What should you do in an economic downturn? Depends . . .

“Out these windows, we will view the collapse of financial history.  One step closer to economic equilibrium.” – Fight Club

Since 1940, the United States has had 12 recessions, as recorded by the Fed.  The graph is below.

Want to start a small business?  Just buy a big one before a recession, and wait!  Saves a lot of hassle!  The gray bars are recessions.

Why do we have recessions?

There have been several economists who have tried to explain this.  One of the earlier explanations was from Ludwig Von Mises.  Von Mises, being Austrian, was the founder of what is known as the “Austrian” school of economics.  Austrian economists are the mortal enemy of Keynesian economists (named after John Maynard Von Keynes, it being a new rule that every economist must now have “Von” in their middle name).  Often the Austrians and Keynesians will have gang fights over who has better economic theory, but they’re economists, so the gang fights look like slap fights between anemic three-year-old girls.

Von Mises felt that recessions were caused by a debt cycle.  At a time (like today) you can borrow massive amounts of money at very low interest rates.  My current house is mortgaged at 4% or so, but my first house was financed at a rate just over 9%, and that was a bargain at the time.  And my current savings account pays interest in dust and, on a good year, in little balls of dryer lint.

Little known fact:  Ludwig Von Mises (Miller) was Superbowl® 50 MVP!

This condition (like we’re in today) encourages investment, and discourages savings.  An example:

The little town I’m in has one hotel that was built since Bill Clinton was president.  There are a collection of at least two other (nice) hotels around town.  And, there are about three hotels that were constructed when the building code required use of lead pipes, lead paint, and asbestos carpet.  So, there are hotels for moderate budgets (like $90 a night) all the way down to hotels that take payment in squirrel pelts (tanned only – no raw pelts).  No five star hotels, but, really, this town isn’t one you’d come to visit as a tourist.

But somebody decided we needed another hotel.  And they built one – a brand new, brand name hotel in a town that already had enough rooms.  Why?

Interest rates are low, so the hotel company is just looking for places to spend money.  If they can borrow it at 5%, they don’t have to make too much money for the investment to pay off.

In an environment with low interest rates and large amounts of money available, companies will borrow money to do almost anything – projects that are crappy at 10% interest look great at a 5% cost of capital.  So they borrow first to do the “great” projects and, once those are done, companies then borrow to do the so-so projects.

What happens when the interest rate goes up?  Or the business ideas that are presented are so silly (strawberry picker making $15,000 a year buys $720,000 California house – LINK) that when they make the papers they become legendary.  Another way to tell is when a Wells Fargo® bank has a Starbucks© inside it’s lobby – and the Starbucks has a Wells Fargo™ bankette inside.  With a tiny Starbucks©.  You can tell that maybe, just maybe, the economy is nearing peak stupid.  (This happened in Houston – there was a Starbucks™ in the mall in front of the Target©.  The Target® had a Starbucks™ just inside the door.  So did the Wells Fargo© bank. Next to the Target™.)

As we watched the housing market collapse, as well as the financial shenanigans machine industry that supported it, my lawyer friend said to me . . . “Well, when you’re at the beach and the tide goes, out, you see who wasn’t wearing any clothing.”  The length of time of artificially low interest rates and the greater the amount of “silly” investment is like a drunk’s binge – the longer it lasts the bigger the hangover.

Examples of irrational thought:

• The price of a house never goes down – it’ll go up forever. And this one is in a great location, right next to the high paying jobs at the chemical plant.
• The price of a stock never goes down – stocks will go up forever. And that new car will never replace horses!  Silly!
• Comics are totally the best investment anyone could ever make. This issue of Teen Manga 2000 will be worth millions!
• “It’s different this time.”
• “Stocks have reached a new permanent high plateau.”
• “This company, Montgomery Ward Toys ‘r’ Us Sears Tesla will last forever . . . .

And then, something happens.  Oh, sure, it looks like . . . 9/11.  If the economy were healthy and operating on all cylinders, 9/11 wouldn’t have led to a recession.  The reason for the recession isn’t what’s in the papers – the economy was sick from too much bourbon.  It was going to throw up anyway.

Make no mistake – the United States is an economic engine.  2% growth is middling, but a 2% contraction is catastrophe.  Why?

All of the jobs are created at the margin, at that 1% or 2% of growth.  A small contraction ripples through the economy – now people are losing jobs.  A 2% contraction is really a 3% or 4% contraction.  That can set off a chain reaction (like during the Great Depression) – those people aren’t consuming, so the next group of people lose their jobs/businesses.  And so on.

Also, in the past, inflation was a thing that happened.  Now we pretend it doesn’t, even as food goes from a $5 lunch to a $10 lunch, minimum.

Eventually, however, the Central Bank (in the case of the United States) can hold back the interest rates no longer – it has to raise them or risk the currency (dollar) becoming worthless.  Interest rates rise.

Formerly profitable projects and businesses are no longer profitable at the new rate.  They get cancelled, or in some cases abandoned during construction.  Or the entire business fails.  The average business lasts . . . 10 years, regardless of age.  Big ones, small ones, they get eaten or fail.  It’s part of that regrowth that’s actually nice about capitalism.  Wouldn’t it be nice if the DMV had to compete to get you to come in and get license plates or a new driver’s license?

So how should you behave in an economic contraction?

First, the pitfalls:  being right early is EXACTLY the same as being totally wrong.  In 1994 I saw that Marvel® had a great group of characters, and if they could only exploit them, they’d have a franchise that was worth millions.  So, I placed a big bet – $2000 – on Marvel™ Entertainment stock.  Which promptly went bankrupt, making my investment worth a handful of magic beans.  Sigh.  Again, being right early is exactly the same as being wrong.

Second:  Getting out early (which I’ve done a time or two or almost always) has proven to be a killer.  Getting out while the market is still going up has cost me a lot of gains.  Not that I’m complaining – the world has been awesome for me, but I really wish I could afford a private island with a heliport inside and extinct volcano.  I’ll have to buy an island without a volcano.  Again.  Sigh.  Is an extinct volcano too much to ask?

So, what do you do when faced with an economic downturn?  I’ve developed a helpful graphic:

Size of Downturn	Best Investment	Amount of Panic	Beware of:	Move to:
1-3%	Stay the course – keep investing every month.	Bernie Sanders waves his hands and screams for more aid.	Falling stocks.	A nice property you bought at a bargain.
Less than 5%	Whiskey.  AAA Bonds of solid countries, like Switzerland.  Gold.	Bernie Sanders takes his hand out of his pockets and puts them in yours.	Communist revolution.  Oh, wait, they already got California.	Montana or Idaho.
More than 10%	Ammunition.  Even more whiskey.	Bernie Sanders forms a cannibal paramilitary organization.	Better Call Saul being cancelled.	Your island with a helipad in an extinct volcano.

The real answer is that response to a downturn depends on:

How much money you have.  If you have plenty, you’ll be fine.

How long the downturn lasts.  If a year or two, you’ll figure it out.  If a decade or more?  Yikes!   (Unless you have lots of money.)

How severe the downturn is.  See above.  The “More than 10%” is not really all that much of a joke.

How much your job is impacted.  This you can figure out now.  If your company could do fine without you, you don’t figure into any strategic initiatives, and you make a lot of money?  I hope you saved some, because you and dozens of people that look just like you will be looking for a job soon enough.

Ma Wilder’s family, the McWilders, took in a batch of neighbor kids during the Great Depression and helped to raise them.  Great Grandpap McWilder was wistfully employed on the railroad and operating a boarding house.  Plus he ran a gambling house (I think) that sold illicit whiskey.  He did what he had to do to get by during the Depression.

Great Grandfather Wilder ran a bank that did fine during the Depression.  Never had to hustle, worked banker’s hours.  Depression?  Not for him.

So, be like Von Mises and Great Grandfather Wilder!  Blitz that recession!