Will there ever be another recession?

Brace yourself.
Brace yourself.
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Yes, of course there will be. Though no one can say when for sure. It has been more than 10 years since the United States was last in a recession, the longest expansion in US history (at least since economists began to keep count) and there are no obvious signs that one is coming. And perhaps it won’t next year, the year after, or for the next 10 years. Australia is pushing 30 years without a recession. It is possible the US could go another 20, too.

What causes a recession?

Economic booms don’t die of old age and studies show the odds of a recession don’t increase over time. A recession is usually caused by some external shock. Past examples include a sudden increase in oil prices (in the 1970s), a collapse in housing prices (2008), or the US Federal Reserve suddenly and unexpectedly increasing interest rates by a few percentage points (1930s and early 1980s). And there are recession-causing candidates milling about now. The primary one is political uncertainty, with the outcome  of November’s election—between an unpredictable president and a democrat who might raise taxes—a potential trigger. The possibility of a trade war is non-trivial, which could cause a recession. Economic instability in China could leak out. A hard Brexit could have spill over impact and rattle shaky markets.

So far, this economy has been fairly resilient. Despite some surprising election results in 2016, an on-going threat of a trade war, and the president bullying the central bank, the economy has kept chugging along.

There is always the possibility of shocks and which one will cause a recession one is never predictable. Sometimes the economy can weather a shock, other times a seemingly small thing sends markets into free-fall. Rather than trying to guess what may cause the next recession, it may be more productive to assess how reliant the economy is to an economic shock.

The warnings signs

The IMF has issued warning about the market for leveraged loans which are made to private companies with weak credit ratings and are carrying excessive amounts of debt. The global market for these types of loans has swelled to more than $1 trillion as the low-interest rate environment compelled investors to look for higher yielding assets. Lenders became less particular about who they’d lend to and extended credit to companies with less-than-stellar balance sheets. The sheer size of the outstanding leveraged loans may not cause a recession, but it does make the overall economy more vulnerable if there’s a negative shock. Taking on debt can help companies grow, but if rates increase or capital becomes unavailable, as often happens when there’s a shock, these companies will have problems rolling over their debt and could face hardship or go out of business.

The Bank of International Settlements, an international organization that offers ideas to central banks, is also concerned about ‘zombie firms,” their term for companies that should go out of business, but because interest rates are so low and capital is plentiful, can survive by taking out cheap loans. In the long run, the trend is worrying because it diverts capital and labor from more productive places. It also makes the economy more vulnerable, because if credit suddenly because unavailable, many of these firms could go out of business at the same time, causing a surge in unemployment.

In normal circumstances, central banks can help prevent a recession. They can cut rates and intervene in markets when there’s a negative shock to prevent a recession or make a recession less painful.  But central banks are already in expansionary mode, cutting interest rates to near, or even below, zero. Those efforts may add to an already growing economy, but it also leaves central bankers with less ammunition if there’s an unexpected, recession-inducing shock. There is only so much further they can cut rates. And the results are mixed on how effective other policies, like quantitative easing for long-term government bonds, have been. One of the few tools left for central bankers is currency depreciation, which could make a recession worse if the shock is global and other central banks try to manipulate their currencies at the same time.

There are reasons to be worried the economy is vulnerable to a recession. There are, and always will be, sources of potential shocks. But so far the US economy has defied expectations and keeps expanding. It is impossible to know when it will stop, but some day it surely will.