Recession Coming?
Recession talk is in the air. It’s the narrative of the month amongst the talking heads. What’s it all about?
Part of the answer is wishful thinking. The theory being . . . if only we can talk the economy into a recession, there is no chance that Donald Trump will win reelection. It is unclear to me that a socialist sounding Democratic nominee (the probable result if Biden gets both feet in his mouth once too often) will be seen as the best response to tough economic times by voters in flyover country.
There is also a distinct possibility that the Chinese think that working the trade war will cause a recession and rid them of Mr. Trump. His attack on Chinese trade practices is ham handed, but it is having an impact. Xi may think he would have better luck negotiating with Ms. Warren. My bet is that Jerry Nadler will not be holding hearings on Chinese interference in our elections.
The answer is that we will have a recession! I can’t tell you when it will begin or how long it will last or how deep it will be . . . and neither can anybody else. Recessions are about misallocation of resources, but they are also about the perception/emotional response to those misallocations. The tipping point between greed and fear is impossible to predict. We have recessions on a regular basis because we are human beings whose decision making process is far less than fully rational. We will continue to make dumb investment decisions.
We currently have several misallocations going on. There is a significant market in no-covenant leveraged loan pools, which is a bug in search of a windshield. We have a $1.6 trillion student loan portfolio, only 40% of which is being serviced on time and in full. Neither of those should severely impact a $20 trillion a year economy. However, a run of any kind can spark a flight to safety and a liquidity squeeze. When confidence is lost, recession occurs. Fear freezes economic activity. Loans don’t get rolled over.
My concern is the thin ice on which we are skating. Virtually every advanced economy in the world is highly leveraged. Consumers, financial institutions, businesses and (especially) governments are sitting on massive piles of debt. In addition, we have a huge load of unfunded mandates. Decreasing birth rates and longer life spans mean there is a large and expanding pool of old folks who have been promised support. Money has not been set aside to keep that promise. My calculation is that America has an actuarial shortfall (the difference between projected collections and projected payouts) of $130,000,000,000,000 over the next 30 years as the Baby Boom generation ages and dies.
If we do have a loss of confidence and if it becomes much harder to roll over debt and if tax receipts decline, the situation could get very nasty. Not a single one of the hoard of people running for the presidency is even talking about the problem. It might be time to invest in some iron underwear.
