Economic Cycles at Varying Times Over Various Industries - Essay Example

International Economic Systems since 1918Since 1918 lots of economic changes has happened. However, the whole timeline of economic and social development can be easily divided into era before and after 1918. Thus, there was a progressive era, depression era, wartime, after war progress etc. We see economical changes from1918s onward in sequence of different eras. From 1890 to 1920 there was an era known as the progressive one as during this time period a new rule was applied that working time should be 8 hours, which caused much of progress in economy. In the early years of American history most political leaders were hesitant to heavily involve the federal government in the private sector, except in the area of transportation (Anderson, T. G., 2001). In general, they accepted the government interference in the economy. The main interference was done with an objective to maintain law and order within the territory. A changing attitude to the issue was seen during the 19th century. During this time small businesses, farm, and labor movements started searching for possible ways to reform their business and to involve government in assisting them with the issues (Baillie, R., Myers, R. J., 1991, p.5) By the start of the new century many political changes had occured that appreciated the government favors and help that gave the rise to progressive era. Different acts were passed on food and administration as well as federal trade agencies development (Schwert, W. G., 1989) In 1913 Henry Ford adopted the moving assembly line with each worker doing one simple task in the production of automobiles. From 1920 to 1929 there was an era known as roaring era. This era was marked by a rapid development of the automobile industry. The list of other industries included oil, glass, and road-building industries. The other tendency was that tourism enhanced and more consumers started to use cars, what led to a perspective that was far wider than simple shopping. A remarkable feature of those times was prospering of small cities. As for large cities they had their best time. This time of American history was marked by a boom in construction of offices, factories and homes. The other important tendency was that the industry helped to transform both business and everyday life into something that singled out the US from other states (Shiller, R. J., 1981). Millions of people migrated to nearby cities. However, in October 1929, the stock market crashed and banks began to fail in the Wall Street Crash of 1929. Stock market crashed was started from US and spreads to whole world where the prices of the stock exchange was lower down leads to stock crash that was the start of the depression period. (Poon, S., Granger, C., 2005) 1929 to 1941 This period was marked as depression period. Although the time for depression varies depending on the state it is generally stated that great depression stated in 1929 and lasted until the late 1930s or early 1940s. It was the longest and most devastating period in human history. The Great Depression is considered to be the worst economic downturn ever in the US history that had impact on the whole world. Official beginning of the depression is regarded to be the Black Tuesday of October 29, 1929. Several main causes are named to lead to the depression. First was unequal distribution of wealth between the rich and the middle class as well as between industry and agriculture (Gusmorino). Second was numerous bank failures and debt deflation (Waggoner). Third was overproduction and under-consumption in industry and agriculture (Rothbard). Fourth was the extensive stock market speculation that led to the stock market crash in October 1929 (USA Depression). However, all these factors were greatly interrelated adding to dramatic economic downturn, massive unemployment and poverty. The rise in nation’s total realized income was from $74.3 billion in 1923 to $89 billion in 1929 (Gusmorino). Still, these incomes were distributed unevenly between upper and middle classes. The combined income received by the top 0.1% of American population equaled to the incomes of 42% of Americans on the other end of the scale; top Americans controlled 34% of savings, while other 80% of people did not have any. Average Americans enjoyed only 9% increase in their disposable income from 1920 to 1929, while Americans within top 0.1% had their incomes increased by 75% (Gusmorino). A major reason for such gap in income was popularized in theory by economists Waddill Catchings andWilliam Trufant foster (Causes of the Great Depression, Wikipedia). Their theory stated that “economy produced more than it consumed, because consumers did not have enough income” while benefits produced by increased productivity went into corporations’ profits and then into the stock market. The consumption during the Great Depression contracted greatly, which can be seen from the statistics Depression’s impact on people in terms of consumer spending on some selected items: Consumer spending (in billions) on selected items, 1929-33   1929 1933 Food $19.5 $11.5 Housing $11.5 $  7.5 Clothing $11.2 $  5.4 Automobiles $  2.6 $  0.8 Medical care $  2.9 $  1.9 Philanthropy $  1.2 $  0.8 Value of shares on the NYSE $89.0 $19.0               Historical Statistics of the United States. During the period from 1923 to 1929 increase in average output per worker in manufacturing was 32%, while the increase in average wages for manufacturing jobs for the same period was only 8% (Gusmorino). Obviously, the wage increase rate was far behind the increase rate in productivity resulting in less disposable income for workers and more capital available for corporations to invest. The government and Federal Reserve at that time favored excessive business investments into boosting industrial capacities through low discount rates (Gusmorino; Rathbard; Wikipedia), which resulted in overinvestment and overproduction of the goods that consumers could not afford to buy. A contemporary article in Current History of 1932 stated: “We still pray to be given each day our daily bread. Yet there is too much bread, too much wheat and corn, meat and oil and almost every other commodity required by man for his subsistence and material happiness. We are not able to purchase the abundance that modern methods of agriculture, mining and manufacturing make available in such bountiful quantities. […] Through such a period of imbalance, the U.S. came to rely upon two things in order for the economy to remain on an even keel: credit sales, and luxury spending and investment from the rich” (Gusmorino). Therefore, the solution was to give the consumers possibility to buy on credit and, thus, increase consumer spending. The possibility to buy and pay later was quickly caught on. Credits were easy to get and large numbers of people borrowed money from banks. People started not only buying desired goods on credit terms (Gusmorino), but also started investing by buying stocks at high prices in hopes of selling at even higher prices (Maxwell). Stock prices were soon overestimated and were kept artificially high, creating a stock market bubble. However, when stock market crashed due to fraudulent speculations stock (Stock Market Crash of 1929) holders rushed to sell their stock, but were not able to receive their investments back losing their financial means for leaving. Big declines in the stock market reduced peoples wealth and decreased spending (Waggoner). Many companies went bankrupt putting people without earnings, and those companies that managed to stay preferred to lay off their work force. The unemployment rate sharply rose to 25%. A quick and decisive response to such developments in the economy was made by the President Hoover, who called a series of White House conferences with the leading financiers and industrialists of the country, to encourage them to keep wage rates and expand their investments. The President insisted that “immediate “liquidation” of labor had been the industrial policy of previous depressions. […]If wage rates were to be reduced eventually, they must be reduced no more and no faster than the cost of living had previously fallen, (so that) the burden would not fall primarily on labor” (Rathbard 210)Although from the economic point of view such steps would intensify depression by reducing purchasing power, Hoover insisted on industry trying to keep people employed, and spreading necessary reductions in work should over all employees by reducing the work-week. According to Hoover’s program, “reducing the work-week could only spread unemployment, and prevent that pressure of the unemployed upon wage rates which alone could have restored genuine full employment and equilibrium to the labor market. If industry followed this course, great hardship and economic and social difficulties would be avoided” (Rathbard 211). Many industrialists agreed to Hoover’s program and encouraged other nation employers to keep the wages rate and work force. Henry Ford’s reply to this situation was even to announce a wage increase (Rathbard, 212) as he believed that “if the prices of goods are above the incomes of the people, then get the prices down to the incomes. Ordinarily, business is conceived as starting with a manufacturing process and ending with a consumer. If that consumer does not want to buy what the manufacturer has to sell him and has not the money to buy it, then the manufacturer blames the consumer and says that business is bad, and thus, hitching the cart before the horse, he goes on his way lamenting” (Ford). Although Ford Motor Company, for example, tried to keep its work force employed and maintain higher wage rate, it had to cut the wages, reduce the scale of the operations and lay off workers next year (Rathbard, 270). The great depression had shocking effects in nearly every country, developed or underdeveloped. Unemployment in the U.S. rose to 25%, and in some countries raised up to 33% (Bentz, Y. 2003). Overall historical statistics of the Great Depression’ impact on the economy was:   1929 1933 Banks in operation 25,568 14,771  Prime interest rate 5.03% 0.63% Volume of stocks sold (NYSE) 1.1 B 0.65 B Privately earned income $45.5B $23.9B Personal and corporate savings $15.3B $2.3B Historical Statistics of the United States. Reasons of prolonged depression It seems that there are lots of reasons of prolonged depression in US. Here we through light on some reasons of the long depression. In 1920, the manufacturing, selling, import and export were restricted due to the amendment constitution of the United States. Whereas it was never illegal to possess the liquor this leads to the under consumption of the alcohol, this cause to the illegal and well organized criminal gang development in united states those were exploded in numbers, finances, power, and influence on city politics. Coal mining was replaced by oil. The great depression was followed by the stock crash as the economy goes down. The Federal Reserve Board did not directly causes the depression but it did not made any effort to prosper by not helping banks. The money supply fall by one-third, and it was difficult to get loans. President, Herbert Hoover during his last years passed a massive tax increase to boost drooping federal revenues, and signed the protectionist Smoot-Hawley Tariff, which provoked vengeance by Canada, Britain, Germany and other trading partners. Further major policy mistakes are discussed in terms of monetary contraction, tax hikes, restrictions on international trade, high prices etc. Monetary Contraction, Due to the fault of the Federal Reserve the depression was precipitated by a one-third drop in the money supply from1929 to 1933. The Federal Reserve made further errors that put the economy back. Meanwhile, ‘many bank failures in the early 1930s compounded the money supply shrinkage and increase the economic fears.” () A main problem was that most states prevents their bank branching that restricts the banks to wide spreads its portfolio across the borders. Tax Hikes. In the early 1920s, Treasury Secretary Andrew Mellon championing income tax cuts that reduced the top individual rate from 73 to 25 %. But these successful taxes cuts were forgotten as the economy goes downwards after 1929. President Hoover signed into law the Revenue Act of 1932, which was the largest peace time tax increase in U.S. history. The act increased the top individual tax rate from 25 to 63 %. (Black, F. 1976) The highest individual rate was increased to 79 %. State and local governments for the first time increased taxes during the 1930s, and on many individuals income tax imposed. All these taxes “increases decrease the incentives for work, investment, and entrepreneurship at a time when they were needed.” (Bollerslev, T., 1986) Restriction on International Trade In 1930, President Hoover made a remarkable step. He made a radical decision to sign the law which was later on known as the infamous Smoot-Hawley trade act. This act helped to raise import tariffs to the average number which was close to 59 percent on more. More than 60 countries in the world were restricted to imports products of US. As new trade restrictions were imposed around the world, trade fall. By 1933, world trade goes down to just one-third of the 1929 level. Keeping High Prices In National Industrial Recovery Act of 1933 stated that more than 500 industries will face the need to limit their competition. These companies were also told to maintain high prices and wages. Businessmen who cut prices were fined, and sometimes arrested. There was no price war at that time. (Chordia, T., and Shivakumar, L., 2002) The Agricultural Adjustment Act of 1933 also Restrict the production to keep prices high. “Excess” output was destroyed or wasted .While millions of Americans were going hungry, the government cultivated under 10 million acres of crops, slaughtered 6 million pigs, and left fruit to rot. 1941 to 1945 It was the war time control, during this era the industries were asked to manufacture the war products instead of local products such as automakers built tanks and aircraft, for making the United States the "arsenal of democracy." 1945 to 2010 The time period from 1945 to 1973 was the golden era for the United States as about 200 million war bonds were matured at that time similarly Bill also financed for the education of the people. By 1970 council of economic advisors was developed that increases the employment, profits and reduces the inflation. From the early 1960 the factors appear about the economy decline and in 1970 it happened in great extend. At that time US depends on OPEC for oil consumptions that result in decline of oil in 1973 and 1979. That was a big shock to them. Then Under President Nixon government experiment of wages and price control. The Britten Wood agreement also collapse on 1971-1972. Then President Nixon blocked the gold window at the Federal Reserve, then US totally goes off the gold. In 1974, productivity decrease by 1.5%, but it recovers very soon. In 1976, Jimmy Carter becomes the new president, But in his period inflation goes to its climate and productivity and growth was very small. In 1981, Ronald Reagan introduced Reaganomics. That is economic policies, in that policy they used to cut 25% federal income tax. Inflation dropped from 13.5% annually in 1980 to just 3% annually in 1983 due to depression and the funds. (Bikhchandani, S., Hirshleifer, D., Welch, I., 1992) In 1992 Bush and a third party candidate lost election from Bill Clinton. With in his period though the inflation was there but people can purchase a lot at that time. Then the period of globalization came, it was the time when American moves to third word countries they experience the cheap labor and taken benefit of them. 2008 is the disaster for the economy for whole word as for Americans as well, many banks went bankrupt, such as Lehman Brothers with $690 billion in assets; other include an insurance company AIG, and a leading bank citigroup. And there are some other companies facing crisis at that time. (Ghysels, E., Santa-Clara, P., Valkanov, R., 2006) By the 2008 there was some major financial crisis occuring and it happened with automobile industry with big companies like General Motors, Ford and Chrysler they were on the verge of bankruptcy. There are lots of problems at retailer sides as well. In Feb 2009 Barak Obama sign American Recovery and Reinvestment Act of 2009 the bill provides $787 billion in stimulus through a combination of spending and tax cuts. (Banerjee, A. V., 1992) The cause of great depression is still under the debate of different economist, but many agreed upon that it is due to the crisis in stock market. The events that can be seen in periods of depression are shortage of supply, increase in prices, and increase in unemployment. However, historians have no consent in relating the causal relationship among various events and the role of government financially viable policy in causing or increasing the Depression. Spending Rate and Equity Volatility In order to measure the relationship between how consumer spending affects equity price volatility and impact on eventual stocks prices, we need to develop a proxy that will result in determining the relationship that would translate the whole macroeconomic context. So to determine the consumer spending rate, we will do a detailed analysis of the fundamental drivers of an economy specified only to US in our case over the past 100 years. In our model our explanatory variable will be the equity return from the three main indices domiciled in US, i.e. S&P 90 Index, S&P 500 Index and DJIA. To add, to filter out the noise and distortion we would take the average return as a final proxy to regress against the independent variables. In our mode we will take the Industrial Production (IP), Consumer Price Index (CPI)_, Commodity Producer Price (CPP), Credit Spreads ( CS), Bond Indices (BAA) and S&P Corporate Earning (EA). All these factors are proxy to determine the macroeconomic indicators which will eventually result in the final coefficients and show how each element translates the overall spending rate. (Chordia, T., Shivakumar, L., 2002) According to economic principles the supply creates its own demand, which is true to some extent and can be well spaced in the vice versa spectrum. In a time series analysis we will need to distinguish between different chronological eras of US history in relation to economic swings. From recession to abnormal growth all the eras are respectively defined and seasonality adjusted returns are normalized to regress during the period under review. Volatility Chronology Taking Log of the equity volatility and observing how the pattern is followed during various economic regimes helps to understand that at time when the volatility increases it is an indication of economic down turn. Hence, the opposite is true when the value declines. From the time line before the Great Depression that started in 1929 the volatility started to rise and it peaked during the period 1929 to 1940. Since the economic conditions started to take off from that time the volatility in equity returns diminished and bottomed around 1960 when the economic thrift made all the fundamentals signal prosperity. Afterwards, since 1980 the financial markets have been introduced with sophisticated financial instruments which contain highly volatile derivatives. In this context, and similar kind products were widely available to small investors, which created a bubble. In the most recent times the first bubble that went bust was that of subprime mortgages, which had washed away billions dollars from the balance sheet of many financial institutions. Inherently these included a feature of free at the money call to the home buyer which virtually mitigated the owners risk for the first three years. (De Long, Shleifer, Summers Waldmann, 1990). Therefore, excessive demand inflated home prices across the US. When the prices reached a certain threshold and fetching even higher prices seemed impossible, the bears took over the market and the whole economy crashed and the equity volatility was obviously bound to peak. Consumption and Economic State As it has been already discussed, we will derive our model on the basis of well-established economic principle affecting the spending rate and industrial production. Their relationship will define our hypostasis of how spending and equity return are related. From the stock market perspective it has been quite a well-established phenomenon that earnings growth is a function of sales and profit margin growth. As industrial production IP witnesses a lower demand, the equity prices shrinks and the volatility is thus increased if the future sales are unpredictable. This uncertainty is varied and is much related to the state of economy. During the great depression same rate of the future uncertainty was anticipated as volatility raised and return diminished. Empirical studies indicate a strong relationship between IP and Equity returns and the co movement between the two is high. The question that still arises in one’s mind is how and where the liquidity drains in times of economic depressions whilst the overall liquidity available in the market remains the same. In order to answer this question and understand the dynamics of this spending or liquidity trap we need to take a closer look not just at M 1 and M 2 money supply, but on a broader spectrum to define the overall economic activity. Model Results In order to measure the true pattern of each component, we have scaled the volatility in each element in a mean standard deviation space. As Z scores are produced for each component the independents regress. Since the correlation results are varying for different regimes it is more appropriate that we utilize the multiple regression results in order to estimate the dependency of our dependent variable which we used to proxy spending rate across various time lines. Before embarking on running regression, principle component analysis on each element is traced to witness whether or not much of the variation is explained by each component alone in order to include them in our list of variables. Adjusted R2 for the model turned out to be 0.64, which is quite reasonable. To add, the contribution of each factor is given above which shows how much each element is factoring in achieving this results. Each of the elements had a T statistic of over 1.96. With such sample observations each component thus has a 95% confidence level. (Anderson, T. G., 2001) The unexplained variation could not be further reduced due to many other relating factors which were not included in the model. However, it can be concluded that with such lengthy time space we can now predict future volatility as a function of these elements. Liquidity Function Contrary to the traditional belief, liquidity in a system is not a function of money supply. Instead it is much more affected by the level of risk aversion in any economy. This natural phenomenon is what maneuvers the economic state in any system. Risk aversion is much dependent on the future expectations, and analysts usually are subject to psychological bias. That is why their expectations are highly influenced by the recent incidents. For this reason if the economy is booming they tend to forget that the cycle would ever reverse likewise the opposite happens when the economy shrinks. In order to assess the true future potential such market corrections have to be taken into account as they do affect the consumer spending as well as equity returns. Importantly, both rebound as more and more investors realize the optimal potential based on the fundamental grounds. Economic Development Economic cycles are witnessed at varying times over various industries and thus differ among regions. However, the great depression was the time when every part of the world got affected during the same time period. After World War I, economic activity and development across the globe picked up at a phenomenal pace until the 1930s when the period of abnormal growth could not sustain its pace even further, as political upheavals reshaped similarly to economic powers, who by then managed to prove their dominance in air and over land as well. Empirically, much of the development is followed by the World Wars, which have played a pivotal role in developing nations. Hence, those who had learnt from the lesson are now the economic giants. The story that is common to all the developed nations as we see them in modern day. (Anderson, 2001) Conclusion From the historical and economic standpoint, much of the variation in demand is a function of macroeconomic indicators factored in our model. Moreover, in our study we have reviewed liquidity or spending as a measure of risk aversion which to an extent plays a dominant role in defining the consumer spending and, thus, eventually the equity prices. Since there is no proxy through which we could have captured this relationship and non availability, we have not included risk aversion in our model. Had we had any such components available, our regression results might have performed even better. References: Anderson, T. G., et al. (2001). ἀ e distribution of realized stock return volatility. Journal of Financial Economics 61:43–76. Baillie, R., and Myers, R. J. (1991). Bivariate GARCH estimation of the optimal commodities futures hedge. Journal of Applied Econometrics 6:109–24. Banerjee, A. V. (1992). A simple model of herd behavior. 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