No, we are not headed for a recession
(and why some people think we are)
On October 11, the S&P 500 and Dow Jones Industrial Average experienced their first major dip in over nine years falling by about six percent. The ensuing volatility swings have caused pundits and talking heads to decry the end of the stock market claiming that another recession is just around the corner. “The volatility index this,” and “The ballooning of the national debt that,” are just a few of the wild proclamations that “experts” seem to be spouting on a loop. So-called “experts” like Peter Schiff and many other no-name media contributors across the blogosphere say we’re in a bubble that’s about to erupt and cause a recession bigger than the last one. Fortunately, nothing could be further from the truth.
Unfortunately, like most things in the realm of finance news, one must look at the “good” reason and the “real” reason. (I’ll get to this later) The good news though, is that we are not headed for a recession. We can all calm down. Let me explain.
But in order to understand anything we first need a little historical context so bare with me.
Nassim Taleb, the author of the infamous The Black Swan, put out a follow up in 2012 called Antifragile. “Antifragility,” as he describes, “is a property of systems that increase in capabiltiy, resilience, or robustness as a result of stressors, shocks, volatility, noise, mistakes, faults, attacks, or failures.” What he means is that in order for something to become stronger, it must be given shocks to its system so that it can react appropriately. Kind of like how evolution granted us strong bones or how our skin tans in reaction to sun exposure or how a tree trunk grows thick in response to the wind. In order for something to change and grow strong it must be given stressors so that it can react appropriately.
Our market, in other words, is stronger than it’s ever been because it has been put through appropriate stressors and has grown stronger because of it. The real reason for EVERY recession is essentially financial innovation gone wild.
The real reason for EVERY recession is essentially financial innovation gone wild.
2009: Collateralized mortgage debt
Banks took on so much debt that even a 1% downturn would cause them to go bankrupt (which of course is exactly what happened). People always called this the “housing crisis” but it was not actually a housing crisis at all. Housing prices began to decline in 2006, two years before the recession began. This was the result of a new financial device that caused banks to go crazy with greed.
2001: The Tech Bubble mixed with accounting tomfoolery from Enron
Internet companies became the flavor of the month. Two year old companies with no revenue were filing IPOs. Investors piled into these companies because the Internet was the hot new thing. It was going to put traditional retailers out of business and was going nowhere but up. Of course, many of these companies went bust. Fortunately, the internet was still a relatively small part of the economy at that time so the recession was relatively small. This was not actually a “tech bubble” so much as it was an “IPO bubble.”
At the same time, illegitimate accounting practices (accruing revenues that hadn’t been made) caused Enron to go belly-up and many employees 401K’s to go to zero. This caused fear in the market which caused instability.
And just for fun, we’ll add 9/11 and the election of George W. Bush. Many people believed Bush to be a warmonger so throw that on top of 9/11 and you get the IPO bubble, Enron, and war.
1990: Oil shock and Junk Bonds
The oil shock was merely a reaction to us going to war with the Middle East. Junk bonds, again, financial innovation gone wild. A junk bond is a high-risk, high-yield security typically used to raise quick capital in order to finance a takeover. They’re called “junk” as a way to deter retail investors from getting involved with them. Junk bonds were a new financial instrument that hit the street and got a lot of investors excited and involved. While thery’re not exactly illegal, the overexcitement at their prospect got too many people involved. Obviously, since they’re high risk, a lot of them crashed and a lot of money was lost.
1980–82: Irananian revolution and inflation leftover from the removal of the Gold standard
Interest rates spiked after the removal from the gold standard but then declined shortly thereafter. However, in the late 70s to early 80s interest rates suddenly spiked again. In order to combat this, the Fed did the only thing they can do which is raise interest rates. Interest rates were raised to a whopping 18.5% (currently interest rates are at a low of 2.25% and usually sit somewhere around 3.5%).
When interest rates are that high, nobody of sound mind is going to finance a car or a house or an education. They put that money in the bank. Companies can’t borrow money at that high of an interest rate which means less people get hired and less people have jobs and less people have money to spend.
1932: Higher tariffs, higher taxes, and a trade surplus
The roaring twenties led people to believe that the market would rise forever and the US was destined for greatness. Sadly, this caused overproduction of marketable goods, unsustainable growth in the industrial sector, and gave banks reason to vastly overextend credit. S — t hit the fan, so to speak, in 1929 and caused a huge sell-off in the market. This caused a panic selling of assets followed by deflation in asset and commodity prices, drops in credit, and disruption of trade.
The government enacted the Hawley-Smoot Tariff act, which raised tariffs on imports to a staggering 59% in an attempt to try to get people to buy domestic goods. The government raised taxes from an already high of 25% up to 83% so they could try to create jobs. Obviously we know how good the government is at making jobs and FDR’s New Deal did little to bring the US out of the recession. And naturally, because workers could not sell their goods, there was a huge trade surplus. A trade surplus is bad, it means people are making but not buying. What we really want is a trade deficit, it means that people are buying so much that not enough is being made.
So these three factors: tariffs, taxes, and a trade surplus sank the US into the Great Despression. Fortunately, I like to think we have learned from our mistakes.
Currently there are no new financial instruments that can be abused, there are no wars to cause turmoil, and there is no reason to suggest that consumer spending might suddenly drop off.
So why all the fuss?
Taxes, Tariffs, Debts, and Agendas
Taxes
The middle class’ highest tax rate has dropped from 25% to 22%. This is the lowest in around 50 years. Obviously, less tax means more money to spend and spending is good for the economy. Meanwhile, the corporate tax rate has dropped from 35% to 21%, while arguably unnecessary, it means that companies have more money to invest in new projects, hire more workers, and return more money to shareholders. It also incentivizes tax repatriation wherein companies bring money held overseas at lower tax rates back in to the country.
Many people believe the government needs more money. I for one, am becoming more convinced that the more money that becomes privately held is ultimately good for our economy. (When was the last time the government built a rocket ship, created a cancer-curing medicine, or engineered an electric car that can travel 600 miles?
Tariffs
While President Trump claims that the raising tariffs on imported goods is to help repatriate jobs to the US, the real reason (again good reason vs real reason) is to penalize countries that have irrationally raised their tariffs to unfair levels above our tariffs. Obviously, a tariff war is undesirable. The goal is 0% tariffs. But China has an average 3.54% tariff which is more than double the US’s tariff of 1.6% So, while we have the stronger hand, we might as well fight to bring those down.
Debt
Nobody knows hows economics works. While we do have a pretty shockingly high national debt, it doesn’t really matter. The US dollar is very strong and accepted pretty much worldwide. We will never have to pay that back. The only thing we have to pay is the interest. The US currently only owes 2.2% on it’s debt. And we have gone from a 15% federal outlay to 7%. Basically, the US has no trouble paying back it’s debt. The federal debt is merely a talking point that politicians love to use to scare people into voting for them (and more specifically make their opponent appear irresponsible).
Agendas
Like I stated earlier, as with everything one hears in the press, we must ask “What’s the good reason vs what’s the real reason?” Don’t get me wrong. I love Peter Schiff. I love a contrarian whether I agree with him or not. But when Peter Schiff claims that we’re headed for a recession, what he’s really hoping is that people will listen to him, pull out of stocks, and put their money in to gold. If people pull out of stocks, stock prices drop which means he can buy up more stocks at cheaper prices. Then, when people put their money in to gold, the price of gold will rise and he can cash out his gold reserves for a nice profit.
In the finance world, a world where everyone is trying to one up each other in order to make money, you must always ask yourself, “Why are they sharing this information?” More often than not, it’s because they want you to listen to them and do exactly what they say.
Another agenda is simply the press’ supreme hatred for Donald Trump. If it’s not obvious to you then I’m afraid you’re not paying attention. Now I’m not claiming Donald Trump is the greatest president in the world; in fact, it’s actually pretty obvious that he doesn’t know what he’s doing, but he’s also not the worst. However, the press wants to do everything in their power to convince the populace to unelect Donald Trump next time around. Unfortunately the press is pretty liberally biased and since our country has somewhat devolved into an “us against them” mentality, claiming that Donald Trump is crashing the market is just another tool in their handybelt to attempt to convince readers and watchers of this fact.
Here’s the truth
The recession of 2008 was the worst our country has experienced since the Great Depression. But there were very specific reasons for why it happened. In 2008 the market dropped 20% in a matter of days. We’ve been in a bull market ever since. They call it a bull market but it was actually more of a recovery for about 6–7 of those years; and a slow recovery at that. The volatility we’ve been seeing recently is simply a return to normal. The market is supposed to have volatility; it may seem bearish at times but that’s not unusual, and certainly not cause for alarm. The swings may seem a bit larger than what is to be expected but that’s just because speculators are overreacting because we aren’t used to it after almost 10 years of steady growth. And if the market does drop, don’t get alarmed because that simply means you can buy more for less.
