“I thought the crisis was behind us now?”
Just a comment I read when scrolling through LinkedIn the other day. It is clear that today, we speak less of the pandemic. The situation seems to have evolved to some manageable extent, at least. While countries mostly lifted all restrictive measures, attention turned towards the Ukraine war, adding to an already unstable and unpredictable environment. If the world did not already count enough disrupted supply lines and empty shelves, now it surely does. With this situation not anywhere close to being resolved, it is understandable that we still often speak of crisis in general.
The real elephant in the room, however, is inflation. It’s everywhere now, we can’t really avoid it. Unfortunately, this doesn’t stop with oil prices or real estate, like it might (sort of) have done in recent occasions. Many governments, central banks, economists and other influential figures have until now downplayed inflation like it was temporary and not to be feared. These figures took turns to blame it on the pandemic, supply line disruptions and now the war but never questioned money printing. While those reasons do have a major impact, surely both the FED and the ECB printing out almost a third of all the money supply during the last two years also are culprits in their own right.
“But why is inflation such an important matter? I mean it always seems to exist, doesn’t it?”
As long as economies produce and trade, companies hire, and GDP grows steadily, regular inflation is not much of a threat. In that case, what is produced then sold contributes to compensating for inflation. Economic output compensates for rising prices. Most of society get their fair share of a newly produced cake and they don’t really feel like it’s a problem paying slightly more for their groceries. Inflation might be felt, but not to a point where it really is problematic since purchasing power is grossly maintained.
However, when the economy somewhat slows down, for one reason or another, that’s when it becomes problematic. When a recession ensues, there is lower global economic output, lower purchasing power, more lay-offs, and that’s rather… bad. Recessions and crises are perfectly normal, they are part of cycles. A recession is to the economy what winter is to nature. In fact, you should wish for them because without crises, there would not be booms. Just like without winter, there wouldn’t be crops.
The fear of stagflation
The real problem arises when a recession ensues and high inflation is present at the same time. That’s what we call “stagflation”; an odd word that you might have heard of lately. If you’re not scared yet, let me tell you why it belongs to the “mean monsters” category.
Imagine that you asked your boss for a raise because you’ve been working at the same place for years and you feel like you deserve one. She tells you that she can’t because sales are decreasing and it is currently too much of a risk for the company. You will have to wait. That night, you come home to your girlfriend and she tells you that her company announced that they will have to cut costs. Either they put people on temporary unemployment, or they lay off a bunch of employees. She’s unsure of whether she will be able to keep her job.
Anyway, it’s the weekend and now comes the time when you’re both in a supermarket and you notice that the bill has increased by a few euros since last week. It makes you think. “How can prices rise so fast? I literally bought the same basket as last week. What is it going to cost next week? Or next month?” Another tough pill to swallow, just wait till you receive those energy bills at the end of the month.
Maybe the second part of the story is more relatable as to where things stand today. Since the first months of the pandemic, most sectors of the economy have been able to pick themselves up and go again. There might have been lay-offs and unemployment at the start, but since then, much less. What if that were to change? What if the economy had to go through a recession for logical reasons? Unfortunately, at that point, the state of the economy could not suffice to help us cruise past inflation.
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Are we in trouble?
We might well be. One of the reasons for that is that central banks have already printed so much money, and can’t really do it anymore. Another reason is that governments are crawling under debt, so they can’t really lower taxes or help with programs and subsidies like they usually do during a recession. They used that card two years ago. To conclude the macroeconomic review of doom: central banks cannot really raise interest rates. Raising interest rates is something that normally helps reduce inflation, but they can’t really do it because the weight of interest on the debt of governments would be too heavy. This would both increase the risk of default and lower their capacity to borrow more money.
How did we end up in this situation I hear you say? Through a mix of greed, lack of care and naivety. Central bankers should have known better but they chose to act blindly and quite honestly lie to the general public. It seemed that they had their own agenda and prioritised salvaging markets before the rest. A lot of money printing sent them parabolic.
Naturally, this situation helped investors at first, both small and large fortunes, everyone had a chance if they were invested. Most markets saw unprecedented gains through 2020 and 2021 but started bleeding heavily in 2022, wiping out most of the gains made during the bull market. Things have a fair chance of getting uglier, no one knows, but past recessions have often led to markets losing half of their value. It has taken markets years, sometimes decades, to recover to previous price levels.
What to do?
The first thing is not to succumb to panic. You have to realise that I paint a rather grim picture like most media outlets currently do. This is a bias. It is a perspective that we have in this current context. Some things do not look too good, and I think they are worth pointing out. They make you feel like they will get worse.
That being said, you have to understand that there is no better moment than a recession to invest (carefully) in. During a recession, financial markets are typically at their lows and offer great investment possibilities. This might also be a time to spend a weekend on some budgeting and thinking about being more careful during the next few months. There is an opportunity for you to acquire a lot of valuable experience for sure.
As always, we have to remember that there are many things that we don’t control. We can only control our cash flows and investment strategy along with a range of financial and non-financial decisions but that’s about it. The economy, money printing, war, and shortages are out of our control. We have to focus on what we can do and not worry about what we can’t change. Being scared won’t help, being rational will.
Stay tuned because next week we will release another article in which we will look at ways to manage your money during a recession.
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