Last week, I put a pair of sneakers in my dryer to warm them up before a cold morning run. The rhythmic thump of my shoes hitting the bottom of the dryer drum after cycling up the right side and then being pulled down by gravity got me thinking about economics.
Do businesses, credit and the economy expand and contract in a somewhat predictable pattern, just like the huuuuuuuum, thump, huuuuuuuum, thump of my shoes in the dryer? This is the question Ray Dalio of Bridgewater Associates attempted to answer with a thirty-minute animated film in 2013. The film gathered a lot of attention from finance and non-finance people alike (Bill Gates said the film “would help everyone” who watched it, and former Fed Chairman Paul Volcker said it “casts strong light on how the economy actually works”).
In simplistic terms, the film tells us that when investors borrow money, they are borrowing from themselves in the future. If you borrow $10,000 now and spend it on college tuition, after graduation you will need to decrease spending to pay back the $10,000 (plus the cost of money, interest). Increase, decrease, increase, decrease, just like my shoes in the dryer. If we aggregate everyone together – collectively, “the economy” – Dalio argues/explains that broader trends exist: people and businesses tend to increase and decrease spending and borrowing simultaneously.
Figuring out where we are in the cycle can be worthwhile. If a money manager suspects a recession is coming in the next twelve months, for instance, she might load up on safe Treasury bonds before everyone else does. But answering the question “where are we in the economic cycle?” turns out to be tough. Recent research from Goldman Sachs, however, takes a stab at it.
Using a model of fifteen economic variables (employment, manufacturing, equity market levels, etc.), Goldman says we are still in the early stages of the economic cycle.
My shoes are just barely making their way up the dryer drum, they argue, and surely we have a long way to go before the thump (Goldman gives us just a 5% probability of recession in the next six months). Underlying their assessment of our location in the cycle are labor market slack, subdued inflation and monetary policy consistent with “easing.”