Blackers Blog

What Lies Ahead?

In life we are surrounded by cycles of varying degrees. From the orbit of the planets to the pendulum of a clock and everything in between, almost everything has its own tempo and rhythm. Nothing is static.

Unfortunately, despite the cyclical nature of things touching every aspect of our lives, we have a strong predisposition to think in linear, straight-line terms. This displays itself in all manner of things from economists forecasting booms that will never end to real estate agents forecasting ever increasing house prices.

This extrapolation of what we have recently witnessed, projecting more of the same into the future is the single best reason why most experts are consistently useless at predicting recessions or depressions in the economy.

One of the earliest discoveries of economic cycle theory was made by the Russian economist Nikolai Kondratiev in 1925. He found that there was a general business cycle lasting between sixty to seventy years with three key phases being expansion, stagnation and recession. Unfortunately for Nikolai, Stalin did not like his conclusion and had him sent to a gulag for eight years before having him executed in 1938.

Since his death, Kondratiev’s theory has been refined, and numerous cycles of different durations have been discovered and added to the mix, however the basis of his theory remains the same. In simple terms it is a story of boom to bust.

In the early stages credit flows into the productive areas of the economy, leading to a huge amount of economic activity bringing growth and prosperity.

As the cycle wears on, this explosive growth results in the economy becoming saturated and stagnating, leading to a reduction of investment opportunities and a gradual lowering of credit standards.

Faced with this lack of opportunity, this ‘easy money’ starts to move away from productive industry and head towards other areas of the economy e.g. housing, stock markets etc, thus starting an ‘asset price bubble’ - the more these assets go up in price, the more money flows into them, which pushes them up even higher, which sucks in even more money etc etc.

Towards the end of the cycle, credit is expanding at an incredible rate and flowing solely into speculative assets; people are overcome with speculative fervour -nothing and nobody is going to convince them that the party is going to end! Debt levels expand to massive proportions and finally the inevitable happens…… markets crash and a financial crisis follows.

Once all the excesses have been squeezed out of the system by bankruptcy, default and inflation, and debt levels have returned to normal (think 1930’s depression), the economy is ready to start the cycle all over again.

So, you might ask, having weathered the financial crisis of 2008 are we ready to embark on a new cycle once again? The answer unfortunately is no.

After studying hundreds of debt bubbles, Reinhart and Rogoff (two economists that do know what they are talking about!) found that not only has excessive debt repeatedly led to financial crises in almost all countries over the last two centuries, but that these high debt levels take years to work off, and this deleveraging creates a prolonged slump whilst Governments, businesses and consumers rebuild their finances.

In other words, it is not just one short financial crisis and then off we go again, a short, sharp, shock is quickly forgotten. We seem to require pain over a prolonged period in order to engender behavioural change, and that is precisely what we get during the deleveraging process.

It is important though to understand that we do not face a period of unrelenting financial crisis, there will be periods where we experience cyclical recoveries similar to what we have had since 2009. Unfortunately these periods of recovery will feel more like mini-recessions than booms, and once they have run their course we will once again feel the effects of the deleveraging process as the next crisis hits.

And so although the 2008 crisis was the first, it will be followed over the next few months and years by credit crises in the Euro Zone, Japan and others until finally it comes home to roost, in the USA.

It would appear that we have at least another five years of the process before we can even consider an endgame, and the financial pressure will continue to build every time we get another crisis.

Anyone believing that we will quickly return to the ‘normal’ days of pre 2008 is sadly mistaken. However, better to be informed as to what we face than shove your head in the sand (or anywhere else that feels comfortable) and hope for the best.

If by this stage you are starting to feel depressed, don’t worry. There are courses of action to take to help protect yourself and your family, and to insulate yourselves from what is coming, and I will go into more detail on them in a future post.