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

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 Federal Reserve Bank of Richmond, these phases are inevitable. The more you understand their phases, causes, and history, the more you can protect yourself from their effects.

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

Boom

In the boom phase, growth is positive. If economic growth remains in the healthy range of 2%-3%, 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 typically end unless the economy overheats. There's too much liquidity in the money supply, leading to inflation. As prices rise, irrational exuberance takes hold of investors. The 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.

Peak

The end of the boom or expansion phase is the peak. According to the National Bureau of Economic Research, it's the inflection point where the economy stops expanding.

Bust

The bust phase is the contraction stage of the business cycle. It is brutish, nasty, and mercifully short. On average, it lasts 11 months. The economy contracts, 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 on business activities such as purchasing, hiring, and investing.

Trough

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 and recession.

The bust phase stops when supply lowers prices enough to stimulate demand. It occurs when prices are so low that those investors who still have cash start buying again. 

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.

Asset bubbles can be just as dangerous. There have been seven since 2005. They occurred in housing, oil, gold, U.S. Treasurys, 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 uses economic indicators to determine when each of the four phases occurred. The most important is the quarterly gross domestic product report. It also uses monthly reports, including employment, real personal income, industrial production, and retail sales. 

As shown in the chart below, there have been 29 booms or busts since 1929. The NBER has data on boom and bust cycles since 1857. 

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
Bust	Dec 2007 - Jun 2009	Subprime mortgage crisis
Boom	Jul 2009 - Jan 2020	ARRA and QE
Bust	Feb 2020 - Now	COVID pandemic