The Coming Recession

A recession is definitely coming, of that much you can be sure.

But let’s be honest: so is Christmas and so are broken promises. As long as the world remains and human activity continues, economic cycles will come and go. You can predict with certainty that snowstorms and recessions will arrive, it’s just that you can’t predict exactly when, or what they’ll look like.

What we do know is what causes recessions, in a general sense. Essentially, a recession is a general reduction in spending across the board, meaning that less goods and services are purchased, which means that those who generate such goods and services will receive less money, which in turn means they will have less to spend, and so on. This is why recessions tend to feed on themselves and get worse before they get better.

Why does the general public collectively decide to spend less? Generally speaking, it’s because they have less purchasing power than they used to have, or they think that this is going to be the case.

A reduction in purchasing power can be caused by money becoming more expensive (ie. increased interest rates), by increased taxes, by widespread unemployment, but often just by pervasive pessimism. If everybody starts thinking gloomy thoughts, a recession is sure to appear. Economics is in large part about self-fulfilling prophecies.

We can also predict with certainty that the coming recession will end and good times will roll again. In fact, the good times after a recession tend to be better than the good times before the recession.

There are a handful of common-sense reasons for this, the most important of which is that eventually your “stuff” begins to wear out, break down, or become obsolete, and you’ll need to replace things, and when society in general has no choice but to spend again, the recession ends and “good times” return. Often with a vengeance. The fact that we live in a society of rapid technological change probably means that obsolescence is reached sooner, therefore accelerating our need to replace, and thus helping shorten and minimise recessions. Not to mention the fact that most of our stuff isn’t built to last.

Just as governments can provoke recessions by increasing interest rates and raising taxes, they can also prime the economic pump by reducing taxes, reducing interest rates, and by pumping money into the economy. They can also drive economic cycles up or down by “jawboning”, that is, by continuous and pervasive happy talk or scary talk.

Bear in mind, too, that banks make money both in good times and in bad, but they make a lot more money in the good times. Taking hits on bad loans does little for the bottom line, so generally speaking banks will provide a lot of muscle to get us out of recessions.

Although we can psyche ourselves into a recession, it’s not common that we wish our way out. That’s just human nature– our collective thinking tends to be “glass half full” when we should be exercising caution and “glass half empty” when we should be optimistic. This is why it’s important for our leaders to show courage and speak with optimism when things are dark, to stem the tide of Eeyorism and sow our minds with the seeds of hope. The tide will inevitably turn, but sooner if we can be convinced that tomorrow will be a better day and start to spend again.

All this can sound simplistic, but economics, at the end of the day, is just a clear-eyed study of basic human behaviour. We’ve been acting pretty well the same since we came out of our caves. By and large we are herd animals, and we become unreasonably optimistic or irrationally pessimistic by reason of how everyone else is behaving.

The more important question for each of us is how to be prepared to survive the downturns and thrive in the upturns. Warren Buffet puts it simply: “Be fearful when others are greedy and greedy when others are fearful.” In other words, when the rest of the world is spending like drunken sailors, slow it down and put away reserves for the hard times ahead, and when the rest of the world is in full panic mode, take advantage of the bargains which will inevitably present themselves.

In other words, those who practice good economic habits at all times will weather the tough times and prosper in the good times, while those who spend like there’s no tomorrow will be ill prepared when tomorrow arrives without a suitcase. There are enough stories about ants and grasshoppers that I don’t need to repeat any here!