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Booms and Busts: The Economic Cycle in Action Marcus D. Niski Booms and Busts… As we have already observed, the economies of all countries are subject to what is known as cyclical affects or affects which influence their economic cycle in terms of both what is known as short run and long run factors… Booms: An economic boom is characteristics by a range of economic factors in the cycle such as: High levels of investment High levels of employment High levels of demand High levels of spending Buoyant share prices Psychological optimism regarding employment, spending and the general health of the economy Strong housing prices Busts: Characteristically, busts are an opposite trended of the reverse factors – also characterised by pessimisms in general terms about the state of the economy and d it short-medium term future. Busts are known as a period of recession in the economy where growth is slow and the prevailing economic data suggest what economists in the media often refer to as ‘sluggish’ behaviour. Depressions: a severe economic downturn Depressions are technical extended long running periods of downturn in the economy that are characterised by three quarters of negative growth in the economy. Depressions often result in massive social and economic instability and have profound consequences for any society as they impact at the every level of the economy and society. The Great Depression of the 1930s The Great Depression The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s. It was the longest, most widespread, and deepest depression of the 20th century, and is used in the 21st century as an example of how far the world's economy can decline in global terms… The depression originated in the U.S with the famous CRASH on Wall Street., starting with the stock market crash but quickly spreading to almost every country in the world. The Great Depression had devastating effects in virtually every country, rich and poor. Personal income, tax revenue, profits and prices dropped, and international trade plunged. Before we move on to further analysis, let’s pause for a moment a look at what happens when a market collapses and what sort of factors might be at work. Let’s look at the so-called tech wreck of the early 2000’s as an example. The technological ‘bubble’ that followed on from rapid investment in the Internet in the late 1990s and early 2000’s is an excellent example of what happens when a market crashes and the sorts of economic and psychological factors that are involved. Like many bubbles before it, the tech wreck is a good example of a sometimes highly predictable crash. Indeed, the tech wreck was brought about by a number of factors including: – Inflated prices based on paper values rather than real values (asset v price bubbles) – Investor over confidence - Elements of corruption/ manipulation of the business model – Psychological bull run behavior Consequently the market crashes due to: – Prices plummeting for stocks based on a correction to the above as both the perceived and real re-evaluations took place – Mass selling behavior – Loss of confidence in the sector by investors - Exposure of poor real values to perceived values - Businesses in the sector not making anticipated profits – Panic through the market So let’s move back to the Great Depression… Economic historians most often attribute the start of the Great Depression to the sudden and total collapse of US stock market prices on October 29, 1929, known as Black Tuesday. However, SOME DISPUTE EVEN TODAY THAT THE CRASH WAS A SYMPTOM RATHER THAN A CAUSE OF THE GREAT DEPRESSION. Even after the Wall Street Crash of 1929, some optimism persisted for some time; John D. Rockefeller said that: "These are days when many are discouraged. In the 93 years of my life, depressions have come and gone. Prosperity has always returned and will again." The stock market turned upward in early 1930, returning to early 1929 levels by April, though still almost 30% below the peak of September 1929. Together, government and business actually spent more in the first half of 1930 than in the corresponding period of the previous year. But consumers, many of whom had suffered severe losses in the stock market the previous year, cut back their expenditures by ten percent, and a severe drought ravaged the agricultural heartland of the USA beginning in the summer of 1930. By the mid 1930s interest rates had dropped to low levels and consumer investment and spending were both depressed. Conditions in the farming sector also declined and commodity prices declined. Protectionist tariff polices ensued and the US government moved to instituted the SmootHawley Tariff Act aimed at protecting US trade against the actions of its competitors. • Some economists argued that this in fact help to exacerbate the situation because it further slowed down US international trade, which in turn, affected US stocks of gold that further aggravated the crisis rather than alleviated it By 1930 a steady decline in the world economy in that would reach the bottom by 1933…. “25 percent of all workers and 37 percent of all nonfarm workers were completely out of work.” (Great Depression, by Gene Smiley, The Concise Encyclopedia of Economics) By 1939, in fact, the world would be at war with Hitler’s Germany invading Poland. Ironically , a war economy would help to repair the damage done to the US economy eventually leading it to becoming an economic engine of growth by the 1950s with the re-construction of Japan playing an important role in this process. Causes of the Great Depression “What caused the Depression? This question is a difficult one, but answering it is important if we are to draw the right lessons from the experience for economic policy. Solving the puzzle of the Depression is also crucial to the field of economics itself because of the light the solution would shed on our basic understanding of how the economy works...” Current US Federal Reserve Bank Governor Ben S. Bernanke, At the H. Parker Willis Lecture in Economic Policy, Washington and Lee University, Lexington, Virginia, March 2, 2004 in a speech entitled– Money, Gold, and the Great Depression Causes of the Great Depression “During the first decades after the Depression, most economists looked to developments on the real side of the economy for explanations, rather than to monetary factors. Some argued, for example, that overinvestment and overbuilding had taken place during the ebullient 1920s, leading to a crash when the returns on those investments proved to be less than expected. Another once-popular theory was that a chronic problem of "under-consumption"--the inability of households to purchase enough goods and services to utilize the economy's productive capacity--had precipitated the slump.” (ibid) “The slowdown in economic activity, together with high interest rates, was in all likelihood the most important source of the stock market crash that followed in October. In other words, the market crash, rather than being the cause of the Depression, as popular legend has it, was in fact largely the result of an economic slowdown and the inappropriate monetary policies that preceded it. Of course, the stock market crash only worsened the economic situation, hurting consumer and business confidence and contributing to a still deeper downturn in 1930.” (ibid) Time Line to The Great Depression… 1929 U.S. decline in industrial production August: The recession begins, two months before the crash. Production falls by 20%. October 24: Stock market crash begins. October 25: Brief surge on the market. October 29: 'Black Tuesday'. U.S. Stock market collapse. Decline in the commodity prices. The stock market crash had little substantive effect on the recession because only 16% of the population was involved in the market, and only 10% of wealth was lost. However, the crash created uncertainly in people’s minds about the future of the economy. This distrust in future income reduced consumption expenditure. As demand for commodities decreased, so did their prices.[1] 1930 February: Federal Reserve cuts interest rates from 6% to 4% June 17: Smoot-Hawley Tariff Act passed. September - December: First U.S. bank failures 1931 May: Creditanstalt, Austria's premier bank, goes insolvent. May-June: Second U.S. bank failures / Change in people's expectation of the economy If people expect the deflation to continue, they anticipate that prices will be even lower in the future than they are now. They hold off on purchases to take advantage of the expected lower prices. They are reluctant to borrow at any nominal interest rate because they will have to pay back the loan in dollars that are worth more when prices are lower than they are now. In short, the real interest rate rises above the nominal rate (Temin 56). July: Germany banking crisis September 21: Britain goes off the gold standard. September - October: Substantial amount of dollar assets are converted to gold in the US September - December: Fed increases interest rates Fed wanted to stabilize the dollar without going off the gold standard. As a result, production continued to plummet and the depression intensified. November - Summer 1932: Foreign trade restrictions / Imperial Preference 1932 April - June: Government conducted open market transactions to increase money supply. July: The Government discontinued open market operations. 1933 Franklin D. Roosevelt elected President. US goes off the gold standard. US goes on silver standard. The Great Crash of 1929 http://www.youtube.com/watch?v=RJpLMv gUXe8