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is a recession inevitable?

By: Frank Armstrong

By: Frank Armstrong, CFP, AIF

When the stock market re-opened on September 17th, the bear came to the party and he ate everybody’s lunch! The one-day results were not pretty. US prices adjusted to about what foreign markets had already attained. On the other hand, trading was orderly, and the neither the system nor the market crashed.

The fact that the markets could even open at all such a short time after such massive destruction is a testament to the genius and courage of all involved. It was a heroic and remarkable achievement. The benefits of re-opening are both symbolic and real, setting the stage for a return to “normal”.

On Tuesday markets stabilized, albeit at a lower level than before the tragedy. Wednesday saw more turbulence. As we have previously noted, isolated or random disasters generally have little long-term effect on either stock markets or economic activity. My best guess is that six months from now, markets will be trading very close to where they would have been anyway.

However, this shock came at a time when the world’s economies were already showing signs of weakness causing speculation and/or predictions that a recession is inevitable. That’s one possible outcome, but there are other equally likely possibilities.

The inevitable recession is a worst-case scenario where the world’s governments all stand idly by while an economic tailspin develops. I wouldn’t want to bet on it. It’s far from a sure thing. In fact, betting on the worst-case scenario is in itself a high-risk strategy. If the market recovers, you will endure real, permanent, painful losses. Liquidating your portfolio now, or selling short is a bet against economic and market recovery.

Let’s look at some steps that governments around the world could take that collectively could provide powerful stimulus to jump-start a recovery.

Short term and immediate:

  • Inspire confidence. Consumer and business confidence is key to any economic recovery. A few more leaders like Mayor Rudolph W. Giuliani (no matter what you think of his previous record) would be the best tonic we could hope for.
  • Increase money supply. The Federal Reserve has already injected massive amounts of liquidity into the economic system by simply repurchasing outstanding federal debt. When the Fed retires debt, the dollars that they pay for it are immediately available to the economy.
  • Lower interest rates. It’s not an accident that the Federal Reserve lowered rates a half point just before the market opened. Lower rates help business and consumers finance capital spending and investments. Other banks around the world took the same approach.
  • Deficit spending. Spending money that it doesn’t currently have is a classic, proven pump priming technique. Any government can print as much money as it wants to stimulate economic activity. Inflation is not a primary concern now that would prevent modest deficit spending.
  • Tax cuts, and or direct payments. Lowering taxes allows individuals and businesses to spend and invest more.

Longer term and structural reform:

  • Reduce Regulations. Regulations are important to the smooth functioning of any society. But, many regulations are outdated, excessive or counter productive. Compliance acts like a tax, soaking up time and funds. Relaxing them frees up resources for better use.
  • Trade Liberalization and reduce tariffs. Stimulating trade increases economic activity for all parties. Expanding NAFTA to other Latin American countries is long overdue.
  • Privatize. Inefficient government enterprises consume capital and drag down economic activity. Governments worldwide that have privatized industries have seen economic growth and increased efficiency.
  • Strengthen the financial system. Some countries, notably Japan, have insolvent banks that should be allowed to fail. The overhanging bad debts prevent effective capital formation and endanger the entire economic system. The US cleaned up our banks during the 80s, a painful process that laid the groundwork for economic expansion during the 90s.

Contrary to our occasional beliefs, governments are not entirely clueless. Especially democracies, which need to satisfy multiple conflicting interests, seem to lurch erratically toward doing the right thing. However, a clear mandate is likely to emerge from this tragedy expediting the political process.

In short, a prolonged recession is avoidable using well known, proven economic techniques. It would be reasonable to expect concerted coordinated world government actions to head one off. Long-term investors have every reason to expect economic recovery. The sky need not fall!