The U.S. Economy is Entering a New Thirteen Year Cycle

 

I believe the U.S. is about to enter a new thirteen-year cycle with unknown consequences. I first became interested in the topic of thirteen-year cycles in 1995 when I was Chief Equity Strategist at Salomon Brothers. I wrote “1996: Stock Market Bubble or Paradigm Shift?” in December 1995. In that report I discussed what appeared to be distinct 13-year stock market cycles in equity valuations. After a long 27 years this post updates that view to help explain the U.S. economy over the past eight decades. In fact, I have identified seven such cycles.

 

In that report I noted that there was a thirteen-year period, 1918-1931, between the end of World War I and the onset of the Great Depression. I choose 1931 instead of 1929 because the year 1931 was the year when the depression became Great. Because the Great Depression was not the only episode where a major economic contraction followed a war, investors and economists wondered if history would repeat after World War II ended in 1945.

 

The first cycle occurred from 1932-1945 where the hitherto laissez faire economy of the United States was transformed in the dying moments of the Hoover Administration, the New Deal, and the war economy into an economy with substantial government involvement, the rise of industrial unions, the creation of a social safety net and the commandeering of resources to win World War II. It truly was a revolution in economic affairs.

 

The second cycle (1945-1958) was characterized as the transition from a war economy to a peacetime economy leading to a sustained consumer boom centering on suburban housing and automobile production. The boom was reinforced with a high level of peacetime defense spending to handle both the Korean War and the exigencies of the Cold War. Despite the boom, the gret fear during that period was the fear of a renewed depression.

 

The third cycle began with the 1957-58 recession which was the third and worst downturn since the end of the war. The economy did not evolve into a depression, but rather fiscal and monetary policy came to the rescue and a sharp recovery ensued. With the arrival of the Kennedy Administration in 1961, Keynesian economics offered the promise that government policy had the ability to tame the business cycle and fear of a new depression disappeared. Both investors and economists cheered the “soaring 60’s.” Thus, a thirteen year cycle was born beginning in 1958 and ended in 1971 with Nixon taking America off the gold standard and implementing wage and price controls. Something went awry in the Keynesian wonderland.

 

What went awry was, of course, inflation. In December 1967 Milton Friedman delivered his now famous presidential address to the American Economic Association. He argued that there was no long run trade-off between unemployment and inflation. As a result, the counter-cyclical policies advocated by the Keynesians would lead to ever higher inflation, which was proved out in the 1970s. The next thirteen-year cycle 1968-1981 was a period of high inflation and stagflation. Admittedly there is some overlap here. Thus, if the 1960’s represented the heyday of Keynesian economics the 1970’s represented the heyday of monetarism.

 

A new cycle emerged in 1982-1995 where after Fed Chairman Paul Volcker broke the back of inflation, the fear of a renewed inflation dominated both the economy and the financial markets. Instead of fearing depression, investors feared a renewal of inflation. It was the mirror image of the 1945-1958 period.

 

However, a new thirteen-year cycle, 1995-2008, emerged after Fed Chairman Alan Greenspan pre-empted an emerging inflation in 1994 by doubling the federal funds rate from 3% to 6%. That action put a dagger into inflation expectations and ushered in the heyday of the Federal Reserve. Economists and investors believed that price stability was the path to long term growth and the Fed had the ability to keep the economy on an even keel. A key feature of the period was the full flowering of globalization which suppressed inflation.

 

The Fed was so good at maintaining economic stability that a “Minsky moment” arrived in 2008. Macroeconomic stability led to financial instability where investors were lulled into taking and unprecedented level of financial risks. As a result, housing crashed, and layers of financial derivatives caused the financial system to buckle as it had not done so since 1931-32.

 

The 2008-09 financial crash signaled the onset of new cycle which forced the Federal Reserve to engage in hitherto unprecedented monetary policies and caused to the new Obama Administration to revive expansionary fiscal policies that were long thought to be obsolete. To head off an impending debt deflation the Fed adopted a zero-interest rate policy, bought trillions of dollars of questionable paper and proceeded on a policy of quantitative easing to keep the economy flush with liquidity. Those policies were reintroduced on steroids in 2020 with the emergence of the COVID pandemic. The great fear during this period was the potential for new financial crisis and the ongoing risk of an incipient deflation.

 

With respect to fiscal policy the Obama Administration offered up a large, but inadequate, $900 billion fiscal package. In 2021 the Biden Administration overlearned the lesson of 2009 and offered up an unprecedented level of fiscal stimulus. That stimulus along with supply constraints associated with the pandemic brought with it an inflation rate unseen since the early 1980’s. Put bluntly, the thirteen-year cycle that began in 2008 came to an end in 2021.

 

My guess is that we are at the very beginning of new thirteen-year cycle with unknown consequences. I would speculate that the next thirteen years will bring with it a much higher rate of inflation than we have been used to, a multiyear bond bear market and a partial deglobalization of the economy caused by local politics, supply chain issues and geopolitical tensions. To me the big question is whether this cycle will bring with it a stagflation or a high cap-ex/high inflation economy with a cap-ex boom coming from the in-shoring production and energy transition. As they say, time will tell.