On The Looming Recession

It’s been over 2 years since President Trump took office. There have been ups and downs, but the general consensus up to recently was that the present administration had been good for the economy. In recent months the story has changed as a slowdown has manifested itself. The President blames the situation on the interest rate hikes by the Federal Reserve Bank, and he has been right in doing so. By the same account, the previous economic success had little to do with marginal changes in governing style.

The reality of the situation is that many countries around the world are in a state of limbo in which, although there’s no panic, there’s no growth either. The economic growth forecasts for the United States and the Global Economy have been in decline; inflation forecasts have been rising. Through simple arithmetic operations, this points to a negative expectation for the change in real GDP per capita, which is a widely accepted figure to compare the present average quality of life to the past.

When analyzing the causes of what is happening and what is about to happen, many are tempted to resort to the apparent and the noisy; they are mistaken in doing so. It is true that the trade war with china represents an important opportunity cost for some companies, but this and similar situations are not really a primary factor in creating the looming recession. This is going to happen is not something right now, it is something that has been cooking for several years.

The Origin

In our daily lives, we do our transactions (buying and selling in general) through a fiduciary medium called currency, and colloquially known as money. It is a tremendously effective way to carry out the exchanges that help us move from a state of less to more comfort and satisfaction. Without this, we would have to look for someone who wants what we offer and has what we want.

Fiduciary media are not goods in themselves, but rather represent goods, as they are interchangeable. If the entire economy consisted of 10 exactly equal apples, and there were $100, then each apple would be interchangeable for $10. As this does not mean we can eat $10, the simple fact of possessing currency does not satisfy any need, but it means that the person who paid you with that currency satisfied some of your needs with what you bought, and that you can satisfy some of your future needs when using that currency to buy something.

In essence, possessing currency is a sign that society owes you something, because you gave something to society (as long as you have obtained that currency through voluntary exchange). The currency which is obtained through theft, fraud, taxes or printing does not fit into this category.

For a long time, the fiduciary media were tied to gold, which meant that the quantity of currency units was limited, and not controlled by a centralized organ. Back then there was no general inflation, because if there is only $100 and the quantity of apples increases through production, it is impossible to increase the price of the apple. A general fall in prices is not bad if the amount of currency is fixed, because this means that there are more products to satisfy more needs in the economy. Likewise, if the quantity of products is fixed and the amount of currency is fixed, then if the price of product a falls, it is because the price of product b increases, and this means that society needs more product b than product a in that moment.

Now the fiduciary media is not tied to anything, and it is the central banks that control it. The Federal Reserve Bank of the United States decides the amount of dollars (USD) that are issued. The printing press is mostly imaginary, as most of the currency units it creates are virtual. The problem of the amount of currency units, known as the “money supply”, not being limited is that if there are 10 apples, but the central bank ‘prints’ $100 in addition to the $100 that already existed, giving a total of $200, now each apple is priced at $20. This is called inflation. The reason why this is a problem is that the central bank is not producing anything and still gets purchasing power, and that purchasing power does not come out of nowhere, but it is subtracted from people who already had currency. The new currency units steals value from the old currency units.

It is true that the new currency units ends up in everyone’s pockets, but those who win are the first possessors, since at the beginning the prices have not adjusted. The way in which central banks introduce new currency units, known as liquidity injection, is through the financial system. Therefore, inflation benefits the richest, and hurts all others, especially the poorest.

When the central bank injects liquidity, given that the financial system has more currency to lend, there is a credit expansion. As there is a bigger supply of credit without changing the demand, the price drops (in this case is called the interest rate). The injection of liquidity causes an artificial drop in the interest rate.

An alternative effect of the expansion of credit is that it makes it appear that there are more resources in the economy than there really are, since more currency circulates without prices still adjusting. This causes projects to start which in reality are not sustainable. In order to sustain this artificial prosperity effect, it is necessary to inject more liquidity, but the more liquidity is injected, there is more inflation.

The Limbo

What is happening is not the President’s fault. The looming recession was put in the oven by the central banks of many countries. The hunger for power and the short-term vision led the politicians of the world to sacrifice the ever closer future, to create the artificial appearance of prosperity in order to look good before the citizens and try win elections.

At the moment in which I write this, we are in a state of limbo, the panic has not yet manifested, but demand and economic activity are already falling as the supply does not stop increasing. There will come a time when those who undertook projects that were not sustainable in reality, will realize that the resources they needed to succeed do not exist. Those who decide to throw the towel first will lose less. Those who cling to a project destined to fail will lose the most.

The process has already begun, the credit contraction is evident: there are already people trying to sell, there are already companies declaring bankruptcy, but the prices of capital (meaning real estate, labor and means of production in general, not consumption-ready products) have not yet started to fall. It is very unlikely that consumer prices will go down during the recession at all.

At this moment we are at the top of the roller coaster, there is noise no longer, but we are yet to start falling.

The Storm

Although it is already certain that there will be a recession, what we still do not have completely clear is when the panic will begin and how long it will last. There is a consensus among economists from various schools, including rivals like Murphy and Krugman, that the most likely, given current trends, is that the panic will begin somewhen around the end of 2019 and the beginning of 2020.

How long a recession lasts depends on the amount of government intervention and what the central bank does. The more the government and the central bank interfere, the harder the recession.

What led us to this point is that the entrepreneurs made bad investments because the reality seemed to be something that is not, so that the resources are not allocated in the most efficient way. The recession is a correction through which society reallocates its resources in order to make better use of them.

When companies go bankrupt, their resources do not disappear, they are put to better use. When panic starts, the projects that are not profitable in reality will release the capital they have, and the projects that are profitable will acquire it. It is a process of purification.

Government interference can never reallocate resources to be used more efficiently (in the technical sense of the word) than what the market ordains. And since the recession is a market mechanism for resources to reach their use of maximum efficiency, it’s going to take more time if the government does not get out of the way.

This is what happened in the Great Depression in 1929 and in the Great Recession in 2008. As in the present, there were injections of liquidity, credit expansion, inefficient investment, inflation, credit contraction and panic. In these two cases the politicians believed themselves heroes when in fact all the programs, like the New Deal or the Bailout, ended up worsening the situation and lengthening the recession. The reason you have never heard of the panic of 1921 is that the government intervention was relatively nil and everything was resolved in 6 months.

The Preparations

My recommendations to survive, and even take advantage of the looming recession are:

  1. If you plan to sell a business or property in the next two years, sell as soon as possible. When the panic begins, the price will fall.
  2. Liquidate your financial assets.
  3. Convert your savings to gold or other precious metal. Usually, when there is a panic, the price of gold increases, so it does not lose purchasing power.
  4. Once the panic starts, stay calm and use the gold to buy capital at a discount.

With these four simple steps you will be able to preserve your estate intact and help society to be more efficient.

Categories: Politics

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