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Tuesday, March 24, 2009

Understanding the business cycle (or is it the interventionist cycle?)

In a column published here, investment advisor Justin Charbonneau with McLean & Partners offers his thoughts on the business cycle, the stock market cycle, and what he calls the emotional cycle.

Here’s an excerpt:

Still thinking of investing in the stock market, even with the current turmoil?

That's good, because there are opportunities. There are three important cycles, however -- the business cycle, the stock market cycle, and the emotional cycle -- you should pay attention to so as to better manage your stock portfolio.

A business cycle is divided into phases, each describing economic activity as it moves from a peak to a trough and back again. Each phase describes the behavior of a variety of economic indicators which reflect basic business conditions. Always remember, however, that the government's role in establishing such conditions must also be measured concurrently. Business cycles normally last between 3.5 to seven years.

What’s interesting here is the comment by Charbonneau that “the government's role in establishing such conditions must also be measured” when trying to understand, and profit from, the business cycle.

In a column in Liberty magazine entitle "Peak and Trough," Fred Foldvary argues that the government’s role in establishing such conditions is considerable. In fact, he calls the business cycle the “intervention” or “economic distortion” cycle.

Here’s an excerpt (not found online):

The reason there has not been a consensus on the “business” cycle is that there are several types of fluctuations that run concurrently, making the ups and downs look random, but if we separate out the major and the minor patterns, we can see a regularly occurring major cycle that has gone on for 200 years. An analysis of major cycles shows that the cause of booms and subsequent downturns is government intervention. A pure free market is not inherently unstable. The major booms and recessions should be accurately called “the intervention cycle” or “the economic distortion cycle.”

According to Foldvary, a free market is not inherently unstable, and neither is a free society, although Western Standard blogger Mike Cust argues otherwise here.

Western Standard readers who long for the feel of a dead-tree format may want to subscribe to Liberty magazine. If you use the link here, the Western Standard will get a small commission. 

You can learn more about Liberty magazine here and here.

Posted by Matthew Johnston

Posted by westernstandard on March 24, 2009 | Permalink


Matthew, whatever Michael actually means, I see less instability in a free society. Intervention, and central planning, at best, delay and magnify the inevitable. There is no net increase in stability.

There are billions of people on earch, all interacting many many times a day, in self interested ways. All these interactions, in a free market, send the signals of demand to the martket. To put into perspective the hopelessness of trying to induce stability into a free market, consider a simple deck of 52 cards.

Imagine there were 10 BILLION people on earth, for 1 MILLION years, and they all did nothing but shuffle decks of cards, once per second each. After 1 MILLION years they would only shuffle 1 BILLIONTH of a BILLIONTH, of a BILLIONTH of the possible outcomes.

So with society being a little more complex than a deck of cards, I stuggle to appreciate how anyone can possibly plan even the smallest of societies. How is it possible that they would be able to know the many possible negative outcomes resulting from their intervention?

Until this IS possible, then intervention will always lead to less stability overall.

Posted by: TM | 2009-03-24 10:18:57 PM

Cust is mistaken to interpret Schumpeter's concept of "creative destruction" as implying "instability" in free markets.

Think of an ecosystem in equilibrium. There will be plenty of dying and decaying along with birth and growth. Death and decay are a necessary part of the cycle of regeneration and evolution. But overall, the system is in basic stasis - neither collapsing nor experiencing a wild burst of speciation. There may at times be cataclysmic events that totally upset the equilibrium - events like meteor impacts, or major techtonic shifts - that destabilize the entire system. And these cataclysmic events are always follwed by a burst of speciation, as nature fills the void created by the destructive event. But there is nothing inherently unstable about ecologies.

Likewise, free markets are constantly undergoing regeneration and evolution. Wars (like meteors), and large-scale misallocations caused by bad government policies (like plate techtonics), might periodically cause cataclysmic meltdowns in the economy. But there is nothing inherent in a free market that would lead it to spontaneously combust, especially not in anything like a regular "cycle."

For those seeking a bit more nuance: There might be small-scale cyclical instabilities within an ecology - exemplified by the fox-rabbit population cycle - but that's because nature is not forward-thinking enough to smooth out natural mini-booms and mini-busts. Developed economies, on the other hand, have things like futures markets to deal with agricultural cycles, for example. At bottom, it is always government policy, or cataclysmic natural events (e.g. an unanticipated drought), that destroy free markets.

Conceivably, a big enough new discovery - such as cold fusion - could cause massive dislocations to the economy, too. But so far nothing like that has ever happened, except in science fiction and the fevered brains of socialists.

Posted by: Grant Brown | 2009-03-25 2:40:18 AM

Although I believe our fractional reserve system, central banks, and general gov't interference exacerbates business cycles, I have trouble believing the cycle can ever be completely eliminated. Human beings, by nature, overextend themselves during good times and become too fearful during slowdowns. We often act in herd mentalities and I don't think these things will ever change.

Posted by: Charles | 2009-03-25 11:04:36 AM


The point is, in a stable, free-market economy, there is no "herd" to follow. No generalized "good times" and "bad times." Those are entirely the product of bad government policy - since government is the only institution that is large enough to have such a broad, systemic influence on the economy.

Old-style leftists used to worry about bigness, and the uncontroled power bigness tends to confer. Now leftists champion bigness and the monopolozation of power into ever fewer hands - through government. Can you imagine if a CEO of a widely held corportation directly controled 40% of the GDP?... Yet that is effectively what power politicians weild - and leftists want more of it!

Posted by: Grant Brown | 2009-03-25 11:55:02 AM


You really didn't need to write that last paragraph. You're preaching to the choir.

Regardless of whether I believe the business cycle can be completely eliminated, I still support complete economic liberalization.

Posted by: Charles | 2009-03-25 12:22:57 PM

Great comments.

In Mike's defense, I think he draws a distinction between economic stability and social stability.

I tend to think this is a false dichotomy.

Posted by: Matthew Johnston | 2009-03-26 9:48:19 PM

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