Sometimes I think that the Keynesian and Austrian Schools of economic thought can be merged into a consistent synthesis that would disagree about the goals of policy, but largely agree on how economies work. One of the men that would help promote such an idea would be Hyman Minsky.
One of the beauties of capitalist economies is that they are dynamically unstable. Businessmen as a whole for a variety of reasons tend to over- and underestimate the desirability of doing business as a group. There at least two reasons for this. First, there is trend-following, because success by one businessman causes others to try it, until it is overdone, then a large number of businessmen drop out, setting the stage for the next cycle. Second there are shocks correlated across the system, whether it is monetary policy (too high/low for too long), tariffs, tax changes, wars, technological shifts, etc.
This instability is actually a plus for the system, because each period of failure creates the seeds for the next round of success, as vulture investors pick over the assets of failed firms and redeploy them to longer lasting practical uses. The decks have to be cleared of bad ideas every now and then, or else the marginal efficiency of capital declines, along with overall interest rates.
But central banks prolong cycles by bailing out marginal ideas and not letting them purge, also creating a culture where risk is not respected, because the central bank will ride to the rescue. Today, we are at such a “Minsky Moment,” where we rescue the marginal, and overleverage some currently healthy segments of the economy, while housing-related and high-yield related items die a lingering death. We will likely set up the seeds of the next bubble in the next year, while we reconcile only the most egregious of business ideas. (Amazing how many real estate agents and mortgage loan brokers there are, huh? Same for investment bankers… time to redirect these bright people to solving operational business problems, and away from financing issues.)
Now, maybe this time we run into the brick wall, where inflation rises amid weak business conditions, as it did in the 70s. At that point, the economy will take the pain. Bernanke will keep the economy from a 30s experience, but possibly at the price of a 70s experience. After all, which would you rather have, depression or stagflation? Both are unpopular words, and I hate dragging them out, but if the price of avoid Depression is Stagflation, the present FOMC will take that cost.
Great post David! I would second that there are too many smart people in finance and not in the “real” world creating a service or goods based business. Altucher on Real Money has written in a similar vein discussing his experiences during the internet start-up era. I am part owner (among other things) of a vehicle delivery service (semi-trucks and buses) and your description of the business cycle is very applicable. Although the barrier of entry is higher now than 10 years ago(insurance during delivery) we still have a steady entry of low margin competitors (cents per mile over what you pay your contract driver) that never seem to go away! Our strategy to survive this cycle is refuse low margin business; keep costs under control, and constantly look for better margin deliveries. It doesn’t hurt to work on a few things to portray as “value added” and avoid the arguement over price. Inevitably the larger players undercharging for their business to capture volume will get tired of losing money and either raise prices or get out of the business. The smaller ones almost always fail or never accumulate the capital to handle larger volumes when margins expand.