Friday, December 5, 2008

What Goes Up...

It’s no secret that we are in a dip in the economic cycle right now. Some people call it an economic downturn or a market correction or rolling readjustment or (the dreaded word) recession. What exactly does that mean? How did we get here? You might be surprised to find out that although we live in a multi-trillion-dollar worldwide economy the economics gurus with their decades of experience and computer modeling and high falutin’ degrees can’t agree on a simple definition. The common definition of recession that gets batted around the media is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters. Pretty straightforward, but you know it can’t be that easy. A slightly more precise definition follows: A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.

Has anyone noticed that everybody cringes at calling the economic downturn a recession? I think it’s pretty obvious why the government doesn’t want to call it a recession – so they don’t get blamed. In the 19th century it was call an economic panic or a crisis. Well, these words were too inflammatory, so the government forbade them and came up with a new label – depression. That was all great until the 30’s came along and we had a Great Depression. After that everyone was a little shell-shocked (oops, sorry) everybody had post traumatic stress disorder so they didn’t like “depression” any more. What next? Recession. That sounds much better, doesn’t it? Kind of like my hairline or the tides. Seems like a natural occurrence. In fact in the 70’s the “Inflation Czar” of the Carter administration mentioned that we were running the risk of a deep economic depression. He was immediately reprimanded and told to never utter the “D” word again. So at the next press conference he mentioned that (and I am quoting here) “…we are at the risk of having the worst banana in 45 years…” Silly. But no more silly than changing words in order to attempt to prevent the inevitable. Words are not the cause of the problem.

Here’s a little simplification of how our economy works. When the economy is growing consumers feel confident in the future, so they buy more crap that they don’t need. In response to consumer demand, manufacturers hire more people and buy more raw materials. Increased employment means even more consumers can buy useless stuff. Investors believe the upward trend will continue, so the buy more stocks and the value of stocks increase. The stock market tends to rise upward and investments make money. Pretty simple, right? Well, it’s a little too simple. In fact it’s very fragile. When we reach a peak of the economy consumers get restless. They have some extra cash and they have bought all of the nonsense that they need to feel good, so they start to save. Then they start to worry about how long the economic good times will last, so they buy even less and start to pay down debt. People start to talk about bananas. In response to decreased demand, producers lay off people and decrease consumption of raw materials. Unemployed workers have less to spend, so demand decreases more. When a lot of people are unemployed and fight for the same jobs, companies don't have to pay as much to get someone to fill the position. People that have jobs fear they will loose their jobs, so they spend even less and save more. Investors fear the value in stocks will decrease, so they don’t invest in new companies. The stock market falls, and ba-da-bing – banana. Just take a look at the markets that are hardest hit in today’s recession. Manufacturing, construction and retail are all down in the last couple of months. They are all directly affected by consumer spending. Talk about recession and a recession you’ll get.

It is a natural cycle. You can see this trend pretty obviously if you look back at the past couple of decades. The National Bureau of Economic Research publishes data on economic trends. The high points of the economy in the recent past have occurred in 1980, 1981, 1990, and 2001. Guess when there have been recessions. Turn your monitor upside down and scroll to the bottom of the page for the answer. WAIT! Put that thing down, you’re making me dizzy. The recessions have followed immediately after in 1980, 1982, 1991, and 2001.

The worst recession in the last 60 years was from November 1973 to March 1975, where GDP fell by 4.9%. Right now unemployment is at about 6% and the GDP might drop by a couple of percent at most. For a reality check let’s look at how things were in the Great Depression. In the 30’s manufacturing declined by 47%, unemployment was at 25%, the GDP dropped by 30%, and around 6000 banks and loan companies ate shit. That won’t and can’t happen now. We live in a world economy that has an incredible number of buffers and safeguards. Look at it this way, in 1990 the market went down 9% (for the S&P 500) resulting in the recession in early ‘91, but those losses were followed by significant gains of more than 30% in the S&P 500 later in 1991. In 2002, stock market losses of 22% for the S&P 500 were followed by a 28% gain the next year. Keep your head up folks.

Why does it seem like everyone is freaking out this time? One word – Boomers. They are getting old…well, in fact they are old…old enough to start thinking about retirement. They are freaking out because the money they have squirreled into their 401k has gotten pissed away because their kids are paying off credit card debt instead of buying a singing Billy Bass to put above their mantle. I’ve lost ~30% of my 401k the last time I checked, but retirement is so far away to me that they might as well give me my statement with a picture of Alfred E. Newman on it. It’s an abstraction like “god” or “sex with a living human”. But the Boomers, the Boomers are sweating under their comb-overs because they are worried that they might have to work for an extra three years to make up losses.

So right now everyone is buzzing about how bad everything is, but the solution is simple. Buy more junk! That’s the beauty of a capitalist economy. If you buy more useless crap the economy will get better. Spend, spend, spend! Unfortunately it’s also the worst part of capitalism – mass consumption of nonsense. But I’ll leave that topic for another day when I don’t have to listen to some middle-aged whiner poo-pooing about the possibility that they might have to work for a living just a little bit longer.

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