With economic activity slowing down, S&P 500 and Dow Jones experiencing one of the biggest crashes in history, FED stimulating the economy by cutting interest rates and doing quantitative easing, all signs point to an impending recession with grave consequences. Therefore, the following article should provide essential information about what a recession is, what causes it, how the government is trying to prevent it and most importantly how to be prepared when the time comes to face the ugly sides of a recession.
What is a recession?
Recession is a term to define the slowdown of a countries economy for a longer period of time. In other words, recessions occur when a countries economy reached it's maximum growth point and starts declining for at least two consecutive quarters (half a year). Identifying a recession is done by looking up the countries GDP (gross domestic product). The GDP is a gathering of various economic factors like consumer consumption, public and private investment, government spending and export/import ratio to measure the economic output of a country during a year.
Are recessions supposed to happen?
Yes, they are, even though the lower and middle class will have to go through a hard time coping with a recession. Recessions are part of the business cycle and play a key part for a healthy economy in the long run.
What is the Business Cycle?
The business cycle is the natural rise and fall of economic growth (production output of goods and services) that occurs over time.
As seen in the image above, it's made up of 4 stages:
Expansion: When the expansion stage occurs, the economy is booming.During the stage, unemployment declines, incomes, production, and sales skyrocket. The economy has a steady flow in the money supply and investment is rising.
Peak: In the peak phase economy overheats, reaching it's the maximum level of growth. Purchasing power is reaching all time lows as inflation increases. Economic indicators stop growing. Investors overvalue assets, leaving them empty handed as they create bubbles like the famous dot-com bubble or the recent housing bubble.
- Recession: With people taking financial measures like changing consumer behavior and hoarding money, the decline in demand is imminent, leaving production, sales and other sectors in the dust. As a consequence, unemployment rate decreases, income becomes stagnant and stocks enter a bear market.
- Through: The through stage rings the end of the recession. Unemployment rate, consumer confidence and investment levels reach the bottom. Furthermore, number of filed bankruptcies stops increasing and other signs of a recession indicate that the economy is ready for a recovery.
Can the government prevent a recession?
Short answer: No, they can't. Governments can't prevent the start of a recession, but what they can do is delaying a recession by using financial instruments to stimulate the economy which makes the after effect of the upcoming recession in the end much harder. Thus, the question is not if a recession will happen, rather the question should be how long can the government keep the bubble alive till it busts one day.
Which financial tools can be applied by the FED and central banks?
- cutting interest rates: interest rates are rates a entity has to pay back when loaning money out from a bank. To keep the cash flow running, governments encourage businesses to take out loans with low interest rates. But, at the same, cutting interesting lead to more so-called "zombie companies" that are heavily in dept and need one or a series bailouts or are kept afloat by lenient creditors and below-market interest rates. Some states already go so far and offer negative interest rates. Meaning, you get money for loaning money out, which ultimately leads to hyperinflation in the worst case.
- quantitative easing: Quantitative easing is the introduction of new money into the money supply by a central bank. Or in other words "printing new money". Although the inflation rate in most industrial countries lie between 1-2%, in terms of being a store of value fiat money is not a good example as saving rate are much lower than inflation rate. In order to bailout companies during a economic crisis (such as during the 2008 real estate bubble), countries print so much money which increases their dept level to an unsustainable amount.
- cutting taxes: Comparing this "solution" to the two mentioned methods above, cutting taxes seems the only reasonable solution that might work in the short term. Whether it's income, payroll tax, corporate tax, duties or excise taxes, cutting taxes allows companies and workers to remain liquid during a recession. But, this only works temporary as companies eventually run out of money and the government has no budget left to spend.
How to prepare yourself for a recession?
Going through a recession can be challenging and rough. The most important thing during a financial meltdown is to remain calm. Keep in mind that every recession will come to an end, with average recessions lasting about 22 months.
Some things you can do to prepare for a recession:
- pay down dept: Paying down your high interest debt is critical because it takes pressure off of your cash flows if you run into financial trouble. If you don’t pay down your debt and are only able to make the minimum payments on your credit cards, your balances can quickly balloon.
- increase your emergency fund: In case of a job loss or other unexpected situations that prevents you from making money, it's crucial to have an emergency fund for 3 to 6 months of living expenses in a savings account.
- lower your spending: Stop purchasing things you don't need. During a crisis, each dollar counts. Instead of buying a brand new iPhone, keep your money on the sideline for more important purchases.
- start/keep investing: Jack Welch, a former CEO and investor once said: "Never miss out on an opportunity like a good recession". As most people start panic selling during a recession, smart investors use recessions as an opportunity to buy stocks and other assets at a discount. History proofs that companies with solid fundamentals always recover from a recession with a promising ROI(return on investment).
- Look out for job opportunities: No job is guaranteed during a recession. Before you might lose your job, already start making side hustles and look out for job opportunities in case you get fired.
Having all things considered, here are the main takeaways: Recessions play a normal part in an economy, causing unemployment, high inflation and lower productivity. Central banks try delaying a recession by using financial tools such as tax cuts or money printing. The most important thing is to never go unprepared into a recession. Saving money, looking for side gigs and other important steps can make the life much easier during a recession.
I would greatly appreciate feedback! Did you agree with the points I've covered above? Did I forgot some other key points? Let me know in the comments below!
Having that said,
Thanks for reading!