The talk of a prolonged recession is on all our minds these days. Though there is no "official" proof that we are in a recession yet, since it requires two consecutive down quarters to establish a recession, there is no doubt that we are presently in one and that the results of this one will be deeper than any most of us have ever known. Unemployment is rising every month, consumer confidence is in a virtual free-fall, and spending is down. In an economy in which 70% of the action is found in sales this is a very bad sign. So what makes an economy go into such a recession?
The National Bureau of Economic Research, a nonpartisan body of economists, determines the official start and end dates of a recession, using a range of data. The bottom line, no pun intended, is that a recession is a prolonged and significant decline in economic activity. These declines will be seen in personal income, employment, production, and sales. The simple fact is that all economies go through boom and bust cycles.
Recessions generally result from excess capacity, thus when supply exceeds demand we are in a recession. When the economy is growing then businesses build factories, buy more inventory and hire more workers. But business has a way of misjudging long-term desire on the part of consumers so when anticipated demand begins to decrease the economy shrinks. Businesses responds by cutting back; e.g., purchases, workers and investments.
Most economists agree that our present problem stems from excess housing, which then drove the prices of all our homes down. Dropping home prices then had a deleterious impact on the rest of the economy. Some suggest that we will need one month of a down turn in the housing market for every month we boomed to get back to a normal place. This would be about 30 months if my general sense of things is accurate. (Please do not hold me to this number. I am not an economic prophet!)
But what about the markets? Markets do not always fall when the economy weakens. When FDR became president in 1933 the economy was in a shambles but the stock market was already growing again, having rallied by 30% from its low in 1932. Markets often anticipate downturns and fall just before a recession. This being the case the large market drops in September-November make economists quite sure that what follows is a really deep recession. But in October of 1987 we had a huge drop in the Dow only to see the economy remain strong until much later on.
How long will this current recession last? Could it become a Great Depression? As long as we've had market economies, since the mid-1880s, the U. S. has suffered 32 recessions! One of the worst was in 1873. The economy boomed following the Civil War but then a real estate bust in Europe led to the collapse of the largest U. S bank, sending shock waves through Wall Street. This recession lasted for more than five years!
Every recession is not launched by a market drop-off. The 1990-91 recession was begun by the end of the Cold War and the battle of first Gulf War. The defense industry contracted sharply and defense-related jobs were lost, along with manufacturing and exports. The national economy shrank 1.3%.
The worst modern recession was in 1980-82, following the Jimmy Carter era. Unemployment exceeded 10% for the first time since the Great Depression. The Midwest and industry were hardest hit. Steel lost 30% alone. Inflation also rose to levels around 20%. I still recall the term "stagflation" coming into vogue during this time. I remember it as the worst time, at least for me personally.
So what constitutes a depression? If a recession lasts for more than two years, with unemployment at 25% or higher, it's designated a depression. Since 1900 we have experienced only one–the Great Depression, which spanned the entire decade of the 1930s. This is why my parents always responded to money and economic hardship the way that they did. They were teens and young adults during those years and gained their values and lessons through such a difficult decade. Most believe the Great Depression ended only because of World War II, not because of government intervention in the economy. (I agree with this view and believe that it can be convincingly argued.)
Are recessions getting worse? The 22 recessions recorded prior to World War II lasted an average of 20 months. The 10 recessions since have averaged half that time. A major reason for this is that the Federal Reserve has gotten better at stimulating the economy when it starts to decline. This means, in simple lay terms, that the government pumps money (liquidity) into the economy. The truth seems to be that recessions have been milder since World War II but so are the recoveries. After the 2001 recession we had what has been called a "jobless recovery." This may be why many never acknowledged the strength of the economy during most of the Bush presidency.
It is here that the media plays such a huge role in the modern age, but one that is hard to fully grasp. Consumer confidence is either weakened or strengthened by the daily reports of the economy. I get the sense that most people think the economy has been really bad for eight years now. The way the media reports this economic news has, to some extent at least, impacted how we all feel about our economy. I know people who think that the last eight years have been horrible economically. Looking at the big picture this has quite simply not been the case. In this instance the way we hear this news impacts what we actually do with money and how we perceive what is happening around us.
So how do recessions finally end? Businesses start hiring again, consumers feel more secure and begin to spend again. Such recoveries vary but they all have these basic elements. Some recoveries include further dips, thus looking like a W, while others are more L-shaped. The way to avoid a long-term downturn is to use federal stimulus. Warren Buffett expresses it this way: "There is only one institution in the world that can borrow enough for long enough to counteract all those recessionary forces. And that's the United States Treasury."
How much do our presidents impact these recessions? My answer is very little. They can do reasonably good things to help the recessions become shorter but they can do almost nothing to stop them. This is a major reason why I find it almost amusing that both parties have used recessions to gain political power. Reagan used it to defeat Carter, Clinton to defeat George H. W. Bush and Obama to beat McCain, who was seen as a third-term Bush.