Boom and Bust Cycle, Causes, History, and How to Protect Yourself

28 Booms and Busts Since 1929

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The boom and bust cycle is the alternating phases of economic growth and decline. It's another way to describe the business cycle or economic cycle. According to the , they appear to be inevitable. But the more you understand their phases, causes, and history, the more you can protect yourself.

Phases of the Boom and Bust Cycle

The boom and bust cycle has the same four phases as the business cycle.

Phase Boom and Bust Business Cycle
1. Boom Expansion
2. End of Boom Peak
3. Bust Contraction
4. End of Bust Trough

In the boom phase, growth is positive. If gross domestic product growth remains in the healthy 2% to 3% range, it can stay in this phase for years. It accompanies a bull market, rising housing prices, wage growth, and low unemployment.

The boom phase doesn't end unless the economy is allowed to overheat. That's when there's too much liquidity in the money supply, leading to inflation. As prices rise, irrational exuberance takes hold of investors. The GDP growth rate grows above 4% for two or more quarters in a row. 

You know you're at the end of a boom phase when the media says the expansion will never end. That's when even the grocery clerk is making money from the latest asset bubble.

The end of the boom or expansion phase is the peak. According to the , it is the inflection point where the economy stops expanding.

The bust phase is the contraction phase of the business cycle. It is brutish, nasty, and mercifully short. It rarely lasts more than 18 months. GDP turns negative, the unemployment rate is 7% or higher, and the value of investments falls. If it lasts more than three months, it's a recession. It can be triggered by a stock market crash, followed by a bear market.

A stock market crash can cause a recession. As stock prices fall, everyone loses confidence in the state of the economy. When investors don’t feel confident about the future outlook, they pull out their investments. They cut back business activities such as purchasing, hiring, and investing.

The trough is the inflection point where the economy stops contracting and begins to expand.

Causes

Three forces combine to cause the boom and bust cycle. They are the law of supply and demand, the availability of financial capital, and future expectations. These three forces work together to cause each phase of the cycle.

In the boom phase, strong consumer demand is the leading force. Families are confident about the future, so they buy more now. They know they'll get better jobs, and their home values and investments will increase in value. This demand means companies have to boost supply, which they do by hiring new workers. Capital is easily available, so consumers and businesses alike can borrow at low rates. That stimulates more demand, creating a virtuous circle of prosperity.

If demand outstrips supply, the economy can overheat. Also, if there's too much capital chasing too few goods, it causes inflation. When this happens, investors and businesses try to outperform the market. They ignore the risk of bad investments to achieve gain. 

In the bust phase, the main force is plummeting expectations about the future. Investors and consumers get nervous when the stock market corrects or crashes. Investors sell stocks. They buy safe-haven investments that traditionally don't lose value, such as bonds, gold, and the U.S. dollar. As companies lay off workers, consumers lose their jobs and stop buying anything but necessities. That causes a downward spiral. If it continues, it can lead to an economic depression.

The bust phase stops when supply lowers prices enough to stimulate demand. That happens when prices are so low that those investors that still have cash start buying again. Confidence can be restored more quickly with central bank monetary policy and government fiscal policy

Protect Yourself from the Boom and Bust Cycle

The best way to protect against the boom and bust cycle is to rebalance your investment portfolio once or twice a year. It will automatically make sure you buy low and sell high. For example, if commodities do well and stocks do poorly, your portfolio will have too high a percentage of commodities. To rebalance, you'll sell some commodities and buy some stocks. That forces you to sell the commodities when prices are high and buy the stocks when prices are low.

Know the causes of recession so you can hedge your finances before it happens. Follow the top five leading economic indicators. Look out for signs such as high interest rates. That could lead to declining home prices as sellers offset the higher mortgage costs. Another significant sign is a decline in durable goods orders.

If you're really concerned, you can take these six steps to prepare for an economic collapse. Although a collapse is highly unlikely, these steps will also help you weather a bust phase.

Asset bubbles can be just as dangerous. There have been seven since 2005. They occurred in housing, oil, gold, U.S. Treasuries, the stock market, the U.S. dollar, and bitcoin. Study them to make sure you don't get caught up in the next one.

History

The NBER provides the history of boom and bust cycles. It determines when each of the four phases occurred with economic indicators. These include GDP statistics, , real personal incomeindustrial production, and retail sales

Since 1929, there have been 28 cycles. On average, the booms last 38.7 months and the busts last 17.5 months. Data on the  go as far back as 1857.  Historical fed funds rates go back to 1971.

U.S. Boom and Bust Cycles Since 1929

Cycle Duration Comments
Bust Aug 1929 - Mar 1933 Stock market crash, higher taxes, Dust Bowl.
Boom Apr 1933 - Apr 1937 FDR passed New Deal.
Bust May 1937 - Jun 1938 FDR tried to balance budget.
Boom Jul 1938 - Jan 1945 World War II mobilization.
Bust Feb 1945 - Oct 1945 Peacetime demobilization.
Boom Nov 1945 - Oct 1948 Employment Act. Marshall Plan.
Bust Nov 1948 - Oct 1949 Postwar adjustment.
Boom Nov 1949 - Jun 1953 Korean War mobilization.
Bust Jul 1953 - May 1954 Peacetime demobilization.
Boom Jun 1954 - Jul 1957 Fed reduced rate to 1.0%.
Bust Aug 1957 - Apr 1958 Fed raised rate to 3.0%.
Boom May 1958 - Mar 1960 Fed lowered rate to 0.63%.
Bust Apr 1960 - Feb 1961 Fed raised rate to 4.0%.
Boom Mar 1961 - Nov 1969 JFK stimulus spending. Fed lowered rate to 1.17%.
Bust Dec 1969 - Nov 1970 Fed raised rate to 9.19%.
Boom Dec 1970 - Oct 1973 Fed lowered rate to 3.5%.
Bust Nov 1973 - Mar 1975 Nixon added wage-price controls. Ended gold standard. OPEC oil embargo. Stagflation.
Boom Apr 1975 - Dec 1979 Fed lowered rate to 4.75%.
Bust Jan 1980 - Jul 1980 Fed raised rate to 20% to end inflation.
Boom Aug 1980 - Jun 1981 Fed lowered rates. 
Bust Jul 1981 - Nov 1982 Resumption of 1980 recession.
Boom Dec 1982 - Jun 1990 Reagan lowered tax rate and boosted defense budget.
Bust Jul 1990 - Mar 1991 Caused by 1989 Savings and Loan Crisis.
Boom Apr 1991 - Feb 2001 Ended with bubble in internet investments.
Bust Mar 2001 - Nov 2001 2001 recession caused by stock market crash, high-interest rates.
Boom Dec 2001 - Nov 2007 Derivatives created housing bubble in 2006.
Bust Dec 2007 - Jun 2009 Subprime mortgage crisis, 2008 financial crisis, the Great Recession.
Boom Jul 2009 - Now American Recovery and Reinvestment Act and quantitative easing.