Every Discussion of the Economy Keeps Coming Back to the Same Keynes Quote

When the economy gets hot, and inflation pressure starts to build, naturally the talk always turns to rate hikes as a tool to tamp things down.

However, in Chapter 22 of his book “The General Theory of Employment, Interest, and Money,” John Maynard Keynes offered a different prescription:

Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest![5] For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.

Obviously, this sounds highly counterintuitive. But in conversation after conversation, this idea of the permanent “quasi boom” as a remedy for the boom itself comes up. 

For example, next week on the podcast we have a discussion with Ryan Petersen, the CEO of the logistics firm Flexport. His firm helps companies deal with logistics and shipping , which — as everyone knows these days  — are a mess. One solution would be an expansion of shipping capacity, but that’s only going to happen if firms expect the current global trading boom to last. If the expectation is that we just go back to the pre-virus slump, why invest more?

It was the same theme in our recent conversation about lumber. As Stinson Dean of Deacon Trading explained, part of the reason everyone is caught short lumber right now is a conservative mindset forged in the years following the housing crash:

And I think I can say that we’re more conservative than others because of what we went through in 2006, 2007 and 2008. And what we ignored in 2006 and ‘07, and paid the piper in 2008. And we, we really were one of the sectors that really never — still haven’t — reached and eclipsed our peak, if you just look at housing starts. And it was pretty devastating, as you can imagine, for everyone involved. And so a lot of people got cleaned out. And if you survived and you’re still around today and you survived 12 years ago, it’s because you’re extremely conservative, right?

You hold a lot of cash. You don’t put your neck out too much. You’re slow to reinvest. You’re slow to hire. You’re slow to expand. You’re slow to buy more trucks because — what if, right? It’s such a fear. And ultimately you’re also slow to buy a bunch of inventory. You want as little inventory as possible in case the bottom falls out. So that’s very fresh even all this time later in everyone’s mind. And again, the names that are around right now are around because they were able to scrap, scrape and survive being the epicenter of the great financial meltdown. And so there’s just a characteristic of these legacy names and the folks who run them that they’re just conservative. And the same with the home builders. You’re listening to the home builders, they’re paying down debt and they’re not aggressively going after land and they’re playing it safe. And it’s like, what are we doing here? We have this massive housing shortage, but you can just feel how hesitant everyone is to believe it. Me included last March! I was like, depression. This is bad. Stock market sell off. Lumber future sell off. And I mean, I was quoted in the WSJ that April that nobody’s thinking about buying a new home. That’s the last thing on anyone’s mind.

And so we all derisked, we sold down our inventories to almost nothing. The sawmills, if they had any extra inventory on the ground which they typically operate with to fill in the gaps and smooth out the supply chain in case there’s a weird production run glitch, they can pull from inventory, fill the car and get a gun. They sold those stacks down to pavement. Lumber dealers went and sold, their inventory down to nothing. Middlemen and liquidity providers — same thing. None of us wanted the risk on. So then we started the rebound and the short of it is prices went from 250 on the future screen to $350 to $450 to $500.

We’d be paying less for lumber today had we maintained a steady boom in housing over the last several years, but instead we allowed the ecosystem to atrophy and now we’re paying the price.

If we actually want to build enough houses for people, if we want to have enough trade capacity to meet everyone’s needs, then the boom needs to be sustained so businesses will have a reason to think their investments in new capacity are justified. Conversely, an expectation that the Fed will hike as soon as things start to get hot (a reasonable expectation for the past several decades) has the exact opposite effect.

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