On average, there is a recession every 7 years. The last one we had was in 2008. As of this year, however, we’re in our 11th year of growth, the longest period without a recession on record.
In this article, I offer some layman’s reasons as to why we’ve had this growth, and why it’s going to end soon. And why, when it does end, it’s going to hurt.
The 2008 recession was caused, in part, by reckless banks lending money to people who wanted to buy homes and quickly resell them for profit. Before the bust, experts argued that property was safe: at no point in the previous 30 years had there been any house price deflation. Belief in the stability of property caused home buyers to take increasing risks on it. Banks, likewise, took ever greater risks lending money to home buyers who should not have been eligible for loans.
Add to this the innate structural issues of the time: America, as a nation, was living beyond its means on debt. People bought goods which they didn’t need, with money they didn’t have.
Eventually, the party came to a crashing halt. Banks lost money when homeowners defaulted. The crunch spread to all other sectors, and the extent of the black hole of debt was eventually unearthed. Lehman brothers went under. Other banks had to be bailed out.
Corrections are natural and necessary
Corrections are part of a natural economic cycle: over time factories tend to increase production, eventually generating more than they can sell. When goods can’t be sold, profits fall and workers are inevitably laid off. This causes even less goods to be purchased because people have even less money to spend. A recession results. With enough time, however, supply and demand eventually realign and growth resumes.
The last correction in 2008 was long overdue, and was worsened by the fact that it should have happened sooner. Governments across the world, rather than treating the disease at its source, instead prescribed aspirin for a proverbial broken leg.
Economic corrections are never politically popular. Nobody likes losing their job. Nobody likes getting poorer. So, rather than letting corrections happen, governments, instead, paper over structural issues with more debt. Easy borrowing in an environment of low interest rates means more people buying goods they can’t afford.
When money flows with this kind of voodoo economics, factories continue to scale up production to meet artificial demand. Eventually when the demand stops, it does so abruptly, and the correction is not just a squeeze, but a catastrophic life-changing event. 2008 was one such event for many people. Had it happened 3 years earlier, it may have been a mere discomfort.
A rapid global economic turnaround was generated after 2008 through two primary means:
- China stimulated its own, internal, demand by going into debt itself (having previously relied on the US debt to fuel growth). Chinese household debt, for example, rose from under $1 trillion dollars before 2008, to $5 trillion dollars, as of 2018, an increase from 10% to 50% of GDP. As a proportion of disposable income, this represents a rise from 40% to over 100%. The widely acknowledged (but unquantified) contribution of shadow-banking may mean the true debt picture is far worse.
2. The USA shifted its own debt to new outlets. Corporations began to borrow money. Corporate debt is now at 45% of GDP, 5% higher than it was at the dawn of the 2007 downturn. Student debt has grown from $600 billion (near 2008) to $1.4 trillion (as of 2018). Added to this are the record low interest rates which have encouraged investors to move money out of banks and into the stock market in search of better returns. This flow has inflated stocks far beyond their underlying value. Lower taxes and increased government borrowing have, likewise, helped to fuel government debt.
The borrowing, at times, appears to be sinisterly circular: government borrows money from its own citizens, and then lends that money back to many of the same citizens in, for example, the form of student loans.
The result of massive debt creation of this form has been a global economy that looks cosmetically good but which is deeply unwell.
Trump should have pressured the Federal Reserve to raise interest rates in order to reduce borrowing. He should have raised taxes to balance the books in a move of fiscal responsibility, making up for the profligate deficits of Obama and Bush.
Growing debt and increasing recession risk
Instead, Trump has pressured the Federal Reserve to lower interest rates, further stoking raging fires in the stock market and credit industries. He has continued to run amok with the spending habits of previous administrations. The national debt of the US is now at 106% of GDP, outdone only by the debt generated during World War 2.
The USA, China and other global powerhouses are living on debt, at both a government and a citizen level. Sooner or later borrowed money must be repaid. When that finally happens, a recession is inevitable. And because corrective actions were not taken sooner, when the eventual downturn does happen, it will be long and it will be painful and it will be necessary.
The danger is that there is a precedent for treating debt with more debt. And the temptation will be to do the same during the next downturn. How long can the can be kicked down the road? And at what cost?
When the party is in full swing, nobody imagines it will ever be over. The same words are always echoed:
“This time is different!”
The truth is, it never is.