Why is there a business cycle? Someone once noted that people could tolerate any condition except the possibility of one. This one condition is prolong periods of prosperity. Incredible as it seems, this observation contains more than just a kernel of truth, and helps to explain where we are in our current business cycle.
When the economy starts to recover from a stiff downturn, people are understandably doubtful about the tenacity of the young expansion. They hold back on their discretionary spending and their use of debt.
As the upturn ages, people become more confident and think that the expansion will last indefinitely. (This has a similar ring to peoples’ recent attitudes towards real estate) Business people take on more debt to leverage their profit margins. The consumer will also be increasing their debt burdens to finance their growing consumption habit. This increase confidence of consumers is also reflected in their disregard of saving. Soon a point of no return is reached where the cost of servicing the debt is growing faster than consumers’ income. This scenario also holds true for over-indebted businesses.
Now the expansion starts to stall because businesses and consumers can not sustain this level of credit expansion. A period of credit liquidation ensues and a new downturn begins. The severity of the downturn depends on several factors. These include the oversupply of goods and services, the level of debt buildup, and government economic policies (namely tax and trade policies).
For argument purposes, let’s say it is possible to eliminate the business cycle. Then the question is— what is the price to be paid. What price you ask! Yes, there is always a price because the cardinal law of economics is— there is no such thing as a free lunch.
The business cycle will always be with us. You might say it is the result of the genetic make-up of mortals. No government policy or regulation can abolish it.
The price paid is lost opportunities and slower long-term economic growth. Downturns, recessions as they are called, have a beneficial purpose. Their purpose is to provide renewed liquidity to the business system. Think of it as the catharsis of the economic system. Recessions cleanse the system of marginal companies and transfer their resources to stronger more productive enterprises. This sets the stage for the next upward expansion. Without recessions there would be stagnation.
Recessions can be painful for most, but a time of great opportunity for some. Downturns provide the opportunities for those clever individuals, who have the wherewithal (the liquidity), to purchase assets on the cheap. These assets are then transferred into more productive hands, and the economy benefits.
No matter how many rules or laws politicians put in place, the business cycle is here to stay. Your goal is to take advantage of swings in the cycle to gain market share.