Is The Fed Responsible For The Great Financial Crisis?

"Recessions are a natural economic feature and their regular occurrence is healthy and indeed essential," is how Deutsche's Jim Reid introduces his investigation into post-Fed un-natural business cycles. Without them there is a serious danger of bubbles and the misallocation of resources as the further market participants detach themselves from the last downturn the more they tend to under-estimate risk. We,

Jim Reid, Deutsche Bank: The history of business cycles in the US

The chart below shows the duration of each economic expansion (i.e. between all US recessions) since the NBER started collating statistics from 1854. This highlights the fact that prior to the GFC the three preceding expansions were in the top five on record. We can also show that this cycle is now almost exactly average length through history.


If we re-order these cycles by duration we can show more clearly how this current US expansion compares to those through history.


We passed the median cycle length at the start of 2012 and we will be past the historical average point by the end of this month (September 2012). This expansion is now the 12th longest out of 34 since 1854.

There are those that suggest that the Fed's inception back in 1913 has allowed for longer business cycles and for those interested we have colour coded those cycles (above) that occurred after this point, and also those post WWII when overall economy debt seemed to start a YoY increase that continues to this day. Countering the argument for longer post-1913 cycles would be the view that without the Fed helping to elongate several recent cycles, the GFC we've just been through might not have been anywhere near this deep and we are therefore now left in a unique situation at what is at the likely end of a multi-decade leverage binge consisting of several artificially long cycles. We are also now arguably in a liquidity trap where the Fed are less potent that they have been before in their near 100 year history.

The three 'super-cycles' between 1982 and 2007 were the exception rather than the norm, one where Central Banks and Governments had almost total flexibility over policy. The conditions that allowed for these long cycles perhaps started a decade earlier with the already much talked about collapse of the Gold Standard.

Unfortunately the 25-30 year build up of excess that this facilitated led to the GFC being the worst crisis since the 1930s and we have now likely moved to an era where policymakers no longer have the flexibility that defined the previous 25-30 years. Most Developed World (DW) Governments are up against their fiscal limits and are actually being forced into economically damaging austerity. We also have interest rates across the Western World that remain close to zero with little room to be lowered further. While we do have money printing, we are close enough to a liquidity trap that flooding the market with printed money doesn't have the same immediate impact on the economy as a cut in interest rates did in the long leveraging stage of the super-cycle.

So not only are we battling with the huge structural problems that the post-credit crisis world brings, we are fighting it without much policy flexibility and are indeed being forced into a reversal of stimulus at arguably exactly the wrong time.

So it all adds up to a return to more normal length business cycles in our opinion. Indeed one could make an argument for shorter cycles than normal given the lack of policy flexibility relative to most of history.

We, like Jim, would argue that the reason the Great Financial Crisis was so deep was due to the authorities continued refusal to let the business cycle take its natural course.