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A Recession Starts to Look Real

After too much easy cash, is recession a question of time?


ike the cartoon character paddling his feet midair after running off a cliff, the Federal Reserve suddenly finds itself with few good options to deal an economy turning south.

At the beginning of the COVID-19 pandemic, the Fed cut interest rates to zero, trying to encourage as much consumption as possible at a time of unprecedented uncertainty. The cheap credit also helped employers keep their businesses running.

On top of that, the Trump administration provided generous stimulus checks to most Americans, which the Biden administration doubled down on, adding more stimulus checks and ramping up government spending, printing trillions of new dollars. People rushed to buy everything from new phones to new cars. (Remember last year, when it was almost impossible to buy even a used car?)

However, the combination of “cheap money,” expensive government stimulus, and broken supply chains (including chaos at the ports) created a spike in demand for goods. The result: 8.6 percent inflation, the most in 40 years.

Now the Federal Reserve faces the dilemma of how to raise interest rates — which will curb demand for goods and bring prices down — without causing consumption to crash, which lead to businesses closing and massive layoffs. Fed chairman Jerome Powell has no easy choices.

“It is really tough to point to a part of the economy in equilibrium right now,” says Professor Scott Latham of UMass Lowell Manning School of Business. “It’s like a snow globe that we shake up, and the snow flutters about and settles. Consumer sentiment, corporate investment, job creation, are not only in a state of flux, they are at odds. It’s tough to read the tea leaves right now.”

Professor Latham says all recessions are due to fundamental problems in the economy, compounded by uncertainly: The 2008 “Great Recession” was caused by speculative housing mechanics across the board, and when the bottom dropped out, people panicked. The dot-com recession was caused by speculative tech business models, and similarly subsequent panic.

In the current situation, he says, the degree of Covid stimulus, compounded by what he calls “the Fed’s inability to act in the past decade,” has contributed to the surge in inflation. And now with the interest rate hike, and more anticipated in the next year, businesses are very concerned, and will likely start to pull back on investments in equipment and labor.

“The Biden Administration is to blame as well — they put too much money in the economy,” says Professor Latham. “While it was well intended, economists cautioned them against such a large scale dump. The US economy was addicted to cheap money. It wasn’t sustainable, and frankly I am surprised we got this far without feeling some pain.”

Recession is a tough subject, says Professor Larry Harris, Fred V. Keenan Chair of Finance at the USC Marshall School of Business, who served as chief economist at the SEC from 2002 to 2004. And it never affects all sectors of society equally. “As economic activity decreases, some people will end up getting laid off and losing their jobs. So people who lose their jobs are the most vulnerable, often people in the service industries.”

Raising interest rates, Professor Harris explains, does away with easy credit and makes money more scarce. “And anything that people spend on, they just spend less. So discretionary services, such as beauty parlors — women won’t go there as often.Basically, people will try to save money.”

Professor Latham foresees the job market tightening in the next quarter, wages beginning to drop, and people’s personal economic lot in life will just get a bit tougher. “We are starting to see evidence of jobs being pulled back, and layoffs. It will hit certain geographic areas harder. In Boston, we are a highly diversified economy with several industry clusters — financial services, health care, life sciences, technology. We will weather it better than, say, Michigan, which is largely dependent on consumer packaged goods and automotive manufacturing.”

Professor Harris says it’s clear that interest rates will continue to rise in the immediate future. “So people who have money right now should not invest in long-term certificates of deposit. They should wait till rates get higher. And people living on the edge should start cutting back now and save more, so that they’ll have money in case they lose their jobs.”

He points out one other unfortunate effect of recessions. “Another thing that hurts in a recession is that philanthropic giving drops. And so Jewish institutions that are dependent on philanthropic giving need to control their budgets now and start saving, because it’s likely that donations will decrease.”

Professor Latham has some advice for those contemplating a job change. “The press has been pumping ‘the Great Resignation’ and the fact that job seekers and employees have more leverage than companies right now. That is likely to shift in the next few quarters. So just be smart around career decisions. Start to reskill toward the new emerging technologies, business models, and disruption — out of most recessions come a pretty significant bump in economic activity. Be prepared and get marketable skills.”

So, although rising interest rates will push housing prices and mortgage rates beyond reach for many, Professor Latham sees a light at the end of the tunnel.

“I like to be optimistic, and in the wake of a rough few years, the last thing we need is a recession, or, heaven forbid, a period of stagflation. On a broader economic level, we are on the verge of a massive explosion of innovation in areas like life sciences, artificial intelligence, robotics, and IT that will drive economic growth. So the engine for growth is there, but the factors working against such growth — Ukraine, Covid, political unrest — are strong as well. I think a mild recession is likely in the next 18 months, but the former positive factors will be stronger than the latter.”


(Originally featured in Mishpacha, Issue 917)

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