As we saw in Part 1 to this series, in today’s financial cycle, which is really a credit cycle, recession is triggered by lower asset prices instead of lower asset prices being triggered by recession. Borrowers will be hit by dropping stock and bond prices, leading to a higher number of defaults. This, in turn, will push banks to reduce their lending, and less capital available for businesses will squeeze earnings and decrease economic activity. Whether this recession will begin in the US or in Europe, it will spread globally.
Since a US recession will increase federal spending and reduce tax revenue, we can expect the deficit to reach—or go beyond—the yearly $2 trillion mark, and total government debt could reach $30 trillion four years down the road. The result will be higher tax burdens and constrained private capital markets.
Job-automation technology is developing fast, and being forced to cut costs, businesses will increasingly move towards job automation, doubling or tripling the effect it has already had on the labor markets—especially the service industry.
As you can see from the chart (courtesy of Philippa Dunne, The Liscio Report), the ratio of workers covered by unemployment insurance is at its lowest point in 45 years. In today’s increasing freelance economy, this will have a devastating effect if/when they start losing their jobs.
Working-class Americans will show their displeasure with this by voting for politicians that wish to increase safety net programs. The costs of such programs will skyrocket, resulting in increased taxes, roll back of corporate tax cuts, and increased regulation.
Most likely, this will lead to a second recession, like we saw in 1980 and 1982. If this happens, we’ll see unemployment numbers in the teens and minimal to negative GDP growth
Quantitative easing and deficit spending—and a debt reset
Long before that happens, however, the Federal Reserve will engage in significant quantitative easing. This will not necessarily involve “printing” money. Instead, the Fed will use excess bank reserves to purchase debt, adding it as an asset on their balance sheet. This could reach upwards of $20 trillion in a decade or so—about five times what we saw after 2008. To avoid deflation, the Treasury will inject money into the economy through deficit spending.
All of this is not set in stone, of course. After all, we haven’t been in a comparable situation. But let’s say they take these actions—will they work? No, because globally we simply have too much debt, much of it unpayable. Instead, the major central banks in the world will agree to reset the debt. It’s to early to try to guess how, just that it will because it must happen.