Bring The Pain!

Is a recession just what the doctor ordered?

With every central bank meeting and subsequent interest rate bump, we get one step closer to a shrinking economy, otherwise known as a recession. 

Central bankers and politicians will never admit that they are purposely trying to create a recession. Their actual goal is to “slow” the economy just enough to bring demand down perfectly in line with supply. If they can thread the needle, nobody will lose a job or miss a rent payment, and inflation will settle back down to normal levels. Unfortunately, this won’t be easy.

Every incremental rise in interest rates operates on a lag that is estimated to take 6-12 months to fully impact the economy. This makes the job of central bankers extraordinarily difficult. Imagine driving a car where your steering, throttle, and brake inputs take somewhere between 10-20 seconds to register and you begin to understand how difficult this task is for the world’s central bankers. You would very likely crash that car. 

The market economy is messy and imperfect and the job of getting inflation under control is going to result in a lot of people losing jobs, defaulting on mortgages, and getting their cars repossessed. But the people in charge will never tell you this because “Vote for me and lose your job and your car” is a really shitty campaign slogan. 

While us old school capitalists acknowledge the necessity of recessions, politicians will go to extremes to avoid experiencing one under their watch. Is there any way the economy can correct itself without imposing harm on innocent families? 

Some people do think we can get inflation under control without a traditional recession. Earlier this year a couple of short video clips caught fire on social media. The videos were by Kyla Scanlon, a young economics grad who has done an amazing job of harnessing social media to build a brand of original economic commentary that is snappy and humorous. She’s great at what she does. Unfortunately, I can’t agree with her take here.

The first video starts with her asking the question “Do we need a recession?” and immediately answering - “no.” 

“A recession would probably fix some things, sure,” she said, admitting that it would bring down demand and get inflation under control. She also raised the point that a slowdown wouldn’t fix supply chain issues caused by Covid shutdowns. So far, I agree.

“But we don’t need to achieve (this) by invoking wreckage.” She claimed. “We just need better policy.” 

Better policy? What is this magic policy that can correct economic imbalances without inflicting any pain? Anyone…? 

It’s partially government policies and central bank hubris that got us here in the first place - you know, the massive injections of monetary and fiscal stimulus that were used to get us through C-19 shutdowns and a stubborn belief in central planning. And yet we have faith in government to fix this mess? 

Capitalism relies on the concept of creative destruction - the strong survive and the weak adapt or die. In a follow-up, Scanlon explained the Austrian economic model that sees a recession as a healthy way to regulate the long-term health of an economy (in the same way that forest management requires clearing away brush). But she seems to dismiss it as anachronistic. 

There’s a particular school of thought she seems to follow that believes that economic pain isn’t “necessary,” and that we can get inflation under control with “better policy.” 

Of course, we would all love it if we could restore economic equilibrium without causing anyone any hardship, especially society’s most vulnerable, who far too often bear the brunt of tough economic times. We just don’t know how to do it. I mean, I’d love to know how to lose weight and get ripped on a diet of pizza, beer, and ice cream, but I’m not sure there’s any degree of “better policy” that could possibly get me there (if anyone has any ideas, you have my email).

Is a recession necessary? 

Unfortunately, yes, it probably is. 

Economist Allison Schrager explains why in this Bloomberg piece: 

It does no one any favors to remove risk from their life. It’s better to accept that downturns happen, that sometimes wealth is lost, and then help people become more resilient during the setbacks the economy throws at them. This involves more modest monetary policy and a safety net that provides insurance against the very worst shocks, protecting the most vulnerable, but otherwise allowing for failure. Attempts at risk elimination make people less resilient. Promising households and the private sector that they’ll always be bailed out encourages more debt—and less resilience to shocks. 

In essence… taking the economic medicine now is preferable to being forced to take it later, in the same way that making the sacrifices necessary to take care of your health today will make you more immune to sickness and disease in the future. 

Despite spending all of this time pondering interest rates and recession risk, I continue to implore you to ignore macroeconomics in your investment decision making process. None of this should matter to your investment policy, or how you go about preserving your wealth. 

The principles remain the same. 

Own a diversified basket of productive assets. 

Invest in human ingenuity. 

Maintain a defensive posture (revisit Chapter 17 of my book if you need a reminder of why low risk rules). 

Tune out the noise. 

Focus on the longer term. 

We will emerge from this. We will be fine. With a long enough time perspective, all inflation and economic turmoil is, in fact, transitory. Don’t let it throw you off your plan.