Lessons in recessions

The ‘r’ word is all pervading and persuading. Last month, Prime Minister Kevin Rudd finally admitted what most of us had already interpreted through the broadcast media. It would be virtually impossible for Australia to avoid slipping into a recession.

 

“It is clear that the impact of a worsening economic global recession will make it virtually impossible for Australia to sustain a positive economic growth for the period ahead, with impacts, of course, for budget and employment, which underlines the importance of global action in response to the global recession,” Prime Minister Rudd said.

 

While words like the economy and recession continue to be thrown about with such alarming regularity, it is taken for granted that everyone thinks like an economist and therefore knows how the economy is measured and what a recession is. In reality, they are concepts that few audiences fully understand and know how to define.

 

Business Matters spoke with economy experts in order to communicate the language of economics and define the term and process of a ‘recession’.

 

Technically, an economy is in recession if it experiences two consecutive quarters of negative growth in the country’s gross domestic product (GDP). 

 

However, the broad definition is not universally agreed upon because the word itself had wider meaning. Generally, all markets tend to go down when there is a recessionary period and markets go up when it is climbing out of that period so consideration must be given to a broad range of economic indicators.

 

According to the Australian Bureau of Statistics, changes in the Australian economic indicators to watch include national and international accounts; consumption investment; production; price indexes; labour force and demography; incomes and labour costs; finance markets; and state, national and international comparisons.  

 

RECESSION OR DEPRESSION?

 

The old joke between economists states that a recession is when your neighbor loses his job, and a depression is when you lose your job. Jokes aside, a downturn across a wide range of economic indicators is generally labeled as a recession while an extended period of economic stagnation usually stops being referred to as a recession and becomes a depression.

 

The Great Depression in the 1930s lasted for many years, but prior to that, any downturn in economic activity was usually labeled as a depression. It was only during the Great Depression that the term recession was developed to differentiate the length of these phases.

 

Comparing the Great Depression to the current recession helps to put things in perspective. The 1930s witnessed the United States’ GDP drop by 33 per cent, while the current economic downturn has seen their GDP drop between just three and four per cent. 

 

If we look at global GDP, it is clear that our country is not in such a bad space. Recent data released in Australia said that for the first time in eight years, GDP was well below market fall costs of 0.2 per cent, while experts predicted it would rise to between just negative 0.3 and 0.5 per cent. It would seem that Australia is a long way from any great depression.

 

FEAR FACTORS

 

Recessions, as well as depressions, can be activated by many factors. The most common factors are typically a sustained period of growth followed by inflation - price rises caused by a demand that exceeds supply - followed by rising interest rates. This reduces the enthusiasm for spending and therefore makes it difficult for businesses to raise their prices, which causes economic stagnation.

 

Refocus financial and lifestyle management director Neville Martens agreed that this cycle was the main reason behind why recessions had to occur.

“Normal economic decline would be as a result of high interest rates, a lack of spending and a drop in profits, share prices and market prices,” Neville said.

 

“At this point, it becomes necessary to look ahead and stimulate the economy again. In order to that, there tends to be a drop in interest rates because as they drop, mortgage and vehicle repayments become easier.

 

“By encouraging more spending and more credit, you push inflation up but at the same time, you have rising consumer confidence people where people feel good, investments and interest rates go up and then you have to slow the whole thing down again.”

 

Recessions can also be caused by a disintegration of the distorted perception in which people feel wealthier than they actually are, or value their assets at a higher rate than what they are actually worth.

 

“Recessions are driven by sentiment, by the way people feel. If they feel less willing to spend money that may be directly or indirectly related to where interest rates are on the interest rate cycle,” Neville said.

 

“Ultimately, putting that mix together you are going to have a situation where share prices drop, business turnover drops, there is no spending, which is usually driven by high interest rates meaning mortgage rates, large debts, and asset repayments rise, so you spend less elsewhere.”

 

Words like recession present daunting images of people losing their homes, losing their jobs, businesses closing, and general poverty across the board. When scare mongering and fanning the flames of a recession begin, it is hardly helpful.   

 

The Cycle of Market Emotions is a perfect example that points out how volatility creates uneasiness, which eventually leads to panic. Neville explained that when people invest, they are usually pretty optimistic. The markets then start rising, and there is excitement about making a great investment. It becomes a thrill and there is encouragement to invest more money. However, this is where the market reaches the top and the point of maximum financial risk and people become euphoric about their  investment.

 

At the point of maximum financial risk, the cycle turns and things start going down a little. People become a little anxious which is followed by denial and ultimately people become a bit fearful and desperate, then they may panic. It would seem we have reached this point.

 

“You speak to anyone about the value of their assets today. Their home, investments, they are all down. But if they understand why and how it will come right, then they shouldn’t panic or capitulate.”

 

It would be good to point out that the bottom of the cycle is also the point of maximum investment opportunity. According to Neville, it is crucial to apply logic and strip out emotion because if a decision is made by greed or fear, mistakes will be made.

 

“If common sense picks a fight with emotion, the latter stands no chance,” he said.

 

SUNNY SIDE UP

 

The 2008 CIA World Factbook has claimed that Australia’s economy is the 14^th largest economy in the world and reports from Bloomberg have revealed a clear pattern that the market in Australia always recovers from recessions strongly. The good news is that positive changes will start to happen but unfortunately, the bad news is that things might get a little worse before they get better.

 

“The sad thing is that if we look at the cycle, even job losses are necessary. It is understandably hard for those people, who have lost their job, but from an economic perspective, the economy will recover quicker, it will be healthier, and those people will be reemployed again,” said Neville.

 

“I wouldn’t give you a date but we are closer to the end than the beginning, by probably quite a long stretch. With the advent of computerisation, combined with stimulus packages, I think we will slowly start to climb out of this recession.

 

“In the next few years we are going to get some great returns and we will probably look back and say that this was the best investment period of our lives.”

 

Neville also added that the opportunities that lay ahead were exciting.

“It has been such a massive, negative impact and usually as a result of that impact you have a massive opportunity for investment and to make money. As much as it hurt going in, it will be great fun coming out of it,” he said.

 

As the economy picks up again, try to remember what they say: the bigger the party, the bigger the hangover.

WHAT’S THE TIME?

 

The concept of the investment clock has been around since 1937, and can be used as an indicator for understanding the cycle of the economy. According to the Australian Securities Exchange, the current economic cycle has been so volatile that the time on the clock has moved from 12 to seven in just 17 months.

 

Business Matters talked to three economic experts to find out if they were able to name the time on the economic clock, as well as provide their views on the clock’s value.

 

Neville Martens, financial planner, REFOCUS

“I think we are about at seven. Usually in a cycle there is a period where interest rates start very low. As they go up there is a slow down in the economy and a slowdown in people spending money. The broad overview is you know it must be seven because of where interest rates are, and where inflation and GDP is heading. We also have the benefit of hindsight.”

 

Bob Mark, financial planner, ABN AMRO MORGANS

“The economic clock is not really exact, especially because the causes of this recession have come from left field. It is not really a tool that we use because it is also difficult to identify how long it is between each of the steps. But by and large, the cycle of the economic clock holds true and is appropriate.”

 

Andrew Buhk, financial advisor, DBSN GROUP

“My view of where we are is about 4.30 to 5, only because I think we still have some more pain to go before we begin economic recovery. With the stimulus that has been put in across the world, I see us potentially climbing towards recovery by the end of the year. The biggest issue is that nine tenths of the world have not experienced this kind of financial turmoil so I believe that this creates uncertainty as to whether we come out quickly or slowly.”

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