Cees Bruggemans: Rockets and recessions

By Cees Bruggemans

A recession is two or more quarters of falling GDP (national income, output). But what sets it in motion and how does it play out? How imminent is one?

The onset of a recession is like a three-stage rocket, one stage after the other kicking in to give it enough momentum to do the job – in the case of a rocket to break free of gravity, in the case of an economy to lose the plot.

The initiating force (first stage) is usually some kind of shock.

This can come from the outside, for instance a drastic fall in Dollar export prices (abrupt fall in gold price in olden days) or an abrupt increase in a Dollar import prices (oil), either way implying a massive hit (impoverishment) to income and asset values of producers and consumers.

The hit can also come from government side with either a large enough tax increase and/or spending curtailment intent on rightsizing state finances even at the expense of short-term economic stability or the central bank jacking interest rates with the aim of addressing inflation expectations or rightsizing internal imbalances (large current account deficit), again willingly sacrificing short-term economic stability (continuity) in order to do necessary repairs.

In either instance, if the hit is large enough, the quantum of real income withdrawn from the economy may be enough to set in motion deceleration of economic activity.

A third category at this first stage may be some catastrophe, natural or man-made, causing enough instant damage to affect economic activity.

If this is the initiating stage, what is most important next is how society and the economy respond. If the response is shock to the point of trauma, as expectations become affected and behaviour responds negatively to events, we can see reinforcement of the initial decline in GDP, national income (ability and willingness to spent) and output. The lift accelerates its descent.

Essentially what happens in this second stage is that sentiment turns cautious, even fearful, in the presence of events that imply no good for somebody, directly or indirectly. As hopefully happens when approaching a red traffic light, one naturally slows down, warned of danger not to keep going at high speed.

In economic activity, this translates primarily for business into managing cash flow and debt defensively and cutting down on orders placed with suppliers. In sensing a possible downside in sales and not wanting to end up with too many inventories, businesses prefer to dip into inventories a bit more, letting them run down while events show greater clarity as to what will follow.

But such order reductions translate as less production, less output and more stress for suppliers, setting in motion their defensive reactions.

Households can postpone purchases that will not immediately have a major impact on day-to-day living. For instance, any item with a long economic life may have some utility left and its replacement can be delayed.

This especially affects durable goods (anything with an economic life over three years) and even semi-durables (clothing, shoes). If the initiating shock and resulting fear (about jobs, debt and future income) is severe enough, households may even resort to trading down (consciously seeking cheaper, less branded day-to-day product, less fancy fashionable shopping outlets) or simply going without some stuff (belt tightening). Indeed, abstinence may take hold for awhile, often for the first time in adulthood.

The corporate equivalent is to cut down on the office flowers, paper clips; but also on newspapers, entertainment, travel, advertising, new hiring, new offices, and  equipment replacement. In today's cost-conscious world, many of such "savings" have become permanently part of the culture, but good times may have caused some belt loosening (Galbraith's infamous 'bezzle'), which the onset of danger may abruptly invite to be reversed.

All hands on deck and at your posts. We are under attack!

Between them, these two stages (shock impact and defensive withdrawal from spending) can cause enough output decline and therefore enough income decline at the hands of third parties (reduced overtime, bonuses, jobs, business cash flow) for there to be involuntary belt tightening, thus causing a generalised third stage of spending & output cutbacks.

By now we have entered the third stage of GDP decline and it will eventually (often only six months later) be confirmed that we are officially in a state of recession.

Its depth and duration will be a function of how big the shock and the reaction is and how widespread the fallout, but also whether there was early (or late) policy response trying to counter and reverse the recessionary dynamic.

Also, if the shock hits don't keep repeating, the descent dynamics eventually run out of steam and the economy stabilizes at a lower level, everyone gets an opportunity to examine their reaction functions. If it was all a bit over the top and overdone with the dangers being less than imagined, it will be okay to come out of the fox holes and a natural perking up can commence that eventually gives a GDP tally higher than the previous one, thus ending the recession.

The more experienced, diversified and bigger an economy, the greater the ability to withstand shock or internalize it.

An enormous range of forces therefore go into making and undoing a recession.

As to whether SA is on the brink of slipping into recession, neither fiscal or monetary policy is likely to impart a large enough shock to do the job.

Our Dollar export price declines have been slow enough, spread over a number of years, for us to adjust to them. You don't sleepwalk into a recession.

Our politics have at times heart-stopping moments (Juju being assisted out of Parliament, the President having fits of giggles) but apparently these don't really count, being merely cheap entertainment driving some of their audiences to drink, but not beyond it.

Switching off the lights doesn't count either because we all do that at least once a day. But switching off all the juice and keeping it switched off for three months while medieval pandemonium erupts all round would definitely count. As would nuclear war, an asteroid impact, or a Great financial Crisis (as erupted in 2008). And of course a currency ambush, if intense enough, with interrupted or merely disturbed foreign capital flows hitting the Rand hard enough to cause an inflation shock (thus resulting in an interest rate shock in turn hitting growth).

But short of any such, recession is far away, with so much resource slack in our system.

Then again, what haven't we thought of that could instantly make us fearful enough to sound the general retreat?