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December 12, 2006 by Gary North, Ph.D.
I've got bad news and good news. The bad news: A recession is coming in 2007. The good news: A recession is coming in 2007. There is nothing like a recession to create depression in most people's minds &endash; good, old-fashioned emotional depression. But for a self-selected minority, a recession is the opportunity of a decade &endash; maybe a lifetime. Most people watch, helpless, as housing prices fall, the stock market falls, business income falls, and job opportunity falls. A few people take the initiative, redouble their efforts, and position themselves for the recovery phase, which lasts far longer than the recession. For the unlucky few, they get fired. In the midst of a tight job market, they are sent on their way. But the debt meter keeps ticking: mortgage, phone, electricity, insurance, etc. We don't get recessions often. In my job market career, there have been only six: 1970, 1974, 1980, 1981, 1991, 2001. Some analysts would say 1980 and 1981 were really only one. I would agree. They both had the same cause: tight-money policy by the Federal Reserve System, begun in 1979, after a dozen years of monetary inflation. Because the most recent one was so mild, housing prices continued to rise. What fell was the personal savings rate. In the past, people have saved more during recessions. In 2001, not only did they not save more, they saved less. Fear did not overtake them. Unemployment rates close to 10% are a dim memory for most Americans. Unemployment always hits the manufacturing sector harder than it hits services. The percentage of the American population involved in manufacturing has been falling for a generation. Unemployment for white, married males is always lower &endash; no more than half &endash; what it is for single non-white males. So, when we read of rising unemployment, we who are white, married, and male rarely face the threat of getting fired. What we face is falling prices of our equity investments. We see our stock mutual funds fall. Because only the top 20% of wealth owners own stocks, except in pension funds, this loss affects a minority of the population. As for pension funds, Americans still think that somehow, they will be able to retire at someone else's expense. They believe, because they have been told, that the stock market always comes back. It hasn't come back from the fall it took 2000 &endash; not the Standard & Poor's 500, which reached 1550. But pension fund owners still have faith. Somehow, something miraculous will happen, and their retirement dreams will come true. They won't, of course. The next recession will remind a growing number of Americans: They will not be able to retire. THE NEXT RECESSION I think we are headed for a recession in 2007. The main indicator is the inverted yield curve: the short-term T-bill rate is above the 10-year T-bond rate, as well as the 30-year T-bond rate. You can track this here. This oddity appears before every recession. It exists because bond investors are generally a lot wiser than stock investors. They are mainly institutional buyers and rich buyers. They see what is coming earlier than stock investors do. When they see recession coming, they are willing to lock in their money for 30 years rather than get paid a higher rate for money tied up for 90 days. They think rates are coming down. They want to lock in high rates. Why should interest rates come down? Because rates fall during recessions. There is reduced demand for loans: fear of debt. There is also money flowing out of the stock market into CD's, T-bills, and simple bank accounts: fear of capital losses. People care more about the return of their capital more than the return on their capital. I suggest that you begin arranging your plans for 2007 on the assumption that unemployment will rise, consumer demand will fall, and your employer's income will decline. I am not predicting a depression. The word "depression" applies to the economy of 1930&endash;39. It doesn't apply to anything before or since. But in terms of the psychological condition known as depression, it applies well to recessions. Assessing a recession is the official task of a private research institution, the National Bureau of Economic Research. It uses a complex formula to announce, retroactively when or if a recession began and when it ended. So, when the country is in a recession, people aren't told this officially until months into it, and maybe only after it has ended, as happened in 2001. But the pain imposed is still just as great, no matter when the definition is officially applied to the economy. WHO SUFFERS MOST? CEOs of large corporations still draw their million-dollar salaries, but the value of their stock options falls. This is where most of their compensation comes from. Commissioned salesmen struggle. They face buyers who say, "Sorry. I'm just not interested. Things are tight." This is why stockbrokers have a very hard time in recessions. They rely on year-end bonuses for most of their income, and the bonuses disappear. Brokerage firms struggle. The merger & acquisition experts, especially the newcomers, get fired. Fiat money fuels M&A, and fiat money gets turned off prior to a recession &endash; as is happening today. In the recession, the merged firms turn out to be bloated, patched-together absorbers of capital. The hoped-for synergy fades in a sea of red ink. The poster child merger of our era was Time-Warner and AOL. In early 2000, just before the merger took place, I said it would not work. It didn't. It was obvious to me at the time. It was not obvious to Ted Turner. Anyone in the home-building industry is hit hard in most recessions. That was not the case in 2001. Residential housing continued to boom, fueled by cheap mortgage rates and fiat money. But in the next recession, this scenario is far less likely. There is too great an overhang of unsold new houses. It is getting larger. The auto industry is always hit hard. Ford is already on the ropes, having just borrowed $18 billion and for the first time having to collateralize the loans with its factories. GM is in big trouble, as Kerkorian's recent sale of his shares indicates. Chrysler is doing better than the Big Two, but we are still in a boom economy. When a recession hits, almost nobody really needs to buy a new car. They fix the old one. They make do. Used cars fall in price, so they can buy a used car if they must. The next recession will be devastating to what remains of the American auto industry. But the average Joe or Jane is not hit hard. The average American has few savings, and most are in short-term credit instruments like bank accounts and money-market funds. Americans see their interest income fall, but this is marginal in their lives because they have so little money invested. They do not see their principal fall. They are salaried. Their employer's doors stay open. Treasury Bond holders do very well. Their assets appreciate when long-term interest rates fall. Then what is really so bad about recessions? Mainly, a recession is a matter of temporarily closed-off opportunities and dreams deferred. Middle managers have career paths blocked. Promotions are more common in boom times than in bust times. But this process is now inevitable anyway. Americans have no savings to speak of. Middle managers may have under-funded private pensions. They have Social Security. Maybe a few of them have $50,000 in mutual funds. They will not be able to maintain their present lifestyles on the income generated by these assets. Their wives will resent having to drop back to the lifestyle of their grandmothers. This is like going on a permanent diet. Hardly anyone sticks to a diet. So, millions of middle managers will stay on the job. When aging men stay on the job, career openings close. This scenario is going to mark the next two decades, and maybe longer. The attrition process will slow. All but the hottest of hot shots will find themselves locked into their present jobs, unable to move up. For people with guaranteed salaries &endash; government employees, mainly &endash; recessions reinforce their decisions to play it safe in their careers. This tends to lock them into careers that have minimal prospects for wealth. These people dream of retirement. But retirement always proves more expensive than planned because the central bank always returns to inflation to escape the effects of the recession. The Great Depression was not so bad for public school teachers and government employees, whose salaries gave them a degree of income security. The depression so scarred the American population that the post-War era was one in which young people and returning vets dreamed of earning a college degree, getting that secure job, and buying safety at the expense of a shot at wealth. The novel and movie, "The Man in the Gray Flannel Suit," marked these people's dream. Voters accepted an expansion of government that would have been inconceivable in 1914 and only barely conceivable in 1930. On the other hand, for those few who are nimble and not in debt, recessions are great opportunities. You can buy low, to sell high at the peak of the next boom. Businesses can spend more money on advertising at a time when their competitors are running a tight defensive ship. It is easier to increase your company's market share in a recession than in a boom, when everyone in your industry is growing and spending big bucks on marketing. Fear and shrinking receipts in an industry become unique opportunities for companies with cash in reserve and a marketing strategy suitable for declining consumer demand. DEALING WITH YOUR GREATEST CAREER FEAR Whether the next recession is a threat or an opportunity depends on your mental attitude and your capital base. For most people, a recession is a threat, though not a catastrophe. But it will reinforce the mentality of safety. It will undermine most people's confidence in their ability to make a major upward move in their careers and lifestyles. This is why you would be wise to think through the effects of recession on your short-term prospects and your long-term prospects. Will you be in a position to re-position your career? That is, will you be able to take advantage of the widespread emotional paralysis that will be induced by the recession? When others are hunkering down, will you be able to move ahead? Here is what I have in mind. Try to identify a growing market that is likely to grow even faster if times get tough. If you can do this, you will be in a position to use the recession as a launching pad. Keep your eyes peeled. Let me tell you what I'm planning. I'm working on a CD-ROM/Internet-based high school curriculum for home schoolers. This is a growing market. Unlike most markets, a recession will make it grow faster. When a recession hits, money will get tight. Single-income families that are presently spending (say) $3,500 a year to send their children to a private high school will start looking for cheaper alternatives. I will be able to offer a program for about $400. My main cost will be marketing. I am good at marketing. To compete, I must offer something unique. My curriculum will show a high school student how to start and run a successful home business. It will also let the student quiz out of the first year and a half of college for an additional $800. Then the business will put the student through college. His family will not pay a dime for college education beyond the initial $800. Is this worth $400 a year for four years? For some families, yes. Do you understand my strategy? I will use low-cost digital technology to convert my information into a marketable product. Price it so that buyers of much a higher-priced product have an incentive to switch. I will be able to offer a one-year money-back guarantee. If the freshman student doesn't show major progress, the parents can get a full refund. No private day school can offer this because of teacher salaries and mortgage costs. My goal is not to take market share away from other CD-ROM/Internet-based programs. My goal is to compete against traditional bricks-and-mortar schools that cannot possibly compete on the basis of price. My strategy will work in boom times. "I'll teach your child how to start and run a home-based business." It will also work in a recession, when family budgets get tight. "Why pay $3,500 a year, when $400 buys a better education for your teenager?" I offer this only as an example. In every field, there are great opportunities, in good times and bad. But the average Joe or Jane is not actively looking for these opportunities. They do not perceive the truth of what Rev. Russell Conwell described a century ago: We are surrounded by acres of diamonds. If you doubt me, read what he wrote. CONCLUSION Painful as recessions are, they offer great opportunities. New markets appear, new incentives appear, and buyers are willing to pay for services rendered. They will re-structure their monthly budgets to take advantage of these opportunities. There will be losers, of course: those businesses that fail to meet consumer demand under the new conditions. But there will be winners. If the Federal Reserve System would stick to its guns and refuse to inflate in the next recession, the economy could adjust on a permanent basis. I don't think this is likely. The FED will inflate once again. This is what central banks do. For the moment, the FED is not inflating. The yield curve is inverted. The recession is in the pipeline. You can prepare for it now or deal with it later. Don't let it blindside you.
Dr. Gary North earned a Ph.D. in history and is one of America's keenest economic analysts and commentators. He supports the Austrian school of economics and is a previous assistant to libertarian congressman Dr. Ron Paul. Visit his website at http://garynorth.com. To subscribe to Gary North's Reality Check go to http://www.dailyreckoning.com/sub/GetReality.cfm If you enjoyed this essay and would like to read more of Gary's writing please visit his website at http://www.garynorth.com or http://www.freebooks.com
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