Give Me a Recession, Please!

But though a recession is never an ideal, we don’t live in a perfect world. Sometimes we overindulge, and our New Year’s morning isn’t all that festive after a raucous previous evening’s celebration. I’d like to argue that sometimes a little recession is a necessary correction for past mistakes. And when it’s time, choosing the “hair of the dog” rather than some strong coffee is really a bad idea—so a recession can be the lesser of two evils.

Why do recessions happen?

That is a huge question, beyond simple analysis…but I will give it a try.

Perhaps it’s because people everywhere, somehow, get collectively depressed and cut their spending. Or Scrooge-y governments opt for austerity, cutting spending and increasing taxes, and/or raising interest rates, grabbing the punch bowl away from our celebration, plunging nations into the darkness of a very unnecessary recession. Or you are a small country “cursed” with oil reserves, and as the oil runs dry, your exports tumble, you sell your Mercedes, and ask for an IMF bailout. Or, if you are John Maynard Keynes, maybe those mysterious “animal spirits” are causing an irrational exuberance that eventually collapses. Or maybe it’s sunspots, toying with crop yields. 

So, is this recession the fault of individual mass psychosis, government frugality, resource depletion, the manias involved with speculation, or…God?

I vote for none of the above, and instead, ascribe it to pure human folly, with a smidgen of hubris and incompetence, flavored with good intentions, fueled by the people in charge of monetary policy, aided and abetted by rational politicians. And if I’m right, a little recession is good for the soul…of a country. The real tragedy is that recessions are pretty much avoidable.

To understand the “receding,” one must understand the ascent. The boom precedes a bust. The overindulgence happens before the Alka Seltzer. 

Let’s first look at a boom. Everyone loves a good economic boom. Jobs are easy to find, the rising tide lifts everyone’s boat, interest rates are still low, and housing prices are up, up, and away! I remember hearing right before the 2008 crash about a survey of Californians, whose home prices had been rising at a 20% annual clip: what struck me is that most of them expected the 20% appreciation to continue, forever. So a $1m home would, in 12 years, be worth about $15 million. That fact alone is nearly enough for me to question my previous snide comment about animal spirits.

But why does an economic party get out of control? Likely, the same reason John Belushi’s “Animal House” went sideways. 

In the economy’s case, look at the money, not the liquor.

In our current system, where money is unbacked by anything except the verbal pledges of Federal Reserve officials, there’s a bias for low interest rates. Consumers like cheap auto loans, homeowners love to refinance their mortgages, prospective homeowners love lower mortgage rates, businesses love to borrow cheaply, and the government officials love to finance that debt at 2% rather than 8%. On our $33 trillion of debt, that 6% difference is—once fully rolled over—roughly $2 trillion in interest payments saved per year—enough to fund our defense spending for nearly three years!

So whenever a war or an emergency occurs, officials want to print money to pay for it or at least lower interest rates to add juice to a sputtering system. Money supply skyrocketed during WWI, the 1920s, WWII, the Vietnam War, during the “dot.com" bubble, the Great Financial Crisis, and Covid. Monetary policies have long and variable lags. At first, lower interest rates increase investment of all sorts; asset prices (stocks and home prices) also rise, and eventually prices for goods and services increase. The Fed notices this inflation, and eventually acts, increasing interest rates and/or lowering the growth of money supply, and this tightening also incurs lags.

Eventually, the recession happens. In the US, whenever we’ve had inflation rates over 4% and unemployment rates under 4% (such as 2023), a recession has always followed. 

To blame the recession on the Fed raising interest rates is silly, rather like blaming a hangover on coffee. But to blame the Fed’s fueling the boom? That is probably appropriate. And congress spending more money—that’s the aiding and abetting.

Here’s an oft-forgotten example. During WWI, the Fed let the money supply grow at a 12% to 16% annual rate; when the Great War finished, and inflation increased, the Federal Reserve increased interest rates to 8% and the rate of money growth plunged into negative territory, and by 1921 a recession—worse than the first year of the Great Depression—occurred. Unemployment rose to double or triple today’s rate, and the federal government…did pretty much nothing.

By 1923 all was well. The recession didn’t prompt bailouts, helicopter money, or welfare. Markets adjusted. This laissez faire approach was likely the last non-response to a bust.

In the 1930s, it was a vastly different story. The Fed—whose primary job was to safeguard banks from failure, presided over a third of them failing after the monetary expansion of the 1920s. And the federal government (we can blame both the Hoover and Roosevelt administrations for this error) tried to raise wages and prices, thinking that then people would have more “purchasing power,” stimulating demand.

That failed, which explains why unemployment was still 14.6% (!) in 1940. So the recession lasted over a decade—becoming a depression, which is officially a “really bad recession.” Unemployment finally dropped during WWII, but not because of the war per se. It dropped mostly because wages dropped because of wartime price controls. 

One counterintuitive point in economics is that for recovery to occur, prices must drop, and in the Depression, real wages increased, which created and maintained the high unemployment during the 1930s. 

Here’s an analogy: suppose the fruit manager at Sendiks buys 10,000 bananas for $.25 a pound, but after a week, 9,000 are left, and they’ve gone from green to yellow to yellow with small brown spots; so he raises the price to $.30 a pound.

Oops. The “unemployed’ bananas become, at best, banana bread, and at worse, they are tossed. 

If workers’ wages drop from artificially high levels, on the other hand (as they did during our recent bout of inflation), mass unemployment is unlikely…which helps explain the abnormally low unemployment rate in 2023.

So, while the occasional recession is likely avoidable in theory, in reality, it’s the response to the fun times of low interest rates and easy money. And, like a hangover, it’s over pretty quickly, if officials do the right thing.

Which involves, mostly, doing nothing, or at least avoiding attempts to increase total demand. If governments were to do nothing during a recession today, it would be akin to you wearing a flapper dress or a top hat to a Packers game: it’s so very out of fashion.

James Grant notes this anomaly in his book, The Forgotten Depression: "The essential point about the…downturn of 1920–1921 is that it was kind of a last demonstration of how a price mechanism works and the last governmentally unmediated business cycle downturn, meaning it was the last one that the government didn't attempt to treat with fiscal intervention.”

In 1921, President Harding did do one significant thing: he signed a law increasing tariffs. So, he did…the wrong thing. Despite that mistake, the economy recovered quickly.

So the next time you hear suggestions to “do nothing” in a downturn, remember that sometimes, doing nothing is the best thing to do. Just expect to get awkward stares at your top hat.