Symptomatic to Systemic

Understanding Postwar Cycles and Financial Debacles

Steven Ricchiuto

• Publisher: Greenleaf Book Group Press
• Year: 2018
• Print ISBN: 9781626345942
• eBook ISBN: 9781626345959
• Topic: Economics
• Subtopic: Economic History
• Index: Economics

In Symptomatic to Systemic, Steven Ricchiuto examines an exhaustive data set of analytics around each postwar business cycle. He identifies the underlying causes precipitating downturns in the economy and finds that financial dislocations and debacles have undergone a distressing evolution. They are no longer the result of a classic economic contraction, but seemingly systemic causes that operate independently of traditional predictors of recessions.  Ricchiuto's book helps readers recognize the factors that are driving key markets and interpret the new indicators of economic health. Symptomatic to Systemic provides clues as to where the next contraction may surface so that readers won't be caught unaware.

Section 1

What Is a Business Cycle?

What is a recession? A recession is a significant decline in economic activity, spread across the economy—lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesales or retail sales. According to the National Bureau of Economic Research (NBER), a recession begins just after the economy reaches a peak in activity, and ends as the economy reaches its trough. Between the trough and peak, the economy is in expansion. In choosing business cycle turning points, the NBER places particular emphasis on real personal income, less transfer payments, such as Social Security, and employment. These two monthly indicators measure activity across the broad economy, while industrial production and the monthly measures of sales at all levels of the production/distribution chain principally reflect manufacturing. The NBER Business Cycle Dating Committee—the arbiter of business cycle dating—also looks at a host of other indicators in forming its decisions on business cycle turning points.

The NBER prefers to wait for sufficient data before determining turning points, rather than rushing into a decision. This creates a significant lag in the process of dating the cycle turning points. The lag has led economists to view a recession as two consecutive quarterly declines in real GDP, as an alternative to the NBER’s approach in calling the beginning of a recession. However, it should be noted that this process does align precisely with the official business cycle turning points determined by the NBER.

Depressions are deeper and last longer than a recession. For example, the Great Depression of the 1930s resulted in a decline in real GDP in excess of 10 percent, and a jobless rate that briefly touched 25 percent. More recently, economists have added another subcategory to contractions—a Great Recession. This is a consolidation that is deeper and longer than a recession, but not as bad as a depression. The 2007– 2009 recession lasted eighteen months, and resulted in a 4.2 percent peak-to-trough decline in real GDP. A drop of 6.3 percent in employment and a 17.1 percent tumble in industrial production exceeded the comparable measure in each of the previous ten postwar business cycles, but also fell far short of the comparable measures available for the 1930s decline.

The next natural question to address is, what causes a recession? History suggests that several factors can be identified as causing a broad-based decline in economic activity. A tightening in monetary policy is a common cause of postwar business cycles. Inflation concerns brought about by excess demand (a supply shock) has tended to motivate the Federal Reserve to constrict credit by hiking short-term rates. Energy price shocks are a prime example of a supply shock that has influenced Fed policymakers’ decisions. Fiscal policy has contributed to either higher or lower inflation by stimulating or reducing excess demand through either tax policy or defense spending, or both. Government spending on social programs has tended to grow over time, with one significant inflection point during the Johnson-era Great Society experiment (see Chapter 5). Besides policy mistakes or unintended consequences of policy shifts, a collapse in confidence or a loss in wealth can also result in a recession. Additionally, deterioration in credit quality has also triggered a reduction in liquidity, resulting in a collapse in economic activity. The seeds of the Great Recession can be traced back to the July 2007 collapse of two hedge funds owned by Bear Stearns, a result of their investment in collateralized debt obligations (CDOs), which were later downgraded by Moody’s and Standard & Poor’s (S&P), and wiped out their capital. This event weakened the investment bank, and ultimately led to its distress sale to JPMorgan Chase & Co.

NBER Business Cycle Reference Dates, 1948–2009

Source: National Bureau of Economic Research

Economists have tended to divide the history of business cycles into two groups: those that occurred prior to World War II and those that occurred in the past seventy years. The significant shift in the role the US economy played in the global economy after the war—and the restructuring of the economy itself to reflect this new status—renders a somewhat meaningless comparison to the recessions prior to 1948. It could be argued that the recent rise of China as a global macro power may result in another break in the history of business cycles, but for now, this analysis will concentrate on the last eleven cycles.

Chapter 1

The 1948–1949 First Postwar Recession

The end of postwar wage and price controls in mid-1946, and the backlog of demand for goods and services created by World War II, produced a spike in inflation. Policymakers relied on a new Keynesian style of government–intervention to dial back inflation and the fears that it would become entrenched. The political realities, however, led to a pro-cyclical tax cut instead of a revenue-neutral rebalancing of the tax burden. This forced the Fed to implement credit controls because its interest rate tools were still focused on keeping the government’s interest expense as low as possible. Credit controls proved to be a blunt instrument, and the reduction in demand produced an inventory liquidation cycle, and the recession.

World War II ended on September 2, 1945, and the economy was vastly different from the Depression-era days that preceded US involvement in the conflict. Domestic manufacturing had expanded dramatically, labor unions had become well entrenched in key industries, and the US emerged from the war as a superpower. The 1948–1949 recession was technically not the first downturn to follow the war, but it was the first real test of the new political economy—or the government’s ability to fulfill its obligations under the Employment Act of 1946. This seminal legislation obliged the federal government to seek to maintain “maximum employment, production, and purchasing power.” The short February to October 1945 downturn was the result of the conversion from military to civilian production. The November 1948–October 1949 recession was the first test of the government’s new built-in stabilizers—passed as part of the New Deal—as well as its ability to manipulate fiscal and monetary policy to counteract the adverse effects of the downturn. There was a fear, heading into the recession, that the boom of the postwar period would be followed by a return to the prewar depression once the pent-up demand had been satisfied.

Fiscal policy is one of two major levers that can be used to stimulate or constrain economic growth in order to smooth out the business cycle. Unlike monetary policy, which is the lever that can be manipulated by the Federal Reserve, fiscal policy is controlled by Congress. By decreasing taxes or increasing government spending, Congress can indirectly boost real GDP. Lowering taxes boosts consumer and corporate spending on goods and services, resulting in rising disposable income. Gains in income tend to lead to increased spending on goods and services. Increasing government procurement directly increases demand for goods and services in the economy, and in the process, also increases income generated in the economy, which leads to a second round of increased spending. Increasing taxes and cutting government spending has the exact opposite effect on the economy.

Monetary policy, on the other hand, refers to the central bank’s ability to influence the level of short-term rates, which can be used to either reduce or increase the cost of borrowing by households and corporations. A lower borrowing cost tends to boost spending, whereas higher short rates tend to constrain spending by hiking the cost of financing. Keynesianism is a branch of economic theory that emphasizes the use of fiscal policy as a means of smoothing out the cyclical ups and downs that naturally occur in the economy. The manipulation of short-term interest rates and the supply of liquid assets in the economy is referred to as monetarism.

The memory of the Great Depression ran deep, and there were broad-based concerns that once the backlogged demand for construction and durables that had been created by the war was satisfied, a normal level of demand in the economy would be insufficient to maintain full employment, without massive government programs to absorb the excess supply. The mildness of the recession was subsequently seen as proof that the new elements of long-term strength had been built into the economy in the late 1930s and early 1940s. The 1948–1949 recession experience resulted in a psychological shift among economists that long-run prosperity would now be inherent, and that inflationary-driven business cycles had not been eliminated, but the magnitude had been dampened on the downswing.

What kind of recession was it? The consensus is that it was a simple inventory/inflation cycle. In response to the lack of goods available during the war, household savings expanded and provided the primary source of funding that the government needed to expand its purchases of military equipment and supplies. The return to a more normal savings rate in the postwar period fueled a boom in household demand for cars, vacuum cleaners, refrigerators, washing machines, and radios. Returning GIs got married and quickly began to have families, creating a backlog in housing. This surge in demand led to a greater need for expanded manufacturing and transportation facilities. These investments were paid for by the accumulated profits that companies had earned during the war. It is estimated that the postwar investment cycle peaked in 1946–1947 at 33 percent above the prewar top in 1941. Following the end of wartime price controls in mid-1946, consumer prices surged from 2.3 percent to a 14.4 percent annualized rate in 1947.

The domestic pressures on inflation were amplified by the increased Cold War tensions and the demands created by the European Economic Recovery Plan. The resulting spike in inflation was broad-based, and was quickly seen as a major economic imbalance that had to be addressed at the national level, given the new interventionist/Keynesian view of fiscal policy. In his economic report to Congress, released in January 1948, President Truman highlighted the problem of inflation and the need to establish policies that would increase production to satisfy increased household and business demand for goods and services. Seven recommendations were made, but not all were implemented. The president requested that Congress do the ...

Table of contents

• Cover Page
• Title
• Copyright
• Contents
• Preface
• Introduction
• SECTION 1 What Is a Business Cycle?
• Chapter 1 The 1948–1949 First Postwar Recession
• Chapter 2 The 1953–1954 Post-Korean War Recession
• Chapter 3 The 1957–1958 Eisenhower Recession
• Chapter 4 The 1960–1961 Rolling Adjustment Recession
• Chapter 5 The 1969–1970 Nixon Recession
• Chapter 6 The 1973–1975 Oil Crisis Recession
• Chapter 7 The January to July 1980 Carter Credit Control Recession
• Chapter 8 The 1981–1982 Iranian Energy Crisis Recession
• Chapter 9 The July 1990–March 1991 Gulf War Recession
• Chapter 10 The March 2001–November 2001 9/11 Recession
• Chapter 11 The December 2007–June 2009 Subprime Recession
• Summary
• SECTION 2 Evolution of Financial Debacles
• Chapter 12 Financial Dislocations and the Business Cycle
• Chapter 13 From Small to Large to Systemically Important
• Chapter 14 From One-Off to Industry and Sector-Wide Dislocations
• Chapter 15 Corporate Governance Credit Cycle
• Chapter 16 Subprime Credit Cycle
• Chapter 17 International Financial Crises and Their Link to US Debacles
• Conclusion
• Acknowledgments
• About The Author