The Coming Economic Crash

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The widely observed yield curve, which measures the difference in interest rates between short-term and long-term bonds, has inverted this week—signaling a looming recession—and though many experts are particularly concerned given the heightened risks from rampant inflation and Russia’s invasion of Ukraine, others say there’s time for stocks to rally before the seemingly inevitable economic shock.

The yield curve inverted on Friday—a near-perfect historical indicator of a looming recession—but … [+] that doesn’t necessarily mean investors need to run and hide.

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6. Gross domestic product

A recession basically means that the economy isn’t growing — and the barometer of economic growth is a measure called gross domestic product (GDP). This means it’s worth monitoring this quarterly data because any signs of a faltering economy are bound to show up here.

But it’s also worth comparing gross domestic product with economists’ longer-run expectations, Donisanu says. This can help you know whether general fluctuations in GDP are any cause for concern, and it can also help you determine what the “output gap” is.

An output gap shows the difference between the actual output for the U.S. economy and what economists view as its maximum potential, and it can be either positive or negative. Real GDP, which shows growth adjusted for inflation, exceeded its potential in 2018 for the first time since 2007, according to a report from the Congressional Budget Office.

“When actual GDP is rising above its potential, we’ve historically seen these trends where the actual GDP rises above potential and it hits sort of a peak, rolls back over and falls below potential,” Donisanu says. “These are the cycles that ebb and flow over time.”

The U.S. economy grew by 3.1 percent in the first quarter of 2019 and expanded by 2.1 percent in the second quarter of 2019, according to the Department of Commerce. The Federal Reserve’s long-run growth potential for the U.S. economy is at 1.9 percent, according to its Summary of Economic Projections updated in June.

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2. Taxes Bring In Less Revenue

During an economic downturn, states typically see a decline in revenue, according to the Brookings Institute.

State sales tax can be especially discerning of consumer confidence. A common reason sales tax revenue can come up short before or during a recession is because Americans aren’t buying enough goods and services that the government can tax. And when consumer spending plunges, recessions usually follow.

If You’re Worried About the Recession: 100 Ways To Make Your Money Last Until You’re 100

Are There Any Benefits to a Recession?

It’s tough to find much of a silver lining when the cloud of recession is looming. But for the optimistic, there is good news, especially considering 2022’s endlessly rising prices: Slower inflation.

Although the goal of the Federal Reserve is to simultaneously tap the brakes on inflation while avoiding a recession, sometimes the latter could help stifle the former. While a recession won’t necessarily stop inflation, it can help slow it down — and at its current rate of 8.5%, inflation definitely needs some slowing down.

Also, since a declining stock market is part of a recession, savvy investors with cash on hand have an opportunity to buy stocks at a discount. 

Hemline index

The "hemline index" emerged on the back of a thesis in the 1920s by Wharton Business School economist George Taylor. The theory is that skirts become shorter when markets are on the rise and longer in downturns.

The economic exuberance of the 1920s and the appearance of knee-length flapper skirts, along with the emergence of the mini skirt in the 1960s amid stronger financial conditions, have been cited as examples to support this theory.

However, there have often been questions raised over its credibility.

A study published in 2010 by the Erasmus School of Economics Econometric Institute, in the Netherlands, collected monthly data on hemlines between 1921 and 2009.

"The main finding is that the urban legend holds true but with a time lag of about three years," the authors of the report said.

Interest Rates Now

Interest rates? What interest rates? Dropping interest rates to zero was essentially the first lever that Jerome Powell pulled in trying to stimulate the economy before he proceeded to flood the bond markets and bank balance sheets with newly created money in an effort to keep markets liquid. What’s more, Powell has already predicted that interest rates would stay that way through 2022 as the economy continues to struggle and unemployment rates remain at their highest levels since the Great Depression.

Growth will slow. That’s not necessarily a bad thing

Last year was the best year for economic growth since the mid-1980s, and the best for job growth on record. Those kinds of explosive gains — enabled by vaccines and fueled by trillions of dollars in government aid — were not likely to be repeated this year.

In fact, some slowdown is probably desirable. The rapid rebound in consumer spending, especially on cars, furniture and other goods, has overwhelmed supply chains, driving up prices. Demand for workers is so strong that jobs are going unfilled despite rising wages. Jerome H. Powell, the Fed chair, said recently that the labor market had gotten “tight to an unhealthy level.”

Some economists, particularly on the left, took issue with that claim, arguing that the hot labor market was good for workers. But even most of them said the recent pace of job growth was unsustainable for long.

“We have torn back toward normal at a really fast pace, and it would be unrealistic to think that could continue,” said Josh Bivens, the director of research at the Economic Policy Institute, a progressive think tank. Even slower wage growth, he said, wouldn’t worry him, as long as pay increases didn’t fall further behind inflation.

But some economists cautioned against rooting for a slowdown in a rare moment when low-wage workers were seeing substantial pay increases, and unemployment was falling for vulnerable groups. The unemployment rate among Black Americans fell to 6.2 percent in March, but was still nearly double that of white Americans.

“The recovery from my perspective is fairly robust, and so why not enjoy this right now?” said Michelle Holder, president of the Washington Center for Equitable Growth, a progressive think tank. She said that while economists were right to be concerned about high inflation, “I don’t think similar voices were this bent out of shape about high unemployment.”

3. Employment Data

The day the monthly jobs report is released is often economists’ favorite day of the month.

During (what’s generally) the first Friday of each month, the Department of Labor publishes the broadest measure of the job market. The report contains a number of data points, including the percentage of the workforce that’s unemployed and the number of jobs each sector created.

It’s important to pay attention to these employment measures.

But there are more than just headline numbers worth following. Deeper within the report is what some economists say is a leading indicator: the number of hours worked.

“It’s a decent leading indicator. When the economy slows, businesses are getting worried about future sales,” Sweet says. “The first thing they cut are hours.”

Temporary help is another good measure, Sweet says. When businesses hire temporary workers, it could indicate that they’re not as confident about the future of the economy.

Both of those measures have remained fairly consistent, though it edged down to the lowest level since Sept. 2017 in the Labor Department’s most recent jobs report. Average weekly hours worked edged down in July to 34.3 from 34.4, where it had been since April.

The number of individuals who completed temporary jobs also edged up in July, at about 602,000 individuals, compared with 577,000 in June, the latest employment report showed. Over the past five months, that total has averaged out to about 579,000 individuals.

Sweet’s favorite, however, is jobless claims. This indicator provides a more down-to-the-minute view of the labor market, he says. It’s published every Thursday, compared with monthly for the Labor Department’s report.

“They’re fairly easy to count. It’s just the number of people applying for unemployment benefits,” Sweet says. “If something was wrong with the labor market, it would come up in weekly jobless claims.”

Initial jobless claims for the week that ended on Aug. 3 totaled 209,000, according to the Department of Labor. During the week that ended on April 13, however, claims fell to a near 50-year low.

[READ: 5 ways to help make your career recession-proof]

Economic Factors of a Recession

Real changes in economic fundamentals, beyond financial accounts and investor psychology, also make critical contributions to a recession. Some economists explain recessions solely due to fundamental economic shocks, such as disruptions in supply chains, and the damage they can cause to a wide range of businesses.

Shocks that impact vital industries such as energy or transportation can have such widespread effects that they cause many companies across the economy to retrench and cancel investment and hiring plans simultaneously, with ripple effects on workers, consumers, and the stock market.

There are economic factors that can also be tied back into financial markets. Market interest rates represent the cost of financial liquidity for businesses and the time preferences of consumers, savers, and investors for present versus future consumption. In addition, a central bank's artificial suppression of interest rates during the boom years before a recession distorts financial markets and business and consumption decisions. All of these factors may cause a recession over time.

In turn, the preferences of consumers, savers, and investors place limits on how far such an artificially stimulated boom can proceed. These manifest as economic constraints on continued growth in labor market shortages, supply chain bottlenecks, and spikes in commodity prices (which lead to inflation). When not enough resources can be made available to support all the business investment plans, a rash of business failures may occur due to increased production costs. This situation may be enough to tip the economy into a recession.

Examples of an economic collapse in the world

Economic collapse can be long and short, depending on its severity. US Great Depression of the 1930s is a longstanding example. The Great Depression of the 1930s lasted three and a half years, wiping out more than a quarter of US GDP. Also, the unemployment rate during the Depression rose to 23%.

The financial crisis of 2007-2009 is another example of an economic collapse, although it lasted much shorter than the Great Depression. One of the triggering factors is a speculative activity in the housing sector in the United States. The bubble burst and resulted in the bankruptcy of large financial institutions such as Lehman Brothers.

The collapse also occurred in several other countries such as the Soviet Union, Greece, and Argentina. In the cases of Greece and Argentina, the collapse started as a debt crisis. The crisis then forced the country to devalue its currency, win international bailout support, and reform government.

In Indonesia, the economic collapse also took place in 1997. It started from the economic crisis, which then spread to the economy, causing social unrest, and forcing Soeharto to resign.

The effects of the crisis were severe. In November 1997, the depreciation of the currency caused public debt to soar to USD60 billion. That puts enormous pressure on the government budget. And, as a result, in 1998, Indonesia’s real GDP contracted by 13.1%. Inflation soared to the level of 72%. Meanwhile, the rupiah, which was in the range of IDR2,600 per USD in early August 1997, depreciated to IDR11,000 per USD in January 1998.

Key Predictors, Indicators and Warning Signs of a Recession

When searching for predictors and indicators of a recession, you’re likely to get myriad answers on what they actually are. Of all possible causes, you’ll likely hear the term “inverted yield curve” the most.

What Is a Yield Curve?

If the Pumpkin Spice Latte is the harbinger of autumn, the inverted yield curve is the harbinger of another recession. At least, that’s what some speculative economists will have you think.

In mid-August 2020, interest rates flipped on short- and long-term U.S. Treasury bonds, creating what is known as the inverted yield curve. Put simply: Some investors are losing faith in the long-term health of the economy, and, as a result, there is a higher demand for short-term bonds.

The following graph shows two inversions of the yield curve in 2001 and 2007 — both of which preceded recessions.

While the COVID-19 crisis of 2020 and the resulting lock-downs that resulted from it are unique, there was an inverted yield curve in March of 2019, indicating that the possibility of a future recession was imminent.

Other Indicators of a Recession

Besides the inverted yield curve, there are other signs of a recession. John Hilsenrath, a Wall Street Journal senior correspondent, explained some potential recession indicators on the publication’s podcast, The Journal. Among them are:

  • Excessive spending. For the Great Recession, this would be the housing bubble; in the early 2000s, the tech bubble.
  • Shocks to the system. In 2008, this was the collapse of Lehman Brothers, and in the early ’90s, it was the oil price spike.
  • The Fed hiking interest rates. To try to curb inflation, sometimes the Fed will raise interest rates. Hilsenrath said the Fed sometimes goes “too far.” For example, Deutsche Bank on April 26 — before the news of the GDP contraction — revised a previous statement it had made when it became the first major financial institution to forecast a “mild” recession. Now, the bank is predicting a major economic downturn, and it’s blaming the Fed’s aggressive anti-inflation hiking of interest rates.

Other indicators could be a contraction of the stock market. On Jan. 3, the S&P 500 was just shy of 4,800. By the end of January, it was just above 4,300 for a loss of nearly 500 points. By the start of March, it was below 4,200, where it remains today.

Some people fear a recession when things have simply been “too good” for a long time. The recession caused by the coronavirus is an example of a shock to the economic system.

What Happens During a Recession?

Recessions can be nerve-wracking for everyone, namely because unemployment levels rise across a variety of sectors within the economy, which means millions of people can lose their jobs. This can create a snowball effect where the economy gets worse and worse before getting better. Here’s what you can expect to happen during a recession:

  • Unemployment Rises: One of the first things to occur during a recession is an increase in unemployment levels. This is because during recessions, businesses often have to cut spending, and employees are often one of the first expenses to be cut.
  • Less Spending: When employees are laid off, their income is obviously affected. With little or no income, consumers are less likely to spend, which puts less money into the economy and hurts businesses and stocks.
  • Government Debt Increases: With businesses laying off workers and those workers filing for unemployment, government debt grows as it tries to stabilize the economy with stimulus bills and aid.
  • Assets Lose Value: Many assets, especially stocks and homes, can lose their value, which can result in homebuyers and investors to lose money or even become bankrupt.
  • Interest Rates Drop: During recessions, the Federal Reserve typically slashes interest rates in an effort to stimulate the economy. This makes it more likely for businesses and consumers to take out loans and put more money into the economy to get it back on track.
  • Difficulty Finding Jobs: Widespread unemployment can saturate the job market as more and more people are out looking for jobs. This can be seen with the boomerang generation (25-34 year-olds) who suffered greatly after the Great Recession and are still living at home with their parents in an effort to save money.

Recessions can be troubling for people from all wa

Recessions can be troubling for people from all walks of life due to their broad reach across the economy. With that in mind, it’s important for individuals and businesses to understand what happens during a recession in order to figure out solutions to get back on solid ground.

Further Reading

Recession Risks Are ‘Rising’ As Federal Reserve Scrambles To Fight Inflation, Experts Say (Forbes)

The Fed Has Made a U.S. Recession Inevitable (Bloomberg)

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