Economic Framework to Understand Boom-Bust cycle

Introduction:

The following series of notes represent the outcome from dialogue had with respect to the theoretical economic frameworks. This is important to understand because how we think about economic systems – which all are inherently complex – will help us forecast where it is heading. In other words, having proper perspective of the way things should be and the way they are now helps us frame the present circumstances in such a way that we can understand (or at the very least try).

The following perspective is merely a point of view and do not claim to be perfect. My goal is that it will be taken as a means to stimulate dialogue and thought.

Topic 1. If a fixed-money system limits the boom-bust cycle, why did the more fixed-money systems of the pre-Fed era have so many more booms, busts, panics, and depressions?

Three points on this question:

- First, all man-made systems are imperfect, so no man-made system will prevent “boom, busts, panics, and depressions” from occurring.

- Second, without going into the rabbit hole of precisely defining each term, yes, the pre-Fed era had “boom, bust, panics, and depressions.” But to say that there were more or less, masks some important distinctions: pre-FED, “booms, busts, panics, and depressions” were for the most part parochial, both in location and/or markets (e.g. the railroad investment mania of the 19^th century had little impact on the average person and impacted mostly the investor class). It is not the number of “booms, busts, panics, and depressions” that is germane, what is important is their magnitude. Read economic historian Charles Kindleberger’s Manias, Panics, and Crashes. His classic book goes through the history of manias, panics, and crashes, and then lists the top 10. If my memory serves me right, 8 out of the 10 crashes occurred post Fed era. At the time the book was written, the crash of 2008 had not happen, and most certainly that one would have made the list. Let’s put aside the 2020 crash due to the lockdown, as that was a very unique event in human history, what becomes apparent is that each successive crisis post-Fed era are more pronounced and impact is broader (aka contagion risk).   

- Third, as briefly mentioned in my second point, a fixed-money system would limit the boom-bust cycle, but mainly in the context its broad economic impact. I do not know the exact number of boom-busts in the pre-Fed era, but what I am certain is that you will rarely see a boom-bust, say, in the likes of the ‘Great Depression’ or ‘Great Recession’. What you will find in the pre-Fed era are many localized issues (e.g., bank runs in the specific regions; or investment crashes that would impact the money centers without much impact to the broader population, etc.).