Sunday, October 31, 2010

8 Phase Economic Cycle in Central Banking System and Fed's Next Stimulus

                October was a busy month and hence could not write much, but a lot happened over this month. Federal Reserve started talking about confirming Stimulus II / QE II (Printing Money out of thin air and Spending it once again). It was highly anticipated since last few months. Now before jumping into impact of Quantitative Easing on us, let's try to understand some basic economic cycle in Central Banking.

Here is the presentation that I believe will be useful to understand the same. I have articulated "8 Phase Economic Cycle in Central Banking System"  that has been running since beginning of Central Bank system e.g. (1913 in US). Please open it in separate window to see completely.

In order to prove demonstrated cycle, see graph below from Federal Reserve's site that shows both Interest Rate and (Recession periods with gray bars.) What you can clearly observe is,

# Every time recession comes i.e. we enter in gray area, Central Bank lower interest Rates.
# Baring early 90s recession for all other cases, higher interest rates have become pin for recession.

US Recessions

From 1980s till date Interest Rates are clearly going down as a trend. In US. (Reason why everyone has some connection with US monetary policy is that USD is world reserve currency and all currencies are pegged to USD except few. Hence everyone is impacted by USD in some or other way)

What differentiates 2008 crisis than all previous recessions are below facts.
# Continuing it's downward trend, Interest Rates are actually touched "0" (indicating weak and phony system) and economy still could not come up.
# So as additional measure, Lot of money was printed out of thin air in 2008-2009 (Which has never happened to this extent) and FED is speaking to "Act More"!!! 
#Graph below shows base money which is very sensitive thing. As you can see since 1910, this is the first time it has been increased this high.
#During 80s, Reason for 20% + Interest rate was to soak out 13% additional liquidity introduced in 70s. Here Base has increased by 120% and they are speaking of increasing it even more in QE II. Just imagine interest rates in 2020. 

US Money Supply

In short since we are stuck in Phase 1 out of 8 Phase cycle, as demonstrated on Presentation above, FED is printing huge money to send economy to Phase 2,3, 4. Obviously consequences are clear as there are only 3 Roads that go from here.

# If we succeed to Go to Phase 2, 3, 4 we will have great economy to begin with and very low unemployment in theory, but later it will turn out to be Zimbabwe style Hyperinflation, Price Controls and so on in whole world except few creditor nations.
# If we never succeed Go to Phase 2, 3, 4 (like till now ) we will end up in Stagflation i.e. both high unemployment and high inflation (But not hyper).
# If someone like Paul Volker comes again, who understand system better, for restoring currency value he will raising interest rates significantly and will allow severe but essential recession  (this is rare as it won't get political buy in.). But the only possible solution for survival in long term.

Let's see where we go...


  1. Well written Amaresh. Thanks for sharing thoughts.

    The raising and lowering of the interest rates are meant to regulate the economy. However, clearly the govt doesn't regulate it until balloons burst. And of course it is the common-man who pays severe price for it.

    So what's the solution, according to you, to break this vicious cycle ? What's the new system ? Is there a way to make the economy self-regulating ?

    Wishing you a Happy Diwali !
    - Atish .

  2. Amaresh Ashok GangalNovember 1, 2010 at 9:19 PM

    Thanks Atish for your comment. Solution is very Simple.
    1) Don't have paper currency. Have it tagged to bullion. Do you think someone will give bad loan in era of Hard Currency ?
    2) Rather than worrying of bonuses and salary of CEOs, let them loose jobs, make them seat home, and let banks fail. Believe me it would have been major mess!! but by now system would have cleaned up and started coming up clearly.

    Wish you a happy Diwali as well!!


  3. very Nice analysis in simple words yet again!
    So somethings gotta give, and its gotta be Fed again, if not for our next generations ;)
    So,500 billion it is this time to start with!

    Unexpected for me, the RBI raises rates by Just 25 basis points & Subbarao even indicates taking a pause in further hikes,while US goes to relax their already 'loose' policy!
    Personally I hope, Mr.Subbarao reconsiders & acts like his predecessor, unless he wants to do another Bernanke ;)

  4. Amaresh Ashok GangalNovember 2, 2010 at 8:57 PM

    Thanks Dheeraj,

    Yes I agree Primary Goals of Central Banks should be to Preserve the value of currency. Except Singapore, Switzerland, no one is doing it today.

    Germany looks like serious about it and may be in time to come they will do it.


  5. Solid, informative article. It seems to me that "recession" is equal to "money-not-changing-hands". The banks are too scared and controlled to allow any "borrowing" at this point ~ even to solid, "low-risk" people. Until money is available, and people are comfortable buying, purchasing, investing, it will be very difficult financially.


  6. Amaresh Ashok GangalNovember 3, 2010 at 4:26 PM

    Thanks Ralph,

    Absolutely true.. We are in Rock and HardPlace. Till "money-not-changing-hands" we have gloom . If it starts we have "Uncontrollable Boom". Finally Doom is inevitable.


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