How to Predict the Next Economic Swing
Economies are in a constant state of flux. One minute a country is buzzing with positive activity, the next it’s experiencing a period of decline. The most memorable decline in recent memory was the 2011 financial crisis. Following on from a similar period of decline in 2008, Black Monday saw the US stock market crash and the United States sovereign debt rating downgraded from AAA (risk free) to AA+.
The world experienced another wave of economic turbulence in 2022, with the aftershocks reverberating into 2023. Like all testing times, there isn’t much the average person can do. Economies are finely balanced systems that can tip one way or the other when even the smallest variable changes. That’s an important point to understand.
Economic Swing Theories
People tend to assume that economic downswings should be preventable because they have a negative impact on our lives. That’s a fair way to think but, in reality, economic activity fluctuates which means there will always be times of prosperity and times of austerity. Knowing this is the first step in predicting the next swing.
Of course, no one can ever be 100% accurate when it comes to predicting the next period of economic growth or decline. However, by simply knowing that swings happen, you’re already on the right track. Using this as a starting point, we can defer to the work of agricultural economist Nikolai D. Kondratiev.
Economies Tend to Move in Cycles
Kondratiev studied 150 years’ worth of price cycles for copper and agricultural commodities during the early 20th century. He found they typically experienced “long-term cycles” during which prices fluctuated in wave-like patterns over 50-year periods. This theory has since been applied to economies at large and combined with other so-called cycles.
Again, these theories and cycles don’t necessarily give you the power to predict the future with 100% accuracy. By understanding that major industries and economies have historically gone through patterns of change, you can start to think about what might happen in the future. What’s more, by simply knowing that economic trends are cyclical, you can be better prepared for recurring events.
Some of the most commonly observed and defined financial cycles are:
- The business cycle: This cycle is based on a 40- to 45-month inventory cycle during which business activity can rise and fall. Essentially, there will be times when supply is high and demand is low and vice versa. These swings can affect the output and income of businesses.
- The Juglar cycle: This fixed investment cycle was identified by Clément Juglar in 1862. It observes a period of seven-to-10-year oscillations in fixed capital investments. Basically, this cycle looks at the flow of investments into stocks. The level of investment reflects the current financial state of an economy i.e. if investments are high, there’s more free capital within an economy. The Juglar cycle is split into four phases: prosperity, crisis, liquidation and recession.
- The Kuznets cycle: This cycle looks at periods of economic growth that span 15 to 25 years. It was proposed by Simon Kuznets who observed waves of change within economies due to mass migration. Put technically, Kuznets found that economic waves are influenced by demographic processes, including immigrant inflows/outflows. Increased immigration leads to a construction boom. This leads to more business activity which, in turn, increases the workforce. This economic growth leads to inequality as certain demographics prosper more than others. Things then start to swing in the other direction as inequality reduces. In unison, these swings result in a U-shaped curve of economic growth.
That’s an overview of how financial cycles can occur. Even if the specifics of each theory are up for debate, the point we’re making here is that swings (positive and negative) tend to occur in waves. These waves, according to the theories above, can happen over predictable time periods. Therefore, in an effort to predict the future, we can say (based on theory) that periods of growth and decline will occur at least once every seven to 25 years.
Make Sure You Plan Ahead
On a practical level, the economic calendar for major economies, including the US, UK, and Australia, can shed some light on potentially significant events in a given year. For example, if you scroll through the economic calendar for 2023 and filter the results based on importance, events such as unemployment statistics and retail sales are revealed.
Let’s say the UK government published its unemployment statistics in April and numbers are down. This would suggest the economy is in a stronger position than it was during the previous reporting period. From this, you can think about the theory of cycles and, potentially, conclude that the UK is in a positive wave. This is a very simplistic way of looking at economies, but it can be a useful way not just to anticipate swings but understand what’s going on.
Understand the Big Things to Control the Small Things
As we’ve said, you can’t control the economy. However, with a bit of knowledge, you stand a better chance of navigating the good and bad times. For example, if you’re aware a recession is brewing, you can take steps to minimize the amount of credit you have and cut unnecessary spending. Conversely, during prosperous times, you might want to take more chances and make investments or start a business. These aren’t hard and fast rules.
The point here is that understanding the swings of an economy can give you a better perspective on your own finances. Once you’re able to notice how the economy is performing and when a potential change is coming, you can adjust accordingly. Understanding the cyclical nature of economies and learning to spot when swings might occur are skills everyone interested in finance and personal wealth should acquire. Even if you’re not 100% accurate with your assessments, simply being aware of what’s happening and what might happen can give you a much better handle on your finances, which can only be a positive.