How to Prepare for the Recession

July 29, 2022 Updated: July 29, 2022

Commentary 

The United States is in recession. While two consecutive negative GDP prints is a raw (technical) measure of a recession, there’s no escaping from it anymore.

Essentially, many are wondering, how deep will the recession be? As I have detailed in my previous columns, the coming economic downturn is likely to be very deep indeed. I don’t think we are facing just a recession but a “multifaceted economic crisis” consisting of several overlapping crises.

How does one prepare for such an event?

I have studied economic crises for 14 years, of which 10 years were in academia. Our firm, GnS Economics, has, since June 2018, provided guidelines for crisis preparation. Here, I will provide the building blocks of recession and crisis preparation for households and companies.

However, let’s start with a generalized take on how recessions and economic depression affect the economy, trade, banking, and income. In simplified terms, economic downturns can be presented using a four-sector model according to the depth of the downturn and its effect of the credit and capital markets.

Epoch Times Photo
A figure presenting the scenarios for changes in the economic operation environment in recessions and depressions for households and corporations. (GnS Economics, and Philip Kotler and John Caslione, “Chaotics: The Business of Managing and Marketing in the Age of Turbulence,” 2009.)

Scenario 1

Let’s first go through the recession dynamics. In the upper-right corner, we would be facing a shallow, possibly a localized recession, concentrating on a certain area and/or some countries, from which recovery would be quick. Credit and capital markets would stay functional throughout the “ordeal.” Governments and central banks would have plenty of tools to combat the recession (e.g., interest rates would be high and government debt low). In addition, the indebtedness of households, corporations, and investors would be moderate entering the recession, and leverage among them would reach safe (low) levels quickly. Global trade would be unaffected. An example of this would be the recession that followed the bursting of the tech bubble during the late 1990s. We clearly are not there now.

Scenario 2

In the lower-right quadrant, we would be facing a global recession. Downturn would affect all sectors of the economy, and capital and credit markets would become dysfunctional or they would even run a risk of a closure. The availability of credit to households and governments would diminish, and the price (interest) of credit would rise considerably. Government involvement would be needed to keep credit flowing.  Leverage among households, corporations, and investors would fall heavily. Global trade disruptions would emerge. Authorities, however, would be able to contain the fallout, and recovery would start relatively quickly. An example of this would be the global recession of 2008–09.

Many are hoping that we would be entering the lower-right quadrant, but that is unlikely. Leverage ratios, especially among corporations and investors, are very high—in some cases even extreme—and central banks and governments have very little room to maneuver, at least using traditional methods, such as interest-rate cuts and issuance of more sovereign debt. Several governments, like those of the United States, Japan, and Italy, are highly indebted. This means their ability to stomach higher interest rates is gravely limited.

What this means is that we will, most likely, enter either one of the scenarios in the left-hand side of the figure, but which one?

Scenario 3

In the upper-left quadrant, the hit on the economy would be heavy, but authorities would be able to stop it from escalating into full-blown global depression though monetary and fiscal policies. As explained above, this is unlikely now, as authorities really do not have much traditional capacity left. It is, of course, possible that governments and central banks will do “whatever it takes” to stop the recession from escalating into a global depression, but that would require some extreme measures, such as central banks taking an extremely large role in the capital markets, the issuance of central bank digital currencies, and government taking over large parts of the economy. It would “socialize” our economies and turn them to something very different than what they are now.

However, it’s also possible that if the Russia–Ukraine war and sanctions related to it cause widespread shortages during the coming fall and winter, there’s nothing that can be done to stop the crisis from escalating into a full-blown global depression. That is why we need to be prepared of entering into the lower-right quadrant or a global depression.

Scenario 4

This plot line would affect households and corporations in drastic ways. The availability of credit would collapse or disappear altogether. Credit lines of households and corporations would be withdrawn, wherever possible, and the global flow of credit would simply seize up. Market liquidity would collapse, and equity and bond markets would crash. Unemployment would skyrocket, globalization would reverse as countries would pivot toward protecting their own assets and citizens. Attitudes would turn nationalistic and defensive. Recovery would be painful and slow.

What can be done to prepare for such a cataclysmic event?

‘Prepare, Secure, and Capitalize’

Our survival strategies for firms, households, and investors follow a simple logic: prepare, secure, and capitalize. At its heart is the concept of “counter-cyclicality,” derived from Keynesian economic theory. In it, corporations, households, and investors mitigate the effects of business cycles and aim to exploit them instead of slavishly following them. Naturally, this is easier said than done—but it can be done!

In the current situation, preparation should follow three simple strategies: Hedge, hedge, hedge! One should pay back as much of his or her debt as possible to hedge against further interest-rate rises (a bit late, however, in the United States), hedge their asset portfolio against a possible (likely) collapse of the equity and corporate bond markets, and make efforts to secure alternative income streams (“side hustles”) for the crisis. We have detailed these in our recently updated Bear’s Lair report. I will also provide specific details on preparation in my newsletter.

Historically, one of the best crisis hedges has been (physical) gold. On average, its value approximately triples within three years after the onset of a crisis. This happened, for example, during the Great Depression of the 1930s, as well as during the financial crisis of 2007–09 and subsequent recession. One also needs to have a secure (liquid) source of funds to be able to benefit from the “fire sale” of assets that often occur near the bottom of the crisis. Physical gold, in an easily sellable form, is probably the most secure liquid asset there is.

It is quite obvious that there’s no time to waste in preparation of what’s about to hit our economy. As we warned the subscribers of our Deprcon Service in April 2022:

“If the Fed pushes ahead with strong rate rises and hastened balance sheet run-off, artificial liquidity will be drawn from the markets and financial conditions will turn noticeably tighter during the summer. Thus, we urge everyone to enjoy the summer, because fall is likely to bring ‘heavy skies’ over the global economy and the financial markets.”

Now, for example, manufacturing indexes of the Federal Reserve Bank of Philadelphia are already in a state of collapse. The U.S. Federal Reserve is raising rates and its balance sheet is shrinking, implying that quantitative tightening has begun.

Come fall, the “perfect storm” is likely to be upon us.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.

Tuomas Malinen is a CEO GnS Economics, a Helsinki-based macroeconomic consultancy, and an associate professor of economics. He studied economic growth and economic crises for 10 years in the academia. In his newsletter, Tuomas deals with forecasting and how to prepare for the recession and approaching crisis.