Economics Tricks

So it begins. Preparation for a recession that was generally considered highly unlikely last summer is now considered by most economists to be more than likely. Of course, a recession was always likely, because recession and growth are two fundamental components of the economic cycle. The word recession carries a huge emotional burden, much like the words cancer and bankruptcy. What we don't understand we fear. But the word recession can be used in the same paragraph as the words optimism and health. Let's explore what this could mean to us as individuals and business owners, because our personal responsibilities and our economic responsibilities are potentially in conflict during this time.

Our young country and economy have done a generally admirable job of understanding and ultimately managing the economic cycle, particularly when one considers how much the world has changed in 250 years. Yes, we failed to mitigate the economic meltdown that led to the Great Depression in the early 20th century. Until then, corrections had been allowed to go deep enough to rid the system of all excesses of the prior growth period, and that had been a successful formula. The increasingly global nature of economics by the 1920s introduced new risk, and global poverty was the result. Our country's economic and financial management skills improved dramatically as a result of those lessons, and we can be reasonably sure that history will not repeat itself.

Since the end of World War II we have been in an era of economic management that allows the economy to experience the necessary booms and busts (i.e., growth and correction), but with controls. Each upswing of the economic cycle is associated with some form of speculation that eventually builds to excess. In the 1980s it was junk bonds, in the 1990s it was tech stocks, and in the 2000s it has been real estate. What will it be next? Watch emerging market equities and resources like alternative energy -- good candidates for our next phase of excessive growth. Though the roots of the next phase of excess are being planted now, first we must deal with the necessary correction phase, which given the recent rounds of government intervention, will likely be preceded by one more uptick in growth.

The tax rebate and spending program just announced is generally responsible. Theoretical debates aside (Democrats want more unemployment and safety net benefits, Republicans want to lock in Bush's tax cuts beyond 2010), getting consumers to spend more freely will have a positive impact on the contracting economy, which will delay and soften the oncoming recession. But from another perspective, the individual responsibility to save and prepare for the future, this approach smacks of immoderation. Which one is correct? Both perspectives are correct.

In an ideal world, consumers would all have paid off credit card debt, increased home equity, and put money into retirement savings and short-term liquidity accounts during the past six years of economic growth. That type of fiscal prudence at the individual level would have reduced the economic growth we experienced and it would have reduced some excess in the system.

The US government will provide incentives for consumers to spend more money, starting in May when US citizens below certain income levels receive their rebates. The mere anticipation of the rebates will motivate many people to spend now, so the benefits of economic stimulation will begin almost immediately.

How do individuals reconcile the need to demonstrate fiscal responsibility with the overall economy's need for spending? Depending on your perspective, this may seem a moot point. Those who have been mindful of future recessions are savings minded. Those who have not started taking savings seriously are not likely to begin now. But this is a serious personal philosophical question with which serious people should grapple.

Start by understanding that all debt is not bad. The savings-minded have a tendency to be debt averse. Extreme debt aversion is what prolonged the Great Depression long past the point when the economy should have recovered. As long as the debt incurred provides greater return than savings alone would yield, debt is an intelligent choice. Debt is bad when it fuels consumption that has no long-term benefit. Even with the housing market continuing its correction, housing remains an intelligent debt. This correction will end, the next growth cycle will begin, and smart investments in real estate will continue to pay off.

Recent economic anxiety and fear of changing government administration in 2009 has caused businesses to batten the hatches, slightly increasing unemployment for the first time in a few years. But an interesting trifecta -- the government's new financial incentives for business to invest in infrastructure, the weak dollar creating export growth, and the emerging baby-boomer retirement wave -- should contribute to earnings growth for American workers.

This adds up to one more opportunity to improve individual financial positions without the cumulative effect of short-term contraction of the economy. If individuals were not spending so much money servicing credit card debt, those dollars would be available for consumption that has no long-term economic benefit, giving individuals rewards such as vacations while providing the economy with cash flow. Now is a very good time to invest in homes, commercial real estate, and reasonable-return infrastructure for businesses. It is time to pay down short-term debt in order to be financially healthy when the correction occurs. If increased wages pan out, consumers will have money to both spend and save. The discipline is to ensure that saving is a well-considered part of that equation.

(c) 2008. Andrea M. HIll.