muthukumar arumugam

Slowdown Vs Recession

In special talks on November 4, 2008 at 1:55 pm

If you are a guy who gets hooked to the business channels and those pink papers, there is a maximum possibility of you listening to the word Recession, spelt out by those once blue eyed boys of Wall Street and the so called economists (but their predictions go seldom rightJ). But there will be another group of ever optimistic guys, who says that’s just a slowdown and not a recession. Just tried to dissert what do these terms means to simple souls like us and where does the current crisis/situation leading to? 

First, let’s get to our basics,

A Recession is a period of negative economic growth for more than two quarters in a row. A country’s GDP is a good measure of Economic growth. A recession might last for a period of six month to 2 years. A vicious cycle of fall in sales, fall in profits and decline in economic growth, ultimately results in unemployment and lower consumer spending, the key reflector of recession.

A slowdown is just a slower growth of economy, and might be industry specific. But a recession will have its impact on all the industries and all walks of life. To be more precise, if the same situation persists for another month, what US will undergo will be a recession and what India would undergo will be a slowdown. (Already there are signs of FM and PM hinting that we might not be able to achieve the projected growth – the GDP growth is getting revised every time FM meets the press…).

But is recession a sudden explosion due to the financial crisis? NO, says the basics of economics. This is not a new phenomenon, but a recurring cycle, which will take place and which had, in the past.

Economy and industries will always run in cycle. The Industrial cycle will more or less follow economic cycle, since the major industries rely on the major economic factors and the allied /service industries solely depend on major industries. So, let us see the economic cycle first. An economy which grows over a period of time tends to slow down the growth as a part of the normal economic cycle. An economy typically expands for 6-10 years and tends to go into a recession for about six months to 2 years.

Take the period of 2005 to 2007, we all witnessed a massive bull run in the economy and life seemed so sophisticated with easy loans, appreciating assets, huge profit margins, wonderful job market and what not!! Banks gave easy loans to corporate with lesser margins, home loans were disbursed over a coffee (in 2006, one of the Indian banks, which are into trouble now, even advertised this in Media as their USP…). Everyone believed or was made to believe that share prices of companies and the plot/house values will only move upwards…even the then Federal bank’s chairman Mr.Greenspan forgot his basics of economics ,that everything is a cycle. What goes up should come down and now admitting, he might be partially wrong…

 Cut, Late 2007

Share prices fell, people started ‘googling’ a new term, Sub Prime crisis. Governments all through the world were increasing the bank rates, trying to pull out money from the market, desperately wanted to contain the inflation which might gallop at any time. Real estate prices fell and loans became dearer. People began investing in gold and other fixed assets. The world and in particular, the US economy was in a slowdown phase.

Circa 2008, the Industrial growth saw a surge, jobless claims were at its peak, and banks were pressurized to sell not only their products but themselves for a throwaway price. Governments revised their GDPs downwards, share markets crashing worldwide, losing more than 50% of their peak values.

It’s just that everyone is waiting for the NBER (National Bureau of Economic Research) and the Fed Government to officially announce that US is in a recession period.

Why should people other than those in the US, should worry on US getting into recession? It is because the global economy is getting more interconnected and complicated now, and the tremors in the financial heavyweights can cause a catastrophe in other countries (Sounds like Butterfly theory/Chaos theory??) Oil that we use and most of the natural resources are controlled by the Big daddy, and remember most of the countries use dollar as their trading currency. So when prices of oil and gas increase, there is a global impact. Many Asian countries such as Taiwan, China and South Korea are major exporters of consumer goods to the US. Similarly, a good proportion of global consumption for goods and services is accounted for by US. Even though India is not a major export oriented nation, most of its service industries (IT/ITeS/Tourism/Textile etc) are in direct proportion to US consumerism.

A recession can be characterized by

·         Consumers losing confidence in the growth of the economy and spend less.

·         This leads to a decreased demand for goods and services, which in turn leads to a decrease in production, lay-offs and a sharp rise in unemployment and,

·         Investors spend less as they fear stocks values will fall and thus stock markets fall on negative sentiment.

What do the central banks and governments do while an economy is heading towards recession?

·         Central banks cut Interest rates, such that corporate can get access to cheaper money to carry on the business

·         Governments will spend more on development measures like infrastructure spending, manufacturing sector etc, so as to create job opportunities, and indirectly helping lot other allied industries to revive.

·         Government may cut the tax rates to ease the burden of the citizens in a view that they can spend more, which indirectly would create demand and suppliers a.k.a business houses to revive production.

But all these measures also has their ill effects which might attract long term consequences,

Whenever a government cuts tax rates, it takes a big hit in their revenues and by default there will be a deficit in their accounts. This will have an impact on government spending. (Where will they go if they have no/less revenue?). Adding to this the government will also plan to spend more on development and infrastructure. It will be left with no option other than to raise debt thru bonds and spend. This will create a huge fiscal deficit. Also the government needs to oblige the bonds after few years. The problem, which is too much debt, cannot be fixed by creating more debt. That just makes the problem worse. Because of the nature of the banking system, a dollar cannot be created without a dollar’s worth of debt being created. There is another problem of fuelling inflation with more money supply into the system.

To summarize, as the text book says, the effects/indicators of recession would be,

·         Currency crisis

·         Inflation

·         Bankruptcies

·         Foreclosures

·         Reduced sales

·         Stock market crash &

·         Unemployment.

All these terms seem familiar and you feel like you are there already??? Yeah… kindly wait for few more days for the NBER to issue a press release… J

 

 

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  1. Sir,
    i shall congratulate you on posting such interesting & simple drafted posts.My understanding of economic slowdown has gone better now…your understanding of everythn, thought clarity n depiction of same reflects ur perfection.keep penning down such interesting piece of informations.gud luck!!

  2. Good article…:)

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