book.chapter A primer on the cycles of business

The demise of the business cycle has often been predicted, yet it persists over and over again. A more pragmatic view sees the cycles as an intrinsic feature of free market economies. Rather than vainly trying to banish cycles from planning, businesses should aim to understand them better, integrating a cyclical perspective into strategy. Particular wariness is warranted when the consensus holds that current conditions will continue indefinitely, as that often marks a turning point. The formal definition characterizes business cycles as recurring expansions and contractions not periodic in duration but occurring in many activities simultaneously. Early theories attributed cycles to cosmic factors before analysis uncovered economic drivers. This became urgent during the 1930s Great Depression as policymakers sought recovery indicators. By the 1950s, relationships between leading indicators and cycles were elucidated, allowing construction of composite indexes summarizing trends. Policy could respond faster, moderating recent recessions versus the 25 percent 1930s unemployment. Heightened 1990s optimism prompted one senator to declare taming cycles the century’s greatest feat given alternatives like medical advances. He knew, however, the cycle was not fully eradicated. Several factors explain moderated recessions: New Deal automatic fiscal stabilizers; the shift from highly cyclical manufacturing to more stable services; just-in-time supply chains with real-time demand data; and skillful monetary policy like interest rate cuts halting the 1987 crash’s spread. Like cycle denial, risk underestimation also cycles. Long expansions fade memories of recessions, boosting optimism and dismissal of risk, causing boom-like behavior until the inevitable correction. Late 1990s irrational exuberance illustrations include: productivity gains supporting endless no-inflation growth; information technology investment to boost productivity; soaring stock prices justified by steady expected growth; media overnight millionaire stories; capacity ramp-ups expecting high growth; theories of permanently higher growth without inflation; forecasts like 36,000 Dow points; and globalization spreading the American economic model. This eerily echoed 1920s pre-Depression sentiment. Two biases were evident: taking credit for good outcomes while blaming others for bad, and seamlessly extrapolating recent performance. New Economy veils hid harsh realities like asynchronous global recessions enabling 1990s U.S. growth without inflation until information technology spending slowed; exponential growth projections far too optimistic once spending represented half of all investment; and company valuation increases dependent on those unsustainable growth expectations. The 2001 recession and 9/11 attack compounded bearish views later exacerbated by accounting scandals. The cycle was alive and well. While correctly deeming cycles tamed by avoiding deep depressions, sustained growth, and prosperity, eliminating recessions is wishful thinking guaranteeing their return as risks are taken based on the assumption they are unlikely. This makes obvious the risks taken only when recession unambiguously returns, unfortunately too late for those overextended. It is impossible to remove cycles from free markets, but understanding them and taking a cyclical view protects against herd mentality when cycles turn. The illusions will recur, with downturns again seen as impossible until the bust and rediscovered risks. Gradually confidence returns, but waiting for popular opinion signals means missing the early upturn. With the right tools, businesses and individuals can see ahead, make decisions giving an edge over competition, and avoid waylaid herd mentalities.