The Boom and Bust Cycle | A Summary of the Four Phases

The boom-and-bust cycle is one of the cyclical realities of the commercial world. In the Biblical Story of Joseph, this trend that all cities go through is highlighted through the dream that the Pharaoh has; and which Joseph successfully interprets. He foresees a time of plenty followed by a time of naught.

Seattle is a city that has a history of boom-and-bust cycles. It exemplifies the commercial cycle of many cities that are built near areas of extensive natural and mineral resources. Seattle has seen its economic fortune rise several times, before going into a precipitous decline. During periods of decline, the city rebirths itself by investing in infrastructure. This leads to a temporal boom; which leads to a bust later on.

Booms and busts are not always precipitated by natural disasters or intentional human folly. They can also occur ‘accidentally’. On 6 June 1889, an accidentally overturned glue pot in a carpentry shop started the most destructive fire in the history of Seattle.

As Seattle’s industry at the time was dominated by logging, the fire had ample fuel to burn. Fed by the shop’s timber and an unusually dry summer, the blaze erupted and devoured the entire area. A nearby liquor store exploded and the alcohol further fuelled the flames. The fire quickly spread as wooden boardwalks carried the flames across streets to ignite other buildings.

The good times never last. That is one of the key lessons of functioning in a boom-and-bust economy. No econometric model can account for such unforeseeable turbulence.

Expansion and Contraction

Periods of expansion and contraction occur sequentially in a boom-and-bust cycle. One complete business cycle has four phases: expansion, peak, contraction and trough. A key feature of the boom and bust cycle is the way in which economic growth and economic decline alternate between one another. According to the Federal Reserve Bank of Richmond, these phases of both boom and bust are inevitable.

The more you understand their phases, the more you can protect or cushion yourself from their effects. First and foremost, the end of the boom or expansion phase occurs when economic growth is at its peak.

The contraction phase then occurs. If it lasts more than three months, it’s a recession. This in turn leads to a bear market. The trough arrives as a turning point. It is when the economy ceases to contract and begins to re-expand.

The best way to protect against the boom and bust cycle is to balance your investments once or twice a year. The trough, as the fourth phase and final phase of the business cycle, is when the decline in economic growth begins reverse and turns positive again.

The economy then begins a transition from the contraction phase to the expansion phase. A trough is displayed on a graph as the lowest point of the curve. It is the rock bottom moment. Economic activity then begins to rise again and the curve moves upward dramatically.