Sonntag, Juni 06, 2010

Swine Cycle Reappears...

Part of the business cycle can be explained as being based in the swine cycle. This is the part of the business cycle that will never go away, and you'll see my point in a moment.

For those who aren't economists, the swine cycle is a simple explanation - but a very accurate one - of what happens when farmers raise pigs for profit and sell them on a market that always clears (supply is such that there remains no demand for a given point in time t) and where there are no price controls.

To make things simple, let's postulate 100 farmers that each produce 10 swine for sale in period t. Total demand is 1 000 swine, there are 1 000 swine produced, and farmers have fairly similar size productivity and resources. It costs 100 to raise a swine to selling age (hence 1 000 swine cost 100 000 per time period) and the profit is 5%, i.e. selling price is 105 000. Other farm activities may or may not have more attractive profit margins. Consumers like their pork, and consume everything produced at this price point; however, there are asymmetric price elasticities that no one knows, i.e. when prices increase, demand decreases and, inversely, when prices decrease, demand increases, but both are non-linear and not easily mapped out (and vary from t to t).

Now, while each farmer produce 10 swine in period t, it takes 6t to raise new swine (i.e. increase their inventory), so farmers entering the market (or increasing their inventory) need 6 time periods t to raise 10 swine for sale, with an inventory, in the pipeline, of 70 swine. If they decide to get out, they sell off their inventory as demanded until they have sold all swine, if they decide to get back in, it takes 6 time periods to have enough swine to sell. They can sell off their inventory all at once if they so desire, but don't have to.

I was originally going to illustrate this with numbers, but because of the variability of farmer behavior, I'd have to break out a spreadsheet, and it's a lovely Sunday out. Hence: doing the calculations are an exercise left to the reader.

What happens? Some farmers decide that swine farming isn't that much fun, and sell off their entire herd at once, increasing the supply for a very brief period, driving down prices. Faced with lowered prices and hence lowered profits, more farmers decide to get out of the swine business, and after several periods of this, the number of swine on the market has fallen significantly below demand. The market tightens up, prices start to rise, farmers start thinking that maybe swine aren't so bad after all, especially given the higher prices. So most of the farmers head back into the business and several periods later, there are so many swine on the markets that prices start to fall again, leading to a permanent cyclical pattern that is, oddly enough, called the swine cycle.

Depending on how farmer behavior is modeled, this can be a strong, erratic, chaotic cycle or a smooth and well-behaved and modulated cycle. Up to the reader to calculate.

So, what does this have to do with anything?

Simple: the important thing is cycles happen because there is a time lag between changes in demand and changes in supply, and changes in supply will cause changes in demand based on prices. In the swine cycle, this is relatively short, but there are other markets that behave, largely, the same, but with rather greater time lags.

This is why this and this is happening.

Real estate is going to tank over the next 20-30 years as supply - housing placed on the market to sell - and demand (especially in the face of strongly tightened credit requirements) find a new equilibrium, one that clears the market of surplus housing (aka baby boomers selling off their houses because it is their nest egg as equity for fixed income for retirement purposes).  That's what you can see in the chart in the first link: how the cycle is hitting different regions right now, based on the cyclical position of these regions in the business cycle for housing. Given the long lead times, the amount of capital involved, and the sincere hope of all of those retiring baby boomers that they can outfox the decline by timing it well (ensuring that lots of housing will remain off the market, re-entering just at those times when the market starts to recover, effectively killing off, time and time again, any price recovery), this is going to a swine cycle of epic proportions.

Education, especially higher education, hasn't had many cycles. In the US it is hitting its first major cycle (go see the second link) and it's going to follow the swine cycle, since academia has acquired such heavy costs (thousands of very well paid tenured professors in fields that are pure luxuries and yes, gender and womyn studies, I am talking about y'all, along with most of the humanities beyond the basics) that it is now driving a generation of consumers - I'm going to call them Generation B (for baby boomer grandchildren and broke because of university-related debt that no longer disappears when you declare bankruptcy) - into relative poverty because they either ended up studying something that only the indulgent and idle would bother to study or studied something no longer in demand (or, more accurately, studied because they were supposed to do so based on an assumption that getting any sort of college education automagically resulted in higher life-time wages).

The result will be financial collapse of many universities and colleges that expanded rapidly because credit was easily available. Go into debt for $100k to get your law degree? No problem, easily financed, and you thought that specializing in humanitarian law was idealistic and noble, not knowing that 90% of such lawyers never earn anything near what is needed to pay back that $100k. Or go into tort law, ignoring the fact that hundreds were doing the same thing and market demand meant that you would never be able to pay back those loans unless you were absolutely brilliant - or, more specifically, you found clients who believed this - or extremely lucky.

If you base going into serious debt in the hope you get lucky, play the lottery. It's not nearly as expensive and, given you apparent lack of understanding about statistics, it's about as good as you're gonna get.

Hence: knowing the swine cycle and, by extension, the business cycle isn't merely a good idea: not knowing about it means you are going to make major mistakes, ones that you can't get out of.

For Generation B, the kids growing up right now, the swine cycle, as well as most of economics, isn't really that hard to learn. Ignore it at your financial peril. Your parents and grandparents have ignored it, and as a result, you're kind of screwed. See what ignoring economics does to you?

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