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In my view, the big debate between fiscal policy and monetary policy, or inflation vs deflation, mostly comes down to looking at a long enough historical timeline to see the full context. The effectiveness of monetary policy, including interest rate manipulation and asset purchases, diminishes significantly when debt is high, interest rates hit the zero bound, and the money multiplier is low.
Rock cycle essay essence, monetary policy is effective at putting the brakes on an economy, but bad at stimulating an economy, whereas fiscal spending has the opposite tilt. The precise path we will take through this decade will depend on myriad fiscal policy choices, social outcomes, geopolitical events, and other variables, so rather than predict exactly how it will play out, we can start with certain observations and decision points, and fill in details over time as we hit certain events.
A lot of people are familiar with normal year business credit cycles. Most readers have lived through several of them, rock cycle essay. At the start of an economic expansion, businesses and consumers start to recover from the previous recession, and so they take on more debt and risk.
As the expansion progresses, this higher and higher level of debt and eventual over-investment from businesses and over-consumption from households make them increasingly leveraged and fragile, rock cycle essay.
Asset prices generally move from cheap to expensive during this process as well. Eventually, some negative catalyst external or self-imposedcombined with the elevated rock cycle essay levels, rock cycle essay, triggers an economic shock and period of deleveraging, which is recessionary.
Policymakers usually respond by offering lower rates and fiscal stimulus to offset this rock cycle essay deflationary period, many defaults occur, the system cleans out some of the excesses of rock cycle essay and unproductive leverage, and then the cycle starts anew.
The problem is that deleveraging rarely reduces debt levels all the way back to where they started in the cycle, in part due to that fiscal and monetary policy response. By the time the dust settles on a short-term deleveraging event, businesses will have collectively reduced rock cycle essay of their debt, rock cycle essay, but still have more debt than when they started the previous short-term cycle, rock cycle essay.
However, monetary policymakers try rock cycle essay get the next business cycle going as quickly as possible, and so they reduce interest rates to lower levels, and therefore encourage more rock cycle essay accumulation.
The chart below shows the business cycles over the past four decades. Corporate debt as a percentage of GDP in blue decreases during recessions shaded in graybut keeps making higher lows and higher highs over the decades, and this is in significant part because interest rates in red reach lower and lower in each cycle and allow for rock cycle essay increased debt accumulation over time.
This is driven in part by monetary policymakers:. Federal debt accumulation tends to run counter-cyclical to this trend. Federal debt rock cycle essay swiftly during recessions, because tax revenues fall due to lower economic output, and federal spending increases to offer extra unemployment benefits and stimulus. In other words, whenever the private sector deleverages a bit in blue below, the public sector leverages up in red below.
This Keynesian approach is driven by fiscal policymakers:. And so we have a string of short-term business cycles building up public and private leverage over decades, leading to something bigger. Fewer people are familiar with the long-term debt cycle, because it only reaches a turning point every several decades, and we have to look back into boring history books to see the details. To make it rock cycle essay, history merely rhymes, rather than repeating itself identically, so analysts have to take historical data and construct forward probabilities from it based on new conditions and notable differences from past analogues, rock cycle essay.
After many of those short-term business cycles accumulate debt from one cycle to the next, to a higher and higher level, rock cycle essay, total debt in the system federal, corporate, household, and other forms of debt reaches extremely high levels, and interest rates run into the zero bound, and policymakers have trouble rock cycle essay them much below that threshold.
The zero bound is where the magic starts to happen, and things change. There were two long-term debt cycles over the past century. The first one peaked in two stages in the s and s, and the second one rock cycle essay in two stages so far in the late s during the period and again into the s. A normal amount of system-wide debt can be deleveraged nominally. People and businesses rock cycle essay for their mistakes by losing money and filing for bankruptcy, creative destruction occurs, strong businesses devour weak businesses, the dust settles, and the system can build up from there.
However, a huge amount of system-wide debt, equal to a few hundred percent of GDP, including up to the sovereign level, is basically impossible to deleverage nominally, because it crashes the whole system when attempting to do so, and creates a vicious cycle. Instead, those peaks tend to be deleveraged with a major expansion of the money supply.
In other words at the end of a long-term debt cycle, the denominator currency goes up a lot more than the numerator nominal debt goes down. Instead, the key mistakes were made in the decades that led up to the peak, with over-use of monetary policy usually accompanied by a set of poor fiscal rock cycle essay that encouraged the build-up of debt in the first place. Similarly, when people get laid off from work, that reduces their consumption, which causes other businesses to lose revenue and lay off their employees as well, rock cycle essay, which further reduces consumption in the system.
With a rock cycle essay default and no fiscal policy response, several banks begin to fail. In a system rock cycle essay normal leverage, the natural deleveraging process can play out and the system remains robust and solvent overall, eventually bottoms, and comes out stronger on the other side with a real market-driven recovery. However, in such a highly-leveraged system at the peak of a long-term debt cycle, with debt that was only able to reach such extreme levels in the first place due to consistent policy intervention during the preceding decades, a series of initial defaults would start triggering a tidal wave of more defaults, and it all would collapse like a Jenga tower because there is too much debt relative to the amount of money in the system.
So, a hands-off policy approach works quite well in normal deleveraging events, but it historically fails in major deleveraging events when debt is at extreme levels, even the sovereign entity is highly leveraged, and a large percentage of people are reliant on government payments.
Even if politicians were to attempt to take the pure austerity route and cut spending programs and let system-wide defaults happen, the economy gets more and more painful, rock cycle essay, and after a few years, rock cycle essay, people vote those politicians out of office in favor of politicians promising stimulus. Another way of putting it, is that a fiat currency regime rarely if ever collapses from lack of printed fiat.
If there is a historically high public and private debt level relative to the number of fiat currency units in the system, they increase the number of fiat currency units in the system.
Plus, rock cycle essay, socioeconomic factors start to get messy in those extreme economic environments. The peaks of long-term debt cycles tend to rock cycle essay come with peak levels of societal wealth concentration, where the gap between the super rich and everyone else becomes wider than normal.
Money ceases to move around the economy smoothly and reach people of all income levels, and instead just concentrates near the top. A combination of tight fiscal policy and loose monetary policy tends to exacerbate that outcome. Populist politics then become more commonplace, and while some strands of it can be quite rational based on countering prevailing policies that are rightly viewed as needing reform, there are also more dangerous or extreme strands that begin to emerge as well, particularly if those initial and more rational strands go unaddressed, rock cycle essay.
Policymakers historically face the choice of doing something to alleviate the financial burdens of the broad population, or risking outright revolution.
In other words, when the top 0. Economic rock cycle essay also tends to be slow and stagnant, since the broad middle class is the engine of the economy. Wealth concentration peaked during high levels of system-wide leverage and low interest rates, and bottomed during periods of low leverage and high inflation and high interest rates:.
Economic theories work well in closed system hypothetical scenarios, but what about open systems where rock cycle essay competitors exist? If one country decides to take the bitter rock cycle essay and go through a decade-long massive nominal default and debt collapse and let everything clean out nominally fair and square, during that whole process they become vulnerable from a geopolitical and military point rock cycle essay view compared to nations that instead choose to intervene with printed money and kick the can down the road and prop up their economies.
So, historically, the difference between a normal short-term deleveraging event rock cycle essay a long-term deleveraging event, rock cycle essay, is that the long-term version usually includes a significant component of currency devaluation.
history, international history, and going back literally thousands of years to ancient Greece and Mesopotamia, the common answer during generational peaks in debt levels, almost inevitably, rock cycle essay, is that currency itself eventually gets devalued by some extent instead of just a nominal debt collapse occurring. Rock cycle essay the Athens of B. The rich, angry at the challenge to their property, prepared to defend themselves by force. Good sense prevailed; moderate elements secured the election of Solon, a businessman of aristocratic lineage, to the supreme archonship.
The rich protested that his measures were outright confiscation; the radicals complained that he had not redivided the land; but within a generation almost all agreed that his reforms had saved Athens from revolution. In a long-term debt cycle deleveraging process, nominal debts may only decrease partially, but currency that the debts are denominated in get devalued and expanded dramatically, either in terms of what it was pegged to or in terms of price inflation, and the result is that the value of existing debt decreases relative to nominal GDP and other broad economic measures, rather than decrease by a lot nominally.
In other words, as I said before, the denominator currency is often expanded to alleviate a system-wide generational debt problem, rather than the numerator nominal debt levels going down much. If we focus on U. history, and separate total debt as a percentage of GDP into 1 federal debt as a percentage of GDP with virtually no nominal default risk and 2 non-federal debt as a percentage of Rock cycle essay that does have substantial nominal default risk, we can see the separate measures used, rock cycle essay.
The orange peaks resulted in deflationary or disinflationary banking crises, while the blue peaks went more in the inflationary devaluation route. Non-federal debt the orange line above looks like it decreased a lot on that chart in the s and early s. Instead, along with that partial nominal deleveraging, the U.
This was a noninflationary currency devaluation, meaning that currency was devalued relative to gold, but was not devalued much against broad prices in general, since the inflationary forces were counter-acting an existing deflationary force of debt. Then, the U.
entered the world war in the early s and began massive deficit spending partially monetized by the Fed buying a lot of Treasuries. People often say the war brought the economy out of the depression. The act of war itself was economically subtractive losing irreplaceable lives and having their expensive rock cycle essay destroyed rock cycle essay foreign soil, half a world awayrock cycle essay, but the productive infrastructure that the war forced the country to build through federal deficit spending, which they were able to come home to and re-purpose for domestic use, was hugely additive in terms of new technology and overall productivity in the subsequent peacetime economy, and this was further boosted with the G.
spending bill to get those soldiers trained or educated as they entered the domestic workforce. After the war, the rock cycle essay debt never really deleveraged much nominally, but they held nominal debt relatively flat for a while, as nominal GDP caught up, partially from growth and partially from inflation, with interest rates capped by the Fed below the inflation rate.
So again, it was a period of aggressive spending and currency devaluation, rock cycle essay, followed by a period of relative austerity, that reduced debt as a percentage of GDP, this time at the federal level.
In modern parlance, the war forced the s to be a very MMT-heavy decade in terms of fiscal and monetary policy, and the pandemic may be a catalyst to make the s decade into a similar outcome, especially given the same long-term debt situation.
In other words, an external catalyst changes the public perception and policymaker perception, about fiscal deficits. In such a scenario of massive deficits and financial repression like the s had, holders of currency and bonds were effectively partially defaulted on in real terms often not nominal terms, especially at the sovereign level and only got part of their purchasing power back.
On the other end, debtors effectively got bailed out and only have to pay back a portion of the purchasing power that was owed, even though they largely paid back the full nominal amount in many cases, but in weaker currency units, rock cycle essay.
Ark Investment Management published a great chart in a recent research paperwhich shows how frequent currency devaluations have been worldwide, rock cycle essay, particularity in the past century:. The percentages would be far higher with those looser cut-offs, rock cycle essay. It only includes currencies that lost half of their purchasing power in five years. The 1H letter by Hirschman Capital noted a similar phenomenon.
Japan, as the largest creditor nation in the world currently, is the one example out of 52 that has avoided that outcome vs the other 51 examples. Their sovereign debt as a percentage of GDP has continued to increase, pushing the previously-known boundaries on how much debt a sovereign entity can hold, rock cycle essay. It became a question of timing, and most importantly, acquiring lifeboats. Investors could have theoretically traded Titanic contracts in the meantime, rock cycle essay, with varying ups and downs in price based on news from the engine room rock cycle essay from the captain about the state of the ship.
They are buying bonds at record high prices aka record low yields at a time when the sovereign is least likely to be able to repay its debt in real purchasing power terms over the next decade or two as some of those long bonds mature. Long duration sovereign bonds with interest rates that are below the prevailing inflation rate, rock cycle essay, are interesting trading vehicles due to their convexity, but are problematic long-term buy-and-hold assets in those environments because they are likely to have negative real yields for quite a while, rock cycle essay.
The vast majority of debts, public and private, are denominated in a specific amount of currency, which has no intrinsic value. During a long-term debt crisis, the money supply gets greatly expanded to deal with that debt burden, and yet those pre-existing debts are still owed in a fixed amount of currency.
So, those debts get partially inflated away. Just like how buying stocks in overvalued equity markets often results in a loss of purchasing power over the next years, lending and buying debt and even holding cash with low interest rates during a debt bubble, rock cycle essay, often results in a loss of purchasing power over the next years as well.
Monetary policy and fiscal policy historically take turns in how potent their effects are on the economy.
During a booming economy, with banks happily lending for productive purposes, and higher interest rates and inflation levels generally, monetary policymakers have the power to put on the brakes, or to lighten up when the economy softens, which means monetary policy has a lot of influence, for better or worse.
As debt builds up in the system, economic growth slows, and the money multiplier shrinks. The Great Depression and the Great Recession were during periods of significant money multiplier bottoms, which along with the zero bound being reached, is what made them so different than every other normal recession. This chart shows the monetary base as a percentage of GDP in blue, and the money multiplier in orange:. Even as the monetary base expanded, the money multiplier kept stagnating.
Then, World War II in the s forced them to build a ton of productive industrial assets via massive federal deficit spending and financial repression, and existing debts were further devalued by inflation.
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1 day ago · Essay on life cycle of butterfly for kindergarten. Referencing a book in a research paper. rock music essay introduction. Negative effects of homework essay. Essay on my country cleanliness. My favourite place to visit essay for class 1 essay ber wrde essay format in ielts 1 day ago · International business essay topics on class mother Essay 5, subhash chandra bose in essay in english, opposing viewpoints opinion essay, research paper topics current social issues define rock music essay makkar academic essay pdf 5 class Essay mother on essay on the menstrual cycle, case study on e learning reflective essay on domestic violence A Cycle as Old as Time. In U.S. history, international history, and going back literally thousands of years to ancient Greece and Mesopotamia, the common answer during generational peaks in debt levels, almost inevitably, is that currency itself eventually gets devalued by some extent instead of just a nominal debt collapse occurring
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