Understanding the Current Economic Cycle
Summary
TLDRThe speaker discusses the uniqueness of the current economic cycle compared to past experiences, emphasizing the importance of understanding income-driven expansions and their impact on monetary policy and asset prices. They highlight the confusion caused by the absence of traditional credit creation and the shift from credit or money-driven to income-driven economic cycles. The speaker suggests that the main factor leading to a recession would be a rise in long-term interest rates, which would affect asset prices, spending, and ultimately employment and wages, creating a sustainable slowdown in demand.
Takeaways
- 🔄 The current economic cycle is distinct from previous ones, requiring a deeper understanding of its dynamics rather than just the unusual nature of its drivers.
- 💼 The speaker emphasizes the importance of recognizing second and third order consequences of income-driven expansions on monetary policy, asset prices, unemployment, and inflation.
- 🤔 There's a noted confusion among investors and policymakers, as the current cycle doesn't fit the traditional credit or fiscal-driven expansion models, which can be resolved by reframing thinking to an income-driven expansion.
- 🏦 The speaker points out that unlike previous cycles, there is minimal credit creation occurring among households or businesses, yet the economy continues to expand.
- 💡 The traditional income-driven expansion is highlighted as the oldest type of economic financing, where spending leads to income, which in turn leads to more spending in a sustainable cycle.
- 📉 The speaker suggests that asset prices falling, likely due to rising bond yields, could be the catalyst for a shift in consumer behavior from spending to saving, potentially leading to a recession.
- 📈 Despite the absence of significant credit or money creation, asset prices are rising, and the economy is growing, indicating a different type of economic driver at play.
- 💬 The Federal Reserve's confusion is mentioned, with an example of an essay by Neil Kashkari that questions the effectiveness of monetary policy in the current cycle.
- 🌐 The script discusses how business cycles and expansions have commonalities across countries and time, suggesting that the current cycle is not as unusual as it may seem.
- 🏁 The speaker anticipates no recession in the near future, as the conditions that typically lead to one (credit growth slowing down, money growth slowing down) are not present.
- 🛑 The path to a recession, if it occurs, is likely to start with long-term interest rates rising, which would affect asset prices, spending, earnings, incomes, employment, and wages, eventually leading to a slowdown in demand.
Q & A
What is the core idea discussed in the transcript about the current economic cycle?
-The core idea is that the current economic cycle is different from past cycles, requiring a deeper understanding of the dynamics driving it, which are unusual to us but common in the context of historical business cycles and expansions across countries and time.
What does the speaker suggest about the nature of income-driven expansions and their consequences?
-The speaker suggests that income-driven expansions have second and third order consequences for monetary policy, asset prices, unemployment, and inflation, and understanding these can help in framing and comprehending current economic conditions.
Why might the current economic cycle be confusing to some?
-The cycle is confusing because it differs from credit or fiscal-driven expansions. It lacks the usual credit creation among households or businesses, yet the economy continues to expand, which contradicts the traditional economic models.
What does the speaker mean by 'reinforcing mechanism' in the context of economic cycles?
-A 'reinforcing mechanism' refers to a self-sustaining process where one economic activity leads to another in a positive feedback loop, such as increased spending leading to income, which in turn leads to more spending.
How does the speaker describe the relationship between asset prices and consumer spending?
-The speaker describes a scenario where rising asset prices and good wage growth encourage consumers to continue spending, as they feel wealthier and have less incentive to save.
What is the speaker's view on the role of monetary policy in the current economic cycle?
-The speaker believes that monetary policy has been less effective in the current cycle due to the absence of credit creation and suggests that the focus should be on income-driven dynamics.
What does the speaker suggest as the primary factor that could lead to a recession?
-The speaker suggests that a recession could be triggered by a rise in long-term interest rates, which would hurt asset prices, reduce consumer spending, and eventually affect earnings, incomes, and employment.
How does the speaker explain the difference between a 'spiral' and a 'reinforcing mechanism' in economic terms?
-A 'spiral' implies an uncontrolled, escalating cycle, either upwards or downwards, whereas a 'reinforcing mechanism' is a more stable, sustainable process that can continue for an extended period without leading to extremes.
What is the speaker's perspective on the current state of credit creation?
-The speaker notes that there is essentially no credit creation occurring among households or businesses, which is at recession-like levels, yet the economy continues to expand.
What does the speaker imply about the role of fiscal policy in recent years?
-The speaker implies that despite a fiscal contraction over the last three years, the economy has continued to grow, and asset prices have risen, suggesting that the current expansion is not fiscally driven.
What is the speaker's view on the necessity of bond yields rising to create a recession?
-The speaker believes that rising bond yields are a prerequisite for a recession, as they would lead to falling asset prices, reduced consumer spending, and a subsequent slowdown in economic activity.
Outlines
🔍 Understanding Unusual Business Cycles
The speaker emphasizes that the current economic cycle differs from past experiences, requiring a deeper understanding of its driving dynamics. They highlight that income-led expansions have significant second and third-order effects on monetary policy and asset prices. The confusion stems from the unusual nature of the cycle, which contrasts with credit or fiscal-driven expansions. The speaker suggests that reframing the perspective to an income-driven expansion can provide clarity. They also mention the Federal Reserve's (FED) stance and the public's confusion about the current economic situation, suggesting that the cycle's unusual nature is the root of the misunderstanding.
📉 The Role of Asset Prices and Income in Economic Cycles
This paragraph delves into the factors that could lead to a recession, focusing on the importance of asset prices and income growth. The speaker argues that a recession is unlikely unless there is a significant change in consumer behavior, such as increased saving due to fear or falling asset prices. They explain that rising bond yields could be the catalyst for falling asset prices, which in turn would affect spending, earnings, incomes, employment, and wages, eventually leading to a slowdown in demand. The speaker also discusses the sequence of events that could lead to a recession, emphasizing the importance of long-term interest rates and the potential for an exogenous shock to disrupt the economy.
Mindmap
Keywords
💡Business Cycles
💡Income-Driven Expansion
💡Monetary Policy
💡Asset Prices
💡Unsustainable Debt Creation
💡Credit Creation
💡Fiscal Policy
💡Income Growth
💡Asset Price Volatility
💡Bond Yields
💡Recession
Highlights
The current economic cycle is distinct from past experiences, requiring a deeper understanding of its dynamics.
Income-led expansions have second and third order consequences for monetary policy and asset prices.
The gap in understanding stems from a failure to recognize traditional income-driven expansion patterns.
Monetary policy confusion is evident in recent Federal Reserve communications.
Re-framing thinking from credit or fiscal expansions to income-driven can provide clarity.
Current economic expansion lacks the typical credit creation seen in previous cycles.
Economic growth persists despite minimal credit creation, challenging traditional economic models.
The role of money creation in driving asset prices and the macroeconomy has diminished.
The economy is experiencing a type of expansion financing not driven by credit or money creation.
Historical periods of stable money supply saw business cycles driven by income and spending.
The self-reinforcing income-driven mechanism is sustainable and not inherently a spiral.
Fiscal policy has contracted in recent years, yet economic growth and asset prices continue to rise.
The focus should be on income, rather than credit or money, as the primary driver of economic activity.
A recession is not imminent, as the conditions for one are not present in the current income-driven scenario.
For a recession to occur, there must be a decline in income growth and increased fear leading to reduced spending.
Asset price falls, driven by rising bond yields, are the likely catalysts for a shift towards a recession.
The sequence of events leading to a recession begins with long-term interest rate increases.
Last fall's taste of rising bond yields and subsequent easing illustrates the potential triggers for economic slowdown.
Transcripts
with the core idea that um the the cycle
that we're seeing today is very
different than the cycle than that we've
experienced the cyles we've experienced
over the course of our professional
careers and so they require uh the
ability to sort of step back and really
deeply understand um not the the fact
that the Dynamics that are driving them
are unusual to us but actually quite
usual quite common when you think about
how uh business Cycles have and
expansions have occurred you know across
countries across time which is that core
idea of an income Le expansion has a lot
of second and third order consequences
when it comes to monetary policy asset
prices um what's likely to transpire
with uh with you know unemployment
inflation Etc and so I think that's the
main Gap and and and I see it all the
time I see it for instance if you read
you know what the FED writes uh Neil
Kari came out with a with an essay that
basically is like I think monetary
policy is tight but growth doesn't seem
to be slowing down um you know somewhat
confused I think by the cycle that we're
seeing and I think a lot of investors
are confused by it but if you if you
reframe your thinking from credit driven
expansions or a fiscal driven expansion
to instead one that's a traditional
income driven expansion it's going to be
very very helpful in Framing and
understanding what matters and what
doesn't okay let me ask you one thing
before you go because that that I'm it
see it confuses me too and I imagine it
confuses a lot of folks as you point out
so why do you think it is confusing like
where do you think if you had to kind of
pinpoint where that comes from or what
that is what do you think it is well I
think the main thing that's confusing is
um we've had Cycles where inevitably
excesses emerge and where monetary
policy is effective at in excesses so if
you think about like the 06 to 08 you
know housing cycle housing bubble driven
cycle right we had huge credit growth
which got to a point where um where it
was totally unsustainable you know like
people were taking out greater than 100%
LTV loans with no doc financing you know
that didn't have jobs like that's the
sort of thing it you got to a point
where there's so much debt creation that
it was unsustainable that was going to
continue and you had a circumstance
where the fed's tightening
the raising of interest rates at that
time had was relatively effective in
slowing that cycle because 50% of the
loans were uh were uh financed on the
short end or were floating rate loans in
one form or another and so that's kind
of our our our framework that's the way
of our of our thinking but what's
happening today is that there is
essentially no credit creation occurring
uh among households or businesses it's I
mean there's not literally zero but
we're basically at recession like levels
of credit creation already and yet the
economy
expands and and so that's that's the
thing that's confusing is that if you
think about the economy through the lens
of credit being the driver and you think
about the economy uh through the lens of
money being the driver right because in
the post GFC period you know money
creation went up and down and up and
down and that drove waves uh in in the
in asset prices in the macro economy but
again what's happened in the postco
period is uh in the last couple of years
is that uh asset prices are going up the
economy is strong and money creation is
negative right and so what that
highlights is it's not money creation
it's not credit creation it's something
different it's a different type of
financing of an economic expansion and
it's a is it is in many ways the oldest
type uh of financing of an economic
expansion if you just go back to periods
where money supply was constant and
where there weren't well-developed Banks
how did to get business Cycles well
someone started spending and they handed
it to somebody and was somebody's income
and that person started spending and
they handed to somebody somebody's
income and that's a natural that's not a
spiral I think too often people go Oh
you mean there's a spiral it's not a
spiral it's just a rein a
self-reinforcing mechanism it's not a
spiral upwards or downwards it's a it's
a reinforcing mechanism a sustainable
reinforcing mechanism that can continue
for an extended period of time and
that's exactly what we're seeing is not
credit not money money um even the
fiscal story which really mattered right
after covid you know we've had actually
a fiscal contraction over the last three
years and nonetheless we continue to see
growth continue to plug along pretty
well and we continue to see asset prices
rise and it's all around that income
point so I also take it no recession
ahead or at least not anytime soon well
I think the main thing on the on on that
idea is um in order to get you have to
ask yourself what do you have to get in
order to get a recession uh and if it's
not credit growth slowing down and if
it's not money growth slowing down then
what you have to do is you have to you
have to get that income growth that's
happening you have to get people to
spend less of that income and how does
that work well the way that they spend
less of that income is they get scared
they you get scared that you have to
save more and spend less and so how does
that happen well the key way that that
happens uh is through asset prices fall
and so how are so because you know as
long as asset prices are going up and
you're earning a good wage like you keep
spending you know it's very natural that
people just keep spending as long you
know if you're again if you're a middle
class household like your house has gone
up 100% in value in the last you know
five years your 41k is up you know 50 to
100% in value in the last five years
like there's no reason to save right so
the question is what creates the
incentive to save and what creates the
incentive to save is falling asset
prices and what creates falling asset
prices in this environment is rising
bond yields and so that's when you talk
about when are we going to have a
recession we probably will have a
recession it'll happen at some point the
question is really the ordering which is
you start with uh long-term interest
rates have to rise and then that'll hurt
asset prices and then that'll hurt
spending and then that'll hurt earnings
and incomes and then that'll hurt
employment and then that'll start to
slow wages and then that will create
slowing uh a sustainable slowing of
demand but the path is that is in that
direction right so one has to the
ordering matters first Bonos have to
rise or I mean maybe there'll be an
exogenous shock but really first Bonos
have to rise that's the most you know
that's the the most likely way in which
this overall Dynamic starts to slow and
we saw a taste of that last fall but you
know Bon yels touched five and then they
went down and there was a big easing
that happened in response and so we did
really get that Dynamic to play out long
enough or high enough or painful enough
to start to really shift what's going on
with economic conditions and so the
question is not really when will uh when
will the recession come the question is
much more what has to happen to get to
the point of recession and the first
step of that is Bon's after r
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