Counter cyclic programming

This post is in response to a comment by DaWei on a previous post “Deficit fetishism“. I felt that rather than have a long comment that might never be read I would create a post that has a slightly better chance of being read.

In the comment DaWei expressed skepticism on the idea of counter cyclic spending by governments and I wanted to explain my thoughts and understanding. It is well known in economics that businesses operate in cyclic fashion. Meaning that an industry will be at a point where there is more demand than supply, the industry reacts by creating more supply, almost universally to excess, then there is a period of excess supply compared to demand, triggering a retrenchment of the industry. These boom and bust cycles are actually a critical element of capitalism and I suspect that any effort to ameliorate these cycles (on an industry level) is doomed to create permanent disconnects between supply and demand (as opposed to cyclic periods of under and over supply). These cycles generally operate independently of other industries and generally have little effect on the economy overall, that is, until one of the booms (bubbles) becomes so huge that it begins to influence allied industries and eventually the economy as a whole. Then, when the inevitable down cycle begins, there is a self-reinforcing element (which we are all so very familiar with at the moment) where the lack of demand in one industry due to the over supply is continually exacerbated by depressing demand in other industries. This effect spreads far and wide and can easily (and has easily, in the past) result in a depression that can take years, sometimes decades, to dig out of.

Around a century ago economic thinkers started to promote the idea of counter cyclic investment, not just for governments, but for corporations as well. Indeed, this approach can, in fact, work equally as well for individuals. I will initially focus on the corporate aspect as I think that can most easily lay the ground work for extending it governments and even individuals. Lets make the assumption that corporations are run by intelligent people who have studied history in general and are experts in the history of their industry (sadly, I see very little evidence that this assumption is safe, in fact, the opposite assumption is probably better). These corporate titans are well away of the cyclic nature of their business, understand the demand that is available to the industry in aggregate and can make very accurate assessments of the supply as well as accurate forecasts of the coming over supply. Thus, they can predict with a fair amount of accuracy exactly when the boom will be over and when the bust will begin (note that if you don’t care about the long-term health and welfare of the company you manage, following this approach fails to maximize the earning potential of the executive). As such, those executives will then begin to reduce capital investments in supply build up before the end of the boom and will start to ‘harvest’ profit from the now dwindling margins. Thus, when the boom ends, they have _not_ over built their supply, have _not_ over extended their resources and have _not_ put themselves in a position to make panicky short-term decisions. Instead, they now have extra resources to cherry pick capacity, and more importantly, personnel, from the other, less intelligently run corporations in the industry. In addition (and this is where we get to the counter cyclic spending), because they are a well run organization, their cost of money (the interest they have to pay on their debt) tends to be much lower than the industry in general, so they can leverage that lower interest rate to snap up further bargains. They can also invest in R&D to lay the ground work for the next boom cycle and be even better positioned than their less well managed competitors. A few of these boom and bust cycles could see even a small, but well run, organization expand to become a dominant competitor (then, sadly, the corporation tends to suffer from ‘brain death’ and starts to be incompetently managed, but that just makes room for the next well managed organization). Thus, the well run corporation can make counter cyclic spending decisions, taking on increased debt during the bad times and paying down that debt during the good times.

This exact same approach works for individuals as well, though our ‘great’ American society has so thoroughly drowned itself in debt during the boom times that there are very few individuals indeed who can qualify for the best interest rates during the bust times. However, those that are smart enough (sadly, I cannot count myself as one of them, partly because I am a risk seeker and try to ride the boom to its end (very dangerous and highly ineffective, sort of like playing the lotto to cover your retirement)) are extremely well positioned to pick up revenue generating assets during the down-cycle. A perfect example is in the Detroit area. Houses have got so cheap that people can buy them and simply turn around and rent them and make 20% or more on their money (not even counting the almost certainly increased value of the house over the long term!). The people who have been smart enough to save during the boom times have the cash on hand to make these ‘fire sale’ purchases and indeed, because of their stellar credit, they don’t need to pay 100% with their own cash, but can leverage borrowed money (at historic low rates) to further increase their purchasing power. That there are so few individuals in the US capable of making such plays is a testament to how well the oligarchy had convinced the population to live well beyond its means.

The basic rule of thumb in business and economics (not, I assure you, that many of our ‘great’ titans of industry understand even basic rules of thumb, business OR economics, for reasons I will explain a bit later) is to evaluate your cost of money vs the return you could get on that money. Say, for instance, you could get a ‘risk free’ return on your money of 10% after taxes, tags, title and destination charges. If you can obtain money for (the interest rate is) less than 10%, then you should be borrowing as much as you can. Conversely, if your cost of money is greater than 10%, you would be a fool to borrow. Now, nothing is risk free (unless you are a member of the oligarchy or operate a ‘too big to fail’ bank, of course, in which case the government simply mints money for your own personal use), so the reality is the present value of the return is not exactly 10%, it probably has a spread that might even run from negative to very high indeed (in the world of competitive businesses, anything over 15% after taxes, etc. is considered ‘very high indeed’). Thus, you can’t make a simple calculation looking at the cost of your money to know if you should make an investment. There are also situations where the cost of our money is not fixed as you could make short-term borrowing decisions (which tend to have lower rates) and then repeatedly roll that debt over instead of paying a higher rate for longer terms. So, this can get very complicated indeed and during normal economic times there is a huge amount of judgement involved and, honestly, a bit of gambling.

During abnormal economic times, though, such as boom or bust periods, the calculus often can yield near crystal clear decisions. If you can purchase an asset for less than what the asset is worth due to the panicky selling because of a bust, and your cost of money is reasonable, then making the buy is almost (in fact should be) automatic. Conversely, particularly during the later periods of the boom, making investments into increasing your supply potential would be highly counter productive, no matter how cheap your money. Intelligent managers who understand the cyclic nature of their industry can anticipate the boom and bust cycles well enough that over the long run they will increase their market share (and almost certainly profitability) with each cycle.

So what does this have to do with governments? Well, governments are not (supposed to be) motivated by profit, but for the greater good of the society it is operated on behalf of (yes, I fully understand how idiotic that statement is in our current oligarchical, police state situation, I am discussing what can be, not what is). Thus the calculus for deciding what investments to make during normal economic times can be very challenging indeed. However, during adverse times (boom and bust, just as before, though as long as specific industries operate independently the government can (and should) stand by), just like in the corporate and individual case, counter cyclic operations not only can benefit society by making it more efficient over time, but can actually reduce the depth (and to a certain degree the height, but that is not guaranteed) of the cycles, even further providing a benefit. By having a government that makes investments during the down cycles the government is creating ‘artificial’ demand for the excess supply (note that this isn’t specific (or shouldn’t be) to any given industry, each industry should be allowed to operate in its own boom and bust cycle) which helps to ameliorate the depth of the cycle (it also can have the unfortunate side effect of prolonging the bust cycle (and enriching those managers not capable of recognizing and preparing for the bust (any of this sound even a wee bit familiar?)) if done on an industry specific way as the down cycle is necessary to flush out the excess supply).

Now, for our specific situation… For reasons I don’t quite understand (same for Japan as well), our government can borrow at rates that can arguably be lower than inflation, meaning for all intents and purposes investors are willing to pay our government to lend money to it. As such, that money can arguably be called ‘free’ as a consequence, thus any return becomes infinite. Because of that situation, our government should be borrowing its ass off and plowing that money into such things as infrastructure rehabilitation, research, improving our Universities, etc. (NOT bailing out ‘too big to fail’ banks!). Naturally, the flip side is that when the economy has picked itself back up and starts its self-reinforcing run up to the next boom, our government should be paying back that money so that the next down cycle it can repeat the behavior.

Of course, that is not what is happening, the reality is the oligarchy controls our government and it is operated for the soul benefit of the oligarchy at the expense of the (increasingly shrinking) middle class. Since, as I mentioned in the previous post, rich people don’t like to stimulate the economy (even though it would make them richer still), we get austerity for the masses and huge bonuses for the oligarchy. However, my goal with this post is to outline how things could be done, for the greatest good for the greatest number, all without creating any sort of long-term danger to our country. It doesn’t have to be theory, and indeed, for periods of the last century it wasn’t. Not all of the counter cyclic investment was intelligent (recall the stranglehold that the military-industrial complex has on defense spending), but it did produce a long wave of prosperity that was widely shared amongst the population.

So, why are we not seeing counter cyclic investments in our industry and government? Beyond, of course, the above mentioned oligarchical personal immunity to the down cycle, there is also a situation where the captains (I no longer want to dignify them with the title ‘titan’) of industry as well as the members of our government all came from the exact same parents and exact same schools and nearly universally got their lofty positions simply by being born to the right parents and having been sent to the right schools. Ignoring the self-reinforcing nature of having these students taught by professors carefully selected by the same people, because they got their lot in life by the genetic luck of the draw instead of any inherent skill, on average they are no smarter than those poor people who have the opposite misfortune and are living as trolls under a bridge somewhere. Would anyone consider a homeless person begging for handouts at the stop light be ideal for running a Fortune 500 company? Other than (possibly) learning more during their extremely expensive education, on average there is no significant difference between these two groups of people, so why have these rich kids run our companies and government? Well, that is just how things have worked out at present in our ‘great’ country and these captains of industry are a) not experts in history in general, nor history specific to their industry and more importantly, b) are only motivated by personal fortune seeking and even if they somehow could see the on-coming train mistaken for the light at the end of the tunnel, would want to maximize their personal fortune at the expense of the company they ‘manage’. As for our government, well, the individuals operating it are no smarter, on average, than the a fore mentioned homeless people, exactly like the a fore mentioned captains of industry, and, on average, they are also personally motivated at increasing their wealth at the expense of the ‘company’ they ‘manage’ as well.

Can we break this cycle? Not as long as the oligarchy controls everything and I am having a great deal of difficulty envisioning any scenario (including most forms of bloody revolution, I would have you know) to get our country to a point where we have merit-based decisions for leadership, corporate or government.

Author: Tfoui

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