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By: Frank Knopers
Due to high inflation and a deteriorating economic outlook, we expect different Banks an economic recession. The U.S. central bank also does not rule out the possibility that interest rate hikes could push the economy into recession. ends up. But what does that mean exactly? And when do we speak of an economic depression or stagflation? And what does this mean for the economy and for your wealth?
According to the U.S. National Bureau of Economic Research (NBER), a recession occurs when economic activity declines significantly across the board and lasts longer than a few months. A recession occurs when the gross domestic product, the value added of all goods and services produced in a country, falls after adjustment for inflation and seasonality. According to the Central Bureau of Statistics, one can also speak of a recession if GDP growth falls below the long-term average. In practice, however, economists define economic contraction for two quarters in a row. In other words, a decline in GDP after adjusting for inflation.
The development of the yield curve is a widely used indicator of a recession. One then looks at the ratio between the 2-year interest rate and the 10-year interest rate. Under normal circumstances, a longer-dated government bond yields more interest, but in uncertain times, investors become cautious and park more wealth in long-term government bonds. If the interest rate on 10-year bonds is lower than that of 2-year loans, this is referred to as an inverted yield curve. Historically, a recession often follows within a year and a half, but not always.
Inverted yield curve is often followed by a recession (Source: Duke Today)
There is no single definition of an economic depression in economics, other than that it is much more severe than a recession. A depression lasts longer and has more far-reaching consequences on the economy and employment. As a rule, a depression occurs when GDP shrinks by more than 10% and unemployment rises to 20%. Also, a depression lasts much longer than a recession, which is two years or more. Depression eventually affects other financial assets, such as real estate.
In a depression, there is low consumer confidence, rising unemployment and falling stock prices for a long time. The latter always happens at the beginning of a recession or depression, because investors immediately anticipate a certain scenario. During the Great Depression of the early 1930s, stock prices continued to fall for a long time, as the economy continued to shrink and the outlook did not improve for a long time. During the 2008 financial crisis, the stock market lost half of its value, but government and central bank intervention quickly led to a recovery. That is why, in the end, this crisis did not become a depression, but a severe recession.
The graph below shows how global industrial production declined during the Great Depression of the early 1930s, during the financial crisis of 2008 and during the corona crisis of early 2020. What is immediately striking is that the Great Depression lasted much longer and ended up being much more drastic for the global economy than the shorter-lived recessions of 2008 and 2020.
Decline in global industrial production during recession and depression (Source: Paul de Grauwe, Eichengreen and O'Rourke, via Voxeu)
Stagflation is an economic term associated with the turbulent 1970s. It is a term first used in 1965 by British politician Iain Macleod. He used this word to describe the economic situation in the United Kingdom at the time. Economic growth stagnated, while inflation rose. This was a special phenomenon at the time, because high inflation was generally accompanied by a boom. Beginning in the 1970s, the media began to adopt this term to describe the combination of economic stagnation and inflation.
The oil crisis and the dollar crisis caused energy prices to rise, causing inflation to skyrocket in the 1970s. At the same time, consumers and businesses were cautious because the outlook was uncertain. Economic stagnation was thus accompanied by high inflation, hence the name stagflation. Central banks fear this scenario, because there is little they can do about it. To get inflation back under control, interest rates have to rise, but that slows down the economy even further. Not raising interest rates can stimulate the economy, but it will further boost inflation. A diabolical and moreover Very topical dilemma.
At the beginning of this year, the economic outlook still looked very favourable. The economy was growing, interest rates were low and there were plenty of jobs. The only source of concern was rising inflation as a result of all the fiscal and monetary stimulus. But the war in Ukraine and the economic war that followed has turned everything upside down. Inflation has continued to rise, which has also led to an increase in interest rates. This combination has significantly worsened the economic outlook, resulting in falling stock prices and uncertainty about the housing market.
The parallel between the present and the stagflation of the 1970s is stark. Even now, we are dealing with high inflation due to high energy prices. There is little central banks can do about that. Still, central banks are raising interest rates, further increasing the likelihood of a recession. The GDP of the eurozone showed a minimal growth of 0.6% in the first quarter of this year, so there is no official recession yet. The European Commission expected economic growth of 2.7% year-on-year this year. Based on these statistics, a recession does not seem to be on the cards.
In the United States, there is already talk of a recession. After a contraction of 1,6% in the first quarter, the economic model of the Atlanta Federal Reserve, GDPNow, foresees a contraction of 1% for the second quarter. This is not yet an official figure, but an estimate based on economic data.
Eurozone GDP still grew in the first quarter (Source: Trading Economics)
The U.S. economy contracted in the first quarter and is now heading for recession (Source: Trading Economics)
De Rabobank expected a mild recession, but not until the fourth quarter of this year. Because households have more savings on average than before the corona crisis and unemployment is still very low, many households will still have a buffer in the coming months to absorb high inflation. That sounds like a stroke of luck, but we have to add that the outlook is very uncertain. If Russia further turn off the gas tap to Europe, this will have major consequences for European industry and economy. The energy crisis could then quickly turn into a recession or possibly even depression.
This will, of course, have an impact on stocks, bonds and the housing market. But what does it mean for the gold market? An analysis of the biggest corrections of the US S&P 500 stock index over the past fifty years shows us that gold in particular is a good hedge. In many cases, the Gold price even see an increase. The only negative outlier was in 1980, when precious metal prices hit record levels. Silver appears to be a less good hedge in times of turmoil in the financial markets. This is because this precious metal has many industrial applications and therefore also moves with the economic cycle. Gold is much less sensitive to this.
How do gold and silver perform during a stock market correction?
This contribution comes from Geotrendlines
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