Maybe recessions and depressions are not that bad

Although they bring fear, pain, and uncertainty, recessions and depressions are a normal part of the business cycle. Below we will explain what they are, what causes them, how they are harmed-and how they can help.

Key points

  • People are often afraid of economic recession, and even more worried about economic depression.
  • During these recessions, the economy has slowed, unemployment has risen, and companies have closed down.
  • However, the economic downturn may also bring benefits, removing underperforming companies and offering the lowest asset sales prices.
  • Inappropriate government policies may reduce or eliminate many of the benefits of recession.

What is an economic depression?

What is a recession?

Let’s start with recession. Broadly speaking, a recession is defined as two or more consecutive quarters of negative economic growth. The most commonly used measure is real gross domestic product (GDP). The National Bureau of Economic Research (NBER) standards are more detailed, including employment levels, real income, retail sales, and industrial output. Economic recessions are usually characterized by disasters in the banking, trade, and manufacturing industries, as well as falling prices, extremely tight credit, low investment, rising bankruptcies, and high unemployment.

A recession is a large-scale, widespread decline in many economic performance indicators that lasts for at least a few quarters.

Many factors can lead to a slowdown in economic activity, including financial sector problems or economic shocks, such as the extreme isolation policy in 2020 that leads to supply chain disruption. However, the term recession is particularly applicable to the down phase of repeated up cycles and the decline in economic activity. Over the years, economists have put forward many theories to explain why the economy experiences these irregular but somewhat wavy patterns of expansion and contraction.

According to the National Bureau of Economic Research, the United States has experienced 33 recessions since 1857, with a duration ranging from six months (January 1980 to July 1980) to 65 months (October 1873 to 1879) March) varies. The average contraction lasted 17.5 months, but since 1945, the duration has been significantly reduced, with an average of 11.1 months.

What is depression?

Depression is more serious than normal recession, and its effects can last for several years. Therefore, it is a challenge for consumers and businesses to survive the depression.

In the United States, the most famous example is the Great Depression of the 1930s. This term actually refers to two official recessions, during which the economy did not return to its pre-recession peak, and then fell back into recession. The first occurred from August 1929 to March 1933, during which GDP fell by 33%. The second time was from May 1937 to June 1938, during which GDP fell by 18%.

The negative effects of the recession

Economic recessions and depressions have both negative and positive effects, and understanding them is one of the best ways to survive the downturn. Let me talk about the negative effects first:

Increase unemployment

Rising unemployment is a classic sign of recession and depression. As companies closed down, they cut wages in response to falling incomes. Compared with the economic recession, the unemployment rate during the recession is much more serious. Generally speaking, the unemployment rate peaks at 6% to 11% during a recession. In contrast, the unemployment rate reached 25% at the end of the first phase of the Great Depression in 1933. Studies have shown that involuntary unemployed people tend to suffer higher levels of anxiety, stress and depression, as well as more frequent hospitalizations and premature deaths than employed people.

Capital destruction

Not only were workers unemployed during the recession, but also a large amount of actual capital goods (factories, buildings, tools, and equipment) were left unused due to the failure and closure of their investments and business activities. Most of the investment capital can eventually be recovered and reorganized into new production activities under the leadership of the new owner, but before that, some will be completely lost due to physical damage or obsolescence, and some have been bound to a physical form or location , It is unprofitable to restore forever, it will only be abandoned and rust (usually literally). This capital destruction marks the permanent loss of some scarce resources in society.

During the recession, labor and capital are idle and unemployed. Economic output has therefore fallen.

Decline in living standards

Unemployment of labor and capital will lead to a decline in economic output, and during an economic recession, real per capita income tends to fall. The decrease in the actual production of goods and services means a corresponding decrease in consumption. Many people are therefore unable to maintain their standard of living. As families feel the pressure, the birth rate drops and the divorce rate rises. In the worst case, malnutrition and homelessness will increase.

Cause fear

Economic recessions and depressions generate a lot of fear. Many people have lost their jobs or businesses, but even those who have kept them are often in a precarious situation and anxious about the future. Fear, in turn, causes consumers to reduce spending and companies to reduce investment, further dragging down the economy.

Drag assets

During a recession, some investors will see a decline in the book value of their assets. Economic recessions usually occur after years of debt-driven asset price bubbles burst. Asset prices in stocks, financial instruments, and real estate have fallen because of the drying up of easily available credit that drove previous price increases. Holders of these assets can see the accounting value of their investment portfolios quickly collapse.

Positive factors of the recession

Despite their pain, recessions can also have some beneficial effects:

Reallocate resources

When an economic recession involves business closures and investment liquidation, the existence of these investments is based on distorted price or interest rate signals, then exposing these erroneous investments and reallocating the promised resources to new ownership for more real production uses is a problem for the economy. The long-term benefits of this will offset some of the pain of temporary unemployment of workers and capital that may occur. In this regard, economic recession itself is part of the economic healing process, just like cutting open an infected wound and draining pus. However, it is not uncommon for this process to be delayed or suppressed by government policies, such as economic stimulus measures, which have supported failed companies and industries.

Disciplinary investors

Economic recessions often punish fringe investors and companies that rely heavily on debt and leverage to adopt risk, speculative investment strategies or business investments. Correcting and liquidating investments that are too risky or overly optimistic in order to use their related resources more carefully is a feature of recession, not a mistake. It instills discipline in market participants over the long term. Likewise, it may cause marginal traders and business owners to exit the stock market or the business world and return to normal wage employment where their labor force may be more appropriately employed. However, this process can also be (and often is) hindered by government or central bank policies to lower interest rates, increase the flow of loose credit, or bail out failed investors, companies, and financial institutions.

Buying opportunity

The other side of the large-scale liquidation that may occur during a recession is the reallocation of assets and actual resources. Tough economic times can create huge buying opportunities. For people entering the market, stocks are cheap. Housing affordability increases, and new home buyers can buy it at a cheaper price. Entrepreneurs may find that the land, labor, and capital they need to start a new business become more affordable. As the recession gives way to recovery, the stock market usually hits higher highs than before the recession or depression. Therefore, the contraction provides investors with an opportunity to make money and have time to wait for the recovery. However, just like the benefits of the aforementioned recession, this situation can be delayed or prevented if the government or central bank takes action to prevent asset prices from falling and re-inflate the market.

Increase savings

Economic difficulties can change the mindset of consumers. Just as a recession can restrain investors, it can also prompt consumers to be more cautious. As credit dries up and income is tight, consumers are forced to live within their income range and no longer try to make ends meet. This usually leads to an increase in the national saving rate and allows economic investment based on people’s delay in meeting demand to increase again. However, this benefit of the economic recession may be undermined by the government’s policies to curb interest rates and encourage excessive consumption during the recession.

In fact, all the benefits that an economic downturn may bring may also be wiped out by government policies that try to make up for losses, bail out failed companies and institutions, or support prices.

Bottom line

Surviving recessions and depressions does not require you to understand all the factors that cause them and their impact on the overall economy. Ideally, we will not experience a recession. However, given that we do, the costs and benefits of the recession are closely intertwined in a painful but possibly necessary adjustment, healing and recovery process. It is important not only to understand the costs of economic recession, but also to understand the benefits of recession. These do not necessarily exceed the cost and damage caused by the recession to each individual or enterprise, but may have a greater long-term positive impact on others and the overall economy.

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