Why do business cycles end?

And some follow-on observations about where we are today.
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So first let’s talk about business & cycles.

Much of business is really just about projections and risk management.

The tricky thing about business is that too much risk can kill you, but so can too little risk.
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The industry I come from (VC-backed software) is always reminding is not to take too little risk. Because our businesses have trivial incremental unit cost, we’re encouraged to juice our burn rates and acquire customers as fast as possible.

And that’s generally sound advice!
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It’s sound because if you run your business conservatively, someone else can come along, clone your product (or value prop), raise more money, and soak up market share faster than you.

With a globally addressable market, moving too slow will kill you.
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But of course moving too fast can kill you as well. This is more obvious you just like... you know... run out of money before you become profitable.

So it’s a delicate game and the skill that we use to help solve this is FP&A (financial projection and analysis).
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The goal of FP&A is to help you build in an appropriate margin of safety, while also taking ground as quickly as possible.

An ideal 'goldilocks' model is not too conservative not too aggressive either, and may have several variants that show various contingencies.
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All businesses are capital constrained and most businesses are competing hard enough for market share that they employ risk capital beyond what their (current) P&L generates. Projections and right-sizing of risk is truly the essence of business.

And herein we find the cycle.
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Since it’s generally smart to use risk capital beyond what your current P&L generates — failure to do so can result in the “too little risk” scenario — but this means you’re relying on those forward revenue projections happening.

But sometimes they don’t.
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There are two dominant ways projections can fail. They can be bad from the outset (overly optimistic) or an exogenous event can invalidate them.

Of course, we all just experienced an example of the second with Covid.
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Large exogenous events create a cascade of damage: as projections are invalidated, finance teams inside companies scramble and activate various contingency plans that often involve layoffs or other cost-saving measures.

And these actions snowball within an economy.
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When large swaths of businesses start doing layoffs due to invalidated projections, this creates a recursive effect on projections generally.

People who get laid off don't spend as much money, further invalidating assumptions of baseline FP&A models relying on those priors.
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This — the broad recalibration of FP&A models — is essentially what happens in recessions.

Defensive models → Moderate models → Aggressive models → Defensive models... etc.

The business cycle is the operator-level view of the “Minsky moment.”
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In order for the business cycle to complete, models need to be cycled down during a period of uncertainty.

These defensive models increase the aggregate robustness of the economy, forming the foundation for the next business cycle upswing.

Now let’s look at where we are.
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First: we had a massive exogenous event. This triggered a liquidity shock and activated many contingency models across the economy.

But then we did something kind of funny.

We elected (ostensibly for ethical reasons) to deny having a full reset during the pandemic.
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So we started interfering with the cycle's terminal causation chain, pushing back against it at multiple levels.

We paid businesses to not activate their contingency plans (PPP loans).

We gave the unemployed money to keep spending up.

We fought back at many levels.
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And it was relatively successful. There’s a reasonable argument that shutting down the economy without doing things like this would have been pretty darn apocalyptic.

But it also implies something else.

We punted on ending the business cycle.

So that bit is still coming.
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So what models are businesses running now?

I think we’d be hard-pressed to say this is a defensive environment. If anything, the aggression is extra high due to inflation hysteria, cheap access to capital, and the recency bias that stumbles will be met with assistance.
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We stalled out the business cycle, so that we didn’t get both that and a pandemic at once.

There is all sorts of debate about whether this was the 'right' thing to do, and frankly I have no idea.

But what I do strongly believe is that the business cycle must still end.
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And if that is correct then... well... this is not yet ‘morning in America.’

It’s a cocktail party at twilight. Those bright, glaring sodium bulb floodlights are not a new dawn.

And while the money masters have made this The Longest Day, night nonetheless approaches.
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