The Recession Always Strikes Three Times.
The too rapid recovery of the economy after the violent fall of 2020 has created major imbalances that we will pay for in the coming months.
Before the beginning of a play, the audience's attention is drawn to a roll of blows struck by a stick. Then three separate blows, which used to be used to coordinate the stagehands, precede the curtain call. Today, the same thing happens in economics. And the play could be called “The Recession”.
At the beginning of 2022, this prospect seemed far-fetched. But many blows have been struck on the international scene. War in Ukraine, cities closed in China due to Xi Jinping's cherished Zero-COVID strategy, high tensions with Russia, which was the world's largest exporter of oil and wheat, persistent problems in supply chains, soaring prices, rising interest rates, financial cracks ...
Signs of a slowdown in economic activity are multiplying. Financial players have changed their rhetoric and their choices. Fed Chairman Jerome Powell has certainly not gone so far as to speak of a “recession”, which would have been a kind of cataclysm. But when asked on the Senate floor about the word, he admitted that “it was certainly a possibility”. Investors are worried about a forthcoming drop in activity.
In their inimitable style, economists at Japan's Nomura Bank chose to headline a note “Building a U.S. recession into our forecast”. Those of the rating agency Fitch believe that “the risk of a recession in the Eurozone is rising as gas rationing looms”.
An unusual cycle
Forecasters are also lowering their figures. We now find forecasts of growth in 2023 at less than 1% for France, which is the second-largest economy in the Eurozone. The experts of the insurer Allianz have published an "adverse" scenario in which its production ... would decline by 2.5%, returning to its level in 2018.
The economic forecasters who engage in this type of exercise usually state that the probability of a dark scenario is low. Those of Allianz evaluate it at ... 40%. That's almost a one-in-two chance!
Such a slowdown in activity is atypical. In France, on average, more than ten years have elapsed between two recessions over the last half-century. This time, the next trough could come just three years after the one in the spring of 2020.
The economy behaves like a car whose movement you want to control after a sudden stop
This gives an indication of the mechanism at work. The low point in 2020, caused by the epidemic and the measures that were taken to contain it, was profound (production fell by a third in a few days). The rebound, however, was very vigorous. So much so that it has caused major tensions in many markets - sea freight, chips, metals, labor. The invasion of Ukraine has made many of them unsustainable.
Now we have to pay the price. The economy is behaving like a car that has gone off the road after a sudden stop caused by an unforeseen obstacle, and where the driver tries to restore the trajectory by violently jerking the steering wheel to one side and then to the other.
The current movement, which could lead us to the recession, is marked by three strong beats, three blows of the baton that announce what is to come. The first blow is the very sharp rise in prices - almost 7% in France over one year, 8% in Germany, 9% in the United States, and 10% in Spain. This surge is brutally and massively reducing purchasing power.
Consumers have certainly put aside a lot of money during the confinements. But it is mainly the wealthiest households that have saved. The others have limited reserves - if they have not borrowed. The states are certainly trying to cushion the blow. The French authorities have been very creative in this respect - vouchers, indemnities, ceilings, allowances, etc. But this is not enough.
The ball is now in the court of the companies. Ideally, they should increase wages to compensate for inflation as much as possible, without compromising their ability to invest - which means differentiated increases from one firm to another.
The darkest scenarios seem likely to come true, but a positive surprise is always possible
The temptation will be to touch salaries very little, which would then lose a lot of purchasing power. The risk is to reduce consumption, and therefore demand, and therefore growth. Or to trigger a social movement that would take wages much further, harming the financial health of companies and the competitiveness of the countries concerned. Ladies and gentlemen, business leaders, place your bets.
The second blow will come from the real estate and construction sectors. With the rise in interest rates, the purchasing power of buyers is falling while prices are rising due to the soaring cost of materials - and new standards in the European Union, for example. This scissor effect is likely to be devastating. And the under-indexation of rents will discourage rental investment. All in all, the entire construction industry is likely to suffer.
The third blow will affect Europe in particular. It will come not from demand but from the supply. It seems increasingly likely that Russia will completely shut off the gas supply to Europe in the coming months. This is of great concern because this gas is very difficult to replace. And the rationing will first affect companies, which will then be forced to produce less.
But perhaps the curtain will finally rise on another play, like “Soft landing” or “Unexpected resistance”. In the theater of the economy, one is often surprised. The great difficulty is that you never know in advance whether it will be good or bad.
Some reading
A $750 Billion Reconstruction in 3 Stages for Ukraine, but Whose Financing Raises Questions. Ukraine is pushing for the use of Russian assets frozen by America and the EU.
Why Did Stock Investors Fail to Anticipate the Inflationary Risk? Because They Had No Plan B. Most had never been confronted with such inflation.
Warren Buffett’s 4 Golden Rules for Making Money During a Bear Market in the Stock Market. A proven strategy over 12 Bear Markets.