138: How HR Should Prepare For A Recession – Part 1

A recession is defined as a significant decline in economic activity spread across the economy, lasting more than a few months.
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A recession is defined as a significant decline in economic activity spread across the economy, lasting more than a few months.

Were you in the workforce back in 2008? Chances are you were. Do you remember the impact the “Great Recession” had on your business? I sure do. We lost over 30% of our clients within a few weeks. We had to let some employees go. Since we didn’t see it coming, we weren’t prepared for it.

Another recession is on the horizon and this one will be worse than the last. That’s not just my opinion.

I fancy myself a student of economics. I’ve been studying the subject for 25 years. The first real book I read on the topic was Restoring the American Dream by Robert J. Ringer, and The Law, by Frederick Bastiat. I’ve read a lot more since then, but nowhere near as much as my mentor and uncle, G. Douglas Anderton… the G-Man as he’s known by. It’s his fault I’m the way I am when it comes to economics and politics. So, a shout out to the G-Man.

I follow a lot of different economists including Doug Casey, Jim Rickards, Peter Schiff, Mike Maloney, Marc Faber,  and contributors to the Foundation for Economic Education and Agora Financial.

What Is a Recession? 

There are several different formulas used for determining if we’re in a recession. One is a negative gross domestic product (“GDP”) for two consecutive quarters… that’s 6 months.

The National Bureau of Economic Research, or NBER has a more in-depth formula.  The NBER is a private, non-profit who’s been conducting and publishing economic research since 1920. The NBER has twenty-six Nobel Prize winners in economics on their team, and more than 1,400 professors of economics and business, who are leading scholars in their fields. That’s an army of researchers…these are really smart people. But they aren’t always right. No one ever is.

Well anyway, they define a recession as a significant decline in economic activity spread across the economy, lasting more than a few months. To determine if we’re in a recession, they look at real GDP, real income, employment, industrial production, and wholesale-retail sales. But, there isn’t a specific formula for calculating a recession.

So, in August 2008, Edward E. Leamer, a UCLA professor, and one of the NBER elite, wrote and published a Working Paper titled “What’s a Recession Anyway”. His point is that you’ve got to have the right formula, or algorithm, for calculating a recession. He wrote “The point of an algorithm is to take the guesswork out of the recession definition.”

That sounds good, right?

He went on to say we need a clear definition so we’re all on the same page, so he came up with an algorithm that perfectly identifies the ten NBER officially recognized recessions since WWII. Then he used that formula to see if we were in a recession in the summer of 2008. Leamer said the punchline of his paper is this: “We are not yet in a recession. For those who insist otherwise, I offer a challenge: What’s your algorithm?” Again, this was in August 2008.

He even goes as far as mocking Warren Buffet for a comment he made on May 3, 2008. Mr. Buffet said: “By any common sense definition, we are in a recession. Business is slowing down.”

The wise Leamer calls Buffet’s comment a “Potter Stewartism”. He’s referencing former Associate Justice of the Supreme Court of the United States, Potter Stewart who made the statement “I’ll know it when I see it”, in 1964 case involving pornography.

Well, as it turns out, Buffett was right and Leamer couldn’t have been more wrong. His algorithm was garbage. It failed to identify the fact that we were already about 8 months into the “Great Recession”.

By September 2008, Congress approved the $700 billion bank bailout, now known as TARP. The recession started many months earlier and this was just the official manifestation of it.

And so, it seems a lot more goes into the calculation than what the NBER uses, and the “I’ll know it when I see it” method works better at identifying a recession. At least if you’re Warren Buffet.

So what other factors might contribute to “a decline in economic activity spread across the economy”, that we can look at?

Household Debt:

How about household debt?

Household debt is back to where it was in 2008, just before the Great Recession. But the mix of debt is different.

Mortgage debt is down because so many lost their homes and BK’ed out of it, but credit card, auto and student loan debt, are way up. Low interest rates and newly printed bail-out money provided to the banks by the U.S. Treasury via the Federal Reserve, have fueled the household debt train, and it’s been chugging down the track and record speed.

Plus, not all debt is created equal. Mortgage debt has a traditionally appreciating asset on the other side of the transaction. But not credit card, auto, and student loan debt. The auto loan is backed by a depreciating asset that has a relatively short life span, and the credit card and student loan don’t have anything asset behind them.

To make things worse, personal savings in the U.S are non-existent. In episode 65, Living Paycheck to Paycheck, I told you, according to CNBC, 66 million Americans have no savings And, Forbes says that 63% of Americans don’t have enough savings to cover a $500 emergency.

In 2012, U.S. household debt was 83% of the GDP, while wage and salary income was 42.6%. So basically Americans, on average, owe twice as much as they earn in a year. And to make matters worse, incomes have been stagnate for the past several years while household debt is going up.

The household debt to GDP ratio was at 79.5% for 2016. That’s lower than it was in 2012. But, one of the factors that goes into calculating GDP is government spending. That’s messed up… the more the government spends, the lower the ratio; and the better the roses smell.

As far as the total amount owed goes, household debt is the same today as it was in 2008, but remember, the mix is different now. It’s a worse mix. And if government had not spent itself into oblivion, the household debt to GDP ratio would be much higher.

There are at least 3 other factors I want to cover but we’ll have to go over those in episode 140 next week in Part 2. Then, i f something else doesn’t come up, we’ll get down to how you can prepare from an HR standpoint, in Part 3 on episode 142.

 

About the author, Thomas

I have 20 of years insurance industry experience in C-level management, focusing on all aspects of workers compensation, risk management, loss control, employee benefits, HR, payroll and professional employer organization (“PEO”) operations. Currently, I am the owner and CEO of Humanly HR, and founder and host of SmallBiz Brainiac; a podcast providing employer intelligence to small business owners.

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