Recession or Soft Landing

This past year, everybody, and their mother, have debated the U.S. economy, some arguing that it was headed for a recession. In contrast, others believed it was simply experiencing a temporary decline following a period of growth during the pandemic. It is my turn to give my opinion on the most talked about macro subject.

How are recessions started?

Recessions are a normal part of the business cycle and occur when there is a significant decline in economic activity. The causes of recessions are varied, but they often stem from a combination of factors such as a decline in consumer spending, an increase in interest rates, and a decrease in business investment. A decline in consumer spending is one of the most common causes of a recession. Businesses sell fewer goods and services when consumers spend less, leading to decreased production and increased unemployment. This decrease in demand for goods and services can cause businesses to cut back on their production and lay off workers. An increase in interest rates can also cause a recession. Higher interest rates make it pricier for businesses and consumers to borrow money, leading to decreased spending and investment. This decrease in demand for goods and services can cause a decline in economic activity. A reduction in business investment can also contribute to a recession.

Businesses cannot create jobs and produce goods and services when they invest less. This can lead to a decrease in economic activity and an increase in unemployment.

A vital feature of a recession is the expansion of credit. Recessions are a result of the expansion of credit in the banking system. Banks and central banks create new money in the form of loans and corresponding deposits, setting a series of economic investments in motion. By distorting the incentives of investors, consumers, and savers in favor of debt-financed investment and consumption and a simultaneous decrease in savings. This creates a temporary illusion of a strong economy as prices and spending rise. However, the illusion cannot last. The conflicts that arise as investors, consumers, and savers try to increase both present and future consumption while decreasing savings often take the form of natural constraints and bottlenecks in supply chains. These lead to business failures, rising unemployment, debt deflation, and all the economic pain of a recession.

Is the upcoming recession inevitable?

Many indicators indicate a possible recession, such as rising inflation, significant company job cuts, and a slow housing market. The Federal Reserve's raising interest rates also adds weight to economic growth and higher interest rates, making borrowing pricier and slowing the construction of new homes.

However, it is essential to note that while a recession may seem inevitable, it is not a done deal. The economy is always in a state of flux and can be influenced by internal and external factors. Some experts argue that the economy may slow down, but a recession is not a foregone conclusion. Factors such as consumer sentiment and business confidence play a significant role in the economy's overall health.

Government policies and programs can also help stimulate economic growth and prevent a recession. The government can implement measures such as increasing spending on infrastructure projects, providing tax cuts to businesses, or increasing social welfare programs to support those affected by the economic downturn.

How can a soft landing be achieved?

A soft landing, on the other hand, is when an economy slows down but avoids a recession. This can be achieved through a combination of monetary and fiscal policy. For example, the Federal Reserve may raise interest rates to slow economic activity and prevent inflation, while the government may provide tax incentives to businesses to encourage investment. A soft landing is often seen as desirable because it allows the economy to slow down without causing significant harm. This can help prevent the economy from overheating and allows for a more sustainable growth rate.

However, achieving a soft landing can be extremely difficult, as many factors can affect the economy. Additionally, the effectiveness of the government's actions can be limited by political considerations and the risk of inflation. Achieving a soft landing in the current economic conditions is like kicking the can down the road. A great analogy is in salary-capped-based sports like the NBA and the NFL.

When a team has a star player, they want to build around him. The team aims to surround him with the best talent to win championships. To accomplish that, the team needs to spend money on the best available players. After numerous championships and staying competitive, the star player retires, and the team is stuck with unwanted players and debt. In this situation, many teams try to kick the can of a rebuild down the road and stay competitive to keep fans in their seats. A rebuild is inevitable if the team ever wants to win more championships. The same can be said for the economy. A rebuild is necessary if they intend to be at their previous high.

My take

It is widely acknowledged that the current credit expansion is the longest on record, and many experts believe that a recession is imminent. The question is not if a recession will happen but when and how severe it will be.

One of the critical indicators of an impending recession is when the economy is considered to be over-extended. This occurs when most investors believe that the top is in.

Psychological factors rather than fundamentals often trigger recessions. For example, if investors believe that a recession is coming, they may sell their stocks, which can cause a sharp decline in the market. This is why it is difficult to predict when a recession will happen. Moreover, even if we had a clear indication of when a recession would occur, investors would likely start selling their stocks before the recession happens, which would trigger the recession prematurely.

The Federal Reserve and the government have been taking steps to delay a recession by not running off their balance sheet as quickly as they said they would and providing subsidies for other commodities. However, it is still being determined whether these actions will ultimately be successful in preventing a recession. Some experts argue that these actions may signal that the Fed believes the economy is on the brink of a recession, which could create a self-fulfilling prophecy.

In conclusion, a recession is likely to happen soon, but it is difficult to predict when and how severe it will be. The current economic expansion is the longest on record, and valuations are high, making the market vulnerable to a sharp drop. While the government and the Federal Reserve are taking steps to delay a recession, whether these actions will ultimately be successful is still being determined. In addition, psychological factors often trigger recessions, and once the market starts to decline, it can be difficult to stop the stampede. As such, we must be aware of the potential risks and have a plan in place for when a recession does occur.

Join the Flagship community and secure your financial future with the guidance of our Captain Crunch.