Economic Downturns and Upturns (Part 2)

 Economic Downturns and Upturns (Part 2)

Proceeding from the first part....

The reversal of the situation we just covered could have far-reaching consequences. It is possible that savings and investment will expand at a substantially higher rate than consumption, rather than the other way around. One example is how Keynes's explanation of aggregate demand's significance was misunderstood before the Great Depression. Consequently, government policies often encouraged large-scale investments rather than boosting aggregate demand. Among the causes of the Great Depression was the unequal distribution of income in the United States, which benefited the wealthy at the expense of middle-class and working-class families. This, in turn, reduced household purchasing power. If investment and savings had grown at a substantially faster rate than consumption, the Great Depression may have easily ensued. Massive savings and investments would result in massive surpluses for the consumption sector's producers. This would cause them to pour even more money into plant and machinery, and the pattern of massive investment followed by surplus for a few years. After a few years, our capacity is enormous, but our consumption and purchasing power are inadequate!

The capacity for production increases to the point where manufacturers aren't interested in reinvesting their surpluses because they have so much spare capacity that families can't afford to use. Investment follows savings, which means savings are not invested first. The paralysis of the economy is caused by people hoarding money, which interrupts the circular flow of revenue. A decrease in demand leads to a corresponding reduction in supply. Since the percentage of unutilized capacity rises even more than previously due to a decline in production, these restrictions make investment in new capacities even less appealing, which in turn raises the hoarded money. The economy enters a downward cycle that might lead to a sharp decline in revenue and a worsening of the unemployment rate. After a while, entrepreneurs see a tremendous investment opportunity, so they start putting all their savings into it. Then, the economy starts growing again. On the other hand, there are cases where the massive surplus of capacity is thrown out due to a lack of demand. This could happen when, for instance, a technological advancement renders outdated facilities and factories obsolete. This eliminates unnecessary capacity, which in turn encourages investment and growth in the economy. In my opinion, this is how the vast majority of economic cycles in the United States and Europe before the 1930s unfolded; investment was the driving force behind each. The investment-led business cycles are what I'd refer to them as.

Stagflations: how do they happen? After a few years of expansion, the Consumption sector eats into Savings, causing surpluses to fall short of expectations for Consumption sector producers during consumption-led cycles. It is necessary to reduce consumption and increase savings in order to rectify the poor savings. The magnitude of the subsequent boom is proportional to the severity of the correction. Consumption can eat away at savings slowly and persistently for a long time during the beginning of the next boom if the correction is large and savings are piled up throughout the downturn. Booms can endure quite long. If the correction is minimal and savings are not excessively high when the bubble starts, the boom can be prevented from happening. Since substantial savings have not been established, the moment consumption begins to eat into savings, savings will plummet below the danger level, the surpluses anticipated by consumption will not materialize, and a recession will begin simultaneously with the commencement of the boom. Booms in these situations may not persist for more than a year or two. It is possible for government action to lead to cases of inadequate corrections. Reducing interest rates and engaging in deficit spending are examples of expansionary policies that the government employs in an effort to stem the decline in aggregate demand. If the government did this, it would be in an effort to stem the tide of falling jobless rates. But when the government steps in, the economy starts growing before people even start cutting back on consumption and saving enough. As the economy begins to grow, spending cuts into savings, which triggers a recession as soon as savings fall below the danger level. Another round of layoffs follows, and the downward spiral resumes. It would be the same old story—the government steps in to try to stop the decline, and more people would lose their jobs. Rising rates of unemployment persist. In the end, producers come to terms with the fact that expansion and low surpluses are permanent features of the market.

The issue of increasing interest rates is a further complication to the already modest surpluses. Investment demand would be high as the economy strives for expansion. Interest rates are going up in a vertical fashion since there is a great demand for the limited money available due to poor savings and high investment demand. To make matters worse, the government is taking out loans and spending more money than it takes in to stimulate the economy, which reduces savings even further. When both short- and long-term interest rates are sky-high, it's like being in a boom era again. A cost-led inflationary spiral develops when interest rates are abnormally high. Investment and production expansion are not appealing to producers in the consumption sector due to extremely high interest rates and limited surpluses. They start hoarding their gains instead of investing or increasing production, which leads to a stagnant economy. Profiteering, under normal circumstances, would cause people to hoard money, which would halt the economy's circulation of funds and eventually paralyze it. But here, capitalists don't retain the money since it would lose value due to inflation caused by the government's expansionary policies and cost-led inflation. Without interfering with the flow of money, they begin spending the pocketed gains.

Why, therefore, does demand remain flat notwithstanding the absence of hoarding? Instead of saving and investing, capitalists are just spending it all. One capitalist now has access to the money that would have gone to one hundred investment workers. The outcome is that one capitalist buys one tube of toothpaste instead of a hundred investment workers buying a hundred tubes! Consequently, consumer spending falls even when people aren't hoarding cash. A capitalist's lifestyle is characterized by high income, minimal consumption, and heavy investment in real estate and stocks. A speculative bubble and skyrocketing inflation are the results of the ever-increasing buying and selling of stocks and real estate. Workers see a decline in their purchasing power as a significant chunk of their salaries goes toward housing costs. Once workers begin to demand greater salaries, wage agreements often include provisions for recurring salary hikes, effectively making inflation a long-term issue. The stagflationary economies of the 1970s benefited from workers' demands for wage hikes, contrary to the claims of some economists who argue that such requests are unreasonable. Workers' requests for wage increases serve as a check on capitalists' speculation, since part of the capitalists' funds are redirected towards wage hikes rather than into irresponsible investment. On the whole, inflation and stagnation go hand in hand. Stagflation is caused by this.

In the 1980s and 1990s, economies around the world experienced a sustained expansion. How were the booms able to persist for such a long time? During this time, investment drove economic booms. These booms were fuelled by massive investments in IT infrastructure. Nonetheless, compared to the investment-led booms that occurred before the 1930s, these massive investments in IT are wholly distinct. There was a significant accumulation of new capacities due to the massive investments made before the 1930s. Due to the large amount of untapped potential, there was a risk of over-investment, which made additional investment seem unappealing and caused investment to fall behind savings. Contrarily, such was not the case with investment in the 1980s and 1990s. Despite spending money on IT, the plant's capacity remained unchanged. Investing massive sums in IT, for instance, will not automatically lead to increased production of automobiles. As a result, we can rule out Great Depressions and expect a boom that lasts as long as investments in information technology do. During this time, why couldn't Consumption reduce Savings? There was zero wage-led and ensuing cost-led inflation because workers were so afraid of being replaced by computers that their bargaining strength was drastically weakened. Thus, manufacturers might invest their surpluses instead of spending them on cost increases. Investing in IT was primarily driven by a desire to decrease costs, which in turn kept consumption from eating into savings. In this manner, neither Savings nor Investment would cause an overabundance of capacity, nor would Consumption reduce Savings. We can rule out both kinds of recessions. As long as money is spent on information technology, booms will continue. Because of this, business cycles were practically nonexistent in the 1980s and 1990s, when booms persisted for an exceptionally long time.

There you have it, a concise overview of the last 250 years of business cycles!

Before we wrap up, a little observation. It would be fantastic for the capitalists if people spent all their money on consumption right away; that way, sales would go up. Consequently, home savings might be seen as a form of consumption. Those household savings are promptly invested to cover this gap. Putting money away for the future is like plugging a hole: a common occurrence. Savings by households, then, have less of an impact on an economy's stability than do capitalist savings. There would be no immediate impact on company profitability from a decline in household savings. Simply keep in mind that the preceding discussion of savings mostly centered around capitalist savings and not household savings.

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