top of page

It has been seen that whenever you mention the “R” word, people assume that you’re either a pessimist or a wannabe Rajan who’s sitting on his cash and burying gold in his backyard. The reality, however, is that recessions are an inevitable component of the economic cycle. No one wants to talk about them because the issue is quite a sensitive Ponzi scheme whose mere mention has the potential of leading us into an economic collapse. This article attempts to substantiate the forecasts of the Financial Recession 2020 and will majorly be seen through the eyes of the World’s de facto economic capital, USA.


Now just because the American economy has seen a period of low interest rates and stable growth does not mean that some catastrophe is on its way, but there are some indications given by the world economy that are elaborated upon in the trends analyzed below:


Gold – Never forget the golden rule – he who has the gold makes the rules. It is the only financial asset that is not simultaneously someone else’s liability. Also, it shines. Gold has shown a high gradience negative relation to the S&P 500 index during periods of recession which implies that when all the stocks come crashing down, the value of gold rises and this trend has been seen in five out of the last seven recessions, with sometimes double-digit appreciation. The reason? It is merely a spiral of sentiments because when people lose money in the stock market, they expect gold prices to rise and invest in it, which, in turn, increases its demand and the price actually rises. Hence, speaking of a recession causes the amateur small players (majority) to move towards this safe investment, and that might add to why gold prices are being projected to rise in the next few years. The other reason is inflation which shares a positive relationship with gold prices. The long term effects of quantitative easing (introducing new money) during the last recession have created an inflationary pressure in the economy which is slowly pushing up the gold prices and might eventually affect sentiments enough for people to shift to gold, hence further pushing its prices up. Goldman Sachs has predicted the prices to rise to $1,375 a troy ounce in the same report that justified its 2018 stagnation to around $1,200. It is believed that gold will enter a bull cycle as soon as it crosses $1,360, beyond which it might even touch $2,500 a troy ounce.


Yield Curve’s possible inversion

It has been seen that whenever you mention the “R” word, people assume that you’re either a pessimist or a wannabe Rajan who’s sitting on his cash and burying gold in his backyard. The reality, however, is that recessions are an inevitable component of the economic cycle. No one wants to talk about them because the issue is quite a sensitive Ponzi scheme whose mere mention has the potential of leading us into an economic collapse. This article attempts to substantiate the forecasts of the Financial Recession 2020 and will majorly be seen through the eyes of the World’s de facto economic capital, USA.

Now just because the American economy has seen a period of low interest rates and stable growth does not mean that some catastrophe is on its way, but there are some indications given by the world economy that are elaborated upon in the trends analyzed below:


Gold – Never forget the golden rule – he who has the gold makes the rules. It is the only financial asset that is not simultaneously someone else’s liability. Also, it shines. Gold has shown a high gradience negative relation to the S&P 500 index during periods of recession which implies that when all the stocks come crashing down, the value of gold rises and this trend has been seen in five out of the last seven recessions, with sometimes double-digit appreciation. The reason? It is merely a spiral of sentiments because when people lose money in the stock market, they expect gold prices to rise and invest in it, which, in turn, increases its demand and the price actually rises. Hence, speaking of a recession causes the amateur small players (majority) to move towards this safe investment, and that might add to why gold prices are being projected to rise in the next few years. The other reason is inflation which shares a positive relationship with gold prices. The long term effects of quantitative easing (introducing new money) during the last recession have created an inflationary pressure in the economy which is slowly pushing up the gold prices and might eventually affect sentiments enough for people to shift to gold, hence further pushing its prices up. Goldman Sachs has predicted the prices to rise to $1,375 a troy ounce in the same report that justified its 2018 stagnation to around $1,200. It is believed that gold will enter a bull cycle as soon as it crosses $1,360, beyond which it might even touch $2,500 a troy ounce.


As technical as it might sound, a yield curve is the graphical representation of bond yields plotted against the length of the maturity period. Now, when we talk of THE yield curve, we are talking about the curve made with reference to the US treasury bonds. So, under normal circumstances, if we take treasury bonds with a variety of maturity periods, we end up with a normal or an upward sloping yield curve. This curve slopes upward mainly due to the Liquidity Premium Theory which basically states that longer-term bonds pose a greater risk for investors since they trap their money for a longer duration. To compensate for their added risk, the long term investors are paid an additional liquidity premium coupon rate, hence resulting in the upward sloping curve.

History backs up the fact that whenever the Yield Curve tends to flatten or invert, a recession hits the economy. The curve can flatten when either the short term yields are rising or the long term yields are declining. The Federal Reserve has the power to move the left side of the curve by increasing the interest/coupon rates (Yield↑ = Coupon rate↑/Price), which is perhaps being done as a measure of quantitative tightening or simply put, to encourage safer investments and tackle inflation. But the change in the coupon payment will take a longer period of time to show its effect on the right side of the curve due to the greater maturity period. Hence, in the short term, the right side is mainly driven by prices of the bonds. These prices are determined by the forces of demand and supply and when more people go for the long term bonds, its price rises causing the yield to fall. (Yield↓ = Coupon Rate/Price↑). This overall fall in the yield flattens the curve and in worse cases, it causes inversion.

Why would anyone go for a long term bond even if its yield is declining? Perhaps because the investors believe that there is some greater risk out there that outweighs the risk and opportunity cost of long term bonds. The risk can be of falling interest rates or poor performance of other investments. Another justification is that long term rates are higher for adjusting the interest payments to inflation, and this interest goes down when people expect less inflation, sometimes even deflation. Basically – an expectation of an economic slowdown. Coming to the current scenario, the yield curve is flattening, more like it was in 2006. Investors fear a possible inversion and their fear itself is enough to expedite this recession!

Where will the recession strike? Although it is quite difficult to accurately put a finger on a particular area, the following are some potential zones where the next recession might strike:

  1. USA: The American Debt crises is often considered to be the classic example of “too big to fail”. But so was Lehman Brothers. The $21 trillion debt, most of which accumulated in the past decade, is catching the world’s eye. About $15.7 trillion is public debt, a major chunk of which is owed to foreign governments, with China leading the list holding debt of $1.1 trillion. Much has been said about this debt’s potential to bring tremors in the global economy if China calls it in it. But that is not the major issue since China will hold on to the US Securities to keep its currency devalued in order to boost its exports. The second component is held by domestic non-governmental investors, the largest of these is the Federal Reserve to which the American government owes $2.4 trillion, and most of it emerged between 2007-2014 when the Fed purchased US government securities to lower the interest rates as a part of quantitative easing to tackle the previous recession. As the long term implication of the “money printing” began to show, the Fed has moved towards a policy of monetary tightening, which will attempt to bring back this money to tackle the inflation caused. So it sells the US treasury securities to the financial institutions, and the increased supply of these securities, causes their prices to fall. There is competition between the American Government and the Fed to sell these which explains why the interest rates are rising. These rising interest rates make government securities a safer option in comparison to corporate stocks and bonds and hence fuel a potential crash in the stock markets. The remaining debt of about $5 trillion is intra-governmental debt used for social security, defence, etc. And that will become a greater liability in the coming years as the baby boomers retire. Overall, everything depends on market sentiments, if the world investors consider the movement to treasury bonds as a recession signal, their moves can fuel a global recession.

  2. The Emerging Markets: The Emerging Market economies refers to those developing nations in which investments are expected to yield higher returns but at greater risk. Back after the financial recession of 2008, the American banks cut their interest rates in order to encourage spending, making these EMs a more attractive option due to the greater rates being offered. Investments poured in and they went on a mostly Dollar-Euro denominated debt binge. Now, as the interest rates of the US government securities rise due to the monetary tightening, the EMs are not as good a deal anymore because the interest gap is falling and the risk in these economies is rising due to faltering faith of investors on their repayment capabilities. When investors move towards buying American securities, it increases the demand for the US dollar and appreciates it, while the Argentinian Peso, Turkish Lira, South African Rand, Indian Rupee and Indonesian Rupiah all have plummeted. Their dollar-denominated debt has become harder to repay. That discourages investors to put their money in these markets. As a result, FIIs also withdraw their investments. The EMs have little choice but to increase their interest rates and adopt a policy of monetary tightening, even though that is something done at a stage of stable growth. Capital control measures, that restrict the withdrawals can be adopted but will discourage fresh investments. Besides, general unrest in global politics has also aggravated the situation. Turkey’s nearly-extremist PM Erdogan’s refusal to increase the interest rates and the eventual trade war with the USA over a jailed American pastor managed to besmirch the market sentiments towards all other EMs as well. Rising oil prices are also expected to sharply increase their deficits since most of them are non-oil producing nations. It is believed that the EMs will remain susceptible for another few years as the interest rates in the USA and Europe continue to rise. The situation hence becomes a double-edged sword; the rising rates will eventually benefit no one but are necessary to tackle the inflation.

  3. The Eurozone: It has been known for decades now that the European Union was never an economically sustainable model, their idea of unity and sovereignty backfired badly when a single monetary policy could not sustain for multiple countries with separate growth rates. The EU currently faces general economic and political instability in the wake of Brexit, the possibility of detachment of Poland due to rise of extremists and of course; the Italian crises, where banks are plagued with negative interest rates, a $408bn soured loan and the number of branches exceeding the number of Pizzerias (Yes, in Italy!). The EU nations have also collectively loaned huge sums to EMs, which are at greater risk of defaulting on these loans owing to the appreciating USD. In fact, the Eurozone had held its breaths during the Turkey-USA economic standoff, because they had an approximate $28 billion stake in the nation, which is still at the threat of default, just like their money in other EMs.


Milder or Worse With the general perspective, the situation is not as bad as it was in 2008 since no bubble as major as the housing one has been identified yet (Although, “No one can see a bubble, that’s what makes it a bubble!”-The Big Short, 2015). The lack of preparedness of the governments is, however, greater this time around. Big spending programmes have to be launched in order to tackle recessions, which seems harder considering how extremist, polarized governments are on the rise around the globe, be it Brazil, Hungary, Poland or even US for that matter. One of the main reasons why the 1930s recession turned into the Great Depression was the Smoot-Hawley tariff act, whose implications were unknown back then. But today we know how tariffs can backfire, and yet, the chauvinist governments are going ahead with it citing myopic growth approaches. Back in 2008, the Dodd-Frank Wall Street regulation act was passed by the newly elected Obama administration which attempted to protect investor interests through strict monitoring of banks in order to ensure they don’t become “too big to fail”. It also ensured that these banks do not invest the depositor’s funds in risky hedge options. But the Trump administration believes that limiting the risk of these institutions also reduces their profit-making abilities and is hence is planning a regulatory reboot for the act, which if not done in an ingenious manner, can unleash catastrophic consequences, because the major problem with this act, as identified by Bernie Sanders, is that it doesn’t really regulate the reckless expansion of the big banks as much as it hinders the survival of the community banks. This lack of coordination within and outside the governments has the potential of worsening a mild economic stagnation into a recession. STEPS THE GOVERNMENT CAN TAKE

  1. Interest Rate Cuts: A cut in interest rates induces more expenditure which fuels a stagnant economy facing a recession, it’s economics 101. The Fed’s interest rates back in 2006-07 were around 5.75% and when the crises struck, they had enough room to cut the rates and encourage expenditure while simultaneously keeping track of inflation. But this time the interest rates, though on a rise, are still at a low of 2%, and reducing it further can set inflation spiralling out of control. Hence, the world cannot solely rely on this tool to battle the crises.

  2. Quantitative Easing (QE): In order to tackle the previous recession, the Fed conducted the largest monetary experiment across the economic history of quantitative easing, (or simply, creating new money). Since money is backed by trust, printing/creating money can be considered as a social experiment rather than a sophisticated monetary policy. As Boston Federal Reserve states, “When the Fed writes a cheque, it is creating money.” The Fed creates money when it buys either Treasury Bonds or Mortgage Backed Securities from commercial banks, where it credits the balances of these banks with “newly created” money. This money increases liquidity in the market and helps the economy recover, but it also shows its effect on the Fed’s balance sheet. To put it into perspective, the Fed’s balance sheet total rose from $0.8 Trillion in 2006 (across all history) to $4 Trillion currently (in 10 years!), with per month creation of $85 million back in 2013. This stimulates the short term growth rate, but in the long run, it creates an inflationary bubble because, after all, it is not real wealth. In order to prevent that from happening, the government adopts a policy of quantitative/monetary tightening, the exact opposite of QE. But taking the money away from the system is not a simple process because for that the Fed has to sell the Government Bonds to the commercial banks. This increases the market supply of these government bonds and consequently causes their prices to fall. The comparatively low demand for these bonds and the pressure to sell them forces the Fed to increase interest rates. Since these bonds are safer and now have increased rates, people start preferring them in comparison to stock market investments. And when people start withdrawing their money from corporate investments, it can cause the stock market to crash. Hence, mouse clicking money into existence, as a way to tackle recessions, may show short term growth trends (like now) but can create another recession in the long term. QE is an unnatural way to deal with the crises, and the world needs to come up with better alternatives.

Indications of an economic slowdown a mere ten years after the previous one reflect how something is really wrong with our systems. Recessions are inevitable, but their frequent incidence is certainly avoidable through proper policy implementation and analysis of the perverse incentives that might come to play, such as the ones in case of QE or Dodd-Frank. These flawed policies paved the way for the shrewd banks to take advantage of their “too big to fail” status back in ‘08. That, though unjustified, is still understandable, considering they are eventually profit churning machines. But the possibility that the next recession might stem partially out of the polarized and extremist approaches of the governments is disheartening because this dismal science will only reduce human lives to mere indicators, whenever their upper hands take fraudulent precedence over the invisible one.

By Riya Kaul




コメント


bottom of page