather than avoided. Think GFC for the same “head in the sand” approach to economic problems.

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