The business cycle that takes place in any country’s economy gives off the illusion that it follows a straight path, but the truth is that once the business cycle of an economy is closely scrutinized, one could see that the business cycle actually oscillates up and down a particular trendline (Khan Academy, 2012). Even though the trends themselves have been different, history has revealed a persistent business cycle within economy occurring periodically, whether it be a decade or a 5-year period. What has left many scholars and majority of the community perplexed is the reasons for the recurring business cycle, how it can be approached and predicted, and how it comes to be. For example, even though the Tulip Mania was experienced in the 17th century, resulting in the people of Netherlands to be in economic depression, numerous other bubbles and manias followed from it, and continues to do so even in our current day. Just as the real estate bubble of the 2000s had popped, a new bubble of cryptocurrency and bitcoin began to form, ready to explode any second. This paper will analyze how the economic machine works by examining the business cycle, exploring the reasons as to why economic bubbles form, and distinguishing between floating and fixed exchange rates.
According to Ray Dalio, economy is a transaction-based system where one exchanges money, credit, or something equivalent for services or goods (Dalio, 2013). The business cycle revolves around this transaction-based system, and is ultimately dependent on how often there is being a trade. Productivity, which is basically how much a single person can generate something of, is a critical part of the economy because with the help of “technology, discoveries of resources, or new business processes,” innovation can push the real GDP, “an actual measure of the goods and services produced by an economy or the productivity,” of an economy to grow (Khan Academy, 2012). Whenever the economy grows within the business cycle, it’s coined the term expansion, because the economy is literally expanding; whenever the economy shrinks within the business cycle, or weakens, it’s coined the term recession, signifying the economy receding (Khan Academy, 2012). Also, an extreme form of recession is a depression. There are many ways an economy can push itself into depression, without even going into recession first, and the reason an economy can so quickly go into depression isn’t due to productivity, real GDP, or nominal GDP. It’s mainly due to people and their emotions that the economy can so quickly spiral down to a depression.
According to Prateek Singh, “a mania occurs when there is an upward movement of price combined with a willingness to pay large sums of money for something valued much lower in intrinsic value” (Singh, 2015). People have the tendency to want to own things they never seen before, and they have the tendency of wanting to do it prior to anyone else could. For example, in the 17th century, when the Turkish sailing ships had brought tulips along with them, the people of Netherlands were fascinated with its unfamiliar beauty. When mosaic, a tulip-breaking virus, became evident, one could notice flame-like designs of different colors on tulips, making it more unique and giving it a rise in popularity. Soon enough, the wealthy merchants and tradesman of Netherlands started to show off their riches through gardens of tulips around their homes, and the tulip’s price heightened in such a quick manner that a flower that wasn’t cared for before now “a single tulip bulb sold for more than ten times the annual salary of a skilled craftsman.” (Singh, 2015). The tulip mania is a great example of a community propelling themselves towards a quick descent due to their desires of wanting to show off and be in possession of exotic things. One would think that the rest of the world would learn from Netherlands’ mistakes, but asset and economic bubbles similar to that of the tulip mania keep on taking place. Just within this past two decades, there was the Dotcom and real estate bubbles that freshly burst.
Despite the numerous examples prior to the current era, people are a slave to their emotions, and allow their feelings to direct them rather than their thoughts and wisdom. It’s unfortunate to say that the world is in the midst of yet another bubble; this one is that of cryptocurrency, and particularly bitcoin. Bitcoin took the whole world by a storm when numerous news began to circulate around that people who had bought $100 worth of bitcoins only a few years back were now returning as millionaires and billionaires (Casey, 2018). Next thing the world knew, everyone began buying cryptocurrency, and wanted their contribution of the riches the current bubble was offering. However, this is a bubble that has yet to pop. Cryptocurrency is being held in high regard right now, and the internet is filled with articles of “Bitcoin Billionaires” and “Cryptocurrency Gold” (Casey, 2018). Not only are people not done with cryptocurrency, but there are still many eager to get their hands on some. An internet outage, a war, government taking over control, are only some of the ways that cryptocurrency can be deemed useless. Soon enough, people will collectively come to the realization that the worth being put on cryptocurrency is much more than its intrinsic value, and a state of panic and turmoil can rise when everyone attempts to get rid of the cryptocurrency they have all at once. If one walks around their town, they will most likely see a few restaurants that accept cryptocurrency, and although those restaurants might look as if they’re fitting in with the current economic society, they fail to realize that they’re putting a portion of their income and profits at risk just to be involved in cryptocurrency. It’s just like how people were selling their life savings and home, things of real value, for tulips in the 17th century; not much has changed.
Last, but not least, “the choice of exchange rate regime or system is one of the most important that the country can make as part of their monetary policy” (tutor2u, 2016). There’s an appropriate type of exchange rate for each economy, them being the floating exchange rate, the managed exchange rate, and the fixed exchange rate. United States has a floating exchange rate, or a fluctuating exchange rate, which means that the external value of a currency depends wholly on market forces of supply and demand, and there’s no interference in the currency markets by the central bank. This again brings the paper back to the point of the willingness to spend money by the community. As long as there’s an extreme willingness to spend money on things with no intrinsic value, the business cycle will continue the way it has been for years.
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