We read a lot about the economy in the news. They are like data points describing the state of the economy, such as GDP, capacity utilization, purchase managers’ index, cpi, etc. Without a general framework in mind, it is overwhelming. We need to have a framework in mind even if it may not be correct. Then, we validate and improve the framework by collecting different data points.
I would not describe myself as a macro guy. Probably it is because I am a fan of Warren Buffett. He emphasizes understanding the business itself instead of focusing on the macroeconomic factor. Indeed, how many times are economists right about the recession? But reading those indicators every day, I cannot deny they do give some directional insights on the business cycle. We can most likely not be able to get the exact timing of boom and bust. But, we can get a sense of which phase the economy is in.
I will share a few general frameworks I have learned from reading the book called, The Guide to Using The Wall Street Journal. Yes, I am reading a book on how to read a newspaper. Indeed, sounds crazy. Basically, I am downloading different frameworks to my mind. I am not very confident they are correct. But I can validate them using data later.
The part that resonates with me is the relationship between capacity utilization, labour productivity, and unit labour costs. Companies are cutting workforce all over the World. When the economy is booming, companies are willing to sacrifice efficiency for growth. When a company is growing fast, the machine has less maintenance, people are working overtime, many new workers joined who are less efficient, and new systems or machines may not be tested. When the economy is going downhill, capacity is in excess. Companies start to cut workforce and emphasize efficiency. If we put ourselves into the management shoes, it is easy to understand the rationale behind it. No one wants to lose opportunities and when there is less income, you cut spending.
The above equation is easy to understand. When the price goes up, consumer demand reduces and vice versa.
There is another part in the book which I haven’t finished. It is about Fiscal Policy. I will update this post once I have finished.
A note of caution is that the formula shown above though suggests a cause-and-effect relationship, I prefer to treat it as a correlation first. The drivers or the causes of the economic cycle, the boom and bust are not obvious here. For example, the first set of equations starts with GDP. Should it be the result? the second set of equations starts with CPI. Should it be the result also? But by comparing the change in the above indicators, we can understand what phase the economy is in.
I have a strong feeling that the boom and bust are caused by human psychology and credit. Our greed and fear of loss. The expansion and contraction of credit. I do not have a clear framework now. More learning is needed.