What is a recession?
“Global recession” has been a recurrent topic of debate over the past decade, reflecting the breadth and severity of the 2007-09 global financial crisis, the halting nature of the recovery, and recently, fears that the global economy is on the edge of another downturn.
A recession is a macroeconomic term that refers to a significant decline in general economic activity, it had been typically recognized as two consecutive quarters of economic decline. In other words, a significant decline in economic activity spread across the economy, lasting more than a few months.
Recession is a normal, albeit unpleasant, part of the business cycle. Recessions are characterized by a rash of business failures and often bank failures, slow or negative growth in production, and elevated unemployment. The economic pain caused by recessions, though temporary, can have major effects that alter an economy. This can occur due to structural shifts in the economy as vulnerable or obsolete firms, industries, or technologies fail and are swept away; dramatic policy responses by government and monetary authorities, which can literally rewrite the rules for businesses; or social and political upheaval resulting from widespread unemployment and economic distress.
What causes a recession?
Loss of Confidence in Investment and the Economy
Loss of confidence prompts consumers to stop buying and move into defensive mode. Panic sets in when a critical mass moves toward the exit. Businesses run fewer employment ads, and the economy adds fewer jobs. Retail sales slow. Manufacturers cut back in reaction to falling orders, so the unemployment rate rises.
Fiscal Tightening Higher taxes
During an economic downturn, states typically see a decline in revenue, according to the Brookings Institute.
State sales tax can be especially discerning of consumer confidence. A common reason sales tax revenue can come up short before or during a recession is because Americans aren’t buying enough goods and services that the government can tax. And when consumer spending plunges, recessions usually follow.
A Stock Market Crash
A sudden loss of confidence in investing can create a subsequent bear market, draining capital out of businesses.
Manufacturing Orders Slow Down
One predictor of a recession is a decline in manufacturing orders. Orders for durable goods began falling in October 2006, long before the 2008 recession hit.
When Asset Bubbles Burst
Asset bubbles occur when the prices of investments such as gold, stocks, or housing become inflated beyond their sustainable value. The bubble itself sets the stage for a recession to occur when it bursts.
The Yield Curve Inverts
Most economists will tell you, there might be no sign of a pending recession more reliable than the inversion of the yield curve. Of course, it doesn’t help that they seem to be the only ones who really understand what an “inverted yield curve” actually is, but so it goes.
The yield curve refers to a graph of the interest rates on Treasuries (government debt) of varying lengths. Money lent for longer periods of time normally has a higher rate to reflect the increased risk, so the graph usually slopes from lower rates for the short-term debt to higher rates for the long-term debt.
However, the value of long-term bonds increases significantly when either interest rates or the stock markets drop, and because both those things happen simultaneously during a recession, bond traders start scrambling for the long-term debt when they feel a downturn is looming. That increased demand can eventually push the interest rates on long-term debt below short-term debt — “inverting” the yield curve.
Past Recessions and Inverted Yield Curves
While the ins and outs of the market for government debt can be difficult to comprehend to the uninitiated, it plays a huge roll in the American economy. What’s more, the reliability of this particular indicator blows most of the others out of the water in the eyes of most economists.
But, every recession in the past century has seen the yield curve invert prior to the downturn in growth, so this has become one of the more closely watched signs.
The impact of the Russian invasion in Ukraine
There are several channels through which the conflict impacts on the world economy. The Ukrainian and Russian economies are key suppliers of commodities, including titanium, palladium, wheat, and corn. Disruptions to the supply chain of these commodities would keep prices high, intensifying for users of such commodities (including car, smartphone, and aircraft makers).
Secondly, a significant escalation in energy prices due to Russia being one of the world’s largest oil producers and energy exporters will lead to higher inflation. Ultimately increasing the cost of living and putting pressure on household consumption.
Finally, political risk and uncertainty may drive up savings ratios and make firms more reluctant to invest.
Hyperinflation is a current risk to the global economy, when prices for energy, food and transport rise, people have to spend more and the cost of living increases. This will push the central banks over the world to tighten fiscal and monetary policy. Which is basically increasing taxes and raising interest rates, making it more expensive for households and businesses to lend money. This means less spending, less spending means less growth.
Higher energy costs, with global supplies already tight, means a noticeable pass through-to retail prices.
A sudden, sustained spike in oil prices due to a geopolitical crisis might simultaneously raise costs across many industries. This causes businesses to cut the employment cost and fire people to make up for the higher input costs.
Stagflation and recession are the known risks when economies stop growing and inflation keeps rising.
Ways to protect yourself
Invest In ‘Real’ Assets
Real assets include precious metals, commodities, real estate, land, equipment and natural resources.
Decrease Your Stock Exposure
You could gradually increase your exposure to bonds and decrease stock exposure, in other words transition to a more defensive way of investing. Getting out of risk assets into safer assets like bonds and precious metals.
Have Additional Income
Even if you have a great full-time job, it’s not a bad idea to have a source of extra income on the side.
Diversify Your Investments
If you don’t have all of your money in one place, your paper losses should be mitigated, making it less difficult emotionally to ride out the dips in the market.