WILL THERE BE RECESSION IN 2019?
Here’s why, here’s the counter-argument, here’s what you should do:
A recession doesn’t mean “bear market”. A bear market is when the stock market goes down 20% or more.
A recession means two quarters in a row of negative growth in the economy.
It means people have stopped buying things and unemployment is going up.
THE DNA OF EVERY RECESSION: FINANCIAL INNOVATION GONE WILD.
A recession in the US occurs when there is ravenous financial innovation run amok.
First someone on Wall Street comes up with a new way to make money.
Then, a ton of money is made (sending the market to highs), then Wall Street goes ravenous with greed, then it comes crashing down and recession results.
THE PAST THREE RECESSIONS:
2009: Great Recession
- Collateralized Mortgage Debt.
This was like an ATM machine for hedge funds and banks in the mid ’00s.
Banks took on so much debt that even a 1% downturn would cause them to go bankrupt (which they did).
(I am leaving out the change in laws about how banks valued their debt, which bracketed the recession, but it’s not that important.)
This WAS NOT a housing crisis. Don’t forget that housing prices began to decline in 2006, two years before Lehman Bros went out of business.
This was purely a crisis that occurred when a NEW FINANCIAL DEVICE caused Wall Street to go “crazy with greed”. We’ll see that quote again.
2001: IPO BUST + ENRON
Wall Street suddenly saw two new ways to make money: IPOs of internet companies with no earnings. And energy deregulation and derivatives selling energy.
There has NEVER been a greater year since 1999 for IPOs. Over $70 BILLION was raised on IPOs for companies with almost zero earnings.
Note: this was not an “internet bubble”. The internet is 1000x bigger. This was an IPO bubble.
Wall Street went “crazy with greed”.
I was dead center. I remember starting a mobile software company in February of 2000 and within two months I had visits from Goldman Sachs, Morgan Stanley, Merrill Lynch, and CS First Boston trying to get my company to IPO.
On the back of their pitches was my potential net worth. Over a billion! On a company with zero revenues. Heck, I didn’t even know what we did for a living.
BOOM! It fell apart.
I won’t explain what electricity deregulation is and how it almost brought down the financial system and the electric grid in the early ’00s (look at California as an example).
Suffice to say, Wall Street made a lot of money before people figured out how to regulate the excesses.
The 2001 recession was one of the smallest ever (partly because the internet was still a small part of the economy and the US still needed electricity).
This despite 9/11 and war.
In fact, value stocks (stocks with high earnings and low values) still went up nicely in the recession.
So… war + financial innovation gone crazy.
- Oil shock (we went to war in the Middle East)
- Junk bonds (a new financial innovation on Wall Street where Michael Milken figured that lending to companies with poor credit ratings was a lucrative strategy)
So banks (and corrupt savings and loans institutions) went “crazy with greed” lending to companies with the WORST credit ratings and this all fell to pieces when corruption mixed with poor lending caused junk bonds to collapse.
So here we have a combination of war + financial innovation.
- Oil shock: Iranian revolution. And oil was a much bigger part of our economy (we did not yet have hybrids)
- Inflation that never really got cured from the early ’70s when we left the gold standard.
But that wasn’t all. There was government involvement.
The Federal Reserve went crazy raising interest rates to stop inflation. They were terrified so they used the only tool at their disposal.
They raised interest rates to 18.5% (currently it is at a low 2.25%).
When interest rates are at 18%, companies can’t borrow money to start new projects and hire new employees.
Less people get hired (the unemployment reached almost 11% as opposed to 3.2% now), so there is less money spent and less demand and the economy goes negative.
So… war + the most extreme use of the tool of interest rates by the Federal Reserve.
LESSON: Don’t incentivize consumers to stop buying! Buying creates jobs, creates industries, creates more money organically.
I can go back: 1973 (war + oil crisis + no gold standard). 1969 (Vietnam), etc.
People say, “this time it’s different”.
NO IT ISN’T!
While there are certainly wars around the world (there always are), there are no wars that we JUST started. Nor is there a war effecting our economic interests.
2) FINANCIAL INNOVATION GONE WILD.
Other than cryptocurrency, which has been mostly a Silicon Valley innovation and not a Wall Street one, there hasn’t been any financial innovation affecting Wall Street banks.
Banks have been heavily regulated lately (perhaps too much so) and, if anything, have not had the opportunities to go even a little crazy (a “little crazy” is a good thing).
Q) WHAT ABOUT TAXES, TARIFFS, AND DEBT?
Anything that reduces consumer demand, hurts the economy. Period.
Higher taxes in the middle class means 100 million people with less demand for products.
Higher tariffs means less demand from the other 7 billion people on the planet for our products (assuming retaliatory tariffs from the countries we go to “tariff war” with).
And higher debt means the government has less money to spend on its citizens (on the surface).
So… are we in trouble?
The middle class’ highest tax rate (depending on how you define the middle class) has gone from 25% to 22%. This is good for the economy. This is the lowest in 50 or so years (I forget).
Tax repatriation (where companies can bring back dollars held in other countries in exchange for a reduced tax rate) means those dollars can now be spent in the United States.
Good for the economy. Good for the consumer. Good for people looking for jobs.
Corporate rate going from 35% to 21% means companies can hire more employees, return more money to shareholders (often pension funds funded by the middle class), and work on more innovations. Again, lowest in decades.
People say: corporations should pay more!
Corporations aren’t stupid. If they pay more, they charge more for their products and hire less people. Bad for economy.
When’s the last time a government agency created a cancer-curing drug or a SPACE SHIP? Private industry makes medicines. And it costs $2.6 billion to get a drug through the FDA. Private industry makes space ships.
Tax breaks are good for innovation and give more money to the middle class.
All tariffs are bad. But countries that have unreasonable tariffs against OUR products are hurting our employees.
I hope there is no tariff war. That would be bad.
But while the US is still the biggest consumer in the world (before China gets there ten years from now) we still have leverage.
The US is penalizing countries that have irrationally raised their tariffs to unfair levels above our tariffs.
So while we still have the upper hand as the biggest consumer in the world, let’s force them to reduce those tariffs.
China has an average tariff of 3.54%. The US, overall, has an average tariff of 1.6%. This is nothing compared to the Smoot-Hawley double digit tariffs of 1929.
Zero tariffs are the goal. But you have to fight with might. So far, tariffs have not effected the economy (look at our unemployment levels as proof).
All we need to care about is: can the US government pay back debt?
With interest payments at an all-time low (the US pays 2.2% on it’s debt), the US has zero issue paying back it’s debts. And it’s gone from 15% of federal outlays to only 7%, making it easier than ever to pay back debts.
Debt is not an issue at all. Certainly not for 2019.
Q) COMPARE TO THE GREAT DEPRESSION?
The Great Depression was a trifecta of sh*t.
1) Higher tariffs (Smoot-Hawley)
2) Higher taxes (tax rate went from 25% to as high as 83%!)
3) And a TRADE SURPLUS
People think a trade surplus is a good thing (it means: more countries are buying from us than we are buying from them).
But it’s usually a sign a big recession is about to happen. It means American consumers ARE NOT BUYING.
Guess what: Americans love to buy things. The only reason we don’t buy (trade surplus) is when we are financially hurting (future recession).
When was the trade deficit lowest in recent years? 2009 and 2001-2. i.e. NOT GOOD YEARS.
So trade deficits are a good thing. Consumers make more money so we buy and then we make more when the money eventually is spent back here.
- The recent market sell-off is barely a blip in the huge run we have had.
- A lot of the selloff was tax-loss selling after years of profits. This is a good sign for January.
- There is no reason to think we are even close to a recession.
- Don’t subscribe to groupthink!
WELL… WHAT SHOULD I DO?
Don’t panic. Live your life. Kiss someone every day.