The first of July 2022 marked the end of the second quarter (April to June) and the start of the third quarter (July to September).
The contemporary definition of a recession is a period of negative economic growth. The period or duration isn’t defined. However, the classic definition of a recession is two consecutive quarters of negative growth. We’re going to use the traditional definition.
The first of July 2022 is a unique date as it’s the first day of a technical recession which is different from an official recession.
Let’s start with explaining an official recession as it’s easier.
The US Bureau of Economic Analysis (BEA) publishes official economic data, including economic output, better known as Gross Domestic Product (GDP). The BEA collects data based on past events using scientific data collection methods. The information collected makes it accurate and reliable.
BEA may take a few weeks before it publishes official data like GDP. First and foremost, it must wait for that quarter to be over before it can collect data. Secondly, the process requires collecting data from various sources.
Official data must show two consecutive quarters of negative growth before a recession can be declared. It takes a while to declare an official recession. The basis of official data is historical data and the quantity of data collected.
In an official recession, the BEA’s official data must show two consecutive quarters of diminishing economic growth.
In a technical recession, the first quarter must show a decline in economic growth using the official GDP described above. In contrast, the second quarter doesn’t need to rely on official data. Usually, the second-quarter data relies on the “best guess”.
Consumer sentiment is a “best guess” or a prediction. The financial markets like the S&P 500 and Nasdaq and commodity markets like the CME (Chicago Merchantile Exchange) indicate consumer behaviour.
For example, if listed companies on stock exchanges report lower quarterly revenues and profits, this will affect the stock price. For example, if Apple reports lower sales, investors will sell their stocks in the company.
If other tech companies like Google, Facebook, etc., report lower sales, their investors will also sell shares. Overall there would be a sell-off in the financial markets.
Companies’ revenues depend on their clients. A client’s expenditure is a company’s revenue. If consumers are spending less, this may mean that there can be pessimism in the financial markets. Lower revenue means the company isn’t attractive to investors, so they sell their investments.
Consumer expenditure, one of the four main components of the calculation of the GPD, is obtained from the companies’ revenues. Lower revenues for companies indicate that the GDP will be lower than expected.
Copper is a metal widely used in appliances, motors, wiring, etc. An indicator of economic strength is copper. If the price goes down, it may be a sign that a recession is on its way.
One does not need the official data to be able to predict a recession accurately.
What causes a recession?
The causes of recessions are different. Regardless, the symptoms or the effects are always the same. For example, the 2008 recession was caused by what’s known as the sub-prime crisis. In a nutshell, banks gave out loans to everyone, even those who couldn’t afford to pay them back. Banks based their assumption that everyone pays their loans.
The upcoming recession’s main characteristic points to supply chain problems. In simple terms, problems originate from the extractions of raw materials and manufacturing bottlenecks. Supply chain problems occur either when demand exceeds supply. Supply chain problems are the leading causes of inflation, as there isn’t enough to keep up with the demand, so prices increase.
Another example relates to the number of suppliers. The invasion of Ukraine and sanctions on Russia reduced the supply of grain, energy products, fertilizers, etc. For example, recent outbreaks of COVID-19 in China forced an entire shutdown of whole regions, putting strain on the supply.
Federal Reserve policy mistake
Increasing interest rates is one of the Federal Reserve’s many tools to control inflation. The notion is that if interest rates increase, people will buy fewer goods as it would be much more attractive for them to save money instead of spending it.
There is a school of thought that the Federal Reserve is making a policy mistake. For example, inflation affects necessities, as opposed to wants. Needs include like items energy, medication and food, among other things. Regardless of how much prices increase, people still need to consume food.
The invasion of Ukraine and the sanctions on Russia are affecting the supply of needs. Therefore increasing interest rates is ineffective. The solution lies in increasing supply to bring down prices.
Some predict the Federal Reserve may need to reverse interest rates downwards in 2023 to stimulate growth.
So far, increases in interest rates haven’t tamed inflation. The demand side isn’t the cause of inflation as people are buying the same amount of food as before. Problems originate from the supply side—the decline in the availability of needs.
Inflation is causing internal strifes in economies like strikes as employees demand higher wages to keep up with the cost of living. The increase in interest rates is forcing businesses into foreclosures, as it’s too expensive for them to borrow money from banks. Companies go bankrupt because their costs have increased as their clients can’t afford to buy their products.
There will come the point where every Government will have to decide which company lives and which one fails.
A bailout is a financial lifeline given to businesses to allow them to continue operating. Bailouts are synonymous with recessions. However, Governments can give bailouts for other reasons, such as protecting national interests like national airlines. One example is Alitalia.
In 2009, the US Government gave bailouts to banks and auto manufacturers. The US Government at that time felt these industries were too essential to fail and worth saving.
Bailouts inside the European Union may be subject to stringent rules, as there can be a fine line between a bailout and state aid. State aid is how European Governments provide money to help ailing national companies due to competition from other EU member states. One example is that national airlines struggled due to pressures from low-cost airlines like EasyJet and Ryanair.
In the case of a bailout, Governments will have a limited amount of cash at their disposal. They may need to decide which business will live and which will get axed.
For example, the German Government is in talks with an energy producer about the possibility of a bailout as it’s on the verge of going bankrupt. As the economic crisis unfolds, we’ll hear more about companies getting bailouts.
Besides bailouts, Governments can take over private companies to protect their national interest. Nationalization is when Governments take over private companies by purchasing shares and injecting cash into the company. One such example is the privatization of companies that produce electricity. When a company is taken over by the state, specific rules and regulations might not apply. For example, the company’s sole revenue can be the Government’s contribution. The Government will be its own client.
One must remember that bailouts and nationalized companies get funded from taxpayers’ money.
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