During the last months, echo and fear of recession have increased greatly in the United States, the first economic world power with a GDP that in 2021 grazed 23 US billion dollars.
This begs the question: is it inevitable? And if so, how could it have been avoided?
Article written by Marco Cazzolli - 16.07.2022
Before delving into the phenomenon’s analysis, it is necessary to understand what recession means and its causes.
The National Bureau of Economic Research, one among the most renowned global research companies, defines recession as “A significant decline in economic activity that is spread across the economy and lasts more than a few months”. The definition emphasises the universality of the phenomenon, which affects indistinctly all economic sectors, and its duration. Despite missing precise timing, it suggests the downturn would not be transitory.
The main causes are:
· Overheated economy
· Asset bubbles
· “Black Swan” events, which are unpredictable events with relevant impact
It is clear how the advent of a pandemic represents a “Black Swan” event, and that this has been the trigger of the recession the United States seem destined to go through from here shortly. The latter is not the only country exposed to that risk, but it surely is the one under the spotlight. Besides, the dramaticism related to the event does not look globally justified by historical data, but is mainly the result of human nature, which tends to draw attention on most recent events deemed important. Today’s situation is not indeed the only difficult period for the country guided by Joe Biden. As a matter of fact, the United States have bumped into about 30 different recessive phases from 1857 to now.
As we have already said, the Covid-19 pandemic has placed not only the United States, but also other countries, in front of a contingence that has consistently burdened different economies. To reduce negative effects, the American government has introduced a plethora of fiscal stimulus aimed at pushing consumes on one hand and production on the other, in search of an eternal balance demand-supply. Policies’ results have brought a constant generalised increase in prices on the consumes side, considered ingenuously or voluntarily transitory, and a consequent trigger of one of the main recessions causes already stated above: overheated economy.
This vicious circle originates from the co-presence of two components: from one hand a high increase of inflation, and on the other hand a decrease of the unemployment rate. On both components the American Central Bank plays a crucial role, of which we will speak in detail later.
Companies need to deal with an ongoing huge increase in demand by growing their productions, to do so they will necessitate of more employees. Difficulties in finding and hiring new staff increase with a low unemployment rate, which forces companies to offer higher salaries. This signifies a growth in salaries which translates into an increase in workers incomes. Moreover, people will be more willing to pay, pushing prices higher. Therefore, there is a positive correlation between salaries and prices.
This situation is attributable to interventions, or missed interventions of FED. The American central bank is in charge both of managing and preventing high inflation on real economy’s side, and of watching over asset bubbles’ creation in the financial system.
To avoid recession, FED has usually opted for the so-called “soft landing”. “Soft landing” means adjusting, through small increases and decreases, interest rates to manage inflation. Only in 1994 this strategy was able to ward off a recessive phase, being indeed extremely complex finding a balance between demand and supply through mild interest rates manipulations. The complexity grows if interventions are introduced later in an iper-globalised world.
It is legitimate to wonder whether this situation could have been somehow predictable.
In order to do so, economists especially keep an eye on three elements: the yield curve of government bonds; ISM Manufacturing Index and consumer confidence.
Treasury yields express market expectations with respect to the performance of the national economy, in details economists investigate the correlation between short-term bonds (5 year) and long-term bonds (30 year). Typically, long-term yields should be higher than short-term homologs, but now it is the contrary, and a so-called “inverted curve” has not happened since 2006 (before the 2007-2009 recession). Since investors are afraid of short-term bonds due to a quick increase in interest rates operated by FED, they adopt a conservative strategy by privileging long-term, selling 5-Year Treasury and buying 30-Year Treasury.
On the other hand, both the second and the third predictive element of a potential recession are indexes. The ISM Manufacturing Index measures the manufacturing activity’s entity registered in the previous month. It is a very common and reliable indicator. Its evolution mirrors the economic trend. In principle, if the value is over 50 and increasing, it indicates economic growth. Equally, if the value decreases, it points out a reduction in economy’s activity. In June 2022, the ISM Index dropped and touched 53 points, emphasising the biggest decrease in manufacturing’s activity since June 2020. Nonetheless, it is fundamental to remember that in March 2020 the same index fluctuated slightly above 40 points.
Source: Tradingeconomics.com
Lastly, the US Consumer Sentiment measures demand’s sentiment and, just like the ISM Manufacturing Index, it has been decreasing for months. A drop in consumer’s confidence causes a lower willingness to pay.
Source: Tradingeconomics.com
Signs of an upcoming recession are all there.
A significant and generalised reduction in economy’s activity obviously has a negative impact on both families and companies, but like every crisis, this could be an opportunity for others. These “others” are the intelligent investors.
A negative sentiment will bring savers to liquidate long positions, as it has been happening for months, and a consequent share prices adjustment. This situation could be an opportunity to buy stocks previously excessively expensive and, in a long-term view, to protect money from inflation, getting a profit.
Some experts, in fact, paint recession as a positive and necessary event of the economy cycle. They state that recession can correct those overvaluations, but other experts do not agree.
A certainty is the importance of information and knowledge. Everyone is interested in understanding what the dynamics behind this phenomenon are, to be protective opportunistic. Speaking of common life’s choices, it is important to know how to behave and what to choose, for instance, between taking out a mortgage or renting a place. Besides, in case of mortgage, what contractual conditions are to be privileged between variable or fixed rate. Or again how to behave with respect to your own professional career and understand if this is the right moment to either look for a new job or wait and keep your current job position.
As already said from key figures of the economic panorama, such as the former United States Secretary of the Treasury Lawrence “Larry” Summers, recession is nearly inevitable. The latest forecasts point out 2023 to be the target year, but looking at recent data the sensation is that recession could become reality in the second half of 2022.
Data says that this is neither the first, nor the last, generalised American economy’s decrease, however, the historical period is not irrelevant, and the current Chinese rise (today’s second world power) could give birth to a changing world order.